-----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, BHwuoqjY93fUdql3mU87uDcrBhUMjX/STetAbG7FS3h6g5CobDgJIdBu5I2sJh0k /QzmEeHBIj7gdtgGBd+Czw== 0001017062-99-000499.txt : 19990325 0001017062-99-000499.hdr.sgml : 19990325 ACCESSION NUMBER: 0001017062-99-000499 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990324 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: 99571795 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 1998 10-K 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, 1998 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)
[CAPTION] 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, 1999, 64,770,111 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 $469,250,000; 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, 1998. 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 13, 1999 to be filed with the Commission not later than April 30, 1999. 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 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, ----------------------- 1998 1997 1996 -------------- --------------- --------------- (IN THOUSANDS) Varco Systems $266,776 $165,510 $117,658 Varco BJ 95,959 68,931 53,830 M/D Totco 94,639 90,601 62,227 Shaffer 256,238 206,483 123,846 Rigtech 21,273 13,372 9,419 -------- -------- -------- $734,885 $544,897 $366,980 -------- -------- --------
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 U.S. 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 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 1 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 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 2 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 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. Six TDS-8S units were delivered in 1998. The Integrated Drilling System ("IDS") is an adaptation of the Top Drive concept which is more compact than its Top Drive counterparts, and which is affixed to a separately installed torque tube rather than rails permanently installed in the derrick. It can be used on rigs which are smaller and which do not have the structural integrity necessary to support a traditional Top Drive. 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. Two TDS-10S units and ten TDS-11S units were sold in 1998. 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 3 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 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. Seventeen units of the PRS were delivered in 1998. 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 ("Pipe Mite") which is used to manipulate and move tubulars while stored in a horizontal position; the Pipe Conveyor 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"). 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. During 1998, 46 BX elevators, 25 PS 21's and 19 PS 30's were delivered to customers. 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 eliminate the need for the larger conventional rotary table. Thirteen units were delivered in 1998. 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 also 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. 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 the drilling operations. Drilling consoles, and recently, the V-ICIS product, 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 6 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). Blowout preventers ("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 normal drilling operations 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. During 1998, PCWD revenue was approximately $1.5 million. 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 though faster ram configuration changes without tripping the stack. Shaffer has booked three orders for NXTs, all of which are expected to be delivered in 1999. Shaffer sells conventional BOP control systems under the registered trademark Koomey(R). The Koomey control system is hydraulically actuated and is used to remotely operate BOPs and associated valves 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. 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 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. 7 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. Prior to 1993, these chokes were manufactured and sold by Varco BJ. 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 extract as many of the cuttings from the mud, thus minimizing the use of the 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. In 1998, 77 units were sold. 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 aim of the system is to release manpower from manual operations while continuously monitoring the process to ensure that it is performing properly. During 1998 Rigtech delivered three AMS 1000 systems. 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 and the V-ICIS control system. At December 31, 1998, the Company employed 372 persons on its engineering and design staffs who were principally engaged in research and development. Total expenditures for research and development were $34.6 million in 1998, $21.1 million in 1997 and $14.3 million in 1996. 8 As of December 31, 1998, the Company held 110 United States patents and had 6 patent applications pending. Expiration dates of such patents range from 1999 to 2015. As of such date the Company also had 189 foreign patents and 17 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. Acquisitions On November 30, 1994 the Company acquired all of the outstanding shares of Rig Technology Limited ("Rigtech"), a company incorporated in Scotland, for a cost of approximately $8,954,000. Rigtech provides equipment and systems used in the handling, mixing, transport and conditioning of drilling fluids and operates as the Company's Rigtech Division. International Operations The Company's products are sold for use in approximately 96 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 54%, 56% and 67% of the Company's total revenues for the years ended December 31, 1998, 1997, and 1996, respectively. For further information regarding the Company's worldwide operations and international sales and rentals, see Note j of Notes to Consolidated Financial Statements. 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 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 3 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 9 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 1998 sales to two customers were $122,010,000 and $100,304,000, respectively. During 1996 sales to one customer amounted to $45,228,000. 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, ------------- 1998 1997 1996 ---- ---- ---- (in thousands) Varco Systems $128,944 $172,838 $ 50,913 Varco BJ 33,587 40,073 9,625 M/D Totco 26,069 16,259 6,258 Shaffer 174,430 224,180 119,611 Rigtech 4,383 9,545 465 -------- -------- -------- Total $367,413 $462,895 $186,872 -------- -------- --------
The Company expects that substantially all of the backlog will be shipped by December 31, 1999. At December 31, 1998 the Company had received $95.8 million in customer cash deposits related to orders included in backlog. 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 competitor with respect to most Varco Systems products is Maritime Hydraulics A/S, a division of Acker Maritime A/S, a Norwegian company. Other competitors with respect to the Top Drive Drilling System include National-Oilwell Inc., A/S Hydralift, another Norwegian company which acquired the rights to the product previously marketed by ACB offshore, a French company, and Tesco 10 Corporation, a Canadian company, that competes principally in the land Top Drive market against Varco Systems' TDS-9S, TDS-10S and TDS-11S. Since its introduction in 1982 and as of December 31, 1998, Varco had sold and delivered over 620 Top Drive Drilling Systems, and the Company believes that its competitors had sold and delivered less than 300 systems during the same time period. 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 Adair Supply Inc. In domestic product sales, the competition consists of Wagner International Inc., Atlas Company 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 Norwegian 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. and Brandt/EPI, a division of Tuboscope Vetco International Corporation. 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 At December 31, 1998 the Company had a total of 2,951 employees (of which 155 were temporary employees). Of such employees, 821 employees were engaged in sales and marketing, 372 employees were engaged in engineering and design, 153 employees were engaged in administrative or clerical capacities, and 1,605 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. 11 MANAGEMENT EXECUTIVE OFFICERS OF THE REGISTRANT The executive officers of Varco are as follows:
NAME AGE POSITION ---- --- -------- Walter B. Reinhold 74 Chairman Emeritus George Boyadjieff 60 Chairman of the Board, President and Chief Executive Officer and Director Richard A. Kertson 59 Vice President-Finance and Chief Financial Officer Donald L. Stichler 55 Vice President, Controller-Treasurer and Chief Accounting Officer and Secretary Robert J. Gondek 55 Vice President and President - M/D Totco Mark A. Merit 41 Vice President and President - Shaffer Roger D. Morgan 55 Vice President and President - Varco Systems Michael W. Sutherlin 55 Vice President and President - Varco BJ
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. 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 President of the Company in May 1981, Chief Executive Officer in April 1991, and Chairman of the Board in May 1998. Mr. Boyadjieff served as Chief Operating Officer from June 1979 until April 1991. Prior to his election as President, 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. Kertson was elected Vice President - Finance and Chief Financial Officer in May 1984. He had been Controller of Varco Oil Tools since January 1982. He joined the Company in October 1975, as Director of Management Information Services. Mr. Stichler was elected Controller-Treasurer in May 1984, Secretary in May 1994, Chief Accounting Officer in May 1995 and Vice President of the Company 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. 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 since 1985. He has been employed by the Company in various capacities since 1980. 12 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 since 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. Sutherlin was elected Vice President of the Company in May 1984 and President-Varco BJ in July 1988. Previously he served as Vice President-Best Operations. He has been employed by the Company in various capacities since 1975. 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. 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 Houston Facilities are 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 which are leased under a long-term lease. The Orange Facility 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, 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 1998 and 1997 as compared to approximately 95% of capacity in 1996. 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 in excess of a two shift operation for 1998 as compared to near capacity in 1997 and 1996. The M/D Totco products are manufactured at the Cedar Park Facility. The Company leased this facility from Cooper Industries, Inc. until 1995 when the Company purchased this facility for approximately $3.6 million. The Cedar Park Facility consists of approximately 200,000 square feet of manufacturing and warehousing space and approximately 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 in excess of a two shift operation in 1998 and 1997 and approximately 95% of capacity during 1996. 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 located in Houston, Texas. In addition, certain products of the Varco BJ Division are manufactured at this facility. The Shaffer facility has been operated by the Company since the acquisition of Shaffer in 1992. The Company estimates that based upon direct labor hours and a two shift operation, utilization of this facility for 1997 and 1996 was in excess of a two shift operation as compared to 80% in 1995. 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 13 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.") Two of the satellite facilities have been listed for sale. An additional manufacturing facility located in Houston (the "Houston BJ Facility") was closed during the fourth quarter of 1992 and activities previously performed at that plant have been moved to other Company locations, principally the Shaffer Facility. The Houston BJ Facility, which consists of approximately 135,000 square feet of manufacturing and office space, and the 32.2 acres of land on which it is located are owned by the Company. This facility has been listed for sale. The Drilling Systems Division's administration 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 22 such facilities throughout the United States in addition to facilities in Brazil, Canada, China, Mexico 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 1998. 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 44 of the Registrant's Annual Report to Shareholders for the year ended December 31, 1998, is hereby incorporated by reference. During the fiscal year ended December 31, 1998 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 22 of the Registrant's Annual Report to Shareholders for the year ended December 31, 1998, is hereby incorporated by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 14 Management's Discussion and Analysis of Financial Condition and Results of Operations on pages 24 through 28 of the Registrant's Annual Report to Shareholders for the year ended December 31, 1998, is hereby incorporated by reference. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 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 considered 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 is subject to interest rate risk on its fixed interest rate debt. Generally, the fair market value of debt with a fixed interest rate will increase as interest rates fall, and the fair market value will decrease as interest rates rise. Fixed interest rate borrowings have not been significant during the three years ended December 31, 1998. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The information required by this item is hereby incorporated by reference to pages 29 through 43 of the Registrant's Annual Report to Shareholders for the year ended December 31, 1998. 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 13, 1999, 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 13, 1999 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT 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 13, 1999. 15 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 13, 1999. 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, 1998, are incorporated by reference in Item 8:
PAGE IN ANNUAL REPORT ------------- Consolidated Balance Sheets-as of December 31, 1998 and 1997................................... 29 Consolidated Statements of Income-Years ended December 31, 1998, 1997 and 1996................ 30 Consolidated Statements of Shareholders' Equity-Years ended December 31, 1998, 1997 and 1996............................................................................... 31 Consolidated Statements of Cash Flows-Years ended December 31, 1998, 1997 and 1996........................................................................................ 32 Notes to Consolidated Financial Statements..................................................... 33
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................................................................. 21 Schedule II - Valuation and Qualifying Accounts............................................ 22
All other schedules for which provision is made in the applicable accounting regulation 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 were filed during the fourth quarter of 1998. (c) Exhibits 16 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. *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. *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. 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 Note Agreement, dated as of July 1, 1992 between Varco International, Inc. and the Purchasers named in Schedule 1 thereto, incorporated by reference to Exhibit 4.0 to Varco's Quarterly report on Form 10-Q for the quarter ended September 30, 1992. 4.2 First Amendment to Note Agreement, dated as of November 12, 1992, to Note Agreement included as Exhibit 4.1 hereto, incorporated by reference to Exhibit 4.3 to Varco's annual report on Form 10-K for the year ended December 31, 1992. 4.3 Waiver and Second Amendment to Note Agreement, dated as of February 25, 1994, to Note Agreement included as Exhibit 4.1 hereto, incorporated by reference to Exhibit 4.4 to Varco's annual report on Form 10-K for the year ended December 31, 1992. 4.4 Waiver, dated as of March 8, 1995, to Note Agreement included as Exhibit 4.1 hereto incorporated by reference to Exhibit 4.4 to Varco's annual report on Form 10-K for the year ended December 31, 1994. 4.5 Waiver and Third Amendment to Note Agreement, dated as of March 8, 1995, to Note Agreement included as Exhibit 4.1 hereto, incorporated by reference to Exhibit 4.5 to Varco's annual report on Form 10-K for the year ended December 31, 1995. 4.6 Waiver and consent to Note Agreement, dated as of June 23, 1997, to Note Agreement included as Exhibit 4.1 hereto, incorporated by reference to Exhibit 4.6 to Varco's annual report on Form 10-K for the year ended December 31, 1997. 4.7 Waiver and Fourth Amendment to Note Agreement, dated as of September 30, 1997, to Note Agreement included as Exhibit 4.1 hereto, incorporated by reference to Exhibit 4.7 to Varco's annual report on Form 10-K for the year ended December 31, 1997. 4.8 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. 4.9 First Amendment to Credit Agreement, dated as of July 15, 1997, to Credit Agreement included
17 as Exhibit 4.8 hereto, incorporated by reference to Exhibit 4.9 to Varco's annual report on Form 10-K for the year ended December 31, 1997. 4.10 Second Amendment to Credit Agreement dated as of August 13, 1997, to Credit Agreement included as Exhibit 4.8 hereto, incorporated by reference to Exhibit 4.10 to Varco's annual report on Form 10-K for the year ended December 31, 1997. 4.11 Third Amendment to Credit Agreement dated as of November 7, 1997 to Credit Agreement included as Exhibit 4.8 hereto, incorporated by reference to Exhibit 4.11 to Varco's annual report on Form 10-K for the year ended December 31, 1997. 4.12 Fourth Amendment to Credit Agreement dated as of February 18, 1998 to Credit Agreement included as Exhibit 4.8 hereto, incorporated by reference to Exhibit 4.12 to Varco's annual report on Form 10-K for the year ended December 31, 1997. *4.13 Fifth Amendment to Credit Agreement dated as of November 3, 1998 to Credit Agreement included as Exhibit 4.8 hereto. 4.14 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 theCorporation'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.
18 10.9+ Amendment 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. 10.15 Amendment dated as of January 11, 1995 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, 1995 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+ 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. 10.20+ Amendment to the Varco 1980 Employee Stock Purchase Plan included as Exhibit 10.19 hereto, incorporated by reference to Exhibit 10.19 to Varco's annual report on Form 10-K for the year ended December 31, 1995. 10.21+ Amendment to the Varco 1980 Employee Stock Purchase Plan included as Exhibit 10.19 hereto. incorporated by reference to Exhibit 10.21 to Varco's annual report on Form 10-K for the year ended December 31, 1996. *10.22+ Varco International Inc. Management Incentive Bonus Plan.
