SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

 

 

Form 10-K

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2006

 

Commission file no. 1-16337

 

Oil States International, Inc.

(Exact name of registrant as specified in its charter)

 

 

Three Allen Center, 333 Clay Street, Suite 4620, Houston, Texas 77002

(Address of Principal Executive Offices) (Zip Code)

 

Registrant’s telephone number, including area code:

(713) 652-0582

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to Section 12(g) of the Act:
None

 

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o

 

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o  No þ

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this form 10-K.  þ

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Exchange Act Rule 12b-2).

Large Accelerated Filer þ     Accelerated Filer o     Non-Accelerated Filer o

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act.  Yes o     No þ

 

State the aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant:

 

 

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date:

As of February 9, 2007     Common Stock, par value $.01 per share     49,298,922 shares

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the Registrant’s Definitive Proxy Statement for the 2007 Annual Meeting of Stockholders, which the Registrant intends to file with the Securities and Exchange Commission not later than 120 days after the end of the fiscal year covered by this Form 10-K, are incorporated by reference into Part III of this Form 10-K.

 

 

TABLE OF CONTENTS

 

 

This Annual Report on Form 10-K contains forward-looking statements within the meaning of Section 27A of the Securities Exchange Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Actual results could differ materially from those projected in the forward-looking statements as a result of a number of important factors. For a discussion of important factors that could affect our results, please refer to “Item 1. Business” including the risk factors discussed therein and the financial statement line item discussions set forth in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” below.

 

Cautionary Statement Regarding Forward-Looking Statements

 

We include the following cautionary statement to take advantage of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 for any forward-looking statement made by us, or on our behalf. The factors identified in this cautionary statement are important factors (but not necessarily all of the important factors) that could cause actual results to differ materially from those expressed in any forward-looking statement made by us, or on our behalf. You can typically identify forward-looking statements by the use of forward-looking words such as “may,” “will,” “could,” “project,” “believe,” “anticipate,” “expect,” “estimate,” “potential,” “plan,” “forecast,” and other similar words. All statements other than statements of historical facts contained in this Annual Report on Form 10-K, including statements regarding our future financial position, budgets, capital expenditures, projected costs, plans and objectives of management for future operations and possible future acquisitions, are forward-looking statements. Where any such forward-looking statement includes a statement of the assumptions or bases underlying such forward-looking statement, we caution that, while we believe such assumptions or bases to be reasonable and make them in good faith, assumed facts or bases almost always vary from actual results. The differences between assumed facts or bases and actual results can be material, depending upon the circumstances.

 

Where, in any forward-looking statement, we, or our management, express an expectation or belief as to the future results, such expectation or belief is expressed in good faith and believed to have a reasonable basis. However, there can be no assurance that the statement of expectation or belief will result or be achieved or accomplished. Taking this into account, the following are identified as important factors that could cause actual results to differ materially from those expressed in any forward-looking statement made by, or on behalf of, our company:

 

 

Our Company

 

Oil States International, Inc. (the “Company”), through its subsidiaries, is a leading provider of specialty products and services to oil and gas drilling and production companies throughout the world. We operate in a substantial number of the world’s active oil and gas producing regions, including the Gulf of Mexico, U.S. onshore, West Africa, the North Sea, Canada, South America and Southeast Asia. Our customers include many of the major and independent oil and gas companies and other oilfield service companies. We operate in three principal business segments — offshore products, tubular services and well site services — and have established a leadership position in each.

 

Available Information

 

The Company maintains a website with the address www.oilstatesintl.com. The Company is not including the information contained on the Company’s website as a part of, or incorporating it by reference into, this Annual Report on Form 10-K. The Company makes available free of charge through its website its Annual Report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, and amendments to these reports, as soon as reasonably practicable after the Company electronically files such material with, or furnishes such material to, the Securities and Exchange Commission (SEC). The Board of Directors of the Company documented its governance practices by adopting several corporate governance policies. These governance policies, including the Company’s corporate governance guidelines and its code of business conduct and ethics, as well as the charters for the committees of the Board (Audit Committee, Compensation Committee and Nominating and Corporate Governance Committee) may also be viewed at the Company’s website. Copies of such documents will be sent to shareholders free of charge upon written request of the corporate secretary at the address shown on the cover page of this Form 10-K.

 

In accordance with New York Stock Exchange (NYSE) Rules, on May 26, 2006, the Company filed the annual certification by our CEO that, as of the date of the certification, the Company was in compliance with the NYSE’s corporate governance listing standards.

 

Our Background

 

Oil States International, Inc. was originally incorporated in July 1995. In July 2000, Oil States International, Inc., including its principal operating subsidiaries, Oil States Industries, Inc. (Oil States Industries), HWC Energy Services, Inc. (HWC), PTI Group Inc. (PTI) and Sooner Inc. (Sooner) entered into a Combination Agreement (the Combination Agreement) providing that, concurrently with the closing of our initial public offering, HWC, PTI and Sooner would merge with wholly owned subsidiaries of Oil States (the Combination). As a result, HWC, PTI and Sooner became wholly owned subsidiaries of Oil States in February 2001. In this Annual Report on Form 10-K, references to the “Company” or to “we,” “us,” “our,” and similar terms are to Oil States International, Inc. and its subsidiaries following the Combination.

 

Acquisitions

 

Since the completion of our initial public offering in February 2001, we have completed 31 acquisitions for total consideration of $355 million. Acquisitions of other oil service businesses have been an important aspect of our growth strategy and plans to increase shareholder value.

 

In 2002, we acquired six businesses for total consideration of approximately $72.1 million. Three of these businesses were rental tool companies added to our well site services segment. An elastomer molding company, certain assets and related liabilities of a subsea pipeline equipment and repair services company and an offshore crane manufacturer and crane repair service provider were acquired and became part of our offshore products segment.

 

In 2003, we spent $16.8 million to acquire five businesses. Three of the businesses were rental tool companies acquired for a total consideration of $10.5 million. The acquired rental tool companies conduct operations in South Texas and Louisiana and were combined with our existing rental tool business within our well site services segment. The remaining two businesses, acquired for aggregate consideration of $6.3 million, were combined with our offshore products segment.

 

In 2004, we acquired six rental tool businesses, a tubular distribution business and a small tooling line for total consideration of $89.1 million. In January 2004, we acquired the stock of five related rental tool companies for $36.6 million and in April 2004 we acquired the assets of a rental tool business for $4.8 million. In May 2004, we purchased an oil country tubular goods (“OCTG”) distribution business for $47.2 million. In October 2004, we acquired a tooling product line into our offshore products segment for $0.5 million.

 

In 2005, we completed nine acquisitions for total consideration of $158.6 million. In our well site services segment we acquired a Wyoming based land drilling company, five related entities providing wellhead isolation equipment and services, and a Canadian manufacturer of work force accommodations. Our tubular services segment acquired a Texas based OCTG distributor, and our offshore products segment acquired a small product line.

 

In August 2006, we acquired three drilling rigs operating in West Texas for total consideration of $14.0 million, including a note payable to the seller of $0.5 million. The rigs acquired, which are classified as part of our capital expenditures in 2006, were added to our existing West Texas drilling fleet in our drilling services business.

 

Workover Services Business Transaction

 

Effective March 1, 2006, we completed a transaction to combine our workover services business with Boots & Coots International Well Control, Inc. (AMEX: WEL) (“Boots & Coots”) in exchange for 26.5 million shares of Boots & Coots common stock and senior subordinated promissory notes totaling $21.2 million. Our workover services business was part of our well site services segment prior to the combination.

 

As a result of the closing of the transaction, we acquired approximately 26.5 million shares of Boots & Coots common stock, which currently represent 44.6% of its outstanding common stock. The senior subordinated promissory notes received in the transaction bear a fixed annual interest rate of 10% and mature four and one half years from the closing of the transaction. In connection with this transaction, we also entered into a Registration Rights Agreement requiring Boots & Coots to file a shelf registration statement within 30 days for all of the Boots & Coots shares we received in the transaction and also allowing us certain rights to include our shares of common stock of Boots & Coots in a registration statement filed by Boots & Coots. The shelf registration statement has been filed by Boots & Coots and was declared effective in the fourth quarter of 2006. The transaction terms also allowed us to designate three additional members to Boots & Coots’ existing five-member Board of Directors. All three directors designated by us have joined the Boots & Coots Board of Directors as of January 1, 2007.

 

The transaction resulted in a non-cash pretax gain of $20.7 million of which $9.4 million has not been recognized in accordance with the guidance set forth in Emerging Issues Task Force Issue No. 01-2 covering gain recognition involving non-cash transactions and retained equity interests. After the gain adjustment and income taxes, the transaction had a $5.9 million, or $0.12 per diluted share, impact on net income and earnings per share, respectively, in 2006. We account for our investment in Boots & Coots utilizing the equity method of accounting. Differences between Boots & Coots’ total book equity after the transaction, net to our interest, and the carrying value of our investment in Boots & Coots are principally attributable to the unrecognized gain on the sale of the workover services business and to goodwill.

 

On February 9, 2007, Boots & Coots announced it had filed a registration statement to sell 26 million shares of common stock including 13 million shares we own. The closing price of Boots & Coots common stock on the date of the announcement was $2.26. We own a total of 26.5 million shares of Boots & Coots common stock with a carrying value of $1.31 per share as of December 31, 2006. There can be no assurance about the timing of this announced stock sale or whether this transaction will ultimately take place.

 

Our Industry

 

We operate in the oilfield services industry and provide a broad range of products and services to our customers through our offshore products, tubular services and well site services business segments. Demand for our products and services is cyclical and substantially dependent upon activity levels in the oil and gas industry, particularly our customers’ willingness to spend capital on the exploration and development of oil and gas reserves. Demand for our products and services by our customers is highly sensitive to current and expected oil and natural gas prices. See Note 14 to our Consolidated Financial Statements included in this Annual Report on Form 10-K for financial information by segment and a geographical breakout of revenues and long-lived assets.

 

Our financial results reflect the cyclical nature of the oilfield services business. Since 2001, there have been periods of increasing and decreasing activity in each of our operating segments.

 

Our Well Site Services businesses, which are significantly affected by the North American rig count, saw decreased activity in 2002 and early 2003 and saw increasing activity from 2003 through 2006. Acquisitions and capital expenditures made in this segment have created additional growth opportunities. In addition, the increased activity supporting oil sands developments in northern Alberta, Canada by our work force accommodations, catering and logistics business in this segment have had a positive impact on this segment’s overall trends.

 

Our Offshore Products segment, which is more influenced by deepwater development activity and rig construction and repair, experienced increased activity during 2003 as we shipped projects from our backlog which had increased in 2002. In 2004, activity in this segment slowed; however, backlog has increased significantly from 2004 to 2006 and is at record high levels currently, which has resulted in improved operating results during 2005 and 2006.

