-----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, LfoaX6b1g3CFZMazoVzsYJ5t6GpbfK1o807e6j4IwIX1vjSek/vyhvgQ5LdJMILO Q59O5PE/3RrQMCMoQnM9xQ== 0000950129-03-001531.txt : 20030325 0000950129-03-001531.hdr.sgml : 20030325 20030325163416 ACCESSION NUMBER: 0000950129-03-001531 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 20021231 FILED AS OF DATE: 20030325 FILER: COMPANY DATA: COMPANY CONFORMED NAME: SMITH INTERNATIONAL INC CENTRAL INDEX KEY: 0000721083 STANDARD INDUSTRIAL CLASSIFICATION: MISCELLANEOUS CHEMICAL PRODUCTS [2890] IRS NUMBER: 953822631 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 001-08514 FILM NUMBER: 03616083 BUSINESS ADDRESS: STREET 1: 16740 HARDY ST STREET 2: P O BOX 60068 CITY: HOUSTON STATE: TX ZIP: 77032 BUSINESS PHONE: 2814433370 MAIL ADDRESS: STREET 1: 16740 HARDY ST STREET 2: P O BOX 60068 CITY: HOUSTON STATE: TX ZIP: 77205 10-K 1 h03433e10vk.txt SMITH INTERNATIONAL, INC.- DECEMBER 31, 2002 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 [NO FEE REQUIRED] FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002 OR | | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 [NO FEE REQUIRED] COMMISSION FILE NUMBER 1-8514 SMITH INTERNATIONAL, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 95-3822631 (STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.) 411 NORTH SAM HOUSTON PARKWAY, SUITE 600 77060 HOUSTON, TEXAS (ZIP CODE) (ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (281) 443-3370 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: COMMON STOCK, $1.00 PAR VALUE NEW YORK STOCK EXCHANGE, INC. PACIFIC EXCHANGE, INC. (TITLE OF EACH CLASS) (NAME OF EACH EXCHANGE ON WHICH REGISTERED) 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 is not contained herein, and will not be contained, to the best of the 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. | | Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Securities Exchange Act of 1934). Yes [X] No [ ]. The aggregate market value of the voting stock held by non-affiliates on June 28, 2002 was $3,347,308,514 (98,161,540 shares at the closing price on the New York Stock Exchange of $34.10, as adjusted for the two-for-one stock split effective July 8, 2002). On June 28, 2002, 101,350,038 shares of common stock, as adjusted for the stock split, were outstanding. For this purpose all shares held by officers and directors and their respective affiliates are considered to be held by affiliates, but neither the Registrant nor such persons concede that they are affiliates of the Registrant. There were 101,774,801 shares of common stock outstanding on March 21, 2003. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement related to the Registrant's 2002 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K. TABLE OF CONTENTS
PART I Item 1. Business........................................................................ 1 Item 2. Properties...................................................................... 8 Item 3. Legal Proceedings............................................................... 9 Item 4. Submission of Matters to a Vote of Security Holders............................. 9 Item 4A. Officers of the Registrant...................................................... 9 PART II Item 5. Market for the Registrant's Common Stock and Related Security Holder Matters.... 10 Item 6. Selected Financial Data......................................................... 11 Item 7. Management's Discussion and Analysis of Financial Condition and Results of 12 Operations...................................................................... Item 8. Financial Statements and Supplementary Data..................................... 23 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial 53 Disclosure...................................................................... PART III Item 10. Directors and Executive Officers of the Registrant.............................. 53 Item 11. Executive Compensation.......................................................... 53 Item 12. Security Ownership of Certain Beneficial Owners and Management.................. 53 Item 13. Certain Relationships and Related Transactions.................................. 53 Item 14. Controls and Procedures......................................................... 53 PART IV Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K................. 54
PART I ITEM 1. BUSINESS GENERAL Smith International, Inc. ("Smith" or the "Company") is a leading worldwide supplier of premium products and services to the oil and gas exploration and production industry, the petrochemical industry and other industrial markets. The Company provides a comprehensive line of technologically-advanced products and engineering services, including drilling and completion fluid systems, solids-control equipment, waste-management services, production chemicals, three-cone and diamond drill bits, turbines, fishing services, drilling tools, underreamers, casing exit and multilateral systems, packers and liner hangers. The Company also offers supply-chain management solutions through an extensive North American branch network providing pipe, valves, fittings, mill, safety and other maintenance products. The Company was incorporated in the state of California in January 1937 and reincorporated under Delaware law in May 1983. The Company's executive offices are headquartered at 411 North Sam Houston Parkway, Suite 600, Houston, Texas 77060 and its telephone number is (281) 443-3370. The Company's annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act of 1934 are made available free of charge on the Company's Internet website at www.smith.com as soon as reasonably practicable after the Company has electronically filed such material with, or furnished it to, the Securities and Exchange Commission. The Company's operations are aggregated into two reportable segments: Oilfield Products and Services and Distribution. The Oilfield Products and Services segment consists of: M-I, which provides drilling and completion fluid systems and services, solids-control and separation equipment, waste-management services and oilfield production chemicals; Smith Bits, which manufactures and sells three-cone drill bits, diamond drill bits and turbine products; and Smith Services, which manufactures and markets products and services used for drilling, workover, well completion and well re-entry operations. The Distribution segment consists of one business unit, Wilson, which markets pipe, valves, fittings, mill, safety and other maintenance products to energy and industrial markets. Financial information regarding reportable segments and international operations appears in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and in Note 13 of the Notes to Consolidated Financial Statements included elsewhere in this Form 10-K. Information related to business combinations appears in Note 2 of the Notes to Consolidated Financial Statements included elsewhere in this Form 10-K. BUSINESS OPERATIONS OILFIELD PRODUCTS AND SERVICES SEGMENT M-I Fluid Products and Services. The Company is a leading worldwide provider of drilling, reservoir drill-in and completion fluid systems, products and engineering services to end users engaged in drilling oil and natural gas wells. Drilling fluids are used to cool and lubricate the bit during drilling operations, contain formation pressures, suspend and remove rock cuttings from the hole and maintain the stability of the wellbore. Engineering services are provided to ensure that the fluid products are applied effectively to optimize drilling operations. These services include recommending products and services during the well planning phase; monitoring drilling fluid properties; recommending adjustments during the drilling phase; and analyzing/benchmarking well results after completion of the project to improve the efficiencies of future wells. M-I offers water-base, oil-base and synthetic-base drilling fluid systems. Water-base drilling fluids are the world's most widely utilized systems, having application in both land and offshore environments. Typically, these systems comprise an engineered blend of weighting materials used to contain formation pressures, and a broad range of chemical additives, designed to yield the specific drilling performance characteristics required for a given drilling project. Oil-base drilling fluids, which primarily are used to drill water-sensitive shales, reduce torque and drag and are widely used in areas where stuck pipe is likely to occur. In certain drilling areas of the world, oil-base systems exhibit comparably higher penetration rates when compared to water-base systems, significantly reducing time on location and overall drilling costs. Synthetic-base drilling fluids are used in drilling environments where oil-base fluids are environmentally prohibited and provide the performance benefits of oil-base systems. Synthetic-base systems are particularly advantageous in the deepwater environment. M-I also provides a comprehensive line of reservoir drill-in fluids which combine the high performance properties of a premium drilling fluid with minimal damaging characteristics of a brine completion fluid. 1 Completion fluids (clear brines) are solids-free, clear-salt solutions with high specific gravities and are non-damaging to the producing formation. Operators use these specially designed fluid systems in combination with a comprehensive range of specialty chemicals to control bottom-hole pressures, while meeting the specific corrosion inhibition, viscosity and fluid loss requirements necessary during the completion and workover phase of a well. These systems are specially engineered to maximize well production by minimizing formation damage that can be caused by solids-laden systems. M-I provides a complete line of completion fluids products and services, including low- and high-density brines, specialty chemicals, filtration and chemical treatment services, wellsite engineering and technical and laboratory support services. Fluid Competition. The major competitors in the worldwide drilling fluids market, which approximated $3.1 billion in 2002, are Baroid Drilling Fluids (a division of Halliburton Company ("Halliburton")) and INTEQ (a division of Baker Hughes, Inc. ("Baker Hughes")). While M-I and these companies supply a majority of the market, the drilling fluids industry is highly competitive, with a significant number of smaller, locally based competitors. The major competitors in the worldwide completion fluids market, which approximated $0.4 billion in 2002, are Baroid Completion Fluids (a division of Halliburton), Tetra Technologies, Inc., BJ Services Company and Ambar, Inc. Generally competition for sales of drilling and completions fluids is based on a number of factors, including wellsite engineering services, product quality and availability, technical support, service response and price. SWACO Products and Services. M-I SWACO provides services, equipment and engineering for solids control, pressure control and waste management to the worldwide drilling market. Solids-control equipment is used to remove drill cuttings from the fluid system, allowing the drilling fluid to be cleaned and recirculated. Solids are normally separated from the drilling fluid using one or a combination of the following: balanced elliptical and linear-motion shale shakers, desanders, disilters, hydroclones, mud cleaners and centrifuges. SWACO designs, manufactures, sells and rents a comprehensive, proprietary line of this equipment for oil and gas drilling processes throughout the world. The Company is also a leading manufacturer and supplier of screens used in solids-control equipment for both oilfield and certain industrial markets. SWACO complements its product offering by providing engineering and technical support to operators and drilling contractors from the planning stages of their projects through waste removal and site remediation. Operators employ SWACO-manufactured pressure-control equipment to drill safely and economically in sour-gas and high-pressure zones. Well killing and high-pressure control drilling chokes, together with related operating consoles, are used in the drilling process during well kicks and well clean-up and testing operations. Degassers and mud gas separators are designed to remove and safely vent entrained gases, including toxic gases such as hydrogen sulfide and corrosive oxygen, from the drilling mud. This equipment reduces the risk of dangerous and costly blowouts caused by recirculating mud that contains natural gas. Key products in SWACO's pressure control product line include the MUD D-GASSER(R) and SUPER CHOKE(TM), both of which hold strong market positions as do the SUPER MUD GAS SEPARATOR(TM) and the SUPER AUTOCHOKE(TM). The latter products represent key advancements in hands-free well pressure control and underbalanced drilling operations. With drilling operations expanding into more environmentally sensitive areas, there has been increased focus on the effective collection, treatment and disposal of waste produced during the drilling of a well. SWACO provides operators with value-added solutions designed to minimize and treat drilling waste. The Company provides a full suite of waste handling, minimization and management products and services that includes the recently acquired CLEANCUT(R) pneumatic conveyance system for collection and transportation of drill cuttings related to offshore drilling programs. SWACO also provides rig vacuum systems for cuttings recovery, high-gravity force drying equipment for liquid/solid separation and cuttings slurification and re-injection processes for reducing haul-off waste. In addition, through the THERMAL PHASE SEPARATION(TM) process, SWACO provides operators a proven technology for maximizing the recovery of drilling fluids, while minimizing wastes. SWACO's waste treatment services encompass a wide range of activities, including site assessment, drill cuttings injection, water treatment, pit closure and remediation, bioremediation, dewatering and thermal processing. The Company has established ENVIROCENTERS(R) in Norway, Germany and the United States designed specifically for recovering, treating and recycling solid and liquid drilling wastes. SWACO Competition. M-I SWACO competes with Brandt/Rigtech (a subsidiary of Varco International, Inc.) and Derrick/Oil Tools. Additionally, there are a number of regional suppliers that provide a limited range of equipment and services tailored for local markets. Competition is based on product availability, equipment performance, technical support and price. 2 Oilfield Production Chemicals. M-I provides a complete line of oilfield specialty chemicals and related technical services through its Oilfield Production Chemical division, acquired in January 2003. Oilfield production chemicals are used to enhance the flow of hydrocarbons from the wellbore by eliminating paraffin, scale and other byproducts encountered during the production process. Oilfield production chemicals are also used to protect piping and other equipment associated with the production, transportation and processing of oil and gas. Production Chemical Competition. The major competitors in the worldwide oilfield production chemical market include Baker Petrolite (a division of Baker Hughes), Ondeo Nalco Energy Services, LP (a division of Suez) and Champion Technologies, Inc. Generally, competition is based on product quality, product performance, technical support and price. Smith Bits Products and Services. Smith Bits is a worldwide leader in the design, manufacture and marketing of drill bits primarily used in drilling oil and natural gas wells. In addition, with the acquisition of Sii Neyrfor during July 2002, Smith Bits is the leading provider of downhole turbine drilling products (referred to as "turbodrills") and services that enhance the operating performance of petroleum drill bits in certain applications. Smith Bits' product offerings are designed principally for the premium market segments where faster drilling rates and greater footage drilled provide significant economic benefits in reducing the total cost of a well. Smith Bits designs, manufactures and markets three-cone drill bits for the petroleum industry, ranging in size from 3 1/2 to 28 inches in diameter. These three-cone bits comprise two major components - the body and the cones, which contain different types of pointed structures referred to as "cutting structures" or "teeth." The cutting structures are either an integral part of the steel cone with a hardmetal-applied surface (referred to as "milled tooth") or made of an inserted material (referred to as "insert"), which is usually tungsten carbide. The Company also produces three-cone drill bits in which the tungsten carbide insert is coated with polycrystalline diamond. In certain formations, bits produced with diamond-enhanced inserts last longer and increase penetration rates, which substantially decreases overall drilling costs. Smith Bits is the leading provider of drill bits utilizing diamond-enhanced insert technology. In addition, Smith Bits designs, manufactures and markets diamond drill bits. Diamond bits consist of a single body made of either a matrix powder alloy or steel. The cutting structures of diamond bits consist of either polycrystalline diamond cutters, which are brazed on the bit, or natural or synthetic diamonds, which are impregnated in the bit. These bits range in size from 2 3/4 to 26 inches in diameter. Smith Bits also designs, assembles and markets a comprehensive line of turbodrills and provides related technical support. Turbodrills, which operate directly above the drill bit, use the hydraulic energy provided by drilling fluid pumps on the rig floor to deliver torque to and rotate the drill bit. These proprietary tools are designed to provide faster rates of penetration, operate in much higher temperature formations, deliver longer downhole life and produce better wellbore quality than conventional positive displacement drilling motors. The turbine drilling motor provides operators with cost effective solutions in demanding environments such as horizontal applications, hard formations and high-temperature zones. The Company manufactures polycrystalline diamond and cubic boron nitride materials that are used in the Company's three-cone and diamond drill bits and other specialized cutting tools. The Company believes that it is one of the world's largest manufacturers of polycrystalline diamond and the only drill bit manufacturer with substantial capabilities in this area. Smith Bits also develops and uses patented processes for applying diamonds to a curved surface which optimize the performance of inserts used in drill bits. As a result, Smith Bits enjoys a competitive advantage in both material cost and technical ability over other drill bit companies. In addition, the Company's in-house diamond research, engineering and manufacturing capabilities enhance the Company's ability to develop the application of diamond technology across other Smith product lines and into non-energy markets. Competition. Besides the Company, Hughes Christensen (a division of Baker Hughes), Security DBS (a division of Halliburton) and ReedHycalog (a division of Grant Prideco, Inc.) are the three major competitors in the drill bit business. While Smith Bits and these companies supply the majority of the worldwide drill bit market, which approximated $1.1 billion in 2002, they compete with more than 20 companies. Generally, competition for sales of drill bits is based on a number of factors, including performance, quality, reliability, service, price, technological advances and breadth of products. The Company believes its quality, reliability and technological advances, such as diamond-enhanced inserts, provide its products with a competitive advantage. 3 Smith Services Products and Services. Smith Services is a leading global provider of technologically advanced drilling, fishing, remedial, multilateral and completion products, services and solutions to the oil and gas drilling industry. Smith Services' Drilling Systems business provides a broad range of downhole impact tools for drilling applications as well as numerous other specialized downhole drilling products and services. Smith Services sells and rents impact drilling tools such as the HYDRA-JAR(R) tool and the ACCELERATOR(R) tool, which are used to free stuck drill strings during the drilling process. Additionally, drilling performance tools such as the HYDRA-THRUST(R) tool, used in the drilling process to maintain constant weight on the drill bit, and Drilling on Gauge subs used for maintaining hole gauge and quality of the wellbore, are examples of Smith Services continuous commitment to developing new technology. Smith Services also offers tubular drill string components, such as drill collars, subs, stabilizers, kellys and HEVI-WATE(TM) drill pipe, and provides related inspection services, including drill string repair and rebuild services. These components and their placement in the drill string are supported by engineering and field technical services in order to optimize bottom hole management techniques. Through state-of-the-art software, Smith Services aids the customer in maximizing the life of drill string components. Rotating drilling heads for flow control in underbalanced drilling applications and automatic connection torque monitoring and control systems are also designed and manufactured by Smith Services. Smith Services also manufactures and markets hole openers and underreamers which are designed to create larger hole diameters in certain sections of the wellbore. The Company's patented RHINO(TM) Reamer, REAMASTER(R) and UNDERREAMMING-WHILE-DRILLING ("UWD(TM)") system are three examples of products that aid the customer in realizing lower drilling costs through technology. Through the use of the UWD system above the drill bit, the operator may drill the main bore with the bit and enlarge the diameter of the hole above the drill bit in the same run. Smith Services' Fishing and Remedial Systems business provides a comprehensive package of fishing, remedial and thru-tubing services. Fishing operations clear and remove obstructions from a wellbore that may arise during drilling, completion or workover activities or during a well's production phase. This operation requires a wide variety of specialty tools, including fishing jars, milling tools and casing cutters, all of which are manufactured by Smith Services. These tools are operated by Company service personnel or sold or rented to third-party fishing companies. Smith Services provides Wellbore Departure Systems and Multilateral Junctions through the manufacture of proprietary casing exit tools which are installed by highly trained technicians. These systems, which include the patented TRACKMASTER(R)WHIPSTOCK SYSTEM, PACK-STOCK(R), ANCHOR-STOCK(R) and the MX(TM) Multilateral junction, allow the operator to divert around obstructions in the main wellbore or reach multiple production zones from the main wellbore (known as multilateral completions). In addition, Smith Services' patented DRILLAHEAD(TM) SYSTEM combined with the XITOR GEOTRACK(TM) One-trip Mills, which mill the casing exit and continue to drill several hundred feet of formation, provide for a "no trip" system which saves the customer time and reduces their overall drilling costs. The Company also provides mechanical, hydraulic and explosive pipe-cutting services to remove casing during well or platform abandonment. Smith Services' Completion Systems business specializes in providing fit-for-purpose liner hanger, liner cementing equipment, isolation packers, retrievable and permanent packers, packer products and multilateral completion equipment. Liner hangers allow strings of casing to be suspended within the wellbore without having to extend the string all the way to the surface and are also used to isolate production zones and formations. Most directional and multilateral wells include one or more hangers due to the difficult casing programs and need for zonal isolation. Using Smith Services' POCKET SLIP(TM) liner hanger system, long heavy liners can be suspended with minimal casing distortion and maximum flow-by area. Packers are mechanically or hydraulically actuated devices which lock into place at specified depths in the well and provide a seal between zones through expanding-element systems. The devices therefore create isolated zones within the wellbore to permit either specific formation production or allow for certain operations, such as cementing or acidizing, to take place without damaging the reservoir. Competition. Smith Services' major competitors in the drilling, remedial, re-entry and fishing services markets are Weatherford International, Inc. ("Weatherford"), Baker Oil Tools (a division of Baker Hughes) and numerous small local companies. The main competitors in the liner hanger and packer markets are Baker Oil Tools, Weatherford and TIW Corporation. The main competitors in the drilling and fishing jar market and the fishing product and service market are Weatherford and National-Oilwell Inc. ("National-Oilwell"). Competition in the drilling and completions sales, rental and services market is primarily based on performance, quality, reliability, service, price and response time and, in some cases, breadth of products. 4 DISTRIBUTION SEGMENT Wilson Products and Services. Wilson is a supply-chain management company which provides products and services to the energy, refining, petrochemical, power generation and mining industries. Wilson operates an extensive network of supply branches, service centers and sales offices through which it markets pipe, valves, fittings, mill, safety and other maintenance products throughout the world, predominately in the United States and Canada. In addition, Wilson provides warehouse management, vendor integration and various surplus and inventory management services. The majority of Wilson's operations are focused on North American distribution of maintenance, repair and operating supplies and equipment with the remainder associated with line pipe and automated valve products (including valve, actuator and control packages). Approximately 60 percent of Wilson's 2002 revenues were generated in the energy segment, which includes exploration and production companies and companies with operations in the petroleum industry's pipeline segment. The remainder related to sales in the downstream and industrial market, which primarily includes refineries, petrochemical plants and other energy-focused operations. Competition. Wilson's competitors in its energy segment operations include National-Oilwell, Redman Pipe and Supply Company and a significant number of smaller, locally based operations. Wilson's competitors in the downstream and industrial market include McJunkin Corporation, WW Grainger and Hagemeyer NV. The distribution market that Wilson participates in is highly competitive. Generally, competition involves numerous factors, including price, experience, customer service and equipment availability. NON-U.S. OPERATIONS Sales to oil and gas exploration and production markets outside the United States are a key strategic focus of Smith's management. The Company markets its products and services through subsidiaries, joint ventures and sales agents located in virtually all petroleum-producing areas of the world, including Canada, Europe/Africa, the Middle East, Latin America and the Far East. Approximately 53 percent, 48 percent and 51 percent of the Company's revenues in 2002, 2001 and 2000, respectively, were derived from equipment or services sold or provided outside the United States. The Company's Distribution operations constitute a significant portion of the consolidated revenue base and are concentrated in North America which serves to distort the geographic revenue mix of the Company's Oilfield segment operations. Excluding the impact of the Distribution operations, 64 percent, 59 percent and 60 percent of the Company's revenues were generated in non-U.S. markets in 2002, 2001 and 2000, respectively. Historically, drilling activity outside the United States has been less volatile than U.S. based activity as the high cost exploration and production programs outside the United States are generally undertaken by major oil companies, consortiums and national oil companies. These entities operate under longer-term strategic priorities than do the independent drilling operators that are more common in the U.S. market. SALES AND DISTRIBUTION Sales and service efforts are directed to end users in the drilling and completion industry, including major and independent oil companies, national oil companies and independent drilling contractors. The Company's products and services are primarily marketed through the direct sales force of each business unit. In certain non-U.S. markets where direct sales efforts are not practicable, the Company utilizes independent sales agents, distributors or joint ventures. Smith maintains field service centers, which function as repair and maintenance facilities for rental tools, operations for remedial and completion service and a base for the Company's global sales force, in every major oil and gas producing area of the world. The location of these service centers near the Company's customers is an important factor in maintaining favorable customer relations. 5 MANUFACTURING The Company's manufacturing operations, along with quality control support, are designed to ensure that all products and services marketed by the Company will meet standards of performance and reliability consistent with the Company's reputation in the industry. Management believes that it generally has sufficient internal manufacturing capacity to meet anticipated demand for its products and services. During periods of peak demand, certain business units utilize outside resources to provide additional manufacturing capacity. RAW MATERIALS Through its company-owned mines in and outside the United States, M-I has the capability to produce a large portion of its requirements for barite and bentonite. Barite reserves are mined in the United States, the United Kingdom and Morocco. Bentonite is produced from ore deposits in the United States. Mining exploration activities continue worldwide to locate and evaluate ore bodies to ensure deposits are readily available for production when market conditions dictate. In addition to its own production, M-I purchases a majority of its worldwide barite requirement from suppliers outside the United States, mainly the People's Republic of China, India and Morocco. The Company purchases a variety of raw materials for its Smith Bits and Smith Services units, including alloy and stainless steel bars, tungsten carbide inserts and forgings. Generally, the Company is not dependent on any single source of supply for any of its raw materials or purchased components. The Company purchases a significant amount of tungsten carbide inserts and U.S. forging requirements from two suppliers under separate supply agreements. The Company believes that numerous alternative supply sources are available for all such materials. The Company produces polycrystalline diamond materials in Provo, Utah and Scurelle, Italy for utilization in various Company products as well as direct customer sales. The Company believes that it enjoys a competitive advantage in the manufacture of diamond drill bits because it is the only diamond drill bit producer with substantial polycrystalline diamond manufacturing capabilities. PRODUCT DEVELOPMENT, ENGINEERING AND PATENTS The Company's business units maintain product development and engineering departments whose activities are focused on improving existing products and services and developing new technologies to meet customer demands for improved drilling performance and environmental-based solutions for drilling and completion operations. The Company's primary research facilities are located in Houston, Texas; Stavanger, Norway; and Aberdeen, Scotland. The Company also maintains a drill bit database which records the performance of drill bits over the last 17 years, including those manufactured by competitors. This database gives the Company the ability to monitor, among other things, drill bit failures and performance improvements related to product development. Management believes this proprietary database gives the Company a competitive advantage in the drill bit business. The Company has historically invested significant resources in research and engineering in order to provide customers with broader product lines and technologically-advanced products and services. The Company's expenditures for research and engineering activities are attributable to the Company's Oilfield Products and Services segment and totaled $50.6 million in 2002, $50.8 million in 2001 and $42.4 million in 2000. In 2002, research and engineering expenditures approximated 2.2 percent of the Company's Oilfield Products and Services segment revenues. Although the Company has over 1,200 issued and pending patents and regards its patents and patent applications as important in the operation of its business, it does not believe that any significant portion of its business is materially dependent upon any single patent or group of patents or upon patent protection in general. EMPLOYEES At December 31, 2002, the Company had 11,165 full time employees throughout the world. Most of the Company's employees in the United States are not covered by collective bargaining agreements except in certain U.S. mining operations of M-I and several distribution locations of Wilson. The Company considers its labor relations to be satisfactory. 6 RISK FACTORS This document and other filings with the Securities and Exchange Commission contain "forward-looking statements", as defined in the Private Securities Litigation Reform Act of 1995. These forward-looking statements discuss the Company's outlook, financial projections, business strategies as well as various other matters. Our forward-looking statements are based on assumptions that we believe to be reasonable but that may not prove to be accurate. All of the Company's forward-looking information is, therefore, subject to risks and uncertainties that could cause actual results to differ materially from the results expected. Although it is not possible to identify all factors, these risks and uncertainties include the risk factors discussed below. Demand for our products and services is dependent upon the level of oil and natural gas exploration and development activities. The level of worldwide oil and natural gas development activities is primarily influenced by the price of oil and natural gas and price expectations. In addition to oil and natural gas prices, the following factors impact exploration and development activity and may lead to significant changes in worldwide activity levels: Overall level of global economic growth and activity; Actual and perceived changes in the supply and demand for oil and natural gas; Political stability of oil-producing countries; Finding and development costs of operations; and Decline and depletion rates for oil and natural gas wells. Changes in any of these factors could adversely impact our financial condition or results of operations. We are a multinational oilfield service company and have operations in certain countries that are inherently subject to risks of war, local economic conditions, political disruption, civil disturbance and policies that may: Disrupt oil and gas exploration and production activities and our operations; Restrict the movement of funds and other assets; Lead to U.S. government or international sanctions; and Limit access to markets. The occurrence of any of these events could adversely impact our financial condition or results of operations. 7 ITEM 2. PROPERTIES The principal facilities and properties utilized by the Company at December 31, 2002 are shown in the table below. Generally the facilities and properties are owned by the Company.
Approx. Principal Products Processed Land Bldg. Space Location or Manufactured (Acres) (sq. ft.) - --------------------------------- ---------------------------------------------- --------- ------------ Oilfield Products and Services Segment: Houston, Texas .......... Tubulars, surface and downhole tools, remedial products, liner hangers, diamond drill bits, drilling and fishing jars and fishing tool equipment 82 618,000 Ponca City, Oklahoma .... Three-cone drill bits 15 207,000 Florence, Kentucky ...... Separator units, mill units, parts, screens 15 145,000 and motors Aberdeen, Scotland ...... Downhole tools and remedial products 10 132,000 Greybull, Wyoming ....... Bentonite mine and processing 8,394 110,000 Tulsa, Oklahoma ......... Oilfield and industrial screening products 7 95,000 Saline di Volterra, Italy Three-cone drill bits 11 92,000 Edinburgh, Scotland ..... Wire cloth and oilfield screening products 3 91,400 Aberdeen, Scotland ...... Downhole tools and remedial products 10 91,000 Karmoy, Norway .......... Barite and bentonite processing 5 51,000 Greystone, Nevada ....... Barite mine and processing 268 50,000 Battle Mountain, Nevada . Barite processing 23 43,000 Provo, Utah ............. Synthetic diamond materials 4 43,000 Nisku, Canada ........... Tubulars and drill collars 10 42,000 Zelmou, Morocco ......... Barite mine 3,954 41,000 Zavalla, Texas .......... Drilling fluid chemical products 33 36,000 Nivellas, Belgium ....... Separator units, mill units, parts, screens 5 32,000 and motors Scurelle, Italy ......... Diamond drill bits and synthetic diamond 4 31,000 materials Amelia, Louisiana ....... Barite processing 26 25,000 Spruce Grove, Canada .... Drilling fluid processing 3 24,000 Berra, Italy ............ Solids control equipment 2 24,000 Salzweld, Germany ....... Drilling fluid processing 2 23,000 Galveston, Texas ........ Barite processing 6 21,000 Macon, Georgia .......... Separator units and screens 1 18,000 Aberdeen, Scotland ...... Barite and bentonite processing 2 12,000 Foss/Aberfeldy, Scotland. Barite mine and processing 102 10,000 Mountain Springs, Nevada. Barite mine 900 -- Westlake, Louisiana ..... Barite processing 3 -- Distribution Segment: Houston, Texas .......... Pipe, valves and fittings 11 198,000
The Company considers its mines and manufacturing and processing facilities to be in good condition and adequately maintained. The Company's headquarters is located in a leased office building in Houston, Texas. The Company leases various other administrative and sales offices, as well as warehouses and service centers in the United States and other countries in which it conducts business. Management believes that it will be able to renew and extend its property leases on terms satisfactory to the Company or, if necessary, locate substitute facilities on acceptable terms. 8 ITEM 3. LEGAL PROCEEDINGS Information relating to various commitments and contingencies, including legal proceedings, is described in Note 14 of the Notes to Consolidated Financial Statements included elsewhere in this Form 10-K. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. ITEM 4A. OFFICERS OF THE REGISTRANT (a) The names and ages of all officers of the Company, all positions and offices with the Company presently held by each person named and their business experience during the last five years are stated below. Positions, unless otherwise specified, are with the Company.
NAME, AGE AND POSITIONS PRINCIPAL OCCUPATION DURING PAST FIVE YEARS ----------------------- ------------------------------------------- Doug Rock (56).................... Chairman of the Board; Chief Executive Officer, President and Chief Operating Chairman of the Board, Chief Officer. Executive Officer, President and Chief Operating Officer Loren K. Carroll (59).............. President and Chief Executive Officer of M-I since March 1994; Executive Vice Executive Vice President of the President since October 1992; Chief Financial Officer from October 1992 to April Company; President and Chief 1997; member of the Board of Directors since November 1987. Executive Officer of M-I Neal S. Sutton (57)................ Senior Vice President-Administration, General Counsel and Secretary. Senior Vice President- Administration, General Counsel and Secretary Margaret K. Dorman (39)............ Senior Vice President, Chief Financial Officer and Treasurer since June 1999; Vice Senior Vice President, President, Controller and Assistant Treasurer from February 1998 to May 1999; Chief Financial Officer Director of Financial Reporting and Planning from December 1995 to February and Treasurer 1998. Roger A. Brown (57)................ President, Smith Bits since July 1998; President, Smith Diamond Technology from President, Smith Bits April 1995 to July 1998. John J. Kennedy (50)............... President and Chief Executive Officer, Wilson since June 1999; Senior Vice President, President and Chief Financial Officer and Treasurer from April 1997 to May 1999; Vice President, Chief Executive Officer, Wilson Chief Accounting Officer and Treasurer from March 1994 to April 1997. Richard A. Werner (61)............. President, Smith Services. President, Smith Services David R. Cobb (37)................. Vice President and Controller since July 2002; Assistant Controller from October Vice President and Controller 2001 to June 2002; Assistant Treasurer, Kent Electronics Corporation from April 1997 to September 2001. Alan Simpson (47)................... Vice President, Human Resources since February 2002; Regional Vice President, Vice President, Human Resources North Latin America of M-I from May 1999 to February 2002; UK Manager of Dowell Division of Schlumberger Evaluation and Production Services UK Ltd. from May 1994 to April 1999.
