UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
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þ
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QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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For the quarterly period ended June 30, 2008
or
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o
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TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
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For the transition period from
to
Commission file number: 001-31346
W-H Energy Services, Inc.
(Exact name of registrant as specified in its charter)
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Texas
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76-0281502
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(State or other jurisdiction of
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(IRS Employer
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incorporation or organization)
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Identification No.)
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2000 West Sam Houston Parkway South,
Suite 500
Houston, Texas 77042
(Address of principal executive offices and zip code)
(713) 974-9071
(Registrants telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended during the past 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
þ
No
o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer,
a non-accelerated filer, or a smaller reporting company.
See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
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Large accelerated filer
þ
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Accelerated filer
o
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Non-accelerated filer
o
(Do not check if a smaller reporting company)
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Smaller Reporting Company
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act). Yes
o
No
þ
As of August 5, 2008 there were outstanding 31,014,016 shares of common stock, par value
$0.0001 per share, of the registrant.
W-H ENERGY SERVICES, INC.
INDEX
2
PART I
FINANCIAL INFORMATION
Item 1.
Financial Statements
W-H ENERGY SERVICES, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except per share amounts)
(Unaudited)
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June 30,
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December 31,
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2008
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2007
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Current Assets:
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Cash and cash equivalents
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$
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30,943
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$
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23,076
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Accounts receivable, net of allowance of $6,343 and $6,696, respectively
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281,437
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252,313
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Inventories
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119,232
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102,584
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Deferred income taxes
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15,747
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13,401
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Prepaid expenses and other
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15,309
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15,479
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Total current assets
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462,668
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406,853
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Property and equipment, net
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516,302
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448,913
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Goodwill, net
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171,050
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135,928
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Other assets, net
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28,553
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15,336
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Total assets
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$
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1,178,573
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$
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1,007,030
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Current Liabilities:
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Accrued liabilities
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$
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62,980
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$
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62,059
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Accounts payable
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64,705
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54,756
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Total current liabilities
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127,685
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116,815
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Long-term debt
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225,149
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150,000
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Deferred income taxes
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74,833
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73,526
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Other long-term obligations
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9,669
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11,161
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Commitments and Contingencies
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Shareholders Equity:
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Preferred stock, $0.01 par value, 10,000 shares authorized, none issued and outstanding
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Common stock, $0.0001 par value, 100,000 shares authorized 30,977 and 30,699 shares
issued and outstanding, respectively
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3
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3
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Additional paid-in capital
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301,929
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293,424
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Other comprehensive income
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5,689
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6,291
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Retained earnings
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433,616
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355,810
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Total shareholders equity
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741,237
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655,528
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Total liabilities and shareholders equity
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$
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1,178,573
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$
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1,007,030
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The accompanying notes are an integral part of these consolidated financial statements.
3
W-H ENERGY SERVICES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(In thousands, except per share amounts)
(Unaudited)
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For the Three Months
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For the Six Months
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Ended June 30,
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Ended June 30,
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2008
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2007
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2008
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2007
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Revenues
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$
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346,937
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$
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277,752
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$
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647,905
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$
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550,639
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Costs and expenses:
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Cost of revenues
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191,276
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145,386
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355,314
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292,805
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Selling, general and administrative
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50,874
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44,964
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97,044
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88,244
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Transaction related costs (Note 1)
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5,350
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5,350
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Research and development
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6,849
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5,485
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12,943
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10,201
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Depreciation and amortization
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24,671
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19,162
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47,988
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36,714
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Total costs and expenses
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279,020
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214,997
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518,639
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427,964
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Operating income
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67,917
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62,755
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129,266
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122,675
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Other (income) expense:
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Interest expense, net
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2,770
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1,896
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5,178
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3,889
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Other (income) expense, net
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(4
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(70
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(12
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(41
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Income before income taxes
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65,151
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60,929
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124,100
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118,827
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Provision for income taxes
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24,405
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21,855
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46,294
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43,929
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Net income
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$
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40,746
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$
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39,074
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$
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77,806
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$
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74,898
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Comprehensive income:
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Net income
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$
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40,746
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$
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39,074
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$
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77,806
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$
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74,898
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Increase (decrease) in interest rate swap valuations
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2,126
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989
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(633
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416
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Foreign currency translation adjustment
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333
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16
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31
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194
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Comprehensive income
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$
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43,205
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$
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40,079
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$
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77,204
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$
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75,508
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Earnings per share:
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Basic
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$
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1.33
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$
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1.29
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$
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2.54
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$
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2.48
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Diluted
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$
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1.29
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$
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1.25
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$
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2.48
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$
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2.42
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Number of shares used in calculation of earnings per share:
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Basic
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30,670
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30,315
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30,622
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30,196
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Diluted
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31,480
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31,140
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31,389
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31,008
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The accompanying notes are an integral part of these consolidated financial statements.
4
W-H ENERGY SERVICES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
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For the Six Months
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Ended June 30,
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2008
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2007
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Cash Flows from Operating Activities:
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Net income
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$
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77,806
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$
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74,898
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Adjustments to reconcile net income to cash provided by operating activities
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Depreciation and amortization
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47,988
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36,714
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Provision for doubtful accounts
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(284
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813
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Gain on sales of equipment
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(15,623
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(10,689
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Deferred tax provision
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(1,428
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(2,365
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Share-based compensation
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3,330
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2,888
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Amortization of deferred financing costs
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262
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287
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Excess tax benefit from share-based compensation
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(2,725
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(3,434
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Changes in operating assets and liabilities, excluding effects of acquisitions
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Accounts receivable, net
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(26,161
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(29,875
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Inventories
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(15,806
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(15,112
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Prepaid expenses and other
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540
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(6,917
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Other assets, net
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140
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976
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Accounts payable, accrued liabilities and other
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9,101
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(2,920
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Net cash provided by operating activities
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77,140
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45,264
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Cash Flows from Investing Activities:
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Additions to property and equipment
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(120,081
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(97,776
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Acquisition of businesses, net of cash acquired
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(56,039
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(12,583
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Proceeds from sales of equipment
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26,539
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21,137
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Net cash used in investing activities
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(149,581
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(89,222
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Cash Flows from Financing Activities:
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Proceeds from the issuance of debt
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138,720
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76,931
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Payments on debt
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(63,571
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(56,856
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Proceeds from the exercise of stock options
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2,450
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5,205
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Excess tax benefit from share-based compensation
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2,725
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3,434
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Net cash provided by financing activities
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80,324
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28,714
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Effect of exchange rate changes on cash
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(16
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258
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Net increase (decrease) in cash and cash equivalents
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7,867
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(14,986
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)
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Cash and cash equivalents, beginning of period
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23,076
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36,329
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Cash and cash equivalents, end of period
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$
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30,943
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$
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21,343
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The accompanying notes are an integral part of these consolidated financial statements.
5
W-H ENERGY SERVICES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. Business Organization
Description of Company
W-H Energy Services, Inc., a Texas corporation, and its subsidiaries (collectively, W-H) is
a diversified oilfield service company that provides products and services used in connection with
the drilling and completion of oil and natural gas wells and the production of oil and natural gas.
W-H has the following primary lines of business: (1) drilling related products and services, which
include logging-while-drilling, measurement-while-drilling, directional drilling, down-hole
drilling motors, drilling fluids and rental tools; and (2) completion and workover related products
and services, which include cased-hole wireline logging, perforating, tubing conveyed perforating
and associated rental equipment, coiled tubing, completion fluids and rental tools.
Proposed Acquisition of W-H by Smith International, Inc.
On June 3, 2008, W-H entered into an Agreement and Plan of Merger (the Merger Agreement)
with Smith International, Inc. (Smith) and an indirect wholly owned subsidiary of Smith, pursuant
to which W-H is expected to become a wholly owned subsidiary of Smith (the Acquisition). In
order to effectuate the Acquisition, and in accordance with the Merger Agreement, the Smith
subsidiary has commenced an offer to exchange (the Offer) each outstanding share of W-Hs common
stock validly tendered and not withdrawn in the exchange offer, at the election of the holder of
such share, for:
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$56.10 in cash, without interest, and 0.48 shares of Smiths common stock, par value $1.00
per share, including the associated
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preferred share purchase rights (Smith Common Stock); or
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$93.55 in cash, without interest (the All-Cash Consideration); or
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1.1990 shares of Smith Common Stock (the All-Stock Consideration),
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subject in each case to the election procedures and, in the case of elections of the All-Cash
Consideration or the All-Stock Consideration, to the proration procedures described in Smiths
Prospectus/Offer to Exchange dated June 24, 2008, as amended, included in Smiths Registration
Statement on Form S-4 filed with the SEC on June 24, 2008, as amended, and which, together with the
related letter of election and transmittal, as the same may be amended, constitute the Offer.