19 10.23+ 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. 10.24+ Amendment to Varco International Inc. 1994 Directors' Stock Option Plan, included as Exhibit 10.23 hereto, incorporated by reference to Exhibit 10.26 to Varco's annual report on Form 10-K for the year ended December 31, 1997. 10.25+ The Varco International, Inc. Director Savings Plan incorporated by reference to Exhibit 10.23 to Varco's annual report on Form 10-K for the year ended December 31, 1994. 10.26+ The Varco International, Inc. Executive Management Savings Plan incorporated by reference to Exhibit 10.24 to Varco's annual report on Form 10-K for the year ended December 31, 1994. *11 Statement re computation of per share earnings. *12 Statement re computation of ratios. *13 1998 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, 1998
____________ * 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. 20 (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, 1998 and 1997, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1998. 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 based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the 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, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. 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, 1999 21 VARCO INTERNATIONAL, INC. AND SUBSIDIARIES SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
Column A Column B Column C Column D Column E Additions Additions Balance at Charged to Charged Balance beginning costs and To other Deductions- at end of of period expenses accounts- describe period --------- -------- describe ----------- --------- ---------------- Description (in thousands) ----------- 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 obsolete inventory..... 28,758 1,989 (188) 4,408(2) 26,151 Reserve for assets held for sale................ 5,262 240 (6) 5,508 TOTALS...................................... $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 obsolete inventory 36,879 3,701 (478) 11,344(2) 28,758 Reserve for assets held for sale 4,996 240 (26) 5,262 TOTALS...................................... $43,631 $4,530 ($489) $11,531 $36,141 Year ended December 31, 1996: Deducted from asset accounts: Allowance for doubtful accounts................. $ 1,585 $ 497 ($22) $ 304(1) $ 1,756 Allowance for excess and obsolete inventory..... 39,069 (21) 2,169(2) 36,879 Reserve for assets held for sale................ 4,750 240 (6) 4,996 TOTALS...................................... $45,404 $ 716 ($22) $ 2,467 $43,631
(1) Uncollectible accounts written off, net of recoveries. (2) Obsolete inventories written off. 22 SIGNATURES Persuant 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 : GEORGE I. BOYADJIEFF --------------------------- George I. Boyadjieff Chairman, President and Chief Executive Officer Dated March 19, 1999 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, President and Chief March 19, 1999 GEORGE I. BOYADJIEFF Executive Officer - --------------------------------------- George I. Boyadjieff Principal Financial Officer: RICHARD A. KERTSON Vice President- Finance March 19, 1999 - --------------------------------------- Richard A. Kertson Principal Accounting Officer: DONALD L. STICHLER Vice President, Controller- March 19, 1999 - --------------------------------------- Treasurer and Secretary Donald L. Stichler Other Directors: WALTER B. REINHOLD Director March 19, 1999 - --------------------------------------- Walter B. Reinhold GEORGE S. DOTSON Director March 19, 1999 - --------------------------------------- George S. Dotson ANDRE R. HORN Director March 19, 1999 - --------------------------------------- Andre R. Horn JACK W. KNOWLTON Director March 19, 1999 - --------------------------------------- Jack W. Knowlton LEO J. PIRCHER Director March 19, 1999 - --------------------------------------- Leo J. Pircher CARROLL W. SUGGS Director March 19, 1999 - --------------------------------------- Carroll W. Suggs
23 ROBERT A. TEITSWORTH Director March 19, 1999 - --------------------------------------- Robert A. Teitsworth EUGENE R. WHITE Director March 19, 1999 - --------------------------------------- Eugene R. White JAMES D. WOODS Director March 19, 1999 - --------------------------------------- James D. Woods
24 EX-3.2 2 CERT. OF AMEND. OF ARTICLES OF INCORPORATION EXHIBIT 3.2 CERTIFICATE OF AMENDMENT OF AMENDED AND RESTATED ARTICLES OF INCORPORATION OF VARCO INTERNATIONAL, INC. The undersigned, Richard A. Kertson and Donald L. Stichler, do hereby certify that: 1. They are the duly elected and acting Vice President-Finance and Secretary, respectively, of Varco International, Inc., a California corporation (the "Corporation"). 2. The Amended and Restated Articles of Incorporation of the Corporation are amended by revising Article Three thereof to read in its entirety as follows: "Authorized Shares Three: This corporation is authorized to issue two classes of shares designated respectively "Common Stock" and "Preferred Stock," referred to herein as Common Stock or Common Shares and Preferred Stock or Preferred Shares, respectively. The number of shares of Common Stock is one hundred twenty million (120,000,000) and the number of shares of Preferred Stock is ten million (10,000,000). The Preferred Shares may be issued from time to time in one or more series. The Board of Directors is authorized to fix the number of shares of any series of Preferred Shares and to determine the designation of any such series. The Board of Directors is also authorized to determine or alter the rights, preferences, privileges, and restrictions granted to or imposed upon any wholly unissued series of Preferred Shares and, within the limits and restrictions stated in any resolution or resolutions of the Board of Directors originally fixing the number of shares constituting any series, to increase or decrease (but not below the number of shares of such series then outstanding) the number of shares of any such series subsequent to the issue of shares of that series." 3. The foregoing amendment has been duly approved by the Board of Directors of the Corporation. 4. The foregoing amendment has been duly approved by the required vote of shareholders of the Corporation in accordance with Section 902 of the California Corporations Code; the total number of outstanding shares of each class entitled to vote with respect to the foregoing amendment was 64,324,335 shares of Common Stock and there were no outstanding shares of Preferred Stock. The number of shares of Common Stock voting in favor of the foregoing amendment equaled or exceeded the vote required, such required vote being a majority of the outstanding shares of Common Stock. We further declare under penalty of perjury that the matters set forth in the foregoing Certificate of Amendment are true and correct of our own knowledge. Executed at Orange, California on May 19, 1998. /s/ R. A. Kertson ---------------------------------- Richard A. Kertson Vice President-Finance /s/ Donald L. Stichler ---------------------------------- Donald L. Stichler Secretary [ SEAL OF THE OFFICE OF THE SECRETARY OF STATE ] 2 EX-3.3 3 CERTIFICATE OF DETERMINATION OF RIGHTS Exhibit 3.3 CERTIFICATE OF DETERMINATION OF RIGHTS, PREFERENCES AND PRIVILEGES OF SERIES A PARTICIPATING PREFERRED STOCK OF VARCO INTERNATIONAL, INC. The undersigned, Richard A. Kertson and Donald L. Stichler do hereby certify: 1. That they are the duly elected and acting Vice President-Finance and Secretary, respectively, of Varco International, Inc., a California corporation (the "Corporation"). 2. That pursuant to the authority conferred upon the Board of Directors by the Amended and Restated Articles of Incorporation of the said Corporation, the said Board of Directors on November 6, 1997 adopted the following resolutions creating a series of 80,000 shares of Preferred Stock designated as "Series A Participating Preferred Stock": "RESOLVED, that pursuant to the authority vested in the Board of Directors of the Corporation by the Amended and Restated Articles of Incorporation, the Board of Directors does hereby provide for the creation of a series of Preferred Stock of the Corporation, to be designated "Series A Participating Preferred Stock," initially consisting of 80,000 shares, and does hereby fix and herein state and express such designations, powers, preferences and relative and other special rights and the qualifications, limitations and restrictions of such series of Preferred Stock as follows: Section 1. Designation and Amount. The shares of such series of Preferred Stock shall be designated as "Series A Participating Preferred Stock," and the number of shares constituting such series shall be 80,000. Such number of shares may be increased or decreased by resolution of the Board of Directors; provided, however, that no decrease shall reduce the number of shares of Series A Participating Preferred Stock to less than the number of shares then issued and outstanding plus the number of shares issuable upon exercise of outstanding rights, options or warrants or upon conversion of outstanding securities issued by the Corporation. Section 2. Dividends and Distributions. (a) Subject to the prior and superior right of the holders of any shares of any series of Preferred Stock ranking prior and superior to the shares of Series A Participating Preferred Stock with respect to dividends, the holders of shares of Series A Participating Preferred Stock shall be entitled to receive when, as and if declared by the Board of Directors out of funds legally available for the purpose, quarterly dividends payable in cash on the last day of January, April, July and October in each year (each such date being referred to herein as a "Quarterly Dividend Payment Date"), commencing on the first Quarterly Dividend Payment 1 Date after the first issuance of a share or fraction of a share of Series A Participating Preferred Stock, in an amount per share (rounded to the nearest cent) equal to the then applicable Adjustment Number (as hereinafter defined) times the aggregate per share amount of all cash dividends, and the then applicable Adjustment Number times the aggregate per share amount (payable in kind) of all non-cash dividends or other distributions other than a dividend payable in shares of Common Stock or a subdivision of the outstanding shares of Common Stock (by reclassification or otherwise), declared on the Common Stock of the Corporation (the "Common Stock") since the immediately preceding Quarterly Dividend Payment Date, or, with respect to the first Quarterly Dividend Payment Date, since the first issuance of any share or fraction of a share of Series A Participating Preferred Stock. The "Adjustment Number" shall initially be 1,000. In the event the Corporation shall at any time after November 6, 1997 (the "Rights Dividend Declaration Date") (i) declare and pay any dividend on Common Stock payable in shares of Common Stock, (ii) subdivide the outstanding Common Stock, or (iii) combine the outstanding Common Stock into a smaller number of shares, then in each such case the Adjustment Number in effect immediately prior to such event shall be adjusted by multiplying such Adjustment Number by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event. (b) The Corporation shall declare a dividend or distribution on the Series A Participating Preferred Stock as provided in paragraph (a) above after it declares a dividend or distribution on the Common Stock (other than a dividend payable in shares of Common Stock). (c) Dividends shall begin to accrue on outstanding shares of Series A Participating Preferred Stock from the Quarterly Dividend Payment Date next preceding the date of issue of such shares of Series A Participating Preferred Stock, unless the date of issue of such shares is prior to the record date for the first Quarterly Dividend Payment Date, in which case dividends on such shares shall begin to accrue from the date of issue of such shares, or unless the date of issue is a Quarterly Dividend Payment Date or is a date after the record date for the determination of holders of shares of Series A Participating Preferred Stock entitled to receive a quarterly dividend and before such Quarterly Dividend Payment Date, in either of which events such dividends shall begin to accrue from such Quarterly Dividend Payment Date. Accrued but unpaid dividends shall not bear interest. Dividends paid on the shares of Series A Participating Preferred Stock in an amount less than the total amount of such dividends at the time accrued and payable on such shares shall be allocated pro rata on a share-by-share basis among all such shares at the time outstanding. The Board of Directors may fix a record date for the determination of holders of shares of Series A Participating Preferred Stock entitled to receive payment of a dividend or distribution declared thereon, which record date shall be no more than 60 days prior to the date fixed for the payment thereof. Section 3. Voting Rights. The holders of shares of Series A Participating Preferred Stock shall have the following voting rights: 2 (a) Each share of Series A Participating Preferred Stock shall entitle the holder thereof to a number of votes equal to the then Applicable Adjustment Number on all matters submitted to a vote of the shareholders of the Corporation. (b) Except as otherwise provided herein or required by law, the holders of shares of Series A Participating Preferred Stock and the holders of shares of Common Stock shall vote together as one class on all matters submitted to a vote of shareholders of the Corporation. (c) Except as otherwise provided herein or required by law, holders of Series A Participating Preferred Stock shall have no special voting rights and their consent shall not be required (except to the extent they are entitled to vote with holders of Common Stock as set forth herein) for taking any corporate action. Section 4. Certain Restrictions. (a) The Corporation shall not declare any dividend on, make any distribution on, or redeem or purchase or otherwise acquire for consideration, any shares of Common Stock after the first issuance of a share or fraction of a share of Series A Participating Preferred Stock unless concurrently therewith it shall declare a dividend on the Series A Participating Preferred Stock as required by Section 2 hereof. (b) Whenever quarterly dividends or other dividends or distributions payable on the Series A Participating Preferred Stock as provided in Section 2 are in arrears, thereafter and until all accrued and unpaid dividends and distributions, whether or not declared, on shares of Series A Participating Preferred Stock outstanding shall have been paid in full, the Corporation shall not (i) declare or pay dividends on, make any other distributions on, or redeem or purchase or otherwise acquire for consideration any shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Participating Preferred Stock; (ii) declare or pay dividends on, or make any other distributions on, any shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with Series A Participating Preferred Stock, except dividends paid ratably on the Series A Participating Preferred Stock and all such parity stock on which dividends are payable or in arrears in proportion to the total amounts to which the holders of all such shares are then entitled; (iii) redeem or purchase or otherwise acquire for consideration shares of any stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series A Participating Preferred Stock, provided that the Corporation may at any time redeem, purchase or otherwise acquire shares of any such parity stock in exchange 3 for shares of any stock of the Corporation ranking junior (either as to dividends or upon dissolution, liquidation or winding up) to the Series A Participating Preferred Stock; (iv) redeem or purchase or otherwise acquire for consideration any shares of Series A Participating Preferred Stock, or any shares of stock ranking on a parity (either as to dividends or upon liquidation, dissolution or winding up) with the Series A Participating Preferred Stock, except in accordance with a purchase offer made in writing or by publication (as determined by the Board of Directors) to all holders of the Series A Participating Preferred Stock or to such holders and holders of any shares ranking on a parity therewith upon such terms as the Board of Directors, after consideration of the respective annual dividend rates and other relative rights and preferences of the respective series and classes, shall determine in good faith will result in fair and equitable treatment among the respective series or classes. (c) The Corporation shall not permit any subsidiary of the Corporation to purchase or otherwise acquire for consideration any shares of stock of the Corporation unless the Corporation could, under paragraph (a) of this Section 4, purchase or otherwise acquire such shares at such time and in such manner. Section 5. Reacquired Shares. Any shares of Series A Participating Preferred Stock purchased or otherwise acquired by the Corporation in any manner whatsoever shall be retired and cancelled promptly after the acquisition thereof. All such shares shall upon their retirement become authorized but unissued shares of Preferred Stock and may be reissued as part of a new series of Preferred Stock to be created by resolution or resolutions of the Board of Directors, subject to the conditions and restrictions on issuance set forth herein and in the Amended and Restated Articles of Incorporation, as then amended. Section 6. Liquidation, Dissolution or Winding Up. (a) Upon any liquidation, dissolution or winding up of the Corporation, voluntary or otherwise, no distribution shall be made to the holders of shares of stock ranking junior (either as to dividends or upon liquidation, dissolution or winding up) to the Series A Participating Preferred Stock unless, prior thereto, the holders of shares of Series A Participating Preferred Stock shall have received an amount per share equal to accrued and unpaid dividends and distributions thereon, whether or not declared, to the date of such payment, plus an amount equal to the greater of (1) $1,000, provided that in the event the Corporation does not have sufficient assets, after payment of its liabilities and distribution to holders of Preferred Stock ranking prior to the Series A Participating Preferred Stock, available to permit payment in full of the $1,000 per share amount, the amount required to be paid under this Section 6(a)(1) shall, subject to Section 6(b) hereof, equal the value of the amount of available assets divided by the number of outstanding shares of Series A Participating Preferred Stock or (2) the then applicable Adjustment Number times the aggregate per share amount to be distributed to the holders of Common Stock (the greater of (1) or (2), the "Series A Liquidation Preference"). 