Operating Income Margins Increase to 24%
Operating income increased to a record $84.9 million, or 146% higher than last year's third quarter. Consolidated operating income margins increased to 24% from 14%. The improved margins reflect increased volumes across all three segments and better pricing, primarily at the Company's Drilling Products and Services, and Tubular Technology and Services segments.
Other operating expenses (sales and marketing, general and administrative and research and engineering) increased $6.6 million compared to last year's third quarter, however, as a percentage of revenues, operating expenses were reduced to 19% from 24% for the same period last year. This improvement primarily reflects overhead reductions at the Company's Drill Bits segment.
As part of the Company's comprehensive debt restructuring program that began last quarter, in July 2005 the Company issued $200 million of 6 1/8% Senior Notes due 2015 at par and completed the repurchase of substantially all of its outstanding 9% Senior Notes due 2009. The Company incurred refinancing charges of $21.7 million in the third quarter of 2005 for the early retirement of these Notes. The Company has completed its debt restructuring program and has reduced its weighted average borrowing costs from 9.25% to less than 6%.
Interest expense decreased by $5.2 million reflecting the early redemption of the Company's 9 5/8% Senior Notes in June 2005 and the repurchase of its 9% Senior Notes. Equity income from the Company's unconsolidated affiliates increased by $9.0 million, which primarily reflects increased earnings at Voest-Alpine Tubulars (VAT). VAT benefited from strong demand and pricing for seamless OCTG products.
The Company's annual effective tax rate was estimated to be 27.7% (27.1% for the quarter). This rate includes the effect of the VAT equity investment, which is recorded net of tax. Taking into account taxes provided at VAT, the Company's annual effective tax rate was estimated to be 33.6%.
The Company's debt to book capitalization was 24.3% at September 30, 2005 and cash balance was $25.2 million bringing the net debt to book capitalization to 22.1%.
In July 2005, the Company acquired Corion Diamond Products, Ltd. (Corion), a coring business headquartered in Nisku, Alberta, for approximately $17 million in cash plus contingent consideration of up to an additional $9.5 million payable upon certain performance benchmarks over the next three years. Corion's flagship product is the Corion Express, which allows an operator to take core samples without tripping the drill string, providing substantial savings to the operator as compared to conventional coring techniques. Corion will be included in the Company's Drill Bits segment.
In September 2005, the Company increased its ownership of IntelliServ, Inc. (IntelliServ) from 50% to 100%. IntelliServ is developing a drill string telemetry network embedded within drill pipe. Total consideration paid by the Company was approximately $15 million, which included cash and a note payable, plus a royalty which is contingent on the product's adoption rate and revenues.
Drilling Products and Services
Revenues for the Drilling Products and Services segment were a record $153.2 million during the quarter. This represents a 48% increase over the prior year's third quarter and a 6% sequential increase. Operating income doubled to $47.0 million, compared to $23.2 million in last year's third quarter. These improvements reflect a 30% increase in drill pipe footage sold and an 18% increase in average sales price per foot. Additionally, this segment's Chinese operations improved significantly reflecting strong market demand. Drill pipe production increased to 2.6 million feet during the quarter. Backlog for this segment increased to a record $576.8 million at September 30, 2005, due to strong U.S. drilling activity and a large increase in China reflecting annual purchasing activity.
Drill Bits segment revenues increased to a record $100.1 million during the quarter. This 26% improvement in revenues reflects an 18% increase in the average worldwide rig count, with increased sales primarily in the Canadian and North Sea/Russia markets, coupled with incremental sales related to the Corion acquisition in July 2005. Operating income margins increased to 26% from 20% in last year's third quarter due primarily to decreased overhead expenses and withdrawal from selected low margin areas.
Tubular Technology and Services
Revenues for the Tubular Technology and Services segment increased by 56% to a record $98.9 million, compared to the prior year's third quarter of $63.5 million. Operating income margins increased to 26% from 13% in last year's third quarter. These increases were primarily due to improved results in this segment's XL and TCA divisions. XL benefited from strong deliveries of its Viper(TM) and XLF(TM) (flush thread) connections, several of which had been delayed from the previous quarter, while TCA saw continued pricing improvements and strong demand for specialty products.
This segment primarily includes the operating results of IntelliServ, which was accounted for as an equity method investment until the Company purchased the remaining 50% in September 2005. The operating loss of $1.5 million included in this segment primarily reflects start-up costs associated with the on-going commercialization of the drill string telemetry network.
Corporate expenses for the third quarter of 2005 were $12.2 million compared to $12.4 million in last year's third quarter, which included other charges of $3.8 million related to the relocation of the Company's corporate office. Excluding the charge, the 2005 increase was primarily due to higher costs for stock-based incentive programs and professional fees.
Chairman and CEO, Michael McShane commented, "We are pleased to again report strong quarterly results with record revenues and operating income at each segment despite hurricane related disruptions that impacted earnings by $0.02 - $0.03 per share. In addition to exceptional industry conditions, each segment benefited from successful new products. Long-term growth opportunities were pursued through the acquisitions of Corion and the remaining 50% interest in our IntelliServ joint venture. Geographic expansion of Corion's unique coring services have already proven successful and we expect to announce completion of our first commercial application of IntelliServ during the fourth quarter."
"For the fourth quarter, we anticipate a continuation of the strong worldwide drilling activity with a seasonal increase in Canada. We expect fourth quarter earnings to be in the range of $0.50 to $0.52 per share. With a rising backlog and indications of increased E&P spending levels, we expect continued earnings improvement into 2006."
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