The Offer will expire at 12:00 midnight, New York City time, at the end of August 18, 2008, unless
further extended.
Following consummation of the Offer, W-H will merge with a wholly owned subsidiary of Smith,
with W-H surviving such merger. In the merger, any remaining shares of W-Hs common stock not
tendered pursuant to the Offer will be cancelled and converted into the right to receive $56.10 in
cash, without interest, and 0.48 shares of Smith Common Stock, subject to adjustment pursuant to
the Merger Agreement. Following such merger, W-H, as the surviving corporation of such merger,
will be a wholly-owned subsidiary of Smith and the former W-H shareholders will no longer have any
direct ownership interest in W-H. Such merger will be followed by a second merger pursuant to
which W-H will merge with and into a direct wholly owned subsidiary of Smith, with such subsidiary
surviving such second merger.
W-H expects that the Acquisition will be completed during the third quarter of 2008, but the
closing is subject to customary closing conditions, including (i) there being validly tendered and
not properly withdrawn before the expiration of the Offer at least
66
2
/
3
% of W-Hs outstanding shares
of common stock, (ii) the expiration or termination of the waiting period under the
Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and (iii) Smiths Registration
Statement on Form S-4 having become effective.
6
Through June 30, 2008, W-H had incurred approximately $5.4 million in expenses associated with
the transactions contemplated by the Merger Agreement, including legal fees and fees payable to UBS
Securities LLC (UBS) in respect of that firms fairness opinion provided to W-Hs Board of
Directors in connection with the Acquisition transaction. Such costs have been reported as
transaction related costs on the consolidated statement of operations for the three months and six
months ended June 30, 2008. Pursuant to the engagement letter between W-H and UBS, W-H will be
obligated to pay UBS an additional fee of approximately $22.0 million at the closing of the
Acquisition in respect of the financial advisory services provided by UBS to W-H.
Basis of Presentation
The unaudited Consolidated Financial Statements have been prepared in accordance with
accounting principles generally accepted in the United States for interim financial information and
the instructions to Form 10-Q and Rule 10 of Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by accounting principles generally accepted in the United
States for complete financial statements. For further information, refer to the Consolidated
Financial Statements and footnotes thereto included in W-Hs Annual Report on Form 10-K for the
year ended December 31, 2007 filed with the Securities and Exchange Commission (SEC). In the
opinion of management, all necessary adjustments (which include only normal recurring adjustments)
considered necessary for a fair presentation have been included. Operating results for the three
months and six months ended June 30, 2008 are not necessarily indicative of the results that may be
expected for the year ending December 31, 2008.
Accounting Policies and Procedures
Effective January 1, 2008, W-H adopted SFAS No. 157,
Fair Value Measurements,
(SFAS No. 157)
as it relates to financial assets and financial liabilities. In February 2008, the FASB issued FASB
Staff Position No. FAS 157-2,
Effective Date of FASB Statement No. 157,
which delayed the effective
date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities, except those that
are recognized or disclosed at fair value in the financial statements on at least an annual basis,
until January 1, 2009 for calendar year-end entities. Accordingly, W-H will defer the adoption of
SFAS No. 157 for its nonfinancial assets and nonfinancial liabilities until January 1, 2009. The
adoption of SFAS No. 157 did not cause a change in the method of calculating fair value of assets
or liabilities. The primary impact from adoption was additional disclosures. See Note 6 for more
information.
Effective January 1, 2008, W-H adopted SFAS No. 159,
The Fair Value Option for Financial
Assets and Financial Liabilities including an amendment of FASB Statement No. 115
, (SFAS No.
159). SFAS No. 159 permits entities to choose to measure most financial instruments and certain
other items at fair value on an instrument-by-instrument basis (the fair value option) with changes
in fair value reported in earnings. W-H adopted SFAS No. 159 on January 1, 2008. W-H already
records its hedging activities at fair value in accordance with SFAS No. 133,
Accounting for
Derivative Instruments and Hedging Activities
, as amended. The adoption of SFAS No. 159 had no
impact on W-Hs financial statements as W-H did not elect the fair value option for any other
assets and liabilities.
In December 2007, the FASB issued SFAS No. 141 (revised 2007),
Business Combinations
(SFAS
No. 141R) to change how an entity accounts for the acquisition of a business. SFAS No. 141R
carries forward the existing requirements to account for all business combinations using the
acquisition method (formerly called the purchase method). In general, SFAS No. 141R will require
acquisition-date fair value measurement of identifiable assets acquired, liabilities assumed and
non-controlling interests in the acquiree. SFAS No. 141R will eliminate the current cost-based
purchase method under SFAS No. 141. The new measurement requirements will result in the recognition
of the full amount of acquisition-date goodwill, which includes amounts attributable to
non-controlling interests. The acquirer will recognize in income any gain or loss on the
remeasurement to acquisition-date fair value of consideration transferred or of previously acquired
equity interests in the acquiree. The direct costs incurred to effect a business combination and
the costs the acquirer expects to incur under a plan to restructure an acquired business will be
charged to expense when incurred. SFAS No. 141R will also change the accounting for contingent
consideration, in process research and development, contingencies, and restructuring costs. In
addition, changes in deferred tax asset valuation allowances and acquired income tax uncertainties
in a business combination that occur after the measurement period will impact income taxes under
SFAS No. 141R. SFAS No. 141R is effective for fiscal years beginning on or after December 15, 2008
and interim periods within those years. W-H intends to adopt SFAS No. 141R effective January 1,
2009 and apply its provisions prospectively. W-H currently does not believe that the adoption of
SFAS No. 141R will have a significant effect on its financial statements;
7
however, the effect is
dependent upon whether W-H makes any future acquisitions and the specific terms of those
acquisitions.
SFAS No. 141R amends the goodwill impairment test requirements in SFAS No. 142. For a goodwill
impairment test as of a date after the effective date of SFAS No. 141R, the value of the reporting
unit and the amount of implied goodwill, calculated in the second step of the test, will be
determined in accordance with the measurement and recognition guidance on accounting for business
combinations under SFAS No. 141R. This change could effect the determination of what amount, if
any, should be recognized as an impairment loss for goodwill recorded before the effective date of
SFAS No. 141R. W-H has not determined what effect, if any, SFAS No. 141R will have on the results
of its goodwill impairment testing subsequent to December 31, 2008.
Other than the adoptions of SFAS No. 157 and SFAS No. 159 as of January 1, 2008 described
above, W-H has not added to or changed its accounting policies since December 31, 2007. For a
description of these policies, refer to Note 2 of the Consolidated Financial Statements in W-Hs
Annual Report on Form 10-K for the year ended December 31, 2007.
2. Acquisitions
On February 22, 2008, W-Hs wholly-owned subsidiary, Sup-R-Jar, Inc. (Sup-R-Jar), acquired
substantially all of the assets of a drilling jar company for cash consideration of approximately
$49.9 million. Sup-R-Jar leases and sells these assets to participants in the oil and natural gas
industry. The following table summarizes the preliminary purchase price allocation to the fair
values of the net assets acquired in this acquisition (in thousands):
|
|
|
|
|
Net assets acquired:
|
|
|
|
|
Current assets
|
|
$
|
3,841
|
|
Property and equipment
|
|
|
4,929
|
|
Goodwill
|
|
|
30,384
|
|
Other intangibles and other assets
|
|
|
11,403
|
|
Current liabilities
|
|
|
(616
|
)
|
|
|
|
|
Net assets acquired
|
|
$
|
49,941
|
|
|
|
|
|
On April 9, 2008, W-Hs wholly-owned subsidiary, PathFinder Energy Services, Inc.
(PathFinder), acquired a directional drilling technology company and related technology for cash
consideration of approximately $8.1 million. The technology included in this acquisition is
expected to complement the directional drilling services provided by PathFinder.
Unaudited proforma consolidated financial information for these acquisitions has not been
included as the results were not material to current operations.
3. Earnings per Share
Basic earnings per share is computed by dividing net income by the weighted average number of
shares of common stock outstanding for the period. Diluted earnings per share is computed by
dividing net income by the weighted average number of shares of common stock outstanding for the
period as adjusted for the dilutive effect of stock options and restricted shares. For the three
months and six months June 30, 2008 and 2007, there were no anti-dilutive stock options; therefore,
the effect of all stock options were included in the diluted earnings per share calculation.
