-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, C//P9AlD5aOqPDg8jZTpBuUi34sAq/gldweApRHzc+YmG+rK54UawPcc5nBdFYbM 2NBGR8V59waF4wiSVlw2qg== 0000944209-00-000426.txt : 20000327 0000944209-00-000426.hdr.sgml : 20000327 ACCESSION NUMBER: 0000944209-00-000426 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000324 FILER: COMPANY DATA: COMPANY CONFORMED NAME: VARCO INTERNATIONAL INC CENTRAL INDEX KEY: 0000102993 STANDARD INDUSTRIAL CLASSIFICATION: OIL & GAS FILED MACHINERY & EQUIPMENT [3533] IRS NUMBER: 950472620 STATE OF INCORPORATION: CA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 001-08158 FILM NUMBER: 578031 BUSINESS ADDRESS: STREET 1: 743 N ECKHOFF ST CITY: ORANGE STATE: CA ZIP: 92668 BUSINESS PHONE: 7149781900 MAIL ADDRESS: STREET 1: 743 NO ECKHOFF STREET CITY: ORANGE STATE: CA ZIP: 92668 10-K 1 ANNUAL REPORT UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (MARK ONE) [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999 OR [_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _________________ to ___________________ Commission file number 1-8158 VARCO INTERNATIONAL, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) CALIFORNIA 95-0472620 (state or other jurisdiction (I.R.S. Employer Identification of incorporation or organization) Number) 743 NORTH ECKHOFF STREET, 92868 ORANGE, CALIFORNIA (ZIP CODE) (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) Registrant's telephone number, including area code: (714) 978-1900 Securities registered pursuant to Section 12(b) of the Act: NAME OF EACH EXCHANGE TITLE OF EACH CLASS ON WHICH REGISTERED ------------------- ------------------- Common Stock New York Stock Exchange Preferred Stock Purchase Rights New York Stock Exchange Securities registered pursuant to Section 12(g) of the Act: None 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 -- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K ((S)229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [_] As of March 1, 2000, 65,424,115 shares of common stock were outstanding. The aggregate market value of the common stock on such date (based upon the closing price of such shares on the New York Stock Exchange) held by persons other than affiliates of registrant was approximately $755,190,000; the basis of this calculation does not constitute a determination by the registrant that such persons are affiliates, as defined in Rule 405. DOCUMENTS INCORPORATED BY REFERENCE Part II, Items 5, 6, 7 and 8 The Company's Annual Report to Shareholders for the year ended December 31, 1999. Part III, Items 10, 11, 12 and 13 The Company's definitive Proxy Statement for the Annual Meeting of Shareholders to be held on May 11, 2000 to be filed with the Commission not later than April 30, 2000. ITEM 1. Business Introduction Varco was founded in 1908 and incorporated under the laws of the State of California in 1911. Varco and its subsidiaries are engaged in the design, manufacture, sale and rental of drilling tools, equipment and integrated systems and rig instrumentation used for oil and gas drilling worldwide. The Company's principal products are drilling equipment, drilling rig instrumentation and controls, pressure control and motion compensation equipment, solids control equipment and fluid handling systems. Drilling equipment includes integrated systems for rotating and handling the various sizes and types of pipe utilized on a drilling rig ("drilling systems") and specific purpose pipe handling tools, hoisting equipment and rotary equipment ("oil tools"). Drilling systems are manufactured, sold and rented by the Varco Systems Division while oil tools are manufactured and sold by the Varco BJ Division. Drilling rig instrumentation and control products are manufactured, sold and rented by the M/D Totco Division. Pressure control and motion compensation equipment are manufactured and sold by the Shaffer Division. Solids control equipment and fluid handling systems are sold and rented by the Rigtech Division. The following table sets forth the contribution to the Company's total revenues of its five Divisions:
YEAR ENDED DECEMBER 31, ----------------------- 1999 1998 1997 ---- ----- ---- (IN THOUSANDS) Varco Systems $200,556 $266,776 $165,510 Varco BJ 66,006 95,959 68,931 M/D Totco 69,540 94,639 90,601 Shaffer 237,036 256,238 206,483 Rigtech 16,589 21,273 13,372 -------- -------- -------- Total $589,727 $734,885 $544,897 -------- -------- --------
Sales of the Company's products depend on the level of construction of new drilling rigs and the replacement and upgrading of equipment for existing rigs, particularly for offshore rigs and intermediate to deep land rigs (rigs designed for drilling in excess of 8,000 feet). The level of construction of drilling rigs and the rate at which equipment on existing rigs is replaced or upgraded depends, in substantial part, on the level of worldwide exploration and development drilling activity. Rental revenue, which is generated predominately by the M/D Totco Division, is directly related to the level of drilling activity, particularly in the United States and Canada. Sales of equipment and sales and rentals of instrumentation products have also depended on the design, development and successful introduction of new products for the drilling industry. Equipment and instrumentation are also sold to operators of existing rigs for use as spare or replacement parts. The level of worldwide drilling activity can be influenced by numerous factors, including the prices of oil and gas, economic and political conditions, finding and development costs of oil companies, development of alternative energy sources, availability of equipment and materials, availability of new onshore and offshore acreage or concessions, and new and continued governmental regulations regarding environmental protection, taxation, price controls and product allocations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." The Drilling Process An oil or gas well is drilled by a bit attached to the end of the drill stem which is made up of 30-foot lengths of drill pipe joined by threaded connections known as "tool joints." Heavy drill collars at the 1 bottom of the drill stem put weight on the bit. Using the conventional rotary drilling method, the drill stem is turned from the rotary table in the floor of the drilling rig by torque applied to the "kelly" (a square or hexagonal section of pipe located at the top of the drill stem) by means of the master bushing and kelly bushing. During the drilling process heavy fluids ("drilling mud") are pumped down through the drill stem and forced out through the bit. The drilling mud returns to the surface through the hole area surrounding the drill stem, carrying with it the cuttings drilled out by the bit. The cuttings are removed from the mud by a filtering system and the mud is continuously recirculated back into the hole. The drilling mud also serves to contain pressure surges ("kicks") that may intrude into the formation. As the hole depth increases, the kelly must be removed frequently so that additional 30-foot sections of pipe can be added to the drill stem, which may reach lengths in excess of five miles. When the bit becomes dull, the entire drill stem is pulled out of the hole and disassembled, the disconnected sections of pipe are set aside or "racked," the old bit is replaced and the drill stem reassembled and lowered back into the hole (a process called "tripping"). During drilling and tripping operations, tool joints must be screwed together and tightened ("spun in" and "made up"), and loosened and unscrewed ("broken out" and "spun out"). When the hole has reached certain depths, all of the drill pipe is pulled out of the hole and larger diameter pipe known as casing is lowered into the hole and cemented in place in order to protect against collapse and contamination of the hole. The raising and lowering of the drill stem while drilling or tripping, and the lowering of casing into the well bore, are accomplished with the rig's hoisting system. A conventional hoisting system is a block and tackle mechanism and the derrick must have sufficient structural integrity to support the entire weight of the drill stem or casing string. During the drilling process it is possible for formation fluids, such as natural gas, water or oil, to get into the wellbore creating additional pressure which, if not controlled, could lead to a "blowout" of the well. To prevent blowouts, a series of high-pressure valves known as blowout preventers ("BOPs") are positioned at the top of the well and, when activated, form pressure tight seals which prevent the escape of fluids. When closed, conventional BOPs prevent normal rig operations and are activated only if drilling mud and normal well control procedures cannot safely contain the pressure. BOPs must be designed to contain pressure of up to 15,000 psi. After the well has reached its total depth and the final section of casing has been set, the drilling rig is moved off of the well and the well is prepared to begin producing oil or gas in a process known as "well completion." A producing well may undergo workover procedures to extend its life and increase its production rate. The Top Drive Drilling System, originally introduced by Varco in 1982, significantly alters the traditional drilling process. Using the Top Drive Drilling System, the drill stem is rotated from its top by means of a large electric motor. This motor is affixed to rails installed in the derrick and traverses from near the top of the derrick to the rig floor as the drill stem penetrates the earth. Therefore, the Top Drive eliminates the use of the rotary table for drilling. Components of the Top Drive also are used to connect additional lengths of pipe to the drill stem during drilling operations. Varco Systems The Varco Systems Division designs and manufactures integrated systems for rotating and handling the various sizes and types of pipe used on a drilling rig. They are designed to enhance the safety and productivity of the drilling rig through mechanization and automation. The Varco Top Drive Drilling System ("TDS") combines elements of pipe handling tools, as well as hoisting and rotary equipment, in a single system. Torque to turn the drill stem is imparted directly by means of a large electric motor which moves up and down along rails installed in the derrick and into which the drill stem is connected. During drilling operations, elements of the TDS perform functions such as spinning-in and making-up tool joints. It also incorporates a drill pipe elevator, providing the capability to 2 maneuver a stand of pipe into position to be added to the drill string when drilling, or to hold and hoist the entire drill stem. Drilling with a Top Drive Drilling System provides several advantages over conventional drilling. It enables drilling with three lengths of drill pipe, reducing by two-thirds the time spent in making connections of drill pipe. In addition it facilitates "horizontal" and "extended reach" drilling (the practice of drilling wells which deviate substantially from the vertical) by providing the ability to rotate the pipe as it is removed from, or replaced into, the hole, thus reducing friction and the incidence of pipe sticking. The Top Drive Drilling System also increases the safety of drilling operations. The Top Drive Drilling System has demonstrated substantial economic advantages. Users of the system generally report reductions in drilling time ranging from 20% to 40%. By facilitating extended reach drilling, the TDS increases the area which can be drilled from a given location, such as a fixed platform or man-made island. Thus, the production from a given reservoir of oil can be increased, and the number of costly fixed platforms required to develop the field can be minimized. The Top Drive Drilling System has evolved continuously since its initial introduction. Today, the Top Drive product line includes several models, each designed to satisfy specific customer requirements. The version initially introduced to the market in 1982, the TDS-3, remains a part of the product line. The TDS-4, introduced in 1990, is a two-speed model which permits a variation in speed and torque that is desirable for differing drilling conditions. The TDS-6S, first delivered in 1991, is a dual motor version which provides double the power and torque of a single motor unit. The TDS-7S, initially introduced in 1993, is powered by an alternating current ("AC") motor instead of the direct current ("DC") motor used on previous models. In the fourth quarter of 1997 the first TDS-8S was delivered. The TDS-8S is the AC motor version of Varco Systems' most popular Top Drive, the TDS-4S. The AC system offers lower maintenance cost, as well as providing higher torque for longer periods and a running speed more than twice that of conventional DC motor powered systems. Four TDS-8S units were delivered in 1999. In 1995 the TDS-9S was introduced. It is powered by dual AC motors, is reduced in length and rides on a separately installed torque tube. For these reasons it is especially well suited for sale or rental to the conventional land rig market, where portability is critical. It is designed for ease of installation in existing derricks, can be rigged up and rigged down in a matter of hours, and is easily transported from one location to another. During 1997 the TDS-10S was introduced. The TDS-10S is a smaller version of the TDS-9S designed for use in a variety of smaller land and workover rig applications. The TDS-10S has a 250-ton hoisting capacity as compared to the 400-ton hoisting capacity of the TDS-9S. In 1998 a higher hoisting capacity AC powered Top Drive was introduced, the TDS-11S. The TDS-11S has a hoisting capacity of 500 tons. One TDS-10S unit and nine TDS-11S units were sold in 1999. Pipe racking systems are used to handle drill pipe, casing and other types of pipe (collectively "tubulars") on a drilling rig. Vertical pipe racking systems move drill pipe and casing between the well and a storage ("racking") area on the rig floor. Horizontal racking systems are used to handle tubulars while stored horizontally (for example, on the pipe deck of an offshore rig) and transport it up to the rig floor and raise it to a vertical position from which it may be passed to a vertical racking system. Mechanical vertical pipe racking systems include those developed and sold by BJ Machinery prior to its acquisition by Varco in 1988. Such systems reduce, but do not eliminate, the manual effort involved in pipe handling. The Pipe Handling Machine ("PHM"), introduced by Varco in 1985, provides a fully automated mechanism for handling and racking of drill pipe and drill collars during drilling and tripping operations. It incorporates the spinning and torquing functions of the Automated Roughneck with the automatic hoisting and racking of disconnected sections of pipe. These functions are integrated via computer controlled sequencing, and the Pipe Handling Machine is operated by a person in an environmentally secure cabin. The Automated Roughneck is an automated version of the Iron Roughneck(R), which was originally introduced by Varco in 1976. It is a microprocessor controlled device which automatically 3 performs the torquing and spinning functions required to connect and disconnect sections of drill pipe during drilling and tripping operations, as well as during the setting of casing. The Pipe Racking System ("PRS") is a semi-automated vertical pipe racking system which has evolved from the "Star" system to which the Company acquired the rights in 1990. When used in conjunction with an Automated Roughneck, it provides an alternative to the more fully automated PHM. Like the PHM, it is operated remotely from the driller's cabin by a single operator, but it requires more operator intervention. Its design makes it more easily adapted to a land rig or for retrofitting to an existing offshore rig. The current version of the PRS was introduced in 1996. Vertical pipe racking systems are used predominantly on offshore rigs and are virtually mandatory on floating rigs such as semisubmersibles. Horizontal pipe racking systems were introduced by Varco in 1993. They include the Pipe Deck Machine ("PDM"), which is used to manipulate and move tubulars while stored in a horizontal position; the Pipe Transfer Conveyor ("PTC"), which transports sections of pipe to the rig floor; and a Pickup Laydown System ("PLS"), which raises the pipe to a vertical position for transfer to a vertical racking system. These components may be employed separately, or incorporated together to form a complete horizontal racking system, known as the Pipe Transfer System ("PTS"). Hoisting systems are used to raise or lower the drill stem while drilling or tripping, and the lowering of casing into the well bore. During 1999, the Company introduced its first "Automated Hoisting System" ("AHS"). Varco's AHS uses an AC-powered motor and a braking system that offers precise proportional control. The AHS automates the repetitive hoisting and drilling operations through user-friendly, touch-screen Electronic Driller interface. The AHS is smaller and lighter than conventional hoisting systems. The Company has yet to sell and deliver its first AHS-10. Varco BJ The Varco BJ product line consists of a full complement of conventional rig tools and equipment. It was formed by the combination of the original Varco oil tool products and the related products acquired in the BJ Machinery and the Martin-Decker acquisitions. These products include pipe handling tools, hoisting equipment and rotary equipment. Varco's pipe handling tools are designed to enhance the safety, efficiency and reliability of pipe handling operations. Many of these tools have provided innovative methods of performing the designated task through mechanization of functions previously performed manually. Varco BJ manufactures various tools used in the making up and breaking out of drill pipe, including spinning wrenches, manual tongs, torque wrenches and kelly spinners. The spinning wrench is a tool used to screw together and unscrew sections of drill pipe. Powered pneumatically or hydraulically, it replaces a hazardous device known as a spinning chain. Manual tongs are used to make up or break out tool joints, while the torque wrench is a hydraulically powered device which performs this function with enhanced safety and precision. The kelly spinner is a pneumatically or hydraulically powered tool used to connect and disconnect the kelly to and from the drill stem as additional lengths of pipe are added while drilling. The Company also manufactures other tools used in various pipe handling functions. Slips are gripping devices which hold pipe or casing in suspension while in the hole, and they may be either manual, spring or hydraulically operated. Other products, which include safety clamps, casing bushings and casing bowls, are used to hold and guide drill pipe or casing while in the hole. When drilling, tripping or setting casing, lengths of pipe must be hoisted into position above the hole, lowered into or lifted from the hole and held in suspension while in the hole. Hoisting equipment includes devices used to grip and hold various types of pipe ("tubulars") while being raised or lowered. 4 Drill pipe elevators are used to hold lengths of drill pipe as they are hoisted into position to be attached to the drill stem, and to hold the entire drill stem as it is lowered into or lifted from the hole. Similarly, casing elevators and spiders are gripping devices used to hold the casing as additional lengths are added and lowered into the hole. Links are elongated steel forgings from which the elevator is suspended and which, in turn, hangs from beneath the hook, which is connected to the hoisting mechanism of the drilling rig. The Company manufactures elevators to accommodate a variety of tubulars, as well as a complete line of links and hooks, together with casing elevators and spiders, to handle a variety of casing sizes and accommodate casing weighing up to 1,000 tons. Varco BJ expanded its casing spider line in 1994 with the introduction of the Flush Mounted Spider ("FMS 375"). It is designed to improve safety and efficiency during casing operations by eliminating scaffolding which otherwise must be used as a raised work platform for the rig crew. During 1996, the Varco BJ product line was further expanded with the introduction of the BX Hydraulic Elevator and the PS 21 and PS 30 Hydraulic Power Slips. The BX Hydraulic Elevator increases safety and eliminates the normal rig complement of several different types and sizes of elevators through the use of removable bushings. The PS 21 and PS 30 Power Slips improve both safety and rig efficiency by permitting the handling of all sizes and types of tubulars with a single tool and by incorporating the FMS concept. Rotary equipment products consist of kelly bushings and master bushings. The kelly bushing applies torque to the kelly to rotate the drill stem and fits in the master bushing which is turned by the rotary table on the floor of the rig. Varco BJ produces kelly bushings and master bushings for most sizes of kellys and makes of rotary tables. In 1998, Varco BJ introduced the Rotary Support Table for use on rigs with Top Drive Drilling Systems. The Rotary Support Table is used in concert with the TDS to completely eliminate the need for the larger conventional rotary table. 13 units were delivered in 1998, and ten units were delivered in 1999. A substantial portion of the Company's sales in some of the Varco BJ products is attributable to sales of replacement parts which are subject to normal wear and to sales of spare parts. Replacement parts for kelly bushings, rotary slips, casing tools and spinning wrenches are a material part of the sales of those product lines. M/D Totco The M/D Totco Division designs, manufactures and sells or rents hydraulic and electronic instrumentation and control systems, primarily for use in oil and gas well drilling operations; and, to a lesser extent, provides instrumentation to certain general industrial markets and for use in non- drilling related oilfield applications. A drilling rig instrumentation package is generally comprised of four elements: (1) sensors, which measure selected variables at the point of origin; (2) a mechanical or electronic means of transmitting that data to the display device; (3) a display, which may range in sophistication from a simple gauge to a computer terminal or workstation; and (4) a method for permanently recording and/or electronically transmitting the data for subsequent review and analysis. This equipment must be sufficiently rugged to withstand the hostile environmental conditions of a drilling rig. The driller relies on certain instruments to provide information critical to the operation of the drilling rig. At a minimum, this information includes the status of such basic data as weight-on-bit, rotary RPM, rotary torque, hook load, rate of penetration, mud pit volume, and mud flow. The indicators which display this data are generally contained in a common housing called a drilling console. A drilling console may range in sophistication from a collection of analog gauges to a microprocessor based system such as the M/D Totco "Spectrum 1000". 5 Computer based electronic data acquisition systems provide real-time analysis and display of the various drilling data at the driller's station, as well as other locations around the rig. In 1991 M/D Totco introduced the TOTAL system, a computer-based data acquisition system incorporating up-to-date electronic technology with comprehensive analytical capabilities. The emphasis in TOTAL is on the analysis and interpretation of data via computer software, so that the information displayed to the driller enables him to operate the rig more safely and efficiently. In 1992, the Company licensed from the Sedco Forex Division of Schlumberger Limited the rights to develop, manufacture and market the MDS(TM) System, an advanced computer-based drilling information and alarm system which is integrated with TOTAL. Its software programs incorporate the knowledge and experience of drilling personnel and engineers to provide critical information in a user-friendly format. In addition to MDS(TM), a number of additional analytical capabilities have been developed for the TOTAL System. Drill-Off, a computerized drilling optimization program was jointly developed by M/D Totco and Exxon. An agreement with Schlumberger's Anadril Division, authorizing M/D Totco to manufacture and market a sophisticated kick detection system known as Kick-Alert(SM) was finalized in 1993. A joint effort by M/D Totco and British Petroleum to incorporate a software program known as Early Kick Detection (EKD) on the TOTAL system was completed in 1995. An exclusive Worldwide Marketing agreement with Logware, Inc. to market a Windows(TM) based drilling information system was completed in 1993. The TOTAL system is designed so that it may be scaled to the requirements of a particular drilling operation. For relatively routine drilling requirements it can represent a cost-effective means of providing basic information; however, it can be expanded to encompass the full range of analytical capability for complex and costly offshore drilling. Other drilling related products of M/D Totco include drift indicators, which are used to measure and record the degree of drift of the well from vertical; mechanical recorders, which produce a permanent record in chart form when an electronic system is not being used; drilling control systems (auto- drillers) which automatically maintain a constant pressure on the drill bit, and drilling chokes which provide a remotely actuated method of controlling "kicks." In 1997, M/D Totco introduced the Varco Integrated Control and Information System ("V-ICIS"), a computer-based system which combines the physical control of all of Varco's automated equipment and potentially that of third parties, into a common, user-friendly system which also integrates the analytical capabilities of the TOTAL system. Five V-ICIS systems were delivered in 1998 and 13 in 1999. In 1999, M/D Totco introduced RigSense to the industry as the technological derivative of the existing TOTAL product line. RigSense is a Microsoft WindowsNT(TM) based rig network, which provides a new range of capabilities to the rigsite users in terms of distribution of drilling information, data presentation, data analysis, archiving and ease of use. It provides the driller with the ability to better analyze the drilling data during drilling, send messages to other workstations, and archive the data for further use or transmit the data offsite for additional analysis or for use when drilling future wells. During 1999, sales and rentals of RigSense generated approximately $3.0 million in revenues. Electronic Driller ("ED") was also developed and introduced in 1999. ED is a control system designed to provide steady state drilling conditions at the drill bit through precision drawworks brake control. It is available for upgrading drilling rigs as well as for newly constructed rigs. The system consists of an electronic controller, rig sensors, a rig floor color touch screen display and a disc brake system. The disc brake can either be an existing caliper brake or a new Varco plate disc brake supplied as part of an ED system. Improvements of 30% in rotating hours and a 40% reduction in the number of bits per well have been documented in the field. 15 units have been sold to date. 6 Products of the M/D Totco Division used outside the drilling process include load and radius indicating systems for pedestal type cranes, anchor tension monitoring systems for use in mooring and positioning applications, and specialty scales for industrial use. In 1993, the Company acquired all of the outstanding shares of Metrox, Inc., a manufacturer of strain gauge systems. The acquisition of strain gauge technology provides further penetration into the industrial crane and weight monitoring markets as well as enhancing the overall M/D Totco sensor technology. Strain gauge sensors provide an extremely precise measurement of many factors critical to drilling operations. Drilling consoles, and recently, the V-ICIS, are typically sold as original equipment to the rig manufacturer. However, electronic drilling consoles may be sold as upgrades to existing rigs. In the United States and Canada, most other instrumentation products are rented to the drilling contractor or oil company when necessary, and are therefore, not permanently installed on the rig. Internationally, nearly all instrumentation equipment is sold to the rig owner and becomes a permanent part of the drilling rig. A significant portion of the sales of some instrumentation product lines is in spare and replacement parts. Shaffer The Shaffer Division designs, manufactures, sells and distributes pressure control equipment (including ram blowout preventers, annular or spherical blowout preventers and rotating blowout preventers), blowout preventer control systems, riser and motion compensation systems (including riser tensioners, drillstring compensators and crown mounted compensators). BOPs are devices used to seal the space between the drill string and the borehole to prevent an uncontrolled flow of formation fluids and gases. Shaffer manufactures three types of BOPs. Ram and annular BOPs are back-up devices and are activated only if other techniques for controlling pressure in the well bore are inadequate. When closed, these devices prevent normal rig operations. Ram BOPs seal the wellbore by hydraulically closing rams against each other across the wellbore. Specially designed packers seal around specific sizes of pipe in the wellbore, shear pipe in the wellbore or close off an open hole. Annular BOPs seal the wellbore by hydraulically closing a rubber packing unit around the drill pipe or kelly or by sealing against itself if nothing is in the hole. The rotating BOP allows operators to drill or strip into or out of the well at low pressures without interrupting normal operations. Shaffer expanded its BOP line in 1995 with the introduction of a system for achieving Pressure Control While Drilling (PCWD(R)). This new BOP allows rotating of the drill string to proceed while controlling pressures up to 2,000 psi, and will operate as a normal spherical BOP at pressures up to 5,000 psi. In 1998 Shaffer introduced the "NXT" ram type BOP which eliminates door bolts, providing weight and space savings. Its unique features make subsea operation more efficient through faster ram configuration changes without tripping the stack. During 1999, four units were delivered to customers. Shaffer sells conventional BOP control systems under the registered trademark Koomey(R). The Koomey control system is hydraulically activated and is used to operate BOPs and associated valves remotely for both land systems and offshore systems. With the recent increase in deep-water drilling depths, traditional hydraulic control systems are inadequate to activate BOPs, which rest on the ocean floor and may be 5,000 feet or more below the surface. In 1997, Shaffer introduced the IVth Generation MUX, an electronic control system designed specifically for deep-water applications. Twelve such systems were delivered in 1998 and six in 1999. Riser is large diameter pipe which, when drilling from a floating rig such as a semisubmersible or drillship, connects the rig to the well on the ocean floor. Therefore, the riser string, which consists of sections approximately 75 feet in length connected together, may extend to as much as 10,000 feet. Shaffer 7 purchases the blank pipe, manufactures and attaches connectors to each section and completes it with the attachment of related components. Shaffer sells motion compensation equipment under the registered trademark Rucker(R). Motion compensation equipment stabilizes the bit on the bottom of the hole, increasing drilling effectiveness of floating offshore rigs by compensating for wave and wind action. Shaffer also manufactures tensioners, which provide continuous reliable axial tension to the marine riser pipe and guide lines on floating drilling rigs, tension leg platforms and jack-up rigs. An important product extension in 1996 was the Riser Recoil System, which provides a safe disconnect when the floating rig encounters an unanticipated need to leave location. Shaffer also manufactures and sells flowline devices, primarily Best(TM) chokes, used in the production phase of the oil and gas industry. These chokes are designed for both topside-platform and subsea production, for both standard service and sulfur (H2S) service. Sales of spare and replacement parts, and the repair and reconditioning of used equipment constitute a significant part of Shaffer's revenue. Rigtech The Rigtech Division designs, sells and rents solids control equipment and fluid handling systems. Solids control equipment removes cuttings ("solids") from the drilling fluid so that it may be recirculated, and fluid handling systems automate the process of handling drilling fluids on a drilling rig. Rigtech products are generally subcontracted to third parties for manufacturing. In the drilling operation, mud is pumped down the drill pipe and exits through nozzles in the drill bit. The mud acts as a lubricant to the drill bit, as a pressure equalizer and as a vehicle which carries the drilled solids back to the surface. Shale shakers are the principal solids control machines used to clean the cuttings from the mud, enabling it to be reused. The VSM 100 is designed to pass large volumes of mud over fine mesh screens to maximize the removal of the cuttings from the mud, thus minimizing the use of other solids removal equipment before the mud is recirculated. Other equipment that may be employed to remove solids are the VSM 200 mud cleaner and de-sander and de- silter hydrocyclones. During 1997, Rigtech introduced the VSM 300, a new generation shale shaker designed to operate more efficiently in a wider variety of geologic conditions. The Rigtech fluid handling systems include the AMS 2000 mud chemical handling system, which is designed to handle, store and mix mud chemicals. The mud chemicals are provided to the rig in "big-bags" which are placed in a hopper fitted with a vibrating mechanism. A computer controlled valve in the base of the bag is used to discharge the chemical powder to the mud mixer at the desired rate. The AMS 2000 eliminates the manual handling of large sacks of powdered chemicals, improving efficiency and reducing exposure to a potentially hazardous work environment. The AMS 1000 automated mud system is a computer controlled system which oversees and controls the entire mud management. The purpose of the system is to release manpower from manual operations while continuously monitoring the process to ensure that it is performing properly. Rigtech delivered three AMS 1000 systems in 1998 and four in 1999. In 1999, Rigtech introduced the newly developed `HeviJet' Centrifuge, the first production AC motor driven automated centrifuge developed specifically for the drilling industry. Centrifuges are utilized to remove fine solids from the drilling mud by imparting centrifugal force to the fluid/solid feed. Existing oilfield centrifuges require constant operator attention and have very limited capacity due to the use of low efficiency hydraulic drives. The `Hevijet' Centrifuge has a process capacity of approximately three times that of a standard oilfield unit, and in addition, is designed to operate without the requirement for a dedicated operator. This reduces costs for personnel in addition to reducing drilling mud costs due to more 8 effective cleaning. Rigtech has received orders for eleven Centrifuge units, all of which are expected to be delivered in 2000. Rigtech equipment and systems are designed to minimize the cost of drilling through lowering mud costs and improving operational efficiency, while at the same time reducing the labor requirement and improving the safety of the drilling operation. Research and New Product Development Varco believes that it is a leader in the development of new technology and equipment to enhance the safety and productivity of the drilling process and that its sales and earnings have been dependent, in part, upon the successful introduction of new or improved products. Varco's significant product developments have included the safety spinning wrench, the torque wrench, the spring slip, pneumatically operated casing elevators and spiders, the Automated Roughneck, the Top Drive Drilling System, the Pipe Handling Machine, the Pipe Racking System, the TOTAL system, the V-ICIS control system, the Electronic Driller, the NXT blowout preventor and the automated centrifuge. At December 31, 1999, the Company employed 264 persons on its engineering and design staffs who were principally engaged in research and development. Total expenditures for research and development were $28.8 million in 1999, $34.6 million in 1998 and $21.1 million in 1997. As of December 31, 1999, the Company held 59 United States patents and had 12 patent applications pending. Expiration dates of such patents range from 2000 to 2016. As of such date the Company also had 148 foreign patents and 30 patent applications pending relating to inventions covered by the United States patents. The preceding include patent rights received in connection with the BJ Machinery, Martin-Decker, TOTCO and Shaffer acquisitions. There are no assurances that patents will be granted in response to pending applications. Although the Company believes that its patents and applications have value, competitive products with different designs have been successfully developed and marketed by others. The Company considers the quality and timely delivery of its products, the service it provides to its customers and the technical knowledge and skills of its personnel to be more important than its patents in its ability to compete. While the Company stresses the importance of its research and development programs, the expense and market uncertainties associated with the development and successful introduction of new products are such that there can be no assurance that the Company will realize future revenues from new products. International Operations The Company's products are sold for use in approximately 80 countries by United States customers operating in the United States and abroad, as well as by foreign customers such as privately-owned corporations and national oil companies. The Company includes as an international sale any sale where the product is designated for use other than in the United States. Revenues from products sold for use outside the United States accounted for approximately 47%, 54% and 56% of the Company's total revenues for the years ended December 31, 1999, 1998, and 1997, respectively. For further information regarding the Company's worldwide operations and international sales and rentals, see note j of Notes to Consolidated Financial Statements included in the Company's Annual Report to Shareholders. The Company's international operations are subject to the usual risks of changes in international conditions, such as changes in governmental policies affecting the oil industry (e.g., environmental regulations or the nationalization of the operations of the Company's customers). Most international sales are payable in United States dollars. The Company has a policy prohibiting the payment of any bribe, kickback or similar gratuity to any person in order to facilitate the sale of the Company's products or to secure favorable action by a 9 government official. The Company believes that this policy does not impede its competitive position in the sale of its products abroad. Sales and Distribution To facilitate the distribution of its drilling equipment and pressure control products, the Company maintains domestic sales and service facilities in California, Louisiana, Oklahoma, Texas and Wyoming. The rental of drilling rig instrumentation requires local availability of equipment, transportation of the equipment to the rig site and installation by qualified personnel. To service this market, the Company maintains M/D Totco sales and service facilities in 11 states, including those mentioned above, as well as three locations in Canada. Internationally, the Company maintains offices in Abu Dhabi, Brazil, China, Holland, Moscow, Norway, Scotland, Singapore and Venezuela. The Company employs independent agents in Mexico, South America, Europe, the Middle East, the Far East and Asia, the South Pacific and in parts of the United States. The Company's customers include private and government-owned oil companies, drilling contractors, drilling rig manufacturers, rental tool companies, and supply companies, which supply oilfield products to the end users of the Company's products. Drilling systems, such as the Automated Roughneck, Top Drive Drilling System and pipe racking systems and pressure control and motion compensation equipment, represent significant capital expenditures and are usually sold directly to an oil company, drilling contractor or rig builder. Other drilling equipment products may be sold through supply stores or directly to government- owned oil companies or drilling contractors. During 1999 sales to three customers were $83.9 million, $83.3 million and $68.1 million, respectively. During 1998 sales to two customers were $122.0 million and $100.3 million, respectively. There were no sales to a single customer in 1997 in excess of 10% of total sales. Backlog Sales of the Company's products are made on the basis of written purchase orders or contracts and, consistent with industry practice, by telex, letter or oral commitment later confirmed by a written order. In accordance with industry practice, orders and commitments generally can be cancelled by customers at any time. However the Company, is generally entitled to cancellation fees for expenses and costs incurred prior to the cancellation of orders. In addition, orders and commitments are sometimes modified before or during manufacture of the products. The backlog of unshipped orders was approximately as follows on the dates indicated:
December 31, ------------ 1999 1998 1997 ---- ---- ---- (in thousands) Varco Systems $26,767 $128,944 $172,838 Varco BJ 11,042 33,587 40,073 M/D Totco 7,182 26,069 16,259 Shaffer 17,925 174,430 224,180 Rigtech 845 4,383 9,545 ------- -------- -------- Total $63,761 $367,413 $462,895 ------- -------- --------
The Company expects that substantially all of the backlog will be shipped by December 31, 2000. At December 31, 1999 the Company had received $7.8 million in customer cash deposits related to orders included in backlog. 10 Competition The products of the Company are sold in highly-competitive markets and its sales and earnings can be affected by competitive actions such as price changes, new product development or improved availability and delivery. The Company competes with a large number of companies, some of which are larger than the Company and have greater resources and more extensive and diversified operations. Varco's principal competitors with respect to most Varco Systems products are Maritime Hydraulics A/S, a division of Aker Maritime A/S, a Norwegian company, and National-Oilwell Inc. Other competitors include A/S Hydralift, another Norwegian company, which acquired the rights to the product previously marketed by ACB offshore, a French company, and Tesco Corporation, a Canadian company, that competes principally in the land Top Drive market against Varco Systems' TDS-9S, TDS-10S and TDS-11S. Varco's most significant domestic competitors with respect to oil tools include Phoenix Energy Services, a subsidiary of National-Oilwell Inc., DenCon Oil Tools and Weatherford International, Inc. In foreign markets Varco experiences competition from most of its domestic competitors and from foreign companies as well. M/D Totco competes, in the domestic rental market, with the Swaco Geolograph Division of Smith International, Inc., Petron Industries Inc., and Epoch, a division of Nabors Industries. In domestic product sales, the competition consists of Wagner International Inc., Acadiana Oilfield Instruments, Inc. and a number of smaller regional companies. In the international market it competes with these same companies along with such foreign competitors as Hitec A/S, a division of National-Oilwell, Inc., and Pason Systems, Inc., a Canadian company. Shaffer competes, in the BOP and related controls market, with Cooper Cameron Corporation, Hydril Company, a privately held company, and Stewart and Stevenson Services, Inc. Shaffer's principal competitors with respect to motion compensation equipment are Maritime Hydraulics A/S and A/S Hydralift. Rigtech competes in the solids control equipment market principally with Derrick Manufacturing Inc., Brandt/EPI, a division of Tuboscope Inc., and Swaco, a division of Smith International, Inc. Although accurate industry figures are not available, the Company believes that it has a substantial share of the market for most of its equipment and instrumentation products. Manufacturing and Raw Materials The manufacturing processes for the Company's drilling and pressure control equipment products generally consist of machining, welding and fabrication, heat treating, assembly of manufactured and purchased components and testing. The Company's drilling and pressure control equipment products are manufactured primarily from alloy steel, and the availability of alloy steel castings, forgings, purchased components and bar stock is critical to the production and timing of shipments. The Company believes that there are currently adequate sources of supply for alloy steel castings, forgings, purchased components and bar stock. The primary manufacturing processes associated with instrumentation and solids control products are fabrication, machining, assembly of manufactured and purchased components and testing. The Company believes that adequate sources of supply exist for all such purchased components. Rigtech products are generally subcontracted to third parties for manufacturing. The Company believes that an adequate number of subcontractors exist for the manufacture of Rigtech products. Employees 11 At December 31, 1999 the Company had a total of 1,906 employees (of which 42 were temporary employees). Of such employees, 644 employees were engaged in sales and marketing, 281 employees were engaged in engineering and design, 144 employees were engaged in administrative or clerical capacities, and 837 were engaged in manufacturing. The Company considers its relations with its employees to be excellent and has never suffered a work stoppage or interruption due to a labor dispute. 12 MANAGEMENT EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of Varco are as follows:
NAME AGE POSITION ---- --- -------- Walter B. Reinhold 75 Chairman Emeritus/Director and Consultant George I. Boyadjieff 61 Chairman of the Board and Chief Executive Officer and Director Michael W. Sutherlin 53 President and Chief Operating Officer Richard A. Kertson 60 Vice President-Finance and Chief Financial Officer-Retired Wallace K. Chan 42 Vice President-Finance and Chief Financial Officer Donald L. Stichler 55 Vice President, Controller-Treasurer and Chief Accounting Officer and Secretary Robert J. Gondek 56 Vice President and President - M/D Totco Mark A. Merit 42 Vice President and President - Shaffer Roger D. Morgan 56 Vice President and President - Varco Systems Dietmar Neidhardt 53 President - Rigtech Division James G. Renfro President - Varco BJ Division
Officers are elected by, and serve at the pleasure of, the Board of Directors. Mr. Reinhold has been a director of the Company since 1970. He served as Chairman of the Board from 1976 until 1999 and has been a consultant to the Company since 1999. He served as Chief Executive Officer of the Company from 1970 until 1991, and prior thereto he served as Executive Vice President. He has been employed by the Company since 1949. Mr. Reinhold is a director of Amdahl Corporation. Mr. Boyadjieff was elected Chief Executive Officer of the Company in April 1991 and Chairman of the Board in May 1998. Mr. Boyadjieff served as President of the Company from May 1981 until February 2000 and as Chief Operating Officer from June 1979 until April 1991. Prior to May 1981, he was the Senior Vice President - Operations. He has been a director of the Company since 1976 and joined the Company in 1969. Mr. Boyadjieff is a director of Unit Instruments, Inc. Mr. Sutherlin was elected President and Chief Operating Officer of the Company in February 2000. Mr. Sutherlin served as Vice President of the Company from May 1984 until February 2000 and as President-Varco BJ from July 1988 until February 2000. Previously he served as Vice President-Best Operations. He has been employed by the Company in various capacities since 1975. Mr. Kertson served as Vice President - Finance and Chief Financial Officer from May 1984 until February 2000 when in anticipation of his retirement, he was replaced by Mr. Chan. Prior thereto, Mr. Kertson was Controller of Varco Oil Tools from January 1982. He joined the Company in October 1975, as Director of Management Information Services. Mr. Chan was elected Vice President-Finance and Chief Financial Officer of the Company in February 2000. Prior thereto, Mr. Chan served as the Vice President-Finance of the Varco Systems Division. Mr. Chan has been employed by the Company since November 1992. Mr. Stichler was elected Controller-Treasurer of the Company in May 1984, Secretary in May 1994, Chief Accounting Officer in May 1995 and Vice President in 1998. He served as Corporate Controller from December 1982 to May 1984. He served as Manager of Accounting and Taxation from 1981, when he joined the Company. 13 Mr. Gondek has served as President of the M/D Totco Division since November 1990 and was elected Vice President of the Company in April 1991. From September 1986 until November 1990, Mr. Gondek was the Vice President and General Manager of the TOTCO operations of Baker Hughes Incorporated. Mr. Merit was elected Vice President of the Company and President of Shaffer in October 1992. He had been Vice President-Manufacturing of Varco Systems since August 1991. Previously he was Operations Manager of Varco U.K. Limited from March 1990, and prior to that he was Manager of Engineering Software Development for Varco Systems from 1985. He has been employed by the Company in various capacities since 1980. Mr. Morgan was elected Vice President of the Company in May 1984 and President of Varco Systems in May 1990. He had been Vice President-Materials and Manufacturing of Varco Oil Tools from May 1981. Previously, he was Vice President-Materials and Production of Varco Oil Tools. He has been employed by the Company in various capacities since 1974. Mr. Neidhardt was elected President of Rigtech in April 1998 when he joined the Company. Prior to joining the Company he was employed by Oiltools International Ltd as its Vice President of Product Development. Mr. Neidhardt was employed by Oiltools International Ltd. in various management capacities for 15 years. Mr. Renfro was elected President of Varco BJ in February 2000. Prior thereto, Mr. Renfro served as the Vice President of Manufacturing of the Varco Systems Division from May 1996 and prior thereto he was Vice President of Engineering from 1994. He has been employed by the Company in various capacities since 1988. ITEM 2. PROPERTIES The Company's principal manufacturing facilities are located in Orange, California (the "Orange Facility"), Etten-Leur, The Netherlands (the "Etten-Leur Facility"), Cedar Park, Texas (the "Cedar Park Facility") and Houston, Texas. The Orange Facility and the Etten-Leur Facility are used primarily for manufacturing the Company's drilling equipment; the Cedar Park Facility manufactures primarily instrumentation products; and the facilities located in Houston are primarily used for manufacturing pressure control, motion compensation and drilling equipment and flow line devices. Rigtech products are generally subcontracted to third parties for manufacturing. The Orange Facility occupies approximately nine acres in Orange County, California and includes three manufacturing/warehouse buildings comprising a total of approximately 160,000 square feet and a four-story high-rise facility with automatic storage and retrieval capabilities. The Orange Facility is currently leased under a long-term lease, and the lessors include certain officers, shareholders, and directors of the Company and affiliated trusts. During 1997 the Varco Systems Division leased an additional 19,000 square foot manufacturing building located nearby for a term of five years. The Orange Facility is the primary manufacturing location for the Varco Systems Division, and the Company estimates that based upon direct labor hours and a two shift operation, utilization of this facility was in excess of a two shift operation for 1999, 1998 and 1997. The Etten-Leur Facility consists of approximately 73,000 square feet of manufacturing and warehousing space and approximately 12,900 square feet of office space on approximately six acres of land. This facility is the primary manufacturing location for the Varco BJ Division, and the Company estimates that based upon direct labor hours and a two shift operation, utilization of this facility was approximately 90% for 1999 as compared to in excess of a two shift operation for 1998 and near capacity for 1997. The M/D Totco products are manufactured at the Cedar Park Facility. The Cedar Park Facility consists of approximately 200,000 square feet of manufacturing and warehousing space and approximately 14 33,000 square feet of office space located on approximately 40 acres. The Company estimates that based upon direct labor hours and a two shift operation, utilization of this facility was 80% of a two shift operation in 1999 as compared to utilization in excess of a two shift operation in 1998 and 1997. The Shaffer Division's products are principally manufactured at the "Shaffer Facility", which consists of approximately 286,000 square feet of manufacturing and warehousing space and approximately 77,000 square feet of office space located on approximately 34 acres in Houston, Texas. The Company estimates that based upon direct labor hours and a two shift operation, utilization of this facility for 1999 was approximately 90% and was in excess of a two shift operations for the years 1998 and 1997. In December 1996, Shaffer purchased all the assets, including a 15,000 square foot manufacturing facility, of a Houston machine shop. In February 1997, Shaffer purchased all of the assets of a Houston machine shop operation and simultaneously entered into a five-year lease for the related 80,000 square foot manufacturing facility. Shaffer began operation of the facility in March 1997. During 1997 Shaffer further expanded its manufacturing space by acquiring additional satellite facilities in the Houston area. At the end of 1997 Shaffer leased the above 80,000 square foot facility plus four additional satellite facilities ranging in size from 8,000 square feet to 33,000 square feet (together with the Shaffer Facility, the "Houston Facilities.") One of the satellite machine shops (approximately 25,000 square feet) was sold in April 1999. Two additional facilities have been listed for sale. The Varco Systems Division's administration offices and the Company's executive offices are located in Orange, California adjacent to the Orange Facility. They comprise approximately 36,000 square feet of office space and are leased from certain officers, shareholders and directors of the Company, affiliated trusts and other lessors. The Company owns sales and service facilities in Oklahoma, Wyoming, Scotland and Singapore and leases approximately 11 such facilities throughout the United States in addition to facilities in Abu Dhabi, Brazil, Canada, China, and Venezuela. ITEM 3. LEGAL PROCEEDINGS There are no material pending legal proceedings, other than ordinary routine litigation incidental to the business, to which Varco or any of its subsidiaries is a party or to which any of their property is subject. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matter was submitted to a vote of security holders, through the solicitation of proxies or otherwise, during the fourth quarter of 1999. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS The information concerning the market for the Registrant's Common Stock and related stockholder matters contained under the captions "Price Range of Varco Common Stock," "Dividend Policy" and "Common Stock" on page 48 of the Registrant's Annual Report to Shareholders for the year ended December 31, 1999, is hereby incorporated by reference. 15 During the fiscal year ended December 31, 1999, there were no sales of equity securities of the Registrant by the Registrant which were not registered under the Securities Act of 1933, as amended. ITEM 6. SELECTED FINANCIAL DATA The selected financial information set forth under the caption "Five-Year Financial and Operating Highlights" on page 26 of the Registrant's Annual Report to Shareholders for the year ended December 31, 1999, is hereby incorporated by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 28 through 31 of the Registrant's Annual Report to Shareholders for the year ended December 31, 1999, is hereby incorporated by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The quantitative and qualitative disclosures about market risk included in Management's Discussion and Analysis of Financial Condition and Results of Operations under the caption "Quantitative and Qualitative Market Risk Disclosures" on page 31 of the Registrant's Annual Report to Shareholders for the year ended December 31, 1999, are hereby incorporated by reference. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this item is hereby incorporated by reference to pages 32 through 46 of the Registrant's Annual Report to Shareholders for the year ended December 31, 1999. The Report of Independent Auditors is included in Item 14(d). ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this item is hereby incorporated by reference to the information set forth under the subcaptions "Nominees" and "Section 16(a) Beneficial Ownership Reporting Compliance" under the caption "ELECTION OF DIRECTORS" in the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on May 11, 2000, except that information concerning the Executive Officers of the Registrant is contained in Item 1 under the caption "Executive Officers of the Registrant." ITEM 11. EXECUTIVE COMPENSATION The information required by this item is hereby incorporated by reference to the information set forth under the subcaptions "Compensation and Stock Option Information" and "Compensation Committee Interlocks and Insider Participation" under the caption "EXECUTIVE COMPENSATION" and under the subcaption "Director Compensation" under the caption "ELECTION OF DIRECTORS" in the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on May 11, 2000 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 16 The information required by this item is hereby incorporated by reference to the information set forth under the caption "BENEFICIAL OWNERSHIP OF VARCO SECURITIES" in the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on May 11, 2000. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information required by this item is hereby incorporated by reference to the information set forth under the caption "CERTAIN TRANSACTIONS AND RELATIONSHIPS" in the Registrant's Proxy Statement for the Annual Meeting of Shareholders to be held on May 11, 2000. ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) FINANCIAL STATEMENTS AND SCHEDULES The following consolidated financial statements of Varco International, Inc. and subsidiaries, included in the Registrant's Annual Report to Shareholders for the year ended December 31, 1999, are incorporated by reference in Item 8:
PAGE IN ANNUAL REPORT ------ Consolidated Balance Sheets-as of December 31, 1999 and 1998......................................... 32 Consolidated Statements of Income-Years ended December 31, 1999, 1998 and 1997...................... 33 Consolidated Statements of Shareholders' Equity-Years ended December 31, 1999, 1998 and 1997......... 34 Consolidated Statements of Cash Flows-Years ended December 31, 1999, 1998 and 1997................... 35 Notes to Consolidated Financial Statements........................................................... 36
The Report of Independent Auditors and the following consolidated financial statement schedule of Varco International, Inc., and subsidiaries are included in Item 14(d):
PAGE ---- Report of Independent Auditors........................................................................ 22 Schedule II - Valuation and Qualifying Accounts................................................... 23
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted. Individual financial statements of the registrant have been omitted as the registrant is primarily an operating company and all subsidiaries included in the consolidated financial statements filed, in the aggregate, do not have minority equity interest and/or indebtedness to any person other than the registrant or its consolidated subsidiaries in amounts which together (excepting indebtedness incurred in the ordinary course of business which is not overdue and matures within one year from the date of its creation, whether or not evidenced by securities, and indebtedness of subsidiaries which is collateralized by the registrant by guarantee, pledge, assignment or otherwise) exceed 5 percent of the total assets as shown by the most recent year-end consolidated balance sheet. (b) Reports on Form 8-K No reports on Form 8-K wree filed during the fourth quarter of 1999. On March 24, 2000 the Company filed a Form 8-K reporting that on March 22, 2000, the Company and Tuboscope Inc., a Delaware corporation ("Tuboscope"), entered into an Agreement and Plan of Merger (the "Merger Agreement"). Pursuant to the Merger Agreement, and subject to the conditions set forth therein (including approval of the transaction by the shareholders of the Company and Tuboscope), the Company will be merged with and into Tuboscope (the "Merger"). The name of the combined company will be Varco International, Inc., and the shares of the Combined Company will be listed for trading on the NYSE under the symbol "VRC". In connection with the Merger Agreement, the Company and Tuboscope entered into (i) a Stock Option Agreement dated as of March 22, 2000, pursuant to which Tuboscope has the right, under certain circumstances, to purchase up to 13,023,985 shares of Varco common stock (representing approximately 19.9% of the issued and outstanding shares of Varco common stock) at a price of $14.56 per share and (ii) a Stock Option Agreement, dated as of March 22, 2000, pursuant to which the Company has the right, under certain circumstances, to purchase up to 8,908,653 shares (representing approximately 19.9% of the issued and outstanding shares of Tuboscope common stock) at a price of $17.00 per share. Copies of the Merger Agreement, the two Stock Option Agreements and the joint press release of the Company and Tuboscope regarding the Merger are included as exhibits to the Form 8-K. 17 Exhibits marked with an asterisk are filed herewith. The remainder of the exhibits have heretofore been filed with the Commission and are incorporated herein by reference. Each management contract or compensation plan or arrangement filed as an exhibit hereto is identified by a "+". 3.1 Amended and Restated Articles of Incorporation of Varco, incorporated by reference to Exhibit 3.1 to Varco's annual report on Form 10-K for the year ended December 31, 1995. 3.2 Certificate of Amendment of Amended and Restated Articles of Incorporation of Varco, as filed with the California Secretary of State on June 5, 1998, incorporated by reference to Exhibit 3.2 to Varco's annual report on Form 10-K for the year ended December 31, 1998. 3.3 Certificate of Determination of Rights, Preferences and Privileges of Series A Participating Preferred Stock of Varco, as filed with the California Secretary of State on November 6, 1997, incorporated by reference to Exhibit 3.3 to Varco's annual report on Form 10-K for the year ended December 31, 1998. 3.4 Certificate of Correction of Certificate of Determination of Rights, Preferences and Privileges of Series A Participating Preferred Stock of Varco, as filed with the California Secretary of State on November 14, 1997, incorporated by reference to Exhibit 3.4 to Varco's annual report on Form 10-K for the year ended December 31, 1998. 3.5 Bylaws of Varco, incorporated by reference to Exhibit 3.7 to Amendment No. 1 to Varco's Registration Statement on Form S-1, Registration No. 33-40191. 4.1 Credit Agreement, dated as of June 27, 1997, among Varco International, Inc., the financial institutions listed therein as Lenders, and Union Bank of California, N.A., as Agent, incorporated by reference to Exhibit 4.8 to Varco's annual report on Form 10-K for the year ended December 31, 1997. 4.2 First Amendment to Credit Agreement, dated as of July 15, 1997, to Credit Agreement included as Exhibit 4.1 hereto, incorporated by reference to Exhibit 4.9 to Varco's annual report on Form 10-K for the year ended December 31, 1997. 4.3 Second Amendment to Credit Agreement dated as of August 13, 1997, to Credit Agreement included as Exhibit 4.1 hereto, incorporated by reference to Exhibit 4.10 to Varco's annual report on Form 10-K for the year ended December 31, 1997. 4.4 Third Amendment to Credit Agreement dated as of November 7, 1997 to Credit Agreement included as Exhibit 4.1 hereto, incorporated by reference to Exhibit 4.11 to Varco's annual report on Form 10-K for the year ended December 31, 1997. 4.5 Fourth Amendment to Credit Agreement dated as of February 18, 1998 to Credit Agreement included as Exhibit 4.1 hereto, incorporated by reference to Exhibit 4.12 to Varco's annual report on Form 10-K for the year ended December 31, 1997. 4.6 Fifth Amendment to Credit Agreement dated as of November 3, 1998 to Credit Agreement included as Exhibit 4.1 hereto, incorporated by reference to Exhibit 4.13 to Varco's annual report on Form 10-K for the year ended December 31, 1998. 4.7 Rights Agreement, dated as of November 6, 1997, between Varco International, Inc. and Harris Trust Company of California as Rights Agent, which includes: as Exhibit A thereto, the Form of Certificate of Determination of Rights, Preferences, and Privileges of Series A Participating Preferred Stock of Varco International, Inc.; as Exhibit B thereto, the Form of Rights Certificate; and, as Exhibit C thereto, the Summary of Rights, incorporated by reference to Exhibit 1 to the 18 Corporation's Form 8-A Registration Statement filed November 13, 1997. 10.1+ The Varco 1980 Stock Option Plan, as amended, incorporated by reference to Exhibit 4.5 to Post-Effective Amendment No. 4 to Varco's Registration Statement on Form S-8, Registration No. 2-66830. 10.2+ Amendment to Varco 1980 Stock Option Plan included as Exhibit 10.1 hereto, incorporated by reference to Exhibit 10.2 to Varco's quarterly report on Form 10-Q for the quarter ended September 30, 1984. 10.3+ Amendment to Varco 1980 Stock Option Plan included as Exhibit 10.1 hereto, incorporated by reference to Exhibit 10.3 to Varco's annual report on Form 10-K for the year ended December 31, 1996. 10.4+ The Varco 1982 Non-Employee Director Stock Option Plan, incorporated by reference to Exhibit 19.3 to Varco's quarterly report on Form 10-Q for the quarter ended June 30, 1982. 10.5+ Varco International, Inc. Supplemental Executive Retirement Plan, incorporated by reference to Exhibit 10.6 to Varco's annual report on Form 10-K for the year ended December 31, 1992. 10.6+ Amendment to Varco International, Inc. Supplemental Executive Retirement Plan included as Exhibit 10.5 hereto, incorporated by reference to Exhibit 10.6 to Varco's annual report on Form 10-K for the year ended December 31, 1996. 10.7+ Second Amendment to the Varco International, Inc. Supplemental Executive Retirement Plan, included as Exhibit 10.5 hereto, incorporated by reference to Exhibit 10.7 to Varco's annual report on Form 10-K for the year ended December 31, 1997. 10.8+ Varco International, Inc. Stock Bonus Plan, incorporated by reference to Exhibit 10.8 to Varco's annual report on Form 10-K for the year ended December 31, 1985. 10.9+ Amendments to Varco International, Inc. Stock Bonus Plan included as Exhibit 10.8 hereto, incorporated by reference to Exhibit 10.7 to Varco's annual report on Form 10-K for the year ended December 31, 1995. 10.10+ Amendment to Varco International, Inc. Stock Bonus Plan included as Exhibit 10.8 hereto. incorporated by reference to Exhibit 10.9 to Varco's annual report on Form 10-K for the year ended December 31, 1996. 10.11 Lease dated March 7, 1975, as amended, incorporated by reference to Exhibit 10.7 to Varco's annual report on Form 10-K for the year ended December 31, 1981, and agreement with respect thereto dated as of January 1, 1982, incorporated by reference to Exhibit 10.8 to Varco's annual report on Form 10-K for the year ended December 31, 1982. 10.12 Agreement dated as of January 1, 1984, with respect to Lease included as Exhibit 10.11 hereto, incorporated by reference to Exhibit 10.13 to Varco's annual report on Form 10-K for the year ended December 31, 1984. 10.13 Agreement dated as of February 8, 1985, with respect to Lease included as Exhibit 10.11 hereto, incorporated by reference to Exhibit 10.14 to Varco's annual report on Form 10-K for the year ended December 31, 1984. 10.14 Agreement dated as of April 12, 1985 to Lease included as Exhibit 10.11 hereto, incorporated by reference to Exhibit 10.2 to Varco's Quarterly Report on Form 10-Q for the quarter ended June 30, 1985. 19 10.15 Amendment dated as of January 11, 1996 to Lease included as Exhibit 10.11 hereto, incorporated by reference to Exhibit 10.12 to Varco's annual report on Form 10-K for the year ended December 31, 1995. 10.16 Standard Industrial Lease-Net dated September 29, 1988 for the premises at 743 N. Eckhoff, Orange, California, incorporated by reference to Exhibit 10.14 to Varco's annual report on Form 10-K for the year ended December 31, 1988. 10.17 First amendment dated as of January 11, 1996 to Lease included as Exhibit 10.16 hereto, incorporated by reference to Exhibit 10.15 to Varco's annual report on Form 10-K for the year ended December 31, 1995. 10.18+ The Varco International, Inc. 1990 Stock Option Plan, as amended, incorporated by reference to Exhibit 4.2 to Varco's Registration Statement on Form S-8, Registration No. 333-21681. *10.19+ Amendments to the Varco International, Inc. 1990 Stock Option Plan included as Exhibit 10.18 hereto. *10.20+ Form of amendment to stock option agreements under the Varco International, Inc. 1990 Stock Option Plan, included as Exhibit 10.18 hereto. 10.21+ Varco 1980 Employee Stock Purchase Plan, as amended, incorporated by reference to Exhibit 28 to Varco's Registration Statement on Form S-8, Registration No. 33-36841. 10.22+ Amendment to the Varco 1980 Employee Stock Purchase Plan included as Exhibit 10.21 hereto, incorporated by reference to Exhibit 10.19 to Varco's annual report on Form 10-K for the year ended December 31, 1995. 10.23+ Amendment to the Varco 1980 Employee Stock Purchase Plan included as Exhibit 10.21 hereto, incorporated by reference to Exhibit 10.21 to Varco's annual report on Form 10-K for the year ended December 31, 1996. *10.24+ Varco International Inc. Management Incentive Bonus Plan. 10.25+ Varco International Inc. 1994 Directors' Stock Option Plan, incorporated by reference to Exhibit 10.24 to Varco's annual report on Form 10-K for the year ended December 31, 1995. 10.26+ Amendment to Varco International Inc. 1994 Directors' Stock Option Plan incorporated by reference to Exhibit 10.26 to Varco's annual report on Form 10-K for the year ended December 31, 1997. *10.27+ The Varco International, Inc. Director Deferred Compensation. *10.28+ The Varco International, Inc. Deferred Compensation Plan. *11 Statement re computation of per share earnings. *12 Statement re computation of ratios. 20 *13 1999 Annual Report to Shareholders, to the extent expressly incorporated by reference in this Report on Form 10-K. Such Annual Report, except for those portions so incorporated by reference, is furnished only for information and is not to be deemed filed herewith. *21 Subsidiaries of Varco. *23 Consent of Independent Auditors. *27 Financial Data Schedule December 31, 1999 ____________ * Filed herewith + Management contract, compensation plan or arrangement. As to any security holder of the Registrant requesting a copy of this Form 10-K, the Registrant will furnish copies of any exhibits listed above as filed with this Form 10-K upon payment to it of its reasonable expenses in furnishing such exhibits. 21 (d) Schedules The Report of Independent Auditors and the schedule listed in the Index to Financial Statements and Schedules (Item 14(a)) are filed as part of this Annual Report on Form 10-K. REPORT OF INDEPENDENT AUDITORS Shareholders and Board of Directors Varco International, Inc. We have audited the accompanying consolidated balance sheets of Varco International, Inc. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1999. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Varco International, Inc. and subsidiaries at December 31, 1999 and 1998, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. /s/ ERNST & YOUNG LLP Orange County, California February 8, 2000 22 VARCO INTERNATIONAL, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Column A Column B Column C Column D Column E ------------------- -------------------------------------------- ------------------ ------------ Additions --------------------------- Charged to Balance at Charged to other Balance beginning costs and accounts- Deductions- at end of Description of period expenses describe describe period - ---------------------------------------------------------------------------------------------------------------------------------- (in thousands) Year ended December 31, 1999: Deducted from asset accounts: Allowance for doubtful accounts........ $ 3,351 $ 57 $ 6 $ 460 (1) $ 2,954 Allowance for excess and obselete 26,151 6,611 93 16,112 (2) 16,743 inventory........ Reserve for assets held for sale....... 5,508 814 0 6,322 --------------------------------------------------------------------------------- TOTALS $35,010 $7,482 $ 99 $16,572 $26,019 ================================================================================== Year ended December 31, 1998: Deducted from asset accounts: Allowance for doubtful accounts.......... $ 2,121 $1,331 $ 48 $ 149 (1) $ 3,351 Allowance for excess and obselete 28,758 1,989 (188) 4,408 (2) 26,151 inventory....... Reserve for assets held for sale......... 5,262 240 (6) 5,508 ---------------------------------------------------------------------------------- TOTAL $36,141 $3,560 ($140) $ 4,551 $35,010 ================================================================================== Year ended December 31, 1997: Deducted from asset accounts: Allowance for doubtful accounts....... $ 1,756 $ 589 ($11) $ 213 (1) $ 2,121 Allowance for excess and obselete 36,879 3,701 (478) 11,344 (2) 28,758 inventory......... Reserve for assets held for sale....... 4,996 240 (26) 5,262 ------------------------------------------------------------------------------------ TOTALS $43,631 $4,530 ($489) $11,531 $36,141 ====================================================================================