9
NAME, AGE AND POSITIONS PRINCIPAL OCCUPATION DURING PAST FIVE YEARS ----------------------- ------------------------------------------- Earl M. Springer (52) ........ Vice President, Business Development since February 1998; Manager of Business Development Vice President, Business from July 1997 to February 1998; Manager of Technology Development from August 1994 to Development July 1997. Geri D. Wilde (52)............ Vice President, Taxes since February 1998; Director of Taxes from April 1997 to Vice President, Taxes and February 1998; Assistant Treasurer since April 1997; Manager of Taxes and Payroll of M-I Assistant Treasurer from December 1986 to April 1997.
(b) All officers of the Company are elected annually by the Board of Directors at the meeting held immediately following the annual meeting of stockholders. They hold office until their successors are elected and qualified. There are no family relationships between the officers of the Company. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER MATTERS. The common stock of the Company is traded on the New York Stock Exchange and the Pacific Stock Exchange. The following are the high and low sale prices for the Company's common stock as reported on the New York Stock Exchange Composite Tape for the periods indicated, and adjusted for the two-for-one stock split effective July 8, 2002.
COMMON STOCK -------------------- HIGH LOW --------- --------- 2001 First Quarter $42.26 $33.66 Second Quarter 42.22 29.89 Third Quarter 30.55 16.15 Fourth Quarter 28.55 17.15 2002 First Quarter $34.94 $23.19 Second Quarter 38.72 30.23 Third Quarter 36.24 25.79 Fourth Quarter 35.95 26.55
On March 21, 2003, the Company had 2,265 common stock holders of record and the last reported closing price on the New York Stock Exchange Composite Tape was $34.10. The Company has not paid dividends on its common stock since the first quarter of 1986. The determination of the amount of future cash dividends to be declared and paid on the common stock, if any, will depend upon the Company's financial condition, earnings and cash flow from operations, the level of its capital expenditures, its future business prospects and other factors that the Board of Directors deems relevant. 10 ITEM 6. SELECTED FINANCIAL DATA
FOR THE YEARS ENDED DECEMBER 31, ----------------------------------------------------------------- 2002 2001 2000 1999(b) 1998(c) ---------- ---------- ---------- ---------- ---------- (In thousands, except per share data) STATEMENT OF OPERATIONS DATA: Revenues ............................ $3,170,080 $3,551,209 $2,761,014 $1,806,153 $2,118,715 Gross profit ........................ 918,302 1,045,804 745,169 467,940 629,059 Operating income .................... 256,148 371,510 199,026 149,532 125,309 Net income .......................... 93,189 152,145 72,800 56,724 34,069 Earnings per share - diluted basis(a) ............................ 0.93 1.51 0.72 0.58 0.35 BALANCE SHEET DATA: Total assets ........................ $2,749,545 $2,735,828 $2,295,287 $1,894,575 $1,758,988 Long-term debt ...................... 441,967 538,842 374,716 346,647 368,823 Total stockholders' equity .......... 1,063,535 949,159 817,481 720,220 634,034
The Notes to Consolidated Financial Statements and Management's Discussion and Analysis of Financial Condition and Results of Operations included elsewhere in this Form 10-K should be read in order to understand factors such as changes in the method of accounting for goodwill, business combinations completed during 2002, 2001 and 2000, and unusual items which may affect the comparability of the information shown above. (a) All fiscal years prior to 2002 have been restated for the impact of a two-for-one stock split, which was effective July 8, 2002. (b) In July 1999, the Company completed a transaction with Schlumberger Limited related to the combination of certain M-I and Dowell drilling fluid operations under a joint venture arrangement. Schlumberger contributed its non-U.S. drilling fluid operations and paid cash consideration of $280.0 million to the Company in exchange for a 40 percent minority ownership interest in the combined operations. The Company recognized a non-recurring gain of $81.4 million in connection with this transaction. (c) In 1998, the Company recognized $82.5 million of charges related to restructuring efforts and costs associated with the acquisition and integration of Wilson Industries, Inc. 11 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The following "Management's Discussion and Analysis of Financial Condition and Results of Operations" is provided to assist readers in understanding the Company's financial performance during the periods presented and significant trends which may impact the future performance of the Company. This discussion should be read in conjunction with the Consolidated Financial Statements of the Company and the related notes thereto included elsewhere in this Form 10-K. The Company manufactures and markets premium products and services to the oil and gas exploration and production and petrochemical industries and other industrial markets. The Company's worldwide operations are largely driven by the level of exploration and production activity in major energy-producing areas and the depth and drilling conditions of these projects. Drilling activity levels are primarily influenced by energy prices but may also be affected by expectations related to the worldwide supply of and demand for oil and natural gas, finding and development costs, decline and depletion rates, political actions and uncertainties, environmental concerns, capital expenditure plans of exploration and production companies and the overall level of global economic growth and activity. The Company's current year results are expected to be influenced by the anticipated five percent to ten percent increase in average worldwide activity levels during 2003 and, to a lesser extent, the acquisition of the oilfield chemical business of Dynea International, which was completed subsequent to year-end. The majority of the year-over-year increase in drilling activity is expected to be reported in North America. Drilling activity in the United States and Canada is heavily influenced by natural gas fundamentals, as over 80 percent of the North American rig count is currently natural gas-directed. Natural gas storage levels in the United States, which were in excess of the historical five-year average throughout most of 2002, have recently been reduced due to a combination of declining production and higher weather-related demand. Over the past twelve months, U.S. natural gas storage levels have declined close to 50 percent, which has contributed to average natural gas prices increasing nearly threefold. Although, to date, exploration and production companies have not committed significant capital for new drilling programs, management believes operators will increase spending throughout 2003 due to the favorable commodity price environment and the reduction in U.S. natural gas supplies. Drilling activity in markets outside of North America, which is primarily influenced by crude oil fundamentals, has remained relatively consistent throughout 2002 and is not forecasted to increase significantly in 2003. While worldwide activity levels are currently above the average reported in 2002, various factors, including political and regional instabilities, oil and natural gas storage levels, commodity prices and depletion rates, will likely influence drilling activity on a going forward basis. The Company's business outlook is highly dependent on the general economic environment in the United States and other major world economies, which ultimately impact energy consumption and the resulting demand for our products and services. Further weakness in the global economic environment could result in a substantial decline in worldwide drilling activity, adversely impacting the Company's future financial results. Management also believes the increasing complexity of drilling programs has resulted in a shift in exploration and production spending toward value-added, technology-based products, which reduce operators' overall drilling costs. The Company continues to focus on investing in the development of technology-based products that considerably improve the drilling process through increased efficiency and rates of penetration and reduced formation damage. Management believes the overall savings realized by the use of the Company's premium products, such as polycrystalline diamond drill bits, diamond-enhanced three-cone drill bits and synthetic drilling fluids, compensate for the higher costs of these products over their non-premium counterparts. FORWARD-LOOKING STATEMENTS This discussion contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 concerning, among other things, the Company's outlook, financial projections and business strategies, all of which are subject to risks, uncertainties and assumptions. These forward-looking statements are identified by their use of terms such as "expect," "anticipate," "believe," "estimate," "project" and similar terms. The statements are based on certain assumptions and analyses made by the Company that it believes are appropriate under the circumstances. Such statements are subject to general economic and business conditions, industry conditions, changes in laws or regulations and other factors, many of which are beyond the control of the Company. Should one or more of these risks or uncertainties materialize, or should the assumptions prove incorrect, actual results may vary. 12 RESULTS OF OPERATIONS Segment Discussion The Company markets its products and services throughout the world through four business units which are aggregated into two reportable segments. The Oilfield Products and Services segment consists of three business units: M-I, Smith Bits and Smith Services. The Distribution segment includes the Wilson business unit. The revenue discussion below has been summarized by business unit in order to provide additional information in analyzing the Company's operations. Dollars presented below are in thousands.
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------------------------------------------------ 2002 2001 2000 -------------------------- -------------------------- -------------------------- AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT ----------- ----------- ----------- ----------- ----------- ----------- REVENUES: M-I ............................ $ 1,558,672 49 $ 1,627,600 46 $ 1,236,999 45 Smith Bits ..................... 324,735 10 398,204 11 328,192 12 Smith Services ................. 399,502 13 398,327 11 289,935 10 ----------- ----------- ----------- ----------- ----------- ----------- Oilfield Products and Services 2,282,909 72 2,424,131 68 1,855,126 67 Wilson ......................... 887,171 28 1,127,078 32 905,888 33 ----------- ----------- ----------- ----------- ----------- ----------- Total ...................... $ 3,170,080 100 $ 3,551,209 100 $ 2,761,014 100 =========== =========== =========== =========== =========== =========== REVENUES BY AREA: United States .................. $ 1,492,710 47 $ 1,829,378 52 $ 1,349,812 49 Canada ......................... 286,640 9 400,124 11 380,316 14 Non-North America .............. 1,390,730 44 1,321,707 37 1,030,886 37 ----------- ----------- ----------- ----------- ----------- ----------- Total ...................... $ 3,170,080 100 $ 3,551,209 100 $ 2,761,014 100 =========== =========== =========== =========== =========== =========== OPERATING INCOME: Oilfield Products and Services . $ 266,692 12 $ 354,614 15 $ 188,017 10 Distribution ................... (4,026) -- 22,893 2 16,655 2 General Corporate .............. (6,518) * (5,997) * (5,646) * ----------- ----------- ----------- ----------- ----------- ----------- Total ...................... $ 256,148 8 $ 371,510 10 $ 199,026 7 =========== =========== =========== =========== =========== =========== M-I AVERAGE WORLDWIDE RIG COUNT: United States .................. 946 43 1,307 49 1,071 46 Canada ......................... 255 12 330 12 323 14 Non-North America .............. 989 45 1,040 39 935 40 ----------- ----------- ----------- ----------- ----------- ----------- Total ...................... 2,190 100 2,677 100 2,329 100 =========== =========== =========== =========== =========== ===========
* not meaningful 13 Oilfield Products and Services Segment Revenues M-I provides drilling and completion fluid systems, engineering and technical services to the oil and gas industry through its M-I Fluids division. M-I's SWACO division manufactures and markets equipment and services for solids-control, separation, pressure control, rig instrumentation and waste-management. M-I's business operations are largely influenced by the number of offshore drilling programs, which are more revenue-intensive than land-based projects due to the complex nature of the related drilling environment. M-I reported revenues of $1.6 billion for the year ended December 31, 2002, a decline of four percent from the prior year period. Excluding the impact of acquired operations, revenues were ten percent below the prior period and compared to an 18 percent decline in the average M-I worldwide rig count. The majority of the base revenue decline was attributable to the lower number of land-based drilling programs in the Western Hemisphere markets, primarily the United States, Argentina and Venezuela. Lower sales of synthetic drilling fluids, related to a 22 percent reduction in the average number of U.S. offshore drilling projects, accounted for the remainder of the year-to-year variance. M-I's 2001 revenues of $1.6 billion were 32 percent above the amount reported in 2000. The revenue growth was attributable to a 15 percent increase in worldwide drilling activity and, to a lesser extent, acquisitions and improved pricing. After excluding the effect of acquired operations, M-I's 2001 revenues were 22 percent above the prior year level with revenue growth reported in all geographic regions. The majority of the base-business revenue expansion was reported in the United States and Europe/Africa due to higher demand for fluid products and fluid processing services. Smith Bits designs, manufactures and sells three-cone drill bits, diamond drill bits and turbines for use in the oil and gas industry. Prior to the transfer of its mining bit operations to an unconsolidated joint venture in October 2001, Smith Bits also supplied drill bits to the mining and construction industry. For the year ended December 31, 2002, Smith Bits' revenues totaled $324.7 million. Revenues for the Smith Bits unit, which due to the nature of its product offerings correlate more closely to the rig count than any of the Company's other operations, were 18 percent below the prior year and mirrored the decline in worldwide activity levels. The majority of the revenue variance resulted from lower unit sales of three-cone bits, reflecting the 28 percent reduction in U.S. drilling activity. Reduced activity levels in certain Latin American markets, specifically Colombia, Argentina and Venezuela, accounted for the remainder of the year-to-year variance. Smith Bits' 2001 revenues totaled $398.2 million, a 21 percent increase over the 2000 level. Excluding the impact of mining bit operations, revenues grew 25 percent year-to-year and compared to a 15 percent increase in the average worldwide rig count. The majority of the base revenue growth was driven by increased drilling activity in the United States and Europe/Africa and, to a lesser extent, the impact of improved pricing and market penetration. Smith Services manufactures and markets products and services used in the oil and gas industry for drilling, workover, well completion and well re-entry. Smith Services reported revenues of $399.5 million for the year ended December 31, 2002. Revenues were comparable with amounts reported in the prior year period, as incremental revenues from acquired operations offset a 13 percent decline in base business volumes. The base revenue reduction primarily reflects the effect of a 27 percent decline in North American activity levels, which impacted demand for drilling-related products and services, including tubulars and inspection services. Smith Services' 2001 revenues totaled $398.3 million, a 37 percent increase over the 2000 level. The significant revenue growth was attributable to higher worldwide activity levels and new contract awards. Smith Services' base revenues increased over 2000 levels in all geographic regions, with approximately two-thirds of the improvement reported in the United States. On a product basis, over 60 percent of the revenue improvement was attributable to increased demand for drilling-related products and services, including drill pipe, tubulars and inspection services. 14 Operating Income Operating income for the Oilfield Products and Services segment was $266.7 million, a 25 percent decline from the prior year period. Segment operating margins were 12 percent for the year ended December 31, 2002, approximately three percentage points below the prior year's level. The year-over-year decrease in segment operating income relates to decreased gross profit, primarily associated with lower sales volumes, as the Company has experienced minimal pricing erosion to date. To a lesser extent, decreased demand for higher-margin products, specifically drill bits and premium drilling fluids which accounted for over three quarters of the revenue decline, contributed to the gross profit reduction. Segment operating expenses were comparable with the prior year, as the effect of lower employee profit-sharing requirements and the elimination of goodwill amortization was offset by incremental expenses associated with acquired operations and higher costs incurred under medical and casualty insurance programs. For the year ended December 31, 2001, segment operating income increased $166.6 million above the previous year due to higher gross profit primarily associated with the 31 percent revenue improvement, partially offset by higher variable-based operating expenses. Segment operating margins increased to 15 percent in 2001, five percentage points above the prior year's level. Approximately three-quarters of the year-over-year expansion in operating margins was attributable to improved gross profit margins, reflecting improved pricing and the leverage of higher volumes on the Company's manufacturing and service infrastructure. Operating expenses, as a percentage of revenues, also declined from 2000 and accounted for the remainder of the margin expansion. Distribution Segment Revenues Wilson markets pipe, valves, fittings and mill, safety and other maintenance products to energy and industrial markets, primarily through an extensive network of supply branches concentrated in the United States and Canada. The segment has the highest North American revenue exposure of any of the Company's operations, with 96 percent of Wilson's 2002 revenues generated in those markets. For the year ended December 31, 2002, Distribution revenues were $887.2 million, a 21 percent decline from the prior year's level. Over 70 percent of the revenue variance was reported in the energy branch operations related to a combination of lower North American drilling and completion activity and reduced Canadian tubular product sales due to increased competition from steel mills. Lower spending for major maintenance programs and projects by customers in the U.S. industrial and petrochemical markets contributed to the remainder of the segment's revenue variance. Wilson's revenues totaled $1.1 billion in 2001, an increase of 24 percent from 2000. The Van Leeuwen operations, which were acquired in January 2001, contributed approximately two-thirds of the year-over-year revenue growth. The majority of the eight percent increase in base-business revenues was reported in the U.S. energy branch operations, which benefited from higher customer spending on exploration and production programs and line pipe projects. Operating Income Distribution segment operating income declined $26.9 million from the amounts reported in 2001. The operating income variance reflects lower gross profit associated with the reported revenue decline, partially offset by a reduction in variable-based operating expenses. As a percentage of sales, operating income decreased two percentage points from the prior year, as lower sales volumes impacted coverage of fixed sales and administrative support costs. Wilson's 2001 operating income of $22.9 million was $6.2 million above the level reported in 2000. Operating income approximated two percent of revenue in 2001, slightly above the 2000 level due to the impact of the revenue growth on coverage of sales and administrative support expenses. Gross profit margins were consistent with the prior year, with an improvement in gross margins in the U.S. energy branches offset by the effect of a higher proportion of industrial and downstream revenues, which traditionally generate lower gross profit margins. 15 For the periods indicated, the following table summarizes the results of operations of the Company and presents these results as a percentage of total revenues (dollars in thousands):
FOR THE YEARS ENDED DECEMBER 31, --------------------------------------------------------------------------- 2002 2001 2000 ----------------------- ----------------------- ----------------------- AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT ---------- ---------- ---------- ---------- ---------- ---------- Revenues ....................... $3,170,080 100 $3,551,209 100 $2,761,014 100 ---------- ---------- ---------- ---------- ---------- ---------- Gross profit ................... 918,302 29 1,045,804 29 745,169 27 Operating expenses ............. 662,154 21 674,294 19 546,143 20 ---------- ---------- ---------- ---------- ---------- ---------- Operating income ............... 256,148 8 371,510 10 199,026 7 Interest expense, net .......... 38,349 1 42,464 1 34,895 1 ---------- ---------- ---------- ---------- ---------- ---------- Income before income taxes and minority interests ........... 217,799 7 329,046 9 164,131 6 Income tax provision ........... 66,632 2 106,397 3 54,998 2 ---------- ---------- ---------- ---------- ---------- ---------- Income before minority interests .................... 151,167 5 222,649 6 109,133 4 Minority interests ............. 57,978 2 70,504 2 36,333 1 ---------- ---------- ---------- ---------- ---------- ---------- Net income ..................... $ 93,189 3 $ 152,145 4 $ 72,800 3 ========== ========== ========== ========== ========== ==========
2002 versus 2001 Consolidated revenues were $3.2 billion, 11 percent below the prior year's level. The majority of the revenue reduction was reported in the Company's Distribution operations, which are concentrated in North America and were impacted by the significant decline in corresponding activity levels. The revenue variance was also influenced by the impact of revenues from acquired operations and, to a lesser extent, the contribution of certain Oilfield segment operations to an unconsolidated joint venture in the fourth quarter of 2001. Excluding the net impact of acquired and divested operations, base revenues declined 15 percent from the prior year, as demand for the Company's products and services was impacted by a 26 percent reduction in Western Hemisphere drilling activity. Base revenue growth in the Eastern Hemisphere markets, attributable to increased activity levels and new contract awards, served to partially offset the overall revenue decline. Gross profit was $918.3 million, 12 percent below the prior year period. The decrease in gross profit reflects lower sales volumes associated with the reduction in worldwide activity levels and, to a lesser extent, decreased demand for higher-margin Oilfield segment products. Gross profit margins for the year were 29 percent of revenues, comparable with the prior year period. An increased proportion of Oilfield segment revenues in 2002, which generate higher gross profit margins than the Distribution operations, served to mask the margin deterioration reported in the Oilfield segment. Operating expenses, consisting of selling, general and administrative expenses, decreased $12.1 million from the prior year amount. The operating expense decline was attributable to cost reduction efforts initiated in response to the decrease in Western Hemisphere activity levels, lower employee profit-sharing requirements and the elimination of goodwill amortization in accordance with SFAS No. 142. Incremental expenses from acquired operations and the increased cost of medical and casualty insurance programs served to partially offset the overall expense decline. As a percentage of revenues, operating expenses increased two percentage points, reflecting lower fixed cost coverage related to the overall sales and administrative functions in both of the Company's operating segments. Net interest expense, which represents interest expense less interest income, decreased $4.1 million from the prior year. The minimal increase in average debt levels, primarily related to financing acquisitions in the fourth quarter of the prior year, was more than offset by the impact of reduced short-term interest rates on the Company's variable rate debt. 16 The effective tax rate approximated 31 percent, which was below both the 32 percent effective rate reported in the prior year and the U.S. statutory rate. The effective tax rate was lower than the U.S. statutory rate due to the impact of M-I's U.S. partnership earnings for which the minority partner is directly responsible for its related income taxes. The Company properly consolidates the pre-tax income related to the minority partner's share of U.S. partnership earnings but excludes the related tax provision. The effective tax rate declined one percentage point from the prior year due to the elimination of goodwill amortization, a portion of which was not tax deductible, and a favorable shift in the geographic mix of pre-tax income toward lower rate jurisdictions. Minority interests reflect the portion of the results of majority-owned operations which are applicable to the minority interest partners. Minority interests totaled $58.0 million in 2002, a $12.5 million reduction from the prior year. The decrease reflects the lower profitability of the M-I joint venture, partially offset by the impact of acquiring a majority interest in United Engineering Services LLC in the fourth quarter of 2001. 2001 versus 2000 Consolidated revenues were $3.6 billion, 29 percent above the prior year, with higher revenue reported across all operating units and geographic regions. Two-thirds of the improvement was generated by the Company's base operations. The Company reported organic revenue growth of 19 percent from 2000, comparing favorably to the 15 percent increase in average worldwide drilling activity. The majority of the consolidated base revenue growth was reported in the United States and Europe/Africa. The period-to-period increase in revenues was also attributable to acquired operations and, to a lesser extent, the impact of improved pricing and market penetration experienced in the Company's Oilfield operations. Gross profit was $1.0 billion, 40 percent in excess of the prior year due primarily to the higher reported revenue levels. Gross profit margins rose over two percentage points to 29 percent of revenues in 2001, reflecting the impact of price increases and higher sales volumes on fixed cost coverage in the Oilfield Products and Services segment. A higher proportion of Oilfield segment revenues in 2001, which generate higher gross profit margins than the Distribution business, also favorably affected the overall percentage. Operating expenses increased $128.2 million, or 24 percent, from the amount reported in 2000. The majority of the overall increase in operating expenses was attributable to the expansion in base business volumes, which contributed to a 16 percent increase in average personnel levels over 2000. Incremental operating expenses associated with acquired operations contributed to the higher expense levels, to a lesser extent, accounting for approximately 40 percent of the variance from the prior year. Operating expenses as a percentage of revenues declined almost one percentage point from 2000, reflecting higher fixed cost coverage related to the overall sales and administrative functions in both of the Company's operating segments. Net interest expense increased $7.6 million from 2000. Average debt levels rose $158.9 million year-over-year, reflecting borrowings necessary to finance 15 acquisitions in 2001. The Company's average borrowing rate declined approximately 70 basis points in 2001, partially offsetting the impact of the increase in average debt levels on the interest expense variance. The effective tax rate approximated 32 percent, which was below both the 34 percent effective rate reported in the prior year and the U.S. statutory rate. The effective rate was below the U.S. statutory rate due to the impact of M-I's U.S. partnership earnings for which the minority partner is directly responsible for its related income taxes. The Company properly consolidates the pre-tax income related to the minority partner's share of U.S. partnership earnings but excludes the related tax provision. The effective tax rate declined from the prior year, primarily due to a favorable shift in the geographic mix of pre-tax income toward lower rate jurisdictions. Minority interests reflect the portion of the results of majority-owned operations which are applicable to the minority interest partners. Minority interests was $70.5 million, an increase of $34.2 million from 2000 reflecting primarily the improvement in profitability of the M-I joint venture. 17 LIQUIDITY AND CAPITAL RESOURCES General At December 31, 2002, cash and cash equivalents equaled $86.8 million. During 2002, the Company's operations generated $323.5 million of cash flows, which is $117.8 million above the amount reported in 2001. The improvement is related to the significant decline in North American drilling activity, which reduced working capital levels, particularly the required investment in accounts receivable and inventories. In 2002, cash flows used in investing activities totaled $139.2 million, primarily attributable to capital expenditures and, to a lesser extent, amounts required to fund acquisitions. During 2002, the Company invested $78.8 million in property, plant and equipment, net of cash proceeds arising from certain asset disposals. Projected net capital expenditures for 2003 are expected to increase to approximately $85.0 million, as higher drilling activity is expected to impact the level of investment in manufacturing and rental tool equipment. Capital spending in 2003 is expected to primarily consist of spending for routine additions of property and equipment to support the Company's operations and maintenance of the Company's capital equipment base. In addition to the investment in capital equipment, the Company funded four acquisitions during 2002 for cash consideration of $60.2 million and purchased stock of a majority-owned subsidiary totaling $0.2 million. Cash flows from operations exceeded cash required to fund investing activities, resulting in repayments of $116.0 million in outstanding indebtedness. Cash flows used in financing activities, which totaled $142.6 million for 2002, were also impacted by minority partner cash distributions of $31.6 million and proceeds from the exercise of stock options totaling $5.0 million during the year. The Company's primary internal source of liquidity is cash flow generated from operations. Cash flow generated by operations is primarily influenced by the level of worldwide drilling activity, which affects profitability levels and working capital requirements. Capacity under revolving credit agreements is also available, if necessary, to fund operating or investing activities. The Company has various revolving credit facilities in the United States. As of December 31, 2002, the Company had $360.0 million of capacity available under these facilities for future operating or investing needs. The Company also has revolving credit facilities in place outside of the United States, which are generally used to finance local operating needs. At year-end, the Company had available borrowing capacity of $47.9 million under the non-U.S. borrowing facilities. The Company's external sources of liquidity include debt and equity financing in the public capital markets, if needed. The Company carries an investment-grade credit rating with recognized rating agencies, generally providing the Company with access to debt markets. The Company's overall borrowing capacity is, in part, dependent on maintaining compliance with financial covenants under the various credit agreements. As of year-end, the Company was well within the covenant compliance thresholds under its various loan indentures, as amended, providing the ability to access available borrowing capacity. Management believes funds generated by operations, amounts available under existing credit facilities and external sources of liquidity will be sufficient to finance capital expenditures and working capital needs of the existing operations for the foreseeable future. Subsequent to December 31, 2002, M-I acquired certain oilfield chemical assets of Dynea International in exchange for cash consideration of $78.6 million. The transaction was funded with cash on hand and $37.2 million of borrowings under the Company's revolving credit agreement. Management continues to evaluate opportunities to acquire products or businesses complementary to the Company's operations. Additional acquisitions, if they arise, may involve the use of cash or, depending upon the size and terms of the acquisition, may require debt or equity financing. 18 The Company has not engaged in off-balance sheet financing arrangements through special purpose entities, and the consolidation of the Company's minority ownership positions would not result in an increase in reported leverage ratios. The Company has no contractual arrangements in place that could result in the issuance of additional shares of the Company's common stock at a future date other than the Company's stock option program, which is discussed in Note 1, "Summary of Significant Accounting Policies," and Note 12, "Employee Stock Options." The Company believes that it has sufficient existing manufacturing capacity to meet current demand for its products and services. Additionally, inflation has not had a material effect on the Company in recent years and is expected to have a modest impact on the operations in the foreseeable future. The Company has generally been able to offset most of the effects of inflation through productivity gains, cost reductions and price increases. Contractual Obligations, Commitments and Contingencies The following table summarizes the Company's debt maturities and future minimum payments under non-cancelable operating leases having initial terms in excess of one year (in thousands):
Operating Debt Lease Period Due Maturities Commitments Total ---------- ---------- ----------- -------- 2003 ................................. $159,692 $ 34,452 $194,144 2004 ................................. 19,888 23,064 42,952 2005 ................................. 32,152 17,160 49,312 2006 ................................. 13,152 12,663 25,815 2007 ................................. 156,736 9,766 166,502 Thereafter ........................... 220,039 36,755 256,794 -------- -------- -------- $601,659 $133,860 $735,519 ======== ======== ========
