On the Heels of a Disaster, Smith Sees a Bright Future

At the recent Offshore Technology Conference in Houston, where the world’s oil service companies show off their latest wares, Smith International Inc. hosted one of the biggest and brightest exhibits.

“I was shocked,” said Jeffrey Freedman, a longtime Smith watcher who follows the industry for the investment firm of Smith Barney, Harris Upham & Co. “I expected to see a tiny thing from Smith, and there they were, front and center, with the biggest display.”

Just fourteen months after filing for bankruptcy to protect itself from a $205-million judgment won by its archrival, Hughes Tool Co., Newport Beach-based Smith has emerged from the shadows.

The new, lean Smith has shrunk from 10 divisions to three and has a corporate staff of 42, down from 117 a year ago.

Despite a $149-million loss in fiscal 1986, Smith executives predict a profitable first quarter for 1987. The company has $150 million cash on hand, and Smith’s stock price has climbed from $1.50 a share in the second quarter of 1986 to $5.25 in trading on the New York Stock Exchange on Friday.

The burden of seven separate appeals filed by Hughes was lifted Thursday when a bankruptcy judge dismissed them all. And Smith continues to negotiate a reduced settlement of the $205-million patent infringement award with the newly merged Baker-Hughes.

Aggressive Marketing

Although conscious of disastrous market conditions and burdened by the weight of its legal problems, Smith is aggressively marketing a line of new oil patch products and planning for its future.

“Most analysts see us as a survivor,” said Chief Financial Officer Loren K. Carroll.

Indeed, industry analysts say Smith’s bold approach at the trade show and its new line of drilling equipment reflect the confidence gained from surviving the worst year in its history.

Still, some analysts now question whether Smith can remain independent in a shrinking universe of oil services companies. But that question won’t have to be answered until Smith emerges from its Chapter 11 reorganization.

Smith’s horrendous year began in February, 1986, when the Newport Beach-based firm lost an acrimonious 14-year-old patent infringement battle to Houston-based Hughes Tool Co. A Los Angeles federal judge ruled that Smith’s use of Hughes’ patented drill bit technology was worth $205 million, making it one of the largest damage awards in U.S. history. A few days later, seeking to protect its assets, Smith filed for protection under Chapter 11 of the federal bankruptcy code.

Outside the Los Angeles federal courthouse, 1986 was not much better for Smith.

For the year ended Dec. 31, Smith suffered a $149-million net loss on revenues of $415.2 million. At its peak in 1981, Smith reported $1.2 billion in revenues and net income of $133.1 million.

Sales to Smith’s primary customers--oil companies--plunged because a worldwide oil glut forced oil prices to a low of about $10 a barrel. At those depressed prices, oil companies stopped drilling, and the number of drilling rigs active in the United States plummeted 59% to 896 rigs.

In response to all these factors, Smith slashed its worldwide work force from 7,400 to 3,100 and sold 87% of its U.S. manufacturing capacity.

Today, Smith Chairman Jerry W. Neely cheerfully says that the staff is so lean that there are only three people between him and the customer.

“You can’t say poor us when everybody else is in the same boat,” Neely said in his first interview in more than a year.

Neely says he spends his time supervising day-to-day business operations, while Carroll deals primarily with the bankruptcy proceedings.

“I try to make everybody feel they have a stake in this,” said Neely, who meets frequently with his division managers and employees in an effort to boost morale.

“Our customers have been very supportive,” Neely said. “And our suppliers are standing by us.”

Close-Knit Group

He says the remaining Smith employees are a loyal, close-knit group who believe in the company’s future. When asked how he has hung on through adversity, he thought for a moment, and then said: “You either quit and leave or deal with the realities of life.”

Neely, who will earn $300,000 this year, admits that it is sometimes difficult to concentrate on the business at hand while worrying about the $205-million Hughes judgment. A federal appellate court in Washington is expected to make a decision within the month on whether or not to uphold the judgment.

Even if it is upheld, Neely says, Smith has “26 or 29 plans, and none suggest you just give them the keys (to Smith).”

He says any reorganization must be fair to all the creditors, not just Hughes.

Smith executives say they welcomed the recent merger between Baker International Inc. and Hughes because Smith and Baker have always had a cordial relationship. Baker had been based in nearby Orange until moving its headquarters to Houston in March. Baker officials have been acting as intermediaries in negotiations between Smith and Hughes for months. Carroll has attended several meetings in Orange County, Texas and New York City.