8
The following reconciles basic and diluted weighted average shares outstanding (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended
|
|
|
Six Months Ended
|
|
|
|
June 30,
|
|
|
June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
Basic weighted average shares outstanding
|
|
|
30,670
|
|
|
|
30,315
|
|
|
|
30,622
|
|
|
|
30,196
|
|
Dilutive effect of stock options and
restricted shares
|
|
|
810
|
|
|
|
825
|
|
|
|
767
|
|
|
|
812
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Diluted weighted average shares outstanding
|
|
|
31,480
|
|
|
|
31,140
|
|
|
|
31,389
|
|
|
|
31,008
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4. Inventories
The components of inventories as of June 30, 2008 and December 31, 2007 are as follows (in
thousands):
|
|
|
|
|
|
|
|
|
|
|
June 30, 2008
|
|
|
December 31, 2007
|
|
Finished goods
|
|
$
|
85,250
|
|
|
$
|
73,999
|
|
Work-in-process
|
|
|
12,261
|
|
|
|
10,937
|
|
Raw materials and supplies
|
|
|
32,022
|
|
|
|
27,227
|
|
Inventory reserve
|
|
|
(10,301
|
)
|
|
|
(9,579
|
)
|
|
|
|
|
|
|
|
Inventories
|
|
$
|
119,232
|
|
|
$
|
102,584
|
|
|
|
|
|
|
|
|
5. Credit Facility
W-H maintains a revolving credit facility with certain lenders to provide for its cash,
liquidity and other borrowing needs. The credit facility provides for aggregate borrowings of up to
$375.0 million and matures on May 5, 2010. As of June 30, 2008, W-H had an outstanding loan balance
of $225.1 million and approximately $10.5 million in letters of credit issued under its credit
facility, resulting in an available borrowing capacity on such date of approximately $139.4
million.
Amounts borrowed under the credit facility bear interest, at W-Hs election, at either a
variable rate equal to LIBOR, plus a margin ranging from 1.0% to 2.0%, depending upon W-Hs
leverage ratio, or an alternate base rate equal to the higher of (1) the prime rate or (2) the
federal funds rate plus 0.5%, plus a margin ranging from zero to 1.0%, depending upon W-Hs
leverage ratio.
In May 2005, W-H entered into interest rate swap agreements with a total notional amount of
$150.0 million related to its credit facility. Under these agreements, W-H receives interest at a
floating rate equal to the three-month LIBOR rate and pays interest at a fixed rate of 4.24%.
Including the effect of the interest rate swap agreements, W-H was incurring interest at a weighted
average rate of approximately 4.9% on its total outstanding borrowings as of June 30, 2008.
The credit facility is secured by a lien on substantially all of W-Hs property and assets, a
pledge of all the capital stock of W-Hs domestic subsidiaries and a pledge of not greater than 65%
of the capital stock of each of W-Hs top tier foreign subsidiaries. In addition, the credit
facility is guaranteed by all of W-Hs domestic subsidiaries. The credit facility requires, among
other things, that W-H maintain certain financial ratios, including a leverage ratio and an
interest coverage ratio, and a specified net worth. The credit facility limits the amount of
capital expenditures W-H may make, the amount of debt W-H may incur outside of the credit facility,
the amount of future investments W-H may make, the ability of W-H to pay dividends and the ability
of W-H to engage in certain business combination transactions.
Although the consummation of the Offer would result in an event of default under W-Hs
revolving credit facility, giving the lenders thereunder the right to accelerate all indebtedness
outstanding thereunder, W-H and Smith intend to repay amounts outstanding and terminate the credit
facility contemporaneously with the closing of the Offer.
9
6. Fair Value Disclosures
SFAS No. 157 defines fair value, establishes a framework for measuring fair value under
generally accepted accounting principals and expands disclosures about fair value measurements. The
provisions of this standard apply to other accounting pronouncements that require or permit fair
value measurements. The adoption of SFAS No. 157, as it relates to financial assets, had no impact
on W-Hs consolidated financial position, results of operations and cash flows. W-H is currently
evaluating the potential impact of SFAS No. 157, as it relates to nonfinancial assets and
nonfinancial liabilities, on its consolidated financial position, results of operations and cash
flows.
SFAS No. 157 establishes a three-level valuation hierarchy for disclosure of fair value
measurements. The valuation hierarchy categorizes assets and liabilities measured at fair value
into one of three different levels depending on the observability of the inputs employed in the
measurement. The three levels are defined as follows:
Level 1 inputs to the valuation methodology are quoted prices (unadjusted) for
identical assets or liabilities in active markets.
Level 2 inputs to the valuation methodology include quoted prices for similar assets
and liabilities in active markets, and inputs that are observable for the asset or liability,
either directly or indirectly, for substantially the full term of the financial instrument.
Level 3 inputs to the valuation methodology are unobservable and significant to the
fair value measurement.
A financial instruments categorization within the valuation hierarchy is based upon the
lowest level of input that is significant to the fair value measurement. W-Hs assessment of the
significance of a particular input to the fair value measurement in its entirety requires judgment
and considers factors specific to the asset or liability. The following table presents information
about W-Hs assets and liabilities measured at fair value on a recurring basis as of June 30, 2008,
and indicates the fair value hierarchy of the valuation techniques utilized by W-H to determine
such fair value (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Level 1
|
|
|
Level 2
|
|
|
Level 3
|
|
|
Total
|
|
Assets:
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
$
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate swaps
|
|
$
|
|
|
|
$
|
2,425
|
|
|
$
|
|
|
|
$
|
2,425
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following methods and assumptions were used to estimate the fair values of the assets and
liabilities in the table above:
Interest Rate Swaps
W-Hs interest rate swaps are valued using the counterpartys
marked-to-market statement, which can be validated using modeling techniques that include
market inputs such as publicly available interest rate yield curves, and is designated as Level
2 within the valuation hierarchy.
The Company has no assets or liabilities measured at fair value on a recurring basis that meet
the definition of Level 3, which is significant unobservable inputs.
7. Litigation
W-H is from time to time a party or otherwise subject to legal proceedings, claims,
investigations and other proceedings in the ordinary course of its business. These matters
typically involve tort, workers compensation, commercial, employment and infringement and other
intellectual property claims. Where appropriate, W-H makes provision for a liability with respect
to these claims in its financial statements in accordance with generally accepted accounting
principles. These provisions are reviewed periodically and adjusted to reflect the impact of
negotiations, settlements, rulings, advice of legal counsel and events pertaining to a particular
case. Litigation is inherently unpredictable. Based upon information currently available,
management believes that the ultimate liability with respect to these proceedings and claims will
not materially affect W-Hs consolidated results of operations or financial position.
10
8. Shareholders Equity
Stock options
A summary of W-Hs stock options from December 31, 2007 to June 30, 2008 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted Average
|
|
|
|
|
Number of
|
|
Weighted Average
|
|
Remaining
|
|
Aggregate
|
|
|
Options
|
|
Price per Share
|
|
Contractual Term
|
|
Intrinsic Value
|
|
|
|
|
|
|
|
|
|
|
(Years)
|
|
(Amounts in thousands)
|
Outstanding at December 31, 2007
|
|
|
1,565,138
|
|
|
$
|
16.76
|
|
|
|
|
|
|
|
|
|
Granted
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
|
(137,300
|
)
|
|
|
19.65
|
|
|
|
|
|
|
$
|
7,525
|
|
Expired/canceled
|
|
|
(36,250
|
)
|
|
|
19.44
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at June 30, 2008
|
|
|
1,391,588
|
|
|
|
16.41
|
|
|
|
4.1
|
|
|
|
100,393
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Exercisable at June 30, 2008
|
|
|
1,205,713
|
|
|
|
15.50
|
|
|
|
3.7
|
|
|
|
96,746
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted Stock
During the six months ended June 30, 2008, W-H awarded a total of 154,500 shares of restricted
stock under its 2006 Stock Awards Plan to certain employees. The fair value of the restricted stock
issued was approximately $8.8 million and will be recognized as compensation expense over the
vesting period of 48 months.
A summary of W-Hs restricted stock from December 31, 2007 to June 30, 2008 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted
|
|
|
|
|
|
|
|
Average
|
|
|
|
Number of
|
|
|
Fair Value
|
|
|
|
Shares
|
|
|
Per Share
|
|
Nonvested balance at December 31, 2007
|
|
|
148,084
|
|
|
$
|
53.05
|
|
Granted
|
|
|
154,500
|
|
|
|
55.17
|
|
Vested
|
|
|
(41,000
|
)
|
|
|
52.53
|
|
Forfeited
|
|
|
(1,500
|
)
|
|
|
56.36
|
|
|
|
|
|
|
|
|
Nonvested balance at June 30, 2008
|
|
|
260,084
|
|
|
$
|
52.74
|
|
|
|
|
|
|
|
|
9. Operating Segments
Management has elected to aggregate W-Hs business unit segments based on the differences in
each segments customers, the products and services offered and other economic characteristics.
Based on these criteria, management has identified the following reportable segments: (1) drilling
related products and services and (2) completion and workover related products and services. The
accounting policies of the operating segments are the same as those described in the summary of
significant accounting policies in W-Hs Annual Report on Form 10-K for the year ended December 31,
2007.
