Oil States International - 10-Q quarterly report FY

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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.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer” and “large accelerated filer” in Rule 2b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

The Registrant had 49,581,940 shares of common stock outstanding and 1,538,903 shares of treasury stock as of October 20, 2006.

INDEX

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(In Thousands, Except Per Share Amounts)

CONSOLIDATED BALANCE SHEETS
(In Thousands)

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)

     The accompanying unaudited consolidated financial statements of Oil States International, Inc. and its wholly-owned subsidiaries (the Company) have been prepared pursuant to the rules and regulations of the Securities and Exchange Commission pertaining to interim financial information. Certain information in footnote disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP) have been condensed or omitted pursuant to these rules and regulations. The unaudited financial statements included in this report reflect all the adjustments, consisting of normal recurring adjustments, which the Company considers necessary for a fair presentation of the results of operations for the interim periods covered and for the financial condition of the Company at the date of the interim balance sheet. Results for the interim periods are not necessarily indicative of results for the year.

     Preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosed amounts of contingent assets and liabilities and the reported amounts of revenues and expenses. If the underlying estimates and assumptions, upon which the financial statements are based, change in future periods, actual amounts may differ from those included in the accompanying consolidated condensed financial statements.

     From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board (the FASB), which are adopted by the Company as of the specified effective date. Unless otherwise discussed, management believes the impact of recently issued standards, which are not yet effective, will not have a material impact on the Company’s consolidated financial statements upon adoption.

     The financial statements included in this report should be read in conjunction with the Company’s audited financial statements and accompanying notes included in its Annual Report on Form 10-K for the year ended December 31, 2005.

     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. Earlier adoption is permitted, provided the company has not yet issued financial statements, including for interim periods, for that fiscal year. The Company is currently evaluating the impact of SFAS 157, but 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 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.

     Additional information regarding selected balance sheet accounts is presented below (in thousands):

     On August 23, 2006, the Company acquired the drilling assets of Eagle Rock Drilling, L.L.C. (Eagle Rock) for total consideration of $14.0 million which consisted of a cash payment and a note payable to the former owner of $13.5 million and $0.5 million, respectively. Eagle Rock owned and operated three rigs in the Permian Basin area of West Texas. These rigs are now included in our drilling services business in our well site services segment.

     On February 1, 2005, the Company completed the acquisition of Elenburg Exploration Company, Inc. (Elenburg), a Wyoming based land drilling company for total consideration of $22.1 million, including transaction costs and a note payable to the former owners of $0.8 million. At the date of acquisition, Elenburg owned and operated seven rigs that provided shallow land drilling services in Montana, Wyoming, Colorado, and Utah. The Elenburg acquisition allowed the Company to expand its drilling business into different geographic areas. The operations of Elenburg have been included in the “drilling and other” business within the well site services segment.

     Effective May 1, 2005 and June 1, 2005, the Company acquired Stinger Wellhead Protection, Inc., certain affiliated companies and related intellectual property, (collectively, Stinger) for total consideration of $96.1 million, including transaction costs and 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 the Company’s rental tool and services capabilities, especially in the pressure pumping market. The operations of Stinger have been included in the rental tools business within the well site services segment.

     On June 2, 2005, the Company purchased Phillips Casing and Tubing, L.P. (Phillips) for total consideration of $31.2 million, including transaction costs. Phillips distributes oil country tubular goods (OCTG), primarily carbon ERW (electronic resistance welded) pipe, from its facilities in Midland and Godley, Texas. The operations of Phillips have been combined within the tubular services segment.

     On June 6, 2005, the Company acquired Noble Structures, Inc. (Noble) for total consideration of $8.7 million, including transaction costs and a note payable of $0.8 million. The acquisition expanded the Company’s accommodation manufacturing capabilities in Canada in order to meet increased demand for remote site facilities, principally in the oil sands region. The operations of Noble have been combined with our accommodations business within the well site services segment.