In the normal course of business with customers, vendors and others, the Company is contingently liable for performance under standby letters of credit and bid and performance bonds which totaled $72.4 million at December 31, 2002. The amount primarily consists of a $25.0 million standby letter of credit, supporting notes issued in conjunction with the acquisition of CleanCut Technologies, and various performance bonds, of which $33.1 million expire in 2003. Management does not expect any material amounts to be drawn on these instruments. The Company routinely establishes and reviews the adequacy of reserves for estimated future environmental clean-up costs for properties currently or previously operated by the Company. Although the Company believes it is in substantial compliance with environmental protection laws, estimating the related liability is difficult considering the continual changes in environmental regulations and the potential identification of new sites. In connection with most business acquisitions, the Company obtains contractual indemnifications from the seller related to environmental matters. These indemnifications generally provide for the reimbursement of environmental clean-up costs incurred by the Company for events occurring or circumstances existing prior to the purchase date, whether the event or circumstance was known or unknown at that time. A substantial portion of the Company's total environmental exposure is associated with its M-I operations, which are subject to various indemnifications from former owners. As of December 31, 2002, the Company has established an environmental reserve of $12.1 million. This amount reflects the future undiscounted estimated exposure related to identified properties, without regard to indemnifications from former owners. While actual future environmental costs may differ from estimated liabilities recorded at December 31, 2002, the Company does not believe that these differences will have a material impact on the Company's financial position or results of operations, subject to the indemnifications in place. In the event that i) the parties providing the environmental indemnifications do not fulfill their obligations, and ii) costs incurred to remediate the identified properties reach estimated maximum exposure limits, the Company would be required to establish additional environmental reserves of up to $25.0 million, impacting earnings and cash flows in future periods. 19 CRITICAL ACCOUNTING POLICIES AND ESTIMATES The discussion and analysis of financial condition and results of operations are based upon the Company's consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. The Company evaluates its estimates on an on-going basis, based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. The Company believes the following describes significant judgments and estimates used in the preparation of its consolidated financial statements: The Company extends credit to customers and other parties in the normal course of business. Management regularly reviews outstanding receivables and provides for estimated losses through an allowance for doubtful accounts. In evaluating the level of established reserves, management makes judgments regarding the parties' ability to make required payments, economic events and other factors. As the financial condition of these parties change, circumstances develop or additional information becomes available, adjustments to the allowance for doubtful accounts may be required. The Company has made significant investments in inventory to service its customers around the world. On a routine basis, the Company uses judgments in determining the level of reserves required to state inventory at the lower of cost or market. Management's estimates are primarily influenced by technological innovations, market activity levels and the physical condition of products. Changes in these or other factors may result in adjustments to the carrying value of inventory. Deferred tax assets and liabilities are recognized for differences between the book basis and tax basis of the net assets of the Company. In providing for deferred taxes, management considers current tax regulations, estimates of future taxable income and available tax planning strategies. In certain cases, management has established reserves to reduce deferred tax assets to estimated realizable value. If tax regulations, operating results or the ability to implement tax planning strategies vary, adjustments to the carrying value of deferred tax assets and liabilities may be required. The Company records liabilities for environmental obligations when remedial efforts are probable and the costs can be reasonably estimated. Management's estimates are based on currently enacted laws and regulations. As more information becomes available or environmental laws and regulations change, such liabilities may be required to be adjusted. Additionally, in connection with acquisitions, the Company generally obtains indemnifications from the seller related to environmental matters. If the indemnifying parties do not fulfill their obligations, adjustments of recorded amounts may be required. The Company maintains insurance coverage for various aspects of its business and operations. The Company retains a portion of losses that occur through the use of deductibles and retentions under self-insurance programs. Management regularly reviews estimates of reported and unreported claims and provides for losses through insurance reserves. As claims develop and additional information becomes available, adjustments to loss reserves may be required. 20 RECENT ACCOUNTING PRONOUNCEMENTS On January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 provides updated guidance concerning the recognition and measurement of an impairment loss for certain types of long-lived assets and modifies the accounting and reporting of discontinued operations. The adoption of SFAS No. 144 did not have a material impact on the Company's consolidated financial position or results of operations for the year ended December 31, 2002. On December 31, 2002, the Company adopted the disclosure requirements of SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation and amends the disclosure requirements of SFAS No. 123. On January 1, 2003, the Company adopted SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 addresses the financial accounting and reporting for retirement obligations and costs associated with tangible long-lived assets. The adoption of SFAS No. 143 is not expected to have a material impact on the Company's consolidated financial position or results of operations for the year ending December 31, 2003. From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board ("FASB") which are adopted by the Company as of the specified effective date. Unless otherwise discussed, management believes the impact of recently issued standards, which are not yet effective, will not have a material impact on the Company's consolidated financial position or results of operations upon adoption. 21 QUALITATIVE AND QUANTITATIVE MARKET RISK DISCLOSURES The Company is exposed to market risks from changes in interest rates and foreign exchange rates and enters into various hedging transactions to mitigate these risks. The Company does not use financial instruments for trading or speculative purposes. See Note 7, "Financial Instruments," for additional discussion of hedging instruments. The Company's exposure to interest rate changes is managed through the use of a combination of fixed and floating rate debt and by entering into interest rate contracts, from time to time, on a portion of its long-term borrowings. The Company had no interest rate contracts outstanding as of December 31, 2002 and 2001. At December 31, 2002, 24 percent of the Company's long-term debt carried a variable interest rate. Management believes that significant interest rate changes will not have a material near-term impact on the Company's future earnings or cash flows. The Company's exposure to changes in foreign exchange rates is managed primarily through the use of forward exchange contracts. These contracts increase or decrease in value as foreign exchange rates change, to protect the value of the underlying transactions denominated in foreign currencies. All currency contracts are components of the Company's hedging program and are entered into for the sole purpose of hedging an existing or anticipated currency exposure. The gains and losses on these contracts offset changes in the value of the related exposures. The terms of these contracts generally do not exceed two years. As of December 31, 2002, the notional amounts of fair value hedge contracts and cash flow hedge contracts outstanding were $43.4 million and $31.4 million, respectively, and the fair value exceeded the notional amount of these contracts by $3.6 million. As of December 31, 2001, the notional amounts of fair value hedge contracts and cash flow hedge contracts outstanding were $43.1 million and $15.5 million, respectively, and the fair value exceeded the notional amount of these contracts by $1.4 million. In some areas, where hedging is not cost effective, the Company addresses foreign currency exposure utilizing working capital management. The Company utilizes a "Value-at-Risk" ("VAR") model to determine the maximum potential one-day loss in the fair value of its foreign exchange sensitive financial instruments. The VAR model estimates were made assuming normal market conditions and a 95 percent confidence level. The Company's VAR computations are based on the historical price movements in various currencies (a "historical" simulation) during the year. The model includes all of the Company's foreign exchange derivative contracts. Anticipated transactions, firm commitments and assets and liabilities denominated in foreign currencies, which certain of these instruments are intended to hedge, were excluded from the model. The VAR model is a risk analysis tool and does not purport to represent actual losses in fair value that will be incurred by the Company, nor does it consider the potential effect of favorable changes in market factors. The estimated maximum potential one-day loss in fair value of currency sensitive instruments, calculated using the VAR model, was not material to the Company's financial position or results of operations. 22 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Below is a copy of the report previously issued by Arthur Andersen LLP, the Company's former independent public accountants, related to the Company's consolidated financial statements for the years ended December 31, 2001 and 2000. Arthur Andersen ceased operations in 2002 and is unable to issue an updated report. Certain financial statements covered by this report have not been included in the accompanying financial statements. REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To Smith International, Inc.: We have audited the accompanying consolidated balance sheets of Smith International, Inc. (a Delaware corporation) and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of operations, stockholders' equity and comprehensive income and cash flows for each of the three years in the period ended December 31, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Smith International, Inc. and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. ARTHUR ANDERSEN LLP Houston, Texas January 29, 2002 23 INDEPENDENT AUDITORS' REPORT To the Board of Directors and Stockholders of Smith International, Inc.: We have audited the accompanying consolidated balance sheet of Smith International, Inc. and subsidiaries (the "Company") as of December 31, 2002, and the related consolidated statements of operations, stockholders' equity and comprehensive income and cash flows for the year then ended. Our audits also included the financial statement schedule listed in Part IV, Item 15(a)(2). These consolidated financial statements and financial statement schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audit. The consolidated financial statements and financial statement schedule of the Company as of December 31, 2001 and for each of the two years in the period ended December 31, 2001, prior to the revisions discussed below, were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those financial statements in their report dated January 29, 2002. We conducted our audit in accordance with auditing standards generally accepted in the United States of America. 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 audit provides a reasonable basis for our opinion. In our opinion, such 2002 consolidated financial statements present fairly, in all material respects, the financial position of Smith International, Inc. and subsidiaries as of December 31, 2002, and the results of its operations and its cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such 2002 financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly in all material respects the information set forth therein. As discussed in Note 1 to the financial statements, effective January 1, 2002, the Company changed its method of accounting for goodwill and other intangible assets upon adoption of Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." As discussed above, the consolidated financial statements and financial statement schedule of the Company as of December 31, 2001 and for each of the two years in the period ended December 31, 2001 were audited by other auditors who have ceased operations. These financial statements have been revised to i) give effect to a two-for-one stock split during 2002 (Notes 1, 3, 9 and 12), ii) include the transitional disclosures required by SFAS No. 142 (Notes 1 and 5), and iii) include expanded disclosures relating to foreign currency contracts (Note 7) and the Company's supplemental executive retirement plan (Note 10). We audited the adjustments, transitional disclosures and expanded disclosures described above. Our procedures included a) agreeing previously reported weighted average shares outstanding, stock option, net income and goodwill amounts to the previously issued financial statements, b) agreeing the transitional adjustments and expanded disclosure amounts to the Company's underlying records obtained from management, and c) testing the mathematical accuracy of the applicable 2001 and 2000 amounts. In our opinion, such adjustments and disclosures for 2001 and 2000 are appropriate and have been properly applied. However, we were not engaged to audit, review or apply any procedures to the 2001 and 2000 consolidated financial statements and financial statement schedule of the Company other than with respect to such adjustments and disclosures, and accordingly, we do not express an opinion or any other form of assurance on the 2001 and 2000 consolidated financial statements and financial statement schedule taken as a whole. DELOITTE & TOUCHE LLP Houston, Texas February 20, 2003 24 SMITH INTERNATIONAL, INC. CONSOLIDATED BALANCE SHEETS ASSETS
DECEMBER 31, ------------------------ 2002 2001 ---------- ---------- (In thousands) CURRENT ASSETS: Cash and cash equivalents ...................................... $ 86,750 $ 44,683 Receivables, less allowance for doubtful accounts of $12,338 and $10,921 in 2002 and 2001, respectively ....................... 633,918 752,165 Inventories, net ............................................... 634,488 653,151 Deferred tax assets, net ....................................... 25,403 35,414 Prepaid expenses and other ..................................... 46,355 37,618 ---------- ---------- Total current assets ......................................... 1,426,914 1,523,031 ---------- ---------- PROPERTY, PLANT AND EQUIPMENT: Land ........................................................... 33,412 28,390 Buildings ...................................................... 125,589 100,888 Machinery and equipment ........................................ 506,245 482,045 Rental tools ................................................... 268,134 243,913 ---------- ---------- 933,380 855,236 Less-Accumulated depreciation .................................. 414,160 366,739 ---------- ---------- Net property, plant and equipment .............................. 519,220 488,497 ---------- ---------- GOODWILL, net of accumulated amortization of $53,586 ............. 620,075 574,550 OTHER ASSETS ..................................................... 183,336 149,750 ---------- ---------- TOTAL ASSETS ..................................................... $2,749,545 $2,735,828 ========== ==========
The accompanying notes are an integral part of these financial statements. 25 SMITH INTERNATIONAL, INC. CONSOLIDATED BALANCE SHEETS LIABILITIES AND STOCKHOLDERS' EQUITY
DECEMBER 31, --------------------------- 2002 2001 ----------- ----------- (In thousands, except par value data) CURRENT LIABILITIES: Short-term borrowings and current portion of long-term debt ................ $ 159,692 $ 148,693 Accounts payable ........................................................... 256,069 284,502 Accrued payroll costs ...................................................... 49,946 81,803 Income taxes payable ....................................................... 43,936 41,143 Other ...................................................................... 85,453 109,863 ----------- ----------- Total current liabilities ................................................ 595,096 666,004 ----------- ----------- LONG-TERM DEBT ............................................................... 441,967 538,842 DEFERRED TAX LIABILITIES ..................................................... 64,679 40,504 OTHER LONG-TERM LIABILITIES .................................................. 67,011 51,027 MINORITY INTERESTS ........................................................... 517,257 490,292 COMMITMENTS AND CONTINGENCIES (Note 14) STOCKHOLDERS' EQUITY: Preferred stock, $1 par value; 5,000 shares authorized; no shares issued or outstanding in 2002 or 2001 ........................................... -- -- Common stock, $1 par value; 150,000 shares authorized; 101,546 shares issued in 2002 (50,594 shares issued in 2001, on a pre-split basis) ............. 101,546 50,594 Additional paid-in capital ................................................. 345,911 389,989 Retained earnings .......................................................... 655,643 562,454 Accumulated other comprehensive income ..................................... (10,435) (24,748) Less-Treasury securities, at cost; 2,384 common shares in 2002 (1,192 common shares in 2001, on a pre-split basis) .................................... (29,130) (29,130) ----------- ----------- Total stockholders' equity ............................................... 1,063,535 949,159 ----------- ----------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ................................... $ 2,749,545 $ 2,735,828 =========== ===========
The accompanying notes are an integral part of these financial statements. 26 SMITH INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------------- 2002 2001 2000 ----------- ----------- ----------- (In thousands, except per share data) Revenues ........................................... $ 3,170,080 $ 3,551,209 $ 2,761,014 Costs and expenses: Costs of revenues ................................ 2,251,778 2,505,405 2,015,845 Selling expenses ................................. 520,509 520,004 415,448 General and administrative expenses .............. 141,645 138,561 119,579 Goodwill amortization ............................ -- 15,729 11,116 ----------- ----------- ----------- Total costs and expenses ....................... 2,913,932 3,179,699 2,561,988 ----------- ----------- ----------- Operating income ................................... 256,148 371,510 199,026 Interest expense ................................... 40,928 45,359 36,756 Interest income .................................... (2,579) (2,895) (1,861) ----------- ----------- ----------- Income before income taxes and minority interests ........................................ 217,799 329,046 164,131 Income tax provision ............................... 66,632 106,397 54,998 ----------- ----------- ----------- Income before minority interests ................... 151,167 222,649 109,133 Minority interests ................................. 57,978 70,504 36,333 ----------- ----------- ----------- Net income ......................................... $ 93,189 $ 152,145 $ 72,800 =========== =========== =========== Earnings per share: Basic ............................................ $ 0.94 $ 1.53 $ 0.73 =========== =========== =========== Basic, excluding impact of goodwill amortization . $ 0.94 $ 1.62 $ 0.81 =========== =========== =========== Diluted .......................................... $ 0.93 $ 1.51 $ 0.72 =========== =========== =========== Diluted, excluding impact of goodwill amortization $ 0.93 $ 1.61 $ 0.80 =========== =========== =========== Weighted average shares outstanding: Basic ............................................ 98,984 99,504 99,206 Diluted .......................................... 100,091 100,448 100,604
The accompanying notes are an integral part of these financial statements. 27 SMITH INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, ------------------------------------- 2002 2001 2000 --------- --------- --------- (In thousands) Cash flows from operating activities: Net income ................................................. $ 93,189 $ 152,145 $ 72,800 Adjustments to reconcile net income to net cash provided by operating activities, excluding the net effects of acquisitions: Depreciation and amortization ............................ 89,327 92,895 80,688 Minority interests ....................................... 57,978 70,504 36,333 Provision for losses on receivables ...................... 9,593 2,986 3,277 Increase (decrease) in LIFO inventory reserves ........... 439 (1,163) 1,339 Gain on disposal of property, plant and equipment ........ (4,645) (6,385) (5,755) Foreign currency translation losses (gains) .............. (864) 889 487 Changes in operating assets and liabilities: Receivables .............................................. 119,600 (31,748) (156,792) Inventories .............................................. 33,675 (33,819) (38,345) Accounts payable ......................................... (32,817) (35,738) 31,943 Other current assets and liabilities ..................... (39,756) 4,412 38,739 Other non-current assets and liabilities ................. (2,193) (9,213) (6,994) --------- --------- --------- Net cash provided by operating activities .............. 323,526 205,765 57,720 --------- --------- --------- Cash flows from investing activities: Acquisition of businesses, net of cash acquired ............ (60,152) (248,127) (145,371) Purchases of property, plant and equipment ................. (97,051) (127,642) (94,581) Proceeds from disposal of property, plant and equipment .... 18,247 18,228 16,705 Purchases of stock in majority-owned subsidiary ............ (231) (2,084) -- --------- --------- --------- Net cash used in investing activities .................. (139,187) (359,625) (223,247) --------- --------- --------- Cash flows from financing activities: Proceeds from issuance of long-term debt ................... 15,902 371,250 128,195 Principal payments of long-term debt ....................... (130,775) (222,584) (33,918) Net change in short-term borrowings ........................ (1,170) (26,052) 44,290 Purchases of treasury stock ................................ -- (21,428) -- Proceeds from exercise of stock options .................... 5,047 5,519 18,059 Contributions from (distributions to) minority interest partner .................................................. (31,600) 55,400 21,600 --------- --------- --------- Net cash provided by (used in) financing activities .... (142,596) 162,105 178,226 --------- --------- --------- Effect of exchange rate changes on cash ...................... 324 (106) (282) --------- --------- --------- Increase in cash and cash equivalents ........................ 42,067 8,139 12,417 Cash and cash equivalents at beginning of year ............... 44,683 36,544 24,127 --------- --------- --------- Cash and cash equivalents at end of year ..................... $ 86,750 $ 44,683 $ 36,544 ========= ========= =========
The accompanying notes are an integral part of these financial statements. 28 SMITH INTERNATIONAL, INC. CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME FOR THE YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000 (IN THOUSANDS, EXCEPT SHARE DATA)
COMMON STOCK ACCUMULATED --------------------------- ADDITIONAL OTHER NUMBER OF PAID-IN RETAINED COMPREHENSIVE SHARES AMOUNT CAPITAL EARNINGS INCOME ----------- ------------ ----------- ----------- ------------- Balance, December 31, 1999 ............... 49,585,911 $ 49,586 $ 351,397 $ 337,509 $ (10,570) Comprehensive income: Net income ............................. -- -- -- 72,800 -- Currency translation adjustments ....... -- -- -- -- (7,223) ----------- ----------- ----------- ----------- ----------- Comprehensive income ..................... -- -- -- 72,800 (7,223) ----------- ----------- ----------- ----------- ----------- Exercise of stock options ................ 833,019 833 30,851 -- -- ----------- ----------- ----------- ----------- ----------- Balance, December 31, 2000 ............... 50,418,930 50,419 382,248 410,309 (17,793) Comprehensive income: Net income ............................. -- -- -- 152,145 -- Currency translation adjustments ....... -- -- -- -- (5,057) Changes in unrealized fair value of derivatives .......................... -- -- -- -- (963) Minimum pension liability adjustments .. -- -- -- -- (935) ----------- ----------- ----------- ----------- ----------- Comprehensive income ..................... -- -- -- 152,145 (6,955) ----------- ----------- ----------- ----------- ----------- Purchases of treasury stock .............. -- -- -- -- -- Exercise of stock options and stock grants 175,000 175 7,741 -- -- ----------- ----------- ----------- ----------- ----------- Balance, December 31, 2001 ............... 50,593,930 50,594 389,989 562,454 (24,748) Comprehensive income: Net income ............................. -- -- -- 93,189 -- Currency translation adjustments ....... -- -- -- -- 13,597 Changes in unrealized fair value of derivatives .......................... -- -- -- -- 3,266 Minimum pension liability adjustments .. -- -- -- -- (2,550) ----------- ----------- ----------- ----------- ----------- Comprehensive income ..................... -- -- -- 93,189 14,313 ----------- ----------- ----------- ----------- ----------- Exercise of stock options and stock grants 276,993 277 6,597 -- -- Two-for-one common stock split (Note 9) .. 50,675,019 50,675 (50,675) -- -- ----------- ----------- ----------- ----------- ----------- Balance, December 31, 2002 ............... 101,545,942 $ 101,546 $ 345,911 $ 655,643 $ (10,435) =========== =========== =========== =========== ===========
TREASURY SECURITIES --------------------------- COMMON STOCK --------------------------- TOTAL NUMBER OF STOCKHOLDERS' SHARES AMOUNT EQUITY ----------- ----------- ------------ Balance, December 31, 1999 ............... (655,854) $ (7,702) $ 720,220 Comprehensive income: Net income ............................. -- -- 72,800 Currency translation adjustments ....... -- -- (7,223) ----------- ----------- ----------- Comprehensive income ..................... -- -- 65,577 ----------- ----------- ----------- Exercise of stock options ................ -- -- 31,684 ----------- ----------- ----------- Balance, December 31, 2000 ............... (655,854) (7,702) 817,481 Comprehensive income: Net income ............................. -- -- 152,145 Currency translation adjustments ....... -- -- (5,057) Changes in unrealized fair value of derivatives .......................... -- -- (963) Minimum pension liability adjustments .. -- -- (935) ----------- ----------- ----------- Comprehensive income ..................... -- -- 145,190 ----------- ----------- ----------- Purchases of treasury stock .............. (536,200) (21,428) (21,428) Exercise of stock options and stock grants -- -- 7,916 ----------- ----------- ----------- Balance, December 31, 2001 ............... (1,192,054) (29,130) 949,159 Comprehensive income: Net income ............................. -- -- 93,189 Currency translation adjustments ....... -- -- 13,597 Changes in unrealized fair value of derivatives .......................... -- -- 3,266 Minimum pension liability adjustments .. -- -- (2,550) ----------- ----------- ----------- Comprehensive income ..................... -- -- 107,502 ----------- ----------- ----------- Exercise of stock options and stock grants -- -- 6,874 Two-for-one common stock split (Note 9) .. (1,192,054) -- -- ----------- ----------- ----------- Balance, December 31, 2002 ............... (2,384,108) $ (29,130) $ 1,063,535 =========== =========== ===========
The accompanying notes are an integral part of these financial statements. 29 SMITH INTERNATIONAL, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (All dollar amounts are expressed in thousands, unless otherwise noted) 1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES Basis of Presentation Smith International, Inc. ("Smith" or the "Company") provides premium products and services to the oil and gas exploration and production industry, the petrochemical industry and other industrial markets. The accompanying consolidated financial statements were prepared in accordance with U.S. generally accepted accounting principles and all applicable financial statement rules and regulations of the Securities and Exchange Commission (the "Commission"). Management believes the consolidated financial statements present fairly the financial position, results of operations and cash flows of the Company as of the dates indicated. The consolidated financial statements include the accounts of the Company and all wholly and majority-owned subsidiaries. Investments in affiliates in which ownership interest ranges from 20 to 50 percent, and the Company exercises significant influence over operating and financial policies, are accounted for on the equity method. All other investments are carried at cost, which does not exceed the estimated net realizable value of such investments. All significant intercompany accounts and transactions have been eliminated. Audited Financial Information for Periods Prior to Fiscal 2002 Arthur Andersen LLP ("Arthur Andersen") served as the Company's independent auditors until their dismissal on April 15, 2002, at which time Smith's Board of Directors appointed Deloitte & Touche LLP. Accordingly, Arthur Andersen performed audits of the Company's consolidated financial statements as of December 31, 2001 and 2000 and for the fiscal years then ended and issued an unqualified opinion dated January 29, 2002. Arthur Andersen ceased operations during 2002 and is unable to consent to the inclusion of their previously issued opinions on the Company's financial statements in filings with the Commission. Although the accompanying balance sheet as of December 31, 2001 and the related consolidated statements of operations, stockholders' equity and comprehensive income and cash flows for each of the two years in the period ended December 31, 2001, are not covered by a current consent from the Company's former independent auditors, management has included these financial statements in order to provide historical information as required by the Commission. Management is not aware of any event or circumstance which would have precluded Arthur Andersen from reissuing their opinion on the Company's 2000 and 2001 consolidated financial statements. Use of Estimates Preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosed amounts of contingent assets and liabilities and the reported amounts of revenues and expenses. Management believes the most significant estimates and assumptions are associated with the valuation of accounts receivable, inventories and deferred taxes as well as the determination of liabilities related to environmental obligations and self-insurance programs. If the underlying estimates and assumptions, upon which the financial statements are based, change in future periods, actual amounts may differ from those included in the accompanying consolidated financial statements. Cash and Cash Equivalents The Company considers all highly liquid financial instruments purchased with an original maturity of three months or less to be cash equivalents. 30 Inventories Inventories are stated at the lower of cost or market. Cost is determined by the first-in, first-out ("FIFO"), last-in, first-out ("LIFO") or average cost methods. Inventory costs consist of materials, labor and factory overhead. Fixed Assets Fixed assets, consisting of rental equipment and property, plant and equipment, are stated at cost, net of accumulated depreciation. The Company computes depreciation on fixed assets using principally the straight-line method. The estimated useful lives used in computing depreciation generally range from 20 to 40 years for buildings, three to 25 years for machinery and equipment, and five to ten years for rental equipment. Leasehold improvements are amortized over the lives of the leases or the estimated useful lives of the improvements, whichever is shorter. For income tax purposes, accelerated methods of depreciation are used. Costs of major renewals and betterments are capitalized as fixed assets. Expenditures for maintenance, repairs and minor improvements are charged to expense when incurred. When fixed assets are sold or retired, the remaining cost and related accumulated depreciation are removed from the accounts and the resulting gain or loss is included in the consolidated statement of operations. Goodwill and Other Intangible Assets Goodwill represents the excess of cost over the fair value of net assets acquired. On January 1, 2002, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets," which addresses financial accounting and reporting matters. In accordance with SFAS No. 142, the Company discontinued amortizing goodwill to earnings as of January 1, 2002. The Statement also requires that goodwill be tested for impairment on an annual basis, or more frequently if circumstances indicate that an impairment may exist. During the first quarter of 2002, the Company completed the transitional impairment test required by SFAS No. 142 for goodwill recorded as of the adoption date. The transitional goodwill impairment test involved a comparison of the fair value of each of the Company's reporting units, as defined, with their carrying value and resulted in the identification of no impairment. The accompanying consolidated statements of operations provide relevant disclosures related to recorded goodwill amortization and the after-tax impact which would have resulted from the adoption of SFAS No. 142 as of January 1, 2000. The Company amortizes identifiable intangible assets, generally consisting of patents, trademarks and non-compete agreements, on a straight-line basis over their expected useful lives, which range from three to 27 years. The adoption of SFAS No. 142 also required the Company to re-evaluate the remaining useful lives of its intangible assets to determine whether the periods being used were appropriate. No changes to the carrying value of the intangibles, nor the remaining useful lives, were recorded as a result of the review. Impairment of Long-Lived Assets Management reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. If an evaluation is required, the estimated future cash flows associated with the asset will be compared to the asset's carrying amount to determine if an impairment exists. 31 Foreign Currency Translation and Transactions Gains and losses resulting from balance sheet translation of operations outside the United States where the applicable foreign currency is the functional currency are included as a component of accumulated other comprehensive income within stockholders' equity. Gains and losses resulting from balance sheet translation of operations outside the United States where the U.S. dollar is the functional currency are included in the consolidated statements of operations. Gains and losses resulting from foreign currency transactions, excluding cash flow hedges discussed below, are recognized currently in the consolidated statements of operations. Financial Instruments The nature of the Company's business activities involves the management of various financial and market risks, including those related to changes in currency exchange rates and interest rates. The Company occasionally employs derivative financial instruments such as foreign exchange contracts, foreign exchange options and interest rate contracts to mitigate or eliminate certain of those risks. The Company does not enter into derivative instruments for speculative purposes. On January 1, 2001, the Company adopted SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which requires that derivatives be recorded on the balance sheet at fair value and establishes criteria for designation and effectiveness of hedging relationships. The adoption of SFAS No. 133 did not have a material impact on the Company's financial position or results of operations. The Company records changes in fair market value related to fair value hedges, which includes foreign exchange contracts, to general and administrative expenses in the consolidated statements of operations. Additionally, the Company records changes in value related to cash flow hedges, which includes foreign exchange contracts and interest rate swaps, to accumulated other comprehensive income. Environmental Obligations Expenditures for environmental obligations that relate to current operations are expensed or capitalized, as appropriate. Liabilities are recorded when environmental clean-up efforts are probable and their cost is reasonably estimated, and are adjusted as further information is obtained. Such estimates are based on currently enacted laws and regulations and are not discounted to present value. Income Taxes The Company accounts for income taxes using an asset and liability approach for financial accounting and income tax reporting based on enacted tax rates. Deferred tax assets are reduced by a valuation allowance when it is more likely than not that some portion, or all, of the deferred tax assets will not be realized. Revenue Recognition The Company's revenues are composed of product sales, rental, service and other revenues. The Company recognizes product sales revenues upon delivery to the customer, net of applicable provisions for returns. Rental, service and other revenues are recorded when such services are performed. Minority Interests The Company records minority interest expense which reflects the portion of the earnings of majority-owned operations which are applicable to the minority interest partners. The minority interest amount primarily represents the share of the M-I profits associated with the minority partner's 40 percent interest in those operations. To a lesser extent, minority interests include the portion of CE Franklin Ltd. and United Engineering Services LLC earnings applicable to the minority shareholders. 32 Stock-Based Compensation The Company's Board of Directors and its stockholders have authorized an employee stock option plan. As of December 31, 2002, 6.2 million shares were issued and outstanding under the program and an additional 3.3 million shares were authorized for future issuance. Options are generally granted at the fair market value on the date of grant, vest over a four-year period and expire ten years after the date of grant. Certain option awards granted on December 4, 2001 were subject to stockholder approval which was not obtained until April 24, 2002. Accordingly, these options were granted with a strike price more than five percent below the market value on the date of issuance and do not meet the conditions necessary to qualify as a non-compensatory option grant. Compensation expense related to these grants is being recognized over the four-year vesting period and resulted in the inclusion of $0.3 million of related expense in the accompanying consolidated statement of operations for the year ended December 31, 2002. The Company continues to apply Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related interpretations in accounting for its stock option program, as allowed under SFAS No. 123, "Accounting for Stock-Based Compensation." Therefore, for all options other than those mentioned above, the Company elects to make pro forma disclosures versus recognizing the related compensation expense in the accompanying consolidated financial statements. Had the Company elected to apply the accounting standards of SFAS No. 123, the Company's net income and earnings per share would have approximated the pro forma amounts indicated below (in thousands, except per share data):
2002 2001 2000 ----------- ----------- ----------- Net income, as reported ..................... $ 93,189 $ 152,145 $ 72,800 Add: Stock-based compensation expense included in reported income, net of related tax effect ....................... 182 -- -- Less: Total stock-based compensation expense determined under the Black-Scholes option-pricing model, net of related tax effect ................................... (7,894) (6,432) (4,343) ----------- ----------- ----------- Pro forma net income ........................ $ 85,477 $ 145,713 $ 68,457 =========== =========== =========== Earnings per share: As reported: Basic ..................................... $ 0.94 $ 1.53 $ 0.73 Diluted ................................... 0.93 1.51 0.72 Pro forma: Basic ..................................... $ 0.86 $ 1.46 $ 0.69 Diluted ................................... 0.85 1.45 0.68