Drilling Related Products and Services
The drilling segment provides products and services used by oil and natural gas companies,
drilling contractors and other oilfield service companies for the drilling of oil and natural gas
wells. These products and services are used primarily throughout North America and in select
international areas. This segment includes the following business lines: (1)
logging-while-drilling; (2) measurement-while-drilling; (3) directional drilling; (4) down-hole
drilling motors; (5) drilling fluids and (6) rental tools.
Completion and Workover Related Products and Services
The completion and workover segment provides products and services primarily to customers
onshore in the United States and offshore in the Gulf of Mexico. These products and services
include: (1) cased-hole wireline logging, perforating, tubing conveyed perforating and associated
rental equipment; (2) coiled tubing; (3) completion fluids and (4) rental tools.
11
Summary Information
W-H recognizes revenues, operating income, depreciation and amortization expense, total assets
and capital expenditures by segment. Interest expense and other income (expense) are not monitored
by segment. Summarized information for W-Hs reportable segments is contained in the following
tables (in thousands):
As of and for the three months ended June 30, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Drilling
|
|
Completion
|
|
Corporate
|
|
Total
|
Revenues
|
|
$
|
222,984
|
|
|
$
|
123,953
|
|
|
$
|
|
|
|
$
|
346,937
|
|
Operating income
|
|
|
43,242
|
|
|
|
34,842
|
|
|
|
(10,167
|
)
|
|
|
67,917
|
|
Depreciation and amortization
|
|
|
14,899
|
|
|
|
9,709
|
|
|
|
63
|
|
|
|
24,671
|
|
Total assets
|
|
|
765,202
|
|
|
|
375,212
|
|
|
|
38,159
|
|
|
|
1,178,573
|
|
Capital expenditures
|
|
|
43,840
|
|
|
|
18,113
|
|
|
|
35
|
|
|
|
61,988
|
|
As of and for the three months ended June 30, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Drilling
|
|
Completion
|
|
Corporate
|
|
Total
|
Revenues
|
|
$
|
179,141
|
|
|
$
|
98,611
|
|
|
$
|
|
|
|
$
|
277,752
|
|
Operating income
|
|
|
41,307
|
|
|
|
26,032
|
|
|
|
(4,584
|
)
|
|
|
62,755
|
|
Depreciation and amortization
|
|
|
11,600
|
|
|
|
7,493
|
|
|
|
69
|
|
|
|
19,162
|
|
Total assets
|
|
|
578,163
|
|
|
|
320,623
|
|
|
|
39,087
|
|
|
|
937,873
|
|
Capital expenditures
|
|
|
28,681
|
|
|
|
21,428
|
|
|
|
426
|
|
|
|
50,535
|
|
As of and for the six months ended June 30, 2008:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Drilling
|
|
Completion
|
|
Corporate
|
|
Total
|
Revenues
|
|
$
|
417,237
|
|
|
$
|
230,668
|
|
|
$
|
|
|
|
$
|
647,905
|
|
Operating income
|
|
|
80,835
|
|
|
|
63,289
|
|
|
|
(14,858
|
)
|
|
|
129,266
|
|
Depreciation and amortization
|
|
|
28,962
|
|
|
|
18,899
|
|
|
|
127
|
|
|
|
47,988
|
|
Total assets
|
|
|
765,202
|
|
|
|
375,212
|
|
|
|
38,159
|
|
|
|
1,178,573
|
|
Capital expenditures
|
|
|
75,843
|
|
|
|
44,185
|
|
|
|
53
|
|
|
|
120,081
|
|
As of and for the six months ended June 30, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Drilling
|
|
Completion
|
|
Corporate
|
|
Total
|
Revenues
|
|
$
|
358,402
|
|
|
$
|
192,237
|
|
|
$
|
|
|
|
$
|
550,639
|
|
Operating income
|
|
|
80,289
|
|
|
|
51,884
|
|
|
|
(9,498
|
)
|
|
|
122,675
|
|
Depreciation and amortization
|
|
|
22,173
|
|
|
|
14,426
|
|
|
|
115
|
|
|
|
36,714
|
|
Total assets
|
|
|
578,163
|
|
|
|
320,623
|
|
|
|
39,087
|
|
|
|
937,873
|
|
Capital expenditures
|
|
|
54,593
|
|
|
|
42,530
|
|
|
|
653
|
|
|
|
97,776
|
|
12
W-H operates in the United States, the North Sea and other select geographic regions. The
following is summary information by geographic region (in thousands):
Revenues
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months
|
|
|
For the Six Months
|
|
|
|
Ended June 30,
|
|
|
Ended June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
United States
|
|
$
|
315,597
|
|
|
$
|
249,898
|
|
|
$
|
585,537
|
|
|
$
|
487,185
|
|
North Sea
|
|
|
10,875
|
|
|
|
12,923
|
|
|
|
24,577
|
|
|
|
28,723
|
|
Other
|
|
|
20,465
|
|
|
|
14,931
|
|
|
|
37,791
|
|
|
|
34,731
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
346,937
|
|
|
$
|
277,752
|
|
|
$
|
647,905
|
|
|
$
|
550,639
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating Income
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
For the Three Months
|
|
|
For the Six Months
|
|
|
|
Ended June 30,
|
|
|
Ended June 30,
|
|
|
|
2008
|
|
|
2007
|
|
|
2008
|
|
|
2007
|
|
United States
|
|
$
|
62,422
|
|
|
$
|
57,304
|
|
|
$
|
117,223
|
|
|
$
|
111,035
|
|
North Sea
|
|
|
1,090
|
|
|
|
2,864
|
|
|
|
3,997
|
|
|
|
4,616
|
|
Other
|
|
|
4,405
|
|
|
|
2,587
|
|
|
|
8,046
|
|
|
|
7,024
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
67,917
|
|
|
$
|
62,755
|
|
|
$
|
129,266
|
|
|
$
|
122,675
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
|
|
|
|
|
|
|
|
|
June 30,
|
|
|
December 31,
|
|
|
|
2008
|
|
|
2007
|
|
United States
|
|
$
|
469,470
|
|
|
$
|
404,111
|
|
North Sea
|
|
|
13,088
|
|
|
|
13,588
|
|
Other
|
|
|
33,744
|
|
|
|
31,214
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
516,302
|
|
|
$
|
448,913
|
|
|
|
|
|
|
|
|
13
Item 2.
Managements Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
In addition to historical information, this report contains forward-looking statements within
the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange
Act of 1934 that involve risks, uncertainties and assumptions. The words believe, expect,
plan, intend, estimate, project, will, could, may, and similar expressions are
intended to identify forward-looking statements. Actual results may differ materially from the
results discussed in the forward-looking statements as a result of important risk factors
including, but not limited to, trends in oil and natural gas prices, capital expenditures by
customers, oil and natural gas industry activity, difficulty in continuing to develop, produce and
commercialize technologically advanced products and services, weather conditions in offshore and
land markets, risks associated with events that result in personal injuries, loss of life, damage
to or destruction of property, equipment or the environment and suspension of operations,
unavailability of or costs associated with insurance, our ability to attract and retain skilled
workers, the loss of key members of management, competition in our industry, compliance with and
developments in environmental and other governmental regulations, loss of use of certain
technologies, the concentration of customers in the energy industry, our ability to successfully
integrate future acquisitions, political and economic risks including changes in tax laws, an
impairment of goodwill, as well as restrictions on our ability to raise additional funds. For
additional discussion of these risks, please see the discussion set forth under the heading Item
1A Risk Factors contained in our most recent Annual Report filed on Form 10-K with the SEC.
Proposed Acquisition of W-H by Smith International, Inc.
As more fully described in Note 1 to our Consolidated Financial Statements, on June 3, 2008,
we entered into an Agreement and Plan of Merger (the Merger Agreement) with Smith International,
Inc. (Smith) and an indirect wholly owned subsidiary of Smith, pursuant to which we are expected
to become a wholly owned subsidiary of Smith (the Acquisition). In order to effectuate the
Acquisition, and in accordance with the Merger Agreement, the Smith subsidiary has commenced an
offer to exchange (the Offer) each outstanding share of our common stock validly tendered and not
withdrawn in the exchange offer, at the election of the holder of such share, for:
|
|
|
$56.10 in cash, without interest, and 0.48 shares of Smiths common stock, par value $1.00
per share, including the associated
|
preferred share purchase rights (Smith Common Stock); or
|
|
|
|
|
$93.55 in cash, without interest (the All-Cash Consideration); or
|
|
|
|
|
1.1990 shares of Smith Common Stock (the All-Stock Consideration),
|
subject in each case to the election procedures and, in the case of elections of the All-Cash
Consideration or the All-Stock Consideration, to the proration procedures described in Smiths
Prospectus/Offer to Exchange dated June 24, 2008, as amended, included in Smiths Registration
Statement on Form S-4 filed with the SEC on June 24, 2008, as amended, and which, together with the
related letter of election and transmittal, as the same may be amended, constitute the Offer.