     Changes in the carrying amount of goodwill for the nine month period ended September 30, 2006 are as follows (in thousands):

     As of September 30, 2006 and December 31, 2005, long-term debt consisted of the following (in thousands):

     Comprehensive income for the three and nine month periods ended September 30, 2006 and 2005 was as follows (in thousands):

     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, which is explained below.

     SFAS 123R is effective for all stock options we grant beginning January 1, 2006. For those stock option awards granted prior to January 1, 2006, but for which the vesting period is not complete, we used the modified prospective transition method permitted by SFAS 123R. Under this method of accounting, the remaining unamortized value of non-vested options will be expensed over the remaining vesting period using the grant-date fair values. Our options typically vest in equal annual installments over a four year service period. Expense related to an option grant is recognized on a straight line basis over the specific vesting period for those options.

     The fair value of options is determined at the grant date using a Black-Scholes option pricing model, which requires us to make several assumptions, including risk-free interest rate, dividend yield, volatity and expected term. The risk-free interest rate is based on the U.S. Treasury yield curve in effect for the expected term of the option at the time of grant. The dividend yield on our common stock is assumed to be zero since we do not pay dividends and have no current plans to do so in the future. The expected market price volatility of our common stock is based on an estimate made by us that considers the historical and implied volatility of our common stock as well as a peer group of companies over a time period equal to the expected term of the option. The expected life of the options awarded in 2006 was based on a formula considering the vesting period and term of the options awarded as permitted by U.S. Securities and Exchange Commission regulations.

     The table below summarizes stock option activity pursuant to our plans for the nine months ended September 30, 2006:

     During the first nine months of 2006, we issued stock options for 515,000 shares of our common stock with a weighted average exercise price of $35.17 per share. The exercise price is the closing price of our common stock on the date of grant. The options vest in four equal installments on the first, second, third and fourth anniversaries of the date of grant and have a term of six years. The weighted-average fair value of options granted during the first nine months of 2006 was determined to be $12.89 per option based on the following weighted average assumptions:

     The total intrinsic value of options exercised during the three and nine months ended September 30, 2006 was $0.7 million and $17.9 million, respectively. Cash received from option exercises during the three and nine months ended September 30, 2006 totaled $0.5 million and $8.3 million, respectively.

     The following tables summarize the range of exercise prices and the weighted average remaining contractual life of the options outstanding and the range of exercise prices for the options exercisable at September 30, 2006:

     During the first nine months of 2006, we granted restricted stock awards totaling 113,787 shares valued at a total of $3.9 million. A total of 24,250 of these awards vest in four equal annual installments, 61,400 of these awards vest in two equal annual installments and the remaining 28,137 awards vest after one year.

     Impact of Adoption of SFAS 123R. Stock based compensation pre-tax expense recognized under SFAS 123R in the three and nine months ended September 30, 2006 totaled $1.6 million and $5.8 million, or $0.02 and $0.07 per basic and diluted share, respectively. For the three and nine months ended September 30, 2005, our stock compensation expense related primarily to restricted stock awards and totaled $196,000 and $362,000, respectively. At September 30, 2006, $12.1 million of compensation cost related to unvested stock options and restricted stock awards attributable to future performance had not yet been recognized.

     The following table illustrates the pro forma effect on net income and income per share for the three and nine months ended September 30, 2005 had we applied the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (in thousands except per share amounts):

     On November 10, 2005, the FASB issued FASB Staff Position No. FAS 123(R)-3, “Transition Election Related to Accounting for Tax Effects of Share-Based Payment Awards.” We have elected to adopt the alternative transition method provided for in this FASB Staff Position for calculating the tax effects of share-based compensation pursuant to FAS 123R. The alternative transition method includes a simplified method to establish the beginning balance of the additional paid-in capital pool related to the tax effects of employee share-based compensation, which is available to absorb tax deficiencies recognized subsequent to the adoption of FAS 123R.