In addition to the stock option program described above, the Company maintains a stock grant program. The stock grants are issued at par value and are subject to a four-year cliff-vesting schedule. Compensation expense, calculated as the difference between the market value on the date of grant and the exercise price, is being recognized ratably over the vesting period and resulted in the inclusion of $0.6 million, $0.6 million and $0.5 million of related expense in the accompanying consolidated statements of operations for the years ended December 31, 2002, 2001 and 2000, respectively. 33 Recent Accounting Pronouncements On January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 provides updated guidance concerning the recognition and measurement of an impairment loss for certain types of long-lived assets and modifies the accounting and reporting of discontinued operations. The adoption of SFAS No. 144 did not have a material impact on the Company's consolidated financial position or results of operations for the year ended December 31, 2002. On December 31, 2002, the Company adopted the disclosure requirements of SFAS No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure." SFAS No. 148 provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation and amends the disclosure requirements of SFAS No. 123. On January 1, 2003, the Company adopted SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 addresses the financial accounting and reporting for retirement obligations and costs associated with tangible long-lived assets. The adoption of SFAS No. 143 is not expected to have a material impact on the Company's consolidated financial position or results of operations for the year ending December 31, 2003. From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board ("FASB") which are adopted by the Company as of the specified effective date. Unless otherwise discussed, management believes the impact of recently issued standards, which are not yet effective, will not have a material impact on the Company's consolidated financial position or results of operations upon adoption. 34 2. BUSINESS COMBINATIONS During 2002, the Company completed four acquisitions in exchange for aggregate cash consideration of $60.2 million, the issuance of $24.8 million of notes payable and the assumption of certain liabilities. Significant 2002 transactions include: On July 31, 2002, the Company acquired certain turbodrilling assets of Neyrfor-Weir Ltd. in exchange for cash consideration of $25.3 million. The acquired operations, which design proprietary turbodrilling equipment and provide related services for horizontal and directional drilling applications, have been integrated into the Company's Oilfield Products and Services segment. On October 11, 2002, M-I acquired CleanCut Technologies ("CleanCut") for cash consideration of $16.1 million and the issuance of notes to sellers totaling $23.9 million. CleanCut, formerly based in Scotland, designs, manufactures and installs waste collection and transportation systems for offshore drilling operations. On November 28, 2002, M-I acquired IKF Services, a drilling fluids and solids-control company located in Russia, for cash consideration of $13.4 million. In addition, M-I may be obligated to provide additional consideration of up to $9.0 million at a future date, dependent upon whether terms under the earn-out arrangement are met. The excess of the purchase price over the estimated fair value of the net assets acquired amounted to $35.6 million, which has been recorded as goodwill in the Oilfield Products and Services segment. Substantially all of the goodwill related to the 2002 acquisitions is expected to be deductible for tax purposes. The purchase price allocation related to certain of the 2002 acquisitions is based upon preliminary information and is subject to change when additional data concerning the contingent consideration and final asset and liability valuations is obtained. Material changes in the preliminary allocations are not anticipated by management. During 2001, the Company completed 15 acquisitions in exchange for aggregate cash consideration of $248.1 million and the assumption of certain liabilities. On a combined basis, the minority partner in M-I contributed $43.4 million of cash to the joint venture in connection with transactions completed during the year. Significant 2001 transactions include: On January 31, 2001, the Company acquired substantially all of the U.S. net assets of Van Leeuwen Pipe and Tube Corporation ("Van Leeuwen") for cash consideration of $41.1 million. Van Leeuwen, a leading provider of pipe, valves and fittings to the refining, petrochemical and power generation industries, has been integrated into the Company's Distribution segment operations. On August 22, 2001, M-I acquired BW Group plc ("BW Group"), based in Scotland, for cash consideration of $20.5 million and the assumption of certain indebtedness. BW Group provides drilling and completion fluids and related engineering services to the North Sea market. On October 2, 2001, M-I acquired The SulfaTreat Company, a natural gas production services company headquartered in the United States, for cash consideration of $35.0 million. On October 23, 2001, M-I acquired the oilfield and industrial screen operations of Madison Filter Belgium S.A. ("Madison") for cash consideration of $93.5 million. Madison, which includes United Wire Ltd. based in Scotland and Southwestern Wire Cloth, Inc. based in the United States, manufactures and markets screens for oilfield shakers and provides screening products for use in a broad range of industrial markets. The excess of the purchase price over the estimated fair value of the net assets acquired amounted to $137.1 million, which has been recorded as goodwill. Of this amount, $135.8 million relates to the Oilfield Products and Services segment and $1.3 million is associated with the Distribution segment. Goodwill associated with 2001 acquisitions completed prior to July 1 was amortized on a straight-line basis over a 20-year period; however, goodwill related to transactions completed subsequent to that date was not amortized in accordance with the provisions of SFAS No. 142. 35 During 2000, the Company acquired six operations in exchange for aggregate cash consideration of $145.4 million and the assumption of certain liabilities. The minority partner in M-I contributed $21.6 million of cash to the joint venture in connection with an acquisition. Significant 2000 transactions include: On January 15, 2000, the Company acquired Texas Mill Supply and Manufacturing, Inc. ("Texas Mill") in exchange for cash consideration of $30.0 million. Texas Mill was a U.S.-based provider of industrial mill and safety products and management services primarily to the refining, power generation and petrochemical markets. On November 30, 2000, M-I acquired the drilling fluids and solids-control assets of Bolland & Cia. S.A., based in Argentina, for cash consideration of $25.5 million. On December 15, 2000, M-I acquired the Sweco Division of Emerson ("Sweco") for cash consideration of $75.0 million. Sweco manufactures, markets and services specialty separation equipment for oilfield applications and a broad range of industrial markets. The excess of the purchase price over the estimated fair value of the net assets acquired amounted to $111.9 million, which has been recorded as goodwill. Of this amount, $95.3 million relates to the Oilfield Products and Services segment and $16.6 million is associated with the Distribution segment. Goodwill associated with 2000 acquisitions was amortized on a straight-line basis over a 20-year period. The following unaudited pro forma supplemental information presents consolidated results of operations as if the Company's significant current and prior year acquisitions had occurred on January 1, 2001. The unaudited pro forma data is based on historical information and does not include estimated cost savings; therefore, it does not purport to be indicative of the results of operations had the combinations been in effect at the dates indicated or of future results for the combined entities (in thousands, except per share data):
2002 2001 ------------- ------------- Revenues ................................. $ 3,205,194 $ 3,680,175 Net income ............................... 96,211 156,161 Earnings per share: Basic .......................... $ 0.97 $ 1.57 Diluted ........................ 0.96 1.55
The following schedule summarizes investing activities related to 2002, 2001 and 2000 acquisitions included in the consolidated statements of cash flows:
2002 2001 2000 --------- --------- --------- Fair value of tangible and identifiable intangible assets, net of cash acquired ..................... $ 57,480 $ 195,500 $ 91,167 Goodwill recorded .................................. 35,616 137,100 111,892 Total liabilities and minority interests assumed ... (32,944) (84,473) (57,688) --------- --------- --------- Cash paid for acquisition of businesses, net of cash acquired .................................... $ 60,152 $ 248,127 $ 145,371 ========= ========= =========
36 3. EARNINGS PER SHARE Basic earnings per share ("EPS") is computed using the weighted average number of common shares outstanding during the period. Diluted EPS gives effect to the potential dilution of earnings which could have occurred if additional shares were issued for stock option exercises under the treasury stock method. During 2002, the Company's Board of Directors approved a two-for-one stock split effected in the form of a stock dividend. All prior year weighted average share and option amounts have been restated for the effect of the stock split. Outstanding employee stock options of 1.7 million and 0.4 million as of December 31, 2002 and 2001, respectively, were not included in the computation of diluted earnings per common share as the exercise price was greater than the average market price for the Company's stock during the corresponding period. The following schedule reconciles the income and shares used in the basic and diluted EPS computations (in thousands, except per share data):
2002 2001 2000 -------- -------- -------- BASIC EPS: Net income ...................... $ 93,189 $152,145 $ 72,800 ======== ======== ======== Weighted average number of common shares outstanding ............ 98,984 99,504 99,206 ======== ======== ======== Basic EPS ....................... $ 0.94 $ 1.53 $ 0.73 ======== ======== ======== DILUTED EPS: Net income ...................... $ 93,189 $152,145 $ 72,800 ======== ======== ======== Weighted average number of common shares outstanding ............ 98,984 99,504 99,206 Dilutive effect of stock options. 1,107 944 1,398 -------- -------- -------- 100,091 100,448 100,604 ======== ======== ======== Diluted EPS ..................... $ 0.93 $ 1.51 $ 0.72 ======== ======== ========
37 4. INVENTORIES Inventories consist of the following at December 31:
2002 2001 --------- --------- Raw materials ............................................ $ 49,880 $ 50,821 Work-in-process .......................................... 54,201 65,008 Products purchased for resale ............................ 155,202 154,787 Finished goods ........................................... 399,252 406,143 --------- --------- 658,535 676,759 Reserves to state certain U.S. inventories (FIFO cost of $265,304 and $276,031 in 2002 and 2001, respectively) on a LIFO basis ........................................... (24,047) (23,608) --------- --------- $ 634,488 $ 653,151 ========= =========
5. GOODWILL AND OTHER INTANGIBLE ASSETS The following schedule presents goodwill, net of amortization, on a segment basis as of December 31, 2002 and 2001 and the related changes in the carrying amount of goodwill:
Oilfield Distribution Segment Segment Consolidated ----------- ----------- ------------ Balance as of December 31, 2000 .... $ 415,593 $ 38,354 $ 453,947 Goodwill acquired .................. 135,800 1,300 137,100 Purchase price and other adjustments 313 (1,081) (768) Amortization ....................... (14,197) (1,532) (15,729) ----------- ----------- ----------- Balance as of December 31, 2001 .... 537,509 37,041 574,550 Goodwill acquired .................. 35,616 -- 35,616 Purchase price and other adjustments 9,661 248 9,909 ----------- ----------- ----------- Balance as of December 31, 2002 .... $ 582,786 $ 37,289 $ 620,075 =========== =========== ===========
The accompanying consolidated balance sheets as of December 31, 2002 and 2001 include $60.1 million and $31.1 million of intangible assets (net of accumulated amortization of $13.2 million and $10.0 million), respectively, which are classified in other assets. Amortization expense related to intangible assets for the years ended December 31, 2002, 2001 and 2000 amounted to $3.2 million, $2.1 million and $1.3 million, respectively. 38 6. DEBT The following summarizes the Company's outstanding debt at December 31:
2002 2001 --------- --------- CURRENT: Short-term borrowings .................................................................... $ 49,978 $ 50,156 Current portion of long-term debt ........................................................ 109,714 98,537 --------- --------- Short-term borrowings and current portion of long-term debt ............................ $ 159,692 $ 148,693 ========= ========= LONG-TERM: Notes: 6.75% Senior Notes maturing February 2011 with an effective interest rate of 6.83% Interest payable semi-annually (presented net of unamortized discount of $840 and $1,084 in 2002 and 2001, respectively) ........................................................ $ 219,160 $ 248,916 7.0% Senior Notes maturing September 2007 with an effective interest rate of 7.07% Interest payable semi-annually (presented net of unamortized discount of $485 and $589 in 2002 and 2001, respectively) ................................................... 149,515 149,411 Floating Rate Senior Notes maturing October 2003. Interest payable quarterly at adjusted LIBOR as defined (2.90% at December 31, 2002) and described below (presented net of unamortized discount of $127 and $295 in 2002 and 2001, respectively) ........... 74,873 74,705 7.7% Senior Secured Notes maturing July 2007. Principal due in equal annual installments of $7.1 million. Interest payable semi-annually .......................... 35,714 42,857 7.63% Notes payable to insurance companies maturing April 2006. Principal due in equal annual installments of $3.3 million. Interest payable semi-annually .............. 13,333 16,666 Notes payable to various individuals maturing September 2004. Interest payable quarterly at adjusted LIBOR as defined (1.27% at December 31, 2002) and described below ......... 23,854 -- Bank revolvers payable: $250.0 million revolving note expiring July 2005. Interest payable quarterly at base rate (4.25% at December 31, 2002) or Eurodollar rate, as defined (2.07% at December 31, 2002) and described below (replaced $120.0 million facility which was terminated in 2002) .......................................................... 15,000 50,800 M-I $150.0 million revolving note expiring July 2005. Interest payable quarterly at base rate (4.25% at December 31, 2002) or Eurodollar rate, as defined (2.07% at December 31, 2002) and described below (replaced $80.0 million facility which was terminated in 2002) .......................................................... -- 30,900 Term loans and other ..................................................................... 20,232 23,124 --------- --------- 551,681 637,379 Less-Current portion of long-term debt ................................................... (109,714) (98,537) --------- --------- Long-term debt ......................................................................... $ 441,967 $ 538,842 ========= =========
Principal payments of long-term debt for years subsequent to 2003 are as follows: 2004........................................... $ 19,888 2005........................................... 32,152 2006........................................... 13,152 2007........................................... 156,736 Thereafter..................................... 220,039 ------------- $ 441,967 =============
39 The Company's short-term borrowings consist of amounts outstanding under lines of credit and short-term loans. Certain subsidiaries of the Company have unsecured credit facilities with non-U.S. banks aggregating $97.9 million. At December 31, 2002, $47.9 million of additional borrowing capacity was available under these facilities. These borrowings had a weighted average interest rate of eight percent at December 31, 2002 and 2001. The 6.75 percent, 7.0 percent and Floating Rate Senior Notes are unsecured obligations of the Company issued under an Indenture dated September 8, 1997. The Indenture contains no financial covenants, nor any restrictions related to the payment of cash dividends to common stockholders. The Company's 6.75 percent and 7.0 percent Senior Notes are redeemable by the Company, in whole or in part, at any time prior to maturity at a redemption price equal to accrued interest plus the greater of the principal amount or the present value of the remaining principal and interest payments. The Company's Floating Rate Senior Notes accrue interest based on a variable rate, subject to quarterly adjustments, equal to LIBOR plus 112.5 basis points and have no redemption feature. In July 2002, the Company terminated its existing revolving credit facility, which was scheduled to expire in December 2002, and replaced it with an unsecured facility provided by a syndicate of nine financial institutions. The new revolving credit agreement (the "Agreement"), which expires July 2005, includes a $400.0 million committed line of credit with a $25.0 million letter of credit sub-facility. The Agreement allows for the election of interest at a base rate, or a Eurodollar rate ranging from LIBOR plus 62.5 to 75.0 basis points depending on amounts drawn under the facility. The Agreement also requires the payment of a quarterly commitment fee of 15 basis points on the unutilized portion of the facility and compliance with certain customary covenants, including maintenance of specified debt-to-total capitalization and interest coverage ratios, as defined. The LIBOR interest margins and the commitment fee are subject to adjustment depending on the senior debt rating of the Company. As of December 31, 2002, the Company had $15.0 million drawn and $25.0 million of letters of credit issued under the facility, resulting in additional borrowing capacity of $360.0 million. In October 2002, the Company issued $23.9 million of notes payable to certain former shareholders in connection with the CleanCut transaction. The majority of the notes, which mature in September 2004, include callable provisions at the option of the noteholder beginning April 2003. These notes have been properly classified as short-term borrowings in the accompanying consolidated balance sheet. The Company was in compliance with its loan covenants under the various loan indentures, as amended, at December 31, 2002. Interest paid during the years ended December 31, 2002, 2001 and 2000, amounted to $41.2 million, $39.4 million and $35.4 million, respectively. 40 7. FINANCIAL INSTRUMENTS Foreign Currency Contracts From time to time, the Company enters into spot and forward contracts as a hedge against foreign currency denominated assets and liabilities and foreign currency commitments. The terms of these contracts generally do not exceed two years. For fair value hedges, settlement and market value gains and losses are recognized currently through earnings, and the resulting amounts generally offset foreign exchange gains or losses on the related accounts. Gains or losses on designated cash flow hedge contracts are deferred to accumulated other comprehensive income. As of December 31, 2002, the notional amounts of fair value hedge contracts and cash flow hedge contracts outstanding were $43.4 million and $31.4 million, respectively, and the fair value exceeded the notional amount of these contracts by $3.6 million. As of December 31, 2001, the notional amounts of fair value hedge contracts and cash flow hedge contracts outstanding were $43.1 million and $15.5 million, respectively, and the fair value exceeded the notional amount of these contracts by $1.4 million. Fair Value of Other Financial Instruments The recorded and fair values of long-term debt at December 31 are as follows:
2002 2001 ----------------------------- ----------------------------- Recorded Fair Recorded Fair Value Value Value Value ------------- ------------- ------------- ------------- Long-term debt............... $ 551,681 $ 597,143 $ 637,379 $ 649,329
The fair value of the remaining financial instruments, including cash and cash equivalents, receivables, payables and short-term borrowings, approximates the carrying value due to the short-term nature of these instruments. 8. INCOME TAXES The geographical sources of income before income taxes and minority interests for the three years ended December 31, 2002 were as follows:
2002 2001 2000 -------- -------- -------- Income before income taxes and minority interests: United States ................... $ 40,198 $174,223 $ 74,681 Non-United States ............... 177,601 154,823 89,450 -------- -------- -------- Total ........................... $217,799 $329,046 $164,131 ======== ======== ========
The income tax provision is summarized as follows:
2002 2001 2000 -------- -------- -------- Current: United States ................... $ (3,027) $ 57,553 $ 12,111 Non-United States ............... 44,260 46,226 23,138 State ........................... 1,839 3,774 146 -------- -------- -------- 43,072 107,553 35,395 -------- -------- -------- Deferred: United States ................... 18,738 (5,341) 11,601 Non-United States ............... 4,822 4,185 8,002 -------- -------- -------- 23,560 (1,156) 19,603 -------- -------- -------- Income tax provision .............. $ 66,632 $106,397 $ 54,998 ======== ======== ========
41 The consolidated effective tax rate (as a percentage of income before income taxes and minority interests) is reconciled to the U.S. federal statutory tax rate as follows:
2002 2001 2000 ------ ------ ------ U.S. federal statutory tax rate .......................... 35.0% 35.0% 35.0% Minority partner's share of U.S. partnership earnings .... (3.6) (4.3) (4.3) Non-deductible expenses .................................. 0.7 1.7 1.9 Benefit of foreign sales corporation and extraterritorial income exclusion ....................... (0.7) (1.1) (0.6) State taxes, net ......................................... 0.8 1.1 0.1 Non-U.S. tax provisions which vary from the U.S. rate/non-U.S. losses with no tax benefit realized ....... (1.2) -- 1.6 Other items, net ......................................... (0.5) (0.1) (0.2) ------ ------ ------ Effective tax rate ....................................... 30.5% 32.3% 33.5% ====== ====== ======
The components of deferred taxes at December 31 are as follows:
2002 2001 -------- -------- Deferred tax liabilities attributed to the excess of net book basis over remaining tax basis (principally depreciation): United States ............................... $(50,727) $(36,459) Non-United States ........................... (38,225) (19,523) -------- -------- Total deferred tax liabilities ................ (88,952) (55,982) -------- -------- Deferred tax assets attributed to net operating loss and tax credit carryforwards: United States ............................... 2,088 -- Non-United States ........................... 21,817 27,261 Other deferred tax assets (principally accrued liabilities not deductible until paid and inventories): United States ............................... 41,868 52,442 Non-United States ........................... 2,249 880 -------- -------- Subtotal .................................. 68,022 80,583 Valuation allowance ............................. (18,916) (28,778) -------- -------- Total deferred tax assets ..................... 49,106 51,805 -------- -------- Net deferred tax liabilities .............. $(39,846) $ (4,177) ======== ======== Balance sheet presentation: Deferred tax assets, net ...................... $ 25,403 $ 35,414 Other assets .................................. 6,263 5,862 Other current liabilities ..................... (6,833) (4,949) Deferred tax liabilities ...................... (64,679) (40,504) -------- -------- Net deferred tax liabilities .............. $(39,846) $ (4,177) ======== ========
42 Total foreign operating loss carryforwards at December 31, 2002, resulted in a deferred tax asset of approximately $21.8 million, of which $14.9 million has been offset by recording a valuation reserve. These losses are available to reduce the future tax liabilities of their respective foreign entities. Approximately $11.4 million of these losses will carryforward indefinitely, while the remaining losses expire at various dates. U.S. foreign tax credit carryforwards of $2.1 million are available to reduce taxes through 2007. The Company's valuation allowance was reduced by $9.9 million in 2002 and $3.5 million in 2001, primarily due to the expiration of net operating loss and tax credit carryforwards outside the United States. Income taxes paid during the years ended December 31, 2002, 2001 and 2000, amounted to $39.7 million, $87.9 million and $23.0 million, respectively. The Company has provided additional taxes for the anticipated repatriation of certain earnings of its non-U.S. subsidiaries. Undistributed earnings above the amounts upon which additional taxes have been provided, which approximated $47.9 million at December 31, 2002, are intended to be permanently invested by the Company. It is not practicable to determine the amount of applicable taxes that would be incurred if any of such earnings were repatriated. 9. STOCKHOLDERS' EQUITY Stock Split On June 6, 2002, the Company's Board of Directors approved a two-for-one stock split, effected in the form of a stock dividend. Stockholders of record as of June 20, 2002 were entitled to the dividend, which was distributed on July 8, 2002. Unless otherwise noted, all prior year share and option amounts included in the accompanying consolidated financial statements and related notes have been restated for the effect of the stock split. Treasury Share Repurchases During 2001, the Company's Board of Directors authorized a share buyback program which allows for the repurchase of up to five million shares of common stock, subject to regulatory issues, market considerations and other factors. During 2001, the Company repurchased 536,200 shares, on a pre-split basis, of common stock at an aggregate cost of $21.4 million. The acquired shares, as adjusted for the two-for-one stock split, have been added to the Company's treasury stock holdings and may be used in the future for acquisitions or other corporate purposes. Future repurchases under the program may be executed from time to time in the open market or in privately negotiated transactions. Stockholder Rights Plan On June 8, 2000, the Company adopted a Stockholder Rights Plan (the "Rights Plan") to replace a similar plan which expired on June 19, 2000. 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 June 20, 2000. The Board also authorized the issuance of one such Right for each share of the Company's common stock issued after June 20, 2000 until the occurrence of certain events. The Rights are exercisable upon the occurrence of certain events related to a person (an "Acquiring Person") acquiring or announcing the intention to acquire beneficial ownership of 20 percent or more of the Company's common stock. When the rights become exercisable, each holder (except an Acquiring Person) will be entitled to purchase, at an effective exercise price of $175, shares of the Company's common stock having a market value of twice the Right's exercise price, subject to adjustment. The Acquiring Person will not be entitled to exercise these Rights. In addition, if the Company is involved in a merger or other business combination transaction, or sells 50 percent or more of its assets or earning power to another entity, each Right will entitle its holder to purchase, at the Right's then current exercise price, shares of common stock of such other entity having a value of twice the Right's exercise price. The Rights are subject to redemption at the option of the Board of Directors at a price of one-half of a cent per Right until the occurrence of certain events. The Rights currently trade with the Company's common stock, have no voting or dividend rights and expire on June 8, 2010. 43 Accumulated Other Comprehensive Income As of December 31, 2002, accumulated other comprehensive income in the accompanying consolidated balance sheet includes $9.2 million of cumulative currency translation losses and $3.5 million of cumulative minimum pension liability adjustments, partially offset by $2.3 million of cumulative changes in unrealized fair value of derivatives. Approximately $2.0 million of the cumulative changes in unrealized fair value of derivatives is expected to be recognized as after-tax earnings during the fiscal year ending December 31, 2003. 10. RETIREMENT PLANS Defined Contribution Plans The Company established the Smith International, Inc. 401(k) Retirement Plan (the "Plan") for the benefit of all eligible employees. Employees may voluntarily contribute up to 12 percent of compensation, as defined, to the Plan. The Company makes retirement, matching and, in certain cases, discretionary matching contributions to each participant's account under the Plan. Participants receive a full match of the first 1 1/2 percent of their contributions along with a retirement contribution ranging from two percent to six percent of their qualified compensation. In addition, the Board of Directors may provide discretionary matching contributions based upon financial performance to participants who are employed by the Company on December 31. M-I has a Company Profit-Sharing and Savings Plan (the "M-I Plan") under which participating employees may contribute up to 15 percent of their compensation, as defined. Under the terms of the M-I Plan, qualified employees are eligible to receive basic, matching and profit-sharing contributions with the approval of the Employee Benefits Committee and, in certain instances, the Board of Directors. Participants are eligible to receive a basic contribution equal to three percent of qualified compensation, and a full match of the first 1 1/2 percent of their contributions. In addition, the Board of Directors may provide discretionary profit-sharing contributions based upon financial performance to participants who are employed by M-I on December 31. The Company recognized expense totaling $17.6 million, $25.5 million and $20.7 million in 2002, 2001 and 2000, respectively, related to Company contributions to the plans. Certain of the Company's subsidiaries sponsor various defined contribution plans. The Company's contributions under these plans for each of the three years in the period ended December 31, 2002, were immaterial. Deferred Compensation Plan The Company maintains a Supplemental Executive Retirement Plan ("SERP"), a non-qualified, deferred compensation program, for the benefit of officers and certain other eligible employees of the Company. Participants may contribute, on a pre-tax basis, up to 100 percent of cash compensation, as defined. Plan provisions allow for retirement and matching contributions, similar to those provided under the Company's defined contribution programs, and, in certain cases, an interest contribution in order to provide a yield on short-term investments equal to 120 percent of the long-term applicable federal rate, as defined. In the event of insolvency or bankruptcy, plan assets are available to satisfy the claims of all general creditors of the Company. Accordingly, the accompanying consolidated balance sheets reflect the aggregate participant balances as both an asset and a liability of the Company. As of December 31, 2002 and 2001, $30.6 million and $25.5 million, respectively, are included in other assets with a corresponding amount recorded in other long-term liabilities. During the years ended December 31, 2002, 2001 and 2000, Company contributions to the plan totaled $1.9 million, $1.1 million and $0.7 million, respectively. 44 11. EMPLOYEE BENEFIT PLANS Pension Plans The Company currently maintains various pension plans covering certain U.S. and non-U.S. employees. In connection with the Van Leeuwen transaction, the Company assumed certain pension obligations related to its employees. Future benefit accruals and the addition of new participants under the U.S. plans were frozen prior to 1998. Postretirement Benefit Plans The Company and its subsidiaries provide limited health care benefits for retired employees. Many employees who retire from the Company are eligible for these benefits. The Smith International, Inc. Retiree Medical Plan ("Smith Medical Plan") provides postretirement medical benefits to retirees and their spouses. The retiree medical plan has annual and lifetime limitations on the dollar amount of the Company's portion of the cost of benefits incurred by retirees under the Smith Medical Plan. The remaining cost of benefits in excess of the annual or lifetime limitation is the responsibility of the participants. M-I provides medical coverage to eligible retirees and their dependents under the M-I Drilling Fluids Retiree Medical Plan ("M-I Medical Plan"). Eligibility for inclusion in that plan, however, was closed as of January 1, 1994, to the majority of M-I's employees. M-I contributes to the cost of benefits under this plan; however, these costs are reviewed annually for inflation, and limited to a maximum five percent increase in M-I's contribution per year. Any costs in excess of M-I's maximum contribution are the responsibility of the retirees or their dependents. Although Wilson provides postretirement medical coverage to eligible retirees and their spouses, new employees have not been eligible for inclusion under this program since January 1986. Eligible individuals are able to continue primary medical coverage under Wilson's group insurance program until reaching the age of 65 at which time such coverage becomes secondary for participants electing to remain in the program. Participating retirees are required to contribute a portion of the insurance premiums under the program with Wilson responsible for any costs in excess of those contributions. 45 The following tables disclose the changes in benefit obligations and plan assets during the periods presented and reconcile the funded status of the plans to the amounts included in the accompanying consolidated balance sheets:
POSTRETIREMENT PENSION PLANS BENEFIT PLANS --------------------- --------------------- 2002 2001 2002 2001 -------- -------- -------- -------- Changes in benefit obligations: Benefit obligations at beginning of year $ 16,251 $ 12,320 $ 15,709 $ 13,657 Service cost ............................ 11 -- 220 221 Interest cost ........................... 1,145 731 981 993 Plan participants' contributions ........ -- -- 624 522 Actuarial loss (gain) ................... 789 486 (4,084) 1,821 Plan amendments ......................... -- -- (1,435) -- Business acquisition .................... -- 4,872 -- -- Plan settlements ........................ -- (1,720) -- -- Benefits paid ........................... (889) (438) (1,434) (1,505) -------- -------- -------- -------- Benefit obligations at end of year ...... $ 17,307 $ 16,251 $ 10,581 $ 15,709 ======== ======== ======== ======== Changes in plan assets: Fair value of plan assets at beginning of year ................................. $ 13,288 $ 11,879 $ -- $ -- Actual return on plan assets ............ (1,164) 229 -- -- Employer contributions .................. 2,505 -- 810 983 Plan participants' contributions ........ -- -- 624 522 Business acquisition .................... -- 3,338 -- -- Plan settlements ........................ -- (1,720) -- -- Benefits paid ........................... (889) (438) (1,434) (1,505) -------- -------- -------- -------- Fair value of plan assets at end of year $ 13,740 $ 13,288 $ -- $ -- ======== ======== ======== ======== Funded status ........................... $ (3,567) $ (2,963) $(10,581) $(15,709) Unrecognized net actuarial loss (gain) .. 5,073 2,004 (4,425) (584) Unrecognized prior service cost ......... -- -- (2,281) (1,089) -------- -------- -------- -------- Prepaid benefit (accrued liability) ..... $ 1,506 $ (959) $(17,287) $(17,382) ======== ======== ======== ========
Assumptions used for financial reporting purposes to compute net benefit expense and its components are as follows:
PENSION PLANS POSTRETIREMENT BENEFIT PLANS --------------------------------- ---------------------------------- 2002 2001 2000 2002 2001 2000 ------- ------- ------- ------- ------- ------- Weighted average assumptions: Discount rate ............................. 6.75% 7.25% 7.40% 6.75% 7.25% 7.26%-7.40% Expected return on plan assets ............ 8.50% 8.50% 8.50% N/A N/A N/A Components of net periodic benefit expense: Service cost .............................. $ 11 $ 50 $ -- $ 220 $ 221 $ 248 Interest cost ............................. 1,145 1,061 898 981 993 1,066 Return on plan assets ..................... (988) (887) (742) -- -- -- Amortization of prior service cost ........ -- -- -- (243) (234) (234) Amortization of loss (gain) ............... 73 260 (1,319) (243) (350) (125) ------- ------- ------- ------- ------- ------- Net periodic benefit expense (credit) ..... $ 241 $ 484 $(1,163) $ 715 $ 630 $ 955 ======= ======= ======= ======= ======= =======
46 The health care cost trend rate assumption can have a significant effect on the amounts reported. An increase of one percentage point in the health care cost trend rate would increase the accumulated postretirement benefit obligation and the aggregate of the service and interest cost components of the postretirement benefits expense by $0.4 million and $0.1 million, respectively. A decrease of one percentage point in the health care cost trend rate would decrease the accumulated postretirement benefit obligation and the aggregate of the service and interest cost components of the postretirement benefits expense by $0.6 million and $0.1 million, respectively. 12. EMPLOYEE STOCK OPTIONS A summary of the Company's stock option program is presented below. Historical balances have been restated for the impact of the two-for-one stock split.