The Offer will expire at 12:00 midnight, New York City time, at the end of August 18, 2008, unless
further extended.
Following consummation of the Offer, we will merge with a wholly owned subsidiary of Smith,
with our company surviving such merger. In the merger, any remaining shares of our common stock
not tendered pursuant to the Offer will be cancelled and converted into the right to receive $56.10
in cash, without interest, and 0.48 shares of Smith Common Stock, subject to adjustment pursuant to
the Merger Agreement. Following such merger, we, as the surviving corporation of such merger, will
be a wholly-owned subsidiary of Smith and our former shareholders will no longer have any direct
ownership interest in us. Such merger will be followed by a second merger pursuant to which we
will merge with and into a direct wholly owned subsidiary of Smith, with such subsidiary surviving
such second merger.
We expect that the Acquisition will be completed during the third quarter of 2008, but the
closing is subject to customary closing conditions, including (i) there being validly tendered and
not properly withdrawn before the expiration of the Offer at least 66
2
/
3
% of our outstanding shares
of common stock, (ii) the expiration or termination of the waiting period under the
Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended, and (iii) Smiths Registration
Statement on Form S-4 having become effective.
14
Overview of Our Products and Services
We provide drilling related products and services and completion and workover related products
and services to major and independent oil and natural gas companies, drilling contractors and other
oilfield service companies. The majority of our revenues are generated from charging our customers
day rates, based on the number of days our products and services are used. We also sell certain
products used in the exploration for and production of oil and natural gas and receive revenues
from our customers in connection with these sales. Our primary expenses are salaries for our
personnel and the costs associated with expendable parts and supplies, research and development,
repair and maintenance of rental equipment and costs of products sold as well as general
operational costs. As a result of increased demand and competition for skilled personnel,
compensation costs to attract and retain employees have continued to rise.
Prices for oil and natural gas are subject to large fluctuations in response to relatively
minor changes in the supply of and demand for oil and natural gas, market uncertainty, expectations
and a variety of other factors. Any prolonged increase or decrease in oil and natural gas prices
affects the levels of exploration, development and production activity as well as the entire health
of the oil and natural gas industry. Demand for our drilling related products and services is
directly affected by the level of exploration, development and production activity of, and the
corresponding capital spending by, oil and natural gas companies. Demand for our completion and
workover related products and services also depends on oil and natural gas production activity,
which may be less immediately affected by changes in oil and natural gas prices.
In July 2001, exploration and development activity levels in the United States peaked and
subsequently began to decline primarily as a result of lower natural gas prices. This decline
continued through April 2002, at which point the United States drilling rig count reached a low of
738, which consisted of 110 offshore rigs and 628 land rigs. As natural gas prices climbed and
remained relatively strong, rig count levels began to recover in 2003, and this trend has continued
through the first quarter of 2008. This increase, however, resulted from an increase in land-based
rigs. According to statistics published by Baker Hughes, the average number of rotary rigs
operating in the United States was 1,649, 1,768 and 1,817 for 2006, 2007 and for the six months
ended June 30, 2008, respectively. Of these figures, land rigs comprised 1,559, 1,695 and 1,754,
respectively, and offshore rigs comprised 90, 73 and 63, respectively, for the same periods. For
the week ended July 25, 2008, an average of 67 rotary rigs were operating offshore in the United
States.
The search for natural gas has been the primary focus of domestic drilling for the last
several years as approximately 80% of the domestic drilling rig count has been natural gas
drilling. We believe that the outlook for domestic natural gas exploration and development activity
remains positive. First, due to significantly higher natural gas production decline rates, more
wells must be drilled to maintain or increase natural gas production. As reported by RigData, the
number of wells drilled annually has increased approximately 57% from 27,252 in 2003 to an
estimated 42,695 for the twelve months ended June 30, 2008. Second, our supply of natural gas
continues to be provided primarily by domestic drilling. We believe these factors should keep
upward pressure on long-term natural gas prices and domestic drilling. As a result, we are focusing
our capital expenditure investments in locations which are attracting long-term investment in oil
and natural gas exploration and development.
Drilling Related Products and Services
Revenue from our drilling related products and services segment constituted approximately 64%
of our consolidated revenue for the six months ended June 30, 2008. Approximately 85% of our
drilling segment revenue for the six months ended June 30, 2008 was generated in the United States,
including the Gulf of Mexico. The remaining 15% was generated in various international locations.
We have sought to increase the content of our land-based services as onshore drilling activity
in the United States has improved. As a result of growth in the domestic non-vertical rig count, we
have successfully leveraged our directional drilling business to effect an increase in the
utilization of our measurement-while-drilling and logging-while-drilling tools and down-hole
drilling motor fleet. The increased utilization of our measurement-while-drilling and
logging-while-drilling tools and down-hole drilling motor fleet has helped to offset the slowdown
in domestic offshore activity.
15
Outside of the United States, the North Sea remains our largest market segment. For the
remainder of 2008, we expect to see increasing drilling activity in the Middle East and a modest
increase in activity levels in our other foreign markets.
A key challenge that our drilling related products and services segment faces is the demand by
our customers for more efficient and technologically advanced services and tools. We have invested
substantial time and capital into developing and commercializing technologies that are of value to
our customers and that enable us to compete effectively with the major integrated oilfield service
companies. During 2004, we began to market our PathMaker
®
3-Dimensional Rotary Steerable
line of tools with the introduction of our PathMaker
®
tool in the 12
1
/
4
-inch hole size.
The PathMaker
®
tool in the 8
1
/
2
-inch hole size became available on a commercial basis
during the first quarter of 2007. Other sizes of the PathMaker
®
tool are currently in
development. We expect commercialization of the 3-Dimensional Rotary Steerable technology to
further improve the utilization of our logging-while-drilling, measurement-while-drilling and
directional drilling services, as our customers are increasingly requiring this type of technology
as a prerequisite for submitting bids on a drilling project or contract.
In 2004, our subsidiary, PathFinder Energy Services, Inc. (PathFinder), introduced the first
of the Survivor
tm
tools designed for use in high pressure and high temperature
conditions (up to 25,000 psi and 350°F) with the commercialization of its dual frequency Array Wave
Resistivity tool. That tool is now available in 4
3
/
4
, 6
3
/
4
, 8 and 9
1
/
2
-inch outside diameter sizes.
The Survivor
tm
tool series currently also includes
Survivor
tm
HDS-1
tm
(a high precision directional survey
tool),
Survivor
tm
DPM
tm
(Dynamic Pressure Module) and
Survivor
tm
SDNSC
tm
(4
3
/
4
-inch outside diameter Slim Density
Neutron Standoff Caliper tool).
Completion and Workover Related Products and Services
Our completion and workover related products and services segment provided approximately 36%
of our total consolidated revenue for the six months ended June 30, 2008. Revenues provided by this
segment are almost entirely derived from the United States and the Gulf of Mexico. Demand for this
segments products and services has historically been less immediately affected by changing oil and
natural gas prices and, thus, has tended to be less directly impacted by these changes than is our
drilling related products and services segment. However, the onshore content of our business line
has increased over the past few years and has resulted in a proportionately greater amount of
completion services which are associated with exploration and development activity, rather than
workover services which are associated with production activity.
We have increased our revenue capacity in this segment through capital spending which, when
combined with our acquisitions and strategic land-based expansion efforts, has strengthened and
further diversified our operations. Continued growth in this segment will be dependent upon, among
other factors, industry activity levels, prices of oil and natural gas, our capital expenditure
program and our ability to attract and retain qualified service personnel and field engineers
required to operate the specialized equipment used in this business. Increased competition in
certain markets within this segment has adversely impacted utilization and pricing and increased
the demand for qualified personnel.
Results of Operations
The following information should be read in conjunction with our Consolidated Financial
Statements and the accompanying notes presented elsewhere in this Form 10-Q.
Three Months Ended June 30, 2008 Compared to the Three Months Ended June 30, 2007
Revenues.
Revenues increased by $69.2 million, or approximately 25%, to $346.9 million for
the three months ended June 30, 2008 from $277.7 million for the three months ended June 30, 2007.
This increase was primarily attributable to higher levels of activity, increased demand for certain
of our products and services and additional revenue capacity from our capital expenditure
investments.