(1) Uncollectible accounts written off, net of recoveries. (2) Obsolete inventories physically disposed of. 23 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. VARCO INTERNATIONAL, INC. By: /s/ GEORGE I. BOYADJIEFF --------------------------- George I. Boyadjieff Chairman and Chief Executive Officer Dated March 24, 2000 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. Principal Executive Officer and Director: Chairman and Chief Executive Officer March 24, 2000 /s/ GEORGE I. BOYADJIEFF - --------------------------------------- George I. Boyadjieff Principal Financial Officer: /s/ WALLACE K. CHAN Vice President- Finance and March 24, 2000 - --------------------------------------- Wallace K. Chan Chief Financial Officer Principal Accounting Officer: /s/ DONALD L. STICHLER Vice President, Controller- March 24, 2000 - --------------------------------------- Donald L. Stichler Treasurer and Secretary Other Directors: /s/ WALTER B. REINHOLD Director March 24, 2000 - --------------------------------------- Walter B. Reinhold /s/ GEORGE S. DOTSON Director March 24, 2000 - --------------------------------------- George S. Dotson /s/ ANDRE R. HORN Director March 24, 2000 - --------------------------------------- Andre R. Horn /s/ JACK W. KNOWLTON Director March 24, 2000 - --------------------------------------- Jack W. Knowlton /s/ LEO J. PIRCHER Director March 24, 2000 - --------------------------------------- Leo J. Pircher /s/ CARROLL W. SUGGS Director March 24, 2000 - --------------------------------------- Carroll W. Suggs
24 /s/ ROBERT A. TEITSWORTH Director March 24, 2000 - ----------------------------------- Robert A. Teitsworth /s/ EUGENE R. WHITE Director March 24, 2000 - ----------------------------------- Eugene R. White /s/ JAMES D. WOODS Director March 24, 2000 - ----------------------------------- James D. Woods
25 EX-10.19 2 AMENDMENTS TO 1990 STOCK OPTION PLAN Exhibit 10.19 Amendments to the Varco International, Inc. 1990 Stock Option Plan WHEREAS, the Board of Directors of the Corporation deem it desirable and in the best interests of the Corporation and its shareholders that the Corporation's 1990 Stock Option Plan (the "Plan") be amended in certain respects; NOW, THEREFORE, BE IT RESOLVED, that paragraph F of Section 6(b) of the Plan be, and the same hereby is, amended to read in its entirety as follows: F. Other Severance. In the event an employee's employment with Varco and its subsidiaries is terminated for any reason other than as set forth in paragraphs D and E above, any Nonstatutory Option which he holds may be exercised, to the extent it was exercisable on the date of termination of his employment, within such period after the date of termination of his employment (not to exceed ninety (90) days) as the Committee shall prescribe in his option agreement. For purposes of this Paragraph F, an employee's employment shall be deemed to have terminated on the earlier of the date his employment terminates or the date he receives written notice that his employment is or will be terminated. Such Option shall expire upon the expiration of such period unless the employee dies prior thereto, in which event he shall be deemed to have died on the date his employment terminated; provided, however, in no event shall such Option be exercised more than ten years from the date such Option was granted. and further RESOLVED, that paragraph F of Section 6(c) of the Plan be, and the same hereby is, amended to read in its entirety as follows: F. Other Severance. In the event an employee's employment with Varco and its subsidiaries is terminated for any reason other than as set forth in paragraphs D and E above, any Incentive Stock Option which he holds may be exercised, to the extent it was exercisable on the date of termination of his employment, within such period after the date of termination of his employment (not to exceed ninety (90) days) as the Committee shall prescribe in his option agreement. For purposes of this Paragraph F, an employee's employment shall be deemed to have terminated on the earlier of the date his employment terminates or the date he receives written notice that his employment is or will be terminated. Such Option shall expire upon the expiration of such period unless the employee dies prior thereto, in which event he shall be deemed to have died on the date his employment terminated; provided, however, in no event shall such Option be exercised more than ten years from the date such Option was granted. and further RESOLVED, that the Compensation Committee of the Board of Directors, as the Committee under the Plan, is authorized, in its sole discretion and from time to time, to amend any option outstanding under the Plan in a manner consistent with the foregoing amendments to the Plan; and RESOLVED, that each of the officers of the Corporation be, and he hereby is, authorized and directed to perform all acts and to execute and deliver all certificates and documents and to take or cause to be taken all other action as any such officer may deem necessary or appropriate to carry out the foregoing resolutions and to comply with the terms and provisions of the Plan. EX-10.20 3 FORM OF AMENDMENT TO STOCK OPTION PLAN Exhibit 10.20 Form of Amendment to Stock Option Agreements VARCO INTERNATIONAL, INC. AMENDMENT TO STOCK OPTION AGREEMENT This AMENDMENT TO STOCK OPTION AGREEMENT, dated ___________, is made by and between VARCO INTERNATIONAL, INC., a California corporation ("Varco") and the employee executing this Amendment below as Employee (the "Employee"). W I T N E S S E T H: WHEREAS, the Employee was granted one or more options on or prior to May 13, 1999 (the "Outstanding Options") to purchase shares of Varco's Common Stock pursuant to Varco's 1990 Stock Option Plan; and WHEREAS, the Outstanding Options are evidenced by one or more Stock Option Agreements (the "Option Agreements") made by Varco for the benefit of the Employee; and WHEREAS, on May 13, 1999, the Board of Directors of Varco approved certain amendments to the Plan and authorized the Compensation Committee (the "Committee") of the Board of Directors of Varco, in its sole discretion, to amend outstanding options consistent with the amendments to the Plan; and WHEREAS, the Compensation Committee of the Board of Directors of Varco has approved an amendment to the Outstanding Options and authorized the execution and delivery of amendments to the Outstanding Options incorporating such amendment; and NOW, THEREFORE, the parties hereto hereby agree as follows: 1. Each of the Outstanding Option Agreements is hereby amended as follows: The provisions of each Outstanding Option Agreement providing for the termination of the option upon the termination of the Employee's employment with Varco and its subsidiaries in cases other than the Employee's death or retirement under certain circumstances, wherever located and however designated or numbered, are hereby amended to read in their entirety as follows: "Subject to the provisions hereof relating to the termination of the Option upon the death of the Employee or the retirement of the Employee in specified circumstances, on the 90th day following the termination of the employment of Employee with Varco and its subsidiaries for any reason whatsoever, including, without limitation, any termination caused by Employee's quitting, resigning or having been discharged. For the purposes of this paragraph an Employee's employment shall be deemed to have terminated at the earlier of the date his/her employment actually terminates or the date he/she receives written notice that his/her employment is or will be terminated. If the Employee dies after his employment has terminated but before the expiration of such 90-day period, he/she shall be deemed to have died on the date his/her employment terminated. As used in this paragraph, the term "Employee", if not otherwise defined herein as the holder of the Option, shall mean the employee holding the Option. 2. This Amendment shall not be effective with respect to an Outstanding Option unless executed by both Varco and the Employee prior to the termination of such Outstanding Option in accordance with its terms, without giving effect to the foregoing amendment. 3. The Company and the Employee confirm that, as amended by this Amendment, each Outstanding Options shall terminate on the 90th day following the date hereof, or such earlier date as such Outstanding Option shall terminate in accordance with its terms. 3. This Amendment shall be governed by and interpreted in accordance with the laws of the State of California. IN WITNESS WHEREOF, the parties have executed this Amendment on the day and year first above written. "Varco" VARCO INTERNATIONAL, INC. By_______________________________ Richard A. Kertson Vice President-Finance "Employee" __________________________________ Signature __________________________________ Printed Name 2 EX-10.24 4 MANAGEMENT INCENTIVE BONUS To: Compensation Committee Exhibit 10.24 From: Dick Kertson Date: February 7, 2000 Re: Proposed Financial Criteria and Structure--2000 Management Incentive Bonus Plan The general structure of the Plan and the financial performance criteria employed remain generally unchanged from recent years; however, two additional financial performance criteria have been included to provide heightened emphasis on inventory management and new product development. As in past years, the cash bonus payout is expressed as a percentage of annual salary and is a function of Salary Grade and the overall financial performance level achieved. Overall financial performance is measured by profitability (Net Income at the total Company level and Operating Income at the Division level) and return on investment (Economic Value Added or "EVA" at both the total Company and Division level). To earn the bonus points associated with a given level of overall financial performance, both the minimum profit and return on ---- investment associated with that level must be achieved. In 2000, additional bonus points may be earned by reaching above-plan inventory turnover and new product revenue. In 1999, achieving the "Financial Plan" (the original Annual Financial Plan as revised in the January quarterly update) equated to 7 Bonus Points for the total Company (on a scale of 2-15). For the Drilling Systems and Oil Tools Divisions reaching the Financial Plan generated 10 points, and for M/D Totco, Shaffer and Rigtech, 6 points. This disparity between target points reflected the fact that the 1999 Financial Plan for Drilling Systems and Oil Tools was at or above 1997 performance, and for the other three Divisions and the total Company it was below that of 1997, on approximately the same revenue. The ratio of bonus to salary which represented the average target percentage in the salary survey data was set at 7 points, and the 75/th/ percentile ratio was set at 11 points. 1999 financial performance resulted in 13 points for Drilling systems, 7 points for Oil Tools, 5 points for Shaffer, and 7 points for the total Corporation. M/D Totco and Rigtech did not reach the minimum financial performance necessary to qualify for a bonus. Our experience over several years demonstrates that this methodology creates a very strong relationship between actual financial performance and incentive pay. A summary of the key elements of the proposed 2000 Management Incentive Bonus Plan follows: . Achieving the Annual Financial Plan ("AFP") would result in 7 Bonus Points for the total Company, as well as each Division (on a scale of 2-15). Each of the Division Plans is judged to have approximately the same degree of challenge. . In addition, achieving specific inventory turnover and new product revenue levels above the AFP enable each Division to earn incremental bonus points (or partial points), the sum of which could result in up to 2 additional Bonus Points. . Reflecting a significantly lower level of financial performance for the Varco International as compared to the 1997-1999 period, the bonus percentages (bonus/salary ratio) associated with each Bonus Point level have been revised downward for all Salary Grades. The 7 Bonus Point level generally yields payout ratios below the 25/th/ percentile when compared to the salary survey data. The median ratio would generally equate to the 11- 12 point level and the 75\th\ percentile ratio to the 13-14 point performance level. In addition to the cash bonus, it is proposed that each participant in the Plan be once again eligible for a Stock Bonus, based on total Company performance. As has been the case for several years, the Stock Bonus would be paid in Varco stock having a value equal to 1/3 of the bonus amount due a participant based on his/her Salary Grade and the total Company financial performance level achieved. For Division Presidents, 30% of the cash bonus amount is based upon the points attributable to total Company performance. For 2000 achieving the AFP financial performance would result in Management Incentive Bonuses totaling approximately $2,265,0000, 6.9% of Pre-Tax Income. For 1999 the comparable figures were $3,273,000 and 5.5%. Again in 1998 we propose that Corporate Officers have the opportunity to increase their cash bonus by 50%, or decrease it by 33%, depending on the performance of Varco Stock relative to a group of 9 peer companies. Specifically, if the year-to-year increase in the price of Varco Stock (as measured by the average of the last 5 trading days of 2000 divided by the average for the last 5 trading days of 1999) is among the top 3 of 10 companies, Corporate Officers' cash bonuses would be increased by 50%; if Varco's Stock price increase is among the bottom 3 of the group such bonuses would be reduced by 33%. (Note that this element of the Plan comes into play only during stock price appreciation). We believe that this aspect of the bonus program achieved its objective of focusing increased attention on stock price performance. The peer group would again include: Baker Hughes, Halliburton, Schlumberger, Smith International, Cooper Cameron, Tuboscope International, National Oilwell, Weatherford International, and IRI. 2000 BONUS POINTS
BONUS POINTS = 2 3 4 5 6 7 8 -------------------------------------------------------------------------- E.P.S. $ 0.05 $ 0.10 $ 0.15 $ 0.20 $ 0.25 $ 0.30 $ 0.35 NET INCOME 3.4 6.7 10.1 13.4 16.8 20.1 23.5 AVERAGE INVESTMENT 226.2 229.8 233.4 237.0 240.6 244.2 249.6 NET INCOME R.O.I. 1.5% 2.9% 4.3% 5.7% 7.0% 8.2% 9.4% EVA $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 DRILLING SYSTEMS: REVENUE 84.7 89.7 94.8 99.8 104.8 109.8 115.8 OPERATING INCOME 7.4 9.2 10.9 12.7 14.4 16.2 18.3 AVERAGE NET ASSETS 55.5 56.7 57.9 59.1 60.3 61.5 63.3 EVA $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 OIL TOOLS: REVENUE 36.4 38.6 40.7 42.9 45.0 47.2 49.8 OPERATING INCOME 3.5 4.3 5.0 5.8 6.5 7.3 8.1 AVERAGE NET ASSETS 16.3 16.8 17.3 17.9 18.4 18.9 19.7 EVA $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 M/D TOTCO: REVENUE 41.7 44.2 46.7 49.2 51.6 54.1 57.1 OPERATING INCOME 2.6 3.4 4.3 5.2 6.0 6.9 8.0 AVERAGE NET ASSETS 28.7 29.3 29.9 30.5 31.1 31.7 32.6 EVA $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 9 10 11 12 13 14 15 -------------------------------------------------------------------------- E.P.S. $ 0.40 $ 0.45 $ 0.50 $ 0.55 $ 0.60 $ 0.65 $ 0.70 NET INCOME 26.8 30.2 33.5 36.9 40.2 43.6 46.9 AVERAGE INVESTMENT 255.0 260.4 265.8 271.2 277.2 283.2 289.2 NET INCOME R.O.I. 10.5% 11.6% 12.6% 13.6% 14.5% 15.4% 16.2% EVA $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 DRILLING SYSTEMS: REVENUE 121.8 127.9 133.9 139.9 146.6 153.3 160.0 OPERATING INCOME 20.4 22.5 24.6 26.7 29.1 31.4 33.8 AVERAGE NET ASSETS 65.1 66.9 68.7 70.5 72.5 74.5 76.5 EVA $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 OIL TOOLS: REVENUE 52.4 55.0 57.5 60.1 63.0 65.9 68.8 OPERATING INCOME 8.9 9.6 10.4 11.2 12.0 12.9 13.8 AVERAGE NET ASSETS 20.5 21.2 22.0 22.8 23.6 24.5 25.4 EVA $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 M/D TOTCO: REVENUE 60.0 63.0 66.0 68.9 72.2 75.5 78.8 OPERATING INCOME 9.1 10.2 11.2 12.3 13.4 14.6 15.7 AVERAGE NET ASSETS 33.5 34.4 35.3 36.1 37.1 38.1 39.1 EVA $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0
2000 BONUS POINTS
2 3 4 5 6 7 8 -------------------------------------------------------------------------- SCHAFFER: REVENUE 77.5 82.1 86.7 91.3 95.9 100.5 106.0 OPERATING INCOME 3.0 4.6 6.2 7.8 9.4 11.0 12.4 AVERAGE NET ASSETS 72.1 73.2 74.3 75.4 76.5 77.6 79.3 EVA $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 RIGTECH REVENUE 13.0 13.7 14.5 15.3 16.0 16.8 17.7 -1.2 -1.0 -0.7 -0.4 -0.2 0.1 0.5 AVERAGE NET ASSETS 14.1 14.3 14.4 14.6 14.8 15.0 15.3 EVA $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 9 10 11 12 13 14 15 -------------------------------------------------------------------------- SCHAFFER: REVENUE 115.5 117.0 122.5 128.0 134.2 140.3 146.4 OPERATING INCOME 13.8 15.1 16.5 17.9 19.3 20.6 22.0 AVERAGE NET ASSETS 80.9 82.6 84.2 85.9 87.7 89.5 91.4 EVA $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 RIGTECH REVENUE 18.6 19.6 20.5 21.4 22.4 23.5 24.5 OPERATING INCOME 0.9 1.4 1.8 2.4 2.9 3.5 4.1 AVERAGE NET ASSETS 15.6 15.8 16.1 16.4 16.7 17.0 17.3 EVA $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0 $ 0.0
2000 BONUS PLAN
TOTAL DIVISIONS INCREMENTAL REVENUE 15.0 15.0 15.0 15.0 15.0 0.0 18.0 REVENUE 253.4 268.4 283.4 298.4 313.4 328.4 346.4 OPERATING INCOME 15.3 20.5 25.8 31.0 36.3 41.5 47.3 AVERAGE NET ASSETS 186.7 190.3 193.9 197.5 201.1 204.7 210.1 OPRA 8.2% 10.8% 13.3% 15.7% 18.0% 20.3% 22.5% ----- TOTAL DIVISIONS INCREMENTAL REVENUE 18.0 18.0 18.0 18.0 20.0 20.0 20.0 REVENUE 364.4 382.4 400.4 418.4 438.4 458.4 478.4 OPERATING INCOME 53.0 58.9 64.6 70.4 76.7 83.1 89.4 AVERAGE NET ASSETS 215.5 220.9 226.3 231.7 237.7 243.7 249.7 OPRA 24.6% 26.6% 28.6% 30.4% 32.3% 34.1% 35.8%
2000 BONUS PLAN
GRADE LEVEL 2 3 4 5 6 7 8 9 10 11 12 13 14 15 - ----------------------------------------------------------------------------------------------------------------------------------- EXEC 0% 0% 30% 35% 40% 45% 50% 55% 60% 65% 70% 80% 85% 95% 16 0% 0% 21% 24% 27% 30% 33% 36% 40% 44% 48% 53% 58% 64% 15 0% 0% 18% 21% 24% 27% 30% 33% 37% 41% 44% 49% 54% 59% 14 0% 0% 16% 18% 20% 22% 25% 28% 31% 34% 37% 40% 44% 49% 13 8% 10% 12% 14% 16% 18% 20% 22% 25% 28% 31% 34% 37% 41% 12 6% 7% 9% 10% 11% 13% 15% 17% 19% 21% 23% 25% 27% 30% 10/11 5% 6% 7% 8% 9% 10% 11% 12% 13% 15% 17% 19% 21% 23%
EX-10.27 5 DIRECTOR DEFERRED COMPENSATION PLAN EXHIBIT 10.27 Varco International Inc. Director Deferred Compensation Plan Varco Director Deferred Compensation Plan TABLE OF CONTENTS ----------------- Page ---- ARTICLE I......................................................................1 1.1 - Title....................................................................1 1.2 - Definitions..............................................................1 ARTICLE II.....................................................................4 2.1 - Participation............................................................4 ARTICLE III....................................................................5 3.1 - Elections to Defer Compensation..........................................5 3.2 - Investment Elections.....................................................6 ARTICLE IV.....................................................................7 4.1 - Deferral Account.........................................................7 4.2 - Employer Contributions Account...........................................7 ARTICLE V......................................................................9 5.1 - Deferral Account.........................................................9 5.2 - Employer Contributions Account...........................................9 ARTICLE VI....................................................................10 6.1 - Distribution of Deferred Compensation...................................10 6.2 - Forfeitures.............................................................11 6.3 - Nonscheduled In-Service Withdrawals.....................................11 6.4 - Hardship Withdrawals....................................................12 6.5 - Inability to Locate Participant.........................................12 6.6 - Pre-Retirement Death Benefit............................................12 6.7 - Trust...................................................................13 ARTICLE VII...................................................................14 ADMINISTRATION................................................................14 7.1 - Committee...............................................................14 7.2 - Committee Action........................................................14 7.3 - Powers and Duties of the Committee......................................14 7.4 - Construction and Interpretation.........................................15 7.5 - Information.............................................................15 ii 7.6 - Compensation, Expenses and Indemnity....................................15 7.7 - Quarterly Statements....................................................16 7.8 - Disputes................................................................16 ARTICLE XIII..................................................................18 8.1 - Unsecured General Creditor..............................................18 8.2 - Restriction Against Assignment..........................................18 8.3 - Withholding.............................................................18 8.4 - Amendment, Modification, Suspension or Termination......................19 8.5 - Governing Law...........................................................19 8.6 - Receipt or Release......................................................19 8.7 - Payments on Behalf of Persons Under Incapacity..........................19 8.8 - Headings, etc. Not Part of Agreement....................................19 iii Varco Director Deferred Compensation Plan (Effective as of April 1, 1999) Varco International, Inc. (the "Company") hereby establishes the Varco Director Deferred Compensation Plan (the "Plan"), effective as of April 1, 1999, to provide a tax-deferred capital accumulation opportunity to its non-employee directors through deferral of director fees. ARTICLE I TITLE AND DEFINITIONS 1.1 - Title. ----- This Plan shall be known as the Varco International, Inc. Director Deferred Compensation Plan. 1.2 - Definitions. ----------- Whenever the following words and phrases are used in this Plan, with the first letter capitalized, they shall have the meanings specified below. "Account" or "Accounts" shall mean a Participant's Deferral Account and/or Employer Contributions Account. "Beneficiary" or "Beneficiaries" shall mean the person or persons, including a trustee, personal representative or other fiduciary, last designated in writing by a Participant in accordance with procedures established by the Committee to receive the benefits specified hereunder (other than those benefits set forth in Section 6.6) in the event of the Participant's death. No beneficiary designation shall become effective until it is filed with the Committee, and no beneficiary designation of someone other than the Participant's spouse shall be effective unless such designation is consented to by the Participant's spouse on a form provided by and in accordance with procedures established by the Committee. If there is no Beneficiary designation in effect, or if there is no surviving designated Beneficiary, then the Participant's surviving spouse shall be the Beneficiary. If there is no surviving spouse to receive any benefits payable in accordance with the preceding sentence, the duly appointed and currently acting personal representative of the participant's estate (which shall include either the Participant's probate estate or living trust) shall be the Beneficiary. In any case where there is no such personal representative of the Participant's estate duly appointed and acting in that capacity within 90 days after the Participant's death (or such extended period as the Committee determines is reasonably necessary to allow such personal representative to be appointed, but not to exceed 180 days after 1 the Participant's death), then Beneficiary shall mean the person or persons who can verify by affidavit or court order to the satisfaction of the Committee that they are legally entitled to receive the benefits specified hereunder. In the event any amount is payable under the Plan to a minor, payment shall not be made to the minor, but instead be paid (a) to that person's living parent(s) to act as custodian, (b) if that person's parents are then divorced, and one parent is the sole custodial parent, to such custodial parent, or (c) if no parent of that person is then living, to a custodian selected by the Committee to hold the funds for the minor under the Uniform Transfers or Gifts to Minors Act in effect in the jurisdiction in which the minor resides. If no parent is living and the Committee decides not to select another custodian to hold the funds for the minor, then payment shall be made to the duly appointed and currently acting guardian of the estate for the minor or, if no guardian of the estate for the minor is duly appointed and currently acting within 60 days after the date the amount becomes payable, payment shall be deposited with the court having jurisdiction over the estate of the minor. "Board of Directors" shall mean the board of directors of the Company. "Code" shall mean the Internal Revenue Code of 1986, as amended. "Committee" shall mean the Committee appointed by the Board of Directors to administer the Plan in accordance with Article VII. "Company" shall mean Varco International, Inc., any successor corporation and each corporation which is a member of a controlled group of corporations (within the meaning of Section 414(b) of the Code) of which Varco International, Inc. is a member. "Compensation" shall mean the Participant's Annual Retainer and Meeting Fees. "Deferral Account" shall mean the bookkeeping account maintained by the Committee for each Participant that is credited with amounts equal to (a) the portion of the Participant's Compensation that he or she elects to defer and (b) earnings or losses pursuant to Section 4.1. "Distribution Subaccounts" shall mean subaccounts of a Participant's Deferral Account and Employer Contributions Account established to separately account for deferred Compensation and Employer Contribution Amounts (and earnings thereon) which are subject to different in-service distribution elections. "Earnings Rate" shall mean, for each Fund, an amount equal to the net rate of gain or loss on the assets of such Fund during each month. 2 "Effective Date" shall mean April 1, 1999. "Eligible Director" shall mean each member of the Board of Directors who is not an employee of the Company. "Employer Contributions Account" shall mean the bookkeeping account maintained by the Committee for each Participant that is credited with an amount equal to the Employer Contribution Amount (if any) and earnings or losses pursuant to Section 4.2. "Employer Contribution Amount" shall mean an amount to equal to a percentage of the amount of Compensation deferred by a Participant or such other amount, which percentage or other amount, if any, shall be determined by the Company, in its sole discretion, and which percentage or amount need not be the same for each Participant. "Fund" or "Funds" shall mean one or more of the investment funds or portfolios selected by the Committee pursuant to Section 3.2(b). "Initial Election Period" for an Eligible Director shall mean the later of: (a) the thirty-day period ending March 31, 1999; or (b) the thirty-day period following the Eligible Director's appointment to the Board of Directors. "Participant" shall mean any Eligible Director who elects to defer Compensation in accordance with Section 3.1 and files a completed insurance application form in accordance with Section 2.1. "Payment Eligibility Date" shall mean the first day of the month following the end of the calendar quarter in which a Participant ceases to be a member of the Board of Directors for any reason. "Plan" shall mean the Varco Director Deferred Compensation Plan set forth herein, now in effect, or as amended from time to time. "Plan Year" shall mean the 12 consecutive month period beginning on January 1 and ending December 31. 3 ARTICLE II PARTICIPATION 2.1 - Participation. ------------- An Eligible Director shall become a Participant in the Plan by (a) electing to defer Compensation in accordance with Section 3.1, (b) filing a life insurance application form along with his or her deferral election form and (c) satisfying any medical underwriting requirement established by the Committee. 4 ARTICLE III DEFERRAL ELECTIONS 3.1 - Elections to Defer Compensation. ------------------------------- (a) Initial Election Period. Subject to Section 2.1, each Eligible Director may elect to defer Compensation by filing with the Committee an election that conforms to the requirements of this Section 3.1, on a form provided by the Committee, no later than the last day of his or her Initial Election Period. (b) General Rule. Subject to the minimum deferral provisions of Section 3.1(c) below, an Eligible Director may elect to defer any percentage of Compensation up to 100%; provided, however, that no election shall be effective to reduce the Compensation paid to an Eligible Director for a calendar year to an amount which is less than the amount that the Company is required to withhold from such Eligible Director's Compensation for such calendar year for any reason (other than contributions to this Plan). (c) Minimum Deferrals. For each Plan Year during which an Eligible Director is a Participant, the minimum amount that may be elected under Section 3.1(b) is $5,000. If the Compensation which the Participant has elected to defer for a Plan Year includes a percentage of the Compensation payable in such Plan Year and the actual amount of such Compensation to be deferred is less than $5,000 for the Plan Year, then no portion of such Compensation shall be deferred under this Plan and any Compensation previously deferred for such Plan Year shall be refunded to the Participant without interest. (d) Effect of Initial Election. An election to defer Compensation during the Initial Election Period shall be effective with respect to Compensation paid with respect to pay periods commencing after the end of the Initial Election Period. (e) Elections other than Elections during the Initial Election Period. Subject to the requirement for filing a completed life insurance form pursuant to Section 2.1, any Eligible Director may participate for any Plan Year by filing an election, on a form provided by the Committee, to defer Compensation as described in paragraph (b) above. An election to defer Compensation for a Plan Year (other than the Plan Year beginning January 1, 1999) must be filed on or before December 15 of the preceding Plan Year and will be effective for Compensation earned during pay periods beginning on or after the following January 1. Each such election shall designate the time at which such deferred Compensation (and allocable earnings) shall be distributed to the Participant in accordance with Article VI of this Plan. 5 (f) In-service Distributions. At the time of making an election to defer Compensation for a Plan Year pursuant to this Section 3.1 (or by May 31, 1999 with respect to the election to defer Compensation for the Plan Year commencing May 1, 1999), a Participant may elect to receive an in-service distribution of the amount deferred under such election, together with any Employer Contribution Amounts for the same Plan Year and earnings credited with respect to such amounts pursuant to Article IV, in a lump sum in any year beginning after the second anniversary of the last day of the Plan Year in which the amount deferred was earned. A Participant may subsequently elect to defer the year of such an in-service distribution to any subsequent year by filing a written election with the Committee, on a form provided by the Committee, at least one year prior to the first day of the previously elected in-service distribution year. The election to defer the year of an in-service distribution may be made no more than twice. (g) Irrevocability. Any election filed pursuant to this Section 3.1 shall be irrevocable except to the extent provided in subsection (f) hereof and Section 6.3. 3.2 - Investment Elections. -------------------- (a) At the time of making the deferral elections described in Section 3.1, the Participant shall designate, on a form provided by the Committee, which of the types of investment funds or portfolios set forth in Appendix A the Participant's Accounts will be deemed to be invested in for purposes of determining the amount of earnings to be credited to each Account. Notwithstanding the foregoing, with respect to deferral elections made during the thirty-day period ending April 30, 1999, the Participant shall designate the types of investment funds or portfolios set forth in Appendix A on or before May 31, 1999. (b) In making the designation pursuant to this Section 3.2, the Participant must specify, in whole numbers, the percentage of his Deferral Account and Employer Contributions Account which shall be deemed to be invested in one or more of the types of investment funds or portfolios listed in Appendix A. Effective as of the end of any month, a Participant may change the designation made under this Section 3.2 by filing an election, on a form provided by the Committee. If a Participant fails to elect a type of investment fund or portfolio under this Section 3.2, he or she shall be deemed to have elected the Money Market option. (c) Although the Participant may designate the type of investment funds or portfolios, the Committee shall select from time to time, in its sole discretion, a commercially available investment fund or portfolio of each of the types described in Appendix A to be the Funds. The Earnings Rate of each such commercially available investment fund or portfolio shall be used to determine the amount of earnings or losses to be credited to Participants' Accounts under Article IV. 6 ARTICLE IV ACCOUNTS 4.1 - Deferral Account. ---------------- The Committee shall establish and maintain a Deferral Account for each Participant under the Plan. For each Participant who makes one or more in-service distribution elections pursuant to Section 3.1(f), the Deferral Account shall be divided into two or more Distribution Subaccounts as necessary to separately account for deferrals which are payable at different times. A Participant's Deferral Account shall be divided (or each Distribution Subaccount of a Participant's Deferral Account shall be further divided) into separate subaccounts ("investment subaccounts"), each of which corresponds to an investment fund or portfolio elected by the Participant pursuant to Section 3.2(a). A Participant's Deferral Account shall be credited as follows: (a) No later than five business days after the end of each month, the Committee shall credit the investment subaccounts of the Deferral Account (or the appropriate Distribution Subaccount of the Participant's Deferral Account) with an amount equal to the Compensation deferred by the Participant during each pay period ending in that month in accordance with the Participant's election under Section 3.2(a); that is, the portion of the Participant's deferred Compensation that the Participant has elected to be deemed to be invested in a certain type of investment fund or portfolio shall be credited to the investment subaccount corresponding to that investment fund or portfolio; and (b) As of the last day of each month, each investment subaccount of a Participant's Deferral Account (or Distribution Subaccount of the Participant's Deferral Account) shall be credited with earnings or losses in an amount equal to that determined by multiplying the balance credited to such investment subaccount as of the last day of the preceding month by the Earnings Rate for the corresponding Fund selected by the Committee pursuant to Section 3.2(b). 