SHARES WEIGHTED AVERAGE UNDER OPTION EXERCISE PRICE ------------ --------------- Outstanding at December 31, 1999 ... 4,978,580 $ 15.69 Options granted .................... 1,063,820 30.68 Options forfeited .................. (72,980) 21.98 Options exercised .................. (1,666,038) 10.59 ---------- ---------- Outstanding at December 31, 2000 ... 4,303,382 21.31 Options granted .................... 1,266,600 23.50 Options forfeited .................. (59,184) 19.54 Options exercised .................. (342,000) 16.13 ---------- ---------- Outstanding at December 31, 2001 ... 5,168,798 22.21 Options granted .................... 1,399,180 33.66 Options forfeited .................. (116,722) 24.43 Options exercised .................. (223,492) 13.93 ---------- ---------- Outstanding at December 31, 2002 ... 6,227,764 $ 25.04 ========== ==========
The number of outstanding fixed stock options exercisable at December 31, 2001 and 2000 was 2,344,510 and 1,650,614, respectively. These options had a weighted average exercise price of $20.46 and $18.99 at December 31, 2001 and 2000, respectively. The following summarizes information about fixed stock options outstanding at December 31, 2002:
Options Outstanding Options Exercisable ------------------------------------------ ------------------------- Weighted Average Weighted Weighted Remaining Average Average Range of Number Contractual Exercise Number Exercise Exercise Prices Outstanding Life Price Exercisable Price - -------------------- ----------- ------------ ----------- ------------ ----------- $ 6.56 - $ 8.94 57,764 2.4 $ 7.77 57,764 $ 7.77 $ 11.78 - $ 19.60 1,875,834 6.4 15.52 1,651,469 14.97 $ 20.57 - $ 27.82 1,620,320 8.2 23.14 576,738 22.42 $ 30.75 - $ 36.52 2,673,846 8.4 33.24 919,135 32.52 --------- ----- -------- --------- ---------- 6,227,764 7.7 $ 25.04 3,205,106 $ 21.21 ========= ===== ======== ========= ==========
47 The pro forma net income and earnings per share data disclosed in Note 1 has been determined as if the Company had accounted for its employee stock-based compensation program under the fair value method of SFAS No. 123. The Company used the Black-Scholes option-pricing model to determine the fair value of each option grant and, accordingly, calculate the stock-based compensation expense. The fair value and assumptions used are as follows:
2002 2001 2000 -------------- -------------- -------------- Fair value of stock options granted........ $15.36 $11.89 $15.33 Expected life of option (years)............ 5.0 6.0 6.0 Expected stock volatility.................. 46.3% 47.0% 43.0% Expected dividend yield.................... N/A N/A N/A Risk-free interest rate.................... 3.2% 4.2% 5.4%
13. INDUSTRY SEGMENTS AND INTERNATIONAL OPERATIONS The Company manufactures and markets premium products and services to the oil and gas exploration and production industry, the petrochemical industry and other industrial markets. The Company aggregates its operations into two reportable segments: Oilfield Products and Services and Distribution. The Oilfield Products and Services segment consists of three business units: M-I, which provides drilling and completion fluid systems and services, solids-control and separation equipment and waste-management services; Smith Bits, which designs, manufactures and sells three-cone drill bits, diamond drill bits and turbines; and Smith Services, which manufactures and markets products and services used for drilling, workover, well completion and well re-entry operations. The Distribution segment consists of one business unit, Wilson, which markets pipe, valves, fittings and mill, safety and other maintenance products to energy and industrial markets. The principal markets for these segments include all major oil and gas-producing regions of the world including North America, Latin America, Europe/Africa, the Middle East and the Far East. The Company's customers include major multi-national, independent and national, or state-owned, oil companies. In addition, the Company provides products and services to customers in the petrochemical and chemical industries and other industrial markets. 48 The following table presents financial information for each reportable segment:
2002 2001 2000 ----------- ----------- ----------- Revenues: Oilfield Products and Services . $ 2,282,909 $ 2,424,131 $ 1,855,126 Distribution ................... 887,171 1,127,078 905,888 ----------- ----------- ----------- $ 3,170,080 $ 3,551,209 $ 2,761,014 =========== =========== =========== Operating Income: Oilfield Products and Services . $ 266,692 $ 354,614 $ 188,017 Distribution ................... (4,026) 22,893 16,655 General corporate .............. (6,518) (5,997) (5,646) ----------- ----------- ----------- $ 256,148 $ 371,510 $ 199,026 =========== =========== =========== Capital Expenditures: Oilfield Products and Services . $ 91,056 $ 118,350 $ 85,225 Distribution ................... 3,401 7,173 7,219 General corporate .............. 2,594 2,119 2,137 ----------- ----------- ----------- $ 97,051 $ 127,642 $ 94,581 =========== =========== =========== Depreciation and Amortization: Oilfield Products and Services . $ 81,924 $ 84,311 $ 72,379 Distribution ................... 5,857 7,687 7,588 General corporate .............. 1,546 897 721 ----------- ----------- ----------- $ 89,327 $ 92,895 $ 80,688 =========== =========== =========== Total Assets: Oilfield Products and Services . $ 2,284,109 $ 2,250,332 $ 1,829,908 Distribution ................... 368,206 386,986 367,220 General corporate .............. 97,230 98,510 98,159 ----------- ----------- ----------- $ 2,749,545 $ 2,735,828 $ 2,295,287 =========== =========== ===========
The following table presents consolidated revenues by country:
2002 2001 2000 ---------- ---------- ---------- United States .................... $1,492,710 $1,829,378 $1,349,812 Canada ........................... 286,640 400,124 380,316 Norway ........................... 187,272 174,576 133,068 United Kingdom ................... 135,921 101,230 84,102 Venezuela ........................ 64,452 109,791 92,294 Other ............................ 1,003,085 936,110 721,422 ---------- ---------- ---------- $3,170,080 $3,551,209 $2,761,014 ========== ========== ==========
49 The following table presents net property, plant and equipment by country:
2002 2001 2000 -------- -------- -------- United States ............... $299,206 $287,630 $226,693 Canada ...................... 27,854 29,012 33,974 Norway ...................... 13,691 12,074 11,565 United Kingdom .............. 23,454 12,766 12,265 Venezuela ................... 12,543 14,926 16,336 Other ....................... 142,472 132,089 108,215 -------- -------- -------- $519,220 $488,497 $409,048 ======== ======== ========
The Company's revenues are derived principally from uncollateralized sales to customers in the oil and gas industry, the petrochemical industry and other industrial markets. This industry concentration has the potential to impact the Company's exposure to credit risk, either positively or negatively, because customers may be similarly affected by changes in economic or other conditions. The creditworthiness of this customer base is strong, and the Company has not experienced significant credit losses on such receivables. The Company's expenditures for research and engineering activities are attributable to the Company's Oilfield Products and Services segment and totaled $50.6 million in 2002, $50.8 million in 2001 and $42.4 million in 2000. 14. COMMITMENTS AND CONTINGENCIES Leases The Company routinely enters into operating and capital leases for certain of its facilities and equipment. Amounts related to assets under capital lease were immaterial for the periods presented. Rent expense totaled $61.3 million, $51.4 million and $39.4 million in 2002, 2001 and 2000, respectively. Future minimum payments under non-cancelable operating leases having initial terms of one year or more are as follows:
AMOUNT --------- 2003........................................ $ 34,452 2004........................................ 23,064 2005........................................ 17,160 2006........................................ 12,663 2007........................................ 9,766 2008 through 2012........................... 15,643 Thereafter.................................. 21,112 --------- $ 133,860 =========
In the normal course of business, the Company enters into lease agreements with cancellation provisions as well as agreements with initial terms of less than one year. The costs related to these leases have been reflected in rent expense but have been appropriately excluded from the future minimum payments presented above. Standby Letters of Credit In the normal course of business with customers, vendors and others, the Company is contingently liable for performance under standby letters of credit and bid and performance bonds which totaled $72.4 million at December 31, 2002. The amount primarily consists of a $25.0 million standby letter of credit, supporting notes issued to certain CleanCut shareholders, and various performance bonds, of which $33.1 million expire in 2003. Management does not expect any material amounts to be drawn on these instruments. 50 Insurance The Company maintains insurance coverage for various aspects of its business and operations. The Company has elected to retain a portion of losses that occur through the use of deductibles and retentions under its insurance programs. Amounts in excess of the self-insured retention levels are fully insured to limits believed appropriate for the Company's operations. Self-insurance accruals are based on claims filed and an estimate for claims incurred but not reported. While management believes that amounts accrued in the accompanying consolidated financial statements are adequate for expected liabilities arising from the Company's portion of losses, estimates of these liabilities may change as circumstances develop. Litigation The Company is a defendant in various legal proceedings arising in the ordinary course of business. In the opinion of management, these matters will not have a material adverse effect on the Company's consolidated financial position or results of operations. Environmental The Company routinely establishes and reviews the adequacy of reserves for estimated future environmental clean-up costs for properties currently or previously operated by the Company. Although the Company believes it is in substantial compliance with environmental protection laws, estimating the related liability is difficult considering the continual changes in environmental regulations and the potential identification of new sites. In connection with most business acquisitions, the Company obtains contractual indemnifications from the seller related to environmental matters. These indemnifications generally provide for the reimbursement of environmental clean-up costs incurred by the Company for events occurring or circumstances existing prior to the purchase date, whether the event or circumstance was known or unknown at that time. A substantial portion of the Company's total environmental exposure is associated with its M-I operations, which are subject to various indemnifications from former owners. As of December 31, 2002, the Company has established an environmental reserve of $12.1 million. This amount reflects the future undiscounted estimated exposure related to identified properties, without regard to indemnifications from former owners. While actual future environmental costs may differ from estimated liabilities recorded at December 31, 2002, the Company does not believe that these differences will have a material impact on the Company's financial position or results of operations, subject to the indemnifications in place. In the event that i) the parties providing the environmental indemnifications do not fulfill their obligations, and ii) costs incurred to remediate the identified properties reach estimated maximum exposure limits, the Company would be required to establish additional environmental reserves of up to $25.0 million, impacting earnings and cash flows in future periods. 15. SUBSEQUENT EVENT (UNAUDITED) Subsequent to December 31, 2002, M-I acquired certain oilfield chemical assets of Dynea International in exchange for cash consideration of $78.6 million. The acquired operations reported revenues of approximately $75.0 million for the year ended December 31, 2002. The transaction was funded with cash on hand and $37.2 million of borrowings under the Company's revolving credit agreement. 51 16. QUARTERLY INFORMATION (UNAUDITED)
FIRST SECOND THIRD FOURTH YEAR ---------- ---------- ---------- ---------- ---------- (In thousands, except per share data) 2002 Revenues ............................ $ 827,377 $ 801,038 $ 777,232 $ 764,433 $3,170,080 Gross profit ........................ 241,502 236,255 217,725 222,820 918,302 Net income .......................... 28,730 26,922 19,790 17,747 93,189 Basic earnings per share ............ 0.29 0.27 0.20 0.18 0.94 Diluted earnings per share .......... 0.29 0.27 0.20 0.18 0.93 2001 Revenues ............................ $ 865,311 $ 872,389 $ 909,682 $ 903,827 $3,551,209 Gross profit ........................ 246,089 258,936 273,056 267,723 1,045,804 Net income .......................... 34,218 37,682 42,066 38,179 152,145 Basic earnings per share ............ 0.34 0.38 0.42 0.39 1.53 Diluted earnings per share .......... 0.34 0.37 0.42 0.38 1.51
52 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE On April 18, 2002, the Company filed a Form 8-K reporting the dismissal of the Company's independent public accountants, Arthur Andersen LLP, and the engagement of Deloitte & Touche LLP as its new independent auditors. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT For information concerning directors of the Registrant, see the information set forth following the caption "ELECTION OF DIRECTORS" in the Company's definitive proxy statement to be filed no later than 120 days after the end of the fiscal year covered by this Form 10-K (the "Proxy Statement"), which information is incorporated herein by reference. For information concerning executive officers of the Registrant, see Item 4A appearing in Part I of this Form 10-K. ITEM 11. EXECUTIVE COMPENSATION The information set forth following the caption "EXECUTIVE COMPENSATION" in the Company's Proxy Statement is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information set forth following the captions "ELECTION OF DIRECTORS", "STOCK OWNERSHIP OF CERTAIN BENEFICIAL OWNERS" and "Equity Compensation Plan Information" in the Company's Proxy Statement is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The information set forth following the captions "ELECTION OF DIRECTORS" and "EXECUTIVE COMPENSATION" in the Company's Proxy Statement is incorporated herein by reference. ITEM 14. CONTROLS AND PROCEDURES The Company maintains disclosure controls and procedures and internal controls designed to ensure that information required to be disclosed in our filings under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time frame specified in the Commission's rules and regulations. Our principal executive and financial officers have evaluated our disclosure controls and procedures within 90 days prior to the filing of the Annual Report on Form 10-K and have determined that such disclosure controls and procedures are effective. There were no significant changes in the Company's internal controls or in other factors that could significantly affect those controls subsequent to the evaluation date. 53 PART IV ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) FINANCIAL STATEMENTS
PAGE REFERENCE --------- (1) Financial statements included in this report: Report of Independent Public Accountants ..................................... 23 Independent Auditor's Report ................................................. 24 Consolidated Balance Sheets at December 31, 2002 and 2001 .................... 25 Consolidated Statements of Operations for the years ended December 31, 2002, 2001 and 2000 ........................................... 27 Consolidated Statements of Cash Flows for the years ended December 31, 2002, 2001 and 2000 ........................................... 28 Consolidated Statements of Stockholders' Equity and Comprehensive Income for the years ended December 31, 2002, 2001 and 2000 ....................... 29 Notes to Consolidated Financial Statements ................................... 30 (2) Financial Statement Schedule II-Valuation and Qualifying Accounts and Reserves 58
All other schedules have been omitted since the required information is not present or not present in amounts sufficient to require submission of the schedule or because the information required is included in the consolidated financial statements or notes thereto. (3) Exhibits and Index to Exhibits 3.1 - Restated Certificate of Incorporation of the Company as amended by Certificate of Amendment of Articles of Incorporation of the Company, dated as of July 8, 1987, and Certificate of Amendment to Restated Certificate of Incorporation of the Company, dated November 17, 1987. Filed as Exhibit 3.1 to the Company's report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference. 3.2 - Certificate of Amendment to Restated Certificate of Incorporation of the Company, dated May 23, 2001. Filed as Exhibit 3.2 to the Company's Registration Statement on Form S-8 dated July 26, 2001 and incorporated herein by reference. 3.3 - Bylaws of the Company as amended to date. Filed as Exhibit 3.1 to the Company's report on Form 8-K dated August 13, 1998 (and filed on August 14, 1998) and incorporated herein by reference. 4.1 - Rights Agreement, dated as of June 8, 2000, between the Company and First Chicago Trust Company of New York, as Rights Agent. Filed as Exhibit 4.1 to the Company's report on Form 8-A, dated June 15, 2000, and incorporated herein by reference. 4.2 - Amendment to Rights Agreement dated June 8, 2000, by and among the Company and First Chicago Trust Company of New York and effective as of October 1, 2001. Filed as Exhibit 4.1 to the Company's report on Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference. 4.3 - Amendment No. 2 to Rights Agreement by and among the Company and EquiServe Trust Company, N.A. and effective as of December 31, 2002.
54 4.4 - Form of Indenture between the Company and The Bank of New York, as Trustee. Filed as Exhibit 4.1 to the Company's Registration Statement on Form S-3 dated August 22, 1997 and incorporated herein by reference. 4.5 - Form of Note. Filed as Exhibit 4.2 to Amendment No. 1 to the Company's Registration Statement on Form S-3 dated September 9, 1997 and incorporated herein by reference. 4.6 - Form of Note. Filed as Exhibit 4.1 to the Company's report on Form 8-K dated February 13, 2001 and incorporated herein by reference. 4.7 - Form of Note dated October 15, 2001. 9. - Not applicable. 10.1 - Smith International, Inc. 1989 Long Term Incentive Compensation Plan, as amended to date. 10.2 - Smith International, Inc. Stock Plan for Outside Directors, as amended to date. 10.3 - Smith International, Inc. Supplemental Executive Retirement Plan, as amended to date. Filed as Exhibit 10.1 to the Company's report on Form 10-Q for the quarter ended September 30, 2001 and incorporated herein by reference. 10.4 - Supply Agreement dated April 2, 1987 between the Company and TCM Holding Corporation and Rogers Tool Works, Inc. for the supply of tungsten carbide products. Filed as Exhibit 10.6 to the Company's report on Form 10-K for the year ended December 31, 1995 and incorporated herein by reference. 10.5 - Amendment to Supply Agreement dated January 22, 1993 between the Company and Rogers Tool Works, Inc. Filed as Exhibit 10.7 to the Company's report on Form 10-K for the year ended December 31, 1995 and incorporated herein by reference. 10.6 - Employment Agreement dated December 10, 1987 between the Company and Douglas L. Rock. Filed as Exhibit 10.11 to the Company's report on Form 10-K for the year ended December 31, 1993 and incorporated herein by reference. 10.7 - Employment Agreement dated January 2, 1991 between the Company and Neal S. Sutton. Filed as Exhibit 10.11 to the Company's report on Form 10-K for the year ended December 31, 1996 and incorporated herein by reference. 10.8 - Employment Agreement dated May 1, 1991 between the Company and Richard A. Werner. Filed as Exhibit 10.12 to the Company's report on Form 10-K for the year ended December 31, 1996 and incorporated herein by reference. 10.9 - Change-of-Control Employment Agreement dated January 4, 2000 between the Company and Douglas L. Rock. Filed as Exhibit 10.11 to the Company's report on Form 10-K for the year ended December 31, 1999 and incorporated herein by reference. 10.10 - Change-of-Control Employment Agreement dated January 4, 2000 between the Company and Neal S. Sutton. Filed as Exhibit 10.12 to the Company's report on Form 10-K for the year ended December 31, 1999 and incorporated herein by reference. 10.12 - Change-of-Control Employment Agreement dated January 4, 2000 between the Company and Loren K. Carroll. Filed as Exhibit 10.14 to the Company's report on Form 10-K for the year ended December 31, 1999 and incorporated herein by reference.
55 10.13 - Change-of-Control Employment Agreement dated January 4, 2000 between the Company and Margaret K. Dorman. Filed as Exhibit 10.15 to the Company's report on Form 10-K for the year ended December 31, 1999 and incorporated herein by reference. 10.14 - Change-of-Control Employment Agreement dated January 4, 2000 between the Company and John J. Kennedy. Filed as Exhibit 10.16 to the Company's report on Form 10-K for the year ended December 31, 1999 and incorporated herein by reference. 10.15 - Change-of-Control Employment Agreement dated January 4, 2000 between the Company and Roger A. Brown. Filed as Exhibit 10.17 to the Company's report on Form 10-K for the year ended December 31, 1999 and incorporated herein by reference. 10.16 - Credit Agreement dated as of July 10, 2002 among the Company and M-I L.L.C., the Lenders parties thereto and Comerica Bank, as Administrative Agent, ABN AMRO Bank N.V., as Syndication Agent, Den Norske Bank ASA, as Documentation Agent, J.P. Morgan Securities Inc., and Credit Lyonnais New York Branch, as Co-Lead Arrangers and Joint Bookrunners. Filed as Exhibit 10.1 to the Company's report on Form 10-Q for the quarter ended September 30, 2002 and incorporated herein by reference. 11. - Not applicable. 12. - Not applicable. 13. - Not applicable. 18. - Not applicable. 19. - Not applicable. 21.1 - Subsidiaries of the Company. 23.1 - Independent Auditors' Consent. 23.2 - Notice regarding Consent of Independent Public Accountants. 99.1 - Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith. 99.2 - Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.
56 (b) REPORTS ON FORM 8-K. The Registrant filed reports on Form 8-K during the quarterly period ended December 31, 2002. All filings were reported under "Item 5. Other Events" and disclosed the following: 1. Form 8-K dated October 1, 2002 which includes the Company's comments on third quarter 2002 outlook. 2. Form 8-K dated October 15, 2002 announcing the acquisition of CleanCut Technologies. 3. Form 8-K dated October 17, 2002 announcing the Company's results for the quarter ended September 30, 2002. 57 SCHEDULE II SMITH INTERNATIONAL, INC. VALUATION AND QUALIFYING ACCOUNTS AND RESERVES (IN THOUSANDS)
ADDITIONS DEDUCTIONS -------------------------- ------------ BALANCE AT CHARGED BALANCE BEGINNING TO AT END OF YEAR EXPENSE OTHER(a) WRITE-OFFS OF YEAR ------------ ------------ ------------ ----------- ------------ Allowance for doubtful accounts: Year ended December 31, 2002 $ 10,921 $ 9,593 $ -- $ (8,176) $ 12,338 Year ended December 31, 2001 10,211 2,986 1,029 (3,305) 10,921 Year ended December 31, 2000 9,636 3,277 793 (3,495) 10,211
(a) Amounts represent accounts receivable reserves related to acquisitions made by the Company during the years presented. 58 CERTIFICATION PURSUANT TO RULE 13A-14 OR 15D-14 OF THE SECURITIES EXCHANGE ACT OF 1934, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Doug Rock, certify that: 1. I have reviewed this annual report on Form 10-K of Smith International, Inc; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c. presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 24, 2003 /s/ DOUG ROCK ---------------------------- ------------------------------------ Doug Rock Chairman of the Board, Chief Executive Officer, President and Chief Operating Officer 59 CERTIFICATION PURSUANT TO RULE 13A-14 OR 15D-14 OF THE SECURITIES EXCHANGE ACT OF 1934, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Margaret K. Dorman, certify that: 1. I have reviewed this annual report on Form 10-K of Smith International, Inc; 2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report; 3. Based on my knowledge, the financial statements, and other financial information included in this annual report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this annual report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a. designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this annual report is being prepared; b. evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this annual report (the "Evaluation Date"); and c. presented in this annual report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a. all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b. any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this annual report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: March 24, 2003 /s/ Margaret K. Dorman ---------------------------- ----------------------------------------- Margaret K. Dorman Senior Vice President, Chief Financial Officer and Treasurer 60 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. SMITH INTERNATIONAL, INC. By: /s/ DOUG ROCK ------------------------------------ Doug Rock Chief Executive Officer, President and Chief Operating Officer March 24, 2003 Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities on the date indicated: /s/ DOUG ROCK Chairman of the Board, March 24, 2003 - ------------------------------------ Chief Executive Officer, (Doug Rock) President and Chief Operating Officer /s/ LOREN K. CARROLL Executive Vice President March 24, 2003 - ------------------------------------ and Director (Loren K. Carroll) /s/ MARGARET K. DORMAN Senior Vice President, March 24, 2003 - ------------------------------------ Chief Financial Officer (Margaret K. Dorman) and Treasurer /s/ BENJAMIN F. BAILAR Director March 24, 2003 - ------------------------------------ (Benjamin F. Bailar) /s/ G. CLYDE BUCK Director March 24, 2003 - ------------------------------------ (G. Clyde Buck) /s/ JAMES R. GIBBS Director March 24, 2003 - ------------------------------------ (James R. Gibbs) /s/ JERRY W. NEELY Director March 24, 2003 - ------------------------------------ (Jerry W. Neely) /s/ WALLACE S. WILSON Director March 24, 2003 - ------------------------------------ (Wallace S. Wilson)
61 EXHIBIT INDEX 4.3 - Amendment No. 2 to Rights Agreement by and among the Company and EquiServe Trust Company, N.A. and effective as of December 31, 2002. 4.7 - Form of Note dated October 15, 2001. 10.1 - Smith International, Inc. 1989 Long Term Incentive Compensation Plan, as amended to date. 10.2 - Smith International, Inc. Stock Plan for Outside Directors, as amended to date. 21.1 - Subsidiaries of the Company. 23.1 - Independent Auditors' Consent. 23.2 - Notice regarding Consent of Independent Public Accountants. 99.1 - Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith. 99.2 - Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.
EX-4.3 3 h03433exv4w3.txt AMENDMENT NO.2 TO RIGHTS AGREEMENT EXHIBIT 4.3 AMENDMENT NO. 2 TO RIGHTS AGREEMENT 1. GENERAL BACKGROUND. In accordance with Section 26 of the Rights Agreement between First Chicago Trust Company of New York and Smith International, Inc. dated June 8, 2000 (the "Agreement"), the parties desire to amend the Agreement. On April 25, 2001, the Board of Directors of Smith International, Inc. approved the assignment of the Rights Agreement between First Chicago Trust Company of New York and Smith International, Inc. dated June 2, 2000 (the "Agreement") to EquiServe Trust Company, N.A., effective as of July 1, 2001. A subsequent amendment to the Agreement effective October 1, 2001, however, was made in error by and between First Chicago Trust Company of New York and Smith International, Inc. 2. EFFECTIVENESS. This Amendment shall be effective as of December 31, 2002 (the "Amendment") and all defined terms and definitions in the Agreement shall be the same in the Amendment except as specifically revised by the Amendment. 3. REVISION. The assignment of the Agreement to EquiServe Trust Company, N.A. was approved by the Board of Directors of Smith International, Inc. and the parties acknowledge and agree that such assignment occurred effective as of July 1, 2001. By This Amendment No. 2, the parties confirm that the Amendment to Rights Agreement effective as of October 1, 2001 by and between First Chicago Trust Company of New York and Smith International, Inc. should have been by and between EquiServe Trust Company, N.A. Notwithstanding the effective date as of this Amendment No. 2, the parties confirm that the assignment occurred effective as of July 1, 2001 and the Amendment to Rights Agreement as of October 1, 2001 is hereby amended to reflect that EquiServe Trust Company, N.A. is the Rights Agent. 