 

Our Tubular Services business is influenced by some of the same factors as our Well Site Services. In addition, during 2004 and 2005, this segment was positively affected in a significant manner by increasing prices for steel products, including the OCTG we sell. During 2006, prices for steel products remained comparatively stable compared to the previous two years.

 

Well Site Services

 

Overview

 

During the year ended December 31, 2006, we generated approximately 34% of our revenue and 61% of our operating income, before corporate charges, from our well site services segment. Our well site services segment includes a broad range of products and services that are used to establish and maintain the flow of oil and gas from a well throughout its lifecycle and to accommodate personnel in remote locations. Our services include drilling services, rental equipment, work force accommodations, catering and logistics services and modular building construction services. We use our fleet of drilling rigs, rental equipment and work force accommodation facilities to serve our customers at well sites and project development locations. Our products and services are used in both onshore and offshore applications throughout the exploration, development, production and abandonment phases of a well’s life. Additionally, our work force accommodations, catering and logistics services are employed to support work forces in a variety of mining and related natural resource applications as well as forest fire fighting and disaster relief efforts.

 

Well Site Services Market

 

Demand for our drilling rigs, rental equipment and work force accommodations, catering and logistics services has historically been tied to the level of activity by oil and gas explorationists and producers. The primary driver for this activity is the price of oil and natural gas. Activity levels have been and we expect will continue to be highly correlated with hydrocarbon commodity prices.

 

Products and Services

 

Drilling Services.  Our drilling services business is located in Odessa, Texas, Wooster, Ohio and Casper, Wyoming and provides drilling services for shallow to medium depths ranging from 2,000 to 11,500 feet. Drilling services are typically used during the exploration and development stages of a field. We have a total of 32 semi-automatic drilling rigs with hydraulic pipe handling booms and lift capacities ranging from 200,000 to 300,000 pounds. Twenty of these drilling rigs are located in Odessa, Texas, eight in the Rocky Mountains region and four are located in Wooster, Ohio. On December 31, 2006, 25 rigs were working or under contract. Utilization increased slightly from 87.8% in 2005 to 90.0% in 2006. We have assembled seven of our new rigs that have been added to our fleet during 2003 through 2006 in our Odessa, Texas facility with components purchased from specialty vendors. Two additional rigs were under construction in Odessa, Texas at December 31, 2006, both of which are expected to commence two-year contracts with an independent E&P company in the Rocky Mountains region by July and September 2007. In August 2006, we acquired three drilling rigs from Eagle Rock Drilling which were added to our existing West Texas drilling fleet. We may continue to add rigs depending upon our market outlook.

 

We market our drilling services directly to a diverse customer base, consisting of both major and independent oil companies. During 2005 we switched from billing on a footage basis to billing on a dayrate basis for many of our drilling rigs. Under a daywork drilling contract, the customer pays for certain costs that the Company would normally provide when drilling on a footage basis, and the customer assumes more risk than on a footage basis. Depending on market conditions and availability of drilling rigs, we may see changes in pricing, utilization and contract terms, which could include requests for footage contracts. The land drilling business is highly fragmented and consists of a small number of large companies and many smaller companies.

 

Rental Equipment.  Our rental equipment business provides a wide range of products for use in the offshore and onshore oil and gas industry, including:

 

 

Our rental equipment is used during the exploration, development, production and abandonment stages. As of December 31, 2006, we provided rental equipment at 53 U.S. distribution points in Texas, Louisiana, Oklahoma, Arkansas, Mississippi, New Mexico, Wyoming, California, Colorado, North Dakota, Utah, Canada, Mexico and Argentina. We provide rental equipment on a day rental basis with rates varying depending on the type of equipment and the length of time rented. In certain operations, we also provide service personnel in connection with the equipment rental. We own patents covering some of our rental tools, particularly, in our wellhead isolation equipment product line.

 

Work Force Accommodations, Catering and Logistics and Modular Building Construction.  We are a large provider of integrated products and services to support workers in remote locations, including work force accommodations, food services, remote site management services and modular building construction. We provide complete design, manufacture, installation, operation and redeployment logistics services for oil and gas drilling, oil sands development in the Fort McMurray region of Northern Canada, offshore construction and diamond mining in Northern Canada. We have also provided these services for other mining ventures throughout the world, pipeline construction, forestry and firefighting operations, disaster relief services and support services for military operations on a worldwide basis. Our work force products and service operations are primarily focused in Canada and the Gulf of Mexico although, in the past, we have also performed catering and facilities management services in other international areas including the Middle East, Europe, Asia and South America. During the peak of our operating season, we typically provide these services in over 200 separate locations with separate location populations ranging from 20 to 2,000 persons. Much of our business line growth and profitability in 2005 and 2006 has been generated from capital investments that we have made in accommodations that support our customers who are developing prospects in the oil sands region of Canada. During 2005 and 2006, we invested capital of $56.5 million in two lodges which accommodate up to 1,548 personnel in the oil sands region. Furthermore, 33% of our planned capital expenditures in 2007 are expected to be spent on accommodations supporting oil sands projects in the Fort McMurray region. We design, construct and install a variety of portable modular buildings, including housing, kitchens, recreational units and offices for lease or sale to the Canadian and Gulf of Mexico markets. Our designers work closely with our clients to build structures that best serve their needs.

 

Offshore Products

 

Overview

 

During the year ended December 31, 2006, we generated approximately 20% of our revenue and 18% of our operating income, before corporate charges, from our offshore products segment. Through this segment, we design and manufacture a number of cost-effective, technologically advanced products for the offshore energy industry. In addition, we have other lower margin products and services such as fabrication and inspection services. Our products and services are used in both shallow and deepwater producing regions and include flex-element technology, advanced connector systems, blow-out preventor stack integration and repair services, deepwater mooring and lifting systems, offshore equipment and installation services and subsea pipeline products. We have facilities in Arlington, Houston and Lampasas, Texas; Houma, Louisiana; Tulsa, Oklahoma; Scotland; Brazil; England; Singapore and Thailand that support our offshore products segment.

 

Offshore Products Market

 

The market for our offshore products and services depends primarily upon development of infrastructure for offshore production activities, drilling rig refurbishments and upgrades and new rig construction. As demand for oil and gas increases and related drilling and production increases in offshore areas throughout the world, particularly in deeper water, we expect spending on these activities to increase.

 

The upgrade of existing rigs to equip them with the capability to drill in deeper water and withstand harsh operating conditions, the construction of new deepwater-capable rigs, and the installation of fixed or floating production systems require specialized products and services like the ones we provide.

 

Products and Services

 

Our offshore products segment provides a broad range of products and services for use in offshore drilling and development activities. In addition, this segment provides onshore oil and gas, defense and general industrial products and services. Our offshore products segment is dependent in part on the industry’s continuing innovation and creative applications of existing technologies.

 

We design and build manufacturing and testing systems for many of our new products and services. These testing and manufacturing facilities enable us to provide reliable, technologically advanced products and services. Our Aberdeen facility provides structural testing including full-scale product simulations.

 

Offshore Development and Drilling Activities.  We design, manufacture, fabricate, inspect, assemble, repair, test and market subsea equipment and offshore vessel and rig equipment. Our products are components of equipment used for the drilling and production of oil and gas wells on offshore fixed platforms and mobile production units, including floating platforms and floating production, storage and offloading (FPSO) vessels, and on other marine vessels, floating rigs and jack-ups. Our products and services include:

 

 

Flexible Bearings and Connector Products.  We are the principal supplier of flexible bearings, or FlexJoints^®, to the offshore oil and gas industry. We also supply connections and fittings that join lengths of large diameter conductor or casing used in offshore drilling operations. FlexJoints^® are flexible bearings that permit movement of riser pipes or tension leg platform tethers under high tension and pressure. They are used on drilling, production and export risers and are used increasingly as offshore production moves to deeper water areas. Drilling riser systems provide the vertical conduit between the floating drilling vessel and the subsea wellhead. Through the drilling riser, equipment is guided into the well and drilling fluids are returned to the surface. Production riser systems provide the vertical conduit from the subsea wellhead to the floating production platform. Oil and gas flows to the surface for processing through the production riser. Export risers provide the vertical conduit from the floating production platform to the subsea export pipelines. FlexJoints^® are a critical element in the construction and operation of production and export risers on floating production systems in deepwater.

 

Floating production systems, including Tension Leg Platforms, Spars and FPSO facilities, are a significant means of producing oil and gas, particularly in deepwater environments. We provide many important products for the construction of these facilities. A tension leg platform is a floating platform that is moored by vertical pipes, or tethers, attached to both the platform and the sea floor. Our FlexJoint^® tether bearings are used at the top and bottom connections of each of the tethers, and our Merlin connectors are used to join shorter pipe sections to form long pipes offshore. A Spar is a floating vertical cylindrical structure which is approximately six to seven times longer

than its diameter and is anchored in place. Our FlexJoints^® are also used to attach the steel catenary risers to a Spar or FPSO and for use on import or export risers.

 

Subsea Pipeline Products.  We design and manufacture a variety of fittings and connectors used in offshore oil and gas pipelines. Our products are used for new construction, maintenance and repair applications. New construction fittings include:

 

 

We provide diverless connection systems for subsea flowlines and pipelines. Our HydroTech^® collet connectors provide a high-integrity, proprietary metal-to-metal sealing system for the final hook-up of deep offshore pipelines and production systems. They also are used in diverless pipeline repair systems and in future pipeline tie-in systems. Our lateral tie-in sled, which is installed with the original pipeline, allows a subsea tie-in to be made quickly and efficiently using proven HydroTech^® connectors without costly offshore equipment mobilization and without shutting off product flow.

 

We provide pipeline repair hardware, including deepwater applications beyond the depth of diver intervention. Our products include:

 

 

Marine Winches, Mooring and Lifting Systems and Rig Equipment.  We design, engineer and manufacture marine winches, mooring and lifting systems and rig equipment. Our Skagit^® winches are specifically designed for mooring floating and semi-submersible drilling rigs and positioning pipelay and derrick barges, anchor handling boats and jack-ups, while our Nautilus^® marine cranes are used on production platforms throughout the world. We also design and fabricate rig equipment such as automatic pipe racking and blow-out preventor handling equipment. Our engineering teams, manufacturing capability and service technicians who install and service our products provide our customers with a broad range of equipment and services to support their operations. Aftermarket service and support of our installed base of equipment to our customers is also an important source of revenues to us.

 

BOP Stack Assembly, Integration, Testing and Repair Services.  We design and fabricate lifting and protection frames and offer system integration of blow-out preventor stacks and subsea production trees. We can provide complete turnkey and design fabrication services. We also design and manufacture a variety of custom subsea equipment, such as riser flotation tank systems, guide bases, running tools and manifolds. In addition, we also offer blow-out preventor and drilling riser testing and repair services.