Revenues from our drilling related products and services increased by $43.9 million, or
approximately 25%, to $223.0 million for the three months ended June 30, 2008 from $179.1 million
for the three months ended June 30, 2007. We attribute the increase in revenues in this segment to:
16
|
|
|
a 6% higher average number of rotary rigs operating in the United States resulting in an
increase in demand for our drilling fluids products, directional drilling services and
technologically advanced services and tools and rental tools;
|
|
|
|
|
our larger asset base resulting from our capital expenditure investments;
|
|
|
|
|
our onshore geographic expansion;
|
|
|
|
|
increases in pricing, particularly for certain drilling fluids products; and
|
|
|
|
|
a full quarter of results from Sup-R-Jar which was acquired during the first quarter of
2008.
|
Revenues from our completion and workover related products and services increased by $25.4
million, or approximately 26%, to $124.0 million for the three months ended June 30, 2008 from
$98.6 million for the three months ended June 30, 2007. We attribute the increase in revenues in
this segment to:
|
|
|
higher demand for our cased-hole wireline services, completion fluid products and coiled
tubing services as a result of an overall increase in activity levels;
|
|
|
|
|
an increase in our coiled tubing and cased-hole wireline fleets and other capital
expenditure investments; and
|
|
|
|
|
our onshore geographic expansion.
|
Cost of Revenues.
Cost of revenues increased by $45.9 million, or approximately 32%, to
$191.3 million for the three months ended June 30, 2008 from $145.4 million for the three months
ended June 30, 2007. As a percentage of revenues, cost of revenues were 55% and 52% for the three
months ended June 30, 2008 and 2007, respectively. The increase in cost of revenues as a
percentage of revenues for the three months ended June 30, 2008 as compared to the three months
ended June 30, 2007 was due primarily to the decline in domestic offshore utilization of our
measurement-while-drilling and logging-while-drilling tools and down-hole drilling motor fleet
which has historically earned higher operating margins than our domestic onshore activity. This
trend was partially offset for the period by higher profit margins on certain of our drilling
fluids products. The margins on certain of these drilling fluids products may decrease as a result
of an increase in our product cost.
Selling, General and Administrative Expenses.
Selling, general and administrative expenses
increased by $5.9 million, or approximately 13%, to $50.9 million for the three months ended June
30, 2008 from $45.0 million for the three months ended June 30, 2007. The increase was primarily
attributable to increased selling costs related to our revenue growth and other personnel
compensation costs related to expansion efforts within all of our business lines. As a percentage
of revenues, selling, general and administrative expenses decreased to 15% for the three months
ended June 30, 2008 from 16% for the three months ended June 30, 2007.
Transaction Related Costs.
Through June 30, 2008, we had incurred approximately $5.4 million
in expenses associated with the transactions contemplated by the Merger Agreement, including legal
fees and fees payable to UBS Securities LLC (UBS) in respect of that firms fairness opinion
provided to our Board of Directors in connection with the Acquisition transaction. Pursuant to the
engagement letter between us and UBS, we will be obligated to pay UBS an additional fee of
approximately $22.0 million at the closing of the Acquisition in respect of the financial advisory
services provided by UBS to us.
Research and Development Expenses.
Research and development expenses increased by $1.3
million, or approximately 24%, to $6.8 million for the three months ended June 30, 2008 from $5.5
million for the three months ended June 30, 2007. This increase was the result of a higher rate of
research and development spending in the 2008 period on PathFinder technologies, including our
PathMaker
®
3-Dimensional Rotary Steerable technology.
Depreciation and Amortization.
Depreciation and amortization increased by $5.5 million, or
approximately 29%, to $24.7 million for the three months ended June 30, 2008 from $19.2 million for
the three months ended June 30, 2007. This increase was principally the result of a larger
depreciable asset base resulting from our capital expenditure investments.
17
Interest and Other Expense.
Interest and other expense for the three months ended June 30,
2008 was $2.8 million, an increase of $1.0 million, or approximately 56%, from $1.8 million for the
three months ended June 30, 2007. This increase was primarily due to higher outstanding borrowings
under our credit facility resulting from our acquisitions, capital expenditures and working capital
requirements.
Provision for Income Taxes.
Our effective income tax rate for the three months ended June 30,
2008 was approximately 37% as compared to 36% for the three months ended June 30, 2007. The
increase in the 2008 effective rate compared to the 2007 period was due primarily to the
non-deductibility of a majority of the costs associated with the transactions contemplated by the
Merger Agreement recognized during the period. Generally, our effective rate varies due to several
factors including, but not limited to, fluctuations in income across international tax
jurisdictions with varying tax rates.
Six Months Ended June 30, 2008 Compared to the Six Months Ended June 30, 2007
Revenues.
Revenues increased by $97.3 million, or approximately 18%, to $647.9 million for
the six months ended June 30, 2008 from $550.6 million for the six months ended June 30, 2007. This
increase was primarily attributable to higher levels of activity, increased demand for certain of
our products and services and additional revenue capacity from our capital expenditure investments.
Revenues from our drilling related products and services increased by $58.8 million, or
approximately 16%, to $417.2 million for the six months ended June 30, 2008 from $358.4 million for
the three months ended June 30, 2007. We attribute the increase in revenues in this segment to:
|
|
|
a 4% higher average number of rotary rigs operating in the United States resulting in an
increase in demand for our drilling fluids products, directional drilling services and
technologically advanced services and tools and rental tools;
|
|
|
|
|
our larger asset base resulting from our capital expenditure investments;
|
|
|
|
|
our onshore geographic expansion;
|
|
|
|
|
increases in pricing, particularly for certain drilling fluids products; and
|
|
|
|
|
results from Sup-R-Jar which was acquired during the first quarter of 2008.
|
Revenues from our completion and workover related products and services increased by $38.5
million, or approximately 20%, to $230.7 million for the six months ended June 30, 2008 from $192.2
million for the six months ended June 30, 2007. We attribute the increase in revenues in this
segment to:
|
|
|
higher demand for our cased-hole wireline services, completion fluid products and coiled
tubing services as a result of an overall increase in activity levels;
|
|
|
|
|
an increase in our coiled tubing and cased-hole wireline fleets and other capital
expenditure investments; and
|
|
|
|
|
our onshore geographic expansion.
|
Cost of Revenues.
Cost of revenues increased by $62.5 million, or approximately 21%, to
$355.3 million for the six months ended June 30, 2008 from $292.8 million for the six months ended
June 30, 2007. As a percentage of revenues, cost of revenues were 55% and 53% for the six months
ended June 30, 2008 and 2007, respectively. The increase in cost of revenues as a percentage of
revenues for the six months ended June 30, 2008 as compared to the six months ended June 30, 2007
was due primarily to the decline in domestic offshore utilization of our measurement-while-drilling
and logging-while-drilling tools and down-hole drilling motor fleet which has historically earned
higher operating margins than our domestic onshore activity. This trend was partially offset for
the period by higher profit margins on certain of our drilling fluids products. The margins on
certain of these drilling fluids products may decrease as a result of an increase in our product
cost.
Selling, General and Administrative Expenses.
Selling, general and administrative expenses
increased by $8.8 million, or approximately 10%, to $97.0 million for the six months ended June 30,
2008 from $88.2 million for
18
the six months ended June 30, 2007. The increase was primarily attributable to increased selling
costs related to our revenue growth and other personnel compensation costs related to expansion
efforts within all of our business lines. As a percentage of revenues, selling, general and
administrative expenses decreased to 15% for the six months ended June 30, 2008 from 16% for the
six months ended June 30, 2007.
Transaction Related Costs.
Through June 30, 2008, we had incurred approximately $5.4 million
in expenses associated with the transactions contemplated by the Merger Agreement, including legal
fees and fees payable to UBS Securities LLC (UBS) in respect of that firms fairness opinion
provided to our Board of Directors in connection with the Acquisition transaction. Pursuant to the
engagement letter between us and UBS, we will be obligated to pay UBS an additional fee of
approximately $22.0 million at the closing of the Acquisition in respect of the financial advisory
services provided by UBS to us.
Research and Development Expenses.
Research and development expenses increased by $2.7
million, or approximately 26%, to $12.9 million for the six months ended June 30, 2008 from $10.2
million for the six months ended June 30, 2007. This increase was the result of a higher rate of
research and development spending in the 2008 period on PathFinder technologies, including our
PathMaker
®
3-Dimensional Rotary Steerable technology.
Depreciation and Amortization.
Depreciation and amortization increased by $11.3 million, or
approximately 31%, to $48.0 million for the six months ended June 30, 2008 from $36.7 million for
the six months ended June 30, 2007. This increase was principally the result of a larger
depreciable asset base resulting from our capital expenditure investments.
Interest and Other Expense.
Interest and other expense for the six months ended June 30, 2008
was $5.2 million, an increase of $1.4 million, or approximately 37%, from $3.8 million for the six
months ended June 30, 2007. This increase was primarily due to higher outstanding borrowings under
our credit facility resulting from our acquisitions, capital expenditures and working capital
requirements.