4 (b) In the event, however, that there are not sufficient assets available to permit payment in full of the Series A Liquidation Preference and the liquidation preferences of all other series of Preferred Stock, if any, which rank on a parity with the Series A Participating Preferred Stock in respect thereof, then the assets available for such distribution shall be distributed ratably to the holders of the Series A Participating Preferred Stock and the holders of such parity shares in proportion to their respective liquidation preferences. (c) Neither the merger or consolidation of the Corporation into or with another corporation nor the merger or consolidation of any other corporation into or with the Corporation shall be deemed to be a liquidation, dissolution or winding up of the Corporation within the meaning of this Section 6. Section 7. Consolidation, Merger, etc. In case the Corporation shall enter into any consolidation, merger, combination or other transaction in which the shares of Common Stock are exchanged for or changed into other stock or securities, cash and/or any other property, then in any such case each share of Series A Participating Preferred Stock shall at the same time be similarly exchanged or changed in an amount per share equal to the then applicable Adjustment Number times the aggregate amount of stock, securities, cash and/or any other property (payable in kind), as the case may be, into which or for which each share of Common Stock is changed or exchanged. Section 8. No Redemption. The shares of Series A Participating Preferred Stock shall not be redeemable. Section 9. Ranking. The Series A Participating Preferred Stock shall rank junior to all other series of the Corporation's Preferred Stock as to the payment of dividends and the distribution of assets upon liquidation, dissolution or winding up, unless the terms of any such series shall provide otherwise. Section 10. Amendment. At any time that any shares or fractions of shares of Series A Participating Preferred Stock are outstanding, the Amended and Restated Articles of Incorporation of the Corporation shall not be further amended in any manner which would materially alter or change the powers, preferences or special rights of the Series A Participating Preferred Stock so as to affect them adversely without the affirmative vote of the holders of a majority of the outstanding shares of Series A Participating Preferred Stock, voting separately as a class. Section 11. Fractional Shares. Series A Participating Preferred Stock may be issued in fractions of a share which shall entitle the holder, in proportion to such holder's fractional shares, to exercise voting rights, receive dividends, participate in distributions and to have the benefit of all other rights of holders of Series A Participating Preferred Stock. Section 12. Consent for Certain Repurchases of Common Stock. Each holder of outstanding shares of Series A Participating Preferred Stock shall be deemed to have consented, 5 for the purposes of Sections 502, 503 and 506 of the California General Corporation Law, to distributions made by the Corporation in connection with the repurchase of shares of Common Stock of the Corporation issued to or held by employees, consultants, officers and directors of the Corporation upon termination of their employment or services with the Corporation pursuant to agreements providing for the rights of repurchase between the Corporation and such persons. RESOLVED FURTHER, that the President or any Vice President and the Secretary or any Assistant Secretary of this corporation be, and they hereby are, authorized and directed to prepare and file a Certificate of Determination of Rights, Preferences and Privileges in accordance with the foregoing resolution and the provisions of California law and to take such actions as they may deem necessary or appropriate to carry out the intent of the foregoing resolution." 3. That the number of shares constituting the Series A Participating Preferred Stock is 80,000. Such number of shares may be increased or decreased by resolution of the Board of Directors; provided, however, that no decrease shall reduce the number of shares of Series A Participating Preferred Stock to less than the number of shares then issued and outstanding plus the number of shares issuable upon exercise of outstanding rights, options or warrants or upon conversion of outstanding securities issued by the Corporation. 4. None of the shares of the Series A Participating Preferred Stock has been issued. We further declare under penalty of perjury that the matters set forth in the foregoing Certificate of Determination are true and correct of our own knowledge. Executed at Orange, California on November 6, 1997. /s/ RICHARD A. KERTSON -------------------------------------------- Richard A. Kertson, Vice President-Finance /s/ DONALD L. STICHLER -------------------------------------------- Donald L. Stichler, Secretary 6 EX-3.4 4 CERTIFICATE OF CORRECTION-DETERMINATION OF RIGHTS EXHIBIT 3.4 CERTIFICATE OF CORRECTION OF CERTIFICATE OF DETERMINATION OF RIGHTS, PREFERENCES AND PRIVILEGES OF SERIES A PARTICIPATING PREFERRED STOCK OF VARCO INTERNATIONAL, INC. The undersigned, Richard A. Kertson and Donald L. Stichler do hereby certify that: 1. They are the duly elected and acting Vice President-Finance and Secretary, respectively, of Varco International, Inc., a California corporation (the "Corporation"). 2. The Certificate of Determination of Rights, Preferences and Privileges of Series A Participating Preferred Stock being corrected was filed with the Secretary of State on November 6, 1997. 3. Section 2(a) of the Certificate of Determination of Rights, Preferences and Privileges of Series A Participating Preferred Stock is corrected to read in its entirety as follows: "Section 2. Dividends and Distributions. (a) Subject to the prior and superior right of the holders of any shares of any series of Preferred Stock ranking prior and superior to the shares of Series A Participating Preferred Stock with respect to dividends, the holders of shares of Series A Participating Preferred Stock shall be entitled to receive when, as and if declared by the Board of Directors out of funds legally available for the purpose, quarterly dividends payable in cash on the last day of January, April, July and October in each year (each such date being referred to herein as a "Quarterly Dividend Payment Date"), commencing on the first Quarterly Dividend Payment Date after the first issuance of a share or fraction of a share of Series A Participating Preferred Stock, in an amount per share (rounded to the nearest cent) equal to the then applicable Adjustment Number (as hereinafter defined) times the aggregate per share amount of all cash dividends, and the then applicable Adjustment Number times the aggregate per share amount (payable in kind) of all non-cash dividends or other distributions other than a dividend payable in shares of Common Stock or a subdivision of the outstanding shares of Common Stock (by reclassification or otherwise), declared on the Common Stock of the Corporation (the "Common Stock") since the immediately preceding Quarterly Dividend Payment Date, or, with respect to the first Quarterly Dividend Payment Date, since the first issuance of any share or fraction of a share of Series A Participating Preferred Stock. The "Adjustment Number" shall initially be 1,000. In the event the Corporation shall at any time after November 6, 1997 (the "Rights Dividend Declaration Date") (i) declare and pay any dividend on Common Stock payable in shares of Common Stock, (ii) subdivide the outstanding Common Stock, or (iii) combine the outstanding Common Stock into a smaller number of shares, then in each such case the Adjustment Number in effect immediately prior to such event shall be adjusted by multiplying such Adjustment Number by a fraction, the numerator of which is the number of shares of Common Stock outstanding immediately after such event and the denominator of which is the number of shares of Common Stock that were outstanding immediately prior to such event provided, however, that no such adjustment shall be made in connection with the two-for-one split of the Common Stock to be effected in the form of a 100% stock dividend declared by the Board of Directors of the Company on November 6, 1997, and payable on December 4, 1997, to the holders of record of the Common Stock as of the close of business on November 20, 1997. 4. This Certificate does not alter the wording of any resolution or written consent which was in fact adopted by the Board of Directors of the Corporation. We further declare under penalty of perjury that the matters set forth in the foregoing Certificate of Determination are true and correct of our own knowledge. Executed at Orange, California on November 13, 1997. /s/ RICHARD A. KERTSON ---------------------- Richard A. Kertson, Vice President-Finance /s/ DONALD L. STICHLER ---------------------- Donald L. Stichler, Secretary EX-4.13 5 5TH AMENDMENT TO CREDIT AGREEMENT EXHIBIT 4.13 VARCO INTERNATIONAL, INC. FIFTH AMENDMENT TO CREDIT AGREEMENT This FIFTH AMENDMENT TO CREDIT AGREEMENT (this "Amendment") is dated as of November 3, 1998 and entered into by and among VARCO INTERNATIONAL, INC., a California corporation ("Company"), THE FINANCIAL INSTITUTIONS LISTED ON THE SIGNATURE PAGES HEREOF (each individually referred to herein as a "Lender" and collectively as "Lenders"), and UNION BANK OF CALIFORNIA, N.A. ("UBOC"), as agent for Lenders (in such capacity, "Agent"), and is made with reference to that certain Credit Agreement dated as of June 27, 1997, as amended by a First Amendement to Credit Agreement dated as of July 15, 1997, by a Second Amendment to Credit Agreement dated as of August 13, 1997, by a Third Amendment to Credit Agreement dated as of November 7, 1997 and by a Fourth Amendment to Credit Agreement dated as of February 18, 1998 (as so amended the "Credit Agreement"), by and among Company, Lenders and Agent. Capitalized terms used herein without definition shall have the same meanings herein as set forth in the Credit Agreement. RECITALS WHEREAS, the parties hereto wish to amend the Credit Agreement in certain respects; NOW, THEREFORE, in consideration of the premises and the agreements, provisions and covenants herein contained, the parties hereto agree as follows: Section 1. AMENDMENTS TO THE CREDIT AGREEMENT A. Amendment to Subsection 1.1. Certain Defined Terms. --------------------------------------------------- Subsection 1.1 of the Credit Agreement is hereby amended by adding thereto the following additional definition: "Scotland Capital Expenditures" means the capital --------- ------- ------------ expenditures to be incurred in 1998 and 1999 in connection with the consolidation of the Scottish operations of Company and its Subsidiaries". B. Amendment to Subsection 7.8. CONSOLIDATED CAPITAL EXPENDITURES -------------------------------------------------------------- Subsection of 7.8D of the Credit Agreement is hereby amended by adding the following at the end thereof: "and provided further that there shall be excluded from the ---------------- foregoing limitations in this Subsection 7.8 the Scotland Capital Expenditures up to a maximum amount of $8,500,000, it being understood that any amount of Scotland Capital Expenditures in excess of $8,500,000 shall be included within the limitations set forth above." Section 2. MISCELLANEOUS A. Reference to and Effect on the Credit Agreement and the Other Loan Documents. (i) Each reference in the Credit Agreement to "this Agreement", "hereunder", "hereof", "herein" or words of like import referring to the Credit Agreement, and each reference in the other Loan Documents to the "Credit Agreement", "thereunder", "thereof" or words of like import referring the Credit Agreement shall mean and be a reference to this Amended Agreement. (ii) Except as specifically amended by this Amendment, the Credit Agreement and the other Loan Documents shall remain in full force and effect and are hereby ratified and confirmed. (iii) The execution, delivery and performance of this Amendment shall not, except as expressly provided herein, constitute a waiver of any provision of, or operate as a waiver of any right, power or remedy of Agent or any Lender under, the Credit Agreement or any of the other Loan Documents. B. Fees and Expenses. Company acknowledges that all reasonable costs, fees and expenses as described in Subsection 10.2 of the Credit Agreement incurred by Agent and its counsel with respect to this Amendment and the documents and transactions contemplated hereby shall be for the account of Company. C. Headings. Section and Subsection headings in this Amendment are included herein for convenience of reference only and shall not constitute a part of this Amendment for any other purpose or be given any substantive effect. D. Applicable Law. THIS AMENDMENT AND THE RIGHTS AND OBLIGATIONS OF THE PARTIES HEREUNDER SHALL BE GOVERNED BY, AND SHALL BE CONSTRUED AND ENFORCED IN ACCORDANCE WITH, THE INTERNAL LAWS OF THE STATE OF CALIFORNIA (INCLUDING WITHOUT LIMITATION SECTION 1646.5 OF THE CIVIL CODE OF THE STATE OF CALIFORNIA), WITHOUT REGARD TO CONFLICTS OF LAWS PRINCIPLES. E. Counterparts; Effectiveness. This Amendment may be executed in any number of counterparts and by different parties hereto in separate counterparts, each of which when so executed and delivered shall be deemed an orginal, but all such counterparts together shall constitute but one and the same instrument; signature pages may be detached from multiple separate counterparts and attached to a single counterpart so that all signature pages are physically attached to the same document. This Amendment shall become effective upon the execution of a counterpart hereof by Requisite Lenders and each of the other parties hereto and receipt by Company and Agent of written or telephonic notification of such execution and authorization of delivery thereof. [Remainder of page intentionally left blank] IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed and delivered by their respective officers thereunto duly authorized as of the date first written above. COMPANY: VARCO INTERNATIONAL, INC. By: /s/ Donald L. Stichler -------------------------------------- Name: Donald L. Stichler ------------------------------------ Title: Vice-President - Treasurer ----------------------------------- Notice Address: 743 North Eckhoff Street Orange, CA 92868 Attention: Chief Financial Officer LENDERS: UNION BANK OF CALIFORNIA, N.A. as a Lender, as Issuing Lender and as Agent By:______________________________________ Name:____________________________________ Title:___________________________________ Notice Address: 445 South Figueroa Street 10/th/ Floor Los Angeles, CA 90071 Attention: Andrew G. Ewing, Jr. IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be duly executed and delivered by their respective officers thereunto duly authorized as of the date first written above. COMPANY: VARCO INTERNATIONAL, INC. By: -------------------------------- Name: ------------------------------ Title: ----------------------------- Notice Address: 743 North Eckhoff Street Orange, CA 92868 Attention: Chief Financial Officer LENDERS: UNION BANK OF CALIFORNIA, N.A. as a Lender, as Issuing Lender and as Agent By: /s/ Andrew G. Ewing, Jr. -------------------------------- Name: Andrew G. Ewing, Jr. ------------------------------ Title: V.P. ----------------------------- Notice Address: 445 South Figueroa Street 10th Floor Los Angeles, CA 90071 Attention: Andrew G. Ewing, Jr. THE CHASE MANHATTAN BANK, as a Lender By: /s/ Peter M. Ling ---------------------------------- Name: Peter M. Ling -------------------------------- Title: Vice President ------------------------------- Notice Address: 600 Travis Street, 20th Floor Houston, TX 77002 Attention: Ki Allen MORGAN GUARANTY TRUST COMPANY OF NEW YORK, as a Lender By: /s/Robert Bottamedi ----------------------------- Name: Robert Bottamedi --------------------------- Title: Vice President -------------------------- Notice Address: 60 Wall Street, 22nd Floor New York, NY 10260 Attention: Rob Bottamedi EX-10.22 6 MANAGEMENT INCENTIVE BONUS PLAN EXHIBIT 10.22 To: Compensation Committee From: Dick Kertson Date: February 3, 1999 Re: Proposed Financial Criteria--1999 Management Incentive Bonus Plan The general structure of the Plan and the financial performance criteria employed remain generally unchanged from recent years. The cash bonus payout is expressed as a percentage of annual salary and is a function of Salary Grade and the financial performance level achieved. 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 financial performance, both the minimum profit and return on ---- investment associated with that level must be achieved. In 1998, achieving the Annual Financial Plan equated to 9 Bonus Points on a scale of 2-15 for all Divisions and the total Company. Reflecting the disparate performance among Divisions and the overall Company shortfall to Plan, only the Drilling Systems Division was above Plan, realizing 14 Bonus Points. The Varco BJ Oil Tools Division was at the 6 point level and the total Company's performance was at 5 points. Neither the MD/Totco, Shaffer, or Rigtech Divisons reached the minimum financial performance necessary to qualify for a bonus. A summary of the key elements of the proposed 1999 Management Incentive Bonus Plan follows: . Achieving the "Financial Plan" (the Original Annual Financial Plan as revised in the January quarterly update) would result in 7 Bonus Points for the total Company, on a scale of 2-15. The Drilling Systems and Oil Tools Divisions would each realize 10 points for reaching the Financial Plan; and M/D Totco, Shaffer and Rigtech would each achieve 6 points at their Financial Plan performance. The disparity between target points reflects the fact that the 1999 Financial Plan for Drilling Systems and Oil Tools is at or above 1997 performance, and for the other three Divisions and the total Company the planned 1999 performance is below that of 1997. . The bonus percentages (bonus/salary ratio) associated with each Bonus Point level have been revised for all Salary Grades. The ratio which equates to the 75th percentile in the salary survey data is set at 11 Bonus Points; the average ratio is set at 7 Bonus Points.. 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, 25% of the cash bonus amount is based upon the points attributable to total Company performance. 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 1999 divided by the average for the last 5 trading days of 1998) 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 include: Baker Hughes, Halliburton, Schlumberger, Smith International, Cooper Cameron, Tuboscope Vetco, National Oilwell, Weatherford International, and IRI. NOTE--9 points = 1997 Actual