Carroll says he is cautiously optimistic about reaching an agreement. He says Smith believes that $10 million would be an appropriate settlement for its infringement on the Hughes’ patent.

“I would be hopeful that with Baker being very well-managed, there may be a settlement,” said Carroll, who carries a half dollar-size rubber O-ring in his briefcase. It is the small rubber device that was at the center of the patent infringement litigation.

“We honestly believe it is not possible to patent an O-ring,” Carroll said.

He says the acrimony between Hughes and Smith stretches back 30 years or more, beginning with a clash in corporate culture and Hughes’ original product dominance in the oil patch.

The hatred spilled into bankruptcy court this year, when Hughes filed seven appeals, objecting to virtually every action approved by U.S. Bankruptcy Judge James R. Dooley in Los Angeles.

‘It’s Harassment’

“Hughes fights everything,” Carroll said. “It’s harassment, nothing more than that.”

But, Baker’s influence has already been felt in court. On Thursday, Judge Dooley dismissed all seven of Hughes’ appeals at the request of Smith and Baker-Hughes.

Sources close to the case say the decision to drop the appeals was made by the Baker executives now working at Hughes.

After the ruling, attorneys for Smith and its unsecured creditors’ committee said they welcomed the action because it will save them a lot of time and money.

Meanwhile, Smith executives say they are confident the company will emerge from bankruptcy stronger and wiser.

” . . . we have a hell of a lot of cash,” Carroll said, expressing optimism despite the large 1986 losses.

Still, Smith executives are not ordering champagne. In addition to the estimated $450 million Smith owes to all its creditors, including Hughes, the company is battling a $21-million claim recently filed by the Internal Revenue Service, which is demanding back taxes from 1980 to 1985. Smith disputes the claim.

And, just being in bankruptcy creates more work and expenses for the beleaguered company. Carroll says Smith spends about $6 million a year on attorney and consulting fees relating to the bankruptcy.

Each Friday, Carroll must submit a voluminous financial report to the court. And, he says, he spends countless hours providing detailed information to the various creditor’s committees. So far, he says, the relationship with Smith’s bankers and others has been cordial.

Bernard Shapiro, an attorney representing the court-appointed unsecured creditors’ committee agrees.

“The relationship with Smith has been very professional, cordial and constructive,” Shapiro said. “When the current oil (drilling) crisis is over, the creditors hope Smith will emerge as a strong competitor.”

Smith has until June 30 to submit a reorganization plan to the bankruptcy court. If it does not meet the deadline, the creditors may submit a plan of their own, Shapiro says.

With the legal dust settling and the stock price rising, Smith has some breathing space to ponder the future. Smith executives say they would like to see Smith maintain its independence, but some Wall Street analysts are skeptical.

Deterrent to Suitors

“I can’t see the company remaining independent,” said Philip K. Meyer, an oil industry analyst for Dillon Read & Co. Inc. “The ultimate resolution is that it has to be bought out.”

Meyer says a likely candidate might be Halliburton Co., a Dallas, Tex.-based oil field services company. But, Meyer and others say Smith’s current bankruptcy has deterred any serious suitors, at least for the moment.

Other analysts are more confident that Smith can make it alone.

“They probably are not going through all this (work) to be snapped up,” said Kevin Simpson, an oil services industry analyst for Drexel Burnham Lambert Inc.

“Smith could be spectacular by itself,” if the oil drilling industry makes a full recovery, Simpson said.

Meanwhile, analysts agree that the unknown quantity in Smith’s future is its newest largest single stockholder.

Industrial Equity (Pacific) Ltd., a New Zealand investment firm, has a 15.2% stake. So far, Carroll says, Industrial Equity has not discussed any specific plans for Smith, but “anything’s possible.” Ronald Langley, president of Industrial Equity’s North American operations, sits on Smith’s board. His company is seeking a second board seat. Industrial Equity has invested about $300 million in U.S. companies, Carroll says.

“We have a good working relationship with Langley,” Carroll said. “They are clearly a friendly company.” Langley was out of the country last week and unavailable for comment.

Carroll says Industrial Equity sought out Smith because “they see we are a worldwide market leader.”