4. Except as amended hereby, the Agreement and all schedules or exhibits thereto shall remain in full force and effect. IN WITNESS WHEREOF, the parties hereto have caused this Amendment No. 2 to be executed in their names and on their behalf by and through their duly authorized officers, as of the 31st day of December, 2002. SMITH INTERNATIONAL, INC. EQUISERVE TRUST COMPANY, N.A. By: /s/ VIVIAN M. CLINE By: /s/ ANTHONY MILO -------------------------- -------------------------- Vivian M. Cline Anthony Milo Title: Assistant Secretary Title: Managing Director EX-4.7 4 h03433exv4w7.txt FORM OF NOTE DATED OCTOBER 15, 2001 EXHIBIT 4.7 GLOBAL SECURITY CUSIP: 832110 AH 3 NO. 001 $75,000,000 THIS NOTE IS A BOOK-ENTRY SECURITY AND IS REGISTERED IN THE NAME OF A DEPOSITORY OR A NOMINEE OF A DEPOSITORY. THIS NOTE IS EXCHANGEABLE FOR NOTES REGISTERED IN THE NAME OF A PERSON OTHER THAN THE DEPOSITORY OR ITS NOMINEE ONLY IN THE LIMITED CIRCUMSTANCES DESCRIBED HEREIN, AND NO TRANSFER OF THIS NOTE (OTHER THAN A TRANSFER OF THIS NOTE AS A WHOLE BY THE DEPOSITORY TO A NOMINEE OF THE DEPOSITORY OR BY A NOMINEE OF THE DEPOSITORY TO THE DEPOSITORY OR ANOTHER NOMINEE OF THE DEPOSITORY) MAY BE REGISTERED EXCEPT IN SUCH LIMITED CIRCUMSTANCES. UNLESS THIS NOTE IS PRESENTED BY AN AUTHORIZED REPRESENTATIVE OF THE DEPOSITORY TRUST COMPANY, NEW YORK, NEW YORK ("DTC"), TO SMITH INTERNATIONAL, INC. (THE "COMPANY") OR ITS AGENT FOR REGISTRATION OF TRANSFER, EXCHANGE OR PAYMENT, AND ANY NOTE ISSUED IS REGISTERED IN THE NAME OF CEDE & CO. OR IN SUCH OTHER NAME AS IS REQUESTED BY AN AUTHORIZED REPRESENTATIVE OF DTC (AND ANY PAYMENT IS MADE TO CEDE & CO. OR TO SUCH OTHER ENTITY AS IS REQUESTED BY AN AUTHORIZED REPRESENTATIVE OF DTC), ANY TRANSFER, PLEDGE, OR OTHER USE HEREOF FOR VALUE OR OTHERWISE BY OR TO ANY PERSON IS WRONGFUL INASMUCH AS THE REGISTERED OWNER HEREOF, CEDE & CO., HAS AN INTEREST HEREIN. THIS NOTE HAS NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933 (THE "SECURITIES ACT") AND MAY NOT BE OFFERED OR SOLD IN VIOLATION OF SUCH ACT. THE HOLDER (AND EACH BENEFICIAL OWNER) HEREOF BY ITS ACCEPTANCE HEREOF (OR ACQUISITION OF A BENEFICIAL INTEREST HEREIN), REPRESENTS THAT IT IS ACQUIRING THIS NOTE FOR INVESTMENT AND NOT WITH A VIEW TO ANY SALE OR DISTRIBUTION HEREOF. THIS NOTE (OR ANY BENEFICIAL INTEREST HEREIN) MAY BE TRANSFERRED ONLY PURSUANT TO ONE OF THE FOLLOWING METHODS: (1) TO THE COMPANY OR THE INITIAL HOLDER, (2) SO LONG AS THIS NOTE IS ELIGIBLE FOR RESALE PURSUANT TO RULE 144A UNDER THE SECURITIES ACT ("RULE 144A"), TO A PERSON WHOM THE SELLER REASONABLY BELIEVES IS A QUALIFIED INSTITUTIONAL BUYER, AS DEFINED IN RULE 144A, THAT IS PURCHASING FOR ITS OWN ACCOUNT OR FOR THE ACCOUNT OF A QUALIFIED INSTITUTIONAL BUYER TO WHOM NOTICE IS GIVEN THAT THE RESALE, PLEDGE OR OTHER TRANSFER IS BEING MADE IN RELIANCE ON RULE 144A, (3) PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OR (4) PURSUANT TO ANOTHER EXEMPTION FROM THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT, IF AVAILABLE, IN EACH CASE IN ACCORDANCE WITH ALL APPLICABLE SECURITIES LAWS OF THE STATES OF THE UNITED STATES OR ANY OTHER APPLICABLE JURISDICTION. THIS NOTE AND RELATED DOCUMENTATION MAY BE AMENDED OR SUPPLEMENTED FROM TIME TO TIME TO MODIFY THE RESTRICTIONS ON AND PROCEDURES FOR RESALES AND OTHER TRANSFERS OF THIS NOTE TO REFLECT ANY CHANGE IN APPLICABLE LAW OR REGULATION (OR THE INTERPRETATION THEREOF) OR IN PRACTICES RELATING TO THE RESALE OR TRANSFER OF RESTRICTED SECURITIES GENERALLY. THE HOLDER (AND EACH BENEFICIAL OWNER) OF THIS NOTE SHALL BE DEEMED, BY THE ACCEPTANCE OF THIS NOTE (OR ACQUISITION OF A BENEFICIAL INTEREST HEREIN), TO HAVE AGREED TO ANY SUCH AMENDMENT OR SUPPLEMENT. ALTHOUGH THE INITIAL HOLDER MAY REPURCHASE NOTES, IT IS NOT OBLIGATED TO DO SO. SMITH INTERNATIONAL, INC. FLOATING RATE NOTE DUE OCTOBER 15, 2003 SMITH INTERNATIONAL, INC., A CORPORATION DULY ORGANIZED AND EXISTING UNDER THE LAWS OF THE STATE OF DELAWARE (THE "COMPANY", WHICH TERM SHALL INCLUDE ANY SUCCESSOR TO THE COMPANY), FOR VALUE RECEIVED, HEREBY PROMISES TO PAY TO CEDE & CO., AS THE NOMINEE OF THE DEPOSITORY TRUST COMPANY, OR REGISTERED ASSIGNS, THE PRINCIPAL AMOUNT OF SEVENTY-FIVE MILLION UNITED STATES DOLLARS ($75,000,000) ON OCTOBER 15, 2003 (THE "MATURITY DATE") AND TO PAY INTEREST AS SET FORTH BELOW ON THE OUTSTANDING PRINCIPAL AMOUNT HEREOF. THIS NOTE WILL BEAR INTEREST FROM OCTOBER 15, 2001, AT THE RATES, DETERMINED QUARTERLY, AS DESCRIBED BELOW. INTEREST SHALL BE PAYABLE QUARTERLY ON JANUARY 15, APRIL 15, JULY 15 AND OCTOBER 15 OF EACH YEAR (EACH, AN "INTEREST PAYMENT DATE"), COMMENCING JANUARY 15, 2002. IF AN INTEREST PAYMENT DATE FALLS ON A DAY THAT IS NOT A BUSINESS DAY, INTEREST WILL BE PAYABLE ON THE NEXT SUCCEEDING BUSINESS DAY WITH THE SAME FORCE AND EFFECT AS IF MADE ON SUCH INTEREST PAYMENT DATE. EACH PERIOD COMMENCING ON AN INTEREST PAYMENT DATE AND ENDING ON THE DAY PRECEDING THE NEXT SUCCEEDING INTEREST PAYMENT DATE IS CALLED AN "INTEREST PERIOD," WITH THE EXCEPTION THAT THE FIRST INTEREST PERIOD SHALL BEGIN ON THE DATE OF THE ISSUANCE OF THIS NOTE AND EXTEND THROUGH JANUARY 14, 2002, THE DAY PRECEDING THE FIRST INTEREST PAYMENT DATE. INTEREST WILL BE PAID TO THE PERSON IN WHOSE NAME THIS NOTE IS REGISTERED AT THE CLOSE OF BUSINESS ON THE 15TH CALENDAR DAY NEXT PRECEDING EACH QUARTERLY INTEREST PAYMENT DATE (THE "REGULAR RECORD DATE"). THIS NOTE WILL BEAR INTEREST FOR EACH INTEREST PERIOD AT A PER ANNUM RATE DETERMINED BY THE TRUSTEE (AS DEFINED BELOW) OR ITS SUCCESSOR APPOINTED BY THE COMPANY, ACTING AS CALCULATION AGENT (THE "CALCULATION AGENT"). THE INTEREST RATE WILL BE EQUAL TO LIBOR (AS DEFINED BELOW) ON THE SECOND LONDON BUSINESS DAY (AS DEFINED BELOW) IMMEDIATELY PRECEDING THE FIRST DAY OF SUCH INTEREST PERIOD (EACH AN "INTEREST DETERMINATION DATE") PLUS 1.125%; PROVIDED, HOWEVER, THAT IN CERTAIN CIRCUMSTANCES DESCRIBED BELOW, THE INTEREST RATE WILL BE DETERMINED IN AN ALTERNATIVE MANNER WITHOUT REFERENCE TO LIBOR. PROMPTLY UPON SUCH DETERMINATION, THE CALCULATION AGENT WILL NOTIFY THE TRUSTEE OF THE INTEREST RATE FOR THE NEW INTEREST PERIOD. FOR PURPOSES OF THIS CALCULATION, "LONDON BUSINESS DAY" IS DEFINED AS A DAY ON WHICH DEALING IN DEPOSITS IN U.S. DOLLARS ARE TRANSACTED, OR WITH RESPECT TO ANY FUTURE DATE, ARE EXPECTED TO BE TRANSACTED, IN THE LONDON INTERBANK MARKET. "LIBOR" FOR ANY INTEREST DETERMINATION DATE WILL BE THE OFFERED RATE FOR DEPOSITS IN U.S. DOLLARS HAVING AN INDEX MATURITY OF THREE MONTHS FOR A PERIOD COMMENCING ON THE SECOND LONDON BUSINESS DAY IMMEDIATELY FOLLOWING THE INTEREST DETERMINATION DATE ("THREE MONTH DEPOSITS") IN AMOUNTS OF NOT LESS THAN $1,000,000, AS SUCH RATE APPEARS ON TELERATE PAGE 3750 (AS DEFINED BELOW), OR A SUCCESSOR REPORTER OF SUCH RATES SELECTED BY THE CALCULATION AGENT AND ACCEPTABLE TO THE COMPANY, AT APPROXIMATELY 11:00 A.M., LONDON TIME, ON THE INTEREST DETERMINATION DATE (THE "REPORTED RATE"). "TELERATE PAGE 3750" MEANS THE DISPLAY DESIGNATED ON PAGE "3750" ON DOW JONES MARKETS LIMITED (OR SUCH OTHER PAGE AS MAY REPLACE THE 3750 PAGE ON THAT SERVICE OR SUCH OTHER SERVICE OR SERVICES AS MAY BE NOMINATED BY THE BRITISH BANKERS' ASSOCIATION FOR THE PURPOSE OF DISPLAYING LONDON INTERBANK OFFERED RATES FOR U.S. DOLLAR DEPOSITS). IF THE FOLLOWING CIRCUMSTANCES EXIST ON ANY INTEREST DETERMINATION DATE, THE CALCULATION AGENT SHALL DETERMINE THE INTEREST RATE FOR THIS NOTE AS FOLLOWS: (i) IN THE EVENT THE REPORTED RATE CANNOT BE DETERMINED AS OF APPROXIMATELY 11:00 A.M. LONDON TIME ON AN INTEREST DETERMINATION DATE, THE CALCULATION AGENT SHALL REQUEST THE PRINCIPAL LONDON OFFICES OF EACH OF FOUR MAJOR BANKS IN THE LONDON INTERBANK MARKET SELECTED BY THE CALCULATION AGENT (AFTER CONSULTATION WITH THE COMPANY) TO PROVIDE A QUOTATION OF THE RATE (A "RATE QUOTATION") AT WHICH THREE MONTH DEPOSITS IN AMOUNTS OF NOT LESS THAN $1,000,000 ARE OFFERED BY IT TO PRIME BANKS IN THE LONDON INTERBANK MARKET, AS OF APPROXIMATELY 11:00 A.M. LONDON TIME ON SUCH INTEREST DETERMINATION DATE, THAT IS REPRESENTATIVE OF SINGLE TRANSACTIONS AT SUCH TIME ("REPRESENTATIVE AMOUNTS"). IF AT LEAST TWO RATE QUOTATIONS ARE PROVIDED, THE INTEREST RATE WILL BE THE ARITHMETIC MEAN OF THE RATE QUOTATIONS OBTAINED BY THE CALCULATION AGENT, PLUS 1.125%. (ii) IN THE EVENT THE REPORTED RATE CANNOT BE DETERMINED AND THERE ARE FEWER THAN TWO RATE QUOTATIONS, THE INTEREST RATE WILL BE THE ARITHMETIC MEAN OF THE RATES QUOTED AT APPROXIMATELY 11:00 A.M. NEW YORK CITY TIME ON SUCH INTEREST DETERMINATION DATE, BY THREE MAJOR BANKS IN NEW YORK CITY, SELECTED BY THE CALCULATION AGENT (AFTER CONSULTATION WITH THE COMPANY), FOR LOANS IN REPRESENTATIVE AMOUNTS IN U.S. DOLLARS TO LEADING EUROPEAN BANKS, HAVING AN INDEX MATURITY OF THREE MONTHS FOR A PERIOD COMMENCING ON THE SECOND LONDON BUSINESS DAY IMMEDIATELY FOLLOWING SUCH INTEREST DETERMINATION DATE, PLUS 1.125%; PROVIDED, HOWEVER, THAT IF FEWER THAN THREE BANKS SELECTED BY THE CALCULATION AGENT ARE QUOTING SUCH RATES, THE INTEREST RATE FOR THE APPLICABLE PERIOD WILL BE THE SAME AS THE INTEREST RATE IN EFFECT FOR THE IMMEDIATELY PRECEDING INTEREST PERIOD. UPON THE REQUEST OF THE HOLDER OF THIS NOTE, THE CALCULATION AGENT WILL PROVIDE TO SUCH HOLDER THE INTEREST RATE IN EFFECT ON THE DATE OF SUCH REQUEST AND, IF DETERMINED, THE INTEREST RATE FOR THE NEXT INTEREST PERIOD. ALL PERCENTAGES RESULTING FROM ANY CALCULATION OF THE INTEREST RATE ON THIS NOTE WILL BE ROUNDED, IF NECESSARY, TO THE NEAREST ONE HUNDRED-THOUSANDTH OF A PERCENTAGE POINT, WITH FIVE ONE-MILLIONTHS OF A PERCENTAGE POINT ROUNDED UPWARD (E.G., 9.876545% (OR .09876545) BEING ROUNDED TO 9.87655% (OR .0987655)). THE CALCULATION AGENT SHALL, AS SOON AS PRACTICABLE AFTER IT HAS DETERMINED THE INTEREST RATE ON THE NOTES ON EACH INTEREST DETERMINATION DATE, CALCULATE THE AMOUNT OF INTEREST PAYABLE IN RESPECT OF THE FOLLOWING INTEREST PERIOD (THE "INTEREST AMOUNT"). THE INTEREST AMOUNT SHALL BE CALCULATED BY APPLYING THE INTEREST RATE ON THE NOTES TO THE PRINCIPAL AMOUNT OF EACH NOTE OUTSTANDING AT THE COMMENCEMENT OF THE INTEREST PERIOD, MULTIPLYING EACH SUCH AMOUNT BY THE ACTUAL NUMBER OF DAYS IN THE INTEREST PERIOD CONCERNED (WHICH ACTUAL NUMBER OF DAYS SHALL INCLUDE THE FIRST DAY BUT EXCLUDE THE LAST DAY OF SUCH INTEREST PERIOD) DIVIDED BY 360 AND ROUNDING THE RESULTANT FIGURE UPWARDS TO THE NEAREST CENT (HALF A CENT BEING ROUNDED UPWARDS). THE DETERMINATION OF THE INTEREST RATE ON THE NOTES AND THE INTEREST AMOUNT BY THE CALCULATION AGENT SHALL (IN THE ABSENCE OF WILLFUL DEFAULT, BAD FAITH OR MANIFEST ERROR) BE FINAL AND BINDING ON ALL PARTIES. NOTWITHSTANDING ANYTHING HEREIN TO THE CONTRARY, THE INTEREST RATE ON THE NOTES SHALL IN NO EVENT BE HIGHER THAN THE MAXIMUM RATE PERMITTED BY NEW YORK LAW, AS THE SAME MAY BE MODIFIED BY UNITED STATES LAW OF GENERAL APPLICATION. THIS NOTE IS ONE OF A DULY AUTHORIZED ISSUE OF DEBENTURES, NOTES, BONDS OR OTHER EVIDENCES OF INDEBTEDNESS OF THE COMPANY (HEREINAFTER CALLED THE "SECURITIES") OF THE SERIES HEREINAFTER SPECIFIED, ALL ISSUED OR TO BE ISSUED UNDER AND PURSUANT TO AN INDENTURE DATED AS OF SEPTEMBER 8, 1997 (THE "INDENTURE"), DULY EXECUTED AND DELIVERED BY THE COMPANY AND THE BANK OF NEW YORK, AS TRUSTEE (HEREIN CALLED THE "TRUSTEE") TO WHICH INDENTURE, ALL INDENTURES SUPPLEMENTAL THERETO AND ALL RESOLUTIONS OF THE BOARD OF DIRECTORS ESTABLISHING THE FORM OR TERMS OF ANY SERIES OF SECURITIES, REFERENCE IS HEREBY MADE FOR A DESCRIPTION OF THE RIGHTS, LIMITATIONS OF RIGHTS, OBLIGATIONS, DUTIES AND IMMUNITIES THEREUNDER OF THE TRUSTEE, THE COMPANY AND THE HOLDERS OF THE SECURITIES. THE SECURITIES MAY BE ISSUED IN ONE OR MORE SERIES, WHICH DIFFERENT SERIES MAY BE ISSUED IN VARIOUS AGGREGATE PRINCIPAL AMOUNTS, MAY MATURE AT DIFFERENT TIMES, MAY BEAR INTEREST (IF ANY) AT DIFFERENT RATES, MAY BE SUBJECT TO DIFFERENT REDEMPTION PROVISIONS (IF ANY), MAY BE SUBJECT TO DIFFERENT SINKING, PURCHASE OR ANALOGOUS FUNDS (IF ANY) AND MAY OTHERWISE VARY AS IN THE INDENTURE PROVIDED. THIS NOTE IS ONE OF A SERIES DESIGNED AS THE FLOATING RATE NOTES DUE OCTOBER 15, 2003 (HEREIN CALLED THE "NOTES") OF THE COMPANY, LIMITED INITIALLY IN AGGREGATE PRINCIPAL AMOUNT TO $75,000,000, WITH THE COMPANY HAVING THE OPTION TO ISSUE ADDITIONAL NOTES IN AN UNLIMITED AGGREGATE PRINCIPAL AMOUNT FROM TIME TO TIME AFTER THE ORIGINAL ISSUANCE OF THE NOTES. SO LONG AS THIS NOTE REMAINS OUTSTANDING, THE COMPANY SHALL MAINTAIN UNDER APPOINTMENT A CALCULATION AGENT, WHICH SHALL INITIALLY BE THE TRUSTEE, TO CALCULATE THE INTEREST RATE PAYABLE ON THIS NOTE IN RESPECT OF EACH INTEREST PERIOD. IF THE CALCULATION AGENT SHALL BE UNABLE OR UNWILLING TO CONTINUE TO ACT AS CALCULATION AGENT OR IN THE EVENT OF THE CALCULATION AGENT FAILING DULY TO ESTABLISH THE APPLICABLE RATE OF INTEREST FOR ANY INTEREST PERIOD, OR IF THE COMPANY SHALL REMOVE THE CALCULATION AGENT, THE COMPANY SHALL APPOINT ANOTHER LEADING COMMERCIAL OR INVESTMENT BANK ENGAGED IN THE LONDON INTERBANK MARKET TO ACT AS THE CALCULATION AGENT; PROVIDED, HOWEVER, THAT THE CALCULATION AGENT SHALL NOT RESIGN OR BE REMOVED UNTIL ACCEPTANCE OF AN APPOINTMENT BY A SUCCESSOR AS EVIDENCED BY AN APPROPRIATE AGREEMENT ENTERED INTO BY THE COMPANY AND SUCH SUCCESSOR CALCULATION AGENT. ALL CERTIFICATES, COMMUNICATIONS, OPINIONS, DETERMINATIONS, CALCULATIONS, QUOTATIONS AND DECISIONS GIVEN, EXPRESSED, MADE OR OBTAINED FOR THE PURPOSES OF THE PROVISIONS HEREOF RELATING TO THE PAYMENT AND CALCULATION OF INTEREST ON THIS NOTE, WHETHER BY THE REFERENCE BANKS (OR ANY OF THEM) OR THE CALCULATION AGENT, SHALL (IN THE ABSENCE OF WILLFUL DEFAULT, BAD FAITH OR MANIFEST ERROR) BE BINDING ON THE COMPANY, THE CALCULATION AGENT AND ALL OF THE HOLDERS AND OWNERS OF BENEFICIAL INTERESTS IN THIS NOTE, AND NO LIABILITY SHALL (IN ABSENCE OF WILLFUL DEFAULT, BAD FAITH OR MANIFEST ERROR) ATTACH TO THE CALCULATION AGENT IN CONNECTION WITH THE EXERCISE OR NON-EXERCISE BY IT OF ITS POWERS, DUTIES AND DISCRETIONS. THE COMPANY SHALL CAUSE TO BE KEPT AT AN OFFICE OR AGENCY TO BE MAINTAINED BY THE COMPANY A REGISTER (THE REGISTER MAINTAINED IN SUCH OFFICE BEING HEREIN REFERRED TO AS THE "NOTE REGISTER") IN WHICH, SUBJECT TO SUCH REASONABLE REGULATIONS AS IT MAY PRESCRIBE, THE COMPANY SHALL PROVIDE FOR THE REGISTRATION OF NOTES AND OF TRANSFERS OF NOTES. THE TRUSTEE IS HEREBY APPOINTED "NOTE REGISTRAR" FOR THE PURPOSE OF REGISTERING NOTES AND TRANSFERS OF NOTES AS HEREIN PROVIDED. THE COMPANY MAY APPOINT CO-REGISTRARS AND MAY CHANGE ANY NOTE REGISTRAR OR CO-REGISTRAR WITHOUT NOTICE. THE NOTES AND ANY CERTIFICATES FOR NOTES ISSUED IN EXCHANGE FOR NOTES OR A BENEFICIAL INTEREST THEREIN WILL BEAR THE LEGENDS SET FORTH IN THIS NOTE, EXCEPT THAT CERTIFICATED NOTES SHALL NOT BEAR THE FIRST AND SECOND SUCH LEGENDS. THE HOLDER OF A NOTE MAY TRANSFER SUCH NOTE, SUBJECT TO COMPLIANCE WITH THE PROVISIONS OF THE THIRD SUCH LEGEND, AS PROVIDED IN THIS NOTE AND THE INDENTURE. UPON THE TRANSFER, EXCHANGE OR REPLACEMENT OF NOTES BEARING ANY SUCH LEGEND, OR UPON SPECIFIC REQUEST FOR REMOVAL OF ANY SUCH LEGEND ON A NOTE, THE COMPANY WILL DELIVER ONLY NOTES BEARING SUCH LEGEND, OR WILL REFUSE TO REMOVE SUCH LEGEND, AS THE CASE MAY BE, UNLESS THERE IS DELIVERED TO THE COMPANY SUCH SATISFACTORY EVIDENCE, WHICH MAY INCLUDE AN OPINION OF COUNSEL, AS MAY REASONABLY BE REQUIRED BY THE COMPANY THAT NEITHER SUCH LEGEND NOR THE RESTRICTIONS ON TRANSFER SET FORTH THEREIN ARE REQUIRED TO ENSURE COMPLIANCE WITH THE PROVISIONS OF THE SECURITIES ACT. IN CASE AN EVENT OF DEFAULT WITH RESPECT TO NOTES, AS DEFINED IN THE INDENTURE, SHALL HAVE OCCURRED AND BE CONTINUING, THE PRINCIPAL HEREOF AND THE INTEREST ACCRUED HEREON, IF ANY, MAY BE DECLARED, AND UPON SUCH DECLARATION SHALL BECOME, DUE AND PAYABLE, IN THE MANNER, WITH THE EFFECT AND SUBJECT TO THE CONDITIONS PROVIDED IN THE INDENTURE. THE INDENTURE CONTAINS PROVISIONS WHICH PROVIDE THAT THE COMPANY AND THE TRUSTEE MAY ENTER INTO ONE OR MORE SUPPLEMENTAL INDENTURES AMENDING THE INDENTURE AND THE SECURITIES OF ANY SERIES WITH THE CONSENT OF THE HOLDERS OF AT LEAST A MAJORITY IN PRINCIPAL AMOUNT OF THE OUTSTANDING SECURITIES OF EACH SERIES AFFECTED BY SUCH SUPPLEMENTAL INDENTURE, AND THE HOLDERS OF AT LEAST A MAJORITY IN PRINCIPAL AMOUNT OF THE OUTSTANDING SECURITIES OF ANY SERIES MAY WAIVE (a) ANY PAST DEFAULT UNDER THE INDENTURE WITH RESPECT TO SUCH SERIES AND ITS CONSEQUENCES AND (b) EITHER PAST OR FUTURE COMPLIANCE BY THE COMPANY WITH ANY PROVISION OF SECTIONS 10.4 TO 10.8 OF THE INDENTURE; PROVIDED THAT, WITHOUT THE CONSENT OF EACH HOLDER OF THE SECURITIES OF EACH SERIES AFFECTED THEREBY, AN AMENDMENT OR WAIVER, INCLUDING A WAIVER OF PAST DEFAULTS, MAY NOT: (i) CHANGE THE DUE DATE OF THE PRINCIPAL OF, OR ANY INSTALLMENT OF PRINCIPAL OF OR INTEREST ON, ANY SECURITY, OR REDUCE THE PRINCIPAL AMOUNT THEREOF OR THE RATE OF INTEREST THEREON OR ANY PREMIUM PAYABLE UPON REDEMPTION THEREOF, OR REDUCE THE AMOUNT OF THE PRINCIPAL OF ANY SECURITY THAT WOULD BE DUE AND PAYABLE UPON A DECLARATION OF THE MATURITY THEREOF PURSUANT TO THE INDENTURE, OR CHANGE THE PLACE OF PAYMENT WHERE, OR THE COIN OR CURRENCY IN WHICH, ANY SECURITY OR ANY PREMIUM OR THE INTEREST THEREON IS DENOMINATED OR PAYABLE (OR, IN THE CASE OF CERTAIN SECURITIES WHICH PROVIDE FOR LESS THAN THE ENTIRE PRINCIPAL AMOUNT THEREOF TO BE DUE AND PAYABLE UPON A DECLARATION OF ACCELERATION OF THE MATURITY THEREOF PURSUANT TO THE INDENTURE, REDUCE THE AMOUNT OF PRINCIPAL PAYABLE UPON SUCH A DECLARATION OF ACCELERATION OF THE MATURITY THEREOF), OR IMPAIR THE RIGHT TO INSTITUTE SUIT FOR THE ENFORCEMENT OF ANY SUCH PAYMENT ON OR AFTER THE DUE DATE THEREOF (OR, IN THE CASE OF REDEMPTION, ON OR AFTER THE REDEMPTION DATE), (ii) REDUCE THE PERCENTAGE OF THE PRINCIPAL AMOUNT OF THE OUTSTANDING SECURITIES OF ANY SERIES, THE CONSENT OF WHOSE HOLDERS IS REQUIRED FOR ANY SUCH SUPPLEMENTAL INDENTURE, OR THE CONSENT OF WHOSE HOLDERS IS REQUIRED FOR ANY WAIVER (OF COMPLIANCE WITH THE AFORESAID PROVISIONS OF THE INDENTURE OR DEFAULTS THEREUNDER AND THEIR CONSEQUENCES) PROVIDED FOR IN THE INDENTURE OR (iii) MODIFY ANY OF THE PROVISIONS OF SECTION 5.13, SECTION 9.2 OR SECTION 10.10 OF THE INDENTURE, EXCEPT TO INCREASE ANY SUCH PERCENTAGE OR TO PROVIDE THAT CERTAIN OTHER PROVISIONS OF THE INDENTURE CANNOT BE MODIFIED OR WAIVED WITHOUT THE CONSENT OF THE HOLDER OF EACH OUTSTANDING SECURITY AFFECTED THEREBY. IT IS ALSO PROVIDED IN THE INDENTURE THAT, SUBJECT TO CERTAIN CONDITIONS, THE HOLDERS OF AT LEAST A MAJORITY IN PRINCIPAL AMOUNT OF THE OUTSTANDING SECURITIES OF ANY SERIES MAY WAIVE AN EXISTING DEFAULT WITH RESPECT TO THE SECURITIES OF SUCH SERIES AND ITS CONSEQUENCES, EXCEPT A DEFAULT IN THE PAYMENT OF PRINCIPAL OF (OR PREMIUM, IF ANY) OR INTEREST ON ANY SECURITY OF SUCH SERIES OR IN RESPECT OF A COVENANT OR PROVISION OF THE INDENTURE WHICH CANNOT BE MODIFIED OR AMENDED WITHOUT THE CONSENT OF THE HOLDER OF EACH OUTSTANDING SECURITY OF SUCH SERIES AFFECTED. UPON ANY SUCH WAIVER, SUCH DEFAULT SHALL CEASE TO EXIST, AND ANY EVENT OF DEFAULT ARISING THEREFROM SHALL BE DEEMED TO HAVE BEEN CURED, FOR EVERY PURPOSE OF THE INDENTURE; BUT NO SUCH WAIVER SHALL EXTEND TO ANY SUBSEQUENT OR OTHER DEFAULT OR IMPAIR ANY RIGHT CONSEQUENT THERETO. NO REFERENCE HEREIN TO THE INDENTURE AND NO PROVISION OF THIS NOTE OR OF THE INDENTURE SHALL ALTER OR IMPAIR THE OBLIGATION OF THE COMPANY, WHICH IS ABSOLUTE AND UNCONDITIONAL, TO PAY THE PRINCIPAL OF AND INTEREST ON THIS NOTE IN THE MANNER, AT THE PLACE, AT THE RESPECTIVE TIMES, AT THE RATE AND IN THE COIN OR CURRENCY HEREIN PRESCRIBED. THE NOTES ARE ISSUABLE ONLY IN FULLY REGISTERED FORM, WITHOUT COUPONS, IN DENOMINATIONS OF $1,000 AND ANY WHOLE MULTIPLE THEREOF. THE NOTES ARE NOT REDEEMABLE BEFORE THE MATURITY DATE. THE COMPANY SHALL HAVE NO OBLIGATION TO REDEEM, PURCHASE OR REPAY THE NOTES PURSUANT TO A MANDATORY REDEMPTION, SINKING FUND OR ANALOGOUS PROVISION OR AT THE OPTION OF A HOLDER THEREOF. AT THE COMPANY'S OPTION, EITHER (i) THE COMPANY SHALL BE DEEMED TO HAVE BEEN DISCHARGED FROM ITS OBLIGATION WITH RESPECT TO THE NOTES ON THE 91ST DAY AFTER THE APPLICABLE CONDITIONS SET FORTH IN SECTION 13.2 OF THE INDENTURE HAVE BEEN SATISFIED ("DEFEASANCE") OR (ii) THE COMPANY SHALL CEASE TO BE UNDER ANY OBLIGATION TO COMPLY WITH ANY TERM, PROVISION OR CONDITION SET FORTH IN SECTION 10.4, SECTION 10.5, SECTION 10.6, SECTION 10.7 AND SECTION 10.8 OF THE INDENTURE WITH RESPECT TO THE NOTES AND CERTAIN RESTRICTIVE COVENANTS AT ANY TIME AFTER THE APPLICABLE CONDITIONS SET FORTH IN SECTION 13.2 OF THE INDENTURE HAVE BEEN SATISFIED ("COVENANT DEFEASANCE"); DEFEASANCE OR COVENANT DEFEASANCE SHALL BE ACCOMPLISHED AS PROVIDED IN AND IN COMPLIANCE WITH THE PROVISIONS OF SECTION 13.2 OF THE INDENTURE. UPON DUE PRESENTMENT FOR REGISTRATION OF TRANSFER OF THIS NOTE AT THE OFFICE OR AGENCY OF THE COMPANY IN NEW YORK, NEW YORK, A NEW NOTE OR NOTES OF AUTHORIZED DENOMINATIONS FOR AN EQUAL AGGREGATE PRINCIPAL AMOUNT WILL BE ISSUED TO THE TRANSFEREE IN EXCHANGE THEREFOR, SUBJECT TO THE LIMITATIONS PROVIDED IN THE INDENTURE, WITHOUT CHARGE EXCEPT FOR ANY TAX OR OTHER GOVERNMENTAL CHARGE IMPOSED IN CONNECTION THEREWITH. THE COMPANY, THE TRUSTEE AND ANY AGENT OF THE COMPANY OR THE TRUSTEE MAY DEEM AND TREAT THE REGISTERED HOLDER HEREOF AS THE ABSOLUTE OWNER OF THIS NOTE (WHETHER OR NOT THIS NOTE SHALL BE OVERDUE AND NOTWITHSTANDING ANY NOTATION OF OWNERSHIP OR OTHER WRITING HEREON), FOR THE PURPOSE OF RECEIVING PAYMENT OF, OR ON ACCOUNT OF, THE PRINCIPAL HEREOF AND, SUBJECT TO THE PROVISIONS HEREOF, INTEREST HEREON, AND FOR ALL OTHER PURPOSES, AND NEITHER THE COMPANY NOR THE TRUSTEE NOR ANY AGENT OF THE COMPANY OR THE TRUSTEE SHALL BE AFFECTED BY ANY NOTICE TO THE CONTRARY. NO RECOURSE UNDER OR UPON ANY OBLIGATION, COVENANT OR AGREEMENT OF THE COMPANY IN THE INDENTURE, ANY INDENTURE SUPPLEMENTAL THERETO OR IN ANY NOTE, OR BECAUSE OF ANY INDEBTEDNESS EVIDENCED THEREBY, SHALL BE HAD AGAINST ANY INCORPORATOR, STOCKHOLDER, OFFICER OR DIRECTOR, AS SUCH, PAST, PRESENT, OR FUTURE, OF THE COMPANY OR OF ANY SUCCESSOR CORPORATION, EITHER DIRECTLY OR THROUGH THE COMPANY OR ANY SUCCESSOR CORPORATION, UNDER ANY RULE OF LAW, STATUTE OR CONSTITUTIONAL PROVISION OR BY THE ENFORCEMENT OF ANY ASSESSMENT OR BY ANY LEGAL OR EQUITABLE PROCEEDING OR OTHERWISE, ALL SUCH LIABILITY BEING EXPRESSLY WAIVED AND RELEASED BY THE ACCEPTANCE HEREOF AND AS PART OF THE CONSIDERATION FOR THE ISSUE HEREOF. THIS NOTE SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF NEW YORK. PURSUANT TO A RECOMMENDATION PROMULGATED BY THE COMMITTEE ON UNIFORM SECURITY IDENTIFICATION PROCEDURES, THE COMPANY HAS CAUSED A CUSIP NUMBER TO BE SET FORTH ON THIS NOTE AS A CONVENIENCE TO THE HOLDER HEREOF. NO REPRESENTATION IS MADE AS TO THE ACCURACY OF SUCH NUMBER AND RELIANCE MAY BE PLACED ONLY ON THE OTHER IDENTIFYING INFORMATION SET FORTH HEREON. THIS NOTE SHALL NOT BE VALID OR BECOME OBLIGATORY FOR ANY PURPOSE UNTIL THE CERTIFICATE OF AUTHENTICATION HEREON SHALL HAVE BEEN MANUALLY SIGNED BY THE TRUSTEE UNDER THE INDENTURE. IN WITNESS WHEREOF, SMITH INTERNATIONAL, INC. HAS CAUSED THIS INSTRUMENT TO BE SIGNED MANUALLY OR BY FACSIMILE BY ITS DULY AUTHORIZED OFFICER AND HAS CAUSED ITS CORPORATE SEAL TO BE AFFIXED HEREUNTO OR IMPRINTED HEREON. DATED: OCTOBER, 2001 SMITH INTERNATIONAL, INC. BY: /s/ MARGARET K. DORMAN ----------------------------- NAME: MARGARET K. DORMAN TITLE: SENIOR VICE PRESIDENT AND CHIEF FINANCIAL OFFICER /s/ NEAL S. SUTTON --------------------------------------- NAME: NEAL S. SUTTON TITLE: SENIOR VICE PRESIDENT--ADMINISTRATION, GENERAL COUNSEL AND SECRETARY CERTIFICATE OF AUTHENTICATION THIS IS ONE OF THE SECURITIES OF THE SERIES DESIGNATED PURSUANT TO THE WITHIN-MENTIONED INDENTURE. THE BANK OF NEW YORK, AS TRUSTEE BY: /s/ ---------------------------- AUTHORIZED SIGNATORY DATE OF AUTHENTICATION: OCTOBER 15, 2001 ASSIGNMENT FOR VALUE RECEIVED, THE UNDERSIGNED SELLS, ASSIGNS AND TRANSFERS THIS NOTE TO - ------------------------------------------------------------------------------ - ------------------------------------------------------------------------------ (PRINT OR TYPE TRANSFEREE'S NAME, ADDRESS, ZIP CODE AND SOCIAL SECURITY OR TAXPAYER IDENTIFICATION NUMBER ABOVE) AND IRREVOCABLY APPOINT _________________________ AGENT TO TRANSFER THIS NOTE ON THE BOOKS OF THE COMPANY. THE AGENT MAY SUBSTITUTE ANOTHER TO ACT FOR HIM. DATED: ---------------- YOUR SIGNATURE: -------------------------------------------- NOTICE: THE SIGNATURE(S) ON THIS ASSIGNMENT MUST CORRESPOND IN EVERY PARTICULAR WITH THE NAME(S) OF THE REGISTERED OWNER(S) APPEARING ON THE FACE OF THE NOTE. -------------------------------------------- SIGNATURE SIGNATURE GUARANTEED BY: - -------------------------------------------- NOTICE: SIGNATURE MUST BE GUARANTEED BY AN "ELIGIBLE GUARANTOR INSTITUTION" MEETING THE REQUIREMENTS OF THE FISCAL AGENT, WHICH REQUIREMENTS WILL INCLUDE MEMBERSHIP OR PARTICIPATION IN STAMP OR SUCH OTHER SIGNATURE GUARANTY PROGRAM AS MAY BE DETERMINED BY THE FISCAL AGENT IN ADDITION TO, OR IN SUBSTITUTION FOR, STAMP, ALL IN ACCORDANCE WITH THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. IN CONNECTION WITH ANY TRANSFER OF ANY OF THIS NOTE, THE UNDERSIGNED CONFIRMS THAT SUCH NOTE IS BEING TRANSFERRED IN ACCORDANCE WITH ITS TERMS. CHECK ONE BOX BELOW (1) [ ] TO THE COMPANY; OR (2) [ ] PURSUANT TO AN EFFECTIVE REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933; OR (3) [ ] INSIDE THE UNITED STATES TO A "QUALIFIED INSTITUTIONAL BUYER" (AS DEFINED IN RULE 144A UNDER THE SECURITIES ACT OF 1933) THAT PURCHASES FOR ITS OWN ACCOUNT OR FOR THE ACCOUNT OF A QUALIFIED INSTITUTIONAL BUYER TO WHOM NOTICE IS GIVEN THAT SUCH TRANSFER IS BEING MADE IN RELIANCE ON RULE 144A, IN EACH CASE PURSUANT TO AND IN COMPLIANCE WITH RULE 144A UNDER THE SECURITIES ACT OF 1933; OR (4) [ ] OUTSIDE THE UNITED STATES IN AN OFFSHORE TRANSACTION WITHIN THE MEANING OF REGULATION S UNDER THE SECURITIES ACT IN COMPLIANCE WITH RULE 904 UNDER THE SECURITIES ACT OF 1933; OR (5) [ ] PURSUANT TO ANOTHER AVAILABLE EXEMPTION FROM REGISTRATION UNDER THE SECURITIES ACT OF 1933. UNLESS ONE OF THE BOXES IS CHECKED, THE TRUSTEE WILL REFUSE TO REGISTER THIS NOTE IN THE NAME OF ANY PERSON OTHER THAN THE REGISTERED HOLDER THEREOF; PROVIDED, HOWEVER, THAT IF BOX (4) OR (5) IS CHECKED, THE TRUSTEE MAY REQUIRE, PRIOR TO REGISTERING ANY SUCH TRANSFER OF THIS NOTE, SUCH LEGAL OPINIONS, CERTIFICATIONS AND OTHER INFORMATION AS THE COMPANY HAS REASONABLY REQUESTED TO CONFIRM THAT SUCH TRANSFER IS BEING MADE PURSUANT TO AN EXEMPTION FROM, OR IN A TRANSACTION NOT SUBJECT TO, THE REGISTRATION REQUIREMENTS OF THE SECURITIES ACT OF 1933, SUCH AS THE EXEMPTION PROVIDED BY RULE 144 UNDER SUCH ACT. - -------------------------------------------------------------------------------- TO BE COMPLETED BY PURCHASER IF (3) ABOVE IS CHECKED. THE UNDERSIGNED REPRESENTS AND WARRANTS THAT IT IS PURCHASING THIS NOTE FOR ITS OWN ACCOUNT OR AN ACCOUNT WITH RESPECT TO WHICH IT EXERCISES SOLE INVESTMENT DISCRETION AND THAT IT AND ANY SUCH ACCOUNT IS A "QUALIFIED INSTITUTIONAL BUYER" WITHIN THE MEANING OF RULE 144A UNDER THE SECURITIES ACT OF 1933, AND IS AWARE THAT THE SALE TO IT IS BEING MADE IN RELIANCE ON RULE 144A AND ACKNOWLEDGES THAT IT HAS RECEIVED SUCH INFORMATION REGARDING THE COMPANY AS THE UNDERSIGNED HAS REQUESTED PURSUANT TO RULE 144A OR HAS DETERMINED NOT TO REQUEST SUCH INFORMATION AND THAT IT IS AWARE THAT THE TRANSFEROR IS RELYING UPON THE UNDERSIGNED'S FOREGOING REPRESENTATIONS IN ORDER TO CLAIM THE EXEMPTION FROM REGISTRATION PROVIDED BY RULE 144A. DATED: ----------------------- ---------------------------------------------- NOTICE: TO BE EXECUTED BY AN EXECUTIVE OFFICER EX-10.1 5 h03433exv10w1.txt 1989 LONG TERM INCENTIVE COMPENSATION PLAN EXHIBIT 10.1 SMITH INTERNATIONAL, INC. 1989 LONG-TERM INCENTIVE COMPENSATION PLAN (As Amended and Restated as of February 2, 2000) 1. PURPOSE OF THE PLAN The purpose of the 1989 Long-Term Incentive Compensation Plan (the "Plan") is to advance the interests of Smith International, Inc. (the "Company") and its shareholders by strengthening the ability of the Company to attract and retain in its employ persons of training, experience and ability, and to furnish additional incentives to officers and valued employees of the Company upon whose judgment, initiative and efforts the successful conduct and development of the business of the Company largely depends. 2. DEFINITIONS Whenever the following terms are used in this Plan, they shall have the meaning specified below unless the context clearly indicates to the contrary. "Board of Directors" shall mean the Board of Directors of the Company. "Cash Award" shall mean a cash award granted pursuant to Section 1 of the Plan. "Committee" shall mean the Compensation and Benefits Committee of the Board of Directors, unless the Board of Directors appoints another committee to administer the Plan. The Committee shall consist of not less than two directors who fulfill the "nonemployee director" requirements of Rule 16b-3 under the Securities Exchange Act of 1934 and the "outside director" requirements of Section 162(m) of the Internal Revenue Code. The Board of Directors shall have the power to fill vacancies on the Committee arising by resignation, death, removal or otherwise. The Board of Directors, in its discretion, may bifurcate the powers and duties of the Committee among one or more separate committees, or retain all powers and duties of the Committee in a single Committee. "Common Stock" shall mean the common shares, $1.00 par value of the Company and any class of common shares into which such common shares may hereafter be converted. "Company" shall mean Smith International, Inc. "Covered Employee" shall mean a named executive officer who is one of the group of covered employees, as defined in Section 162(m) of the Internal Revenue Code and Treasury Regulation Section 1.162-27(c) (or its successor). "Director" shall mean a member of the Board of Directors. "Disinterested Person" shall have the meaning assigned to that term under the rules and regulations of the Securities and Exchange Commission under the Exchange Act. "Eligible Person" shall mean a person eligible to receive an Incentive Award. "Employee" shall mean any employee of the Company, or of any of its present or future parent or subsidiary corporations, or a corporation (or a parent or subsidiary corporation of such corporation) issuing or assuming an Option in a transaction to which Section 425(a) of the Internal Revenue Code applies, whether such Employee is so employed at the time this Plan is adopted or becomes so employed subsequent to adoption of this Plan. "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended. "Fair Market Value" shall mean the average of the high and low prices of a share of Common Stock on the New York Stock Exchange on the date as of which fair market value is to be determined, or if no such sales were made on such date, the closing price of such shares on the New York Stock Exchange on the next preceding date on which there were such sales; provided, however, that the Committee may utilize such other listing or reporting services that in its judgment provide an accurate index of the fair market value of the Common Stock. "Holder" shall mean a person holding an Incentive Award. "Incentive Award" shall mean an Option, Stock Appreciation Right, Restricted Stock, Stock Award or Cash Award granted under the Plan. "Insider" shall mean, while the Company is a Publicly Held Corporation, an individual who is, on the relevant date, an officer, director, or ten percent (10%) beneficial owner of any class of the Company's equity securities that is registered pursuant to Section 12 of the Exchange Act, all as defined under Section 16 of the Exchange Act. "Nonstatutory Stock Option" shall mean an option granted pursuant to Section 7 of the Plan. "Option" shall mean a Nonstatutory Stock Option. "Optionee" shall mean any person holding an Option granted under the Plan. "Parent corporation" and "subsidiary corporation" shall have the meanings assigned to them in Sections 425(e) and 425(f) of the Internal Revenue Code. "Performance-Based Exception" shall mean the exception from the tax deductibility limitations of Section 162(m) of the Internal Revenue Code, as prescribed in Section 162(m) and Treasury Regulation Section 1.162-27(e) (or its successor). "Plan" shall mean the Smith International, Inc. 1989 Long-Term Incentive Compensation Plan as set forth herein, as the same may be amended from time to time. "Publicly Held Corporation" shall mean an issuer (as defined in Section 3 of the Exchange Act), the securities of which are registered under Section 12 of the Exchange Act or that is required to file reports under Section 15(d) of the Exchange Act. "Stock Appreciation Right" shall mean a right granted pursuant to Section 8 or Section 9 of the Plan to receive a number of shares of Common Stock or, in the discretion of the Committee, an amount of cash or a combination of shares and cash, based on the increase in the Fair Market Value of the shares subject to the right. "Stock Award" shall mean a stock award granted pursuant to Section 10 of the Plan. 3. SHARES OF COMMON STOCK SUBJECT TO THE PLAN (a) Effective as of June 20, 2002, subject to Section 3(c) and Section 12 of the Plan, the aggregate number of shares of Common Stock that may be issued or transferred or as to which Stock Appreciation Rights may be exercised pursuant to Incentive Awards under the Plan shall not exceed 14,400,000 shares. Unless the Committee determines that a particular Incentive Award granted to a Covered Employee is not intended to comply with the Performance-Based Exception, the following rules shall apply to grants of Incentive Awards to Covered Employees: (1) Subject to adjustment as provided in Section 12, the maximum aggregate number of shares of Common Stock that may be granted or that may vest, as applicable, in any calendar year pursuant to any Incentive Award held by any individual Covered Employee shall be One Million (1,000,000) shares. (2) The maximum aggregate cash payout with respect to any Incentive Awards granted in any calendar year which may be made to any Covered Employee shall be Ten Million dollars ($10,000,000). (3) With respect to any Incentive Award granted to a Covered Employee that is canceled or repriced, the number of shares subject to such Incentive Award shall continue to count against the maximum number of shares that may be the subject of Incentive Awards granted to such Covered Employee and, in this regard, such maximum number shall be determined in accordance with Section 162(m) of the Internal Revenue Code. (4) The limitations of subsections (1), (2) and (3) above shall be construed and administered so as to comply with the Performance-Based Exception. (b) The shares to be delivered under the Plan shall be made available, at the discretion of the Board of Directors or the Committee, either from authorized but unissued shares of Common Stock or from previously issued shares of Common Stock reacquired by the Company, including shares purchased on the open market. Common Stock issued under the Plan in connection with restricted stock or stock awards shall be issued shares held as treasury shares. (c) If any shares of Common Stock subject to an Option are not issued or transferred and cease to be issuable or transferable for any reason, the shares not so issued or transferred shall no longer be charged against the limitation provided for in Section 3(a) and may again be made subject to Incentive Awards. However, shares as to which an Option has been surrendered in connection with the exercise of a related Stock Appreciation Right shall not again be available for the grant of any further Incentive Awards. If a Stock Appreciation Right not related to an Option expires or terminates without having been exercised, then the number of shares of Common Stock with respect to which the unexercised portion of such Stock Appreciation Right was granted shall no longer be charged against the limitation provided for in Section 3(a) and may again be made subject to Incentive Awards. (d) The Committee may, in its discretion, determine to cancel, and agree to the cancellation of, Options in order to make a participant eligible for the grant of an Option at a lower price than the option cancelled. (e) In the event that shares of Common Stock are issued as restricted stock or pursuant to a stock award and thereafter are forfeited or reacquired by the Company pursuant to rights reserved upon issuance thereof, such forfeited and reacquired shares may again be issued under the Plan, either as restricted stock, pursuant to stock awards or otherwise. 