 

Other Products and Services.  We provide equipment for securing subsea structures and offshore platform jackets, including our Hydra-Lok^® hydraulic system. The Hydra-Lok^® tool, which has been successfully used at depths of 3,000 feet, does not require diver intervention or guide lines.

 

We also provide cost-effective, standardized leveling systems for offshore structures that are anchored by foundation piles, including subsea templates, subsea manifolds and platform jackets.

 

Our offshore products segment also produces a variety of products for use in applications other than in the offshore oil and gas industry. For example, we provide:

 

 

Backlog.  Backlog in our offshore products segment was $349.3 million at December 31, 2006, compared to $110.7 million at December 31, 2005 and $97.5 million at December 31, 2004. We expect the majority of our backlog at December 31, 2006 to be completed in 2007. Our offshore products backlog consists of firm customer purchase orders for which contractual commitments exist and delivery is scheduled. In some instances, these purchase orders are cancelable by the customer, subject to the payment of termination fees and/or the reimbursement of our costs incurred. Although our backlog is an important indicator of future offshore products shipments and revenues, backlog as of any particular date may not be indicative of our actual operating results for any future period. We believe that the offshore construction and development business is characterized by lengthy projects and a long “lead-time” order cycle. The change in backlog levels from one period to the next does not necessarily evidence a long-term trend.

 

Regions of Operations

 

Our offshore products segment provides products and services to customers in the major offshore oil and gas producing regions of the world, including the Gulf of Mexico, West Africa, Azerbaijan, the North Sea, Brazil and Southeast Asia.

 

Customers and Competitors

 

We market our products and services to a broad customer base, including the direct end users, engineering and design companies, prime contractors, and at times, our competitors through outsourcing arrangements.

 

Tubular Services

 

Overview

 

During the year ended December 31, 2006, we generated approximately 46% of our revenue and 21% of our operating income, before corporate charges, from our tubular services segment. Through this segment, we distribute OCTG and provide associated OCTG finishing and logistics services to the oil and gas industry. OCTG consist of downhole casing and production tubing. Through our tubular services segment, we:

 

 

We serve a customer base ranging from major oil companies to small independents. Through our key relationships with more than 20 domestic and foreign manufacturers and related service providers and suppliers of OCTG, we deliver tubular products and ancillary services to oil and gas companies, drilling contractors and consultants predominantly in the United States. The OCTG distribution market is highly fragmented and competitive, and is focused in the United States. We purchase tubular goods from a variety of sources. However, during 2006, we purchased from a single domestic supplier 46% of the tubular goods we distributed and from three domestic suppliers approximately 79% of such tubular goods.

 

OCTG Market

 

Our tubular services segment primarily distributes casing and tubing. Casing forms the structural wall in oil and gas wells to provide support, control pressure and prevent caving during drilling operations. Casing is also used

to protect water-bearing formations during the drilling of a well. Casing is generally not removed after it has been installed in a well. Production tubing, which is used to bring oil and gas to the surface, may be replaced during the life of a producing well.

 

A key indicator of domestic demand for OCTG is the average number of drilling rigs operating in the United States. The OCTG market at any point in time is also affected by the level of inventories maintained by manufacturers, distributors and end users. Demand for tubular products is positively impacted by increased drilling of deeper, horizontal and offshore wells. Deeper wells require incremental tubular footage and enhanced mechanical capabilities to ensure the integrity of the well. Premium tubulars are used in horizontal drilling to withstand the increased bending and compression loading associated with a horizontal well. Operators typically specify premium tubulars for the completion of offshore wells.

 

Products and Services

 

Tubular Products and Services.  We distribute various types of OCTG produced by both domestic and foreign manufacturers to major and independent oil and gas exploration and production companies and other OCTG distributors. We do not manufacture any of the tubular goods that we distribute. As a result, gross margins in this segment are generally lower than those reported by our other segments. We operate our tubular services segment from a total of eight offices and facilities located near areas of oil and gas exploration and development activity. We have distribution relationships with most major domestic and certain international steel mills.

 

In this business, inventory management is critical to our success. We maintain on-the-ground inventory in approximately 60 yards located in the United States, giving us the flexibility to fill our customers’ orders from our own stock or directly from the manufacturer. We have a proprietary inventory management system, designed specifically for the OCTG industry, that enables us to track our product shipments down to the individual joint of pipe.

 

A-Z Terminal.  Our A-Z Terminal pipe maintenance and storage facility in Crosby, Texas is equipped to provide a full range of tubular services, giving us strong customer service capabilities. Our A-Z Terminal is on 109 acres, is an ISO 9001-certified facility and has more than 1,400 pipe racks and two double-ended thread lines. We have exclusive use of a permanent third-party inspection center within the facility. The facility also includes indoor chrome storage capability and patented pipe cleaning machines.

 

We offer services at our A-Z Terminal facility typically outsourced by other distributors, including the following: threading, inspection, cleaning, cutting, logistics, rig returns, installation of float equipment and non-destructive testing.

 

Other Facilities.  We also offer tubular services at our facilities in Midland, Texas and Godley, Texas which were added in the Phillips acquisition. Our Midland, Texas facility covers approximately 60 acres and has more than 400 pipe racks. Our Godley, Texas facility, which services the Barnett shale area, has approximately 60 pipe racks on approximately 13 developed acres and is serviced by a rail spur. Independent third party inspection companies operate within these facilities.

 

Tubular Products and Services Sales Arrangements.  We provide our tubular products and logistics services through a variety of arrangements, including spot market sales and alliances. We provide some of our tubular products and services to independent and major oil and gas companies under alliance arrangements. Although our alliances are generally not as profitable as the spot market and can be cancelled by the customer, they provide us with more stable and predictable revenues and an improved ability to forecast required inventory levels, which allows us to manage our inventory more efficiently.

 

Regions of Operations

 

Our tubular services segment provides tubular products and services principally to customers in the United States both for land and offshore applications. However, we also sell a small percentage for export to other countries, including Brazil, Cameroon, Chad, Columbia, Congo, Ecuador, Egypt, Equatorial Guinea, Gabon, Germany, Guatemala, Hungary, Netherlands, Russia, Scotland, Trinidad, Tunisia and Venezuela.

 

Customers, Suppliers and Competitors

 

Our three largest end-user customers in the tubular distribution market in 2006 were ConocoPhillips, ChevronTexaco Corporation and Chesapeake Energy Corporation. Our three largest suppliers were U.S. Steel Group, Lone Star Steel and Tenaris Global Services USA Corporation (formerly Maverick Tube Corporation). Although we have a leading market share position in tubular services distribution, the market is highly fragmented. Our main competitors in tubular distribution are privately owned distributors including Premier Pipe L.P., Red Man Pipe & Supply Co., Inc., Bourland and Leverich and Pipeco Services.

 

Employees

 

As of December 31, 2006, we had approximately 5,124 full-time employees, 33% of whom are in our offshore products segment, 64% of whom are in our well site services segment, 2% of whom are in our tubular services segment and 1% of whom are in our corporate headquarters. We are party to collective bargaining agreements covering 688 employees located in Canada and the United Kingdom as of December 31, 2006. We believe relations with our employees are good.

 

Government Regulation

 

Our business is significantly affected by foreign, federal, state and local laws and regulations relating to the oil and natural gas industry, worker safety and environmental protection. Changes in these laws, including more stringent regulations and increased levels of enforcement of these laws and regulations, could significantly affect our business. We cannot predict changes in the level of enforcement of existing laws and regulations or how these laws and regulations may be interpreted or the effect changes in these laws and regulations may have on us or our future operations or earnings. We also are not able to predict whether additional laws and regulations will be adopted.

 

We depend on the demand for our products and services from oil and natural gas companies. This demand is affected by changing taxes, price controls and other laws and regulations relating to the oil and gas industry generally, including those specifically directed to oilfield and offshore operations. The adoption of laws and regulations curtailing exploration and development drilling for oil and natural gas in our areas of operation could also adversely affect our operations by limiting demand for our products and services. We cannot determine the extent to which our future operations and earnings may be affected by new legislation, new regulations or changes in existing regulations or enforcement.

 

Some of our employees who perform services on offshore platforms and vessels are covered by the provisions of the Jones Act, the Death on the High Seas Act and general maritime law. These laws operate to make the liability limits established under states’ workers’ compensation laws inapplicable to these employees and permit them or their representatives generally to pursue actions against us for damages or job-related injuries with no limitations on our potential liability.

 

Our operations are subject to numerous foreign, federal, state and local environmental laws and regulations governing the release and/or discharge of materials into the environment or otherwise relating to environmental protection. Numerous governmental agencies issue regulations to implement and enforce these laws, for which compliance is often costly and difficult. The violation of these laws and regulations may result in the denial or revocation of permits, issuance of corrective action orders, assessment of administrative and civil penalties, and even criminal prosecution. We believe that we are in substantial compliance with applicable environmental laws and regulations. Further, we do not anticipate that compliance with existing environmental laws and regulations will have a material effect on our consolidated financial statements. However, there can be no assurance that substantial costs for compliance will not be incurred in the future. Moreover, it is possible that other developments, such as the adoption of stricter environmental laws, regulations and enforcement policies or more stringent enforcement of existing environmental laws and regulations, could result in additional costs or liabilities that we cannot currently quantify.

 

We generate wastes, including hazardous wastes, that are subject to the federal Resource Conservation and Recovery Act, or RCRA, and comparable state statutes. The United States Environmental Protection Agency, or

EPA, and state agencies have limited the approved methods of disposal for some types of hazardous and nonhazardous wastes. Some wastes handled by us in our field service activities that currently are exempt from treatment as hazardous wastes may in the future be designated as “hazardous wastes” under RCRA or other applicable statutes. This would subject us to more rigorous and costly operating and disposal requirements.

 

With regard to our U.S. operations, the federal Comprehensive Environmental Response, Compensation, and Liability Act, or CERCLA, also know as the “Superfund” law, and comparable state statutes impose liability, without regard to fault or legality of the original conduct, on classes of persons that are considered to have contributed to the release of a hazardous substance into the environment. These persons include the owner or operator of the disposal site or the site where the release occurred and companies that disposed of or arranged for the disposal of the hazardous substances at the site where the release occurred. Under CERCLA, these persons may be subject to joint and several liability for the costs of cleaning up the hazardous substances that have been released into the environment and for damages to natural resources, and it is not uncommon for neighboring landowners and other third parties to file claims for personal injury and property damage allegedly caused by the hazardous substances released into the environment. We currently have operations in the United States on properties where activities involving the handling of hazardous substances or wastes may have been conducted prior to our operations on such properties or by third parties whose operations were not under our control. These properties may be subject to CERCLA, RCRA and analogous state laws. Under these laws and related regulations, we could be required to remove or remediate previously discarded hazardous substances and wastes or property contamination that was caused by these third parties. These laws and regulations may also expose us to liability for our acts that were in compliance with applicable laws at the time the acts were performed.