4.2 - Employer Contributions Account. ------------------------------ The Committee shall establish and maintain an Employer Contributions Account for each Participant under the Plan. For each Participant who makes one or more in-service distribution elections pursuant to Section 3.1(f), the Participant's Employer Contributions Account shall be divided into two or more Distribution Subaccounts as necessary to separately account for Employer Contribution Amounts which are payable at different times. A 7 Participant's Employer Contributions Account shall be divided (or each Distribution Subaccount of a Participant's Employer Contributions Account shall be further divided) into separate investment subaccounts corresponding to the investment fund or portfolio elected by the Participant pursuant to Section 3.2(a). A Participant's Employer Contributions Account shall be credited as follows: (a) No later than five business days after the end of any calendar quarter or Plan Year for which the Company, in its sole discretion, decides to credit a Participant with an Employer Contribution Amount, the Committee shall credit the investment subaccounts of the Employer Contributions Account (or the appropriate Distribution Subaccount of the Participant's Employer Contributions Account) with an amount equal to the Employer Contribution Amount applicable to that Participant in accordance with the Participant's election under Section 3.2(a); that is, the portion of the Participant's Employer Contribution Amount which the Participant elected to be deemed to be invested in a certain type of investment fund or portfolio shall be credited to the corresponding investment subaccount; and (b) As of the last day of each month, each investment subaccount of the Employer Contributions Account (or the appropriate Distribution Subaccount of the Participant's Employer Contributions Account) shall be credited with earnings or losses in an amount equal to that determined by multiplying the balance credited to such investment subaccount as of the last day of the preceding month by the Earnings Rate for the corresponding Fund selected by the Committee pursuant to Section 3.2(b). 8 ARTICLE V VESTING 5.1 - Deferral Account. ---------------- A Participant's Deferral Account shall be 100% vested at all times. 5.2 - Employer Contributions Account. ------------------------------ (a) A Participant's Employer Contributions Account shall vest at a rate determined by the Company for each Participant. Each Participant's vesting schedule shall be set forth in a separate letter agreement between the Participant and the Company. (b) Notwithstanding anything contained herein to the contrary, the Committee may, in its sole discretion, provide for 100% vesting of a Participant's Employer Contributions Account at any time. 9 ARTICLE VI DISTRIBUTIONS 6.1 - Distribution of Deferred Compensation. ------------------------------------- (a) Distribution of the amount credited to a Distribution Subaccount of the Participant's Deferral Account and Employer Contribution Account which was established with respect to an in-service distribution election shall be made in a lump sum payment during January of the year elected by the Participant pursuant to Section 3.1(f), provided that the Participant is a member of the Board of Directors on January 1 or such year. In the event the Participant ceases to be a member of the Board of Directors for any reason prior to January 1 of the year elected by the Participant pursuant to Section 3.1(f), the Participant's in-service distribution election(s) with respect to benefits not yet distributed shall no longer be effective and all of the amounts credited to his or her Deferral Account and Employer Contributions Account shall be distributed together as set forth in the following subsections of this Section 6.1. (b) In the event a Participant ceases to be a member of the Board of Directors for a reason other than death, the amount credited to his or her Deferral Account and the vested portion of the amount, if any, credited to his or her Employer Contributions Account shall be distributed in 60 quarterly installments commencing as soon as practicable following his or her Payment Eligibility Date. Notwithstanding the foregoing, a Participant may elect one of the following optional forms of distribution provided that his or her election is filed with the Committee at least one year prior to his or her last day as a member of the Board of Directors on a form to be provided by the Committee: (1) A lump sum payment payable as soon as practicable after the Participant's Payment Eligibility Date, or (2) Either 20 or 40 quarterly installments beginning as soon as practicable following the Participant's Payment Eligibility Date. Notwithstanding anything contained herein to the contrary, in the event that the sum of the amount credited to a Participant's Deferral Account and the vested portion of the amount, if any, credited to his or her Employer Contributions Account is $25,000 or less, such amount shall be paid in a cash lump sum payment as soon as practicable following his or her Payment Eligibility Date. (c) In the event a Participant ceases to be a member of the Board of Directors because of death, the amount credited to his or her Deferral Account and the vested and unvested 10 portion of the amount, if any, credited to his or her Employer Contributions Account shall be paid to his or her Beneficiary in the form of a cash lump sum payment as soon as practicable following the Participant's Payment Eligibility Date unless (1) prior to his or her death the Participant had elected on a form provided by and filed with the Committee that the distribution be made in 20, 40 or 60 quarterly installments beginning as soon as practicable following the Participant's Payment Eligibility Date and (2) the sum of the amount credited to the Participant's Deferral Account and the vested portion of the amount, if any, credited to his or her Employer Contribution Account exceeds $25,000. (d) The Participant's Accounts shall continue to be credited monthly with earnings pursuant to Section 4.1 of the Plan until all amounts credited to his or her Accounts under the Plan have been distributed. (e) In the event that a former Participant dies while receiving installment payments under this Plan, any remaining installments shall be paid to the Participant's Beneficiary as such installments would have otherwise been due to the Participant. 6.2 - Forfeitures. ----------- When a Participant (or, in the case of his or her death, the Participant's Beneficiary) receives a distribution of benefits under this Plan (regardless of whether such payment is a lump sum payment or the first installment payment), the portion of his or her Employer Contributions Account, if any, which is not vested shall be forfeited, and the Company shall have no obligation to the Participant (or Beneficiary) with respect to such forfeited amount. 6.3 - Nonscheduled In-Service Withdrawals. ----------------------------------- At any time prior to his or her last day as a member of the Board of Directors, a Participant may elect to withdraw the entire amount credited to his or her Deferral Account and the vested portion of the amount, if any, credited to his or her Employer Contributions Account, subject to a 10% withdrawal penalty. The Participant may make such an election by filing a written notice with the Committee on a form provided by the Committee. Within 90 days following the Committee's receipt of such notice, an amount equal to the sum of 90% of the amount credited to the Participant's Deferral Account and 90% of the vested portion of the amount, if any, credited to his or her Employer Contributions Account shall be paid to the amount, if any, credited to his or her Employer Contributions Account shall be paid to the Participant in a cash lump sum payment. Upon the payment of such withdrawal, (a) the remainder of the amounts credited to the Participant's Accounts shall be forfeited, (b) the Participant shall cease to participate in the Plan for the remainder of the Plan Year in which the withdrawal occurs and shall be ineligible to participate during the Plan Year immediately 11 following the Plan Year in which the withdrawal occurs, and (c) any deferral elections made by the Participant for such periods shall be terminated. A Participant may not make more than two withdrawals under this Section 6.3. 6.4 - Hardship Withdrawals. -------------------- At any time prior to his or her last day as a member of the Board of Directors, a Participant may request a distribution for hardship without penalty. Such distribution for hardship shall be subject to approval by the Committee and may be made only to the extent necessary to satisfy the hardship. A distribution for hardship shall be granted only for one of the following reasons: (a) A Participant's or dependent's illness or accident; (b) Casualty loss with respect to a Participant's property; or (c) Other circumstances arising out of events beyond the control of the Participant, which the Committee finds are similar to the events described in Section 6.4(a) or (b). 6.5 - Inability to Locate Participant. ------------------------------- In the event that the Committee is unable to locate a Participant or Beneficiary within two years following the Participant's Payment Eligibility Date, the amounts allocated to the Participant's Deferral Account and Employer Contributions Account shall be forfeited. If, after such forfeiture, the Participant or Beneficiary later claims such benefits, such benefits shall be reinstated without interest or earnings, provided that Section 6.2 shall still apply. 6.6 - Pre-Retirement Death Benefit. ---------------------------- (a) If a Participant dies while a member of the Board of Directors, in addition to the payment or payments to the Participant's Beneficiary under Section 6.1(c), a death benefit shall be paid to the Participant's beneficiary under a life insurance policy purchased by or transferred to the trustee of the Trust described in Section 6.7 to insure the life of the Participant (the "Policy"). The death benefit payable to the Participant's beneficiary shall be $300,000. (b) The Participant shall have the right to designate and change such beneficiary (which need not be his or her Beneficiary under this Plan) at any time on a form provided by and filed with the insurance company. If no such form is on file with the insurance company, the death benefit described in the preceding paragraph shall be paid to the Beneficiary. 12 (c) The death benefit payable pursuant to paragraph (a) shall not be paid if an insurance company has not issued a Policy on the life of the Participant at the time of his death and shall be subject to all conditions and exceptions set forth in the Policy. (d) Notwithstanding any provision of this Plan or any other document to the contrary, the pre-retirement death benefit provided under Section 6.6(a) shall be payable solely from the proceeds of the Policy, if any. In addition, no Policy shall be allocated to any Account. 6.7 - Trust. ----- (a) The Company shall cause the payment of benefits under this Plan (excluding the amounts described in Section 6.6) to be made in whole or in part by the Trustee of the Varco Deferred Compensation Plan Trust (the "Trust") in accordance with the provisions of this Section 6.7. The Company shall contribute to the Trust for each Participant an amount equal to the amount deferred by the Participant for the Plan Year and the Employer Contribution Amount for the Participant for the Plan Year, if any; the contributions shall be made no later than the Company's tax return due date for that Plan Year. The Company shall also contribute cash in amounts approximately equal to the "cost of insurance" (as defined in each Policy) for the death benefits described in Section 6.6 for each Participant, provided that such obligation shall not apply with respect to a Policy if the Participant is no longer a member of the Board of Directors. Notwithstanding the foregoing, if the Company acquires a Policy and subsequently transfers it to the Trust, then, prior to the date the Policies are contributed to the Trust, the amounts described in the preceding two sentences shall be used to pay premiums on the Policies, rather than contributed to the Trust. (b) The Committee shall direct the Trustee to pay the Participant or his or her Beneficiary at the time in the amount described in Article VI (excluding amounts described in Section 6.6). In the event the amounts held under the Trust are not sufficient to provide the full amount (excluding amounts described in Section 6.6) payable to the participant or his or her Beneficiary, the Company shall pay the remainder of such amount at the time(s) set forth in Article VI. 13 ARTICLE VII ADMINISTRATION 7.1 - Committee. --------- A committee shall be appointed by, and serve at the pleasure of, the Board of Directors. The number of members comprising the Committee shall be determined by the Board of Directors which may from time to time vary the number of members, provided, however, that the Director of Human Resources for the Company and the Chief Financial Officer of the Company shall be members of the Committee. A member of the Committee may resign by delivering a written notice of resignation to the Board of Directors. The Board of Directors may remove any member by delivering a letter signed by each director notifying such member of his or her removal. Vacancies in the membership of the Committee shall be filled promptly by the Board of Directors. 7.2 - Committee Action. ---------------- The Committee shall act at meetings by affirmative vote of a majority of the members of the Committee. Any action permitted to be taken at a meeting may be taken without a meeting if, prior to such action, a written consent to the action is signed by all members of the Committee and such written consent is filed with the minutes of the proceedings of the Committee. A member of the Committee shall not vote or act upon any matter which relates solely to himself or herself as a Participant. The Chairman or any other member or members of the Committee designated by the Chairman may execute any certificate or other written direction on behalf of the Committee. 7.3 - Powers and Duties of the Committee. ---------------------------------- (a) The Committee, on behalf of the Participants and their Beneficiaries, shall enforce the Plan in accordance with its terms, shall be charged with the general administration of the Plan, and shall have all powers necessary to accomplish its purposes, including, but not by way of limitation, the following: (1) To select the funds or portfolios to be the Funds in accordance with Section 3.2(b) hereof; (2) To construe and interpret the terms and provisions of this Plan; 14 (3) To compute and certify to the amount and kind of benefits payable to Participants and their Beneficiaries; (4) To maintain all records that may be necessary for the administration of the Plan; (5) To provide for the disclosure of all information and the filing or provision of all reports and statements to Participants, Beneficiaries or governmental agencies as shall be required by law; (6) To make and publish such rules for the regulation of the Plan and procedures for the administration of the Plan as are not inconsistent with the terms hereof; and (7) To appoint a plan administrator or any other agent, and to delegate to them such powers and duties in connection with the administration of the Plan as the Committee may from time to time prescribe. 7.4 - Construction and Interpretation. ------------------------------- The Committee shall have full discretion to construe and interpret the terms and provisions of this Plan, which interpretation or construction shall be final and binding on all parties, including but not limited to the Company and any Participant or Beneficiary. The Committee shall administer such terms and provisions in a uniform and nondiscriminatory manner and in full accordance with any and all laws applicable to the Plan. 7.5 - Information. ----------- To enable the Committee to perform its functions, the Company shall supply full and timely information to the Committee on all matters relating to the Compensation of all Participants, their death or other cause of termination, and such other pertinent facts as the Committee may require. 7.6 - Compensation, Expenses and Indemnity. ------------------------------------ (a) The members of the Committee shall serve without compensation for their services hereunder. 15 (b) The Committee is authorized at the expense of the company to employ such legal counsel as it may deem advisable to assist in the performance of its duties hereunder. Expenses and fees in connection with the administration of the Plan shall be paid by the Company. (c) To the extent permitted by applicable state law, the Company shall indemnify and save harmless the Committee and each member thereof, the Board of Directors and each member thereof, and delegates of the Committee who are employees of the Company against any and all expenses, liabilities and claims, including legal fees to defend against such liabilities and claims arising out of their discharge in good faith of responsibilities under or incident to the Plan, other than expenses and liabilities arising out of willful misconduct. This indemnity shall not preclude such further indemnities as may be available under insurance purchased by the Company or provided by the Company under any bylaw, agreement or otherwise, as such indemnities are permitted under state law. 7.7 - Quarterly Statements. -------------------- Under procedures established by the Committee, a Participant shall receive a statement with respect to such Participant's Accounts as of the last day of each calendar quarter. 7.8 - Disputes. -------- (a) Claim. A person who believes that he or she is being denied a benefit to which he or she is entitled under this Plan (hereinafter referred to as "Claimant") may file a written request for such benefit with the Committee, setting forth his or her claim. The request must be addressed to the Committee at the Company's principal place of business. (b) Claim Decision. Upon receipt of a claim, the Committee shall advise the Claimant that a reply will be forthcoming within ninety (90) days and shall, in fact, deliver such reply within such period. The Committee may, however, extend the reply period for an additional ninety (90) days for special circumstances. If the claim is denied in whole or in part, the Committee shall inform the Claimant in writing, using language calculated to be understood by the Claimant, setting forth: (1) the specified reason or reasons for such denial; (2) the specific reference to pertinent provisions of this Plan on which such denial is based; (3) a description of any additional material or information 16 necessary for the Claimant to perfect his or her claim and an explanation why such material or such information is necessary; (4) appropriate information as to the steps to be taken if the Claimant wishes to submit the claim for review; and (5) the time limits for requesting a review under subsection (c). (c) Request for Review. Within sixty (60) days after the receipt by the Claimant of the written opinion described above, the Claimant may request in writing that the Committee review the determination. Such request must be addressed to the Committee, at the Company's principal place of business. The Claimant or his or her duly authorized representative may, but need not, review the pertinent documents and submit issues and comments in writing for consideration by the Committee. If the Claimant does not request a review within such sixty (60) day period, he or she shall be barred and estopped from challenging the original determination. (d) Review of Decision. Within sixty (60) days after the Committee's receipt of a request for review, after considering all materials presented by the Claimant, the Committee will inform the Claimant in writing, in a manner calculated to be understood by the Claimant, of its decision setting forth the specific reasons for the decision and containing specific references to the pertinent provisions of this Plan on which the decision is based. If special circumstances require that the sixty (60) day time period be extended, the Committee will so notify the Claimant and will render the decision as soon as possible, but no later than one hundred twenty (120) days after receipt of the request for review. 17 ARTICLE XIII MISCELLANEOUS 8.1 - Unsecured General Creditor. -------------------------- Participants and their Beneficiaries, heirs, successors, and assigns shall have no legal or equitable rights, claims, or interest in any specific property or assets of the Company. No assets of the Company shall be held under any trust, or held in any way as collateral security for the fulfilling of the obligations of the Company under this Plan. Any and all of the Company's assets shall be, and remain, the general unpledged, unrestricted assets of the Company. The Company's obligation under the Plan shall be merely that of an unfunded and unsecured promise of the Company to pay money in the future, and the rights of the Participants and Beneficiaries shall be no greater than those of unsecured general creditors. It is the intention of the Company that this Plan (and the Trust described in Section 6.7) be unfunded for purposes of the Code. 8.2 - Restriction Against Assignment. ------------------------------ The Company shall pay all amounts payable hereunder only to the person or persons designated by the Plan and not to any other person or corporation. No part of a Participant's Accounts shall be liable for the debts, contracts, or engagements of any Participant, his or her Beneficiary, or successors in interest, nor shall a Participant's Accounts be subject to execution by levy, attachment, or garnishment or by any other legal or equitable proceeding, nor shall any such person have any right to alienate, anticipate, sell, transfer, commute, pledge, encumber, or assign any benefits or payments hereunder in any manner whatsoever. If any Participant, Beneficiary or successor in interest is adjudicated bankrupt or purports to anticipate, alienate, sell, transfer, assign, pledge, encumber or charge any distribution or payment from the Plan, voluntarily or involuntarily, the Committee, in its discretion, may cancel such distribution or payment (or any part thereof) to or for the benefit of such Participant, Beneficiary or successor in interest in such manner as the Committee shall direct. 8.3 - Withholding. ----------- There shall be deducted from each payment made under the Plan or any other compensation payable to the Participant (or Beneficiary) all taxes which are required to be withheld by the Company in respect to such payment or this Plan. The Company shall have the right to reduce any payment (or other compensation) by the amount of cash sufficient to provide the amount of said taxes. 18 8.4 - Amendment, Modification, Suspension or Termination. -------------------------------------------------- The Board of Directors may amend, modify, suspend or terminate the Plan in whole or in part, except that no amendment, modification, suspension or termination shall have any retroactive effect to reduce any amounts allocated to a Participant's Accounts. (Neither the Policies themselves nor the death benefit described in Section 6.6 shall be treated as allocated to Accounts.) 8.5 - Governing Law. ------------- This Plan shall be construed, governed and administered in accordance with the laws of the State of California. 8.6 - Receipt or Release. ------------------ Any payment to a Participant or the Participant's Beneficiary in accordance with the provisions of the Plan shall, to the extent thereof, be in full satisfaction of all claims against the Committee, and the Company. The Committee may require such Participant or Beneficiary, as a condition precedent to such payment, to execute a receipt and release to such effect. 8.7 - Payments on Behalf of Persons Under Incapacity. ---------------------------------------------- In the event that any amount becomes payable under the Plan to a person who, in the sole judgement of the Committee, is considered by reason of physical or mental condition to be unable to give a valid receipt therefor the Committee may direct that such payment be made to any person found by the Committee, in its sole judgement, to have assumed the care of such person. Any payment made pursuant to such determination shall constitute a full release and discharge of the Committee and the Company. 8.8 - Headings, etc. Not Part of Agreement. ------------------------------------ Headings and subheadings in this Plan are inserted for convenience of reference only and are not to be considered in the construction of the provisions hereof. 19 IN WITNESS WHEREOF, the Company, has executed this document this 30th ------ day of March 1999. Varco International, Inc. By: Donald Stichler ---------------------------------- Its: Vice President, Controller-- --------------------------------- Treasurer and Secretary 20 EX-10.28 6 DEFERRED COMPENSATION PLAN EXHIBIT 10.28 Varco International Inc. Deferred Compensation Plan Varco International Inc. Deferred Compensation Plan TABLE OF CONTENTS ----------------- Page ---- ARTICLE I.................................................... 1 1.1 - Title................................................ 1 1.2 - Definitions.......................................... 1 ARTICLE II................................................... 5 2.1 - Participation........................................ 5 ARTICLE III.................................................. 6 3.1 - Elections to Defer Compensation...................... 6 3.2 - Investment Elections................................. 7 ARTICLE IV................................................... 9 4.1 - Deferral Account..................................... 9 4.2 - Employer Contributions Account....................... 10 ARTICLE V.................................................... 11 5.1 - Deferral Account..................................... 11 5.2 - Employer Contributions Account....................... 11 ARTICLE VI................................................... 12 6.1 - Distribution of Deferred Compensation................ 12 6.2 - Forfeitures.......................................... 13 6.3 - Nonscheduled In-Service Withdrawals.................. 13 6.4 - Hardship Withdrawals................................. 14 6.5 - Inability to Locate Participant...................... 14 6.6 - Pre-Retirement Death Benefit......................... 14 6.7 - Trust................................................ 15 ARTICLE VII.................................................. 16 ADMINISTRATION............................................... 16 7.1 - Committee............................................ 16 7.2 - Committee Action..................................... 16 7.3 - Powers and Duties of the Committee................... 16 7.4 - Construction and Interpretation...................... 17 7.5 - Information.......................................... 17 7.6 - Compensation, Expenses and Indemnity................. 17 i 7.7 - Quarterly Statements................................. 18 7.8 - Disputes............................................. 18 ARTICLE XIII................................................. 20 8.1 - Unsecured General Creditor........................... 20 8.2 - Restriction Against Assignment....................... 20 8.3 - Withholding.......................................... 20 8.4 - Amendment, Modification, Suspension or Termination... 21 8.5 - Governing Law........................................ 21 8.6 - Receipt or Release................................... 21 8.7 - Payments on Behalf of Persons Under Incapacity....... 21 8.8 - Headings, etc. Not Part of Agreement................. 21 ii Varco International Inc. Deferred Compensation Plan (Effective as of April 1, 1999) Varco International, Inc. (the "Company") hereby establishes the Varco International Inc. Deferred Compensation Plan (the "Plan"), effective as of April 1, 1999, to provide a tax-deferred capital accumulation opportunity to a select group of management and highly compensated employees through deferral of salary and bonuses. ARTICLE I TITLE AND DEFINITIONS 1.1 - Title. ----- This Plan shall be known as the Varco International Inc. Deferred Compensation Plan. 1.2 - Definitions. ----------- Whenever the following words and phrases are used in this Plan, with the first letter capitalized, they shall have the meanings specified below. "Account" or "Accounts" shall mean a Participant's Deferral Account and/or Employer Contributions Account. "Beneficiary" or "Beneficiaries" shall mean the person or persons, including a trustee, personal representative or other fiduciary, last designated in writing by a Participant in accordance with procedures established by the Committee to receive the benefits specified hereunder (other than those benefits set forth in Section 6.6) in the event of the Participant's death. No beneficiary designation shall become effective until it is filed with the Committee, and no beneficiary designation of someone other than the Participant's spouse shall be effective unless such designation is consented to by the Participant's spouse on a form provided by and in accordance with procedures established by the Committee. If there is no Beneficiary designation in effect, or if there is no surviving designated Beneficiary, then the Participant's surviving spouse shall be the Beneficiary. If there is no surviving spouse to receive any benefits payable in accordance with the preceding sentence, the duly appointed and currently acting personal representative of the participant's estate (which shall include either the Participant's probate estate or living trust) shall be the Beneficiary. In any case where there is no such personal representative of the Participant's estate duly appointed and acting in that capacity within 90 days after the Participant's death (or such extended period as the Committee determines is reasonably 1 necessary to allow such personal representative to be appointed, but not to exceed 180 days after the Participant's death), then Beneficiary shall mean the person or persons who can verify by affidavit or court order to the satisfaction of the Committee that they are legally entitled to receive the benefits specified hereunder. In the event any amount is payable under the Plan to a minor, payment shall not be made to the minor, but instead be paid (a) to that person's living parent(s) to act as custodian, (b) if that person's parents are then divorced, and one parent is the sole custodial parent, to such custodial parent, or (c) if no parent of that person is then living, to a custodian selected by the Committee to hold the funds for the minor under the Uniform Transfers or Gifts to Minors Act in effect in the jurisdiction in which the minor resides. If no parent is living and the Committee decides not to select another custodian to hold the funds for the minor, then payment shall be made to the duly appointed and currently acting guardian of the estate for the minor or, if no guardian of the estate for the minor is duly appointed and currently acting within 60 days after the date the amount becomes payable, payment shall be deposited with the court having jurisdiction over the estate of the minor. "Board of Directors" shall mean the board of directors of the Company. "Bonus" shall mean any cash incentive compensation payable to a Participant in addition to the Participant's Salary after reduction for any salary deferral contributions to a plan described in Section 125 or Section 401(k) of the Code. "Code" shall mean the Internal Revenue Code of 1986, as amended. "Committee" shall mean the Committee appointed by the Board of Directors to administer the Plan in accordance with Article VII. "Company" shall mean Varco International, Inc., any successor corporation and each corporation which is a member of a controlled group of corporations (within the meaning of Section 414(b) of the Code) of which Varco International, Inc. is a member. "Compensation" shall mean the Salary and Bonus that the Participant is entitled to for services rendered to the Company. "Deferral Account" shall mean the bookkeeping account maintained by the Committee for each Participant that is credited with amounts equal to (a) the portion of the Participant's Salary that he or she elects to defer, (b) the portion of the Participant's Bonus that he or she elects to defer, and (c) earnings or losses pursuant to Section 4.1. "Disability" shall mean an incapacity which has rendered the Participant eligible to commence receiving benefits under the Company's long- term disability plan. 2 "Distribution Subaccounts" shall mean subaccounts of a Participant's Deferral Account and Employer Contributions Account established to separately account for deferred Compensation and Employer Contribution Amounts (and earnings thereon) which are subject to different in-service distribution elections. "Earnings Rate" shall mean, for each Fund, an amount equal to the net rate of gain or loss on the assets of such Fund during each month. "Effective Date" shall mean April 1, 1999. "Eligible Employee" shall mean an employee of the Company who is: (a) designated by the Committee to participate in the Plan; and (b) a division or corporate vice president or above. "Employer Contributions Account" shall mean the bookkeeping account maintained by the Committee for each Participant that is credited with an amount equal to the Employer Contribution Amount (if any) and earnings or losses pursuant to Section 4.2. "Employer Contribution Amount" shall mean an amount to equal to a percentage of the amount of Compensation deferred by a Participant or such other amount, which percentage or other amount, if any, shall be determined by the Company, in its sole discretion, and which percentage or amount need not be the same for each Participant. "Fund" or "Funds" shall mean one or more of the investment funds or portfolios selected by the Committee pursuant to Section 3.2(b). "Initial Election Period" for an Eligible Employee shall mean the later of: (a) the thirty-day period ending March 26, 1999; or (b) the thirty- day period following the Eligible Employee's designation by the Committee as an Eligible Employee. "Participant" shall mean any Eligible Employee who elects to defer Compensation in accordance with Section 3.1 and files a completed insurance application form in accordance with Section 2.1. "Payment Eligibility Date" shall mean the first day of the month following the end of the calendar quarter in which a Participant ceases to be employed by the Company, incurs a Disability or dies. "Plan" shall mean the Varco International Inc. Deferred Compensation Plan set forth herein, now in effect, or as amended from time to time. 3 "Plan Year" shall mean the 12 consecutive month period beginning on January 1 and ending December 31, except that the initial Plan Year shall be the period beginning on April 1, 1999 and ending December 31, 1999. "Salary" shall mean the Participant's base salary after reduction for any salary deferral contributions to a plan described in Section 125 or Section 401(k) of the Code. 4 ARTICLE II PARTICIPATION 2.1 - Participation. ------------- (a) Generally. An Eligible Employee shall become a Participant in the ---------- Plan by (1) electing to defer Compensation in accordance with Section 3.1; (2) if required by the Committee, filing a life insurance application form along with his or her deferral election form; and (3) satisfying any medical underwriting requirement established by the Committee. (b) Participants in the Varco Executive Savings Plan. Notwithstanding ------------------------------------------------- the foregoing, an Eligible Employee who is currently participating in the Varco Executive Savings Plan may not become a Participant without completing the "Agreement for Transfer of Policy and Termination of Split-Dollar Life Insurance Agreement" in the form set forth in Exhibit A attached hereto. 