4. ADMINISTRATION OF THE PLAN (a) The Plan shall be administered by the Committee, which shall consist of three or more persons (i) who are not eligible to receive Incentive Awards under the Plan, (ii) who have not been eligible, at any time within one year prior to appointment to the Committee, for selection as persons to whom Incentive Awards may be granted pursuant to the Plan or to whom shares may be allocated or stock options or stock appreciation rights may be granted pursuant to any other plan of the Company or any of its affiliates entitling the participants therein to acquire stock, stock appreciation rights or options of the Company or any of its affiliates and (iii) who are Disinterested Persons. All members of the Committee shall be Disinterested Persons. The Board of Directors may from time to time remove members from, or add members to, the Committee. Vacancies on the Committee, however caused, shall be filled only by the Board of Directors. The Board of Directors may take any action permitted to be taken by the Committee if a majority of the Directors are Disinterested Persons. (b) The Committee shall have and may exercise such powers and authority of the Board of Directors as may be necessary or appropriate for the Committee to carry out its functions as described in the Plan, and any references in the Plan to any specific power or authority of the Committee shall not derogate from the foregoing. The Committee shall have authority in its discretion to determine the Eligible Persons to whom, and the time or times at which, Incentive Awards may be granted and the number of shares subject to each Incentive Award. Subject to the express provisions of the Plan, the Committee shall also have authority to interpret the Plan, to prescribe, amend and rescind rules and regulations relating to it, to determine the terms and provisions of the respective Incentive Award agreements (which need not be identical) and to make all other determinations necessary or advisable for the administration of the Plan. All interpretations, determinations and actions by the Committee shall be final, conclusive and binding upon all parties. (c) No member of the Board of Directors or the Committee shall be liable for any action or determination made in good faith by the Board of Directors or the Committee with respect to the Plan or any Incentive Award thereunder. 5. ELIGIBILITY (a) All full-time salaried Employees (including officers and directors, but excluding directors of the Company who are not also full-time employees of the Company) who are engaged in performing management, supervisory, sales, scientific or engineering services or who have been determined by the Committee to be key Employees are eligible to receive Incentive Awards under the Plan. Eligible employees may be designated individually or by groups or categories (for example, by pay grade) as the Committee deems appropriate. Participation by officers of the Company and any performance objectives relating to such officers must be approved by the Committee. Participation by persons other than officers and any performance objectives relating thereto may be approved by groups or categories (for example, by pay grade) and authority to designate participants who are not officers and to set or modify such targets may be delegated. The Committee shall have authority, in its sole discretion, to determine and designate from time to time those Eligible Persons who are to be granted Incentive Awards, the type of Incentive Award to be granted, and the number of shares of Common Stock or the amount of cash subject to each Incentive Award. In making such determinations, the Committee may take into account the nature of the services rendered by the respective Eligible Persons, their present and potential contributions to the Company's success and such other factors as the Committee in its sole discretion shall deem relevant. (b) An Eligible Person who has been granted an Incentive Award may, if he is otherwise eligible, be granted an additional Incentive Award. (c) No Insider shall be eligible to be granted an Incentive Award that may be subject to Rule 16a-3 under the Exchange Act unless and until such Insider has granted a limited power of attorney to those officers of the Company who have been designated by the Committee for purposes of making required filings under the Exchange Act. 6. FORMS OF INCENTIVE AWARDS Incentive Awards may be granted in the following forms: (a) Nonstatutory Stock Option in accordance with Section 7 of the Plan; (b) Stock Appreciation Right, related to an Option in accordance with Section 8 of the Plan; (c) Stock Appreciation Right not related to an Option in accordance with Section 9 of the Plan; (d) Stock Award in accordance with Section 10 of the Plan; (e) Restricted Stock in accordance with Section 10 of the Plan; (f) Cash Award in accordance with Section 11 of the Plan; or (g) Any combination of the foregoing. 7. NONSTATUTORY STOCK OPTIONS The Committee may at any time and from time to time approve the grant by the Company of Nonstatutory Stock Options to Eligible Persons to purchase shares of Common Stock of the Company, and determine the specific Eligible Persons to whom such Options may be granted, the number of shares subject to each Option, the terms and provisions of the Option agreement, and the time or times at which such Options may be exercised, subject to the following terms and conditions: (a) The date of grant shall be the date the Committee takes the necessary action to approve the grant; provided, however, that if the minutes or appropriate resolutions of the Committee provide that an Option is to be granted as of a date in the future, the date of grant shall be such future date. In any event, the intended Optionee must be an Eligible Person on the date of grant. (b) The purchase price of Common Stock under each Nonstatutory Stock Option shall be determined by the Committee, and will have an exercise price of not less than the Fair Market Value of the Common Stock on the date the Option is granted, subject to adjustment as provided in section 12 below. Options cannot be cancelled and regranted at a lower price. (c) Each Nonstatutory Stock Option shall become exercisable at such time or times during its term as shall be determined by the Committee at the time of grant. The Committee may accelerate the exercisability of any stock option. Subject to the foregoing and with the approval of the Committee, all or any part of the shares of Common Stock with respect to which the right to purchase has accrued may be purchased by the Company at the time of such accrual or at any time or times thereafter during the term of the Option. (d) No Nonstatutory Stock Option may be exercised after ten years from the date the Option is granted. (e) Upon the exercise of a Nonstatutory Stock Option, the purchase price shall be payable in full in cash or its equivalent acceptable to the Company. In the discretion of the Committee, the purchase price may be paid by the assignment and delivery to the Company of shares of Common Stock or a combination of cash and such shares equal in value to the Option exercise price. Any shares so assigned and delivered to the Company in payment or partial payment of the purchase price shall be valued at their Fair Market Value on the exercise date. (f) No fractional shares shall be issued pursuant to the exercise of a Nonstatutory Stock Option, nor shall any cash payment be made in lieu thereof. (g) A Nonstatutory Stock Option shall not be assignable or transferable by the Optionee to whom granted otherwise than by will or the laws of descent and distribution, and may be exercised during the lifetime of the Optionee only by the Optionee; provided, however, that the Optionee may transfer an Option for estate planning purposes for no consideration to (i) any member of his immediate family, (ii) any trust or entity created solely for the benefit of the Optionee or the members of the Optionee's immediate family or (iii) any custodian under the Uniform Transfers to Minors Act or any similar act in effect in any state solely for the benefit of a member of the Optionee's immediate family, and the trustee or the transferee may exercise the transferred Option during or after the lifetime of the Optionee, provided that the trustee or the transferee will remain subject to all the terms and conditions applicable to the Option set forth in the Plan or the Option agreement. For purposes of this Section 7(g), "immediate family" means the Optionee's spouse, children and grandchildren. The provisions of this Section 7(g) shall apply to all past and future Options granted under the Plan regardless of the date of grant. (h) No person shall have the rights and privileges of a shareholder with respect to shares subject to or purchased under a Nonstatutory Stock Option until the date appearing on the stock certificate issued upon the exercise of the Option. (i) To the extent that a Nonstatutory Stock Option is exercised, any related Stock Appreciation Right shall be proportionately reduced by a number of shares equal to the number of shares with respect to which the Option is exercised. (j) Upon approval of the Committee, the Company may repurchase a previously granted stock option from an Optionee by mutual agreement before such option has been exercised by payment to the Optionee of the amount per share by which: (i) the Fair Market Value of the Common Stock subject to the option on the date of purchase exceeds (ii) the option price. (k) Each Nonstatutory Stock Option shall be evidenced by a written agreement and may, but need not, include any other terms and conditions not inconsistent with the Plan as the Committee may approve. 8. STOCK APPRECIATION RIGHTS RELATED TO OPTIONS The Committee may at any time and from time to time approve the grant by the Company of Stock Appreciation Rights to Eligible Persons that are related to Nonstatutory Stock Options, and determine the specific Eligible Persons to whom Stock Appreciation Rights may be granted, the terms and provisions of the Stock Appreciation Rights agreements, and the time or times at which such Stock Appreciation Rights may be exercised, subject to the following terms and conditions: (a) The date of grant shall be the date the Committee takes the necessary action to approve the grant; provided, however, that, if the minutes of appropriate resolutions of the Committee provide that a Stock Appreciation Right is to be granted as of a date in the future, the date of grant shall be such future date. In any event, the intended Optionee must be an Eligible Person on the date of grant. (b) A Stock Appreciation Right may be granted in connection with a Nonstatutory Stock Option, either at the time of the grant of such Option or at any time thereafter during the term of the Option. (c) A Stock Appreciation Right shall entitle the Holder of the related Option, upon exercise of the Stock Appreciation Right, to surrender such Option, or any portion thereof to the extent unexercised (subject to a limitation of 50% of the shares of Common Stock subject to the Option), with respect to the number of shares as to which Stock Appreciation Right is exercised, and to receive payment of an amount computed pursuant to Section 8(e). Such Option shall, to the extent so surrendered, thereupon cease to be exercisable. (d) Subject to Section 8(g), a Stock Appreciation Right granted hereunder shall be exercisable at such time or times, and only to the extent, that a related Option is exercisable and shall not be transferable except to the extent that such related Option may be transferable. The Stock Appreciation Right shall be exercisable only by the Holder thereof or by such other person or entity entitled to exercise the related Option in the event of the death of the Holder. (e) Subject to the right of the Committee to deliver cash in lieu of shares of Common Stock, the number of shares of Common Stock which shall be issuable upon the exercise of a Stock Appreciation Right shall be determined by dividing: (i) the number of shares of Common Stock as to which the Stock Appreciation Right is exercised multiplied by the amount of the appreciation in such shares (for this purpose, "appreciation" shall mean the amount by which the Fair Market Value of the shares of Common Stock subject to the Stock Appreciation Right on the exercise date exceeds an amount which shall be determined by the Committee at the time of grant, which amount for a Director or an executive officer (or equivalent thereof) of the Company, shall not be less than the Fair Market Value of a share of Common Stock at the time of grant); by (ii) the Fair Market Value of a share of Common Stock on the exercise date. (f) In lieu of issuing shares of Common Stock upon the exercise of a Stock Appreciation Right, the Committee may elect to pay the holder of the Stock Appreciation Right cash equal to the Fair Market Value on the exercise date of any or all of the shares which would otherwise be issuable. No fractional shares of Common Stock shall be issued upon the exercise of a Stock Appreciation Right; instead, the holder of the Stock Appreciation Right shall be entitled to receive a cash adjustment equal to the same fraction of the Fair Market Value of a share of Common Stock on the exercise date or to purchase the portion necessary to make a whole share at its Fair Market Value on the date of exercise. (g) The Committee may impose such conditions on the exercise of a Stock Appreciation Right as may be required to satisfy the requirements of Rule 16b-3 under the Securities Exchange Act of 1934 (or any other comparable provisions in effect at the time or times in question). Without limiting the generality of the foregoing, the Committee may determine that a Stock Appreciation Right may be exercised only during the period beginning on the third business day and ending on the twelfth business day following the publication of the Company's quarterly and annual summarized financial data. Such publication shall be deemed to occur when the data first appears on a wire service, in a financial news service or in a newspaper of general circulation. The Company may provide written notification to the Holder of a Stock Appreciation Right specifying the date on which such financial data was published. (h) No Stock Appreciation Right or related Option granted to an officer of the Company may be exercised prior to six months after the date of grant except in the event death or disability of the officer occurs prior to the expiration of the six-month period. (i) Each Stock Appreciation Right shall be evidenced by a written instrument and may, but need not, include any other terms and conditions not inconsistent with the Plan as the Committee may approve. 9. STOCK APPRECIATION RIGHTS UNRELATED TO OPTIONS The Committee may at any time and from time to time approve the grant by the Company to Eligible Persons of Stock Appreciation Rights that are unrelated to Options, and determine the specific Eligible Persons to whom such Stock Appreciation Rights may be granted, the terms and provisions of the Stock Appreciation Rights agreements, and the time or times at which such Stock Appreciation Rights may be exercised, subject to the following terms and conditions. (a) The date of grant shall be the date the Committee takes the necessary action to approve the grant; provided, however, that if the minutes or appropriate resolutions of the Committee provide that a Stock Appreciation Right is to be granted as of a date in the future, the date of grant shall be such future date. In any event, the intended Eligible Person must be an Eligible Person on the date of grant. (b) A Stock Appreciation Right shall entitle the Holder, upon exercise of the Stock Appreciation Right, to receive payment of an amount determined by dividing: (i) the number of shares of Common Stock as to which the Stock Appreciation Right is exercised multiplied by the amount of the appreciation in such shares (for this purpose, "appreciation" shall mean the amount by which the Fair Market Value of the shares of Common Stock subject to the Stock Appreciation Right on the exercise date exceeds an amount which shall be determined by the Committee at the time of grant, which amount for a Director or an executive officer (or equivalent thereof) of the Company, shall not be less than the Fair Market Value of a share of Common Stock at the time of grant); by (ii) the Fair Market Value of a share of Common Stock on the exercise date. (c) In lieu of issuing shares of Common Stock upon the exercise of a Stock Appreciation Right, the Committee may elect to pay the holder of the Stock Appreciation Right cash equal to the Fair Market Value on the exercise date of any or all of the shares which would otherwise be issuable. No fractional shares of Common Stock shall be issued upon the exercise of a Stock Appreciation Right; instead, the holder of the Stock Appreciation Right shall be entitled to receive a cash adjustment equal to the same fraction of the Fair Market Value of the share of Common Stock on the exercise date or to purchase the portion necessary to make a whole share at its Fair Market Value on the date of exercise. (d) The Committee may impose such conditions on the exercise of a Stock Appreciation Right granted hereunder as may be required to satisfy the requirements of Rule 16b-3 under the Securities Exchange Act of 1934 (or any other comparable provisions in effect at the time or times in question). Without limiting the generality of the foregoing, the Committee may determine that a Stock Appreciation Right may be exercised only during the period beginning on the third business day and ending on the twelfth business day following the date of publication of the Company's quarterly and annual summarized financial data. Such publication shall be deemed to occur when the data first appears on the wire service, in a financial news service or in a newspaper of general circulation. The Company may provide written notification to the Holder of a Stock Appreciation Right specifying the date on which such financial data was published. (e) No Stock Appreciation Right granted to an officer of the Company may be exercised prior to six months after the date of grant except in the event death or disability of the officer occurs prior to the expiration of said six-month period. (f) A Stock Appreciation Right shall not be assignable or transferable by the Holder otherwise than by will or the laws of descent and distribution, and may be exercised during the lifetime of the Holder only by the Holder. (g) Each Stock Appreciation Right hereunder shall be evidenced by a written instrument and may, but need not, include any other terms and condition not inconsistent with the Plan as the Committee may approve. 10. STOCK AWARD AND RESTRICTED STOCK The Committee may at any time and from time to time approve the grant by the Company of a Stock Award or Restricted Stock to Eligible Persons, and determine the specific Eligible Persons to whom such Stock awards and restricted stock may be granted, the number of shares to be granted and the terms and provisions of such award of Common Stock. A stock award consists of the transfer by the Company to a participant of shares of Common Stock, without other payment therefor, as additional compensation for his/her services to the Company. A share of restricted stock consists of shares of Common Stock which are sold or transferred by the Company to a participant at a price which may be below their Fair Market Value or for no payment, but subject to restrictions on their sale or other transfer by the participant. The transfer of Common Stock pursuant to stock awards and the transfer and sale of restricted stock shall be subject to the following terms and conditions: (a) The number of shares to be transferred or sold by the Company to a participant pursuant to a stock award or as restricted stock shall be determined by the Committee. The criteria of the grant of performance based restricted stock will be established by the Committee at the date the restricted stock is granted. If the Committee elects to grant time-based restricted stock, such restricted stock shall vest over at least a three (3) year period. (b) The Committee shall determine the prices, if any, at which shares of restricted stock shall be sold to a participant, which may vary from time to time and among participants and which may be below the Fair Market Value of such shares of Common Stock at the date of sale. (c) All shares of restricted stock transferred or sold hereunder shall be subject to such restrictions as the Committee may determine, including, without limitation any or all of the following: (i) A prohibition against the sale, transfer, pledge or other encumbrance of the shares of restricted stock, such prohibition to lapse at such time or times as the Committee shall determine (whether in annual or more frequent installments, at the time of the death, disability or retirement of the holder of such shares, or otherwise); (ii) A requirement that the holder of shares of restricted stock forfeit, or (in the case of shares sold to a participant) resell back to the Company at his cost, all or a part of such shares in the event of termination of his employment during any period in which such shares are subject to restrictions; (iii) A prohibition against employment of the holder of such restricted stock by any competitor of the Company or a subsidiary of the Company, or against such holder's dissemination of any secret or confidential information belonging to the Company or a subsidiary of the Company. (d) In order to enforce the restrictions imposed by the Committee pursuant to (c) above, the participant receiving restricted stock shall enter into an agreement with the Company setting forth the conditions of the grant. Shares of restricted stock shall be registered in the name of the participant and deposited, together with a stock power endorsed in blank, with the Company. (e) At the end of any time period during which the shares of restricted stock are subject to forfeiture and restrictions on transfer, such shares will be delivered free of all restrictions to the participant or to the participant's legal representative, beneficiary or heir. (f) Subject to the terms and conditions of the Plan, each participant receiving restricted stock shall have all the rights of a stockholder with respect to shares of stock during any period in which such shares are subject to forfeiture and restrictions on transfer, including without limitation, the right to vote such shares. Dividends paid in cash or property other than Common Stock with respect to shares of restricted stock shall be paid to the participant currently or, at the election of the participant, be reinvested by the participant under the Company's Automatic Dividend Reinvestment Service. Shares purchased with reinvested dividends shall not be restricted. 11. CASH AWARDS The Committee may at any time and from time to time approve the payment by the Company of a cash award to Eligible Persons. A cash award consists of a monetary payment made by the Company to a participant as additional compensation for his/her services to the Company. Payment of a cash award will normally depend on achievement of performance objectives by the Company or by individuals. The amount of any monetary payment constituting a cash award shall be determined by the Committee in its sole discretion. Cash awards may be subject to other terms and conditions, which may vary from time to time and among participants, as the Committee determines to be appropriate. 12. ADJUSTMENT PROVISIONS (a) Effective as of June 20, 2002, subject to Section 12(b), if the Company should effect any subdivision or consolidation of shares of Common Stock or other capital readjustment, the payment of a stock dividend, stock split, combination of shares, recapitalization, reclassification, or other increase or reduction in the number or kind of shares outstanding, without receiving compensation therefor in money, services or property, then an appropriate and proportionate adjustment shall be made in (i) the maximum number and kind of shares provided in Section 3 of the Plan, (ii) the number and kind of shares or other securities subject to the then outstanding Options and Stock Appreciation Rights, (iii) the number of unvested shares of Common Stock granted pursuant to awards of Restricted Stock or a Stock Award, and (iv) the price for each share or other unit of any other securities subject to then outstanding Options and the value of any then outstanding Stock Appreciation Rights without change in the aggregate purchase price or value as to which such Options or Stock Appreciation Rights remain exercisable. The Board of Directors or Committee shall take such action that it deems appropriate, in its discretion, so that the value of each outstanding Incentive Award to its Holder shall not be adversely affected by a corporate event described in this Section 12(a). The existence of the Plan or outstanding Incentive Awards hereunder shall not affect in any way the right or power of the Company or its stockholders to make or authorize any or all adjustments, recapitalization, reorganization or other changes in the Company's capital structure or its business or any merger or consolidation of the Company, or any issue of bonds, debentures, preferred or prior preference stocks ahead of or affecting the Common Stock or the rights thereof, or the dissolution or liquidation of the Company, or any sale or transfer of all or any part of its assets or business, or any other corporate act or proceeding whether of a similar character or otherwise. (b) Notwithstanding any provision in this Plan or in any Incentive to the contrary, (i) the restrictions on all shares of restricted stock awarded shall lapse immediately; (ii) all outstanding Options and Stock Appreciation Rights will become exercisable immediately; and (iii) all performance objectives shall be deemed to be met and payment made immediately if any of the following events (a "Change of Control") occur unless otherwise determined by the Board of Directors and a majority of the members of the Incumbent Board (as defined below): (i) The acquisition by any individual, entity or group (within the meaning of Section 13(d)(3) or 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "Exchange Act")) (a "Person") of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of 20% or more of either (i) the then outstanding shares of common stock of the Company (the "Outstanding Company Common Stock") or (ii) the combined voting power of the then outstanding voting securities of the Company entitled to vote generally in the election of directors (the "Outstanding Company Voting Securities"); provided, however, that for purposes of this subsection (i), the following acquisitions shall not constitute a Change of Control: (A) any acquisition directly from the Company, (B) any acquisition by the Company, (C) any acquisition by any employee benefit plan (or related trust) sponsored or maintained by the Company or any corporation controlled by the Company or (D) any acquisition by any corporation pursuant to a transaction which complies with clauses (A), (B) and (C) of subsection (iii) of this paragraph (b); or (ii) Individuals who, as of the date hereof, constitute the Board (the "Incumbent Board") cease for any reason to constitute at least a majority of the Board; provided, however, that any individual becoming a director subsequent to the date hereof whose election, or nomination for election by the Company's shareholders, was approved by a vote of at least a majority of the directors then comprising the Incumbent Board shall be considered as though such individual were a member of the Incumbent Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a Person other than the Board; or (iii) Consummation of a reorganization, merger or consolidation or sale or other disposition of all or substantially all of the assets of the Company (a "Business Combination"), in each case, unless, following such Business Combination, (A) all or substantially all of the individuals and entities who were the beneficial owners, respectively, of the Outstanding Company Common Stock and Outstanding Company Voting Securities immediately prior to such Business Combination beneficially own, directly or indirectly, more than 60% of, respectively, the then outstanding shares of common stock and the combined voting power of the then outstanding voting securities entitled to vote generally in the election of directors, as the case may be, of the corporation resulting from such Business Combination (including, without limitation, a corporation which as a result of such transaction owns the Company or all or substantially all of the Company's assets either directly or through one or more subsidiaries) in substantially the same proportions as their ownership, immediately prior to such Business Combination of the Outstanding Company Common Stock and Outstanding Company Voting Securities, as the case may be, (B) no Person (excluding any corporation resulting from such Business Combination or any employee benefit plan (or related trust) of the Company or such corporation resulting from such Business Combination) beneficially owns, directly or indirectly, 20% or more of, respectively, the then outstanding shares of common stock of the corporation resulting from such Business Combination or the combined voting power of the then outstanding voting securities of such corporation except to the extent that such ownership existed prior to the Business Combination and (C) at least a majority of the members of the board of directors of the corporation resulting from such Business Combination were members of the Incumbent Board at the time of the execution of the initial agreement, or of the action of the Board, providing for such Business Combination; or (iv) Approval by the shareholders of the Company of a complete liquidation or dissolution of the Company. (c) Adjustments under Sections 12(a) and 12(b) shall be made by the Committee, whose determination as to what adjustments shall be made and the extent thereof shall be final, binding and conclusive. No fractional interest shall be issued under the Plan on account of any such adjustment. 