BONUS POINTS = 2 3 4 5 6 7 8 --------------------------------------------------------------------- E.P.S. $ 0.45 $ 0.50 $ 0.55 $ 0.60 $ 0.65 $ 0.70 $ 0.75 NET INCOME 30.2 33.5 36.9 40.2 43.6 52.8 50.3 AVERAGE INVESTMENT 283.3 286.8 290.3 293.8 297.3 300.8 297.3 NET INCOME R.O.I. 10.6% 11.7% 12.7% 13.7% 14.6% 17.6% 16.9% EVA $ 3.0 $ 5.6 $ 8.4 $ 11.1 $ 14.0 $ 10.2 $ 19.8 DRILLING SYSTEMS: REVENUE 135.2 139.5 143.7 148.0 152.2 156.5 160.7 OPERATING INCOME 24.5 26.1 27.6 29.2 30.8 32.4 33.9 AVERAGE NET ASSETS 52.6 53.6 54.7 55.7 56.8 57.9 58.9 EVA $ 5.1 $ 5.9 $ 6.8 $ 7.6 $ 8.5 $ 9.4 $ 10.2 OIL TOOLS: REVENUE 57.4 59.2 61.0 62.8 64.6 66.4 68.2 OPERATING INCOME 11.3 12.0 12.7 13.3 14.0 14.7 15.3 AVERAGE NET ASSETS 30.8 31.3 31.7 32.2 32.6 33.1 33.5 EVA $ 2.8 $ 3.2 $ 3.5 $ 3.8 $ 4.2 $ 4.6 $ 5.0 M/D TOTCO: REVENUE 73.8 76.1 78.4 80.7 83.0 85.4 87.7 OPERATING INCOME 13.4 14.3 15.1 16.0 16.8 17.7 18.5 AVERAGE NET ASSETS 37.9 38.5 39.1 39.7 40.3 40.8 41.4 EVA ($0.3) $ 0.1 $ 0.6 $ 1.0 $ 1.5 $ 2.0 $ 2.5 2 3 4 5 6 7 8 - -------------------------------------------------------------------------------------------- SHAFFER: REVENUE 168.0 173.3 178.6 183.9 189.2 194.4 199.7 OPERATING INCOME 13.4 15.4 17.3 19.3 21.2 23.2 25.1 AVERAGE NET ASSETS 75.8 77.1 78.4 79.7 81.0 82.4 83.7 EVA ($1.9) ($0.9) $ 0.2 $ 1.2 $ 2.3 $ 3.4 $ 4.5 RIGTECH REVENUE 11.1 11.4 11.8 12.1 12.5 12.8 13.2 OPERATING INCOME -0.1 0.0 0.2 0.3 0.4 0.5 0.7 AVERAGE NET ASSETS 7.4 7.5 7.6 7.7 7.7 7.8 7.9 EVA ($1.7) ($1.7) ($1.7) ($1.6) ($1.5) ($1.5) ($1.4) GRADE LEVEL 2 3 4 5 6 7 8 - -------------------------------------------------------------------------------------------------
BONUS POINTS = 9 10 11 12 13 14 15 ------------------------------------------------------------------ E.P.S. $ 0.80 $ 0.85 $ 0.90 $ 0.95 $ 1.00 $ 1.10 $ 1.20 NET INCOME 53.6 57.0 60.3 63.7 67.0 73.7 80.4 AVERAGE INVESTMENT 300.8 309.8 318.8 327.8 345.8 363.8 390.8 NET INCOME R.O.I. 17.8% 18.4% 18.9% 19.4% 19.4% 20.3% 20.6% EVA $ 10.2 $ 25.7 $ 28.8 $ 31.8 $ 37.3 $ 42.9 $ 50.7 DRILLING SYSTEMS: REVENUE 165.0 171.1 177.1 183.2 195.4 207.5 225.7 OPERATING INCOME 35.5 37.0 38.5 40.1 43.1 46.1 50.7 AVERAGE NET ASSETS 60.0 61.8 63.6 65.5 69.1 72.8 78.2 EVA $ 11.1 $ 12.0 $ 12.8 $ 13.7 $ 15.4 $ 17.1 $ 19.6 OIL TOOLS: REVENUE 70.0 72.6 75.2 77.7 82.9 88.0 95.8 OPERATING INCOME 16.0 16.6 17.3 17.9 19.2 20.5 22.4 AVERAGE NET ASSETS 34.0 34.8 35.5 36.5 38.4 40.4 43.3 EVA $ 5.3 $ 5.8 $ 6.3 $ 6.7 $ 7.5 $ 8.2 $ 9.3 M/D TOTCO: REVENUE 90.0 93.3 96.6 99.9 106.6 113.2 123.1 OPERATING INCOME 19.4 20.2 21.1 21.9 23.5 25.2 27.7 AVERAGE NET ASSETS 42.0 43.2 44.3 45.5 47.8 50.1 53.6 EVA $ 3.0 $ 3.6 $ 4.3 $ 4.9 $ 6.0 $ 7.0 $ 8.4 9 10 11 12 13 14 15 - -------------------------------------------------------------------------------------------------- SHAFFER: REVENUE 205.0 212.5 220.1 227.6 242.7 257.8 280.4 OPERATING INCOME 27.1 29.0 30.9 32.8 36.5 40.3 46.0 AVERAGE NET ASSETS 85.0 88.4 91.8 95.2 102.0 108.8 118.9 EVA $ 5.6 $ 6.5 $ 7.5 $ 8.4 $ 10.2 $ 12.1 $ 14.7 RIGTECH REVENUE 13.5 14.0 14.5 15.0 16.0 17.0 18.5 OPERATING INCOME 0.8 0.9 1.0 1.2 1.4 1.7 2.0 AVERAGE NET ASSETS 8.0 8.1 8.3 8.4 8.7 9.0 9.5 EVA ($1.3) ($1.2) ($1.1) ($0.9) ($0.7) ($0.6) ($0.3) GRADE LEVEL 9 10 11 12 13 14 15 - ---------------------------------------------------------------------------------------------------
EXEC 30% 36% 42% 48% 54% 60% 65% 16 23% 27% 32% 36% 41% 45% 48% 15 21% 25% 29% 33% 37% 42% 45% 14 18% 21% 24% 28% 32% 36% 38% 13 14% 16% 19% 22% 25% 28% 30% 12 11% 13% 15% 17% 19% 21% 22% 10/11 8% 9% 10% 12% 14% 16% 17%
EXEC 70% 75% 80% 85% 90% 95% 100% 16 52% 56% 60% 64% 67% 70% 73% 15 48% 51% 55% 59% 62% 65% 68% 14 40% 43% 46% 49% 52% 55% 58% 13 32% 35% 38% 41% 44% 47% 50% 12 24% 26% 28% 30% 32% 34% 36% 10/11 18% 19% 21% 22% 24% 26% 28%
EX-11 7 STATEMENT RE COMPUTATION OF PER SHARE EARNINGS Exhibit 11 VARCO INTERNATIONAL, INC. Statement Re Computation of Per Share Earnings
Three Months Ended Twelve Months Ended December 31 1997 December 31 1997 ------------------ ------------------ A. CALCULATION OF ADJUSTED EARNINGS Net Income After Tax $18,320,000 $49,875,000 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, 1997 92 5,896,840,904 64,096,097 1,630,513 65,726,610 Twelve Months Ended December 31, 1997 365 8,668,146,320 63,649,776 1,550,923 65,200,699 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, 199 18,320,000 = $0.28 ------------ 65,726,610 Twelve Months Ended December 31, 19 49,875,000 = $0.76 ------------ 65,200,699 Basic Income Per Share Three Months Ended December 31, 199 18,320,000 = $0.29 ------------ 64,096,097 Twelve Months Ended December 31, 19 49,875,000 = $0.78 ------------ 63,649,776
VARCO INTERNATIONAL, INC. Statement Re Computation of Per Share Earnings
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 STATEMENT RE COMPUTATION OF RATIOS EXHIBIT 12 VARCO INTERNATIONAL, INC. STATEMENT RE COMPUTATIONS OF RATIOS ($000'S)
1998 1997 1996 ------------------------------ Ratio of Earnings to Fixed Charges - ---------------------------------- Earnings: Pretax Income $91,157 $76,696 $38,088 Plus: Interest Expense 1,823 3,510 3,948 Amortization of Debt Issuance Costs 154 154 177 ------------------------------ Total $93,134 $80,360 $42,213 ============================== Fixed Charges: Interest Expense $ 1,823 $ 3,510 $ 3,948 Amortization of Debt Issuance Costs 154 154 177 ------------------------------ Total $ 1,977 $ 3,664 $ 4,125 ============================== Ratio of Earnings to Fixed Charges 47.11 21.93 10.23
EX-13 9 1998 ANNUAL REPORT TO SHAREHOLDERS EXHIBIT 13 - -------------------------------------------------------------------------------- [GRAPHIC OF A CAPITAL Q APPEARS HERE] Varco International, Inc. [1998 Annual Report] Varco achieved record performance in 1998 and strengthened its position as a leading manufacturer of oil and gas well drilling equipment worldwide. What does the future hold? - -------------------------------------------------------------------------------- [GRAPHIC OF CAPITAL A APPEARS HERE] Although 1999 will benefit from previously committed orders, drilling activity has been adversely affected by lower oil and gas prices. Once again, our challenge is to manage successfully through a downturn while taking advantage of new market opportunities. Overall, our strategy remains constant. - -------------------------------------------------------------------------------- [ $ ] Consolidated Financial and Operating Highlights
======================================================================================================= (dollars in thousands, except per share data) Year ended December 31, 1998 1997 1996 1995 1994 ======================================================================================================= Revenues $740,979 $545,789 $368,422 $273,731 $223,601 Net income 60,338 49,875 24,542 14,439 12,161 Diluted income per share .92 .76 .38 .23 .18 Net income as a percent of revenues 8.1% 9.1% 6.7% 5.3% 5.4% Shares used in computing diluted income per share 65,594 65,201 63,463 63,145 67,134 Shareholders' equity $319,367 $253,199 $195,508 $151,179 $163,728 Return on average shareholders' equity 21.8% 22.7% 14.2% 9.2% 7.7% Capital expenditures $ 35,269 $ 35,121 $ 11,023 $ 10,517 $ 5,195 Number of employees 2,951 2,852 1,936 1,636 1,410
For unaudited selected quarterly financial data see Note i of Notes to Consolidated Financial Statements. Varco International, Inc. is a leading manufacturer of products used in the oil and gas well drilling industry worldwide and a leading developer of new technologies to enhance the safety and productivity of the drilling process. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- ====================================================== [GRAPHIC OF RIBBON The Past: Impressive APPEARS HERE] ====================================================== [LINE GRAPH & BAR CHART APPEAR HERE]
YEAR OIL PRICE REVENUE ---- --------- ------- [IN MILLIONS] 1984 $29.38 $ 59.6 1985 $27.98 $ 60.6 1986 $15.07 $ 42.5 1987 $19.16 $ 37.8 1988 $15.97 $ 68.9 1989 $19.58 $ 86.6 1990 $24.50 $132.1 1991 $21.48 $216.6 1992 $20.57 $173.1 1993 $18.46 $193.5 1994 $17.21 $223.6 1995 $18.42 $273.7 1996 $22.10 $368.4 1997 $20.60 $545.8 1998 $14.40 $741.0
REVENUE GROWTH VS. OIL PRICE [BAR CHART APPEARS HERE]
YEAR NET INCOME ---- ---------- [IN MILLIONS] 1984 -$17.9 1985 -$ 1.7 1986 -$ 9.2 1987 -$ 6.0 1988 $ 2.3 1989 $ 2.4 1990 $ 8.7 1991 $14.0 1992 $ 2.4 1993 $ 7.1 1994 $12.2 1995 $14.4 1996 $24.5 1997 $49.9 1998 $60.3
NET INCOME GROWTH no 2. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- [GRAPHIC OF RIBBON APPEARS HERE] [BAR CHART APPEARS HERE]
YEAR DEBT/CAP ---- -------- 1984 61.0% 1985 51.0% 1986 59.0% 1987 44.0% 1988 43.0% 1989 31.0% 1990 36.0% 1991 16.0% 1992 26.0% 1993 24.0% 1994 23.0% 1995 21.0% 1996 14.0% 1997 7.0% 1998 3.0%
DEBT AS A PERCENT OF TOTAL CAPITALIZATION [BAR CHART APPEARS HERE]
YEAR EQUITY ---- ------ [IN MILLIONS] 1984 $ 33.5 1985 $ 32.0 1986 $ 22.9 1987 $ 33.5 1988 $ 48.8 1989 $ 61.0 1990 $ 94.3 1991 $141.9 1992 $144.4 1993 $152.6 1994 $163.7 1995 $151.2 1996 $195.5 1997 $253.2 1998 $319.4
SHAREHOLDERS' EQUITY no 3. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- =================================================================== [GRAPHIC OF TROPHY The Present: Record Performance APPEARS HERE] =================================================================== TO OUR SHAREHOLDERS, CUSTOMERS AND EMPLOYEES For the oil service industry, 1998 was a year of dramatic contrasts. It began on a high note, with more rigs drilling throughout the world than at any time in this decade. The offshore rig fleet was effectively fully employed, with utilization above 95 per cent, and commitments for the construction of new offshore rigs were being announced regularly. Despite some weakening in oil prices beginning in November of 1997, the mood of the industry was decidedly buoyant. However, by the end of 1998, inflation-adjusted oil prices plunged to their lowest level in decades, worldwide drilling activity declined to record lows and offshore rig utilization and dayrates were falling rapidly. The mood turned somber, as oil service companies made a strategic about-face, from a focus on growth and expansion to one of retrenchment. Varco has not been immune to any of these influences. Therefore, it is important to review our 1998 performance against the backdrop of these overall industry conditions. Financial Results Both Revenues and Net Income for 1998 were the highest in the Company's 91-year history. Revenues of $741.0 million were up 36 per cent from $545.8 million in the prior year and more than double the $368.4 million of two years ago. Net Income was $60.3 million, $.92 per share, including a pre-tax charge of $8.5 million, $.09 per share, for severance and other expenses anticipated during 1999 as we reduce our cost structure to conform with current market conditions. Excluding this charge, 1998 income was 32 per cent above the $49.9 million, $.76 per share, earned in 1997. Order bookings for 1998 were $757.4 million before cancellations of $118.0 million, versus $820.9 million in 1997 and $478.5 million in 1996. Through the first half of the year incoming orders maintained a rate somewhat above the 1997 level, before declining in each of the final two quarters. The cancellations, which occurred primarily in the second half of the year, virtually all relate to orders for equipping new offshore rigs. Although nearly all of the rigs under construction have long-term contracts with oil companies, those that do not have been the source of most of the cancellations. Although the December 31, 1998 backlog of $367.4 million is below the $462.9 million at the end of 1997, it is still the second highest year-end total in the Company's history. Most of this backlog is due to be delivered during the next twelve months. Accordingly, it will be toward the end of 1999 or early 2000 before the full impact of the industry slowdown is reflected in our financial results. Meanwhile, our financial condition remains strong. The year-end 1998 Balance Sheet no 4. - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- [GRAPHIC OF TROPHY APPEARS HERE] reflects debt of just $9.9 million and cash and cash equivalents of $29.1 million, providing a solid financial base during this period of market uncertainty. Although 1998 was another year of substantial revenue and profit growth, and represented outstanding financial performance by virtually all measures, any feeling of satisfaction is tempered by the expectation that current market conditions make the road ahead much more difficult. Market Conditions and Outlook As indicated previously, weak oil prices are responsible for the deteriorating market conditions experienced during 1998. After averaging more than $20 per barrel during each of the previous two years, oil prices averaged approximately $14.40 for all of 1998 and $13.50 for the fourth quarter. As a result, in its annual Survey of Worldwide Exploration and Production Expenditures, Salomon Smith Barney predicts that 1999 spending will be down 11 per cent from 1998 levels. That represents the first forecasted year-to-year decline since 1993, and the largest projected drop since 1986. Although our order backlog provides a buffer against the full effect of these reductions during 1999, until oil prices recover and oil companies regain sufficient confidence to increase spending we expect that revenues will be significantly below those of 1998. Strategies With lower oil prices, oil companies will be even more tenacious in their drive to reduce drilling costs. That focus plays into our historical strength and reinforces our continuing efforts to develop products and technologies that help achieve that goal. By being successful in that endeavor we can reduce the negative effect of the market conditions. A primary challenge for us in 1999 is to deliver, install and support the Varco equipment already committed to offshore rigs under construction. These rigs will be the most advanced, automated rigs in the world, and by demonstrating superior performance they can enhance our opportunity to retrofit older rigs with this type of equipment. The realities of our market require that we reduce our cost structure to a level consistent with the sustaining level of business. Accomplishing that while developing new products and ensuring the success of the new advanced technology rigs will require a high level of dedication and skill on the part of our people. We are confident in our ability to achieve these goals. We appreciate your continued support. /s/ George Boyadjieff George Boyadjieff Chairman, President and Chief Executive Officer March 1, 1999 no 5. - -------------------------------------------------------------------------------- ================================================================================ [GRAPHIC APPEARS HERE] The Future: Challenging ================================================================================ Interview with George Boyadjieff Chairman, President and Chief Executive Officer: [PHOTO OF GEORGE BOYADJIEFF APPEARS HERE] Q: 1998 was a year in which record performance was achieved by the Company in a number of areas. What do you consider to be the Company's most significant accomplishments over that period of time? A: The most significant was successfully expanding our capabilities and capacity in order to meet the growth in customer demand. We were able to capture a significant share of the equipment orders for new rigs, and firmly establish ourselves as the major supplier of drilling equipment in the world. We did this without incurring additional debt, which provides the Company with a very strong balance sheet going forward. Q: What were some of your disappointments? A: We were not able to leverage our revenue growth into improved profit margins. Although we anticipated that some inefficiencies were bound to occur with our dramatic growth in employment, which increased by more than seventy per cent over an eighteen-month period, we still expected that we could improve our margins. However, we were not able to make that happen. And, of course the declining industry conditions resulting from low oil prices were both a surprise and a disappointment. Q: Speaking of oil prices, what has been the impact on Varco of the low oil prices which have prevailed for the past 12 months or so? A: There was not much impact until the second half of the year when we began to see a reduced incoming order rate, particularly orders for equipment related to new rig construction. We have also seen some order cancellations where new rig building programs were terminated. The primary impact on 1998 results was in the M/D Totco Division's rental business, which is directly related to the North American rig count. We saw a significant quarter-to-quarter revenue decline there. Q: What are the most significant challenges the Company faces in 1999? A: One challenge for 1999 is to focus on product development, particularly those products that can significantly reduce drilling costs, so that we bring to the market new products which generate revenues to help offset the expected market decline. At the same time, we must deliver the equipment for the rigs currently under construction in a timely manner and ensure that the equipment performs well when it begins operation. no 6. [GRAPHIC APPEARS HERE] Q: What are the Company's strategies for dealing with the current market environment? A: We will stick with the strategies that have made us successful so far. Again, the primary strategy is to continue to introduce new products which reduce drilling costs. Those are the products that can be sold best in a tough market. Of course, we will downsize and reduce costs as appropriate to the market conditions that prevail. Q: Where do you see opportunities for product development and the introduction of new technology? A: The key opportunity is in upgrading existing drilling rigs with automation for improved efficiency, and integrating information technology with automation by using computer-based data collection and analysis to directly control more of the rig functions. This has been done in a number of industries and has resulted in improved efficiency and safety. The drilling industry is no different. Time and again it has been proven that experience can improve a process--but only to a point. Beyond that, the ability to collect data instantaneously, analyze the data and respond appropriately to the conditions it suggests, can produce dramatic improvement. We are only beginning to see this potential with respect to the drilling process. Q: Are you satisfied with the Company's position today? A: As anyone at Varco will tell you, I am, by nature, never satisfied. I do believe that Varco has never been better positioned than it is today. At the same time, we need to increase the intensity of our product development efforts to generate more true "break through" products which dramatically reduce drilling costs. The Top Drive Drilling System has done this and I believe that automated pipe racking can too. Those are the kinds of products that enable us to be successful in a difficult market. Q: When do you expect the current market to turn around? A: I don't know, and to be honest I don't spend a lot of time worrying about it. Nobody has demonstrated an ability to consistently predict oil prices. I believe that Varco's success depends upon our ability to create our own future--to get the best possible results in whatever market environment exists. That's our goal and that's something we can control. no 7. [GRAPHIC OF V APPEARS HERE] From the rig crown to the ocean floor, Varco is the leading supplier of drilling equipment in the world. Our market position is the result of a continuing emphasis on the development of products which enhance the safety and productivity of the drilling process. ================================================================================ [GRAPHIC APPEARS HERE] Operations Review ================================================================================ Industry Trends Conditions in the oil service industry changed dramatically over the course of 1998. Following two years of improvement, the year began with industry activity demonstrating continued strength. Although there was weakness in oil prices, it was generally expected to be mild and short-lived, and the consensus outlook was for continued growth. However, by year-end oil prices plunged to unforeseen levels, and the industry's orientation switched from growth to contraction. Oil prices averaged $18.40, $22.10, and $20.60 per barrel for the years 1995-1997, respectively, and natural gas prices averaged $1.50, $2.50 and $2.50 per thousand cubic feet over the same periods. These commodity prices produced strong cash flow for the major and independent oil companies of the world, and they responded with increased investment in exploration and production ("E & P"). According to Salomon Smith Barney's Annual Survey of Worldwide Oil and Gas Exploration and Production Expenditures, the increases were 9 per cent, 15 per cent and 19 per cent, respectively, for the 1995-1997 period. This investment produced a period of solid growth for the oil service industry. A number of factors converged in late 1997 to precipitate a decline in oil prices. The economic crisis in Asia produced a weakening of demand from an area that had been responsible for much of the growth in recent years. Warmer than normal winter weather throughout the world compounded the problem. Meanwhile, the OPEC members elected to increase their output quotas in November of 1997, and the higher E & P spending increased the supply of oil flowing from the non-OPEC world. The combination of these factors was more severe than originally anticipated, and oil prices, on an inflation-adjusted basis, declined to 25-year lows by late 1998 and early 1999. In this environment, Salomon Smith Barney estimates that growth in E & P spending slowed to 5 per cent for 1998, and indications are that any increase occurred early in the year and that the rate of spending over the second half of the year was well below 1997 levels. In December of 1997 there were 2,318 rigs drilling in the world and the offshore rig fleet was at 95 per cent utilization--effectively fully employed. By December of 1998 the number of rigs drilling had declined by 32 per cent to 1,566 and offshore rig utilization was 83 per cent. The Salomon Smith Barney survey for 1999 projects that worldwide E & P spending will be down 11 per cent from 1998. The survey further indicates that spending plans are based on an average oil price of $14.67, which is above the level existing during early 1999, indicating the potential for further spending reductions if prices do not improve over the course of the year. All indications are for a difficult period ahead for the oil service industry. On a more positive no 9. [ Varco Systems ] [GRAPHIC APPPEARS HERE] Varco Systems designs and manufactures integrated systems for rotating and handling pipe, including Top Drive Systems and horizontal and vertical pipe racking systems. [GRAPHIC APPEARS HERE] note, however, most industry analysts believe that the gap between supply and demand across all segments of the industry is narrower than during previous periods of low oil prices and curtailed activity. Reduced E & P spending will ultimately result in a sufficient reduction in oil supply to provide a basis for recovery. Varco International Varco operates through five independent but complementary Divisions, each providing a portion of the equipment and systems which are integral to the drilling process. When sold as replacement equipment or as a typical upgrade to an existing rig, the products of each Division are usually purchased independently. However, when equipping a new rig or providing a major retrofit of an existing offshore rig, Varco products and systems are frequently sold as a "package" which often involves some level of physical and electronic integration. Although Varco products are used both offshore and onshore, the cost and complexity of offshore drilling requires a substantially greater investment in drilling equipment. Additionally, drilling in extremely deep water from a floating rig, such as a semi-submersible or drillship, requires significantly more equipment than a jackup rig or fixed platform. For example, the value of the equipment which Varco could potentially supply to a deep water rig is approximately $50 million, as compared to approximately $19 million for a harsh environment jackup or platform rig. By comparison, a typical new land rig would create a potential of approximately $3 million of revenue for Varco. While Varco's five Divisions are all influenced primarily by general industry and market conditions, each is also uniquely affected by factors specific to its primary markets and products. Varco Systems designs and manufactures systems and equipment for rotating and handling the various types and sizes of pipe used on a drilling rig. Its products are designed to make the drilling process more productive and safer. At the time of their introduction, Varco Systems' products have typically represented innovative new methods for performing critical drilling functions. The principal products of the Varco Systems Division are the Top Drive Drilling System ("TDS") and pipe handling systems. Introduced in 1982, the TDS is recognized as a more productive means of drilling an oil or gas well than the traditional rotary table. Although its initial applications were primarily offshore and high-cost land drilling where the initial investment could be more quickly returned, more recently the TDS concept has gained acceptance in conventional land drilling. Sales of the TDS are primarily influenced by the construction of new offshore rigs, retrofitting of land rigs and existing offshore rigs, and replacement of previously sold units with newer, upgraded models. To a lesser extent, revenue is derived from the rental of TDS units. no 11. [ Varco BJ ] [GRAPHIC APPPEARS HERE] Varco BJ manufactures a complete line of drilling rig tools and equipment, including pipe handling tools and hoisting and rotary equipment. [GRAPHIC APPEARS HERE] Pipe handling systems are automated or semi-automated devices which provide both vertical and horizontal pipe handling. Vertical pipe racking systems are used to move sections of pipe between the storage ("racking") area on the rig floor and the well center, and to provide the spinning and torquing functions necessary to couple and uncouple sections of pipe. Horizontal pipe racking systems are used to handle various sizes and types of pipe while stored on the pipe deck of an offshore rig, transport pipe sections up to the rig floor, and raise them to a vertical position from which they are passed to a vertical racking system. Automated pipe handling systems were introduced by Varco in 1987 and most units sold to date have been for new offshore rigs. Although new rig construction has been the predominant market, systems more specifically directed to the retrofit market are currently under development. Revenues of the Varco Systems Division were $266.8 million in 1998, up 61 per cent from $165.5 million in 1997 and 127 per cent from $117.7 million in 1996. This Revenue growth is primarily attributable to automated pipe handling systems and related equipment for new offshore rigs. Varco BJ manufactures a complete line of conventional drilling rig tools and equipment. It has evolved from the combination of the original Varco products with several complementary and competitive product lines acquired over the past 10 years. Examples of Varco BJ's products include: elevators, devices which hold pipe while it is being lifted from, or lowered into, the bore hole; slips, which grip pipe and hold it in suspension while in the well; the spinning wrench, a pneumatic or hydraulic powered device used to screw together and unscrew threaded pipe connections; manual tongs, used to make up or break out connections; and casing elevators and spiders, gripping devices used to hold heavy sections of casing while being lowered into the well. Many of these products were original Varco innovations at the time of their introduction, and Varco BJ is regarded as the industry leader in providing quality and reliability. As the Varco product line has moved toward automation and the elimination of personnel from the rig floor, Varco BJ's products have evolved to facilitate this result by providing mechanization and remote activation to tools previously operated manually. While products with these capabilities would be considered mandatory when used in conjunction with a fully automated pipe handling system, they provide sufficient safety and efficiency benefits that they are also sold independently for upgrading existing rigs. Revenues of the Varco BJ Division totaled $96.0 million in 1998, 39 per cent above the $68.9 million in 1997 and 78 per cent above the $53.8 million in 1996. The year-to-year increase in Revenues in 1998 is attributable to generally higher worldwide drilling activity; an emphasis on the replacement and upgrading of older equipment on existing rigs; and the increase in offshore rig construction. no 13. [ M/D Totco ] [GRAPHIC APPPEARS HERE] M/D Totco provides computer-based drilling rig information and control systems, as well as conventional drilling rig instrumentation. [GRAPHIC APPEARS HERE] M/D TOTCO designs and sells computer-based drilling information and control systems, as well as conventional drilling rig instrumentation. Instrumentation systems, at a minimum, consist of sensors which monitor and measure various data relevant to drilling operations and an output or display device. Their basic purpose is to provide the driller and other rig personnel with the information necessary to operate the drilling rig. In recent years, the drilling industry has moved from basic instrumentation toward computer-based information and control systems designed to make the drilling process safer and more efficient. Leading that transition, M/D Totco introduced the TOTAL system in 1991. It consists of sensors, a Data Acquisition Unit ("DAQ") or computer processor, graphical output devices, and data storage and transmission capability. In its basic form, TOTAL collects data and presents it to the driller in an individually configurable graphic or digital format, while also storing it for subsequent analysis. More advanced capabilities include software applications that analyze and interpret the data to assist rig personnel in optimizing drilling operations and anticipating and avoiding potential problems. 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 incorporates the analytical capabilities of the TOTAL system. Orders for 16 systems have been received and the initial four systems were delivered in 1998. Like Varco's other Divisions, M/D Totco's Revenues are influenced by the overall level of drilling activity, rig upgrade and refurbishment, and new rig construction. In general, the nature of its products have caused the first two of these elements to have a relatively greater impact on M/D Totco than on Varco as a whole. In particular, the rental business, which has typically constituted 40 to 45 per cent of its Revenues, is directly influenced by the level of drilling activity, especially in North America. As a result of the declining rig count, M/D Totco's rental Revenues were $30.9 million in 1998, versus $37.6 million in 1997. Overall Revenues were $94.6 million in 1998, as compared to $90.6 million in 1997, and $62.2 million in 1996. Shaffer manufactures and sells pressure control and motion compensation equipment. Pressure control equipment includes blowout preventers ("BOP's") and the control systems that enable their remote activation; and riser, large diameter pipe used to connect a floating offshore rig (semi-submersible or drillship) to the ocean floor. Motion compensation equipment is used on floating rigs to offset the effect of wind and wave action on the drilling process. Shaffer has experienced dramatic growth over the past three years as a result of the increase in deepwater drilling (in excess of 3,000 feet) and the demand for rigs having such capability. Early in no 15. [ Shaffer ] [GRAPHIC APPPEARS HERE] Shaffer manufactures pressure control equipment, including blowout preventers and the related control systems, riser, and motion compensation equipment. [GRAPHIC APPEARS HERE] that period Shaffer benefited from rig owners upgrading the water depth capacity of existing rigs, and later from the building of new deepwater rigs. The impact on Shaffer of either is substantial, as a new deepwater rig requires equipment of the type supplied by Shaffer valued in excess of $30 million, and a major upgrade offers a potential of approximately half that figure. In the ten or so years preceding 1995 there was almost no new investment in rigs of this type; consequently, the recent increase in demand has caused Shaffer's Revenues to increase dramatically. Revenues were $256.2 million in 1998, versus $206.5 million in 1997 and $123.8 million in 1996. This increase in Revenues is directly attributable to the growth of deepwater drilling and the resultant upgrading and construction of rigs capable of such drilling. Rigtech designs and sells solids control equipment and fluid handling systems. During drilling operations drilling fluid ("mud") is circulated through the well bore to contain formation pressure, lubricate the drill bit, and return cuttings to the surface. Rigtech's revenues result primarily from the sale of solids removal equipment, primarily shale shakers, which remove cuttings ("solids") from the drilling fluid so that it may be recirculated, and from the sale of spare and expendable parts for such equipment. Rigtech has also developed equipment and systems which automate the process of handling drilling fluids on a drilling rig ("Automated Mud System" or "AMS"). Included are devices which monitor and control the mixing of drilling fluids, the dispensing of chemical additives, and the movement of fluids between mixing hoppers, the mud pits (from which it is pumped into the bore hole), and back through the cleaning process. During 1998 Rigtech delivered three such systems, the first since the prototype was introduced in 1993. Rigtech's Revenues were $21.3 million in 1998, versus $13.4 million in 1997 and $9.4 million in 1996. The Revenue increase in 1998 is primarily attributable to the AMS. Rigtech, based in Aberdeen, Scotland, was a privately held company prior to its acquisition by Varco in 1994. Although it enjoys a very substantial share of the North Sea market, Rigtech has a relatively small share of the overall worldwide solids control market. Through a combination of product development and geographic expansion, it is Varco's goal to expand considerably that market position. Financial Review 1998 Revenues of $741.0 million were the highest in the Company's history, 36 per cent above the $545.8 million for 1997 and more than double the $368.4 million recorded in 1996. Net Income was $60.3 million, including the special charge described below. Excluding this charge, Net Income of $66.0 million, was up 32 per cent from $49.9 million in 1997 and 169 per cent from $24.5 million in 1996. The growth of the past two years was driven by two primary factors: (1) a trend toward drilling no 17. [ Rigtech ] [GRAPHIC APPPEARS HERE] Rigtech provides solids removal equipment that removes cuttings from the drilling fluid so that it may be recirculated, as well as equipment and systems which automate the mixing, handling and transport of such fluids. [GRAPHIC APPEARS HERE] in deeper water which led to the upgrading of existing offshore rigs and the construction of new rigs and (2) the relatively high level of offshore drilling activity which prevailed for most of the period. Incoming orders for 1998 were $757.4 million (excluding cancellations of $118.0 million), following totals of $820.9 million and $478.5 million, respectively, for the preceding two years. Peak order rates were reached during the second half of 1997 and the first half of 1998, following which the weakening market began to have a significant impact. As a result of the market conditions and declining order rate, the Company recorded a special charge of $8.5 million in the fourth quarter of 1998 for severance and other expenses expected to be incurred during 1999 as the cost base is reduced. Following a sharp increase in 1997, Operating Profit margins (Earnings Before Interest and Taxes, or "EBIT", as a percent of Revenues) were 12.5 per cent in 1998, as compared to 14.7 per cent in the prior year and 11.4 per cent in 1996. The year-to-year decline is attributable to a 3.7 per cent lower Gross Margin and a 0.8 per cent increase in Research and Development expense as a per cent of Revenue, which were only partially offset by a decrease in Selling, General and Administrative expenses in relation to Revenues. The lower Gross Margin results from two primary factors, of roughly equal magnitude: (1) approximately $40 million of Revenue from three new products at low Gross Margins; and (2) higher manufacturing costs and inefficiencies related to the increase in volume and employment over the past two years. While the initial units of a new product typically result in high manufacturing costs and below average Gross Margins, the impact in 1998 was particularly significant due to unusually high new product Revenues. Cash Flow Return on Investment (EBIT plus Depreciation, Amortization and special charge) as a per cent of Average Net Investment (Shareholders' Equity plus Debt less Cash), considered by the Company to be a very meaningful measure of overall financial performance, remained very favorable in 1998 at 41 per cent, unchanged from the prior year and well above the 27 per cent achieved in 1996. The Company's balance sheet remains strong, as cash and cash equivalents of $29.1 million exceeded total Debt of $9.9 million at December 31, 1998 and Shareholders' Equity was $319.4 million. Although the increase in profitability was below our expectations given the substantial Revenue growth, by virtually all measures our 1998 financial performance was very good. Importantly, the rapid growth we have experienced over the past two years has been financed without incurring debt. A strong balance sheet will serve us well in this period of uncertainty. no 19. [BAR CHART APPEARS HERE]
YEAR REVENUES ---- -------- [IN MILLIONS] 1994 $223.6 1995 $273.7 1996 $368.4 1997 $545.8 1998 $741.0
REVENUES [BAR CHART APPEARS HERE]
YEAR NET INCOME ---- ---------- [IN MILLIONS] 1994 $12.2 1995 $14.4 1996 $24.5 1997 $49.9 1998 $60.3
NET INCOME [BAR CHART APPEARS HERE]
YEAR DILUTED INCOME ---- -------------- 1994 $0.18 1995 $0.23 1996 $0.38 1997 $0.76 1998 $0.92
DILUTED INCOME PER SHARE [BAR CHART APPEARS HERE]
YEAR ASSETS ---- ------ [IN MILLIONS] 1994 $257.6 1995 $246.6 1996 $316.0 1997 $471.1 1998 $546.9
TOTAL ASSETS [BAR CHART APPEARS HERE]
YEAR SHARE EQUITY ---- ------------ [IN MILLIONS] 1994 $163.7 1995 $151.2 1996 $195.5 1997 $253.2 1998 $319.4
SHAREHOLDERS' EQUITY [BAR CHART APPEARS HERE]
YEAR % RETURN EQTY ---- ------------- 1994 7.7% 1995 9.2% 1996 14.2% 1997 22.7% 1998 21.8%
RETURN ON AVERAGE EQUITY [BAR CHART APPEARS HERE]