 

In the course of our domestic operations, some of our equipment may be exposed to naturally occurring radiation associated with oil and gas deposits, and this exposure may result in the generation of wastes containing naturally occurring radioactive materials or “NORM.” NORM wastes exhibiting trace levels of naturally occurring radiation in excess of established state standards are subject to special handling and disposal requirements, and any storage vessels, piping, and work area affected by NORM may be subject to remediation or restoration requirements. Because many of the properties presently or previously owned, operated, or occupied by us have been used for oil and gas production operations for many years, it is possible that we may incur costs or liabilities associated with elevated levels of NORM.

 

The Federal Water Pollution Control Act and analogous state laws impose restrictions and strict controls regarding the discharge of pollutants into state waters or waters of the United States. The discharge of pollutants into jurisdictional waters is prohibited unless the discharge is permitted by the EPA or applicable state agencies. Many of our domestic properties and operations require permits for discharges of wastewater and/or stormwater, and we have a system for securing and maintaining these permits. In addition, the Oil Pollution Act of 1990 imposes a variety of requirements on responsible parties related to the prevention of oil spills and liability for damages, including natural resource damages, resulting from such spills in waters of the United States. A responsible party includes the owner or operator of a facility or vessel, or the lessee or permittee of the area in which an offshore facility is located. The Federal Water Pollution Control Act and analogous state laws provide for administrative, civil and criminal penalties for unauthorized discharges and, together with the Oil Pollution Act, impose rigorous requirements for spill prevention and response planning, as well as substantial potential liability for the costs of removal, remediation, and damages in connection with any unauthorized discharges.

 

Some of our operations also result in emissions of regulated air pollutants. The federal Clean Air Act and analogous state laws require permits for facilities in the United States that have the potential to emit substances into the atmosphere that could adversely affect environmental quality. Failure to obtain a permit or to comply with permit requirements could result in the imposition of substantial administrative, civil and even criminal penalties.

 

In response to recent studies suggesting that emissions of certain gases may be contributing to warming of the Earth’s atmosphere, many foreign nations, including Canada, have agreed to limit emissions of these gases, generally referred to as “greenhouse gases,” pursuant to the United Nations Framework Convention on Climate Change, also known as the “Kyoto Protocol”. Methane, a primary component of natural gas, and carbon dioxide a byproduct of the burning of fossil fuels, are examples of greenhouse gases. Although the United States is not participating in the Kyoto Protocol, the current session of Congress is considering climate change legislation, with

multiple bills having already been introduced in the Senate that propose to restrict greenhouse gas emissions. By comparison, several states have already adopted legislation, regulations and/or regulatory initiatives to reduce emissions of greenhouse gases. Also, on November 29, 2006, the U.S. Supreme Court heard arguments on a case appealed from the U.S. Circuit Court of Appeals for the District Columbia, Massachusetts, et al. v. EPA, in which the appellate court held that the U.S. Environmental Protection Agency had discretion under the federal Clean Air Act to refuse to regulate carbon dioxide emissions from mobile sources. Passage of climate change legislation by Congress or a Supreme Court reversal of the appellate decision could result in federal regulation of carbon dioxide emissions and other greenhouse gases. Also, any federal or state restrictions on emissions of greenhouse gases that may be imposed in areas of the United States in which we conduct business could adversely affect our operations and demand for our services.

 

Our operations outside of the United States are potentially subject to similar foreign governmental controls relating to protection of the environment. We believe that, to date, our operations outside of the United States have been in substantial compliance with existing requirements of these foreign governmental bodies and that such compliance has not had a material adverse effect on our operations. However, there is no assurance that this trend of compliance will continue in the future or that such compliance will not be material. For instance, any future restrictions on emissions of greenhouse gases that are imposed in foreign countries in which we operate, such as in Canada, pursuant to the Kyoto Protocol or other locally enforceable requirements could adversely affect demand for our services.

 

Risks Related to Our Business Generally

 

Decreased oil and gas industry expenditure levels will adversely affect our results of operations.

 

We depend upon the oil and gas industry and its ability and willingness to make expenditures which are directly affected by trends in oil and natural gas prices. Demand for our products and services is particularly sensitive to the level of exploration, development and production activity of, and the corresponding capital spending by, oil and natural gas companies, including national oil companies. If our customers’ expenditures decline, our business will suffer. The industry’s willingness to explore, develop and produce depends largely upon the availability of attractive drilling prospects and the prevailing view of future product prices. 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, and a variety of other factors that are beyond our control. A sudden or long term decline in product pricing could materially adversely affect our results of operations. Any prolonged reduction in oil and natural gas prices will depress levels of exploration, development, and production activity, often reflected as reductions in rig counts. Such lower activity levels could materially adversely affect our revenue and profitability. Many factors affect the supply and demand for oil and gas and therefore influence product prices, including:

 

 

 

Extended periods of low oil prices or unsuccessful exploration results may decrease deepwater exploration and production activity and adversely affect our business. Similarly, any such extended periods of low oil prices could adversely affect the level of expenditures for oil sands development and production in Canada.

 

Our offshore products segment depends on exploration and production expenditures in deepwater areas. Because deepwater projects are more capital intensive and take longer to generate first production than shallow water and onshore projects, the economic analyses conducted by exploration and production companies typically assume lower prices for production from such projects to determine economic viability over the long term. The economic analyses conducted by exploration and production companies for very large oil sands developments are similar to those performed for deepwater projects with respect to oil price assumptions. Perceptions of longer-term lower oil prices by these companies can reduce or defer major expenditures given the long-term nature of many large scale development projects, which could adversely affect our revenues and profitability.

 

Because the oil and gas industry is cyclical, our operating results may fluctuate.

 

Oil prices have been and are expected to remain volatile. This volatility causes oil and gas companies and drilling contractors to change their strategies and expenditure levels. We have experienced in the past, and we may experience in the future, significant fluctuations in operating results based on these changes.

 

We do business in international jurisdictions whose regulatory environments and compliance regimes differ from those in the United States. Our business may suffer because our efforts to comply with United States laws and regulations could restrict our ability to do business in international jurisdictions, relative to our competitors who are not subject to United States laws and regulations.

 

Our international business operations include projects in countries where governmental corruption has been known to exist and where our competitors who are not subject to United States laws and regulations, such as the Foreign Corrupt Practices Act, can gain competitive advantages over us by securing business awards, licenses or other preferential treatment in those jurisdictions using methods that United States law and regulations prohibit us from using. For example, our non-U.S. competitors are not subject to the anti-bribery restrictions of the Foreign Corrupt Practices Act, which make it illegal to give anything of value to foreign officials or employees or agents of nationally owned oil companies in order to obtain or retain any business or other advantage. We may be subject to competitive disadvantages to the extent that our competitors are able to secure business, licenses or other preferential treatment by making payments to government officials and others in positions of influence.

 

While we and our subsidiaries are committed to conducting business in a legal and ethical manner, there is a risk of violating the U.S. Foreign Corrupt Practices Act or other applicable anti-corruption regulations that generally prohibit the making of improper payments to foreign officials for the purpose of obtaining or retaining business. Violations of these laws could result in monetary penalties against us or our subsidiaries and could damage our reputation and, therefore, our ability to do business.

 

We might be unable to employ a sufficient number of technical personnel.

 

Many of the products that we sell, especially in our offshore products segment, are complex and highly engineered and often must perform in harsh conditions. We believe that our success depends upon our ability to

employ and retain technical personnel with the ability to design, utilize and enhance these products. In addition, our ability to expand our operations depends in part on our ability to increase our skilled labor force. The demand for skilled workers is high, and the supply is limited. We have already experienced high demand and increased wages for labor forces serving our well site services segment, notably in our accommodations business in Canada. Significant increases in the wages paid by competing employers could further result in a reduction of our skilled labor force, increases in the wage rates that we must pay or both. When these events occur, our cost structure increases and our growth potential could be impaired.

 

The level and pricing of tubular goods imported into the United States could decrease demand for our tubular goods inventory and adversely impact our results of operations. Also, if steel mills were to sell a substantial amount of goods directly to end users in the United States, our results of operations could be adversely impacted.

 

U.S. law currently restricts imports of low-cost tubular goods from a number of foreign countries into the U.S. tubular goods market. If these restrictions were to be lifted or if the level of imported low-cost tubular goods were to otherwise increase, our tubular services segment could be adversely affected to the extent that we then have higher-cost tubular goods in inventory or if prices and margins are driven down by increased supplies of tubular goods. If prices were to decrease significantly, we might not be able to profitably sell our inventory of tubular goods. In addition, significant price decreases could result in a longer holding period for some of our inventory, which could also have a material adverse effect on our tubular services segment.

 

We do not manufacture any of the tubular goods that we distribute. Historically, users of tubular goods in the United States, in contrast to outside the United States, have purchased tubular goods through distributors. If customers were to purchase tubular goods directly from steel mills, our results of operations could be adversely impacted.

 

We are subject to extensive and costly environmental laws and regulations that may require us to take actions that will adversely affect our results of operations.

 

Our drilling operations and our offshore products business are significantly affected by stringent and complex foreign, federal, provincial, state and local laws and regulations governing the discharge of substances into the environment or otherwise relating to environmental protection. We could be exposed to liability for cleanup costs, natural resource damages and other damages as a result of our conduct that was lawful at the time it occurred or the conduct of, or conditions caused by, prior operators or other third parties. Environmental laws and regulations are subject to change in the future, possibly resulting in more stringent requirements. If existing regulatory requirements or enforcement policies change or are more stringently enforced, we may be required to make significant unanticipated capital and operating expenditures.

 

Any failure by us to comply with applicable environmental laws and regulations may result in governmental authorities taking actions against our business that could adversely impact our operations and financial condition, including the:

 

 

We may not have adequate insurance for potential liabilities.

 

Our operations are subject to many hazards. We face the following risks under our insurance coverage:

 

 

 

Even a partially uninsured claim, if successful and of significant size, could have a material adverse effect on our results of operations or consolidated financial position.

 

We are subject to litigation risks that may not be covered by insurance.

 

In the ordinary course of business, we become the subject of various claims, lawsuits and administrative proceedings seeking damages or other remedies concerning our commercial operations, products, employees and other matters, including occasional claims by individuals alleging exposure to hazardous materials as a result of our products or operations. Some of these claims relate to the activities of businesses that we have sold, and some relate to the activities of businesses that we have acquired, even though these activities may have occurred prior to our acquisition of such businesses. We maintain insurance to cover many of our potential losses, and we are subject to various self-retentions and deductibles under our insurance. It is possible, however, that a judgment could be rendered against us in cases in which we could be uninsured and beyond the amounts that we currently have reserved or anticipate incurring for such matters.

 

We might be unable to compete successfully with other companies in our industry.