5 ARTICLE III DEFERRAL ELECTIONS 3.1 - Elections to Defer Compensation. ------------------------------- (a) Initial Election Period. Subject to Section 2.1, each Eligible ----------------------- Employee may elect to defer Compensation by filing with the Committee an election that conforms to the requirements of this Section 3.1, on a form provided by the Committee, no later than the last day of his or her Initial Election Period. (b) General Rule. Subject to the minimum deferral provisions of ------------ Section 3.1(c) below, the amount of Compensation which an Eligible Employee may elect to defer is as follows: (1) Any percentage of Salary up to 100%; and/or (2) Any percentage or dollar amount of Bonus up to 100%; provided, however, that no election shall be effective to reduce the Compensation paid to an Eligible Employee for a calendar year to an amount which is less than the sum of: (a) the amount that the Company is required to withhold from such Eligible Employee's Compensation for such calendar year for purposes of federal, state and local (if any) income tax and employment tax (including Federal Insurance Contributions Act (FICA) tax withholding); and (b) the amount that the Company is required to withhold from such Eligible Employee's Compensation for such calendar year for contributions to any employee benefit plan (other than this Plan). (c) Minimum Deferrals. For each Plan Year during which an Eligible ----------------- Employee is a Participant, the minimum amount that may be elected under Section 3.1(b) is $5,000. This $5,000 minimum deferral for any Plan Year may be met by a combination of deferrals of Salary and/or Bonus for the Plan Year. If the Compensation which the Participant has elected to defer for a Plan Year includes a percentage of the Bonus payable in such Plan Year and the actual amount of such Bonus to be deferred, when combined with the percentage of Salary elected to be deferred for the Plan Year, is less than $5,000 for the Plan Year, then no portion of such Bonus shall be deferred under this Plan, no further Salary shall be deferred for such Plan Year and any Salary previously deferred for such Plan Year shall be refunded to the Participant without interest. (d) Effect of Initial Election. An election to defer Compensation -------------------------- during the Initial Election Period shall be effective with respect to (1) Salary earned during the first pay 6 period beginning after the Initial Election Period and each subsequent pay period beginning in the same Plan Year and (2) to the Bonus paid with respect to services performed in the Plan Year for which the election is made. (e) Elections other than Elections during the Initial Election Period. ----------------------------------------------------------------- Subject to the requirement for filing a completed life insurance form pursuant to Section 2.1, any Eligible Employee may participate for any Plan Year by filing an election, on a form provided by the Committee, to defer Compensation as described in paragraph (b) above. An election to defer Compensation for a Plan Year (other than the Plan Year beginning April 1, 1999) must be filed on or before November 30 of the preceding Plan Year and will be effective for Salary and Bonus earned during pay periods beginning on or after the following January 1. Each such election shall designate the time at which such deferred Compensation (and allocable earnings) shall be distributed to the Participant in accordance with Article VI of this Plan. (f) In-service Distributions. At the time of making an election to ------------------------ defer Compensation for a Plan Year pursuant to this Section 3.1, a Participant may elect to receive an in-service distribution of the amount deferred under such election, together with any Employer Contribution Amounts for the same Plan Year and earnings credited with respect to such amounts pursuant to Article IV, in a lump sum in any year beginning after the second anniversary of the last day of the Plan Year in which the amount deferred was earned. A Participant may subsequently elect to defer the year of such an in-service distribution to any subsequent year by filing a written election with the Committee, on a form provided by the Committee, at least one year prior to the first day of the previously elected in-service distribution year. The election to defer the year of an in-service distribution may be made no more than twice. (g) Irrevocability. Any election filed pursuant to this Section 3.1 -------------- shall be irrevocable except to the extent provided in subsection (f) hereof and Section 6.3. 3.2 - Investment Elections. -------------------- (a) At the time of making the deferral elections described in Section 3.1, the Participant shall designate, on a form provided by the Committee, which of the types of investment funds or portfolios selected by the Committee the Participant's Accounts will be deemed to be invested in for purposes of determining the amount of earnings to be credited to each Account. (b) In making the designation pursuant to this Section 3.2, the Participant must specify, in whole numbers, the percentage of his Deferral Account and Employer Contributions Account which shall be deemed to be invested in one or more of the types of investment funds or 7 portfolios. Effective as of the end of any month, a Participant may change the designation made under this Section 3.2 by filing an election, on a form provided by the Committee. If a Participant fails to elect a type of investment fund or portfolio under this Section 3.2, he or she shall be deemed to have elected the Money Market option. (c) Although the Participant may designate the type of investment ---- funds or portfolios, the Committee shall select from time to time, in its sole discretion, commercially available investment funds or portfolios to be the Funds. The Earnings Rate of each such commercially available investment fund or portfolio shall be used to determine the amount of earnings or losses to be credited to Participants' Accounts under Article IV. 8 ARTICLE IV ACCOUNTS 4.1 - Deferral Account. ---------------- The Committee shall establish and maintain a Deferral Account for each Participant under the Plan. For each Participant who makes one or more in- service distribution elections pursuant to Section 3.1(f), the Deferral Account shall be divided into two or more Distribution Subaccounts as necessary to separately account for deferrals which are payable at different times. A Participant's Deferral Account shall be divided (or each Distribution Subaccount of a Participant's Deferral Account shall be further divided) into separate subaccounts ("investment subaccounts"), each of which corresponds to an investment fund or portfolio elected by the Participant pursuant to Section 3.2(a). A Participant's Deferral Account shall be credited as follows: (a) As of the last day of each month, the Committee shall credit the investment subaccounts of the Deferral Account (or the appropriate Distribution Subaccount of the Participant's Deferral Account) with an amount equal to Salary deferred by the Participant during each pay period ending in that month in accordance with the Participant's election under Section 3.2(a); that is, the portion of the Participant's deferred Salary that the Participant has elected to be deemed to be invested in a certain type of investment fund or portfolio shall be credited to the investment subaccount corresponding to that investment fund or portfolio; (b) As of the last day of the month in which the Bonus or partial Bonus would have been paid, the Committee shall credit the investment subaccounts of the Deferral Account (or the appropriate Distribution Subaccount of the Participant's Deferral Account) with an amount equal to the portion of the Bonus deferred by the Participant in accordance with Participant's election under Section 3.2(a); that is, the portion of the Participant's deferred Bonus that the Participant has elected to be deemed to be invested in a particular type of investment fund or portfolio shall be credited to the investment subaccount corresponding to that investment fund or portfolio; and (c) As of the last day of each month, each investment subaccount of a Participant's Deferral Account (or Distribution Subaccount of the Participant's Deferral Account) shall be credited with earnings or losses in an amount equal to that determined by multiplying the balance credited to such investment subaccount 9 as of the last day of the preceding month by the Earnings Rate for the corresponding Fund selected by the Committee pursuant to Section 3.2(b). 4.2 - Employer Contributions Account. ------------------------------ The Committee shall establish and maintain an Employer Contributions Account for each Participant under the Plan. For each Participant who makes one or more in-service distribution elections pursuant to Section 3.1(f), the Participant's Employer Contributions Account shall be divided into two or more Distribution Subaccounts as necessary to separately account for Employer Contribution Amounts which are payable at different times. A Participant's Employer Contributions Account shall be divided (or each Distribution Subaccount of a Participant's Employer Contributions Account shall be further divided) into separate investment subaccounts corresponding to the investment fund or portfolio elected by the Participant pursuant to Section 3.2(a). A Participant's Employer Contributions Account shall be credited as follows: (a) As of the last day of any month or Plan Year for which the Company, in its sole discretion, decides to credit a Participant with an Employer Contribution Amount, the Committee shall credit the investment subaccounts of the Employer Contributions Account (or the appropriate Distribution Subaccount of the Participant's Employer Contributions Account) with an amount equal to the Employer Contribution Amount applicable to that Participant in accordance with the Participant's election under Section 3.2(a); that is, the portion of the Participant's Employer Contribution Amount which the Participant elected to be deemed to be invested in a certain type of investment fund or portfolio shall be credited to the corresponding investment subaccount; and (b) As of the last day of each month, each investment subaccount of the Employer Contributions Account (or the appropriate Distribution Subaccount of the Participant's Employer Contributions Account) shall be credited with earnings or losses in an amount equal to that determined by multiplying the balance credited to such investment subaccount as of the last day of the preceding month by the Earnings Rate for the corresponding Fund selected by the Committee pursuant to Section 3.2(b). 10 ARTICLE V VESTING 5.1 - Deferral Account. ---------------- A Participant's Deferral Account shall be 100% vested at all times. 5.2 - Employer Contributions Account. ------------------------------ (a) A Participant's Employer Contributions Account shall vest at a rate determined by the Company for each Participant. Each Participant's vesting schedule shall be set forth in a separate letter agreement between the Participant and the Company. (b) Notwithstanding anything contained herein to the contrary, the Committee may, in its sole discretion, provide for 100% vesting of a Participant's Employer Contributions Account at any time. 11 ARTICLE VI DISTRIBUTIONS 6.1 - Distribution of Deferred Compensation. ------------------------------------- (a) Distribution of the vested amount credited to a Distribution Subaccount of the Participant's Deferral Account and Employer Contribution Account which was established with respect to an in-service distribution election shall be made in a lump sum payment during January of the year elected by the Participant pursuant to Section 3.1(f), provided that the Participant is employed by the Company on January 1 of such year. In the event the Participant's employment with the Company is terminated for any reason prior to January 1 of the year elected by the Participant pursuant to Section 3.1(f), the Participant's in-service distribution election(s) with respect to benefits not yet distributed shall no longer be effective and all of the vested amounts credited to his or her Deferral Account and Employer Contributions Account shall be distributed together as set forth in the following subsections of this Section 6.1. (b) In the event a Participant terminates employment for a reason other than death, the amount credited to his or her Deferral Account and the vested portion of the amount, if any, credited to his or her Employer Contributions Account shall be distributed in a lump sum payment payable as soon as practicable following his or her Payment Eligibility Date. Notwithstanding the foregoing, a Participant may elect to receive distribution in 20, 40, or 60 substantially equal quarterly installments beginning as soon as practicable following the Participant's Payment Eligibility Date, provided that his or her election is filed with the Committee at least one year prior to his or her termination of employment on a form to be provided by the Committee. Notwithstanding anything contained herein to the contrary, in the event that the sum of the amount credited to a Participant's Deferral Account and the vested portion of the amount, if any, credited to his or her Employer Contributions Account is $25,000 or less, such amount shall be paid in a cash lump sum payment as soon as practicable following his or her Payment Eligibility Date. (c) In the event a Participant terminates employment because of death, the amount credited to his or her Deferral Account and the vested and unvested portion of the amount, if any, credited to his or her Employer Contributions Account shall be paid to his or her Beneficiary in the form of a cash lump sum payment as soon as practicable following the Participant's Payment Eligibility Date. 12 (d) The Participant's Accounts shall continue to be credited monthly with earnings pursuant to Sections 4.1 and 4.2 of the Plan until all amounts credited to his or her Accounts under the Plan have been distributed. (e) In the event that a former Participant dies while receiving installment payments under this Plan, any remaining installments shall be paid to the Participant's Beneficiary as such installments would have otherwise been due to the Participant. 6.2 - Forfeitures. ------------ When a Participant (or, in the case of his or her death, the Participant's Beneficiary) receives a distribution of benefits under this Plan (regardless of whether such payment is a lump sum payment or the first installment payment), the portion of his or her Employer Contributions Account, if any, which is not vested shall be forfeited, and the Company shall have no obligation to the Participant (or Beneficiary) with respect to such forfeited amount. 6.3 - Nonscheduled In-Service Withdrawals. ----------------------------------- At any time prior to his or her termination of employment from the Company, a Participant may elect to withdraw an amount not in excess of 90% of the amount credited to his or her Deferral Account and 90% of the vested portion of the amount, if any, credited to his or her Employer Contributions Account, subject to a withdrawal penalty described below. The Participant may make such an election by filing a written notice with the Committee on a form provided by the Committee. Within 90 days following the Committee's receipt of such notice, an amount equal to the sum of the amount that the Participant has elected to withdraw from the Participant's Deferral Account and the amount that the Participant has elected to withdraw from his or her Employer Contributions Account shall be paid to the Participant in a cash lump sum payment. Upon the payment of such withdrawal, (a) an amount equal to 11.11% of the amount withdrawn from the Participant's Deferral Account and 11.11% of the amount withdrawn from the Participant's Employer Contributions Account shall be forfeited, (b) the Participant shall cease to participate in the Plan for the remainder of the Plan Year in which the withdrawal occurs and shall be ineligible to participate during the Plan Year immediately following the Plan Year in which the withdrawal occurs, and (c) any deferral elections made by the Participant for such periods shall be terminated. A Participant may not make more than two withdrawals under this Section 6.3. 13 6.4 - Hardship Withdrawals. -------------------- At any time prior to his or her termination of employment from the Company, a Participant may request a distribution for hardship without penalty. Such distribution for hardship shall be subject to approval by the Committee and may be made only to the extent necessary to satisfy the hardship. A distribution for hardship shall be granted only for one of the following reasons: (a) A Participant's or dependent's illness or accident; (b) Casualty loss with respect to a Participant's property; or (c) Other circumstances arising out of events beyond the control of the Participant, which the Committee finds are similar to the events described in Section 6.4(a) or (b). 6.5 - Inability to Locate Participant. ------------------------------- In the event that the Committee is unable to locate a Participant or Beneficiary within two years following the Participant's Payment Eligibility Date, the amounts allocated to the Participant's Deferral Account and Employer Contributions Account shall be forfeited. If, after such forfeiture, the Participant or Beneficiary later claims such benefits, such benefits shall be reinstated without interest or earnings, provided that Section 6.2 shall still apply. 6.6 - Pre-Retirement Death Benefit. ---------------------------- (a) If a Participant dies while employed by the Company, in addition to the payment or payments to the Participant's Beneficiary under Section 6.1(c), a death benefit shall be paid to the Participant's beneficiary under a life insurance policy purchased by or transferred to the trustee of the Trust described in Section 6.7 to insure the life of the Participant (the "Policy"). The death benefit payable to the Participant's beneficiary shall be $300,000. (b) The Participant shall have the right to designate and change such beneficiary (which need not be his or her Beneficiary under this Plan) at any time on a form provided by and filed with the insurance company. If no such form is on file with the insurance company, the death benefit described in the preceding paragraph shall be paid to the Beneficiary. (c) The death benefit payable pursuant to paragraph (a) shall not be paid if an insurance company has not issued a Policy on the life of the Participant at the time of his death and shall be subject to all conditions and exceptions set forth in the Policy and split dollar life 14 insurance agreement in effect between the Participant and the Trustee of the Trust, described in Section 6.7 below. (d) Notwithstanding any provision of this Plan or any other document to the contrary, the pre-retirement death benefit provided under Section 6.6(a) shall be payable solely from the proceeds of the Policy, if any. In addition, no Policy shall be allocated to any Account. (e) Notwithstanding the foregoing, if a Participant dies while employed by the Company, but has a zero balance in his or her Deferral Account and no vested interest in his or her Employer Contributions Account due to distributions under Sections 6.1(a), 6.3, or 6.4, he or she will not be eligible for the death benefit described in Section 6.6(a). 6.7 - Trust. ----- (a) The Company shall cause the payment of benefits under this Plan (excluding the amounts described in Section 6.6) to be made in whole or in part by the Trustee of the Varco International Inc. Deferred Compensation Plan Trust (the "Trust") in accordance with the provisions of this Section 6.7. The Company shall contribute to the Trust for each Participant an amount equal to the amount deferred by the Participant for the Plan Year and the Employer Contribution Amount for the Participant for the Plan Year, if any; the contributions shall be made no later than the Company's tax return due date for that Plan Year. Notwithstanding the foregoing, the Company shall contribute at least an amount equal to the "cost of insurance" (as defined in each Policy) for the death benefits described in Section 6.6 for each Participant, provided that such obligation shall not apply with respect to a Policy if the Participant is no longer employed by the Company. (b) The Committee shall direct the Trustee to pay the Participant or his or her Beneficiary at the time and in the amount described in Article VI (excluding amounts described in Section 6.6). In the event the amounts held under the Trust are not sufficient to provide the full amount (excluding amounts described in Section 6.6) payable to the participant or his or her Beneficiary, the Company shall pay the remainder of such amount at the time(s) set forth in Article VI. 15 ARTICLE VII ADMINISTRATION 7.1 - Committee. --------- A committee shall be appointed by, and serve at the pleasure of, the Board of Directors. The number of members comprising the Committee shall be determined by the Board of Directors which may from time to time vary the number of members, provided, however, that the Director of Human Resources for the Company and the Chief Financial Officer of the Company shall be members of the Committee. A member of the Committee may resign by delivering a written notice of resignation to the Board of Directors. The Board of Directors may remove any member by delivering a letter signed by each director notifying such member of his or her removal. Vacancies in the membership of the Committee shall be filled promptly by the Board of Directors. 7.2 - Committee Action. ---------------- The Committee shall act at meetings by affirmative vote of a majority of the members of the Committee. Any action permitted to be taken at a meeting may be taken without a meeting if, prior to such action, a written consent to the action is signed by all members of the Committee and such written consent is filed with the minutes of the proceedings of the Committee. A member of the Committee shall not vote or act upon any matter which relates solely to himself or herself as a Participant. The Chairman or any other member or members of the Committee designated by the Chairman may execute any certificate or other written direction on behalf of the Committee. 7.3 - Powers and Duties of the Committee. ---------------------------------- (a) The Committee, on behalf of the Participants and their Beneficiaries, shall enforce the Plan in accordance with its terms, shall be charged with the general administration of the Plan, and shall have all powers necessary to accomplish its purposes, including, but not by way of limitation, the following: (1) To select the funds or portfolios to be the Funds in accordance with Section 3.2(b) hereof; (2) To construe and interpret the terms and provisions of this Plan; 16 (3) To compute and certify to the amount and kind of benefits payable to Participants and their Beneficiaries; (4) To maintain all records that may be necessary for the administration of the Plan; (5) To provide for the disclosure of all information and the filing or provision of all reports and statements to Participants, Beneficiaries or governmental agencies as shall be required by law; (6) To make and publish such rules for the regulation of the Plan and procedures for the administration of the Plan as are not inconsistent with the terms hereof; and (7) To appoint a plan administrator or any other agent, and to delegate to them such powers and duties in connection with the administration of the Plan as the Committee may from time to time prescribe. 7.4 - Construction and Interpretation. ------------------------------- The Committee shall have full discretion to construe and interpret the terms and provisions of this Plan, which interpretation or construction shall be final and binding on all parties, including but not limited to the Company and any Participant or Beneficiary. The Committee shall administer such terms and provisions in a uniform and nondiscriminatory manner and in full accordance with any and all laws applicable to the Plan. 7.5 - Information. ----------- To enable the Committee to perform its functions, the Company shall supply full and timely information to the Committee on all matters relating to the Compensation of all Participants, their death or other cause of termination, and such other pertinent facts as the Committee may require. 7.6 - Compensation, Expenses and Indemnity. ------------------------------------ (a) The members of the Committee shall serve without compensation for their services hereunder. 17 (b) The Committee is authorized at the expense of the Company to employ such legal counsel as it may deem advisable to assist in the performance of its duties hereunder. Expenses and fees in connection with the administration of the Plan shall be paid by the Company. (c) To the extent permitted by applicable state law, the Company shall indemnify and save harmless the Committee and each member thereof, the Board of Directors and each member thereof, and delegates of the Committee who are employees of the Company against any and all expenses, liabilities and claims, including legal fees to defend against such liabilities and claims arising out of their discharge in good faith of responsibilities under or incident to the Plan, other than expenses and liabilities arising out of willful misconduct. This indemnity shall not preclude such further indemnities as may be available under insurance purchased by the Company or provided by the Company under any bylaw, agreement or otherwise, as such indemnities are permitted under state law. 7.7 - Quarterly Statements. -------------------- Under procedures established by the Committee, a Participant shall receive a statement with respect to such Participant's Accounts as of the last day of each calendar quarter. 7.8 - Disputes. -------- (a) Claim. A person who believes that he or she is being denied a benefit to which he or she is entitled under this Plan (hereinafter referred to as "Claimant") may file a written request for such benefit with the Committee, setting forth his or her claim. The request must be addressed to the Committee at the Company's principal place of business. (b) Claim Decision. Upon receipt of a claim, the Committee shall advise the Claimant that a reply will be forthcoming within ninety (90) days and shall, in fact, deliver such reply within such period. The Committee may, however, extend the reply period for an additional ninety (90) days for special circumstances. If the claim is denied in whole or in part, the Committee shall inform the Claimant in writing, using language calculated to be understood by the Claimant, setting forth: (1) the specified reason or reasons for such denial; (2) the specific reference to pertinent provisions of this Plan on which such denial is based; (3) a description of any additional material or information 18 necessary for the Claimant to perfect his or her claim and an explanation why such material or such information is necessary; (4) appropriate information as to the steps to be taken if the Claimant wishes to submit the claim for review; and (5) the time limits for requesting a review under subsection (c). (c) Request for Review. Within sixty (60) days after the receipt by the Claimant of the written opinion described above, the Claimant may request in writing that the Committee review the determination. Such request must be addressed to the Committee, at the Company's principal place of business. The Claimant or his or her duly authorized representative may, but need not, review the pertinent documents and submit issues and comments in writing for consideration by the Committee. If the Claimant does not request a review within such sixty (60) day period, he or she shall be barred and estopped from challenging the original determination. (d) Review of Decision. Within sixty (60) days after the Committee's receipt of a request for review, after considering all materials presented by the Claimant, the Committee will inform the Claimant in writing, in a manner calculated to be understood by the Claimant, of its decision setting forth the specific reasons for the decision and containing specific references to the pertinent provisions of this Plan on which the decision is based. If special circumstances require that the sixty (60) day time period be extended, the Committee will so notify the Claimant and will render the decision as soon as possible, but no later than one hundred twenty (120) days after receipt of the request for review. 19 ARTICLE XIII MISCELLANEOUS 8.1 - Unsecured General Creditor. -------------------------- Participants and their Beneficiaries, heirs, successors, and assigns shall have no legal or equitable rights, claims, or interest in any specific property or assets of the Company. No assets of the Company shall be held under any trust, or held in any way as collateral security for the fulfilling of the obligations of the Company under this Plan. Any and all of the Company's assets shall be, and remain, the general unpledged, unrestricted assets of the Company. The Company's obligation under the Plan shall be merely that of an unfunded and unsecured promise of the Company to pay money in the future, and the rights of the Participants and Beneficiaries shall be no greater than those of unsecured general creditors. It is the intention of the Company that this Plan (and the Trust described in Section 6.7) be unfunded for purposes of the Code and for purposes of Title I of ERISA. 8.2 - Restriction Against Assignment. ------------------------------ The Company shall pay all amounts payable hereunder only to the person or persons designated by the Plan and not to any other person or corporation. No part of a Participant's Accounts shall be liable for the debts, contracts, or engagements of any Participant, his or her Beneficiary, or successors in interest, nor shall a Participant's Accounts be subject to execution by levy, attachment, or garnishment or by any other legal or equitable proceeding, nor shall any such person have any right to alienate, anticipate, sell, transfer, commute, pledge, encumber, or assign any benefits or payments hereunder in any manner whatsoever. If any Participant, Beneficiary or successor in interest is adjudicated bankrupt or purports to anticipate, alienate, sell, transfer, assign, pledge, encumber or charge any distribution or payment from the Plan, voluntarily or involuntarily, the Committee, in its discretion, may cancel such distribution or payment (or any part thereof) to or for the benefit of such Participant, Beneficiary or successor in interest in such manner as the Committee shall direct. 8.3 - Withholding. ----------- There shall be deducted from each payment made under the Plan or any other compensation payable to the Participant (or Beneficiary) all taxes which are required to be withheld by the Company in respect to such payment or this Plan. The Company shall have the right to reduce any payment (or other compensation) by the amount of cash sufficient to provide the amount of said taxes. 20 8.4 - Amendment, Modification, Suspension or Termination. -------------------------------------------------- The Board of Directors may amend, modify, suspend or terminate the Plan in whole or in part, except that no amendment, modification, suspension or termination shall have any retroactive effect to reduce any amounts allocated to a Participant's Accounts. (Neither the Policies themselves nor the death benefit described in Section 6.6 shall be treated as allocated to Accounts.) 8.5 - Governing Law. ------------- This Plan shall be construed, governed and administered in accordance with the laws of the State of California. 8.6 - Receipt or Release. ------------------ Any payment to a Participant or the Participant's Beneficiary in accordance with the provisions of the Plan shall, to the extent thereof, be in full satisfaction of all claims against the Committee, and the Company. The Committee may require such Participant or Beneficiary, as a condition precedent to such payment, to execute a receipt and release to such effect. 8.7 - Payments on Behalf of Persons Under Incapacity. ---------------------------------------------- In the event that any amount becomes payable under the Plan to a person who, in the sole judgement of the Committee, is considered by reason of physical or mental condition to be unable to give a valid receipt therefor the Committee may direct that such payment be made to any person found by the Committee, in its sole judgement, to have assumed the care of such person. Any payment made pursuant to such determination shall constitute a full release and discharge of the Committee and the Company. 8.8 - Headings, etc. Not Part of Agreement. ------------------------------------ Headings and subheadings in this Plan are inserted for convenience of reference only and are not to be considered in the construction of the provisions hereof. 21 IN WITNESS WHEREOF, the Company, has executed this document this 30th day of March, 1999. - -------- Varco International, Inc. By: Donald L. Stichler ------------------------------------- Its: Vice President, Controller-- ------------------------------------ Treasurer and Secretary 22 EX-11 7 COMPUTATION OF PER SHARE EARNINGS VARCO INTERNATIONAL, INC. Statement Re Computation of Per Share Earnings Exhibit 11 1 of 2
Three Months Ended Twelve Months Ended December 31, 1999 December 31, 1999 ---------------------------------------- A. CALCULATION OF ADJUSTED EARNINGS Net Income After Tax $ 3,737,000 $36,965,000 Total Number Average Number Stock Option Shares Used Number of of Shares after of Shares Equivalent To Calculate Days Weighing Outstanding Shares Diluted EPS ------------------------------------------------------------------------------- B. CALCULATION OF AVERAGE SHARES OUTSTANDING Common Stock Outstanding from time-to-time during: Three Months Ended December 31, 1999 92 6,008,003,328 65,304,384 802,277 66,106,661 Twelve Months Ended December 31, 1999 365 23,741,706,609 65,045,772 833,207 65,878,979 C. CALCULATION OF EARNINGS PER SHARE Income Per Share = Net Income After Tax ---------------------------------------- Average Shares Outstanding Diluted Income Per Share = Three Months Ended December 31, 1999 3,737,000 = $0.06 ------------- 66,106,661 Twelve Months Ended December 31, 1999 36,965,000 = $0.56 ------------- 65,878,979 Basic Income Per Share Three Months Ended December 31, 1999 3,737,000 = $0.06 ------------- 65,304,384 Twelve Months Ended December 31, 1999 36,965,000 = $0.57 ------------- 65,045,772
VARCO INTERNATIONAL, INC. Statement Re Computation of Per Share Earnings Exhibit 11 Page 2 of 2
Three Months Ended Twelve Months Ended December 31 1998 December 31 1998 ----------------------------------------- A. CALCULATION OF ADJUSTED EARNINGS Net Income After Tax $10,660,000 $60,338,000 Total Number Average Number Stock Option Shares Used Number of of Shares after of Shares Equivalent To Calculate Days Weighing Outstanding Shares Diluted EPS ---------------------------------------------------------------------------------- B. CALCULATION OF AVERAGE SHARES OUTSTANDING Common Stock Outstanding from time-to-time during: Three Months Ended December 31, 1998 92 5,946,770,493 64,638,810 703,460 65,342,270 Twelve Months Ended December 31, 1998 365 23,524,467,433 64,450,596 1,143,823 65,594,419 C. CALCULATION OF EARNINGS PER SHARE Income Per Share = Net Income After Tax ------------------------------------- Total Shares Outstanding Diluted Income Per Share = Three Months Ended December 31, 1998 10,660,000 = 0.16 ------------- 65,342,270 Twelve Months Ended December 31, 1998 60,338,000 = 0.92 ------------- 65,594,419 Basic Income Per Share Three Months Ended December 31, 1998 10,660,000 = 0.16 ------------- 64,638,810 Twelve Months Ended December 31, 1998 60,338,000 = 0.94 ------------- 64,450,596
EX-12 8 COMPUTATIONS OF RATIOS EXHIBIT 12 VARCO INTERNATIONAL, INC. STATEMENT RE COMPUTATIONS OF RATIOS ($000'S)
1999 1998 1997 -------------------------------------------- Ratio of Earnings to Fixed Charges - ---------------------------------- Earnings: Pretax Income $57,946 $91,157 $76,696 Plus: Interest Expense 745 1,823 3,510 Amortization of Debt Issuance Costs 102 154 154 -------------------------------------------- Total $58,793 $93,134 $80,360 ============================================ Fixed Charges: Interest Expense $ 745 $ 1,823 $ 3,510 Amortization of Debt Issuance Costs 102 154 154 -------------------------------------------- Total $ 847 $ 1,977 $ 3,664 ============================================ Ratio of Earnings to Fixed Charges 69.41 47.11 21.93
EX-13 9 VARCO 1999 ANNUAL REPORT EXHIBIT 13 Varco International, Inc. 1999 Annual Report consolidated financial and operating highlights (in thousands, except per share data & employees) Year ended December 31,
1999 1998 1997 1996 1995 - ------------------------------------------------------------------------------------------------------------------ Revenues $592,752 $740,979 $545,789 $368,422 $273,731 Net income 36,965 60,338 49,875 24,542 14,439 Diluted income per share .56 .92 .76 .38 .23 Net income as a percent of revenues 6.2% 8.1% 9.1% 6.7% 5.3% Shares used in computing diluted income per share 65,879 65,594 65,201 63,463 63,145 Shareholders' equity $360,748 $319,367 $253,199 $195,508 $151,179 Return on average shareholders' equity 10.8% 21.8% 22.7% 14.2% 9.2% Capital expenditures $ 12,820 $ 35,269 $ 35,121 $ 11,023 $ 10,517 Number of employees 1,906 2,951 2,852 1,936 1,636