YEAR R&D EXPENSE ---- ----------- [IN MILLIONS] 1994 $11.4 1995 $13.2 1996 $14.3 1997 $21.1 1998 $34.6
R&D EXPENSE [BAR CHART APPEARS HERE]
YEAR % RETURN REV ---- ------------ 1994 5.4% 1995 5.3% 1996 6.7% 1997 9.1% 1998 8.1%
RETURN ON REVENUES [BAR CHART APPEARS HERE]
YEAR EMPLOYEES ---- --------- 1994 1,410 1995 1,636 1996 1,936 1997 2,852 1998 2,951
NUMBER OF EMPLOYEES no 20. Consolidated Financial Statements [ 22 ] Five-Year Financial and Operating Highlights [ 23 ] Management Report of Financial Responsibilities [ 24 ] Management's Discussion and Analysis of Financial Condition and Results of Operations [ 29 ] Consolidated Balance Sheets [ 30 ] Consolidated Statements of Income [ 31 ] Consolidated Statements of Shareholders' Equity [ 32 ] Consolidated Statements of Cash Flows [ 33 ] Notes to Consolidated Financial Statements [ 43 ] Report of Independent Auditors [ 44 ] Stock Information [ $ ] FIVE-YEAR FINANCIAL AND OPERATING HIGHLIGHTS
====================================================================================== (in thousands, except per share amounts) Year ended December 31, 1998 1997 1996 1995 1994(1) ====================================================================================== Summary of Operations Revenues $740,979 $545,789 $368,422 $273,731 $223,601 Gross profit 239,032 196,969 125,816 99,214 86,761 Research and development 34,567 21,084 14,331 13,156 11,438 Selling, general and administrative expenses 109,079 96,398 70,891 61,014 53,798 Special charge 8,500 Interest expense 1,823 3,683 3,948 4,516 4,766 Income before income taxes 91,157 76,696 38,088 21,908 18,917 Income taxes 30,819 26,821 13,546 7,469 6,756 Net income 60,338 49,875 24,542 14,439 12,161 As a per cent of revenues 8.1% 9.1% 6.7% 5.3% 5.4% Return on average shareholders' equity 21.8% 22.7% 14.2% 9.2% 7.7% Per share of Common Stock Basic income per share(2) $ .94 $ .78 $ .39 $ .23 $ .18 Diluted income per share(2) .92 .76 .38 .23 .18 Book value per share 4.94 3.95 3.09 2.51 2.46 ====================================================================================== Year-end financial position Working capital $176,299 $137,477 $120,246 $ 89,187 $112,342 Current ratio 1.8 1.7 2.4 2.5 3.4 Property, plant and equipment - net 89,997 73,862 48,711 45,260 47,659 Total assets 546,920 471,129 316,021 246,571 257,641 Long-term debt 9,845 22,715 29,539 39,349 Shareholders' equity 319,367 253,199 195,508 151,179 163,728 Long-term debt as percent of total capitalization 0.0% 3.6% 10.4% 16.3% 19.4% ====================================================================================== Other Capital expenditures $ 35,269 $ 35,121 $ 11,023 $ 10,517 $ 5,195 Depreciation and amortization 22,121 16,971 13,249 12,347 10,996 Number of employees 2,951 2,852 1,936 1,636 1,410 Average shares used in computing basic income per share(2) 64,451 63,650 62,181 62,610 66,750 Average shares used in computing diluted income per share(2) 65,594 65,201 63,463 63,145 67,134 ======================================================================================
(1) Includes the acquisition of Rig Technology Limited as of November 30, 1994. (2) 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. no 22. [ $ ] 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, 1998, 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 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, President & Vice President -- Finance & Chief Executive Officer Chief Financial Officer February 8, 1999 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, objectives and estimated cost of Year 2000 compliance. 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. no 23. [ $ ] 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, 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. 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 a barrel and ended the year between $11 and $12 a barrel. Natural gas prices averaged approximately $2.04 per thousand cubic feet for 1998 but declined to an average of approximately $1.74 for December. The price of oil averaged approximately $20.60 and $22.10 a barrel for 1997 and 1996, respectively. The price of natural gas averaged approximately $2.50 per thousand cubic feet for each of 1997 and 1996. During 1996 and 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 1996 and 1997. Conversely, the declining commodity prices during 1998 have led to lower cash flows for the oil companies and a reduction in exploration and production expenditures, leading to declining drilling activity. Commodity prices have remained low for the early part of 1999, further negatively impacting the level of worldwide drilling activity. Rig counts, as reported by industry sources, for each of the past three years are summarized in the following table: 1998 1997 1996 -------------------------------------------------------------------- Approximate Average Annual Rig Count: Worldwide average rig count 1,843 2,126 1,836 United States & Canada average rig count 1,088 1,317 1,043 International average rig count 755 809 793 Approximate average number of offshore rigs under contract 555 606 550 In 1998, overall drilling activity, as reflected by the average number of rigs drilling worldwide, fell to its 1996 level after growing by approximately 16% in 1997. Drilling activity declined throughout 1998, ending the year with the December rig count averaging approximately 1,566. Significant in its impact on the Company during 1997 and 1996 was increased worldwide utilization of offshore rigs (rigs under contract as a percent of available rigs), which was driven both by increased demand and by a continually shrinking supply of available offshore rigs. Utilization rates were 94% and 90% for the years 1997 and 1996, respectively, and each of these rates was higher than any year since 1982. The higher utilization was accompanied by increasing 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 the announcement of plans to increase the mobile offshore rig fleet. 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 throughout the year. In December of 1998, the approximate average number of offshore rigs under contract was 510 and the utilization rate was approximately 83%. no 24. [ $ ] 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) 1998 1997 1996 ----------------------------------------------------------- ORDERS Varco Systems $ 258,494 $ 287,435 $ 137,722 Varco BJ 94,968 99,379 56,308 M/D Totco 110,647 100,602 63,950 Shaffer 273,626 311,052 211,539 Rigtech 19,621 22,452 8,969 Cancellations (117,953) ----------------------------------------------------------- Total $ 639,403 $ 820,920 $ 478,488 =========================================================== Orders declined $181.5 million, 22%, in 1998 as compared to 1997. This decline is primarily the result of the reduction in, and cancellation of, orders associated with upgrading and construction of offshore drilling rigs. The cancellations in 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 $67.1 million were incurred by Shaffer and $35.6 million by Varco Systems with the balance distributed among the remaining Divisions. 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 its new drilling rig control system, "V-ICIS," which was introduced in 1997. During 1998, the quarterly order rate declined throughout the year. The first quarter order rate was $299.6 million (less $13.0 million in cancellations) and the fourth quarter order rate was $117.5 million (less $54.4 million in cancellations). The higher level of orders in 1997 as compared to both 1998 and 1996 is 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. During 1997 Shaffer secured several orders to provide pressure control, motion compensation and related equipment, and Varco Systems obtained several orders to provide vertical and horizontal pipe handling systems and Top Drive Drilling Systems ("TDS's") to these rigs. The increase in orders for the Varco BJ and M/D Totco Divisions also resulted, in part, from the offshore rig upgrades and new construction. Rigtech's 1997 increase is primarily due to increased orders of "Automated Mud Systems" for such rigs. In addition to the construction and upgrading of offshore drilling rigs, in 1997 the Company benefited from increased sales of spare and replacement parts and service related to the increase in worldwide drilling activity. The Company estimates that approximately 20% to 25% of its order growth in 1997 is attributable to such increases. Set forth below are the annual revenues for the Company's five Divisions. (in thousands) 1998 1997 1996 ------------------------------------------------------- REVENUES Varco Systems $266,776 $165,510 $117,658 Varco BJ 95,959 68,931 53,830 M/D Totco 94,639 90,601 62,227 Shaffer 256,238 206,483 123,846 Rigtech 21,273 13,372 9,419 ------------------------------------------------------- Total $734,885 $544,897 $366,980 ======================================================= no 25. [ $ ] The Company's sales and rentals 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 is due to the delivery of equipment for offshore rig upgrades and construction and the remainder is 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. The Company's sales and rentals increased by $177.9 million, 48% in 1997 as compared to 1996, with the Shaffer and Varco Systems Divisions accounting for $130.5 million of this increase. Approximately 70% of the increase at each of these Divisions is due to the delivery of equipment for offshore rig upgrades and construction and the remainder is due to the overall drilling activity increase. M/D Totco and Varco BJ revenues increased $28.4 and $15.1 million, respectively. Approximately 55% of these increases are related to the overall drilling activity increase with the balance due to upgrades and rig construction. In early 1999, the price of oil remained in the $11 to $12 a barrel range and drilling activity continued to decline. If the price of oil doesn't increase significantly, management believes that new orders for its products are likely to decline below the fourth quarter rate of $117.5 million and negatively impact future revenues. The effect on 1999 revenues will be somewhat lessened by the shipment of the December 31, 1998 backlog. The Company's backlog of unshipped orders was $367.4 million at December 31, 1998, as compared to $462.9 million at December 31, 1997, and $186.9 million at December 31, 1996. The Company expects that substantially all of the backlog will be shipped by December 31, 1999. At December 31, 1998, the Company had received $95.8 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. As a result of low oil prices and the downturn in drilling activity, the Company anticipates that it will experience additional cancellations. While the Company cannot predict the potential dollar value of any such cancellations, it expects such cancellations will be substantially less than the amount experienced in 1998. The increase in other income for 1998 as compared to prior years is attributable to cancellation fees received for expenses and costs incurred prior to the cancellation of orders. Gross 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 32.5% for 1998, 36.2% for 1997 and 34.3% for 1996. 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 by the decline in rental revenue which carries a higher gross margin than other revenues. 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 higher 1997 margins as compared to 1996 were a result of improved margins at Varco Systems, Varco BJ and M/D Totco. These improvements favorably impacted consolidated margins by 3.2% as their combined margins improved from 38.9% in 1996 to 43.9% in 1997. Price increases accounted for approximately two-thirds of this improvement with the remainder attributable to the favorable Dutch Guilder exchange rate lowering dollar cost at Varco BJ's Netherlands manufacturing facility and to cost reductions. This improvement was partially offset by the larger percentage increase in Shaffer's revenue and by lower margins at the Shaffer Division. Shaffer's products carry lower gross margins (due principally to price competition) than the combined gross margins of the other Divisions. In addition, Shaffer's 1997 margins were negatively impacted by high initial costs on some of its newer products. The Company believes that new product development is significant to the future growth of the Company. Research and development expenses were $34.6 million, $21.1 million and $14.3 million for the years 1998, 1997 and 1996 respectively, and represented 4.7%, 3.9% 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 1999. Selling, general and administrative expenses were $109.1 million in 1998 (14.7% of revenues) as compared to $96.4 million in 1997 (17.7% of revenues) and $70.9 million (19.2% of revenues) in 1996. The increases in 1998 and 1997 as compared to 1996 resulted primarily from increases in employment related costs. The Company expects no 26. [ $ ] that total selling, general and administrative expenses will decline in the future, commensurate with the anticipated revenue levels. It is further expected that the relation of these expenses to revenue will be above the 1998 rate of 14.7%. At December 31, 1998, overall Company employment was 2,951 (including 155 temporary employees) as compared to 2,852 (including 415 temporary employees) at December 31, 1997 and 1,936 (including 220 temporary employees) at December 31, 1996. During the fourth quarter of 1998, the Company recognized an $8.5 million special charge consisting of the following: severance cost 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 has adopted a plan to restructure all of its Divisions' operations consistent with the current and expected lower market conditions. The Company spent $422 thousand of the $7.0 million of cash charges in 1998 and expects to spend substantially all of the remaining cash charges in 1999. The Company's effective income tax rate was 33.8% in 1998 as compared to 35.0% in 1997 and 35.6% in 1996. The lower effective income tax rate in 1998 as compared to 1997 and 1996 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, 1998 the Company had cash and cash equivalents of $29.1 million as compared to $39.8 million at December 31, 1997. During 1998, the Company generated $31.2 million from operations, invested $35.3 million in property, plant and equipment and paid down long-term debt by $10.0 million. In July 1992, the Company sold $50.0 million aggregate principal amount of its 8.95% Senior Notes Due June 30, 1999 (the "Senior Notes") to a group of ten institutional investors pursuant to a Note Agreement dated as of July 1, 1992 (the "Note Agreement"). The remaining $10.0 million principal balance of the Senior Notes is payable on June 30, 1999. 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, 1998, there were no advances outstanding and $4.2 million in letters of credit outstanding under this facility. Both the Note Agreement and the Credit Agreement restrict 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, which is generally the more restrictive of these, 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, 1998, the amount available for dividends and repurchases under the Credit Agreement was $28.0 million. On November 6, 1997, the Board of Directors of the Company declared a two-for-one stock split of its Common Stock, payable on December 4, 1997 to shareholders of record at the close of business on November 20, 1997. Working capital was $176.3 million at December 31, 1998 compared to $137.5 million at December 31, 1997. The Company's current ratio has increased from 1.7 to 1.0 at December 31, 1997 to 1.8 to 1.0 at December 31, 1998. The increase in working capital and current ratio is primarily due to the higher level of receivables and inventory to support the Company's higher revenue levels in 1998. At December 31, 1998, the Company had no long-term debt. Capital expenditures were $35.3 million in 1998 and $35.1 million in 1997. These capital expenditures were primarily for the purchase of additional machine tools to increase manufacturing capacity. The Company expects to reduce its capital expenditures in 1999 to less than $20 million. The Company believes that its December 31, 1998 cash and cash equivalents and its credit facility will be sufficient to meet its capital expenditures, cash portion of the special charge, operating cash needs, and the principal payment on the Senior Notes in 1999. no 27. [ $ ] 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 is continuing to assess the impact that the Year 2000 Issue may have on its information technology ("IT") systems and its operations and has identified the following four key areas of its business that may be affected: Products The Company has developed detailed testing procedures for each of its products that have a date reference. Compliance testing of the Company's products, in accordance with these procedures, is approximately 90% complete with the testing of all products expected to be completed by March 31, 1999. The most extensive testing is in the M/D Totco Division, which develops software for control systems and drilling applications. Based upon the evaluation and testing completed, the Company believes that its currently supported products, as opposed to discontinued and obsolete products, are Year 2000 compliant. The Company has mailed to its customers a list of compliant products and has advised customers which products needed to be upgraded or replaced for Year 2000 compliance. Internal Business Systems The Year 2000 Issue could affect the systems, transaction processing, computer applications and devices used by the Company to operate and monitor all major aspects of its business, including financial systems, customer services, materials requirement planning, master production scheduling, networks and telecommunications systems. The Company has completed its assessment phase and believes that it has identified substantially all of the major systems, software applications and related equipment used in connection with its internal operations that must be modified or upgraded in order to minimize the possibility of a material disruption to its business. The Company is currently in the remediation phase of modifying and upgrading all affected systems and expects to complete this phase by the beginning of the third quarter of 1999. The Company estimates that it will be Year 2000 compliant by the end of the third quarter of 1999. However, any unforeseen problems which occur during the testing phase may adversely affect the Company's Year 2000 readiness. Third-Party Suppliers and Customers The Company relies directly and indirectly, on external systems utilized by its suppliers for materials used in the manufacture of its products. The Company has requested confirmation from its suppliers of their Year 2000 compliance. The Company has received replies from approximately 15% of its suppliers. The replies received indicate that Year 2000 compliance will be achieved. However, there can be no assurance that suppliers will resolve all Year 2000 Issues with their systems in a timely manner. Any failure of third parties to resolve their Year 2000 Issues in a timely manner could result in the material disruption of the business