 

We sell our products and services in competitive markets. In some of our business segments, we compete with the oil and gas industry’s largest oilfield services providers. These companies have greater financial resources than we do. Our business will be adversely affected to the extent that these providers are successful in reducing purchases of our products and services.

 

Risks Related to Our Operations

 

We are susceptible to seasonal earnings volatility due to adverse weather conditions in our regions of operations.

 

Our operations are directly affected by seasonal differences in weather in the areas in which we operate, most notably in Canada and the Gulf of Mexico. A portion of our Canadian work force accommodations, catering and logistics operations is conducted during the winter months when the winter freeze in remote regions is required for exploration and production activity to occur. The spring thaw in these frontier regions restricts operations in the spring months and, as a result, adversely affects our operations and sales of products and services in the second and third quarters. Our operations in the Gulf of Mexico are also affected by weather patterns. Weather conditions in the Gulf Coast region generally result in higher drilling activity in the spring, summer and fall months with the lowest activity in the winter months. In addition, summer and fall drilling activity can be restricted due to hurricanes and other storms prevalent in the Gulf of Mexico and along the Gulf Coast. For example, during 2005, a significant disruption occurred in oil and gas drilling and production operations in the U.S. Gulf of Mexico due to damage inflicted by hurricanes Katrina and Rita. As a result of these seasonal differences, full year results are not likely to be a direct multiple of any particular quarter or combination of quarters.

 

We might be unable to protect our intellectual property rights.

 

We rely on a variety of intellectual property rights that we use in our offshore products and well site services segments, particularly our patents relating to our FlexJoint^® technology and intervention tools utilized in the completion or workover of oil and gas wells. The market success of our technologies will depend, in part, on our ability to obtain and enforce our proprietary rights in these technologies, to preserve rights in our trade secret and non-public information, and to operate without infringing the proprietary rights of others. We may not be able to successfully preserve these intellectual property rights in the future and these rights could be invalidated, circumvented or challenged. If any of our patents or other intellectual property rights are determined to be invalid or unenforceable, or if a court limits the scope of claims in a patent or fails to recognize our trade secret rights, our competitive advantages could be significantly reduced in the relevant technology, allowing competition for our customer base to increase. In addition, the laws of some foreign countries in which our products and services may be

sold do not protect intellectual property rights to the same extent as the laws of the United States. The failure of our company to protect our proprietary information and any successful intellectual property challenges or infringement proceedings against us could adversely affect our competitive position.

 

If we do not develop new competitive technologies and products, our business and revenues may be adversely affected.

 

The market for our offshore products is characterized by continual technological developments to provide better performance in increasingly greater depths and harsher conditions. If we are not able to design, develop and produce commercially competitive products in a timely manner in response to changes in technology, our business and revenues will be adversely affected.

 

Loss of key members of our management could adversely affect our business.

 

We depend on the continued employment and performance of key members of management. If any of our key managers resign or become unable to continue in their present roles and are not adequately replaced, our business operations could be materially adversely affected. We do not maintain “key man” life insurance for any of our officers.

 

If we have to write off a significant amount of goodwill, our earnings will be negatively affected.

 

As of December 31, 2006, goodwill represented approximately 21% of our total assets. We have recorded goodwill because we paid more for some of our businesses than the fair market value of the tangible and separately measurable intangible net assets of those businesses. Current accounting standards, which were effective January 1, 2002, require a periodic review of goodwill for impairment in value and a non-cash charge against earnings with a corresponding decrease in stockholders’ equity if circumstances indicate that the carrying amount will not be recoverable (see Note 6 to our Consolidated Financial Statements included in this Annual Report on Form 10-K).

 

If we were to lose a significant supplier of our tubular goods, we could be adversely affected.

 

During 2006, we purchased from a single domestic supplier approximately 46% of the tubular goods we distributed and from three domestic suppliers approximately 79% of such tubular goods. We do not have contracts with any of these suppliers. If we were to lose any of these suppliers or if production at one or more of the suppliers were interrupted, our tubular services segment and our overall business, financial condition and results of operations could be adversely affected. If the extent of the loss or interruption were sufficiently large, the impact on us would be material.

 

During periods of strong demand, we may be unable to obtain critical project materials on a timely basis.

 

Our operations depend on our ability to procure on a timely basis certain project materials, such as forgings, to complete projects in an efficient manner. Our inability to procure critical materials during times of strong demand could have a material adverse effect on our business and operations.

 

Provisions contained in our certificate of incorporation and bylaws could discourage a takeover attempt, which may reduce or eliminate the likelihood of a change of control transaction and, therefore, the ability of our stockholders to sell their shares for a premium.

 

Provisions contained in our certificate of incorporation and bylaws, such as a classified board, limitations on the removal of directors, on stockholder proposals at meetings of stockholders and on stockholder action by written consent and the inability of stockholders to call special meetings, could make it more difficult for a third party to acquire control of our company. Our certificate of incorporation also authorizes our board of directors to issue preferred stock without stockholder approval. If our board of directors elects to issue preferred stock, it could increase the difficulty for a third party to acquire us, which may reduce or eliminate our stockholders’ ability to sell their shares of common stock at a premium.

 

 

None.

 

The following table presents information about our principal properties and facilities. Except as indicated below, we own all of these properties or facilities.

 

 

We have six tubular sales offices and a total of 53 rental tool supply and distribution points in Texas, Louisiana, New Mexico, Mississippi, Oklahoma, Wyoming, California, Colorado, North Dakota, Utah, Arkansas, Canada,

Mexico and Argentina. Most of these office locations are leased and provide sales, technical support and personnel services to our customers. We also have various offices supporting our business segments which are both owned and leased.

 

We are a party to various pending or threatened claims, lawsuits and administrative proceedings seeking damages or other remedies concerning our commercial operations, products, employees and other matters, including occasional claims by individuals alleging exposure to hazardous materials as a result of our products or operations. Some of these claims relate to matters occurring prior to our acquisition of businesses, and some relate to businesses we have sold. In certain cases, we are entitled to indemnification from the sellers of businesses and in other cases, we have indemnified the buyers of businesses from us. Although we can give no assurance about the outcome of pending legal and administrative proceedings and the effect such outcomes may have on us, we believe that any ultimate liability resulting from the outcome of such proceedings, to the extent not otherwise provided for or covered by indemnity or insurance, will not have a material adverse effect on our consolidated financial position, results of operations or liquidity.

 

On February 18, 2005, we announced that we had conducted an internal investigation prompted by the discovery of over billings totaling approximately $400,000 by one of our subsidiaries (the “Subsidiary”) to a government owned oil company in South America. The over billings were detected by the Company during routine financial review procedures, and appropriate financial statement adjustments were included in our previously reported fourth quarter 2004 results. We and independent counsel retained by our Audit Committee conducted separate investigations consisting of interviews and a thorough examination of the facts and circumstances in this matter. We voluntarily reported the results of our investigation to the Securities and Exchange Commission (the SEC) and fully cooperated with requests for information received from the SEC. On October 31, 2005, our counsel received a “Wells Notice” from the SEC staff indicating that it made a preliminary decision to recommend that the SEC bring a civil action against the Company alleging violations of provisions of the Securities and Exchange Act of 1934 (the Act) relating to the maintenance of books, records and internal accounting controls and procedures as set forth in Sections 13(b)(2)(A) and (B) of the Act. The Company reached a settlement agreement with the SEC on April 27, 2006. The Company consented to an Order by the SEC (the Order), without admitting or denying the findings in the Order, that required the Company to cease and desist from committing or causing violations of the “books and records” and “internal control provisions” of the Act. The settlement did not require the Company to pay a monetary penalty.

 

No matters were submitted to a vote of security holders during the fourth quarter of 2006.

 

Common Stock Information

 

Our authorized common stock consists of 200,000,000 shares of common stock. There were 49,298,922 shares of common stock outstanding as of February 9, 2007, including 256,787 shares of common stock issuable upon exercise of exchangeable shares of one of our Canadian subsidiaries. These exchangeable shares, which were issued to certain former shareholders of PTI in the Combination, are intended to have characteristics essentially equivalent to our common stock prior to the exchange. For purposes of this Annual Report on Form 10-K, we have treated the shares of common stock issuable upon exchange of the exchangeable shares as outstanding. The approximate number of record holders of our common stock as of February 9, 2007 was 50. Our common stock is traded on the New York Stock Exchange under the ticker symbol OIS. The closing price of our common stock on February 9, 2007 was $29.47 per share.

 

The following table sets forth the range of high and low sale prices of our common stock.

 

 

We have not declared or paid any cash dividends on our common stock since our initial public offering and do not intend to declare or pay any cash dividends on our common stock in the foreseeable future. Furthermore, our existing credit facilities restrict the payment of dividends. Any future determination as to the declaration and payment of dividends will be at the discretion of our Board of Directors and will depend on then existing conditions, including our financial condition, results of operations, contractual restrictions, capital requirements, business prospects and other factors that our Board of Directors considers relevant. During the first quarter of 2005, our Board of Directors authorized the repurchase of up to $50 million of our common stock, par value $.01 per share, over a two year period. On August 25, 2006, an additional $50 million was approved for the repurchase program and the duration of the program was extended to August 31, 2008. Through February 9, 2007, we have repurchased 1,824,432 shares of our common stock for $50.0 million under the repurchase program, leaving $50 million available for future share repurchases.

 

PERFORMANCE GRAPH

 

The following performance graph and chart compare the cumulative total stockholder return on the Company’s common stock to the cumulative total return on the Standard & Poor’s 500 Stock Index and Philadelphia OSX Index, an index of oil and gas related companies which represent an industry composite of the Company’s peer group, for the period from December 31, 2001 to December 31, 2006. The graph and chart show the value at the dates indicated of $100 invested at December 31, 2001 and assume the reinvestment of all dividends.

 

COMPARISON OF 5 YEAR CUMULATIVE TOTAL RETURN*
AMONG OIL STATES INTERNATIONAL, INC., THE S & P 500 INDEX
AND THE PHLX OIL SERVICE SECTOR INDEX (OSX)

 

 

Oil States International - NYSE

 

 

 

 

 

Copyright ^© 2007, Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved. www.researchdatagroup.com/S&P.htm

Equity Compensation Plans

 

The information relating to our equity compensation plans required by Item 5 is incorporated by reference to such information as set forth in Item 12. “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” contained herein.

 

Unregistered Sales of Equity Securities and Use of Proceeds

 

None

 

Purchases of Equity Securities by the Issuer and Affiliated Purchases

 

 

 

 

The selected financial data on the following pages include selected historical financial information of our company as of and for each of the five years ended December 31, 2006. The following data should be read in conjunction with Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Company’s financial statements, and related notes included in Item 8, Financial Statements and Supplementary Data of this Annual Report on Form 10-K.