Provision for Income Taxes.
Our effective income tax rate for the six months ended June 30,
2008 and 2007 was approximately 37%. Generally, our effective rate varies due to several factors
including, but not limited to, fluctuations in income across international tax jurisdictions with
varying tax rates.
Recent Accounting Pronouncements
Effective January 1, 2008, we adopted SFAS No. 157,
Fair Value Measurements,
(SFAS No. 157)
as it relates to financial assets and financial liabilities. In February 2008, the FASB issued FASB
Staff Position No. FAS 157-2,
Effective Date of FASB Statement No. 157,
which delayed the effective
date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities, except those that
are recognized or disclosed at fair value in the financial statements on at least an annual basis,
until January 1, 2009 for calendar year-end entities. Accordingly, we will defer the adoption of
SFAS No. 157 for our nonfinancial assets and nonfinancial liabilities until January 1, 2009. The
adoption of SFAS No. 157 did not cause a change in the method of calculating fair value of assets
or liabilities. The primary impact from adoption was additional disclosures. See Note 6 to
Consolidated Financial Statements for more information.
Effective January 1, 2008, we adopted SFAS No. 159,
The Fair Value Option for Financial Assets
and Financial Liabilities including an amendment of FASB Statement No. 115
, (SFAS No. 159).
SFAS No. 159 permits entities to choose to measure most financial instruments and certain other
items at fair value on an instrument-by-instrument basis (the fair value option) with changes in
fair value reported in earnings. We adopted SFAS No. 159 on January 1, 2008. We already record our
hedging activities at fair value in accordance with SFAS No. 133,
Accounting for Derivative
Instruments and Hedging Activities
, as amended. The adoption of SFAS No. 159 had no impact on our
financial statements as we did not elect the fair value option for any other assets and
liabilities.
In December 2007, the FASB issued SFAS No. 141 (revised 2007),
Business Combinations
(SFAS
No. 141R) to change how an entity accounts for the acquisition of a business. SFAS No. 141R
carries forward the existing requirements to account for all business combinations using the
acquisition method (formerly called the purchase method). In general, SFAS No. 141R will require
acquisition-date fair value measurement of identifiable assets acquired, liabilities assumed and
non-controlling interests in the acquiree. SFAS No. 141R will eliminate the current cost-based
purchase method under SFAS No. 141. The new measurement requirements will result in the recognition
of the full amount of acquisition-date goodwill, which includes amounts attributable to
non-
19
controlling interests. The acquirer will recognize in income any gain or loss on the remeasurement to
acquisition-date fair value of consideration transferred or of previously acquired equity interests
in the acquiree. The direct costs incurred to effect a business combination and the costs the
acquirer expects to incur under a plan to restructure an acquired business will be charged to
expense when incurred. SFAS No. 141R will also change the accounting for contingent consideration,
in process research and development, contingencies, and restructuring costs. In addition, changes
in deferred tax asset valuation allowances and acquired income tax uncertainties in a business
combination that occur after the measurement period will impact income taxes under SFAS No. 141R.
SFAS No. 141R is effective for fiscal years beginning on or after December 15, 2008 and interim
periods within those years. We intend to adopt SFAS No. 141R effective January 1, 2009 and apply
its provisions prospectively. We currently do not believe that the adoption of SFAS No. 141R will
have a significant effect on our financial statements; however, the effect is dependent upon
whether we make any future acquisitions and the specific terms of those acquisitions.
SFAS No. 141R amends the goodwill impairment test requirements in SFAS No. 142. For a goodwill
impairment test as of a date after the effective date of SFAS No. 141R, the value of the reporting
unit and the amount of implied goodwill, calculated in the second step of the test, will be
determined in accordance with the measurement and recognition guidance on accounting for business
combinations under SFAS No. 141R. This change could effect the determination of what amount, if
any, should be recognized as an impairment loss for goodwill recorded before the effective date of
SFAS No. 141R. We have not determined what effect, if any, SFAS No. 141R will have on the results
of our goodwill impairment testing subsequent to December 31, 2008.
Liquidity and Capital Resources
Our primary uses for cash are capital expenditures, working capital, research and development
expenditures, and principal and interest payments on indebtedness. Historically, we have also used
cash to consummate acquisitions transactions, but we do not expect to complete any such
transactions during the pendency of the Acquisition transaction. Our primary sources of liquidity
are cash reserves, cash generated by operations and amounts available to be drawn under our
revolving credit facility. To the extent our cash requirements exceed our sources of liquidity, we
will be required to fund our cash requirements through other means, such as through debt and equity
financing activities (although, as discussed under Part II, Item 1A. Risk Factors, we are subject
to contractual restrictions on our ability to engage in such financing activities) or we will be
required to curtail our expenditures.
Cash flow
Working capital was $335.0 million as of June 30, 2008 and $290.0 million as of December 31,
2007. Net cash provided by operating activities was $77.1 million for the six months ended June 30,
2008 and $45.3 million for the six months ended June 30, 2007. Increased cash provided by
operating activities is attributable to higher operating income levels and a decrease in accounts
receivable days outstanding for the 2008 period as compared to the 2007 period.
Net cash used in investing activities was $150.0 million for the six months ended June 30,
2008 and $89.2 million for the six months ended June 30, 2007. The increase in net cash used in
investing activities was principally the result of the Sup-R-Jar transaction and increased capital
expenditures.
Net cash provided by financing activities was $80.3 million for the six months ended June 30,
2008 and $28.7 million for the six months ended June 30, 2007. Changes in net cash related to
financing activities were principally the result of net borrowings under our credit facility in
2008 to fund the Sup-R-Jar transaction and capital expenditures.
For the six months ended June 30, 2008, we made capital expenditures, primarily for rental
equipment, of $120.0 million, which included expenditures for the replacement of rental equipment
damaged or lost down-hole. In addition, we incurred $12.9 million in research and development
expenses for the six months ended June 30, 2008.
20
Capital resources
Credit Agreement
As more fully described in Note 5 to our Consolidated Financial Statements, we maintain a
revolving credit facility to provide for our cash, liquidity and other borrowing needs. Such credit
facility provides for aggregate borrowings of up to $375.0 million and matures on May 5, 2010. As
of June 30, 2008, we had an outstanding loan balance of $225.1 million and approximately $10.5
million in letters of credit issued under our credit facility, resulting in an available borrowing
capacity on such date of approximately $139.4 million. We have entered into interest rate swap
agreements with a total notional amount of $150.0 million related to our credit facility. Including
the effect of the interest rate swap agreements, we were incurring interest at a weighted average
rate of approximately 4.9% on our total outstanding borrowings as of June 30, 2008.
Although the consummation of the Offer would result in an event of default under our revolving
credit facility, giving the lenders thereunder the right to accelerate all indebtedness outstanding
thereunder, we and Smith intend to repay amounts outstanding and terminate the credit facility
contemporaneously with the closing of the Offer.
Future capital requirements
During the pendency of the Acquisition, we will continue to need to make capital expenditures
for tools and rental equipment and make research and development expenditures to maintain and
improve the quality of our products and services. We currently estimate that we will make capital
expenditures of approximately $190 million during 2008 and will make research and development
expenditures of approximately $26.0 million to $27.0 million during 2008. We believe that our
internally generated cash flow, combined with access to our credit facility, will be sufficient to
meet the liquidity requirements necessary to fund our operations, capital expenditures, research
and development and debt service requirements for at least the next 12 months. However, our ability
to maintain our credit facility and the sufficiency of our internally generated cash flow can be
impacted by economic conditions outside of our control.
Off balance sheet arrangements
With the exception of operating leases on real property and automobile leases, we have no
off-balance sheet debt or other off-balance sheet financing arrangements.
Item 3.
Quantitative and Qualitative Disclosures about Market Risk
We are exposed to market risks. Market risk is the potential loss arising from adverse changes
in market prices and rates. We have not entered into derivative or other financial instruments for
trading or speculative purposes. Our market risk could arise from changes in interest rates and
foreign currency exchange rates.
Interest Rate Risk.
We are subject to market risk exposure related to changes in interest
rates. To manage this risk, we have entered into interest rate swap agreements with a total
notional amount of $150.0 million related to our credit facility. Under these agreements, we
receive interest at a floating rate equal to three-month LIBOR plus the applicable spread under our
credit facility and pay interest at a fixed rate of 4.24% plus the applicable spread under our
credit facility. Assuming our current level of borrowings and considering the effect of the
interest rate swap agreements, a 100 basis point increase in the interest rate we pay under our
credit facility would not have had a material impact on our interest expense for the six months
ended June 30, 2008.
Foreign Currency Exchange Risk.
Our earnings and financial position are affected by foreign
exchange rate fluctuations. We currently do not hedge against foreign currency translation risks
and we believe that foreign currency exchange risk is unlikely to be significant to our operations.