For unaudited selected quarterly financial data see note i of Notes to Consolidated Financial Statements. Varco enters the year 2000 as the leading supplier of drilling equipment in the world. In recent years more than 50 rigs have been added to the offshore fleet, among them the most technologically advanced, automated offshore drilling rigs in the industry's history. 3 Varco has been the leading supplier of drilling equipment for these rigs with the leading market position in the majority of its product lines. Why? Varco is advancing the technology of drilling, and drillers and their oil company customers are seeing the results. [COMPOSITE PHOTO OF DRILLSHIP APPEARS HERE] 4 We strive to develop products and systems that reduce drilling time, reduce drilling crews and improve drilling efficiency - enhancing the safety and productivity of the drilling process. [COMPOSITE PHOTO OF RIG EQUIPMENT APPEARS HERE] 7 With the new rigs working, our opportunity is to bring Varco's new level of productive automation to the large number of existing drilling rigs operating around the world. 8 Our strategy is working to our shareholders, customers and employees: Despite a strong and steady increase in oil prices during 1999, market conditions for the oil service industry remained depressed. With oil prices having fallen to $12-$13 per barrel early in the year the OPEC members, together with certain non-OPEC producers, agreed to additional substantial cuts in oil production. That action, together with gradually increasing demand, caused oil prices to increase throughout the year, to an average of approximately $24.56 per barrel in the fourth quarter, and a high of slightly above $30 per barrel in mid-February of 2000. However, oil companies continued to exercise restraint in exploration and production spending, and worldwide drilling activity increased only modestly from the historical lows reached during late 1998 and early 1999. The impact of this weak market on Varco is most clearly reflected in a sharp decline in incoming orders as our primary customers, the offshore drilling contractors, experienced reduced rig utilization and lower dayrates. Our revenues were not as severely impacted, since we entered 1999 with a relatively large order backlog as a result of very strong order bookings during the previous two years. Financial Results Net Income for 1999 was $37.0 million, $.56 per share (diluted), on Revenues of $592.8 million, including a pre-tax net special charge of $4.6 million, $.05 per share (diluted), for severance and other expenses related to further downsizing in the first half of 2000. For the prior year, Revenues were $741.0 million and Net Income was $60.3 million, $.92 per share (diluted), including a special charge of $8.5 million, $.09 per share (diluted). Our already strong financial condition improved further during 1999, as we generated $45.5 million in free cash flow, resulting in a debt-free balance sheet, with $77.9 million in cash and short-term investments at year-end. Reflecting the weak market, order bookings for the year totaled $305.4 million (excluding cancellations of $19.3 million), as compared to $757.4 million (excluding cancellations of $118.0 million) in 1998. Backlog at December 31 was $63.8 million, a level roughly commensurate with the current business level, as virtually all of the equipment ordered during the rig construction cycle of 1997-98 has been delivered. Consequently, we anticipate that Revenues will be more closely tied to the incoming order rate during the coming quarters. [COMPOSITE PHOTO OF GLOBAL LOCATIONS APPEARS HERE] Varco International, Inc. and Subsidiaries 11 Market Position and Strategy Over the past three years the industry has been engaged in an ambitious program of offshore rig construction, particularly floating rigs capable of drilling in very deep water. Upon its completion, some 50 semi-submersibles and drillships will have been added to the fleet, most of which employ key elements of Varco's newer technology drilling equipment, including automated pipe handling systems, computer-based rig control systems, and the latest Top Drive Drilling Systems. The breadth of products Varco has supplied to these rigs, coupled with our high market share, affirms our position as the leading worldwide supplier of drilling equipment. Additionally, as these rigs are placed in operation and the benefits of this technology are demonstrated, we believe the opportunities to retrofit existing rigs with equipment of this type will be significantly increased. With many of these new rigs beginning to drill exploratory wells in the Gulf of Mexico, as well as offshore West Africa and Brazil, numerous hydrocarbon discoveries are beginning to highlight the potential of deepwater fields. Ultimately, the development of these fields is likely to require additional rigs with deepwater capability. Our long-term strategy continues to be centered around the development of new products which enhance the productivity of the drilling process. The recently built rigs afford the opportunity to showcase the benefits those products can provide, thereby creating future growth potential for Varco. Market Outlook The primary determinant of the overall health of the oil service industry is the level of spending for exploration and production ("E&P") on the part of major oil companies and independent oil and gas producers. Despite higher oil prices, E&P spending declined approximately 18 percent during 1999 as caution prevailed. However, Salomon Smith Barney's Annual Survey of Worldwide Exploration and Production Expenditures for 2000 projects a recovery, with spending expected to increase 11 percent. Importantly, these plans are based on an assumed oil price of approximately $19 per barrel, indicating that although current oil prices are not generally viewed as sustainable, a more moderate price scenario appears sufficient to stimulate an improved industry environment. Thus, it appears likely that our market will strengthen over the next few quarters. We believe that any such improvement, coupled with the continuing quest of oil companies to improve drilling efficiency and reduce costs, affords us the opportunity to take full advantage of our capabilities. 12 Varco International, Inc. and Subsidiaries [PHOTO OF GEORGE BOYADJIEFF APPEARS HERE] The Decade Past and Future In our report to you for 1990 we concluded by stating, "The anticipation of continued market improvement, together with our success in developing and acquiring new products, makes us confident that the decade of the 1990's will be the best ever for Varco." While the market improvement was less than we anticipated, and was certainly more uneven, we feel justified in concluding that the past decade was the best in the Company's 91-year history. 1999 Revenues were up 567 percent from those of 10 years ago, an annualized growth rate of 21 percent. Net Income for 1999 increased 1,380 percent from that of 10 years ago. As indicated elsewhere in this report, our stated goal of becoming "the premier supplier of drilling equipment worldwide" has been achieved. As we look to continued growth and accomplishment in the next decade, we expect it will be even better. On February 17, 2000, the Board of Directors elected Michael W. Sutherlin as President and Chief Operating Officer. Before joining the Corporate staff in July of last year, Mike was President of the Varco BJ Division for more than ten years. Mike has over 25 years with Varco, in both finance and operations, and we look forward to his broadened impact on the Company in his new role. Additionally, the Board elected Wallace K. (Wally) Chan as Chief Financial Officer. Wally has been Vice President-Finance of the Varco Systems Division since joining the Company seven years ago, and is replacing Richard A. (Dick) Kertson, Varco's Chief Financial Officer for the past 15 years, who is retiring. Dick has been an important part of our success over that period as Revenues have grown tenfold, and he leaves with the Company in excellent financial condition. Many of our shareholders consider Dick to be one of the best Chief Financial Officers in the oil service segment of the industry. We have been fortunate to have his services for these many years and will miss him and wish him well. We appreciate your continuing support. /s/ George Boyadjieff George Boyadjieff Chairman and Chief Executive Officer February 24, 2000 Varco International, Inc. and Subsidiaries 13 Operations industry conditions The collapse of oil prices in 1998 continued to depress worldwide drilling activity during 1999 despite a dramatic increase in oil prices during the final three quarters of the year and generally favorable natural gas prices throughout the year. Oil prices were lingering in the $12-$13 per barrel range when the OPEC members agreed in March of 1999 to additional production quota reductions of approximately 1.7 million barrels per day. That agreement increased to approximately 4.8 million barrels per day the total reductions which they, together with certain non-OPEC producers, had implemented over a twelve-month period. With the participants exhibiting more discipline in adhering to these quotas than has generally been true in the past, oil prices increased sharply, averaging approximately $17.65, $21.73 and $24.56 over the final three quarters of the year. Natural gas prices, which did not decline as severely during 1998, were modestly higher during 1999, averaging approximately $2.15 per thousand cubic feet versus approximately $2.05 in the prior year. Despite significantly higher oil prices, oil company spending for 1999 was lower than originally projected. Salomon Smith Barney's 1999 Annual Survey of Worldwide Oil and Gas Exploration and Production Expenditures had projected a decline of eleven percent; actual spending fell by an estimated 18 percent. As a result, the total worldwide rig count reached a historic annual low, averaging 1,457 for the year, 21 percent below the prior year average and 31 percent below that of 1997. Offshore rig utilization averaged approximately 75 percent, the lowest since 1989, following three consecutive years above 90 percent. International and offshore drilling, which typically generate more revenue per active rig than other markets, were particularly weak, magnifying the adverse effect on the oil service industry. Although the U.S. and Canadian markets demonstrated improvement in the second half of the year, with rig counts rising above the comparable year-earlier totals, the international rig count remained below that of 1998 throughout the year, and worldwide offshore drilling activity likewise remained below the prior year level. Varco International, Inc. and Subsidiaries 15 Although the average U.S. rig count for 1999 was down 25 percent from 1998, it was above the prior year level during the fourth quarter, due to increased natural gas drilling. Similarly, while the average Canadian rig count in 1999 was five percent below the prior year average, it also rose above that level in the second half. However, the international rig count remained below the 1998 level throughout the year and reflected an average decline of 22 percent. The average number of offshore rigs under contract worldwide during 1999 was down approximately ten percent. In summary, drilling activity was generally very weak throughout 1999, and a modest improvement during the final months of the year in the U.S. and Canada was "too little, too late". The outlook for the oil service industry is more positive than a year ago as oil company spending is expected to increase. However, uncertainty continues as the discrepancy between commodity prices and drilling activity has rarely been as pronounced as it is today. The Salomon Smith Barney Survey for 2000 projects an 11 percent increase in exploration and production spending, which would put it at a level similar to that of 1996. Significantly, the average oil price assumption of the companies surveyed is $19.08 per barrel for 2000, well below the current price, indicating that the oil companies do not view current oil prices as sustainable. Perhaps the potential exists for a more aggressive turnaround if oil prices remain above expectations. In the oil service industry it seems that the duration of any trend is frequently short and reversals are often abrupt. products and markets Varco International is the foremost supplier of drilling equipment in the world today, as evidenced by our leading market position in providing equipment for the new offshore rigs-jackups, semisubmersibles, drillships and fixed platforms- that have been added to the rig fleet over the past few years. Together, Varco's product lines represent approximately 75-80 percent of the total dollar value of all drilling equipment on a typical offshore rig-more than any other single supplier. Varco has the largest market share in the majority of these product lines, and the second largest in virtually all of the others. Varco's most noteworthy product is the Top Drive Drilling System ("TDS"), which was developed and introduced approximately 15 years ago. The TDS provides the power and torque that turns the drill stem during drilling operations, and it has replaced the traditional rotary table method on virtually all offshore rigs. Varco remains the market share leader in supplying the TDS to offshore rigs. Approximately ten years ago Varco introduced automation to the drilling rig with the Pipe Handling Machine ("PHM"). The PHM provides complete remote control 16 Varco International, Inc. and Subsidiaries of the pipe racking function, including connecting and disconnecting stands of pipe, as well as vertically racking pipe as it is removed from, or placed into, the well. Virtually all recently built offshore rigs incorporate automated pipe racking, and Varco's PHM and its derivatives (known collectively as "Pipe Racking Systems" or "PRS's") have the leading market position. More recently, Varco has developed companion products called Pipe Deck Handling Systems. When not required for operations, pipe is stored horizontally on the pipe deck. Pipe Deck Handling Systems mechanize and automate the handling of pipe on the pipe deck and its transfer to the rig floor. Although traditional pipe deck handling methods, which Varco does not provide, are still widely used, the acceptance of mechanization makes Varco the leading supplier of pipe deck handling solutions today. Top Drive Drilling Systems and automated pipe handling products are designed and sold by the Varco Systems Division. The original Varco product line consisted of rig floor tools and equipment, generally referred to as Rotary or Pipe Handling Tools, including slips, elevators, spinning wrenches and casing handling equipment. Today, many of these tools have been mechanized, permitting remote operation. They may be integrated with other components of automated pipe handling systems, or may be used as stand-alone tools to reduce manual effort on rigs which are not fully automated. Varco, through its Varco BJ Division, retains a dominant market position in Pipe Handling Tools. As noted previously, use of the TDS replaces the traditional rotary table for normal drilling; however, it is still used in certain ancillary rig operations. Varco BJ provides a limited use "rotary table" specifically designed for such functions. Through the Shaffer Division, Varco designs and sells pressure control equipment, primarily Blowout Preventers ("BOP's") and the control systems that enable their remote activation. With respect to the new offshore rig construction market, Shaffer and its primary competitor share the top two market positions. Floating rigs, such as semisubmersibles and drillships, are used for drilling in deeper water and require certain drilling equipment not used on jackups or fixed platform rigs. This includes: the "riser string", large diameter pipe connecting the rig to the well on the ocean floor; riser tensioners, devices which hold the riser string in tension; and a motion compensator, equipment designed to offset the heave caused by wind and waves. Each of these products is supplied by the Shaffer Division, which holds the number one market share in motion compensators and riser tensioners and the number two position in the sale of riser pipe. Drilling control systems are used to operate the various pieces of equipment that comprise the drilling rig. Varco's M/D Totco Division has developed the Varco Integrated Control and Information System ("V-ICIS"), a computer-based system which controls the operation of the automated rig components as well as providing drilling information which can be employed to enhance drilling efficiency. Using V-ICIS, rig personnel control all drilling VArco International, Inc. and Subsidiaries 19 functions from an environmentally secure cabin, using touch-screen graphic displays. Thus, rig personnel are removed from the potentially hazardous environment of the rig floor and are presented with information which helps optimize drilling parameters and avoid potential problems. Varco, through its M/D Totco Division, has the leading market position in drilling controls. The Rigtech Division provides solids control equipment, which is used to remove cuttings from drilling fluid ("mud") so that it can be recirculated during drilling operations. Rigtech today has a relatively small share of the worldwide solids control market. Three classifications of drilling equipment that Varco has not historically provided are: mud pumps, which circulate drilling fluid; the drawworks, which provide the rig's hoisting capability; and the rig structure or "derrick", including integral equipment such as the crown block and traveling block. Varco has recently introduced and begun marketing an automated drawworks, but does not participate in the market for the other two products. Land rigs generally use the same types of equipment as offshore rigs, excluding that specifically associated with floating rigs. However, land drilling is typically less rigorous and complex, and the dollar value of equipment used on a typical land rig is only 20 to 30 percent of that of an offshore rig. Therefore, Varco's principal market is offshore drilling although its equipment is frequently used on land rigs as well. Varco has a 25-year history of developing tools and equipment to enhance the safety and productivity of the drilling process. That capability has been significantly expanded over the past ten years through a number of acquisitions which have broadened the Varco product line, and today Varco is the worldwide leader in supplying modern drilling equipment. financial review Revenues for 1999 were $592.8 million, 20 percent below the $741.0 million for 1998, but somewhat above the $545.8 million for 1997. Reflecting the weak market conditions during 1999, incoming orders totaled $305.4 million (excluding cancellations of $19.3 million), the lowest level since 1995, and well below the $757.4 million (excluding cancellations of $118.0 million) and $820.9 million booked in 1998 and 1997, respectively. As a result of the sharply reduced order rate, backlog declined to $63.8 million at year-end, from $367.4 million at December 31, 1998. In response to the market decline, the Company continued to aggressively reduce its cost base during 1999. As a result, Selling, General and Administrative expenses were 22 percent below the 1998 level, and Research and Development costs were down 17 percent. Total employment at December 31, 1999 was 35 percent below the year-earlier level. In spite of these actions, financial results for the year were somewhat disappointing. The weaker 20 Varco International, Inc. and Subsidiaries market activity resulted in lower Revenue from "base" business (such as spare parts, service and repair) while the delivery of large capital equipment orders from backlog, together with the installation and start-up expenses for this equipment, somewhat limited the pace of the cost reductions. Gross margins for 1999 were below the 1998 level, primarily as a result of (1) lower than average margins on several of the Company's newer products; (2) a less favorable product mix, primarily a decline in higher margin rental revenue and an increased percentage of revenue from the Shaffer Division products, which generally carry lower margins than the average across the Company; and (3) the impact of fixed manufacturing costs at reduced volume levels. As a result, Operating Profit margins (earnings before interest, taxes, and special charge) declined to 10.3 percent, from 13.6 percent in 1998 and 14.6 percent in 1997. Cash Flow Return on Investment, defined as Operating Profit plus Depreciation and Amortization as a percent of Average Net Investment (Shareholders' Equity plus Debt less Cash), and considered by the Company to be a very meaningful measure of overall financial performance, was 27 percent for 1999. Although well below the 45 and 42 percent rates achieved during 1998 and 1997, respectively, that result is within the range considered by the Company to be good performance. Net Income for 1999 totaled $37.0 million, $.56 per share (diluted), including the special charge described below. Excluding such charge, Net Income was $39.9 million, $.61 per share (diluted). 1998 results, which also included a special charge, reflected Net Income of $60.3 million, $.92 per share (diluted); or $66.0 million, $1.01 per share (diluted) excluding the special charge. Net Income for 1997 was $49.9 million, $.76 per share (diluted). In the fourth quarter of 1999 the Company recorded a net special charge of $4.6 million for severance and other expenses which it expects to incur in the first half of 2000 as it continues to reduce its cost structure consistent with current market conditions. In the fourth quarter of 1998 the Company took a similar charge of $8.5 million. Cash generation was a particularly strong point of 1999 financial performance, as free cash flow was $45.5 million. Cash and short-term investments totaled $77.9 million at December 31, 1999, and the Balance Sheet was debt-free. [PHOTOS OF OFFSHORE DRILLING RIGS APPEARS HERE] Varco International, Inc. and Subsidiaries 23 [CHARTS APPEARS HERE]
Revenues $ millions 1995 273731 1996 368422 1997 545789 1998 740979 1999 592752
net income $ millions 1995 14439 1996 24542 1997 49875 1998 60338 1999 36965
income per share diluted dollars 1995 0.23 1996 0.38 1997 0.76 1998 0.92 1999 0.56
total assets $ millions 1995 246571 1996 316021 1997 471129 1998 546920 1999 459685
shareholders' equity $ millions 1995 151179 1996 195508 1997 253199 1998 319367 1999 360748
return on average equity percent 1995 9.2 1996 14.2 1997 22.7 1998 21.8 1999 10.8
r&d expense $ millions 1995 13156 1996 14331 1997 21084 1998 34567 1999 28782
return on revenues percent 1995 5.3 1996 6.7 1997 9.1 1998 8.1 1999 6.2
number of employees 1995 1636 1996 1936 1997 2852 1998 2951 1999 1906
[PHOTOS OF OFFSHORE DRILLING RIGS APPEARS HERE] 24 Varco International, Inc. and Subsidiaries five-year financial and operating highlights
(in thousands, except per share amounts and employees) Year ended December 31, 1999 1998 1997 1996 1995 - ----------------------------------------------------------------------------------------------------------- Summary of Operations Revenues $592,752 $740,979 $545,789 $368,422 $273,731 Gross profit 174,274 239,032 196,969 125,816 99,214 Research and development 28,782 34,567 21,084 14,331 13,156 Selling, general and administrative expenses 85,266 109,079 96,398 70,891 61,014 Special charge 4,560 8,500 Interest expense 745 1,823 3,683 3,948 4,516 Income before income taxes 57,946 91,157 76,696 38,088 21,908 Income taxes 20,981 30,819 26,821 13,546 7,469 Net income 36,965 60,338 49,875 24,542 14,439 As a percent of revenues 6.2% 8.1% 9.1% 6.7% 5.3% Return on average shareholders' equity 10.8% 21.8% 22.7% 14.2% 9.2% Per share of Common Stock Basic income $.57 $.94 $.78 $.39 $.23 Diluted income .56 .92 .76 .38 .23 Book value 5.52 4.94 3.95 3.09 2.51 =========================================================================================================== Year-end financial position Working capital $216,853 $176,299 $137,477 $120,246 $89,187 Current ratio 3.6 1.8 1.7 2.4 2.5 Property plant and equipment - net 84,332 89,997 73,862 48,711 45,260 Total assets 459,685 546,920 471,129 316,021 246,571 Long-term debt 9,845 22,715 29,539 Shareholders' equity 360,748 319,367 253,199 195,508 151,179 Long-term debt as percent of total capitalization 0.0% 0.0% 3.6% 10.4% 16.3% =========================================================================================================== Other Capital expenditures $ 12,820 $ 35,269 $ 35,121 $ 11,023 $ 10,517 Depreciation and amortization 23,049 22,121 16,971 13,249 12,347 Number of employees 1,906 2,951 2,852 1,936 1,636 Average shares used in computing basic income per share(1) 65,046 64,451 63,650 62,181 62,610 Average shares used in computing diluted income per share(1) 65,879 65,594 65,201 63,463 63,145 ===========================================================================================================
(1) The income per share amounts prior to 1997 have been restated, as required, to comply with Statement of Financial Account Standard No. 128, Earnings per Share, and the number of shares used in those calculations have been adjusted to give effect to the Company's 1997 two-for-one stock split. See notes to consolidated financial statements. 26 Varco International, Inc. and Subsidiaries management report of financial responsibilities The management of Varco International, Inc. is responsible for the preparation and integrity of the accompanying consolidated financial statements and other financial information contained in this Annual Report. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles and include amounts that are based on management's informed judgments and estimates. In fulfilling its responsibilities for the integrity of financial information, management maintains and relies on the Company's system of internal control. This system includes a program of financial and operational reviews by a professional corporate staff and the independent auditors. The system is designed to provide reasonable assurance that assets are safeguarded, transactions are executed in accordance with management's authorization and accounting records are reliable as a basis for the preparation of the consolidated financial statements. Management believes that, as of December 31, 1999, the Company's internal control system provides reasonable assurance that material errors or irregularities will be prevented or detected within a timely period and is cost effective. The Board of Directors, through its Audit Committee composed solely of non-employee directors, reviews the Company's financial reporting and accounting practices. The Audit Committee recommends to the Board of Directors the selection of independent auditors and reviews their fee arrangements. It meets periodically with the independent auditors and management to review the financial statements of the Company and to review the work of each and the propriety of the discharge of their responsibilities. The independent auditors have full and free access to the Audit Committee, without management present, to discuss auditing and financial reporting matters. /s/ George Boyadjieff /s/ Richard A. Kertson George Boyadjieff Richard A. Kertson Chairman and Chief Executive Officer Vice President - Finance and Chief Financial Officer February 8, 2000 Varce International, Inc. and Subsidiaries 27 management's discussion and analysis of financial condition and results of operations Background The business of the Company depends primarily upon the level of worldwide drilling activity, particularly offshore drilling activity. The level of drilling activity can be influenced by numerous factors, including the prices of oil and gas, economic and political conditions, discovery and development costs of oil companies, oil company's exploration and production spending, development of alternative energy sources, availability of equipment and materials, availability of new onshore and offshore acreage or concessions, and new and continued governmental regulations regarding environmental protection, taxation, price controls and product allocations. Beginning in late 1997 oil and gas prices began to weaken, particularly the price of oil. The weakness continued through 1998 as the price of oil averaged approximately $14.40 as compared to $20.60 per barrel for 1997. During the early months of 1999 the price of oil remained weak, averaging $13.07 for the first quarter. Beginning in March of 1999 the price of oil began a trend upward averaging approximately $17.65, $21.73 and $24.56 for the last three quarters of 1999. Natural gas prices have not fluctuated as dramatically as the price of oil. The price of natural gas averaged approximately $2.50 per thousand cubic feet for 1997 as compared to $2.04 in 1998 and $2.15 for 1999. Commodity prices have continued their upward trend in 2000. The recent price of oil has been as high as $30 per barrel and the price of gas as high as $2.65 per thousand cubic feet. During 1997, these commodity prices resulted in improved profits and cash flows for oil companies. Due in part to these stronger financial results, oil companies increased exploration and production expenditures, leading to increased drilling activity in 1997. Conversely, the declining commodity prices beginning in late 1997 led to lower cash flows for the oil companies and a reduction in exploration and production expenditures, leading to declining drilling activity. Despite the increasing commodity prices, oil companies' exploration and production expenditures in 1999 were below the 1998 level and drilling activity remained depressed. The Company's orders and revenues have been negatively impacted by the decline in worldwide drilling activity which reached historically low levels in the second quarter of 1999. Rig counts, as reported by industry sources, for each of the past three years are summarized in the following table:
1999 1998 1997 ------------------------------------------------------------------------ Approximate Average Annual Rig Count: Worldwide average rig count 1,457 1,843 2,126 United States & Canada average rig count 869 1,088 1,317 International average rig count 588 755 809 Approximate average number of offshore rigs under contract 500 555 606
Although drilling activity began to recover somewhat toward the end of 1999, the average rig count for 1999 represented the lowest in modern history and was down 21% and 31% from the average levels of 1998 and 1997, respectively. The worldwide average rig count for the fourth quarter of 1999 was approximately 1,682. During 1997 worldwide utilization of offshore rigs (rigs under contract as a percent of available rigs) increased, driven both by increased demand and by a continually shrinking supply of available offshore rigs. The utilization rate was 94% for the year 1997, resulting in increased dayrates and longer contract periods, particularly among the "premium" offshore rigs. This resulted in increased cash flow for the Company's major customers, the drilling contractors, and in the construction of more than 50 offshore rigs during the years 1997 to 1999. Both the average number of offshore rigs under contract and the utilization rates began to decline in the second quarter of 1998 and have continued to decline until recently. During 1999 the offshore utilization rate declined to a low of approximately 69% and recovered to a rate of approximately 75% during the month of December. [PHOTOS OF DRILLING EQUIPMENT APPEARS HERE] 28 Varco International, Inc. and Subsidiaries Results of Operations The Company operates principally in the oil and gas well drilling equipment segment of the oilfield service industry. Set forth below are the annual orders for the Company's five Divisions which serve this segment. (in thousands) 1999 1998 1997 ------------------------------------------------------------------------ Orders Varco Systems $ 98,379 $ 258,494 $ 287,435 Varco BJ 45,187 94,968 99,379 M/D Totco 51,335 110,647 100,602 Shaffer 97,470 273,626 311,052 Rigtech 13,051 19,621 22,452 Cancellations (19,347) (117,953) ------------------------------------------------------------------------ Total $ 286,075 $ 639,403 $ 820,920 ======================================================================== Orders declined $353.3 million, 55%, in 1999 as compared to 1998 and declined $181.5 million, 22%, in 1998 as compared to 1997. These declines are primarily the result of the reduction in, and cancellation of, orders associated with upgrading and construction of offshore drilling rigs. The cancellations in 1999 and 1998 were primarily due to customers' terminating the construction of certain offshore drilling rigs and cancelling the related equipment orders. Of the total cancellations, approximately $84.0 million were incurred by Shaffer and $35.6 million by Varco Systems with the balance distributed among the remaining Divisions. Beginning in the second half of 1998, new orders were also negatively impacted at all Divisions by the decline in overall drilling activity. M/D Totco's 1998 increase in orders was due to sales of its new drilling rig control system, "V-ICIS," which was introduced in 1997. During 1999, the quarterly order rate (excluding cancellations) declined to a low of $63.2 million in the second quarter, and improved to $81.8 million and $88.1 million in the third and fourth quarters, respectively. The higher level of orders in 1997, as compared to 1999 and 1998, was primarily due to orders associated with upgrading and construction of offshore drilling rigs, particularly floating rigs that are capable of drilling in water depths exceeding 3,000 feet. Each such rig creates significant potential for the high dollar value products provided by the Shaffer and Varco Systems Divisions. Set forth below are the annual revenues for the Company's five Divisions. (in thousands) 1999 1998 1997 ------------------------------------------------------------- Revenues Varco Systems $ 200,556 $ 266,776 $ 165,510 Varco BJ 66,006 95,959 68,931 M/D Totco 69,540 94,639 90,601 Shaffer 237,036 256,238 206,483 Rigtech 16,589 21,273 13,372 ------------------------------------------------------------- Total $ 589,727 $ 734,885 $ 544,897 ------------------------------------------------------------- The Company's revenues declined by $145.2 million, 20%, in 1999 as compared to 1998. The revenue decreases, except at M/D Totco, in 1999 were generally due to lower shipments of equipment for upgrading, conversion and new construction of offshore drilling rigs and, to a lesser degree, the decline in drilling activity. The lower revenues at M/D Totco were due to the decline in overall drilling activity, particularly in the U.S. and Canada. The Company's revenues increased by $190.0 million, 35%, in 1998 as compared to 1997, with the Shaffer and Varco Systems Divisions accounting for $151.0 million of this increase. Approximately 85% of the increase at each of these Divisions was due to the delivery of equipment for offshore rig upgrades and construction, and the remainder was due to increased sales of spare and replacement parts. Substantially all of the increases at the other Divisions are due to the delivery of equipment for offshore rig upgrades and construction. [PHOTOS OF DRILLING EQUIPMENT APPEARS HERE] Varco International, Inc. and Subsidiaries 29 The Company's backlog of unshipped orders was $63.8 million at December 31, 1999, as compared to $367.4 million at December 31, 1998 and $462.9 million at December 31, 1997. The Company expects that substantially all of the backlog will be shipped by December 31, 2000. At December 31, 1999, the Company had received $7.8 million in customer cash deposits related to orders included in backlog. In accordance with industry practice, orders and commitments generally are cancellable by customers at any time. The 1999 other income primarily consists of interest income. The increase in other income for 1998 as compared to 1997 is attributable to cancellation fees due for expenses and costs incurred prior to the cancellation of orders. Gross profit margins (net sales and rental income less costs of sales and rental income) as a percentage of net sales and rental income for the Company were 29.6% for 1999, 32.5% for 1998 and 36.2% for 1997. The gross margins in 1999 were negatively impacted by (1) high initial costs on newer products at M/D Totco, Rigtech, and Shaffer and retrofit costs on certain new products at Shaffer; (2) the combined product mix impact of a decline in rental income (which carries a higher gross margin than other revenues) and the increase in the proportion of Shaffer revenues to other revenues (Shaffer products carry lower gross margins than other Divisions' products); and (3) higher manufacturing costs and increased manufacturing inefficiencies. New product and retrofit costs accounted for approximately 1.2% of the margin decline and approximately 1.0% was due to the combined product mix impact. 