 

Selected Financial Data

 

 

 

 

 

We believe that net income is the financial measure calculated and presented in accordance with generally accepted accounting principles that is most directly comparable to EBITDA as defined. The following table reconciles EBITDA as defined with our net income, as derived from our financial information:

 

 

You should read the following discussion and analysis together with our consolidated financial statements and the notes to those statements included elsewhere in this Annual Report on Form 10-K.

 

Overview

 

We provide a broad range of products and services to the oil and gas industry through our offshore products, tubular services and well site services business segments. Demand for our products and services is cyclical and substantially dependent upon activity levels in the oil and gas industry, particularly our customers’ willingness to spend capital on the exploration for and development of oil and gas reserves. Demand for our products and services by our customers is highly sensitive to current and expected oil and natural gas prices. Generally, our tubular services and well site services segments respond more rapidly to shorter-term movements in oil and natural gas prices than our offshore products segment. Our offshore products segment provides highly engineered and technically designed products for offshore oil and gas development and production systems and facilities. Sales

of our offshore products and services depend upon the development of offshore production systems, repairs and upgrades of existing offshore drilling rigs and construction of new offshore drilling rigs. In this segment, we are particularly influenced by deepwater drilling and production activities, which are driven largely by our customers’ longer-term outlook for oil prices. Through our tubular services segment, we distribute a broad range of casing and tubing. Sales and gross margins of our tubular services segment depend upon the overall level of drilling activity, the types of wells being drilled (for example, deepwater wells usually require higher priced seamless alloy tubulars) and the level of OCTG inventory and pricing. Historically, tubular services’ gross margin expands during periods of rising OCTG prices and contracts during periods of decreasing OCTG prices. In our well site services business segment, we provide land drilling services, work force accommodations, catering and logistics services and rental tools. Demand for our drilling services is driven by land drilling activity in Texas, New Mexico, Ohio and in the Rocky Mountains area in the U.S. Our rental tools and services depend primarily upon the level of drilling, completion and workover activity in the U.S. and Canada. Our accommodations business is conducted primarily in Canada and its activity levels have historically been driven by oil and gas drilling and mining activities. However, we have seen increased demand in our work force accommodation business as a result of oil sands development activities in Northern Alberta, Canada. Effective March 1, 2006, we completed a transaction to combine our workover services business with Boots & Coots which resulted in our acquiring a 45.6% equity interest in Boots & Coots (see Note 7 to the Consolidated Financial Statements included in this Annual Report on Form 10-K).

 

We have a diversified product and service offering which has exposure to activities conducted throughout the oil and gas cycle. Demand for our tubular services and well site services segments are highly correlated to changes in the drilling rig count in the United States and Canada. The table below sets forth a summary of North American rig activity, as measured by Baker Hughes Incorporated, for the periods indicated.

 

 

The average North American rig count for the year ended December 31, 2006 increased by 278 rigs, or 15.1%, compared to the year ended December 31, 2005. This overall increase in activity, while tempered somewhat by flat activity levels in the U.S. Gulf of Mexico, contributed to increased revenues in our tubular services and well site services segments in 2006. The North American rig count and related oil service activity has remained at high levels generally, although the Canadian rig count in 2007 to-date is down 11.4% from the comparable period in 2006.

 

Our well site services segment results for the year 2006 also benefited from capital spending, which aggregated $117.4 million in the year ended December 31, 2006, the acquisition of Elenburg on February 1, 2005 for total consideration of $22.1 million, the acquisition of Stinger on May 1, 2005 and June 1, 2005 for total consideration of $96.1 million and the impact of increased activity levels and pricing gains in certain business lines.

 

On June 2, 2005 we acquired all of the outstanding stock of Phillips Casing and Tubing, L.P. (Phillips) for total consideration of $31.2 million. This acquisition resulted in increased OCTG inventory and revenues from the date of acquisition. Our tubular services segment shipped 481,900 tons of OCTG in 2006 (118,400 tons in the fourth quarter of 2006) compared to 405,300 tons in 2005 (118,600 tons in the fourth quarter of 2005). Our tubular services segment also benefited in the past year from a 20.5% year over year increase in average U.S. land drilling activity.

 

Management believes that, based on the current economic environment, oil and gas producers will continue to explore for and develop oil and gas reserves at an active pace in spite of a decline in current U.S. domestic natural gas prices, which reflect high storage levels compared to the prior five year historical range, given their longer term views of supply and demand fundamentals. Management estimates that approximately 60% of the Company’s revenues are dependent on North American natural gas drilling and completion activity. We estimate that our

profitability is more evenly impacted by oil price driven activity and natural gas price driven activity. Our customers have increased their spending and commitments for deepwater offshore exploration and development which has benefited our offshore products segment. Our customers have also announced significant levels of expenditures for oil sands related projects in Canada. However, there can be no assurance that these trends will continue and there is a risk that lower energy prices for sustained periods could negatively impact drilling and completion activity and, correspondingly, reduce oil and gas expenditures. Such a decline would be adverse to our business. In addition, particularly in our well site services segment, we must continue to monitor industry capacity additions in relationship to our own capital expenditures and expected returns, considering project risks and expected cash flows from such investments. In tubular services, we continue to monitor industry wide OCTG inventory levels, mill shipments, OCTG pricing and our inventory turnover levels.

 

Consolidated Results of Operations

 

 

We reported net income for the year ended December 31, 2006 of $197.6 million, or $3.89 per diluted share. These results compare to $121.8 million, or $2.41 per diluted share, reported for the year ended December 31, 2005 and $59.4 million, or $1.19 per diluted share, for the year ended December 31, 2004. With continuing strong activity and contributions from acquisitions and capital investments, we recognized year-over-year growth in revenues of 26% in 2006 and 58% 2005. Net income in 2006 included the recognition of a non-cash, pre-tax gain of $11.3 million, or an after-tax gain of $0.12 per diluted share, on the sale of the Company’s workover services business to Boots & Coots.

 

Revenues.  Consolidated revenues increased $391.8 million in 2006 as a result of increased well site services revenues of $109.0 million, or 20%; increased offshore products revenues of $118.5 million, or 44%; and increased tubular services revenues of $164.3 million, or 23%. Consolidated revenues increased $560.6 million in 2005 compared to 2004 as a result of increased well site services revenues of $211.8 million, or 63%; increased offshore products revenues of $64.4 million, or 31%, and increased tubular services revenues of $284.4 million, or 67%.

 

Well site services revenues increased in both 2006 and 2005 due to year-over-year improvements in North American drilling and completion activity, contributions from capital expenditures in both years and acquisitions. These increases were partially offset by the sale of the hydraulic workover business completed in the first quarter of 2006. In addition, prices realized for our rental tools and our drilling and other services improved in 2006 and 2005 compared to prior years, and we experienced increased activity in support of the oil sands developments in Canada in 2005.

 

Offshore products revenues increased in both 2006 and 2005 due to increased deepwater development spending and capital equipment upgrades by our customers.

 

Our offshore products backlog totaled $349.3 million at December 31, 2006, $110.7 million at December 31, 2005 and $97.5 million at December 31, 2004. We believe that the deepwater construction and development business is characterized by lengthy projects and a long “lead-time” order cycle. While changes in backlog levels from one period to the next do not necessarily evidence a long-term trend, we believe activity levels in our offshore

products segment will increase in future periods, given the growth in our backlog, when compared to year end 2005 and 2004 levels.

 

Tubular services revenues increased 23% in 2006 compared to 2005 due to increased U.S. drilling activity and contributions from an acquisition that closed in June 2005. For the year ended December 31, 2006, tons shipped increased by 19% compared to the same period in 2005. Our average OCTG selling prices increased 3.5% from the year 2005 to the year 2006. Tubular services revenues increased 67% in 2005 compared to 2004 due to increased industry demand, higher OCTG prices and contributions from acquisitions completed in May 2004 and June 2005. Our average OCTG selling prices increased 40% from the year 2004 to the year 2005.

 

Cost of Sales and Service.  Our consolidated cost of sales and services increased $261.8 million, or 22%, in 2006 compared to 2005 as a result of increases at well site services of $5.9 million, or 2%, at offshore products of $84.4 million, or 40%, and at tubular services of $171.5 million, or 27%. Our consolidated cost of sales and services increased $431.6 million, or 56%, in 2005 compared to 2004 as a result of increases at well site services of $142.8 million, or 62%, at offshore products of $40.3 million, or 24%, and at tubular services of $248.5 million, or 66%. Generally, the increases in our cost of sales and services in both 2006 and 2005 were in line with our increases in revenues resulting in consistent consolidated gross margins.

 

The increase in cost of sales and services at our tubular services business in 2006 compared to 2005 was slightly higher than the increase in revenues for the same period due to an increase in relatively low margin carbon grade sales when compared to premium grade OCTG sales and less frequent OCTG mill price increases in 2006 when compared to 2005.

 

Accommodations cost of sales and services decreased for the year ended December 31, 2006 compared to 2005 and increased for the year ended December 31, 2005 compared to 2004. In 2005, a large fabrication project was delivered to a customer on a sale basis. In 2004 and 2006, our revenues consisted of a higher mix of service revenue which has a lower cost element.

 

Selling, General and Administrative Expenses.  Selling, general and administrative expenses (SG&A) increased $22.5 million, or 26.6%, in the year ended December 31, 2006 compared to the same period in 2005. During the year ended December 31, 2006, SG&A totaled $107.2 million, or 5.6% of revenues, compared to SG&A of $84.7 million, or 5.5% of revenues, for the year ended December 31, 2005. Increased SG&A expense associated with acquisitions, higher ad valorem taxes for OCTG inventory, increased incentive compensation accruals, and higher stock compensation costs due, in part, to the adoption of SFAS 123R were the primary factors causing the increased SG&A in 2006 compared to 2005.

 

SG&A increased $19.9 million, or 30.6%, in 2005 compared to the same period in 2004. During the year ended December 31, 2005, SG&A totaled $84.7 million, or 5.5% of revenues, compared to SG&A of $64.8 million, or 6.7% of revenues, for the year ended December 31, 2004. Increased SG&A expense associated with acquisitions completed since 2004, higher ad valorem taxes for increased levels of OCTG inventory, increased incentive compensation expense, and higher professional fees associated with Sarbanes-Oxley compliance were the primary factors causing increased SG&A in 2005 compared to 2004.

 

Depreciation and Amortization.  Depreciation and amortization expense increased $7.6 million, or 16.3%, in the year ended December 31, 2006 compared to the same period in 2005. Depreciation and amortization expense increased $10.7 million, or 29.8%, in 2005 compared to 2004. Depreciation and amortization expense increased in 2006 and 2005 due primarily to acquisitions and capital expenditures.

 

Operating Income.  Consolidated operating income increased $103.4 million, or 53%, in 2006 compared to 2005 as a result of increases at well site services of $90.7 million, or 87%, and at offshore products of $29.4 million, or 111%, which were partially offset by decreased tubular services operating income of $8.4 million, or 11%. Consolidated operating income increased $99.5 million, or 105%, in 2005 compared to 2004 as a result of increases at well site services of $49.2 million, or 89%, at offshore products of $19.3 million, or 268%, and at tubular services of $34.0 million, or 83%.