Stock Price Volatility.
The market price of our stock may be influenced by many factors
including variations in our earnings, variations in oil and natural gas prices, the level of
exploration, development and production activity of, and the corresponding capital spending by, our
customers, investor perceptions of us and other oilfield service companies and the liquidity of the
market for our common stock. We believe that the market price of our common stock is significantly
impacted by changes in the market price of Smiths common stock as a result of Smiths common stock
comprising a portion of the consideration in the Acquisition transaction, and we expect this impact
to continue during the pendency of the Acquisition transaction.
21
Item 4.
Controls and Procedures
Disclosure Controls and Procedures.
We maintain disclosure controls and procedures, which are
controls and procedures designed to ensure that the information we are required to disclose in the
reports we file with the SEC is recorded, processed, summarized and reported within the time
periods specified in the rules and forms of the SEC. Based on an evaluation of our disclosure
controls and procedures as of the end of the period covered by this report conducted by our
management, with the participation of our Chief Executive Officer and Chief Financial Officer, our
Chief Executive Officer and Chief Financial Officer believe that these controls and procedures are
effective to provide reasonable assurance that we are able to collect, process and disclose the
information we are required to disclose in the reports we file with the SEC within the required
time periods.
Internal Control over Financial Reporting.
During the period covered by this report, there
were no changes in our internal control over financial reporting that have materially affected or
are reasonably likely to materially affect our internal control over financial reporting.
Our management, including our Chief Executive Officer and Chief Financial Officer, does not
expect that our disclosure controls and procedures or our internal control over financial reporting
will prevent and/or detect all error and all fraud. A control system, no matter how well conceived
and operated, can provide only reasonable, not absolute, assurance that the objectives of the
control system are met. Further, the design of a control system must reflect the fact that there
are resource constraints, and the benefits of controls must be considered relative to their costs.
Because of the inherent limitations in all control systems, no evaluation of controls can provide
absolute assurance that all control issues and instances of fraud, if any, within our company have
been detected.
PART II
OTHER INFORMATION
Item 1. Legal Proceedings.
On June 9, 2008, an action entitled
The Booth Family Trust v. White, et al.
, No. 2008-35207,
was filed in the 269th Harris County Texas District Court. The plaintiff claims to be one of our
shareholders and purports to sue us, the members of our Board of Directors and Smith on behalf of a
class of all holders of our common stock other than the defendants and their affiliates. The
petition alleges that our directors breached the fiduciary duties of care, loyalty, candor, good
faith, independence and fair dealing owed to our shareholders in agreeing to the Offer and the
merger described in Note 1 to our Consolidated Financial Statements, and that we and Smith aided
and abetted these breaches of duty. The plaintiff claims that the consideration to be paid to our
shareholders in connection with the Offer and the merger is unfair and grossly inadequate and did
not result from an appropriate consideration of our value or the strategic alternatives available
to us. The plaintiff alleges that, following the announcement of the Merger Agreement, our stock
has traded over the value of the Offer consideration and that this suggests that the Offer and the
merger does not reflect fair value of our common stock. The plaintiff asserts that our directors
placed their own interests ahead of those of our shareholders in that the Offer and the merger
offers an inadequate premium to the shareholders but will provide substantial personal benefits to
the defendants. The plaintiff claims that the termination fee and no shop provisions of the
Merger Agreement act as a disincentive to other potential bidders and preclude us from taking steps
to maximize shareholder value. The plaintiff also alleges that our directors have failed to
disclose all material information to our shareholders concerning the Offer and the merger. The
petition seeks various forms of injunctive relief including an injunction against the consummation
of the Offer and the merger, an order directing our directors to exercise their fiduciary duties to
obtain a transaction that is in the best interests of us and our shareholders until the sale of our
company is completed and the highest price is obtained, an order rescinding the Offer and the
merger if already consummated, the imposition of a constructive trust upon any benefits improperly
received by defendants, and an award of attorneys and experts fees and costs. On July 3, 2008,
the plaintiff filed an amended petition further alleging that defendants had purportedly failed to
disclose allegedly material information relating to the Offer and the merger.
On July 10, 2008, the parties entered into a Memorandum of Understanding regarding the
settlement of the lawsuit. Under the terms of the proposed settlement, the claims of the named
plaintiff and the proposed class of public shareholders will be dismissed and released on behalf of
the settlement class. Finalization of the proposed settlement remains subject to several
conditions, including court approval and completion of the Offer and the merger. In connection
with the proposed settlement, we and Smith have provided additional disclosures in Smiths
22
Registration Statement on Form S-4 and our Solicitation/Recommendation Statement on Schedule
14D-9, respectively. The parties also contemplate that plaintiffs counsel will petition the court
for an award of attorneys fees and expenses to be paid by defendants, up to an agreed-upon limit.
Item 1A.
Risk Factors
For information regarding risks that may affect our business, see the risk factors included in
our most recent Annual Report on Form 10-K under the heading Risk Factors and for information
regarding the risks associated with Smiths Offer and the Acquisition transaction, see the risk
factors included in Smiths Registration Statement on Form S-4 under the heading Risk Factors.
The following are additional factors that could affect our results of operations, cash flows or
financial position or could cause actual results to differ materially from estimates contained in
our forward-looking statements. We may encounter risks in addition to those described below and in
our Annual Report on Form 10-K for the year ended December 31, 2007. Additional risks and
uncertainties not currently known to us, or that we currently deem to be immaterial, may also
impair or adversely affect our results of operation, cash flows and financial condition.
We are subject to a variety of risks associated with the Acquisition transaction, including risks
associated with contractual constraints on our operating flexibility, uncertainties surrounding the
transaction, diversion of our managements attention from our normal operations and similar risks.
Until the Acquisition transaction has closed, we are subject to provisions of the Merger
Agreement with Smith that require us to operate in the ordinary course consistent with our past
practices and that prohibit us from taking certain actions, in each case, without the prior
approval of Smith. These contractual provisions may prevent us from pursuing otherwise attractive
business opportunities and making other changes to our business that may arise prior to completion
of the Acquisition transaction. Additionally, uncertainty about the effect of the Acquisition
transaction may result in difficulties in retaining and hiring employees and could result in the
loss of customers and suppliers. Finally, our management has been required and is expected to
continue to be required to devote substantial time and attention to the Acquisition transaction.
This diversion of managements attention from its normal operating responsibilities, the
restrictions on our operating flexibility, the potential loss of employees, customers and suppliers
and the transaction-related costs that we have incurred and expect to incur could have a material
adverse effect on our results of operations, cash flows and financial position.
Item 4.
Submission of Matters to a Vote of Security Holders
The 2008 annual meeting of the shareholders of the Company was held on May 21, 2007. The
purpose of the meeting was to elect members of our Board of Directors.
At the annual meeting, each of the directors nominated by our Board of Directors to serve a
one-year term until the 2009 annual meeting of shareholders was re-elected (there were no broker
non-votes):
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For
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Withheld
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Kenneth T. White, Jr.
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26,331,361
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813,048
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John R. Brock
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25,603,370
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1,541,039
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James D. Lightner
|
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25,608,099
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1,536,310
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Christopher Mills
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19,747,694
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7,396,715
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Milton L. Scott
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24,422,308
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2,722,101
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Robert H. Whilden, Jr.
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26,337,779
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806,630
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Item 6.
Exhibits
The documents listed on the Exhibit Index following the signature pages hereto are filed with
this Quarterly Report on Form 10-Q, and the contents of such Exhibit Index are hereby incorporated
herein by reference.
23
SIGNATURES
Pursuant to the requirements 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.
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W-H Energy Services, Inc.
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By:
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/s/
Kenneth T. White, Jr.
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Kenneth T. White, Jr.
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Chairman of the Board, President and Chief
Executive Officer
(Principal Executive Officer)
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Date: August 8, 2008
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By:
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/s/
Ernesto Bautista, III
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Ernesto Bautista, III
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Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
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Date: August 8, 2008
24
EXHIBIT INDEX
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2.1
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Agreement and Plan of Merger dated as of June 3, 2008 among W-H Energy Services, Inc., Smith
International, Inc. and Whitehall Acquisition Corp. (incorporated by reference to W-Hs Current Report
on Form 8-K filed with the Commission on June 5, 2008).
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31.1*
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Certification of Chief Executive Officer of W-H Energy Services, Inc. pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
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31.2*
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Certification of Chief Financial Officer of W-H Energy Services, Inc. pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
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32.1*
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Certification of Chief Executive Officer of W-H Energy Services, Inc. pursuant 18 U.S.C. Section 1350
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32.2*
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Certification of Chief Financial Officer of W-H Energy Services, Inc. pursuant 18 U.S.C. Section 1350
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