of the Company. Any such disruption could have an adverse effect on the Company's operations. The Company does not intend to canvas its customers to insure that customers are Year 2000 compliant. While the Company does not believe that non-compliance by its customers would significantly impact their ability to continue their drilling operations and their ability to purchase drilling equipment, any disruption to the drilling process caused by non-compliance could negatively impact the Company's revenues. Facility Systems Facility systems such as manufacturing equipment, heating, sprinklers, test equipment and security systems may also be affected by the Year 2000 Issue. The Company has commenced an assessment of the impact of all such systems on its facilities and does not anticipate any material impact on the Company's operations. The Company does not separately track internal cost incurred on the Year 2000 Issue. The Company has estimated that approximately 15% to 20% of its IT personnel's time is spent on the Year 2000 Issue. As of December 31, 1998, approximately $500 thousand have been accrued or paid to third parties relating to this issue. The Company has estimated that approximately $1.0 to $2.0 million will be paid in 1999 to third parties for software, hardware and consultation. The Company recognizes the need for developing contingency plans to address the Year 2000 Issues that may pose a significant risk to its on-going operations. Such plans could include the implementation of manual procedures to compensate for system deficiencies. During the remediation phase of the internal business systems, the Company will be evaluating potential failures and will attempt to develop responses in a timely manner. However, there can be no assurance that any contingency plans evaluated and potentially implemented by the Company would be adequate to meet the Company's needs without materially impacting its operations, that any such plan would be successful or that the Company's results of operations would not be materially and adversely affected by the delays and inefficiencies inherent in conducting operations in an alternative manner. no 28. [ $ ] CONSOLIDATED BALANCE SHEETS ==================================================================== (dollars in thousands) December 31, 1998 1997 ==================================================================== Assets Current Assets Cash and cash equivalents $ 29,138 $ 39,827 Receivables -- principally trade, less allowances for doubtful accounts of $3,351 (1998) and $2,121 (1997) 179,241 142,324 Inventories -- Note b 152,412 131,971 Deferred tax assets -- Note d 15,244 12,723 Assets held for sale 7,717 1,326 Prepaid expenses 6,639 4,673 - -------------------------------------------------------------------- Total Current Assets 390,391 332,844 Property, plant and equipment -- at cost, less accumulated depreciation -- Note c 89,997 73,862 Rental equipment -- at cost, less accumulated depreciation 11,440 18,213 Cost in excess of net assets acquired, less accumulated amortization of $8,534 (1998) and $7,415 (1997) 33,511 34,609 Other assets -- Notes a, b & d 21,581 11,601 - -------------------------------------------------------------------- Total Assets $546,920 $471,129 ==================================================================== Liabilities and Shareholders' Equity Current Liabilities Accounts payable -- principally trade $ 45,969 $ 53,394 Customer deposits 95,766 79,068 Other accrued liabilities 23,267 16,174 Accrued payroll and related costs 22,351 22,367 Accrued warranty 7,558 5,490 Taxes payable 9,233 8,874 Current portion of long-term debt -- Note e 9,948 10,000 - -------------------------------------------------------------------- Total Current Liabilities 214,092 195,367 Long-term debt, less current portion -- Note e 9,845 Postretirement obligations -- Note h 6,813 6,561 Other non-current liabilities -- Note d 6,648 6,157 - -------------------------------------------------------------------- Total Liabilities 227,553 217,930 Shareholders' Equity -- Note f Preferred Stock: 10,000,000 shares authorized, none issued and outstanding Common Stock: 120,000,000 shares authorized, 64,642,326 (1998) and 64,171,744 (1997) issued and outstanding, stated value 55,011 54,540 Additional paid-in capital 102,062 96,682 Retained earnings 162,294 101,977 - -------------------------------------------------------------------- Total Shareholders' Equity 319,367 253,199 Commitments and contingencies -- Note g Total Liabilities and Shareholders' Equity $546,920 $471,129 ==================================================================== See notes to consolidated financial statements. no 29. [ $ ] CONSOLIDATED STATEMENTS OF INCOME =============================================================================== (in thousands, except per share data) Year Ended December 31, 1998 1997 1996 =============================================================================== Revenues Net sales $699,966 $ 500,067 $336,120 Rental income 34,919 44,830 30,860 Other income 6,094 892 1,442 - ------------------------------------------------------------------------------- 740,979 545,789 368,422 Costs and expenses Cost of sales 484,165 334,729 231,792 Cost of rental income 11,688 13,199 9,372 Selling, general and administrative expenses 109,079 96,398 70,891 Research and development costs 34,567 21,084 14,331 Special charge -- Note a 8,500 Interest expense 1,823 3,683 3,948 - ------------------------------------------------------------------------------- 649,822 469,093 330,334 - ------------------------------------------------------------------------------- Income before income taxes 91,157 76,696 38,088 Income taxes -- Note d 30,819 26,821 13,546 - ------------------------------------------------------------------------------- Net income $ 60,338 $ 49,875 $ 24,542 =============================================================================== Basic income per share $ .94 $ .78 $ .39 =============================================================================== Shares used in computing basic income per share 64,451 63,650 62,181 =============================================================================== Diluted income per share $ .92 $ .76 $ .38 =============================================================================== Shares used in computing diluted income per share 65,594 65,201 63,463 =============================================================================== See notes to consolidated financial statements. no 30. [ $ ] CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
======================================================================================================================== (in thousands) Common Stock Issued and Outstanding Additional ---------------------- Paid-in Retained Year Ended December 31, 1998, 1997 and 1996 Shares Amount Capital Earnings Total ======================================================================================================================== Balances at December 31, 1995 60,323 $ 50,691 $ 73,861 $ 26,627 $ 151,179 Net income 24,542 24,542 Common Stock issuances 2,876 2,876 16,105 18,981 Foreign currency translation adjustment 806 806 - ----------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1996 63,199 53,567 89,966 51,975 195,508 Net income 49,875 49,875 Common Stock issuances 973 973 6,716 7,689 Foreign currency translation adjustment 127 127 - ----------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1997 64,172 54,540 96,682 101,977 253,199 Net income 60,338 60,338 Common Stock issuances 471 471 5,380 5,851 Foreign currency translation adjustment (21) (21) - ----------------------------------------------------------------------------------------------------------------------- Balances at December 31, 1998 64,643 $ 55,011 $ 102,062 $ 162,294 $ 319,367 =======================================================================================================================
See notes to consolidated financial statements. no 31. [ $ ] CONSOLIDATED STATEMENTS OF CASH FLOWS ============================================================================= (in thousands) Year Ended December 31, 1998 1997 1996 ============================================================================= Operating Activities Net income $ 60,338 $ 49,875 $ 24,542 Items included in net income not requiring (providing) cash: Depreciation 19,875 14,760 10,928 Amortization 2,246 2,211 2,321 Deferred income taxes (6,681) (3,371) (2,772) Write-off of rental equipment 1,500 Postretirement obligations 252 474 840 Other 2,492 1,696 365 Changes in operating assets and liabilities: Receivables (36,917) (47,164) (34,477) Inventories (20,441) (40,098) (22,667) Additions to rental equipment (3,295) (11,494) (10,204) Prepaids (1,966) (516) (624) Accounts payable (7,425) 15,579 16,459 Customer deposits 16,698 76,372 1,842 Accrued liabilities 9,161 5,009 1,941 Accrued payroll (16) 8,970 4,453 Taxes payable 359 3,021 3,968 Other (4,961) 1,986 1,967 - ---------------------------------------------------------------------------- Net Cash from (used in) Operating Activities 31,219 77,310 (1,118) Investing Activities Property, plant and equipment purchases (35,269) (35,121) (11,023) Proceeds from equipment sales 306 1,280 659 - ---------------------------------------------------------------------------- Net Cash (used in) Investing Activities (34,963) (33,841) (10,364) Financing Activities Proceeds from line of credit 61,000 124,500 72,000 Payments on long-term debt and line of credit (71,000) (137,500) (79,000) Proceeds from issuance of Common Stock 3,055 3,914 17,514 Deferred issue costs (350) - ---------------------------------------------------------------------------- Net Cash (used in) from Financing Activities (6,945) (9,436) 10,514 Net (decrease) increase in cash and cash equivalents (10,689) 34,033 (968) Cash and cash equivalents at beginning of year 39,827 5,794 6,762 - ---------------------------------------------------------------------------- Cash and cash equivalents at end of year $ 29,138 $ 39,827 $ 5,794 ============================================================================ See notes to consolidated financial statements. no 32. [ $ ] NOTES TO CONSOLIDATED FINANCIAL STATEMENTS [ 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 field 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. Principle 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. 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. 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 $23,407,000 and $18,261,000 at December 31, 1998 and 1997, 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 totaling $2,376,000, net of accumulated amortization of $6,626,000 at December 31, 1998, 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. no 33. [ $ ] 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, accounts receivable and accounts payable approximated fair value as of December 31, 1998 and 1997 because of the relatively short maturity of these instruments. The carrying value of debt approximated fair value as of December 31, 1998 and 1997, 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 losses in 1998 were $994,000 and the exchange gains in 1997 and 1996 were $264,000 and $283,000, respectively. 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. Special Charge During the fourth quarter of 1998, the Company adopted a plan to restructure all of its Divisions' operations consistent with the current and expected lower market conditions and recognized an $8,500,000 special charge consisting of the following: severance 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. The Company spent $422,000 of the cash provision in 1998 and expects to spend substantially all of the remaining cash costs in 1999. Reclassification Certain amounts in the 1997 and 1996 financial statements have been reclassified to conform with current year classification. [ b ] Inventories Inventories classified as current assets consist of the following: December 31, (in thousands) 1998 1997 ------------------------------------------------------------------------- Raw materials $ 5,806 $ 6,118 Work in process 50,684 43,495 Finished goods 109,581 95,063 Excess of current cost over LIFO value (13,659) (12,705) ------------------------------------------------------------------------- $ 152,412 $ 131,971 ========================================================================= 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 $7,500,000 and $3,500,000 at December 31, 1998 and 1997, respectively. no 34. [ c ] Property, plant and equipment Property, plant and equipment consists of the following: Estimated Useful Lives December 31, (in thousands) 1998 1997 (Years) ------------------------------------------------------------------------- Land $ 2,726 $ 2,663 Buildings and improvements 34,683 28,825 3-30 Machinery and equipment 94,463 83,187 5-12 Furniture and fixtures 28,215 20,447 3-5 Autos and trucks 1,173 1,209 3-5 ------------------------------------------------------------------------- 161,260 136,331 Less accumulated depreciation 71,263 62,469 ------------------------------------------------------------------------- $ 89,997 $ 73,862 ========================================================================= [ d ] Income taxes Significant components of the Company's deferred tax liabilities and assets are as follows: December 31, (in thousands) 1998 1997 - ----------------------------------------------------------------------------- Deferred tax liabilities: Tax over book depreciation $ 3,105 $ 3,805 Deferred tax assets: Intercompany profit elimination 5,322 5,635 Accruals 3,599 2,381 Postretirement benefit obligation 2,819 3,141 Allowance for excess inventory 2,623 2,320 Allowance for warranty cost 2,094 1,617 Allowance for loss on sale of assets 2,021 1,937 Other 2,994 1,666 - ----------------------------------------------------------------------------- Total deferred tax assets 21,472 18,697 Valuation allowance for deferred tax assets (3,206) - ----------------------------------------------------------------------------- Net deferred tax assets 21,472 15,491 ============================================================================= Net deferred taxes $ 18,367 $ 11,686 - ----------------------------------------------------------------------------- Current deferred tax assets $ 15,244 $ 12,723 Noncurrent deferred tax assets (liabilities) 3,123 (1,037) - ----------------------------------------------------------------------------- Net deferred taxes $ 18,367 $ 11,686 ============================================================================= United States and foreign income before income taxes and the components of income tax expense are as follows: December 31, (in thousands) 1998 1997 1996 - ------------------------------------------------------------------------ Income before income taxes: U.S. $74,361 $59,279 $28,347 Foreign 16,796 17,417 9,741 - ------------------------------------------------------------------------ $91,157 $76,696 $38,088 ======================================================================== no 35. [ $ ] Income tax expense (benefit): December 31, (in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------ Current: U.S. $ 28,824 $ 21,340 $ 13,137 Foreign 6,708 5,577 2,913 State 2,231 1,146 850 Utilization of net operating losses and credits (1,509) (1,099) (1,750) Tax benefits credited to paid-in capital 1,246 3,206 1,168 - ------------------------------------------------------------------------------ 37,500 30,170 16,318 Deferred: U.S. (6,681) (4,448) (3,773) Foreign 1,099 1,001 - ------------------------------------------------------------------------------ $ 30,819 $ 26,821 $ 13,546 ============================================================================== Differences between the Company's income tax expense and an amount calculated utilizing the federal statutory rate are as follows: December 31, (in thousands) 1998 1997 1996 - ------------------------------------------------------------------------------- At federal statutory rate $ 31,905 $ 26,844 $ 13,331 Increases (reductions) in taxes: Change in valuation allowance (3,206) FSC benefit (1,788) (2,069) (1,278) State taxes, net of federal benefit 1,450 745 552 Tax impact of non-deductible expenses 877 772 664 Tax rate differential on foreign earnings and losses recorded without tax benefit 829 519 504 Other 752 10 (227) - ------------------------------------------------------------------------------- Total tax provision $ 30,819 $ 26,821 $ 13,546 =============================================================================== Income taxes paid net of refunds received in 1998, 1997, and 1996 were $36,623,000, $24,393,000 and $11,222,000, respectively. The Company is currently under examination by the Internal Revenue Service for the years ended December 31, 1996 and 1995. Management believes the resolution of this examination will not have a material adverse effect on the Company's financial position or results of operations. [ e ] Long-term debt Long-term debt consists of notes payable to institutional investors under an 8.95% Senior Note Agreement (the "Note Agreement.") Principal is due in five equal annual installments which commenced June 30, 1995, and interest is payable semiannually. The Note Agreement 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. The remaining principal balance of $10 million is payable on June 30, 1999. 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 agreement requires a commitment fee of .25% 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, 1998, there were no advances outstanding and $4.2 million in letters of credit outstanding under this facility. Interest paid during 1998, 1997 and 1996 was $1,698,000, $3,664,000 and $5,470,000, respectively. no 36. [ $ ] [ f ] Shareholders' equity On November 6, 1997, the Board of Directors of the Company declared a two-for-one stock split of its Common Stock, payable in the form of a 100% stock dividend, on December 4, 1997 to shareholders of record at the close of business on November 20, 1997. Stock options, and all other agreements payable in the Company's Common Stock, have been adjusted to reflect the split. In addition, the balance shown as Common Stock has been increased to reflect the split with a corresponding decrease in additional paid-in capital. All references to number of shares, except shares authorized, in the consolidated financial statements and related notes have been adjusted to reflect the stock dividend on a retroactive basis. 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, 1998, 2,584,737 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, 1998, 838,415 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. 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:
1998 1997 1996 ----------------------------------------------------------------------- Weighted Weighted Weighted Average Average Average Exercise Exercise Exercise Options Price Options Price Options Price - --------------------------------------------------------------------------------------------- Outstanding at beginning of year 2,324,724 $ 6.15 2,587,968 $ 3.80 2,529,338 $ 3.00 Granted 406,861 20.47 557,502 13.25 739,718 5.54 Exercised 200,152 4.93 790,386 3.40 641,888 2.55 Cancelled 50,288 9.51 30,360 7.54 39,200 3.74 - --------------------------------------------------------------------------------------------- Outstanding at end of year 2,481,145 $ 8.53 2,324,724 $ 6.15 2,587,968 $ 3.80 - --------------------------------------------------------------------------------------------- Exercisable at end of year 1,201,444 803,788 1,030,020 - ---------------------------------------------------------------------------------------------
The following table summarizes information about stock options outstanding at December 31, 1998:
Options Outstanding Options Exercisable ---------------------------------------------------------------------------------- Weighted Average Remaining Weighted Weighted Number Contractual Life Average Number Average Range of Exercise Prices Outstanding (Years) Exercise Price Exercisable Exercise Price $2.28 to $4.625 995,490 4.42 $ 3.06 765,985 $ 3.04 $5.25 to $7.91 577,757 7.13 5.51 277,739 5.79 $10.4375 to $12.9688 538,298 8.37 12.47 117,720 12.47 $18.672 to $23.1875 369,600 8.98 22.21 40,000 18.67 - --------------------------------------------------------------------------------------------------------- $2.28 to $23.1875 2,481,145 6.59 $ 8.53 1,201,444 $ 5.12 - ---------------------------------------------------------------------------------------------------------
no 37. [ $ ] In 1996, the Company adopted the disclosure provisions of FASB Statement No. 123 "Accounting for Stock-Based Compensation". As permitted by that standard the Company continues to follow Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" in accounting for its 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 $985,000, $1,549,000 and $569,000 for the years 1998, 1997 and 1996, 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 consistent with FASB Statement No. 123 methodology, the Company's net income and income per share would have been reduced to the pro forma amounts shown below: 1998 1997 1996 - -------------------------------------------------------------------------------- Net income -- as reported $60,338,000 $49,875,000 $24,542,000 Net income -- pro forma 58,136,000 48,574,000 23,833,000 As reported -- Basic income per share $ .94 $ .78 $ .39 Diluted income per share .92 .76 .38 Pro forma -- Basic income per share $ .90 $ .76 $ .38 Diluted income per shares .89 .74 .38 The fair value of shares is estimated using the Black-Scholes option-pricing model with the following weighted average assumptions: 1990 Stock 1994 Directors' 1980 Stock Option Plan Stock Option Plan Purchase Plan - ------------------------------------------------------------------------- Expected life (years) 6 3 .5 Risk-free interest rate 1998 5.88% 6.5% 5% 1997 6.25% 6% 5.2% 1996 6.2% 6% 5.2% Volatility 1998 48% 48% 48% 1997 45% 45% 45% 1996 42% 42% 42% For the options granted during 1998, 1997 and 1996, the weighted-average fair value at date of grant was $10.65, $6.05, and $2.65 per option, respectively. The weighted-average fair value at date of grant for stock purchase shares during 1998, 1997 and 1996 was $1.21, $2.35 and $.96 per share, respectively. The discounted value of the stock purchase plan shares granted in 1998, 1997 and 1996 using the Black-Scholes option-pricing model was $465,000, $277,000 and $178,000, respectively. At December 31, 1998, the Company had reserved 5,959,853 shares of Common Stock for future issuance in connection with the four stock-based compensation plans. On May 29, 1996, the Company completed the sale of 989,406 shares of its Common Stock at a price to the public of $15.875 per share. A portion of the net proceeds from the sale of approximately $14.6 million was used to make the $10.0 million principal payment due June 30, 1996, on the Senior Notes. 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. no 38. [ $ ] 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. [ 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. Approximate minimum annual rental payments under noncancellable operating leases as of December 31, 1998 are as follows: (in thousands) Real Estate Equipment Total ---------------------------------------------------------------- 1999 $ 3,041 $ 3,291 $ 6,332 2000 2,123 2,323 4,446 2001 1,649 1,084 2,733 2002 1,405 274 1,679 2003 1,277 55 1,332 Thereafter 5,673 5,673 ---------------------------------------------------------------- $ 15,168 $ 7,027 $ 22,195 ================================================================ Rent expense amounted to $8,867,000, $6,696,000, and $5,185,000 for 1998, 1997, and 1996, 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. no 39. [ $ ] [ h ] Benefit Plans In February 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standard No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits" ("Statement 132") Statement 132 does not change the measurement or recognition provisions of previously issued standards, but revises disclosures about pensions and other postretirement benefit plans. The Company adopted Statement 132 in 1998. Restatement of disclosures for the prior years has been made for comparative purposes. 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 $6,500,000, $5,000,000, and $2,400,000, for 1998, 1997 and 1996, 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 $1,084,000, $831,000 and $651,000 in 1998, 1997, and 1996, 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 $3,396,000 and $2,811,000 at December 31, 1998 and 1997, respectively. Expense under the plan was $723,000, $652,000, and $602,000 in 1998, 1997, and 1996, 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% for 1998 and is assumed to decrease gradually to 4.5% 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, 1998, by $870,000 and the aggregate of the service and interest cost components of net periodic postretirement benefit cost for 1998 by $70,000. The weighted-average discount rate used in determining the accumulated postretirement benefit obligation was 6.75% and 7% at December 31, 1998 and 1997, respectively. Net periodic postretirement benefit cost includes the following components: Year ended December 31, (in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- Interest cost $ 723 $ 856 $ 854 Amortization of transition obligation 763 763 763 Amortization of (gain) (513) (378) (382) - -------------------------------------------------------------------------------- $ 973 $ 1,241 $ 1,235 ================================================================================ The following table sets forth the change in benefit obligation of the Company's postretirement benefit plan: At December 31 1998 1997 - -------------------------------------------------------------------------------- Changes in benefit obligation Benefit obligation at beginning of year $ 10,758 $ 12,172 Interest cost 723 856 Benefits paid (721) (767) Actuarial (gain) (404) (1,503) - -------------------------------------------------------------------------------- Benefit obligation at end of year $ 10,356 $ 10,758 Funded status $(10,356) $(10,758) Unrecognized actuarial (gain) (7,126) (7,235) Unrecognized transition obligation 10,669 11,432 - -------------------------------------------------------------------------------- Accrued postretirement benefit obligation $ (6,813) $ (6,561) no 40. [ $ ] 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. [ i ] Selected quarterly financial data (unaudited)
(in thousands except per share data) 1st Quarter 2nd Quarter 3rd Quarter(1) 4th Quarter - ------------------------------------------------------------------------------------------------------------ 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 1997 Revenues $ 101,071 $ 129,634 $ 140,408 $ 174,676 Gross profit 34,612 44,645 52,067 65,645 Income before income taxes 11,506 16,593 20,811 27,786 Income taxes 4,122 5,823 7,410 9,466 Net income 7,384 10,770 13,401 18,320 Basic income per share .12 .17 .21 .29 Diluted income per share .11 .17 .21 .28
(1) Certain amounts in the third quarter of 1998 have been reclassified to conform with year-end classification. [ j ] Business Segment and Geographic Information Effective January 1, 1998, the Company adopted the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("Statement 131"). Statement 131 superseded FASB Statement No. 14, "Financial Reporting for Segments of a Business Enterprise". Statement 131 establishes standards for the way that public business enterprises report information about operating segments in annual financial statements and requires that those enterprises report selected information about operating segments in interim financial reports. Statement 131 also establishes standards for related disclosures about products and services, geographic areas, and major customers. The adoption of Statement 131 did not affect results of operations or financial position, but did affect the following disclosure of segment 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, deferred taxes, and certain intangible assets are not allocated to the Divisions. 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 Executive Officer of the Company. no 41. [ $ ] Selected financial information for the Company's reportable segments for the year ended December 31, 1998, 1997 and 1996 follows:
(in thousands) Varco Systems Varco BJ M/D Totco Shaffer Rigtech Total - ------------------------------------------------------------------------------------------------------------------------------------ 1998 Revenues from external customers $ 266,776 $ 95,959 $ 94,63 $ 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 1996 Revenues from external customers $ 117,658 $ 53,830 $ 62,227 $ 123,846 $ 9,419 $ 366,980 Intersegment revenues 481 38 519 Depreciation and amortization 3,622 988 4,938 2,791 638 12,977 Segment income 17,902 7,297 12,127 15,102 1,331 53,759 Segment assets 76,451 39,283 71,468 101,051 11,863 300,116 Expenditures for long-lived assets 3,192 498 1,276 5,757 300 11,023
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) 1998 1997 1996 - -------------------------------------------------------------------------------- INCOME Segment income $ 117,759 $ 100,179 $ 53,759 Elimination of intercompany profit (1,952) (1,558) (144) Unallocated amounts: Corporate and other expenses (14,327) (18,261) (11,579) Special charge (8,500) Interest expense (1,823) (3,664) (3,948) - -------------------------------------------------------------------------------- Income before income taxes $ 91,157 $ 76,696 $ 38,088 ================================================================================ ASSETS Total assets for reportable segments $ 482,397 $ 420,955 $ 300,116 Assets held at Corporate 64,523 50,174 15,905 - -------------------------------------------------------------------------------- $ 546,920 $ 471,129 $ 316,021 ================================================================================ DEPRECIATION AND AMORTIZATION Depreciation and amortization for reportable segments $ 21,889 $ 16,736 $ 12,977 Other 232 235 272 - -------------------------------------------------------------------------------- $ 22,121 $ 16,971 $ 13,249 ================================================================================ no 42. [ $ ] Information about the Company's revenue and long-lived assets by geographical area for 1998, 1997 and 1996 follows: (in thousands) 1998 1997 1996 - -------------------------------------------------------------------------------- GEOGRAPHIC AREA REVENUE United States $ 340,536 $ 240,706 $ 114,981 Brazil 68,123 26,945 11,049 United Kingdom 53,838 52,705 54,631 Singapore 33,575 32,198 32,732 Rest of World 238,813 192,343 153,587 - -------------------------------------------------------------------------------- Total Net Revenue $ 734,885 $ 544,897 $ 366,980 ================================================================================ GEOGRAPHIC AREA--LONG-LIVED ASSETS United States $ 100,981 $ 100,115 $ 72,944 United Kingdom 16,370 13,488 13,690 Netherlands 11,664 8,243 6,474 Singapore 3,203 1,918 3,505 Rest of World 2,730 2,920 1,578 - -------------------------------------------------------------------------------- Total Long-lived Assets $ 134,948 $ 126,684 $ 98,191 ================================================================================ During 1998 sales to two customers were $122,010,000 and $100,304,000, respectively. During 1996 sales to one customer amounted to $45,228,000. There were no sales to a single customer in 1997 in excess of 10% of total sales. 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, 1998 and 1997, and the related consolidated statements of income, shareholders' equity and cash flows for each of the three years in the period ended December 31, 1998. 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 generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the 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, 1998 and 1997, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. Ernst & Young LLP Orange County, California February 8, 1999 no 43. [ $ ] 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. All per share amounts have been adjusted to reflect the two-for-one stock split. There were 2,452 holders of record of the Common Stock as of the close of business on March 1, 1999
High Low High Low - --------------------------------------------------------------------------------- 1998 1997 First Quarter 28 15 1/4 First Quarter 14 5/8 10 1/2 Second Quarter 32 3/16 18 13/16 Second Quarter 16 3/16 10 3/16 Third Quarter 21 3/8 7 1/8 Third Quarter 24 7/8 14 13/16 Fourth Quarter 13 3/8 5 7/16 Fourth Quarter 33 13/16 17
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 the Note Agreement between Varco and its institutional lenders and Varco's revolving Credit Agreement with three financial institutions. Under the revolving Credit Agreement, which is generally the more restrictive, 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, 1998, the amount available for dividends and repurchases under the credit agreement was $28,015,000. 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 Meeting The Varco International, Inc. 1999 Annual Meeting will be held on May 13, 1999 at the Doubletree Hotel, 100 The City Drive, Orange, California. All shareholders are cordially invited to attend. Annual Report on Form 10-K The Company's Annual Report on Form 10-K for the year ended December 31, 1998, 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@ora.varco.com web site http://www.varco.com no 44. 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 South College Street Aberdeen, Scotland AB1 2LP Varco BJ Nijverheidsweg 45 4879 AP Etten-Leur The Netherlands and 12950 West Little York Houston, Texas 77041 (713) 937-5000 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, President 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 and Consultant to Baker Hughes Incorporated Member of the Audit Committee + Member of the Compensation Committee Officers - ------------- [Varco International, Inc.] George Boyadjieff Chairman of the Board, President and Chief Executive Officer Walter B. Reinhold Chairman Emeritus Robert J. Gondek Vice President Richard A. Kertson Vice President -- Finance and Chief Financial Officer Mark A. Merit Vice President Roger D. Morgan Vice President Michael W. Sutherlin Vice President Donald L. Stichler Vice President Controller -- Treasurer and Secretary Theresa M. Hope Staff Vice President -- Human Resources [Varco Systems] Roger D. Morgan President Wallace K. Chan Vice President -- Finance Brian L. Eidem Vice President -- Product Development Jerry A. Gill Vice President -- Sales Maurice E. Jacques Vice President -- Marketing Andrew P. Lesko Vice President -- Sales, Service and Rental Jama K. Meyer Vice President -- Information Technology James Gregory Renfro Vice President -- Manufacturing Michael Williams Vice President -- New Business Development Dennis E. Yenzer Vice President -- Product Engineering [Varco BJ] Michael W. Sutherlin President Robert R.D. deVries Vice President -- Sales and Marketing Mark D. Galagaza Vice President -- Manufacturing 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 -- Manufacturing Gregory A. Martin Vice President -- International Operations 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 David L. O'Donnell Vice President -- Quality Assurance Lowell B. Stouder Vice President -- Manufacturing [Rigtech] Dietmar Neidhardt President R. Alan Oswald Secretary Varco International, Inc. 743 North Eckhoff Street Orange, California 92868 EX-21 10 SUBSIDIARIES OF VARCO 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 -------------------- Varco de Mexico California 743 No. Eckhoff Street Holdings, Inc. Orange. California 92868 ------------------------ Martin-Decker TOTCO, Inc. Texas 1200 Cypress Creek Road Cedar Park, Texas 78613 ----------------------- Metrox, Inc. California 743 No. Eckhoff Street Orange. California 92868 ------------------------ 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 0il 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 92868 ------------------------ 304774 Alberta Ltd. Alberta, Canada Bay 15 - 2916 5th Ave. N.E. Calgary, Alberta T2A 6M7 Canada ------ Rig Technology Limited United Kingdom South College Street Aberdeen, Scotland ------------------
PAGE 2 OF 2
JURISDICTION OF INACTIVE SUBSIDIARIES INCORPORATION ADDRESS - --------------------- --------------- ------- Varco Marine Tools Texas 12950 West Little York International, Inc. Houston, Texas 77041 -------------------- Varco-Disc California 743 No. Eckhoff Street Orange, California 92868 ------------------------ Best Disc Texas 12950 West Little York Houston, Texas 77041 ---------------------- Varco Eastern, Inc. California 743 NO. Eckhoff Street Orange, California 92868 ------------------------ Varco International Netherlands P.O. Box 507 Finance N.V. Antilles Curacao ------- Varco Singapore, Ltd. California 743 No. Eckhoff Street Orange, California 92868 ------------------------ Varco Middle East California 743 No. Eckhoff Street Orange, California 92868 ------------------------ Varco Electronics, Inc. California 743 No. Eckhoff Street Orange, California 92868 ------------------------ Varco Electronics Disc California 743 No. Eckhoff Street Orange, California 92868 ------------------------ Varco Del Venezuela CA Venezuela 743 No. Eckhoff Street Orange, California 92868 ------------------------
EX-23 11 CONSENT OF INDEPENDENT AUDITORS EXHIBIT 23 CONSENT OF INDEPENDENT AUDITORS We consent to the incorporation by reference to Registration Statements Number 2-66830, 2-96290, 33-36841, 33-62118, 33-61861, 33-61939 and 333-21861 on Form S-8 of Varco International, Inc. and in the related Prospectuses of our report dated February 8, 1999, 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, 1998. /s/ Ernst & Young LLP Orange County, California March 19, 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, 1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. 12-MOS DEC-31-1998 JAN-01-1998 DEC-31-1998 29,138,000 0 182,592,000 (3,351,000) 152,412,000 390,391,000 161,260,000 (71,263,000) 546,920,000 214,092,000 0 157,073,000 0 0 162,294,000 546,920,000 734,885,000 740,979,000 495,853,000 613,432,000 34,567,000 0 1,823,000 91,157,000 30,819,000 60,338,000 0 0 0 60,338,000 0.94 0.92
-----END PRIVACY-ENHANCED MESSAGE-----