 

Interest Expense and Interest Income.  Interest expense increased $5.5 million, or 39.5%, for the year ended December 31, 2006 compared to the year ended December 31, 2005. Interest expense increased $6.2 million, or

81.3%, for the year ended December 31, 2005 compared to the year ended December 31, 2004. Interest expense increased due to higher debt levels resulting from acquisitions and capital expenditures, combined with higher interest rates. The weighted average interest rate on the Company’s revolving credit facility was 6.4% for 2006, 4.7% for 2005 and 3.6% for 2004. Interest income increased in 2006 primarily because of the notes receivable resulting from the sale of our hydraulic workover business (see Note 7 to the Consolidated Financial Statements included in this Annual Report on Form 10-K).

 

Equity in Earnings of Unconsolidated Affiliates.  Our equity in earnings of unconsolidated affiliates is higher in 2006 than 2005 primarily because of the sale of our workover services business and resultant interest in Boots & Coots common stock, which we account for under the equity method (see Note 7 to the Consolidated Financial Statements included in this Annual Report on Form 10-K). Our equity in earnings of unconsolidated affiliates increased in 2005 compared to 2004 due primarily to an equity affiliate in the OCTG business that experienced higher profitability in 2005 compared to 2004.

 

Income Tax Expense.  Our income tax provision for the year ended December 31, 2006 totaled $104.0 million, or 34.5% of pretax income, compared to $60.7 million, or 33.3% of pretax income, for the year ended December 31, 2005 and $29.4 million, or 33.1% of pretax income during the year ended December 31, 2004. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Tax Matters” discussion below.

 

Liquidity and Capital Resources

 

Our primary liquidity needs are to fund capital expenditures, such as expanding our accommodations facilities, expanding and upgrading our manufacturing facilities and equipment, adding drilling rigs and increasing and replacing rental tool assets, funding new product development and funding general working capital needs. In addition, capital is needed to fund strategic business acquisitions. Our primary sources of funds have been cash flow from operations, proceeds from borrowings under our bank facilities and proceeds from our $175 million convertible note offering in 2005 (see Note 8 to Consolidated Financial Statements included in this Annual Report on Form 10-K).

 

Cash totaling $137.4 million was provided by operations during the year ended December 31, 2006 compared to cash totaling $33.4 million provided by operations during the year ended December 31, 2005. During 2006, $95.1 million was used to fund working capital due in part to increases in receivables and inventories in our offshore products segment given the growth in activity.

 

Cash was used in investing activities during the years ended December 31, 2006 and 2005 in the amount of $114.2 million and $229.9 million, respectively. Capital expenditures, including capitalized interest, totaled $129.1 million and $83.4 million during the years ended December 31, 2006 and 2005, respectively. Capital expenditures in both years consisted principally of purchases of assets for our well site services segment. Capital expenditures for wellsite services in 2006 included $59.5 million in accommodations, $32.6 million in drilling services (including $13.1 million for the acquisition of three drilling rigs from Eagle Rock Drilling) and $24.5 million in rental tools. In 2005, we spent $36.8 million in accommodations, $14.0 million in drilling services and $19.8 million in rental tools. In addition, we completed various acquisitions totaling $147.6 million net of cash acquired, during 2005.

 

On February 1, 2005, we completed the acquisition of Elenburg Exploration Company, Inc. (Elenburg), a Wyoming based land drilling company for cash consideration of $21.3 million, net of cash acquired and including transaction costs, but excluding a note payable to the former owners of $0.8 million. At the time of acquisition, Elenburg owned and operated 7 rigs which provided shallow land drilling services in Montana, Wyoming, Colorado, and Utah.

 

Effective May 1, 2005 we acquired Stinger Wellhead Protection, Inc., certain affiliated companies and related intellectual property and, effective June 1, 2005, we completed the acquisition of Stinger’s international operations (collectively, Stinger) for cash consideration of $84.7 million, net of cash acquired and including transaction costs, but excluding a note payable to the former owners of $5.0 million. Stinger provides wellhead isolation equipment and services through its 30 locations in the United States, Canada, Central and South America. Stinger’s patented equipment is utilized during pressure pumping operations and isolates the customers’ blow-out preventers or

wellheads from the pressure and abrasion experienced during the fracturing process of an oil or gas well. The Stinger acquisition expanded our rental tool and services capabilities, especially in the pressure pumping market.

 

On June 2, 2005, we purchased Phillips Casing and Tubing, L.P. (Phillips) for cash consideration of $31.2 million, including transaction costs. Phillips distributes OCTG primarily carbon ERW (electronic resistance welded) pipe, from its facilities in Midland and Godley, Texas.

 

On June 6, 2005, we acquired Noble Structures, Inc. for cash consideration of $7.9 million, including transaction costs, but excluding a note payable of $0.8 million. The acquisition expanded our accommodations manufacturing capabilities in Canada in order to meet increased demand for remote site facilities, principally in the oil sands region.

 

The cash consideration paid for all of our acquisitions in the period was initially funded utilizing our existing bank credit facility and a $25 million bridge loan. The bridge loan was subsequently repaid with proceeds from the 23/8% convertible notes sold in June 2005 (see Note 8 to the Consolidated Financial Statements included in this annual report on Form 10-K).

 

On February 9, 2007, Boots & Coots announced it had filed a registration statement to sell 26 million shares of common stock including 13 million shares we own. The closing price of Boots & Coots common stock on the date of the announcement was $2.26. We own a total of 26.5 million shares of Boots & Coots common stock with a carrying value of $1.31 per share as of December 31, 2006. There can be no assurance about the timing of this announced stock sale or whether this transaction will ultimately take place.

 

We currently expect to spend a total of approximately $203 million for capital expenditures during 2007 to expand our product and service offering, and for maintenance and upgrade of our equipment and facilities. We expect to fund these capital expenditures with internally generated funds and proceeds from borrowings under our revolving credit facilities.

 

Net cash of $11.2 million was used in financing activities during the year ended December 31, 2006, primarily as a result of treasury stock purchases and debt repayments partially offset by proceeds from stock option exercises. A total of $195.3 million was provided by financing activities during the year ended December 31, 2005, primarily as a result of our issuance of $175.0 million of contingent convertible senior notes (see Note 8 to the Consolidated Financial Statements included in this Annual Report on Form 10-K).

 

During the first quarter of 2005, our Board of Directors authorized the repurchase of up to $50 million of our common stock, par value $.01 per share, over a two year period. On August 25, 2006, an additional $50 million was approved and the duration of the program was extended to August 31, 2008. Through December 31, 2006, a total of $50 million of our stock (1,824,432 shares), has been repurchased under this program, leaving a total of up to approximately $50 million remaining available under the program.

 

On December 5, 2006, we amended our existing credit agreement dated as of October 30, 2003 (the Credit Agreement). The amendment to the Credit Agreement increased the total commitments under the Credit Agreement from $325 million to $400 million and extended the maturity of the Credit Agreement to December 5, 2011. The Credit Agreement permits the Company incremental borrowings of up to $100 million under the Credit Agreement, subject to lender approval, on the same terms and conditions. The Credit Agreement, which governs our credit facility, contains customary financial covenants and restrictions, including restrictions on our ability to declare and pay dividends. Borrowings under the Credit Agreement are secured by a pledge of substantially all of our assets and the assets of our subsidiaries. Our obligations under the Credit Agreement are guaranteed by our significant subsidiaries. Borrowings under the Credit Agreement accrue interest at a rate equal to either LIBOR or another benchmark interest rate (at our election) plus an applicable margin based on our leverage ratio (as defined in the Credit Agreement). We must pay a quarterly commitment fee, based on our leverage ratio, on the unused commitments under the Credit Agreement. During the year 2006, our applicable margin over LIBOR ranged from 0.75% to 1.25% and it was 0.75% as of December 31, 2006. Our weighted average interest rate paid under the Credit Agreement was 6.2% during the year ended December 31, 2006 and 4.6% for the year ended December 31, 2005.

 

As of December 31, 2006, we had $215.4 million outstanding under the Credit Facility and an additional $10.7 million of outstanding letters of credit, leaving $173.9 million available to be drawn under the facility. In addition, we have other floating rate bank credit facilities in the U.S. and the U.K. that provide for an aggregate borrowing capacity of $9.0 million. As of December 31, 2006, we had $1.0 million outstanding under these other facilities and an additional $0.6 million of outstanding letters of credit leaving $7.4 million available to be drawn under these facilities. Our total debt represented 32.2% of the total of debt and shareholder’s equity at December 31, 2006.

 

We believe that cash from operations and available borrowings under our credit facilities will be sufficient to meet our liquidity needs in the coming twelve months. If our plans or assumptions change or are inaccurate, or if we make further acquisitions, we may need to raise additional capital. However, there is no assurance that we will be able to raise additional funds or be able to raise such funds on favorable terms.

 

The following summarizes our contractual obligations at December 31, 2006 (in thousands):

 

 

Our debt obligations at December 31, 2006 are included in our consolidated balance sheet, which is a part of our consolidated financial statements included in this Annual Report on Form 10-K. We have not entered into any material leases subsequent to December 31, 2006.

 

Off-Balance Sheet Arrangements

 

As of December 31, 2006, we had no off-balance sheet arrangements as defined in Item 303(a)(4) of Regulation S-K.

 

Tax Matters

 

Our primary deferred tax asset, which totaled $8.2 million at December 31, 2006, is related to $23.4 million in available federal net operating loss carryforwards, or NOLs, as of that date. The NOLs will expire in varying amounts during the years 2010 through 2011 if they are not first used to offset taxable income that we generate. Our ability to utilize a significant portion of the NOLs is currently limited under Section 382 of the Internal Revenue Code due to a change of control that occurred during 1995. We currently believe that substantially all of our NOL’s will be utilized.

 

Our income tax provision for the year ended December 31, 2006 totaled $104.0 million, or 34.5% of pretax income. During the year ended December 31, 2006, the Company recognized a tax benefit triggered by employee exercises of stock options totaling $5.0 million. Such benefit was credited to additional paid-in capital. Our income tax provision for the year ended December 31, 2005 totaled $60.7 million, or 33.3% of pretax income. The income tax provision for the year 2005 included a $4.7 million income tax benefit related to the reversal of substantially all of the remaining valuation allowance applied against NOLs which were recorded as of the prior year end.

 

Critical Accounting Policies

 

In our selection of critical accounting policies, our objective is to properly reflect our financial position and results of operations in each reporting period in a manner that will be understood by those who utilize our financial statements. Often we must use our judgment about uncertainties.

 

There are several critical accounting policies that we have put into practice that have an important effect on our reported financial results.