     The Company’s income tax provision for the three months ended September 30, 2006 totaled $25.8 million, or 34.1%, of pretax income compared to $17.7 million, or 36.9% of pretax income, for the three months ended September 30, 2005. The effective rate was lower in the quarter ended September 30, 2006 principally because of lower nondeductible expenses, higher manufacturing deductions and a lower estimated annual foreign effective tax rate.

     The Company has not provided United States income taxes and foreign withholding taxes on a cumulative total of approximately $236.3 million of undistributed earnings of certain non-United States subsidiaries assumed to be indefinitely invested outside the United States. Should the Company decide to repatriate such foreign earnings, the Company would have to adjust the income tax provision in the period in which management determined that the earnings will no longer be indefinitely invested outside the United States.

     In accordance with SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” the Company has identified the following reportable segments: well site services, offshore products and tubular services. The Company’s reportable segments are strategic business units that offer different products and services. They are managed separately because each business requires different technology and marketing strategies. Most of the businesses were initially acquired as a unit, and the management at the time of the acquisition was retained. Subsequent acquisitions have been direct extensions to our business segments. The separate business lines within the well site services segment have been disclosed to provide additional detail for that segment. Results of our Canadian business related to the provision of work force accommodations, catering and logistics services are seasonal with significant activity occurring in the peak winter drilling season. We sold our workover services, business, effective March 1, 2006, in exchange for an equity interest in Boots & Coots International Well Control, Inc. (AMEX:WEL) (Boots & Coots) and a note receivable – See Note 11.

     Financial information by business segment for each of the three and nine month periods ended September 30, 2006 and 2005 is summarized in the following table (in thousands):

     Effective March 1, 2006, we completed a transaction to combine our workover services business with Boots & Coots in exchange for 26.5 million shares of Boots & Coots common stock valued at $1.45 per share at closing and senior subordinated promissory notes totaling $21.2 million.

     As a result of the closing of the transaction, we own 45.6% of Boots & Coots. 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 and Coots and it is expected to be finalized and effective in the fourth quarter of 2006. The transaction terms also allowed us to designate two additional members to Boots & Coots’ existing five-member Board of Directors and provided us the right to designate an additional board member should we choose. We have designated two additional members to the Boots & Coots Board of Directors.

     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 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 the first quarter of 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 the Company’s 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.

     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 that purchased 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.

     This quarterly report on Form 10-Q 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 “Part I, Item 1.A. Risk Factors” and the financial statement line item discussions set forth in “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Form 10-K Annual Report for the year ended December 31, 2005 filed with the Securities and Exchange Commission on March 2, 2006 and Item 2 of this Form 10-Q, which follows. Should one or more of these risks or uncertainties materialize, or should the assumptions prove incorrect, actual results may differ materially from those expected, estimated or projected. Our management believes these forward-looking statements are reasonable. However, you should not place undue reliance on these forward-looking statements, which are based only on our current expectations. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to publicly update or revise any of them in light of new information, future events or otherwise.

     You should read the following discussion and analysis together with our financial statements and the notes to those statements included elsewhere in this quarterly report on Form 10-Q.

     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 oil country tubular goods (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 primarily 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 International Well Control, Inc. (Amex: WEL) (Boots & Coots), and we now own a 45.6% equity interest in Boots & Coots. See Note 11 to the Unaudited Condensed Consolidated Financial Statements.

     We have a diversified product and service offering which has exposure 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 drilling rig activity, as measured by Baker Hughes Incorporated, for the periods indicated.