1998 gross margins were negatively impacted by high initial costs and retrofit costs on newer products at Shaffer,M/D Totco and Rigtech; higher manufacturing costs and increased manufacturing inefficiencies at all Divisions related to the increase in volume; and the decline in rental revenue. New products and retrofit costs accounted for approximately 2.3% of the 3.7% gross margin decline from 1997; higher manufacturing costs and inefficiencies accounted for approximately 1.0%; and lower rental income accounted for the balance. The Company believes that new product development is significant to the future growth of the Company. Research and development expenses were $28.8 million, $34.6 million and $21.1 million for the years 1999, 1998 and 1997, respectively, and represented 4.9%, 4.7% and 3.9% of revenue, respectively, for those years. The Company expects that research and development expenses will continue at approximately 4.0% to 5.0% of revenue in 2000. Selling, general and administrative expenses were $85.3 million in 1999 (14.4% of revenues) as compared to $109.1 million in 1998 (14.7% of revenues) and $96.4 million (17.7% of revenues) in 1997. The decrease in 1999 expenses is primarily from the reduction in employment related costs; conversely; the increase in 1998 as compared to 1997 resulted primarily from increases in employment related costs. Due to the lower anticipated revenues in 2000, the Company expects that selling, general and administrative expenses as a percent of revenue will be higher than the preceding rates. At December 31, 1999, overall Company employment was 1,906 (including 42 temporary employees) as compared to 2,951 (including 155 temporary employees) at December 31, 1998, and as compared to 2,852 (including 415 temporary employees) at December 31, 1997. During the fourth quarter of 1999, the Company adopted a plan to further reduce the cost structure of all of its Divisions, consistent with current market conditions, and recognized a $5.7 million special charge consisting primarily of cash severance costs for 528 employees. The Company spent $1.9 million of this charge in the fourth quarter of 1999 and expects to spend substantially all of the remaining cost in the first half of 2000. This special charge was reduced by the unused portion of the 1998 special charge, $1.1 million. In 1998 the Company recognized an $8.5 million special charge consisting of the following: severance for 1,100 employees of $6.1 million; a non-cash write-off of rental equipment of $1.5 million; and an allowance for abandoned leases and other obligations of $900 thousand. The Company spent $5.9 million of the cash portion of this charge. In connection with the 1999 restructure plan, the Company discontinued the 1998 plan and $1.1 million of the 1998 special charge was used to reduce the 1999 special charge. The Company's effective income tax rate was 36.2% in 1999 as compared to 33.8% in 1998 and 35.0% in 1997. The higher effective income tax rate in 1999 as compared to 1997 is primarily due to a lower tax benefit from sales through the Company's Foreign Sales Corporation. The lower effective income tax rate in 1998 as compared to both 1999 and 1997 resulted from the elimination in 1998 of the Company's valuation allowance on deferred tax assets. The Company now believes that it is more likely than not that all of its deferred tax assets will be realized. Liquidity and Capital Resources At December 31, 1999, the Company had cash and cash equivalents and short-term investments of $77.9 million as compared to $29.1 million at December 31, 1998. During 1999, the Company generated $62.8 million from operations, invested $12.8 million in property, plant and equipment and paid down debt by $10.0 million. 30 Varco International, Inc. and Subsidiaries On June 27, 1997, the Company entered into a seven-year unsecured revolving credit agreement with three banks (the "Credit Agreement"). The Credit Agreement provides for a credit facility of $65.0 million, inclusive of a $20.0 million letter of credit sub-facility. The maximum available under the Credit Agreement is reduced in equal quarterly amounts over the last four years of the Credit Agreement. Proceeds from the initial advances were used to repay borrowings under a previous credit agreement and for the June 30, 1997 principal and interest payment on the Senior Notes. At December 31, 1999, there were no advances outstanding and $4.4 million in letters of credit outstanding under this facility. The Credit Agreement restricts the payment of dividends (other than dividends payable solely in shares of Common Stock) on, and repurchases of, Common Stock. Under the terms of the Credit Agreement, the amount available for the payment of dividends on, and repurchases of, Common Stock is limited to $5.0 million plus 25% of the Company's consolidated net income arising after June 30, 1997, computed on a cumulative basis. At December 31, 1999, the amount available for dividends and repurchases under the Credit Agreement was $37.3 million. Working capital was $216.9 million at December 31, 1999, compared to $176.3 million at December 31, 1998. The Company's current ratio has increased from 1.8 to 1.0 at December 31, 1998 to 3.6 to 1.0 at December 31, 1999. The increase in working capital is primarily due to the cash generated from operations, resulting in higher cash and cash equivalents at December 31, 1999. In addition, working capital and the current ratio is favorably impacted by the reduction in customer deposits due to shipment of equipment for new rigs. At December 31, 1999, the Company had no long-term debt. Capital expenditures were $12.8 million in 1999 and $35.3 million in 1998. These capital expenditures were primarily for the purchase of an office and service facility and additional machine tools. The Company expects that its 2000 capital expenditures will be the same or lower than 1999 expenditures. The Company believes that its December 31, 1999 cash and cash equivalents, short-term investments and its credit facility will be sufficient to meet its capital expenditures, cash portion of the special charge, and its operating cash needs. Quantitative and Qualitative Market Risk Disclosure The Company is exposed to certain market risks which are inherent in the Company's financial instruments and which arise from transactions entered into in the normal course of business. The Company does not consider these risks significant, and the Company does not enter into derivative financial instrument transactions to offset these risks. Borrowings under the Company's revolving credit facility do not give rise to significant interest rate risks because these borrowings have a variable interest rate. The Company had no fixed interest rate debt at December 31, 1999. Foreign currency exposures, due to rate fluctuations, are minimized by the Company's using natural hedges. Year 2000 Compliance The Year 2000 Issue is the result of computer programs that use only two digits to identify a year rather than four. If not corrected, computer applications could fail or create erroneous results before, during and after the Year 2000. The Company has not experienced any significant impact from the Year 2000 Issue from its products, internal business systems, or facility systems or from third- party suppliers and customers. The Company did not separately track internal cost incurred on the Year 2000 Issue. The Company has estimated that approximately 15% of its Information Technology personnel's time was spent on the Year 2000 Issue. The Company estimates that it paid less than $1.5 million to third parties for software, hardware and consultation. Cautionary Statement Pursuant to the Private Securities Litigation Reform Act of 1995 In accordance with the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995, the Company notes that the statements in this Annual Report, which are forward-looking and which provide other than historical information, involve risks and uncertainties that may impact the Company's results of operations. These forward-looking statements include, among others, statements concerning the Company's general business strategies, customer orders and cancellations, backlog, operating trends, industry trends, the prices of oil and gas, manufacturing capacity, expectations for funding capital expenditures and operations in future periods and plans, and objectives. The Company also continues to face many risks and uncertainties including: changes in the prices of oil and natural gas, changes in capital spending by companies in the oil and gas industry for exploration, development and equipment, potential excess capacities, competitive pressures, technological and structural changes in the industry, litigation and environmental laws. The risks and uncertainties inherent in these forward- looking statements could cause actual results to differ materially from those expressed in or implied by these statements. Varco International, Inc. and Subsidiaries 31 consolidated balance sheets (dollars in thousands) December 31,
1999 1998 - ----------------------------------------------------------------------------------- assets Current Assets Cash and cash equivalents $ 72,606 $ 29,138 Short-term investments 5,253 Receivables - principally trade, less allowances for doubtful accounts of $2,954 (1999) and $3,351 (1998) 140,399 179,241 Inventories - note b 67,811 152,412 Deferred tax assets - note d 7,085 15,244 Assets held for sale 1,951 7,717 Prepaid expenses 4,924 6,639 - ----------------------------------------------------------------------------------- Total Current Assets 300,029 390,391 Property, plant and equipment - at cost, less accumulated depreciation - note c 84,332 89,997 Rental equipment - at cost, less accumulated depreciation 12,107 11,440 Cost in excess of net assets acquired, less accumulated amortization of $9,616 (1999) and $8,534 (1998) 32,229 33,511 Other assets - notes a & b 30,988 21,581 - ----------------------------------------------------------------------------------- Total Assets $459,685 $546,920 =================================================================================== liabilities and shareholders' equity Current Liabilities Accounts payable - principally trade $ 29,643 $ 45,969 Accrued payroll and related costs 18,426 22,351 Other accrued liabilities 14,803 16,679 Customer deposits 7,836 95,766 Accrued warranty 7,034 7,558 Accrued special charge - note a 3,785 6,588 Taxes payable 1,649 9,233 Current portion of long-term debt - note e 9,948 - ----------------------------------------------------------------------------------- Total Current Liabilities 83,176 214,092 Postretirement obligations - note h 6,898 6,813 Other non-current liabilities 8,863 6,648 - ----------------------------------------------------------------------------------- Total Liabilities 98,937 227,553 Shareholders' Equity - notes a, e & f Preferred Stock: 10,000,000 shares authorized, none issued and outstanding Common Stock: 120,000,000 shares authorized, 65,334,082 (1999) and 64,642,326 (1998) issued and outstanding, stated value 55,702 55,011 Additional paid-in capital 106,184 102,062 Other comprehensive income 281 678 Retained earnings 198,581 161,616 - ----------------------------------------------------------------------------------- Total Shareholders' Equity 360,748 319,367 Commitments and contingencies - note g Total Liabilities and Shareholders' Equity $459,685 $546,920 ===================================================================================
See notes to consolidated financial statements. 32 Varco International, Inc. and Subsidiaries consolidated statements of income (in thousands, except per share data) Year Ended December 31,
1999 1998 1997 - ---------------------------------------------------------------------------------- Revenues Net sales $ 568,024 $ 699,966 $ 500,067 Rental income 21,703 34,919 44,830 Other income 3,025 6,094 892 - ---------------------------------------------------------------------------------- 592,752 740,979 545,789 Costs and expenses Cost of sales 407,645 484,165 334,729 Cost of rental income 7,808 11,688 13,199 Selling, general and administrative expenses 85,266 109,079 96,398 Research and development costs 28,782 34,567 21,084 Special charge - note a 4,560 8,500 Interest expense 745 1,823 3,683 - ---------------------------------------------------------------------------------- 534,806 649,822 469,093 - ---------------------------------------------------------------------------------- Income before income taxes 57,946 91,157 76,696 Income taxes - note d 20,981 30,819 26,821 - ----------------------------------------------- ---------------------------------- Net income $ 36,965 $ 60,338 $ 49,875 ================================================================================== Basic income per share $ .57 $ .94 $ .78 ================================================================================== Shares used in computing basic income per share . 65,046 64,451 63,650 ================================================================================== Diluted income per share $ .56 $ .92 $ .76 ================================================================================== Shares used in computing diluted income per share 65,879 65,594 65,201 ==================================================================================
See notes to consolidated financial statements. Varco International, Inc. and Subdiaries 33 consolidated statements of shareholders' equity (in thousands) Year ended December 31, 1999, 1998 and 1997
Accumulated Common Stock Additional Other Com- Issued and Outstanding Paid-in prehensive Retained ---------------------- Shares Amount Capital Income Earnings Total - --------------------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1996 63,199 $ 53,567 $ 89,966 $ 572 $ 51,403 $ 195,508 Comprehensive income Net income 49,875 49,875 Foreign currency translation adjustment 127 127 - --------------------------------------------------------------------------------------------------------------------------------- Comprehensive income 50,002 Common Stock issuances 973 973 6,716 7,689 - --------------------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1997 64,172 54,540 96,682 699 101,278 253,199 - --------------------------------------------------------------------------------------------------------------------------------- Comprehensive income Net income 60,338 60,338 Foreign currency translation adjustment (21) (21) - --------------------------------------------------------------------------------------------------------------------------------- Comprehensive income 60,317 Common Stock issuances 471 471 5,380 5,851 - --------------------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1998 64,643 55,011 102,062 678 161,616 319,367 - --------------------------------------------------------------------------------------------------------------------------------- Comprehensive income Net income 36,965 36,965 Foreign currency translation adjustment (438) (438) Unrealized gains on investments 41 41 - --------------------------------------------------------------------------------------------------------------------------------- Comprehensive income 36,568 Common Stock issuances 691 691 4,122 4,813 - --------------------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1999 65,334 $ 55,702 $ 106,184 $ 281 $ 198,581 $ 360,748 =================================================================================================================================
See notes to consolidated financial statements. 34 Varco International, Inc. and Subsidiaries consolidated statements of cash flows (in thousands) Year ended December 31,
1999 1998 1997 - ------------------------------------------------------------------------------------------------------------------------------- Operating Activities Net income $ 36,965 $ 60,338 $ 49,875 Items included in net income not requiring (providing) cash: Depreciation 20,483 19,875 14,760 Amortization 2,566 2,246 2,211 Deferred income taxes 8,159 (6,681) (3,371) Write-off of rental equipment 1,500 Other 1,627 2,744 2,170 Changes in operating assets and liabilities: Receivables 38,842 (36,917) (47,164) Inventories 84,601 (20,441) (40,098) Additions to rental equipment (6,544) (3,295) (11,494) Prepaids 1,715 (1,966) (516) Accounts payable (16,326) (7,425) 15,579 Customer deposits (87,930) 16,698 76,372 Accrued liabilities (5,203) 9,161 5,009 Accrued payroll (3,925) (16) 8,970 Taxes payable (7,584) 359 3,021 Other (4,600) (4,961) 1,986 - ------------------------------------------------------------------------------------------------------------------------------- Net Cash from Operating Activities 62,846 31,219 77,310 Investing Activities Property, plant and equipment purchases (12,820) (35,269) (35,121) Proceeds from equipment sales 5,470 306 1,280 Purchases of investments (5,253) - ------------------------------------------------------------------------------------------------------------------------------- Net Cash (used in) Investing Activities (12,603) (34,963) (33,841) Financing Activities Proceeds from line of credit 4,000 61,000 124,500 Payments on long-term debt and line of credit (14,000) (71,000) (137,500) Proceeds from issuance of Common Stock 3,225 3,055 3,914 Deferred issue costs (350) - ------------------------------------------------------------------------------------------------------------------------------- Net Cash (used in) Financing Activities (6,775) (6,945) (9,436) Net increase (decrease) in cash and cash equivalents 43,468 (10,689) 34,033 Cash and cash equivalents at beginning of year 29,138 39,827 5,794 - ------------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 72,606 $ 29,138 $ 39,827 ===============================================================================================================================
See notes to consolidated financial statements. Varco International, Inc. and Subsidiaries 35 notes to consolidated financial statements note a. summary of significant accounting policies Description of Business Varco International, Inc. and its subsidiaries (the "Company") are engaged in the design, manufacture, sale and rental of tools, equipment and instrumentation used primarily in the worldwide oil and gas well drilling equipment segment of the oil service industry. The Company operates through five Divisions: Varco Systems, whose products include integrated systems for rotating and handling pipe on a drilling rig; Varco BJ, whose products include pipe handling tools, hoisting equipment and rotary equipment; M/D Totco, whose instrumentation products are used in the management of drilling operations and control of equipment; Shaffer, whose products include pressure control and motion compensation equipment and flow devices; and Rigtech, whose products are used in the handling, mixing, transport and conditioning of drilling fluids. Principles of Consolidation The consolidated financial statements include the accounts of Varco International, Inc. and its wholly-owned subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual amounts could differ from those estimates. Cash and Cash Equivalents The Company considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents. Short-term Investments The Company classifies its short-term investments as available-for-sale securities and carries them at their fair value, based on currently quoted market prices. Unrealized holding gains and losses, net of tax, on securities classified as available-for-sale are carried as a separate component of shareholders' equity. Short-term investments consist of debt securities with interest rates ranging from 5% to 8%. Available-for-sale securities at December 31, 1999 are as follows: Gross Unrealized (in thousands) Cost Gains Fair Value --------------------------------------------------------------------- Obligations of states and political divisions $ 1,265 $ 1,265 Corporate debt securities 3,947 $ 41 3,988 --------------------------------------------------------------------- $ 5,212 $ 41 $ 5,253 --------------------------------------------------------------------- The amortized cost and estimated fair value of available-for-sale securities at December 31, 1999, by contractual maturity, are as follows: Estimated (in thousands) Cost Fair Value --------------------------------------------------------------------- Due in one year or less $ 3,213 $ 3,249 Due after one year 1,999 2,004 --------------------------------------------------------------------- $ 5,212 $ 5,253 --------------------------------------------------------------------- There were no gross realized gains on sales of available-for-sale securities in 1999. Concentrations of Credit Risk Substantially all of the Company's accounts receivable are due from customers in the oil and gas industry, both in the United States and internationally. The Company performs periodic credit evaluations of its customers and generally does not require collateral. In certain circumstances, the Company requires letters of credit to further ensure credit worthiness. 36 Varco International, Inc. and Subsidiaries Inventories Inventories are stated at the lower of cost or market. The Company determines the cost of inventories using the last-in, first-out ("LIFO") method. Rental Equipment Rental equipment is stated at the lower of cost or market, net of accumulated depreciation of $24,663,000 and $23,407,000 at December 31, 1999 and 1998, respectively. Rental equipment is depreciated over estimated useful lives ranging from 3 to 7 years. The equipment is generally leased under short-term arrangements, usually not exceeding 90 days in duration. In 1998, the Company determined, as a result of market conditions, that certain M/D Totco rental equipment would not be rentable in the future. Accordingly, a special non-cash charge of $1,500,000 was incurred to write-off this rental equipment. Depreciation Depreciation is provided using the straight-line method over estimated useful lives ranging from 3 to 30 years. Intangible Assets The excess of cost over net assets of businesses acquired ("goodwill") is amortized on a straight-line basis over periods ranging from 10 to 40 years. The carrying value of goodwill will be reviewed if the facts and circumstances suggest that it may be impaired. If this review indicates that goodwill will not be recoverable, as determined based on the undiscounted cash flows of the entity acquired over the remaining amortization period, the Company's carrying value of the goodwill will be reduced by the estimated shortfall of cash flows. Included in Other Assets are other intangible assets, primarily patents, totaling $7,059,000, net of accumulated amortization of $7,943,000 at December 31, 1999, which are being amortized on a straight-line basis over estimated useful lives ranging from 5 to 17 years. Income Taxes The liability method is used to account for income taxes. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to amounts which are more likely than not to be realized. The provision for income taxes is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities. Impairment of Long-Lived Assets Impairment losses are recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amount. Long- lived assets expected to be disposed of, including excess equipment and production facilities held for sale, are stated at their estimated fair value less cost to sell. Revenue Recognition The Company recognizes revenue upon shipment of product, upon the use of rented equipment and upon the completion of installation work. Fair Value of Financial Instruments The carrying amounts of financial instruments including cash and cash equivalents, short-term investments, accounts receivable and accounts payable approximated fair value as of December 31, 1999 and 1998 because of the relatively short maturity of these instruments. The carrying value of debt approximated fair value as of December 31, 1998 based upon quoted market prices for similar debt issues. Foreign Currency The Company has determined that the United States dollar is the functional currency of all its foreign subsidiaries except for Rig Technology Limited whose functional currency is the British pound sterling. Accordingly, the financial statements of most foreign operations are remeasured in terms of the United States dollar and exchange gains and losses are recognized in operations. The exchange gains in 1999 and 1997 were $1,130,000 and $264,000 respectively; exchange losses in 1998 were $994,000. Financial statements of Rig Technology Limited are translated at current rates of exchange, with gains or losses resulting from translation included in retained earnings. Stock Based Compensation The Company accounts for stock option grants to employees in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees". Per Share Data Basic per share amounts are computed by dividing net income by the weighted average number of common shares outstanding. Dilutive per share amounts are computed by dividing net income by the weighted average number of common shares and dilutive common share equivalents, which consist solely of converting outstanding stock options, using the treasury method. Varco International, Inc. and Subsidiaries 37 Comprehensive Income Effective January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income," which establishes standards for the reporting and display of total comprehensive income and its components in financial statements. The adoption of this statement had no effect on the Company's net earnings or total shareholders' equity for the years ended December 31, 1999, 1998 and 1997. Total comprehensive income represents the net change in shareholders' equity during a period from sources other than transactions with shareholders and as such, includes net earnings. For the Company, the only other components of total comprehensive income are the changes in the cumulative foreign currency translation adjustments and unrecognized gains on available-for-sale securities. Special Charge During the fourth quarter of 1999, the Company adopted a plan to restructure all of its Divisions' operations consistent with the current market conditions and recognized a $5,655,000 special charge consisting primarily of cash severance cost for 528 employees. The Company spent $1,870,000 of this charge in 1999 and expects to spend substantially all of the remaining cost in 2000. This special charge was partially offset by the unused portion of $1,095,000 of the 1998 special charge. In 1998 the Company recognized an $8,500,000 special charge consisting of the following: severance cost for 1,100 employees of $6,100,000; a non-cash write-off of rental equipment of $1,500,000; and an allowance for abandoned leases and other obligations of $900,000. At the termination of the plan, severance for 752 employees totaling $5,185,000 had been incurred. The Company has spent $5,905,000 of the total cash portion of this charge. With the adoption of the 1999 restructure plan, the Company terminated the 1998 plan and used the unused portion, $1,095,000, to reduce the 1999 special charge. Reclassification Certain amounts in the 1998 and 1997 financial statements have been reclassified to conform with current year classification. note b. inventories Inventories classified as current assets consist of the following: December 31, (in thousands) 1999 1998 --------------------------------------------------------------------- Raw materials $ 4,118 $ 5,806 Work in process 14,625 50,684 Finished goods 61,030 109,581 Excess of current cost over LIFO value (11,962) (13,659) --------------------------------------------------------------------- $ 67,811 $ 152,412 ===================================================================== In 1999 LIFO layers of preceding years were reduced which decreased cost of goods sold by $1,698,000 in 1999. A portion of the Company's inventory is not expected to be sold or used within one year and, accordingly has been reclassified as Other Assets. The amount of inventory estimated to exceed one year's usage was $6,500,000 and $7,500,000 at December 31, 1999 and 1998, respectively. note c. property, plant and equipment Property, plant and equipment consist of the following: Estimated Useful Lives December 31, (in thousands) 1999 1998 (Years) ---------------------------------------------------------------------- Land ........................ $ 2,718 $ 2,726 Building and improvements ... 38,341 34,683 3-30 Machinery and equipment ..... 95,604 94,463 5-12 Furniture and fixtures ...... 28,423 28,215 3-5 Autos and trucks ............ 931 1,173 3-5 ---------------------------------------------------------------------- 166,017 161,260 Less accumulated depreciation 81,685 71,263 ---------------------------------------------------------------------- $ 84,332 $ 89,997 ====================================================================== 38 Varco International, Inc. and Subsidiaries note d. income taxes Significant components of the Company's deferred tax liabilities and assets are as follows: December 31, (in thousands) 1999 1998 ------------------------------------------------------------------ Deferred tax liabilities: Tax over book depreciation $ 4,074 $ 3,105 Deferred tax assets: Intercompany profit elimination 3,160 5,322 Postretirement benefit obligation 2,929 2,819 Allowance for loss on sale of assets 2,021 2,021 Allowance for warranty cost 1,903 2,094 Accruals 1,851 3,599 Allowance for excess inventory 1,546 2,623 Other 340 2,994 ------------------------------------------------------------------ Total deferred tax assets 13,750 21,472 Net deferred taxes $ 9,676 $18,367 ================================================================== Current deferred tax assets $ 7,085 $15,244 Noncurrent deferred tax assets and liabilities 2,591 3,123 ------------------------------------------------------------------ Net deferred taxes $ 9,676 $18,367 ================================================================== United States and foreign income before income taxes and the components of income tax expense are as follows: December 31, (in thousands) 1999 1998 1997 --------------------------------------------------------------------- Income before income taxes: U.S. $ 39,993 $ 74,361 $ 59,279 Foreign 17,953 16,796 17,417 --------------------------------------------------------------------- $ 57,946 $ 91,157 $ 76,696 --------------------------------------------------------------------- Income tax expense (benefit): December 31, (in thousands) 1999 1998 1997 --------------------------------------------------------------------- Current: U.S. $ 5,108 $ 28,824 $ 21,340 Foreign 6,728 6,708 5,577 State 891 2,231 1,146 Utilization of net operating losses and credits (1,019) (1,509) (1,099) Tax benefits credited to paid-in capital 582 1,246 3,206 --------------------------------------------------------------------- 12,290 37,500 30,170 Deferred: U.S. 8,857 (6,681) (4,448) Foreign (166) 1,099 --------------------------------------------------------------------- $ 20,981 $ 30,819 $ 26,821 --------------------------------------------------------------------- Varco International, Inc. and Subsidiaries 39 Differences between the Company's income tax expense and an amount calculated utilizing the federal statutory rate are as follows:
December 31, (in thousands) 1999 1998 1997 ----------------------------------------------------------------------------- At federal statutory rate $ 20,281 $ 31,905 $ 26,844 Increases (reductions) in taxes: Change in valuation allowance (3,206) FSC benefit (545) (1,788) (2,069) State taxes, net of federal benefit 579 1,450 745 Tax impact of non-deductible expenses 853 877 772 Tax rate differential on foreign earnings and losses recorded without tax benefit 444 829 519 Other (631) 752 10 ----------------------------------------------------------------------------- Total tax provision $ 20,981 $ 30,819 $ 26,821 -----------------------------------------------------------------------------
Income taxes paid net of refunds received in 1999, 1998, and 1997 were $20,450,000, $36,623,000, and $24,393,000, respectively. The Company is currently under examination by the Internal Revenue Service for the years ended December 31, 1996 and 1995. Management believes that the resolution of this examination will not have a material adverse effect on the Company's financial position or results of operations. note e. long-term debt The Company has a seven-year unsecured revolving credit agreement, dated June 27, 1997, with three banks (the "Credit Agreement"). The Credit Agreement provides for a credit facility of $65.0 million, inclusive of a $20.0 million letter of credit sub-facility. The maximum available under the Credit Agreement is reduced in equal quarterly amounts over the last four years of the Credit Agreement. Advances under the Credit Agreement bear interest at either a prime rate minus .25% or a rate based on the Eurodollar Market. The Credit Agreement requires a commitment fee (currently equal to .175% of the unused portion of the credit facility), restricts additional borrowings if minimum asset levels are not met and contains restrictive covenants requiring the maintenance of certain financial ratios, limitations on additional borrowings and capital expenditures, and restrictions on distribution of cash or other property. At December 31, 1999, there were no advances outstanding and $4.4 million in letters of credit outstanding under this facility. The Credit Agreement restricts the payment of dividends (other than dividends payable solely in shares of Common Stock) on, and repurchases of, Common Stock. Under the terms of the Credit Agreement, the amount available for the payment of dividends on, and repurchases of, Common Stock is limited to $5.0 million plus 25% of the Company's consolidated net income arising after June 30, 1997, computed on a cumulative basis. At December 31, 1999, the amount available for dividends and repurchases under the Credit Agreement was $37.3 million. Interest paid during 1999, 1998 and 1997 was $630,000, $1,698,000, and $3,664,000, respectively. note f. shareholders' equity The Varco 1980 Employee Stock Purchase Plan permits the Company's employees to purchase Common Stock at a price equal to 85% of its fair market value at the beginning or end of a six-month plan period. As of December 31, 1999, 2,899,527 shares have been sold under this plan with a maximum of 4,000,000 shares available for sale under this plan. The Varco International, Inc. Stock Bonus Plan (the "Bonus Plan") authorizes the Compensation Committee of the Board of Directors to award additional compensation to selected key employees of the Company in the form of stock awards payable in shares of Common Stock of the Company to a maximum of 2,000,000 shares. Through December 31, 1999, 958,601 shares have been granted and issued to key employees under the Bonus Plan. The Varco International, Inc. 1990 Stock Option Plan permits, and predecessor plans permitted, the grant of incentive and non-statutory options to key employees and officers. Options granted under the plans must be not less than the fair market value of the stock on the date of grant. Options are exercisable during such periods as determined by the Compensation Committee and expire not later than ten years from the date of the grant. 40 Varco International, Inc. and Subsidiaries The Varco International, Inc. 1994 Directors' Stock Option Plan provides for the grant of a 10,000 share stock option on the initial date of election as a director plus an annual grant of a 10,000 share stock option to each non- employee director. Options granted under this plan are at the fair market value of the stock on the date of grant. Options are exercisable for ten years from the date of the grant unless sooner terminated. Stock option activity for the plans was as follows:
1999 1998 1997 ------------------------------------------------------------------------------------------------- weighted weighted weighted average average average exercise exercise exercise options price options price options price ------------------------------------------------------------------------------------------------- Outstanding at beginning of year 2,481,145 $ 8.53 2,324,724 $ 6.15 2,587,968 $ 3.80 Granted 627,936 9.01 406,861 20.47 557,502 13.25 Exercised 256,780 3.00 200,152 4.93 790,386 3.40 Cancelled 82,390 9.07 50,288 9.51 30,360 7.54 ------------------------------------------------------------------------------------------------- Outstanding at end of year 2,769,911 $ 9.06 2,481,145 $ 8.53 2,324,724 $ 6.15 ------------------------------------------------------------------------------------------------- Exercisable at end of year 1,524,510 1,201,444 803,788 =================================================================================================
The following table summarizes information about stock options outstanding at December 31, 1999:
Options Outstanding Options Exercisable ----------------------------------------------------------------------------------------------------------- Weighted Average Weighted Weighted Remaining Average Average Number Contractual Exercise Number Exercise Range of Exercise Prices Outstanding Life(Years) Price Exercisable Price ---------------------------------------------------------------------------------------------------------- $2.28 to $4.625 760,750 3.96 $ 3.19 689,349 $ 3.21 $5.25 to $8.375 1,051,513 7.58 6.92 357,038 5.67 $10.4375 to $12.9688 605,298 7.67 12.52 275,922 8.84 $18.672 to $23.1875 352,350 7.97 22.16 202,201 21.40 ---------------------------------------------------------------------------------------------------------- $2.28 to $23.1875 2,769,911 6.65 $ 9.06 1,524,510 $ 7.88 ==========================================================================================================
The Company follows Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees", in accounting for its stock based compensation plans. Accordingly, no compensation expense has been recognized for its stock option plans and its stock purchase plan. The compensation cost that has been charged against income for its stock bonus plan was $1,007,000, $985,000 and $1,549,000 for the years 1999, 1998 and 1997 respectively. Had compensation costs for the Company's stock option plans and stock purchase plan been determined based upon fair value at the grant date under these plans, the Company's net income and income per share would have been reduced to the pro forma amounts shown below:
1999 1998 1997 -------------------------------------------------------------------------------- Net income - as reported $ 36,965,000 $ 60,338,000 $ 49,875,000 Net income - pro forma 34,451,000 58,136,000 48,574,000 As reported - Basic income per share $ .57 $ .94 $ .78 Diluted income per share .56 .92 .76 Pro forma - Basic income per share $ .53 $ .90 $ .76 Diluted income per shares .52 .89 .74
Varco International, Inc. and Subsidiaries 41 The fair value of shares is estimated using the Black-Scholes option-pricing model with the following weighted-average assumptions.