 

We have contingent liabilities and future claims for which we have made estimates of the amount of the eventual cost to liquidate these liabilities or claims. These liabilities and claims sometimes involve threatened or actual litigation where damages have been quantified and we have made an assessment of our exposure and recorded a provision in our accounts to cover an expected loss. Other claims or liabilities have been estimated based on our experience in these matters and, when appropriate, the advice of outside counsel or other outside experts. Upon the ultimate resolution of these uncertainties, our future reported financial results will be impacted by the difference between our estimates and the actual amounts paid to settle a liability. Examples of areas where we have made important estimates of future liabilities include litigation, taxes, fines, penalties, interest, warranty claims, contract claims and discontinued operations.

 

The assessment of impairment on long-lived assets, including goodwill and investments in unconsolidated subsidiaries, is conducted whenever changes in the facts and circumstances indicate a loss in value has occurred. The determination of the amount of impairment, which is other than a temporary decline in value, would be based on quoted market prices, if available, or upon our judgments as to the future operating cash flows to be generated from these assets throughout their estimated useful lives. Our industry is highly cyclical and our estimates of the period over which future cash flows will be generated, as well as the predictability of these cash flows and our determination of whether an other than temporary decline in value of our investment has occurred, can have a significant impact on the carrying value of these assets and, in periods of prolonged down cycles, may result in impairment charges.

 

We recognize revenue and profit as work progresses on long-term, fixed price contracts using the percentage-of-completion method, which relies on estimates of total expected contract revenue and costs. We follow this method since reasonably dependable estimates of the revenue and costs applicable to various stages of a contract can be made. Recognized revenues and profit are subject to revisions as the contract progresses to completion. Revisions in profit estimates are charged to income or expense in the period in which the facts and circumstances that give rise to the revision become known. Provisions for estimated losses on uncompleted contracts are made in the period in which losses are determined.

 

Our valuation allowances, especially related to potential bad debts in accounts receivable and to obsolescence or market value declines of inventory, involve reviews of underlying details of these assets, known trends in the marketplace and the application of historical factors that provide us with a basis for recording these allowances. If market conditions are less favorable than those projected by management, or if our historical experience is materially different from future experience, additional allowances may be required. We have, in past years, recorded a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. See Note 10 — Income Taxes in the Consolidated Financial Statements included in this Annual Report on Form 10-K and “Tax Matters” herein.

 

The selection of the useful lives of many of our assets requires the judgments of our operating personnel as to the length of these useful lives. Should our estimates be too long or short, we might eventually report a disproportionate number of losses or gains upon disposition or retirement of our long-lived assets. We believe our estimates of useful lives are appropriate.

 

Since the adoption of SFAS No. 123R, we are required to estimate the fair value of stock compensation made pursuant to awards under our 2001 Equity Participation Plan (Plan). An initial estimate of fair value of each stock option or restricted stock award determines the amount of stock compensation expense we will recognize in the future. To estimate the value of stock option awards under the Plan, we have selected a fair value calculation model. We have chosen the Black Scholes “closed form” model to value stock options awarded under the Plan. We have chosen this model because our option awards have been made under straightforward and consistent vesting terms, option prices and option lives. Utilizing the Black Scholes model requires us to estimate the length of time options will remain outstanding, a risk free interest rate for the estimated period options are assumed to be outstanding, forfeiture rates, future dividends and the volatility of our common stock. All of these assumptions affect the amount and timing of future stock compensation expense recognition. We will continually monitor our actual experience and change assumptions for future awards as we consider appropriate.

 

Recent Accounting Pronouncements

 

On December 16, 2004, the FASB issued FASB Statement No. 123 (revised 2004), Share-Based Payment, which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation. Statement 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows. Generally, the approach in Statement 123(R) is similar to the approach described in Statement 123. However, Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an acceptable alternative.

 

We adopted Statement of Financial Accounting Standards No. 123R (SFAS 123R) effective January 1, 2006. This pronouncement requires companies to measure the cost of employee services received in exchange for an award of equity instruments (typically stock options) based on the grant-date fair value of the award. The fair value is estimated using option-pricing models. The resulting cost is recognized over the period during which an employee is required to provide service in exchange for the awards, usually the vesting period. Prior to the adoption of SFAS 123R, this accounting treatment was optional with pro forma disclosures required. We adopted SFAS 123R using the modified prospective transition method (see Note 13 to the Consolidated Financial Statements included in this Annual Report on Form 10-K).

 

In May 2005, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 154, “Accounting Changes and Error Corrections, a replacement of APB Opinion No. 20 and FASB Statement No. 3.” Among other changes, this Statement requires retrospective application for voluntary changes in accounting principles, unless it is impractical to do so. Guidance is provided on how to account for changes when retrospective application is impractical. This Statement is effective on a prospective basis beginning January 1, 2006.

 

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 (SFAS 157), “Fair Value Measurements,” which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. Early adoption is permitted, provided the company has not yet issued financial statements, including for interim periods, for that fiscal year. The Company plans to adopt the provisions of SFAS 157 in 2008 and, when adopted, does not expect the adoption of SFAS 157 to have a material impact on its results from operations or financial position.

 

In June 2006, the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109 (FIN 48), which clarifies the accounting and disclosure for uncertain tax positions, as defined. FIN 48 requires companies to meet a “more-likely-than-not” threshold (i.e. greater than 50 percent likelihood of a tax position being sustained under examination) prior to recording a benefit for their tax position. FIN 48 seeks to reduce the diversity in practice associated with certain aspects of the recognition and measurement related to accounting for income taxes. This interpretation is effective for fiscal years beginning after December 15, 2006. The Company has not yet determined the impact this interpretation will have on its results from operations or financial position.

 

Interest Rate Risk.  We have long-term debt and revolving lines of credit subject to the risk of loss associated with movements in interest rates. As of December 31, 2006, we had floating rate obligations totaling approximately $215.4 million for amounts borrowed under our revolving credit facilities. These floating-rate obligations expose us to the risk of increased interest expense in the event of increases in short-term interest rates. If the floating interest rate were to increase by 1% from December 31, 2006 levels, our consolidated interest expense would increase by a total of approximately $2.2 million annually.

 

Foreign Currency Exchange Rate Risk.  Our operations are conducted in various countries around the world in a number of different currencies. As such, our earnings are subject to movements in foreign currency exchange rates when transactions are denominated in currencies other than the U.S. dollar, which is our functional currency,

or the functional currency of our subsidiaries, which is not necessarily the U.S. dollar. In order to mitigate the effects of exchange rate risks, we generally pay a portion of our expenses in local currencies and a substantial portion of our contracts provide for collections from customers in U.S. dollars. During 2006, our realized foreign exchange losses were $0.4 million and are included in other operating expense (income) in the consolidated statements of income.

 

Our consolidated financial statements and supplementary data of the Company appear on pages 43 through 74 of this Annual Report on Form 10-K and are incorporated by reference into this Item 8. Selected quarterly financial data is set forth in Note 15 to our Consolidated Financial Statements, which is incorporated herein by reference.

 

There were no changes in or disagreements on any matters of accounting principles or financial statement disclosure between us and our independent auditors during our two most recent fiscal years or any subsequent interim period.

 

 

Evaluation of Disclosure Controls and Procedures.  As of the end of the period covered by this Annual Report on Form 10-K, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2006 in ensuring that material information was accumulated and communicated to management, and made known to our Chief Executive Officer and Chief Financial Officer, on a timely basis to allow disclosure as required in this Annual Report on Form 10-K.

 

Pursuant to section 906 of The Sarbanes-Oxley Act of 2002, our Chief Executive Officer and Chief Financial Officer have provided certain certifications to the Securities and Exchange Commission. These certifications accompanied this report when filed with the Commission, but are not set forth herein.

 

(ii) Internal Control Over Financial Reporting

 

 

The Company’s management report on internal control over financial reporting is set forth in this Annual Report on Form 10-K on Page 43 and is incorporated herein by reference.

 

 

The attestation report of Ernst & Young LLP, the Company’s independent registered public accounting firm, on management’s assessment of the effectiveness of the Company’s internal control over financial reporting and the effectiveness of the Company’s internal control over financial reporting is set forth in this Annual Report on Form 10-K on Page 45 and is incorporated herein by reference.

 

 

There was no change in the Company’s internal control over financial reporting during the Company’s fourth fiscal quarter ended December 31, 2006 that has materially affected, or is reasonably likely to affect, the Company’s internal control over financial reporting.

 

There was no information required to be disclosed in a report on Form 8-K during the fourth quarter of 2006 that was not reported on a Form 8-K during such time.

 

(1) Information concerning directors, including the Company’s audit committee financial expert, appears in the Company’s Definitive Proxy Statement for the 2007 Annual Meeting of Stockholders, under “Election of Directors.” This portion of the Definitive Proxy Statement is incorporated herein by reference.

 

(2) Information with respect to executive officers appears in the Company’s Definitive Proxy Statement for the 2007 Annual Meeting of Stockholders, under “Executive Officers of the Registrant.” This portion of the Definitive Proxy Statement is incorporated herein by reference.

 

(3) Information concerning Section 16(a) beneficial ownership reporting compliance appears in the Company’s Definitive Proxy Statement for the 2007 Annual Meeting of Stockholders, under “Section 16(a) Beneficial Ownership Reporting Compliance.” This portion of the Definitive Proxy Statement is incorporated herein by reference.

 

The information required by Item 11 hereby is incorporated by reference to such information as set forth in the Company’s Definitive Proxy Statement for the 2007 Annual Meeting of Stockholders.

 

The information required by Item 12 hereby is incorporated by reference to such information as set forth in the Company’s Definitive Proxy Statement for the 2007 Annual Meeting of Stockholders.

 

The table below provides information relating to our equity compensation plans as of December 31, 2006:

 

 

 

 

The information required by Item 13 hereby is incorporated by reference to such information as set forth in the Company’s Definitive Proxy Statement for the 2007 Annual Meeting of Stockholders.

 

Information concerning principal accountant fees and services and the audit committee’s preapproval policies and procedures appear in the Company’s Definitive Proxy Statement for the 2007 Annual Meeting of Stockholders under the heading “Fees Paid to Ernst & Young LLP” and is incorporated herein by reference.

 

(a) Index to Financial Statements, Financial Statement Schedules and Exhibits

 

(1) Financial Statements:  Reference is made to the index set forth on page 45 of this Annual Report on Form 10-K.

 

(2) Financial Statement Schedules:  No schedules have been included herein because the information required to be submitted has been included in the Consolidated Financial Statements or the Notes thereto, or the required information is inapplicable.

 

(3) Index of Exhibits:  See Index of Exhibits, below, for a list of those exhibits filed herewith, which index also includes and identifies management contracts or compensatory plans or arrangements required to be filed as exhibits to this Annual Report on Form 10-K by Item 601(10)(iii) of Regulation S-K.

 

(b) Index of Exhibits