     The average North American rig count for the nine months ended September 30, 2006 increased by 337 rigs, or 19.1%, compared to the nine months ended September 30, 2005. This overall increase in activity, while tempered somewhat by lower activity levels in the U.S. Gulf of Mexico, contributed to increased revenues in our tubular services and well site services segments. Our well site services segment results for the first nine months of 2006 also benefited from capital spending, which aggregated $126.5 million for that segment in the twelve months ended September 30, 2006, the acquisition of a company owning and operating certain drilling rig assets operating in the Rocky Mountain area of the US on February 1, 2005 for total consideration of $22.1 million, the acquisition of companies owning and operating certain well isolation tool assets and related intellectual property (collectively, the well isolation tool acquisition) for total consideration of $96.1 million in May and June 2005, the acquisition of certain drilling rig assets operating in west Texas, effective August 23, 2006, for consideration of $14.0 million and the impact of increased activity levels and pricing gains in certain business lines. The Canadian rig count increased 15.4% in the first nine months of 2006 compared to the corresponding period in 2005. Our remote accommodations, catering and logistics services activities benefited from the Canadian rig count increases.

     Repair activity resulting from Hurricanes Katrina and Rita benefited our offshore products and accommodations businesses in the fourth quarter of 2005 and in 2006; however, this activity has decreased in the third quarter of 2006 compared with earlier quarters in 2006.

     During the first nine months of 2006, the results generated by our Canadian workforce accommodations, catering and logistics operations benefited from the strengthening of the Canadian currency. In the first nine months of 2006, the Canadian dollar was worth $0.88 U.S. dollars compared to $0.82 in the first nine months of 2005, an increase of 7.3%.

     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 approximately 363,500 tons of OCTG in the first nine months of 2006 compared to approximately 286,700 tons in the first nine months of 2005. Our tubular services segment also benefited in the past nine months from a 22.2% year-over-year increase in average U.S. land drilling activity.

     Management believes that fundamental oil and natural gas supply and demand factors will continue to support a high level of drilling, completion and exploitation activity which should continue to positively impact the Company. We also believe 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 record 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. In the fourth quarter 2006, activity could see softness in Canada and certain regions of the United States due to the impact of lower natural gas prices on customer spending coupled with holiday and year-end shutdowns. Our customers have increased their spending and commitments for deepwater offshore exploration and development which has benefited our offshore products segment. However, there can be no assurance that these trends will continue and there is a risk that continued energy prices at high sustained levels could negatively impact worldwide economic growth and, correspondingly, reduce the demand for energy causing oil and gas expenditures to decline which would adversely affect 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 to determine our appropriate inventory level.

     Results of Operations (in millions, except margin percentages and per share amounts)

     We reported net income for the quarter ended September 30, 2006 of $50.1 million, or $0.99 per diluted share. These results compare to $30.3 million, or $0.60 per diluted share, reported in the third quarter of 2005. With continuing strong activity and contributions from recent capital investments, we recognized year-over-year growth in revenues and operating income in the third quarter of 2006 of 22% and 47%, respectively.

     We generated $479.5 million of revenues and $75.5 million of operating income in the third quarter of 2006 compared to $394.1 million and $51.3 million, respectively, in the third quarter of 2005. Significant increases in offshore products revenues and operating income coupled with strong year-over-year improvements in well site services contributed to strong third quarter results. Well site services reported higher revenues and operating income due to high levels of North American drilling activity, capital investments made in the past year and contributions from the acquisition of the certain drilling rig assets operating in west Texas in August 2006. Offshore products also generated significantly improved revenues and operating income due to the acceleration in deepwater development spending and related capital equipment upgrades by its customers. In addition, offshore products backlog continued to improve, up 14% during the quarter to $321.2 million. Tubular services reported a year-over-year improvement in revenues due to increased U.S. drilling activity. Operating income for tubular services was lower than the prior year as a result of lower gross margins.

     For the nine months ended September 30, 2006, we reported net income of $148.3 million, or $2.91 per diluted share, on revenues of $1.4 billion and operating income of $224.7 million. For the nine months ended September 30, 2005, we reported net income of $80.4 million, or $1.59 per diluted share, on revenues of $1.1 billion and operating income of $135.5 million. This performance represents year-over-year revenue and operating income increases of 33% and 66%, respectively. Net income in the first nine months of 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 International Well Control, Inc. (Amex: WEL).