1994 1990 Stock Directors'Stock 1980 Stock Option Plan Option Plan Purchase Plan -------------------------------------------------------------------------- Expected life (years) 6 3 .5 Risk-free interest rate 1999 6.5% 6.3% 5.7% 1998 5.9% 6.5% 5.0% 1997 6.3% 6.0% 5.2% Volatility 1999 67% 67% 67% 1998 48% 48% 48% 1997 45% 45% 45%
For the options granted during 1999, 1998 and 1997, the weighted-average fair value at date of grant was $5.65, $10.65, and $6.05 per option, respectively. The weighted-average fair value at date of grant for stock purchase shares during 1999, 1998 and 1997 was $2.21, $1.21 and $2.35 per share, respectively. The discounted value of the stock purchase plan shares granted in 1999, 1998 and 1997, using the Black-Scholes option-pricing model, was $344,000, $465,000 and $277,000, respectively. At December 31, 1999, the Company had reserved 5,723,643 shares of Common Stock for future issuance in connection with the four stock- based compensation plans. During 1997, the Company adopted a Stockholder Rights Plan ("Rights Plan"). As part of the Rights Plan, the Company's Board of Directors declared a dividend of one preferred stock purchase right ("Right") for each share of the Company's Common Stock outstanding on November 27, 1997. The Board also authorized the issuance of one such Right for each share of the Company's Common Stock issued thereafter. The Rights will become exercisable only if, without the prior approval of the Board, a person or group acquires 15% or more of Varco's Common Stock or announces a tender or exchange offer, the consummation of which would result in ownership by a person or group of 15% or more of the Common Stock. Each Right will entitle its holder to purchase one one-thousandth of a share of a new series of the Company's Preferred Stock at an exercise price of $140.00. If a person or group acquires 15% or more of the Company's outstanding Common Stock, each Right will entitle its holder (other than the acquiring person or group) to purchase at the Right's then-current exercise price, a number of shares of Varco Common Stock (or in certain circumstances, cash, property or other securities) having a market value equal to twice the exercise price. In addition, if at any time after such an acquisition, the Company is acquired in a merger or other business combination transaction or 50% or more of its consolidated assets or earning power are sold, each outstanding Right will entitle its holder (other than the acquiring person or group) to purchase, at the Right's then-current exercise price, a number of the acquiring person's common shares having a market value equal to twice the exercise price. Following the acquisition by a person or group of beneficial ownership of 15% or more of the Company's Common Stock and prior to an acquisition of 50% or more of the Common Stock, the Board of Directors may exchange the Rights (other than Rights owned by the acquiring person or group), in whole or in part, at an exchange ratio of one share of Common Stock (or in certain circumstances, cash, property or other securities) per Right. Prior to the acquisition by a person or group of 15% or more of the Common Stock, the Rights are subject to redemption at the option of the Board of Directors at a price of $0.01 per Right. The Rights currently trade with the Company's Common Stock, have no voting or dividend rights and expire on November 5, 2007. note g. commitments and contingencies The Company leases land and its executive offices in Orange, California under two operating leases, from certain officers, directors, and shareholders of the Company. The land lease expires in 2012, has an annual aggregate rental of $480,000 (subject to upward adjustment in 2002 based on appraisals) plus real estate taxes and other expenses. The Company has the option to purchase the leased land at a price equal to the greater of the original cost of the property to the lessors or the fair market value at the time of purchase. The office lease expires in 2005 and has an aggregate annual rental of $378,000 (subject to periodic upward adjustments based upon the consumer price index.) The Company has an option to extend this lease for 60 months based on the then fair market rent of the building. The Company leases most of its sales, service and distribution facilities under agreements ranging from one to eight years. 42 Varco International, Inc. and Subsidiaries Approximate minimum annual rental payments under noncancellable operating leases as of December 31, 1999 are as follows: (in thousands) Real Estate Equipment Total -------------------------------------------------------- 2000 $ 1,923 $ 2,572 $ 4,495 2001 1,456 1,458 2,914 2002 1,257 545 1,802 2003 1,111 182 1,293 2004 1,111 2 1,113 Thereafter 5,073 2 5,075 -------------------------------------------------------- $ 11,931 $ 4,761 $ 16,692 -------------------------------------------------------- Rent expense amounted to $7,639,000, $8,867,000, and $6,696,000 for 1999, 1998, and 1997, respectively. The Company is sometimes named as a defendant in litigation relating to the products and services it provides. The Company insures against these risks to the extent deemed prudent by its management, but no assurance can be given that the nature and amount of such insurance will in every case fully indemnify the Company against liabilities arising out of pending and future legal proceedings relating to its ordinary business activities. The Company provides for costs related to these contingencies when a loss is probable. It is the opinion of management that it is remote that there will be an unfavorable resolution in excess of amounts previously provided. The Company has been designated as a potentially responsible party ("PRP") for two separate waste disposal sites. With respect to both of the sites, numerous other PRPs have similarly been designated. The Company has contribution agreements with other PRPs, and settlements and costs paid by the Company have not been significant. In the opinion of the Company's management neither these nor other environmental matters would have a material adverse effect on the consolidated financial position of the Company. note h. benefit plans The Company has a contributory profit sharing plan covering eligible U.S. employees and certain foreign employees with more than one year's service. Under the plan, the Company contributes from 2% to 20% of its net income (as defined) at the discretion of the Board of Directors. The total contribution may not exceed the maximum amount allowable for income tax purposes. Contributions to the plan amounted to $4,600,000, $6,500,000 and $5,000,000, for 1999, 1998 and 1997, respectively. In 1993, the Company amended its Profit Sharing Plan to designate a portion of profit sharing contributions for retiree healthcare and life insurance benefits for certain eligible employees retiring after December 31, 1993. In 1995 the plan was further amended to include an employer matching contribution. The Company's matching contribution amounted to $1,043,000 $1,084,000, and $831,000 in 1999, 1998 and 1997, respectively. The Company also has a supplemental defined benefits plan providing retirement and death benefits for a number of key employees. The plan is unfunded and the net pension liability was $3,623,000 and $3,396,000 at December 31, 1999 and 1998, respectively. Expense under the plan was $770,000, $723,000 and $652,000 in 1999, 1998, and 1997, respectively. For certain former employees who retired prior to December 31, 1993, healthcare and life insurance benefits are provided through insurance companies. In 1993 the Company adopted FASB Statement No. 106, "Accounting for Postretirement Benefits Other Than Pensions." The transition obligation is being amortized over 20 years. The assumed weighted-average annual rate of increase in the per capita cost of covered benefits is 8.5% for 1999 and is assumed to decrease gradually to 5.0% for 2010 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. For example, increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1999, by $872,000 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1999 by $59,000. The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 7.25% and 6.75% at December 31, 1999 and 1998, respectively. 43 Net periodic postretirement benefit cost includes the following components: Year ended December 31, (in thousands) 1999 1998 1997 ----------------------------------------------------------------------- Interest cost $ 669 $ 723 $ 856 Amortization of transition obligation 763 763 763 Amortization of (gain) (534) (513) (378) ----------------------------------------------------------------------- $ 898 $ 973 $ 1,241 ----------------------------------------------------------------------- The following table sets forth the change in benefit obligation of the Company's postretirement benefit plan: December 31, (in thousands) 1999 1998 ----------------------------------------------------------------------- Changes in benefit obligation Benefit obligation at beginning of year $ 10,356 $ 10,758 Interest cost 669 723 Benefits paid (813) (721) Actuarial loss (gain) 422 (404) ----------------------------------------------------------------------- Benefit obligation at end of year $ 10,634 $ 10,356 Funded status $(10,634) $(10,356) Unrecognized actuarial (gain) (6,170) (7,126) Unrecognized transition obligation 9,906 10,669 ----------------------------------------------------------------------- Accrued postretirement benefit obligation $ (6,898) $ (6,813) ----------------------------------------------------------------------- The Company has an Executive Management Savings Plan and a Directors Saving Plan (the "Plans") which permit eligible executives and the Company's non-employee directors to defer a portion of their compensation. Participants in the Plans may also participate in the Company's "split-dollar" life insurance program pursuant to which the Company will purchase a life insurance policy for a premium equal to the amounts deferred plus any additional amount required to provide a minimum death benefit. Amounts payable to a participant under the Plans are offset by any benefits paid under the participant's life insurance policy. The life insurance policies are intended to provide security for the payment of benefits under the Plans. note i. selected quarterly financial data (unaudited)
(in thousands except per share data) 1stQuarter 2ndQuarter 3rdQuarter 4thQuarter ------------------------------------------------------------------------------------------------- 1999 Revenues $ 152,168 $ 155,877 $ 140,400 $ 144,307 Gross profit 47,321 45,605 43,744 37,604 Special charge 4,560 Income before income taxes 18,145 16,566 15,634 7,601 Income taxes 6,411 5,402 5,304 3,864 Net income 11,734 11,164 10,330 3,737 Basic income per share .18 .17 .16 .06 Diluted income per share .18 .17 .16 .06 1998 Revenues $ 150,191 $ 197,211 $ 193,985 $ 199,592 Gross profit 54,695 67,313 59,445 57,579 Special charge 8,500 Income before income taxes 22,760 29,997 22,574 15,826 Income taxes 7,775 10,268 7,610 5,166 Net income 14,985 19,729 14,964 10,660 Basic income per share .23 .31 .23 .16 Diluted income per share .23 .30 .23 .16
44 note j. business segment and geographic information The Company has five reportable segments-its five Divisions described in note a. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies except that certain expenses, such as interest, amortization of certain intangibles, special charges and general corporate expenses are not allocated to the Divisions. In addition, certain assets including cash and cash equivalents, short-term investments, deferred taxes, and certain intangible assets are held at Corporate. Intersegment sales are recorded at the selling Division's cost plus profit which is calculated as a fixed percentage mark-up on cost. The reportable segments are each managed separately because they manufacture and distribute distinct products with different production processes, and each Division has its own President that reports directly to the Chief Operating Officer of the Company. Selected financial information for the Company's reportable segments for the years ended December 31, 1999, 1998 and 1997 follows:
(in thousands) Varco Systems Varco BJ M/D Totco Shaffer Rigtech Total ----------------------------------------------------------------------------------------------------------------- 1999 Revenues from external customers $ 200,556 $ 66,006 $ 69,540 $ 237,036 $ 16,589 $ 589,727 Intersegment revenues 1,431 170 2,466 4,067 Depreciation and amortization 8,314 2,085 5,476 5,505 895 22,275 Segment income (loss) 41,634 16,006 619 20,022 (3,279) 75,002 Segment assets 94,978 30,932 75,776 128,624 24,099 354,409 Expenditures for long-lived assets 5,051 1,111 199 2,558 3,301 12,220 1998 Revenues from external customers $ 266,776 $ 95,959 $ 94,639 $ 256,238 $ 21,273 $ 734,885 Intersegment revenues 2,798 285 5,429 8,512 Depreciation and amortization 6,851 1,488 5,980 6,611 959 21,889 Segment income (loss) 64,668 24,678 9,061 19,574 (222) 117,759 Segment assets 141,309 58,372 81,905 178,947 21,864 482,397 Expenditures for long-lived assets 15,544 5,758 5,156 3,729 5,082 35,269 1997 Revenues from external customers $ 165,510 $ 68,931 $ 90,601 $ 206,483 $ 13,372 $ 544,897 Intersegment revenues 3,372 320 3,399 41 7,132 Depreciation and amortization 5,499 1,101 5,488 3,789 859 16,736 Segment income 36,272 15,966 20,054 27,102 785 100,179 Segment assets 114,695 47,504 89,036 151,985 17,735 420,955 Expenditures for long-lived assets 11,429 3,086 3,731 16,467 408 35,121
Varco International, Inc. and Subsidiaries 45 The following reconciles segment income to consolidated income before income taxes and segment assets and depreciation and amortization to consolidated assets and consolidated depreciation and amortization. (in thousands) 1999 1998 1997 ----------------------------------------------------------------------- Income Segment income $ 75,002 $ 117,759 $100,179 Elimination of intercompany profit (966) (1,952) (1,558) Unallocated amounts: Corporate and other expenses (10,785) (14,327) (18,261) Special charge (4,560) (8,500) Interest expense (745) (1,823) (3,664) ----------------------------------------------------------------------- Income before income taxes $ 57,946 $ 91,157 $ 76,696 ----------------------------------------------------------------------- Assets Total assets for reportable segments $ 354,409 $ 482,397 $420,955 Assets held at Corporate 105,276 64,523 50,174 ----------------------------------------------------------------------- Total assets $ 459,685 $ 546,920 $471,129 ----------------------------------------------------------------------- Depreciation and amortization Depreciation and amortization for reportable segments $ 22,275 $ 21,889 $ 16,736 Other 774 232 235 ----------------------------------------------------------------------- Total depreciation and amortization $ 23,049 $ 22,121 $ 16,971 ----------------------------------------------------------------------- Information about the Company's revenue and long-lived assets by geographical area for 1999, 1998 and 1997 are as follows: (in thousands) 1999 1998 1997 ----------------------------------------------------------------------- Geographic Area Revenue United States $ 311,577 $ 340,536 $240,706 United Kingdom 41,819 53,838 52,705 Brazil 28,046 68,123 26,945 Singapore 22,887 33,575 32,198 Rest of World 185,398 238,813 192,343 ----------------------------------------------------------------------- Total Revenue $ 589,727 $ 734,885 $544,897 ----------------------------------------------------------------------- Geographic Area-Long-Lived Assets United States $ 93,557 $ 100,981 $100,115 United Kingdom 19,571 16,370 13,488 Netherlands 10,428 11,664 8,243 Singapore 2,948 3,203 1,918 Rest of World 2,164 2,730 2,920 ----------------------------------------------------------------------- Total Long-Lived Assets $ 128,668 $134,948 $126,684 ----------------------------------------------------------------------- During 1999 sales to three customers were $83,899,000, $83,306,000, and $68,088,000. During 1998 sales to two customers were $122,010,000 and $100,304,000. There were no sales to a single customer in 1997 in excess of 10% of total sales. 46 Varco International, Inc. and Subsidiaries report of independent auditors Shareholders and Board of Directors Varco International, Inc. We have audited the accompanying consolidated balance sheets of Varco International, Inc. and subsidiaries as of December 31, 1999 and 1998, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Varco International, Inc. and subsidiaries at December 31, 1999 and 1998, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. /s/ Ernest & Young LLP Orange County, California February 8, 2000 47 stock information Price Range of Varco Common Stock The following table sets forth for the periods indicated the high and low sale prices per share of Common Stock reported by the New York Stock Exchange. There were 2,465 holders of record of the Common Stock as of the close of business on February 23, 2000. High Low High Low 1999 1998 First Quarter 12 15/16 7 First Quarter 28 15 1/4 Second Quarter 12 11/16 8 11/16 Second Quarter 32 3/16 18 13/16 Third Quarter 14 1/4 9 9/16 Third Quarter 21 3/8 7 1/8 Fourth Quarter 12 5/8 9 1/4 Fourth Quarter 13 3/8 5 7/16 Dividend Policy The payment of dividends (other than dividends payable solely in shares of Common Stock) on, and repurchases of, Common Stock are restricted by Varco's revolving Credit Agreement with three financial institutions. Under the revolving Credit Agreement, the amount available for the payment of dividends on, and repurchases of, Common Stock is limited to $5,000,000 plus 25% of Varco's consolidated net income arising after June 30, 1997, computed on a cumulative basis. At December 31, 1999, the amount available for dividends and repurchases under the Credit Agreement was $37,256,000. The Company may also purchase or otherwise acquire shares of Common Stock from the proceeds of the substantially concurrent sale of shares of Common Stock. The Company has not paid a dividend on the Common Stock since 1982, and the Board of Directors presently has no plans to resume the payment of dividends. Annual Report on Form 10-K The Company's Annual Report on Form 10-K for the year ended December 31, 1999, as filed with the Securities and Exchange Commission, is available by writing to Donald L. Stichler, Vice-President, Controller-Treasurer and Secretary, Varco International, Inc., 743 North Eckhoff Street, Orange, California 92868. Common Stock The Company's Common Stock is traded on the New York Stock Exchange under the symbol VRC. Transfer Agent & Registrar Harris Trust Company of California Los Angeles, California e-mail investor-relations@varco.com web site http://www.varco.com 48 Corporate Headquarters Varco International, Inc. 743 North Eckhoff Street Orange, California 92868 (714) 978-1900 Operating Units M/D Totco 1200 Cypress Creek Road Cedar Park, Texas 78613 (512) 340-5000 Shaffer 12950 West Little York Houston, Texas 77041 (713) 937-5000 Rigtech Badentoy Crescent Badentoy Park Portlethen Aberdeen, Scotland AB12 4YD Varco BJ Nijverheidsweg 45 4879 AP Etten-Leur The Netherlands and 12950 West Little York Houston, Texas 77041 (713) 937-5500 Varco Systems 743 North Eckhoff Street Orange, California 92868 (714) 978-1900 Independent Accountants Ernst & Young LLP Orange County General Counsel Pircher, Nichols & Meeks Los Angeles Board of Directors George Boyadjieff Chairman of the Board and Chief Executive Officer of the Company Walter B. Reinhold Chairman Emeritus of the Company George S. Dotson President Helmerich & Payne International Drilling Co. Andre R. Horn* Chairman Emeritus Needham & Company, Inc. Jack W. Knowlton*+ President The Knowlton Co. Leo J. Pircher Partner Pircher, Nichols & Meeks Carroll W. Suggs Chairman of the Board Petroleum Helicopters, Inc. Robert A. Teitsworth*+ Independent Oil & Gas Producer Eugene R. White Retired Chairman of the Board Amdahl Corporation James D. Woods+ Chairman Emeritus of Baker Hughes Incorporated * Member of the Audit Committee + Member of the Compensation Committee Officers Varco International, Inc. George Boyadjieff Chairman of the Board and Chief Executive Officer Michael W. Sutherlin President and Chief Operating Officer Wallace K. Chan Vice President -- Finance and Chief Financial Officer Robert J. Gondek Vice President Richard A. Kertson Vice President -- Finance and Chief Financial Officer - --Retired Mark A. Merit Vice President Roger D. Morgan Vice President Donald L. Stichler Vice President Controller -- Treasurer and Secretary Varco Systems Roger D. Morgan President Brian L. Eidem Vice President -- Product Development Maurice E. Jacques Senior Vice President -- Marketing Andrew P. Lesko Vice President -- Service and Training Jama K. Meyer Vice President -- Manufacturing and Information Technology Michael Williams Vice President -- Sales Dennis E. Yenzer Vice President -- Product Engineering Varco BJ James Gregory Renfro President Robert R.D. deVries Vice President -- Sales and Marketing David B. Mason Vice President -- Product Development Rob C. Voesenek Vice President -- Finance M/D Totco Robert J. Gondek President Ellis Greg Hottle Vice President -- Sales James P. Lawler Vice President -- V-ICIS Installation Gregory A. Martin Vice President -- Rig Instrumentation Charles A. Shamburg Vice President -- Finance Terry L. Tarvin Vice President -- North American Operations Keith A. Womer Vice President -- Research and Development Shaffer Mark A. Merit President Thomas E. Bishop Vice President -- Sales and Service E. J. Devine Vice President -- Finance Tri C. Le Vice President -- Engineering Reid V. Nuttall Vice President -- Information Technology David L. O'Donnell Vice President -- Quality Assurance Mark D. Galagaza Vice President -- Manufacturing Rigtech Dietmar Neidhardt President Add to spine varco international, inc 1999 annual report Varco International, Inc. 743 North Eckhoff Street Orange, California 92868 EX-21 10 SUBSIDIARIES OF VARCO INT'L. EXHIBIT 21 SUBSIDIARIES OF VARCO INTERNATIONAL, INC. ALL 100% OWNED
JURISDICTION OF INCORPORATION ADDRESS ------------- ------- Best Industries, Inc. Texas 12950 West Little York Houston, Texas 77041 -------------------- Martin-Decker TOTCO, Inc. Texas 1200 Cypress Creek Road Cedar Park, Texas 78613 ----------------------- Varco Shaffer, Inc. Texas 12950 W. Little York Houston, Texas 77041 -------------------- Varco International Inc Singapore No. 8 Sixth Lok Yang Road Pte Ltd Jurong Singapore 2262 -------------- Varco BJ Oil Tools B.V. The Netherlands Nijverheidsweg 45 4879 AP Etten-Leur P.O. Box 17, 4870 AA Etten-Leur The Netherlands --------------- Varco (U.K.) Limited United Kingdom Forties Road, Montrose Angus, Scotland --------------- Varco BJ FSC Inc. Barbados 743 No. Eckhoff Street Orange, California 92668 ------------------------ Varco International (Canada)Ltd. Alberta, Bay 15 - 2916 5th Ave. N.E.L Canada Calgary, Alberta T2A 6M7 Canada ------ Rig Technology Limited United Kingdom Badentoy Park Portlethen Aberdeen, Scotland ------------------ Varco Del Venezuela CA Venezuela 743 No. Eckhoff Street Orange, California 92668 ------------------------
EXHIBIT 21 Page 2 of 2 JURISDICTION OF INACTIVE SUBSIDIARIES INCORPORATION ADDRESS - --------------------- ------------- ------- Varco Marine Tools International, Inc. Texas 12950 West Little York Houston, Texas 77041 -------------------- Varco-Disc California 743 No. Eckhoff Street Orange, California 92668 ------------------------ Best Disc Texas 12950 West Little York Houston, Texas 77041 --------------------- Varco Eastern, Inc. California 743 No. Eckhoff Street Orange, California 92668 ------------------------ Metrox, Inc. California 743 No. Eckhoff Street Orange, California 92668 ------------------------ Varco de Mexico Holdings, Inc. California 743 No. Eckhoff Street Orange, California 92668 ------------------------ Varco Singapore, Ltd. California 743 No. Eckhoff Street Orange, California 92668 ------------------------ Varco Middle East California 743 No. Eckhoff Street Orange, California 92668 ------------------------ Varco Electronics, Inc. California 743 No. Eckhoff Street Orange, California 92668 ------------------------ Varco Electronics Disc California 743 No. Eckhoff Street Orange, California 92668 ------------------------ EX-23 11 CONSENT OF INDEPENDENT AUDITORS Exhibit 23 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference in Registration Statements Number 2-66830, 2-96290, 33-36841, 33-62118, 33-61861, 33-61939 and 333-21681 on Form S-8 of Varco International, Inc. and in the related Prospectuses of our report dated February 8, 2000, with respect to the consolidated financial statements and schedule of Varco International, Inc. included in the annual report on Form 10-K for the year ended December 31, 1999. /s/ Ernst & Young LLP Orange County, California March 17, 1999 EX-27 12 FINANCIAL DATA SCHEDULE
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FINANCIAL STATEMENTS OF THE REGISTRANT INCLUDED IN ITS ANNUAL REPORT TO SHAREHOLDERS FOR THE TWELVE MONTHS ENDED DECEMBER 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 12-MOS DEC-31-1999 DEC-31-1999 72,606,000 5,253,000 143,353,000 (2,954,000) 67,811,000 300,029,000 166,017,000 (81,685,000) 459,685,000 83,176,000 0 0 0 161,886,000 198,862,000 459,685,000 589,727,000 592,752,000 415,453,000 505,279,000 28,782,000 0 745,000 57,946,000 20,981,000 36,965,000 0 0 0 36,965,000 0.57 0.56
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