13. GENERAL PROVISIONS (a) With respect to any shares of Common Stock issued or transferred under any provisions of the Plan, such shares may be issued or transferred subject to such conditions, in addition to those specifically provided in the Plan, as the Committee may direct. (b) Nothing in the Plan or in any instrument executed pursuant thereto shall confer upon any Holder any right to continue in the employ of the Company or any of its subsidiaries or affect the right of the Company to terminate the employment of any Holder at any time with or without cause. (c) No shares of Common Stock shall be issued or transferred pursuant to an Incentive Award unless and until all then applicable requirements imposed by federal and state securities and other laws, rules and regulations and by any regulatory agencies having jurisdiction, and by any stock exchanges upon which the Common Stock may be listed, shall have been fully met. As a condition precedent to the issuance of shares pursuant to the grant or exercise of an Incentive Award, the Company may require the Holder to take any reasonable action to meet such requirements. (d) No Holder (individually or as a member of a group) and no beneficiary or other person claiming under or through such Holder shall have any right, title or interest in or to any shares of Common Stock allocated or reserved under the Plan or subject to any Incentive Award except as to such shares of Common Stock, if any, that have been issued or transferred to such Holder. (e) The Company may make such provisions as it deems appropriate for the withholding of any taxes that the Company or any subsidiary corporation determines it is required to withhold in connection with any Incentive Award. (f) No Incentive Award and no right under the Plan, contingent or otherwise, shall be assignable (except as provided in Section 7(g) of the Plan), or subject to any encumbrance, pledge or charge of any nature except that, under such rules and regulations as the Company may establish pursuant to the terms of the Plan, a beneficiary may be designated with respect to an Incentive Award in the event of the death of the Holder of such Incentive Award and except also, that if such beneficiary is the executor or administrator of the estate of the Holder of such Incentive Award, then any rights with respect to such Incentive Award may be transferred to the person or persons or entity (including a trust) entitled thereto under the will of the holder of such Incentive Award, or in the case of intestacy, under the laws relating to intestacy. (g) Nothing in the Plan is intended to be a substitute for, or to preclude or limit the establishment of, any other plan, practice or arrangement for the payment of compensation or benefits to employees generally, or to any class or group of employees that the Company now has or may hereafter lawfully put into effect, including, without limitation, any retirement, pension, insurance, stock purchase, incentive compensation or bonus plan. (h) The Company may make a loan or guarantee a loan to an Optionee in connection with the exercise of an Option in an amount not to exceed the aggregate exercise price of the Option being exercised and any federal and state taxes payable in connection with the exercise for the purpose of assisting such Optionee to exercise such Option. Any such loan or guarantee may be secured by shares of Common Stock or other collateral deemed adequate by the Committee and shall comply in all respects with all applicable laws and regulations. The Board of Directors and the Committee may adopt policies regarding eligibility for such loans and guarantees, the maximum amounts thereof, and any terms and conditions not specified in the Plan upon which such loans will be made and guarantees extended. Notwithstanding the foregoing, the Company will make no such loan or guarantee to a Director or executive officer (or equivalent thereof) of the Company in contravention of the Sarbanes-Oxley Act of 2002. (i) The Company shall have the right to withhold from any payments made under the Plan or to collect as a condition of payment, any taxes required by law to be withheld. At any time when a participant is required to pay to the Company an amount required to be withheld under applicable income tax laws in connection with a distribution of Common Stock or upon exercise of an option or Stock Appreciation Right, the participant may satisfy this obligation in whole or in part by electing (the "Election") to have the Company withhold from the distribution shares of Common Stock having a value equal to the amount required to be withheld. The value of the shares to be withheld shall be based on the Fair Market Value of the Common Stock on the date that the amount of tax to be withheld shall be determined ("Tax Date"). Each Election must be made prior to the Tax Date. The Committee may disapprove of any Election, may suspend or terminate the right to make Elections, or may provide with respect to any Incentive that the right to make Elections shall not apply to such Incentive. An Election is irrevocable. (j) If a participant is an officer of the Company within the meaning of Section 16 of the 1934 Act, then an Election is subject to the following additional restrictions: (i) No Election shall be effective for a Tax Date which occurs within six months of the grant of the award, except that this limitation shall not apply in the event death or disability of the participant occurs prior to the expiration of the six-month period. (ii) The Election must be made either six months prior to the Tax Date or must be made during a period beginning on the third business day following the date of release for publication of the Company's quarterly or annual summary statements of sales and earnings and ending on the twelfth business day following such date. (k) Anything in this Plan to the contrary notwithstanding, the Company, may if it shall determine it necessary or desirable for any reason, at the time of award of any Incentive or the issuance of any shares of Common Stock pursuant to any Incentive, require the recipient of the Incentive, as a condition to the receipt thereof or to the receipt of shares of Common Stock issued pursuant thereto, to deliver to the Company a written representation of present intention to acquire the Incentive or the shares of Common Stock issued pursuant thereto for his own account for investment and not for distribution. (l) Unless otherwise determined by the Committee with respect to any particular Incentive Award, it is intended that the Plan shall comply with the applicable requirements so that any Incentive Award subject to Section 162(m) of the Internal Revenue Code that is granted to a Covered Employee shall qualify for the Performance-Based Exception, except for grants of Options with an Option price set at less than the fair market value of a share of Common Stock on the date of grant. If any provision of the Plan or an Incentive Award would not permit the Plan or Incentive Award to comply with the Performance-Based Exception as so intended, such provision shall be construed or deemed to be amended to conform to the requirements of the Performance-Based Exception to the extent permitted by applicable law and deemed advisable by the Committee; provided, however, no such construction or amendment shall have an adverse effect to the grantee of a prior grant of an Incentive Award or on the economic value to a grantee of any outstanding Incentive Award. 14. AMENDMENT AND TERMINATION (a) The Board of Directors shall have the power, in its discretion, to amend, suspend or terminate the Plan at any time. No such amendment shall, without approval of the shareholders of the Company, except as provided in Section 12 of the Plan: (i) Change the class of persons eligible to receive Incentive Awards under the Plan; (ii) Materially increase the benefits accruing to Eligible Persons under the Plan; (iii) Increase the number of shares of Common Stock subject to the Plan; or (iv) Transfer the administration of the Plan to any person who is not a Disinterested Person. (b) The Committee may, with the consent of a Holder, make such modifications in the terms and conditions of an Option or a Stock Appreciation Right as it deems advisable. (c) No amendment, suspension or termination of the Plan shall, without the consent of the Holder, alter, terminate, impair or adversely affect any right or obligation under any Incentive Award previously granted under the Plan. (d) No amendment to the Plan shall be made that would permit the granting of Incentive Awards to members of the Committee. (e) A Stock Appreciation Right or an Option held by a person who was an Employee at the time such Right or Option was granted shall terminate if and when the Holder ceases to be an Employee, except as follows: (i) If the employment of an Employee is terminated for cause, for which the Company shall be the sole judge, or if the Employee voluntarily resigns, all of the Stock Appreciation Rights and Options of the Employee shall expire immediately. Retirement with the consent of the Company shall not be deemed a voluntary resignation for purposes of this subparagraph (i). (ii) If the employment of an Employee is terminated by the Company other than for cause, for which the Company shall be the sole judge, then the Stock Appreciation Rights and Options expire one year thereafter unless by their terms they expire sooner. During said period, the Stock Appreciation Rights and Options may be exercised in accordance with their terms, but only to the extent exercisable on the date of termination of employment. (iii) If the employee retires at normal retirement age or retires with the consent of the Company at an earlier date the Stock Appreciation Rights and Options of the Employee shall expire three years thereafter unless by their terms they expire sooner. During said period, the Stock Appreciation Rights and Options may be exercised in accordance with their terms, but only to the extent exercisable on the date of retirement. (iv) If an Employee dies or becomes permanently and totally disabled while employed by the Company or a parent or subsidiary corporation, the Stock Appreciation Rights and Options of the Employee shall expire three years after the date of death or permanent and total disability unless by their terms they expire sooner. If the Employee dies or becomes permanently and totally disabled within the one-year period referred to in subparagraph (ii) above, the Stock Appreciation Rights and Options shall expire one year after the date of death or permanent and total disability, unless by their terms they expire sooner. If the Employee dies or becomes permanently and totally disabled within the three-year period referred to in subparagraph (iii) above, the Stock Appreciation Rights and Options shall expire upon the later of three years after retirement or one year after the date of death or permanent and total disability, unless by their terms they expire sooner. During said periods the Stock Appreciation Rights and Options may be exercised by the Employee, or in the event of the death of the Employee, the Stock Appreciation Rights and Options may be exercised by the Employee's designated beneficiaries or personal representatives or the trusts, entities or persons to whom his rights under the Stock Appreciation Rights and Options have been transferred, in accordance with Section 7(g) of the Plan, or have passed by will or the laws of descent and distribution, in accordance with their terms, but only to the extent exercisable on the date of retirement or termination of employment. (v) Notwithstanding the above, a Stock Appreciation Right or Option may not be exercised after the expiration of ten years from the date the Stock Appreciation Right or Option is granted. (f) The Committee may in a particular case provide for earlier termination or expiration periods for any Stock Appreciation Right or Option but may not extend any of the periods provided for in this section. (g) The Committee may in its sole discretion determine, with respect to a Stock Appreciation Right or Option, that any Holder who is on leave of absence for any reason will be considered as still in the employ of the Company, provided that the Stock Appreciation Right or Option shall be exercisable during a leave of absence only as to the amount of number of shares with respect to which it was exercisable at the commencement of such leave of absence. (h) Within two business after the date of a change in beneficial ownership of the Common Stock issued or delivered pursuant to this Plan, an Insider will report to the Secretary of the Company (or other designated person) any such change to the beneficial ownership of Common Stock that is required to be reported with respect to such Insider under Rule 16(a)-3 promulgated pursuant to the Exchange Act. Whenever reasonably feasible, Insiders will provide the Committee with advance notification of such change in beneficial ownership. (i) Effective January 26, 2003, the Company shall provide notice to any Director or executive officer (or equivalent thereof) of the Company, as well as to the Securities and Exchange Commission, of any "blackout period," as defined in Section 306(a)(4) of the Sarbanes-Oxley Act of 2002, in any case in which such Director or executive officer is subject to the requirements of Section 304 of said Act in connection with such "blackout period." (j) Notwithstanding anything in the Plan to the contrary, no shares of Common Stock issued pursuant to this Plan will be delivered to a broker or dealer that receives such shares for the account of an Insider, unless and until the broker or dealer enters into a written agreement with the Company whereby such broker or dealer agrees to report to the Secretary of the Company (or other designated person) a change in the beneficial ownership of such shares. 15. EFFECTIVE DATE OF PLAN AND DURATION OF PLAN This Plan shall become effective upon adoption by the Board of Directors of the Company (February 6, 1989) and Incentive Awards may be made under the Plan at any time thereafter, provided, however, that no shares of Common Stock may be issued under the Plan, no Stock Appreciation Rights granted under the Plan may be exercised and no Cash Award may be paid prior to completion of the following: (a) the approval of the Plan by shareholders owning a majority of the outstanding shares of Common Stock of the Company, with the votes of any officers who are shareholders not being counted for the purpose of determining a majority, (b) the registration of the Plan and securities to be issued in connection therewith under the Securities Act of 1933, and (c) the listing of the shares of Common Stock reserved for issuance under the Plan on the New York Stock Exchange, Inc. and the Pacific Exchange, Inc. Unless previously terminated by the Board of Directors, the Plan shall terminate at the close of business on April 24, 2012, and no Incentive Award may be granted under the Plan thereafter, but such termination shall not affect any Incentive Award issued or granted on or prior to said date. EX-10.2 6 h03433exv10w2.txt STOCK PLAN FOR OUTSIDE DIRECTORS EXHIBIT 10.2 SMITH INTERNATIONAL, INC. STOCK PLAN FOR OUTSIDE DIRECTORS AS AMENDED AND RESTATED EFFECTIVE MAY 22, 2001 WHEREAS, the Company originally adopted the Plan effective as of April 28, 1992; and WHEREAS, the Plan was subsequently amended by the Company by Amendment No. 1 dated April 22, 1998, Amendment No. 2 dated May 1, 1998, Amendment No. 3 dated December 6, 2000 and Amendment No. 4 dated May 22, 2001; and WHEREAS, the Plan is now hereby amended and restated under the form of this document effective as of May 22, 2001, as follows: I. Purposes The purpose of the Smith International, Inc. Stock Plan for Outside Directors (the "Plan") are (i) to provide additional incentive for securing and retaining qualified non-employee persons to serve on the Board of Directors of the Company and (ii) to enhance the future growth of the Company by furthering the Outside Directors' identification with the interests of the Company and its shareholders. II. Definitions (a) In this Plan, except where the context otherwise indicates, the following definitions apply: 1. "AWARD" means an award of Common Stock pursuant to Article V or a Restricted Stock Award pursuant to Article VI. 2. "AWARD DATE" means a date each year during the term of this Plan which shall be determined by the Company.(1) 3. "BOARD" means the Board of Directors of the Company. 4. "INTERNAL REVENUE CODE" means the Internal Revenue Code of 1986, as amended. 5. "COMMON STOCK" means the common stock, $1.00 par value, of the Company. 6. "COMPANY" means Smith International, Inc. 7. "OUTSIDE DIRECTOR" means a person who as of any applicable date is a member of the Board of Directors of the Company, is not an officer of the Company or any subsidiary of the Company, and is not a full-time employee of the Company or any of its subsidiaries. 8. "PARTICIPANT" means an Outside Director who is eligible to receive Common Stock or Restricted Stock granted hereunder. 9. "RESTRICTED STOCK" means Shares of Common Stock issued or transferred to a Grantee pursuant to Article VI of the Plan. 10. "RESTRICTED STOCK AGREEMENT" means the written agreement entered into between the Company and the Participant setting forth the terms and conditions pursuant to which a Restricted Stock Award is granted under the Plan. 11. "RESTRICTED STOCK AWARD" means an authorization by the Board to issue or transfer Restricted Stock to a Participant. 12. "RESTRICTION PERIOD" means the period of time determined by the Board and set forth in the Restricted Stock Agreement during which the transfer of Restricted Stock by the Participant is restricted. 13. "SERVICE YEAR" means each period of one year during the term of this Plan that commences on the date after an Award Date and ends on the next succeeding Award Date. - ---------- (1) Clause II.(a)(1) - Amendment No. 2 dated 5/1/98. 14. "SHARE" means a share of Common Stock that has been previously (i) authorized but unissued, or (ii) issued and reacquired by the Company. 15. "TERMINATION OF DIRECTORSHIP" means the date upon which any Participant ceases to be an Outside Director for any reason whatsoever. The effective date of such Termination of Directorship shall be the actual date of such termination (by death, disability, retirement, resignation, non-election or otherwise). III. Shares of Common Stock Subject to the Plan Subject to the provisions of Article VII of the Plan, the aggregate number of shares of Common Stock that may be issued under the Plan shall not exceed 60,000.(2) The number of Shares of Common Stock subject of Restricted Stock Awards that are forfeited, expired, lapsed or terminated, or are settled in a manner such that all or some of the Shares covered by the Restricted Stock Award are not issued to a Participant, shall again immediately become available for Awards hereunder. The Board may from time to time adopt and observe such procedures concerning the counting of Shares against the Plan maximum as it may deem appropriate. IV. Eligibility Awards of Common Stock and Restricted Stock Awards under this Plan may be granted only to individuals who are Outside Directors. V. Stock Award Each Outside Director shall receive an award of 400 shares of Common Stock on each Award Date with respect to service rendered through the respective Award Date.(3) Such shares shall be authorized but unissued shares or shares of Common Stock previously issued by the Company that have been purchased by or on behalf of the Company in open market transactions or otherwise, or that have otherwise been acquired by the Company. Certificates representing the shares of Common Stock awarded hereunder shall be delivered to the Outside Director within thirty (30) days after each respective Award Date. The provisions of this Section may not be amended more than once every six (6) months other than to comport with changes in the Internal Revenue Code, as amended, or the rules thereunder. - ---------- (2) Clause III - Amendment No. 1 (shares increased from 20,000 to 40,000) dated 4/22/98. Amendment No. 4 (shares increased from 40,000 to 60,000) dated 5/22/01. (3) Clause V - Amendment No. 2, dated 5/1/98. Amendment No. 3 dated 12/6/00 increased the number of shares from 200 to 400. VI. Restricted Stock Awards In its discretion, the Board shall from time to time designate those Outside Directors to be granted Restricted Stock Awards under the Plan, the number of Shares subject to each Restricted Stock Award, and the other terms or conditions relating to the Restricted Stock as it deems appropriate. An Outside Director who has been granted a Restricted Stock Award may, if otherwise eligible, be granted additional Restricted Stock Awards at any time. Restricted Stock Awards may be granted with such restrictions during the Restriction Period as the Board designates in its discretion, any of which restrictions may differ with respect to any particular Participant or group of similarly situated Participants. The terms and conditions of each Restricted Stock Award shall be evidenced by a Restricted Stock Agreement. Unless otherwise specified in the Participant's Restricted Stock Agreement, each Restricted Stock Award shall constitute an immediate transfer of the record and beneficial ownership of the Shares of Restricted Stock to the Participant in consideration of the performance of services as an Outside Director, entitling such Participant to all voting and other ownership rights in such Shares subject to the restrictions thereon. As determined by the Board, Shares awarded pursuant to a grant of Restricted Stock may be issued in the name of the Participant and held, together with a stock powers endorsed by the Participant in blank, by the Board or the Secretary of the Company (or their delegates) as a depository for safekeeping until such time as the forfeiture restrictions and restrictions on transfer have lapsed. All such terms and conditions shall be set forth in the particular Participant's Restricted Stock Agreement. The Board (or its delegate) shall issue to the Participant a receipt evidencing the certificates held by it which are registered in the name of the Participant. Restricted Stock Awards may be subject to the following restrictions until the expiration of the Restriction Period: (i) a restriction that constitutes a "substantial risk of forfeiture" (as defined in Section 83 of the Internal Revenue Code), or a restriction on transferability under Section 83, and (ii) any other restrictions that the Board determines are appropriate. Any such restrictions shall be set forth in the Participant's Restricted Stock Agreement. Coincident with or promptly after the grant date of a Restricted Stock Award, the Company shall cause to be issued a stock certificate, registered in the name of the Participant to whom such Restricted Stock was granted, evidencing such Shares; provided, however, the Company shall not cause to be issued such a stock certificate unless it has received a stock power duly endorsed in blank by the Participant with respect to such Shares. Each such stock certificate shall bear the following legend or any other legend approved by the Company: THE TRANSFERABILITY OF THIS CERTIFICATE AND THE SHARES OF STOCK REPRESENTED HEREBY ARE SUBJECT TO THE RESTRICTIONS, TERMS AND CONDITIONS (INCLUDING FORFEITURE AND RESTRICTIONS AGAINST TRANSFER) CONTAINED IN THE SMITH INTERNATIONAL, INC. STOCK PLAN FOR OUTSIDE DIRECTORS AND A RESTRICTED STOCK AGREEMENT DATED JANUARY 28, 1999 BETWEEN THE REGISTERED OWNER OF SUCH SHARES AND SMITH INTERNATIONAL, INC. RESTRICTIONS ON THE RIGHT TO OWN OR TRANSFER THE SHARES OF STOCK REPRESENTED BY THIS CERTIFICATE HAVE BEEN IMPOSED PURSUANT TO SAID RESTRICTED STOCK AGREEMENT. A COPY OF THE RESTRICTED STOCK AGREEMENT IS ON FILE AT THE PRINCIPAL OFFICE OF THE COMPANY AND WILL BE FURNISHED WITHOUT CHARGE TO THE HOLDER OF THIS CERTIFICATE UPON RECEIPT BY THE COMPANY AT ITS PRINCIPAL PLACE OF BUSINESS OR REGISTERED OFFICE OF A WRITTEN REQUEST FROM THE HOLDER REQUESTING SUCH COPY. Such legend shall not be removed from the certificate evidencing such Shares of Restricted Stock until such Shares vest pursuant to the terms of the Restricted Stock Agreement. The Board, in its discretion, shall have the authority to remove any or all of the restrictions on the Restricted Stock if it determines that, by reason of a change in applicable law or another change in circumstance arising after the grant date of the Restricted Stock Award, such action is appropriate. Subject to any applicable withholding taxes, a stock certificate evidencing the Shares of Restricted Stock with respect to which the restrictions in the Restricted Stock Agreement have lapsed shall be delivered to the Participant (or other appropriate recipient) free of restrictions. Each Participant to whom a Restricted Stock Award is granted shall be required to enter into a Restricted Stock Agreement with the Company in such a form as is provided by the Board. The Restricted Stock Agreement shall contain specific terms as determined by the Board, in its discretion, with respect to the Participant's particular Restricted Stock Award. The Restricted Stock Agreement may include, without limitation, vesting and forfeiture provisions. Nothing in the Plan or in any instrument executed pursuant hereto shall create any rights with respect to continued service as an Outside Director. The Company shall not be obligated to cause to be issued or delivered any certificates evidencing Shares unless and until the Company is advised by its legal counsel that the issuance and delivery of such certificates is in compliance with all applicable laws, regulations of governmental authorities, and the requirements of any securities exchange on which Shares are traded. VII. Adjustment If as a result of recapitalization (or other adjustment in the stated capital of the Company), or as a result of a stock split, merger, consolidation, or other reorganization, the Common Stock of the Company is increased, reduced, or otherwise changed, the number of shares available to be awarded hereunder in the aggregate and on each Award Date, shall be appropriately adjusted. VIII. Termination of Directorship If Termination of Directorship occurs as to an Outside Director prior to the expiration of a Service Year, such Outside Director shall be entitled to receive such number of Shares of Common Stock as equal the nearest whole number of Shares obtained by multiplying 200 by a fraction, the numerator of which is the number of days of such Service Year up to and including the date of the Termination of Directorship and the denominator of which is the number of days in such Service Year. Such shares shall be delivered to such Outside Director within thirty (30) days following the date of Termination of Directorship. IX. Restriction on Resale Shares delivered to Participants under the Plan shall be subject to such restrictions on transferability and disposition as shall be required by Rule 16b-3 of the Securities Exchange Act of 1934 ("Exchange Act") or any successor rule. Each Participant shall not sell or transfer any shares awarded or any shares or other securities issued on account of the shares awarded for at least six (6) months after acquisition except as permitted under the provisions of the Exchange Act or Rule 16b-3 promulgated thereunder. X. Effective Date and Term The Plan was originally effective on April 28, 1992, and was amended and restated effective as of January 1, 1999 and as of May 22, 2001. Unless sooner terminated in accordance with its terms, the Plan shall terminate on April 25, 2011.(4) - ---------- (4) Clause X - Amendment No. 2, dated 5/1/98 and Amendment No. 3 dated 1/1/01. XI. Requirements of Laws The Company shall not be required to issue any shares thereunder if the issuance of such shares shall constitute or result in a violation by the Participant or the Company of any provisions of any law, statute or regulation of any governmental authority. Specifically, in connection with the Securities Act of 1933, the Company shall not be required to issue such shares unless the Company has received evidence satisfactory to it to the effect that the holder of such Shares will not transfer such shares except pursuant to a registration statement in effect under such Act or unless an opinion of counsel satisfactory to the Company has been received by the Company to the effect that such registration is not required. Any determination in this connection by the Company shall be final, binding and conclusive. The Company may, but shall in no event be obligated to, register any securities covered hereby pursuant to the Securities Act of 1933. The Company shall not be obligated to take any other affirmative action in order to cause the issuance of shares pursuant hereto to comply with any law or regulation of any government authority. XII. Restriction on Transfers Rights of Participants to receive Shares hereunder are not assignable or transferable, except by will or by the laws of descent and distribution. Such rights are not subject, in whole or in part, to attachment, execution or levy of any kind but are subject to forfeiture pursuant to the terms of a Restricted Stock Agreement. Upon the death of a Participant, Shares awarded as set forth in Articles V and VI shall be delivered to such person as is entitled thereto by will or by the laws of descent and distribution. Any such determination regarding entitlement to Shares shall be made by the Board or its delegate. XIII. Amendment and Termination Subject to Article V hereof, the Board of Directors may modify, revise or terminate this Plan at any time and from time to time; provided, however, that any such amendment to the Plan that would require the vote or approval of a specified percentage of the Company's shareholders in order to assure that the Plan complies with Rule 16b-3 promulgated by the Securities and Exchange Commission, or any successor or similar provisions thereto, shall only be made upon obtaining such required shareholder vote, or taking such other action in connection with such amendment as the Board deems advisable to operate the Plan in accordance with Rule 16b-3 or such successor or similar rule; provided further that such action shall not adversely affect any Participant's rights under Article V of the Plan related to Services rendered prior to such action. IN WITNESS WHEREOF, this amended and restated Plan is hereby approved and executed by an authorized officer of the Company, effective as of May 22, 2001. SMITH INTERNATIONAL, INC. By: /s/ NEAL S. SUTTON ------------------------------------- Name: Neal S. Sutton ----------------------------------- Title: Sr. VP-Admin., General Counsel ---------------------------------- and Secretary EX-21.1 7 h03433exv21w1.txt SUBSIDIARIES OF THE COMPANY EXHIBIT 21.1 SUBSIDIARIES OF THE COMPANY The following table sets forth all subsidiaries of Smith International, Inc., other than inactive and insignificant subsidiaries that, considered in the aggregate, would not constitute a significant subsidiary, indicating the percentage of issued and outstanding voting securities beneficially owned by it:
% of Direct and Indirect Name of Subsidiary Where Incorporated Ownership - -------------------------------------------- ---------------------------- ----------- S.I. Nederland B.V. Netherlands 100% Smith (Bermuda) Ltd. Bermuda 100% Smith International Acquisition Corp. Delaware 100% Smith International Australia (Pty) Ltd. Australia 100% Smith International Canada Ltd. Canada 100% Smith International do Brasil Ltda. Brazil 100% Smith International Deutschland GmbH Germany 100% Smith International Development Corporation Panama 100% Smith International Inc., S.A. Argentina 100% Smith International Italia, S.p.A. Italy 100% Smith International (North Sea) Ltd. Scotland 100% Smith Internacional de Venezuela, C.A. Venezuela 100% Wilhold, Inc. Delaware 100%
All of the above subsidiaries are included in the Company's consolidated financial statements. EX-23.1 8 h03433exv23w1.txt INDEPENDENT AUDITORS' CONSENT EXHIBIT 23.1 INDEPENDENT AUDITORS' CONSENT We consent to the incorporation by reference in Registration Statement Nos. 333-88918, 333-65912, 333-76633, 333-76635, 333-75763, 33-56693, 33-69840, and 33-31556 on Form S-8 of our report dated February 20, 2003, relating to the consolidated financial statements of Smith International, Inc. and subsidiaries as of and for the year ended December 31, 2002 (which report expresses an unqualified opinion and includes explanatory paragraphs relating to (i) the adoption of a new accounting principle and (ii) the application of procedures relating to certain other revisions and disclosures of financial statement amounts related to the 2001 and 2000 consolidated financial statements that were audited by other auditors who have ceased operations and for which we have expressed no opinion or other form of assurance other than with respect to such revisions and disclosures) appearing in this Annual Report on Form 10-K of Smith International, Inc. for the year ended December 31, 2002. DELOITTE & TOUCHE LLP Houston, Texas March 24, 2003 EX-23.2 9 h03433exv23w2.txt NOTICE RE CONSENT OF INDEPENDENT PUBLIC ACCOUNTANT EXHIBIT 23.2 NOTICE REGARDING CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS Section 11(a) of the Securities Act of 1933, as amended (the "Securities Act"), provides that if part of a registration statement at the time it becomes effective contains an untrue statement of a material fact, or omits a material fact required to be stated therein or necessary to make the statements therein not misleading, any person acquiring a security pursuant to such registration statement (unless it is proved that at the time of such acquisition such person knew of such untruth or omission) may assert a claim against, among others, an accountant who has consented to be named as having certified any part of the registration statement or as having prepared any report for use in connection with the registration statement. Smith International, Inc. ("Smith") dismissed Arthur Andersen LLP ("Arthur Andersen") on April 15, 2002 as its independent public accountants. Arthur Andersen has ceased operations and, as such, is unable to consent to the incorporation by reference of their previously issued audit report with respect to Smith's financial statements as of December 31, 2001 and for the two years ended December 31, 2001 into Smith's previously filed registration statements File No. 33-31556, No. 33-69840, No. 33-56693, No. 333-34249, No. 333-47729, No. 333-62629, No. 333-76633, No. 333-76635, No. 333-80091, No. 333-40734, No. 333-65912 and No. 333-88918. Under these circumstances, Rule 437a under the Securities Act permits Smith to file this Form 10-K, which is incorporated by reference into the above listed registration statements, without a written consent from Arthur Andersen. As a result, with respect to transactions in Smith securities pursuant to the Registration Statements that occur subsequent to the date this Form 10-K is filed with the Securities and Exchange Commission, Arthur Andersen will not have any liability under Section 11(a) of the Securities Act for any untrue statements of a material fact contained in the financial statements audited by Arthur Andersen or any omissions of a material fact required to be stated therein. Accordingly, investors would be unable to assert a claim against Arthur Andersen under Section 11(a) of the Securities Act. EX-99.1 10 h03433exv99w1.txt CERTIFICATION OF CEO PURSUANT TO SECTION 906 EXHIBIT 99.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Smith International, Inc. (the "Company") on Form 10-K for the period ended December 31, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Doug Rock, Chairman of the Board, Chief Executive Officer, President and Chief Operating Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 24, 2003 /s/ Doug Rock --------------- ------------------------------------ Doug Rock Chairman of the Board, Chief Executive Officer, President and Chief Operating Officer EX-99.2 11 h03433exv99w2.txt CERTIFICATION OF CFO PURSUANT TO SECTION 906 EXHIBIT 99.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Annual Report of Smith International, Inc. (the "Company") on Form 10-K for the period ended December 31, 2002 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Margaret K. Dorman, Senior Vice President, Chief Financial Officer and Treasurer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 24, 2003 /s/ Margaret K. Dorman --------------- ------------------------------------ Margaret K. Dorman Senior Vice President, Chief Financial Officer and Treasurer -----END PRIVACY-ENHANCED MESSAGE-----