UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

 

Form 10-K

 

 

 

Commission file number 1-31339

 

 

WEATHERFORD INTERNATIONAL LTD.

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(713)693-4000

 

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

 

Note — Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Exchange Act from their obligations under those Sections.

 

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.  o

 

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 12b-2 of the Exchange Act (Check one):

 

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

 

The aggregate market value of the voting stock held by nonaffiliates of the registrant as of June 30, 2006 was approximately $13.3 billion based upon the closing price on the New York Stock Exchange as of such date.

 

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

 

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Certain information called for by Items 10, 11, 12, 13 and 14 of Part III will be included in an amendment to this annual report on Form 10-K or incorporated by reference from the registrant’s definitive proxy statement for the annual meeting to be held on May 30, 2007.

 

 

PART I

 

 

Weatherford International Ltd. (NYSE:WFT) is one of the world’s leading providers of equipment and services used for the drilling, evaluation, completion, production and intervention of oil and natural gas wells. We were originally incorporated in Delaware in 1972, and as a result of our corporate reorganization in 2002, are now incorporated in Bermuda. Many of our businesses, including those of Weatherford Enterra, have been operating for more than 50 years.

 

We operate in approximately 100 countries through approximately 800 service, sales and manufacturing locations, which are located in nearly all of the oil and natural gas producing regions in the world. We are among the leaders in each of our primary markets, and our distribution and service network is one of the most extensive in the industry.

 

In 2006, we conducted our operations through two principal operating divisions:

 

 

On January 8, 2007, we created the position of Senior Vice President and Chief Operating Officer. During 2007, in conjunction with this organizational change, we decided to merge our two existing divisions, Evaluation, Drilling & Intervention Services and Completion & Production Systems, into a single operating group.

 

Our growth strategy during the past eight years has included a mix of organic product and service development, the acquisition of key technologies, products and services and several notable divestitures. One of our most substantial acquisitions was in August 2005, when we acquired Precision Energy Services and Precision Drilling International. Precision Energy Services broadened our wireline and directional capabilities and strengthened our controlled pressure drilling and testing product lines. Precision Drilling International added land rigs to our portfolio, primarily in the Eastern Hemisphere.

 

Our divestitures include the April 2000 spin-off of our Drilling Products Division to our shareholders through a distribution of the stock of our Grant Prideco, Inc. subsidiary. In February 2001, we completed the merger of essentially all of our Compression Services division into a subsidiary of Universal Compression Holdings, Inc. in exchange for 13.75 million shares of Universal common stock. During 2004 and 2005, we sold our interest in Universal Compression Holdings, Inc. In 2005, we sold our non-core Gas Services International compression fabrication business. This business has been reflected as a discontinued operation in our financial statements.

 

When referring to Weatherford and using phrases such as “we” and “us,” our intent is to refer to Weatherford International Ltd. and its subsidiaries as a whole or on a divisional basis, depending on the context in which the statements are made.

 

Our principal executive offices are located at 515 Post Oak Boulevard, Suite 600, Houston, Texas 77027. Our telephone number is (713) 693-4000, and our Internet address is www.weatherford.com. General information about us, including our Corporate Governance Policies and charters for the committees of our board of directors, can be found on our Web site. On our Web site we make available, free of charge, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file or furnish them to the SEC.

 

The following is a summary of our business strategies and the markets we serve. We have also included a discussion of our divisions, including a description of our products and services offered and our competitors. Divisional and geographic financial information appears in “Item 8. Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements — Note 21.”

 

Strategy

 

Our primary objective is to provide our shareholders with above-average returns on their investment through income growth and asset appreciation.

 

Principal components of our strategy include:

 

 

Markets

 

We are a leading provider of equipment and services to the oil and natural gas exploration and production industry. Demand for our industry’s services and products depends upon the number of oil and natural gas wells being drilled, the depth and drilling conditions of wells, the number of well completions and the level of workover activity worldwide.

 

During the mid-1980s, the drilling industry contracted sharply, correcting a condition of significant overcapacity that existed in the supply of oilfield service and equipment. For the past 20 years, global rig count has cycled up and down with factors such as world economic and political trends that influence supply and demand for energy, the price of oil and natural gas and the level of exploration and drilling for those commodities.

 

The majority of worldwide drilling activity, as measured by rig counts, historically has been concentrated in North America. Over time, activity in North America has increasingly become driven by natural gas consumption on the continent, particularly in the U.S. The percentage of the U.S. rig count dedicated to natural gas drilling has increased from approximately 50% in the early 1990s to approximately 84% in late 2006. Canada has experienced a similar trend, with rigs drilling for natural gas increasing from less than 40% nine years ago to over 71% by the end of 2006. A primary reason for the increasing emphasis on natural gas drilling is that a growing percentage of North American gas wells tend to have above average production decline rates, so that significant numbers of new wells must be drilled over time to maintain ongoing natural gas production. Changes in the balance of natural gas supply and demand affect natural gas storage levels, commodity prices and the volatility of North American drilling activity. In 2006, the North American rig count reached a new recent high, averaging 2,118 rigs for the year, 15% above the previous high in 2005 and 160% above the lowest annual average of the past 15 years, 816, which occurred in 1992.

 

Over the past decade, drilling and completion activity has grown faster in international markets than in North America. In 2006, approximately 70% of the worldwide drilling and completion expenditures occurred in markets outside North America (excluding Russia and China). Drilling activity outside North America tends to be less volatile. Most contracts span two to three years as a consequence of the significant investment and complexity surrounding international projects. Drilling decisions relating to these projects therefore tend to be evaluated and monitored with a longer-term perspective in regard to oil and natural gas pricing. In addition, the international market is dominated by major oil companies and national oil companies, which tend to have longer-term objectives than the typical independent producer in North America. In the past 15 years, the non-North American average annual rig count has cycled between a high of 915 rigs in 1991 and a low of 588 rigs in 1999. In 2006, the international rig count averaged 910 rigs. Since 1999, the international market has recovered slowly; however, we

believe the geological future of the industry is in both international markets and deep water because of the maturity and declining quality of North American fields.

 

In the late 1990s, we began a concerted program to expand our operations and shift more of our business internationally by using the strength of Weatherford Enterra’s international presence to introduce new and existing products and services into these markets. Today we operate in approximately 100 countries in the major oil and natural gas producing areas of North and South America, Europe, Africa, Russia, Commonwealth of Independent States, China, Southeast Asia and the Middle East. In 2006, our revenue split was 56% North America and 44% international.

 

In 2006, our Evaluation, Drilling & Intervention Services Division generated approximately 51% of its revenues outside North America, and our Completion & Production Systems Division generated approximately 32% of its revenues internationally. With the increasing importance of international hydrocarbon production, we continue to focus on growth in international markets.

 

As a result of the maturity of the world’s oil and natural gas reservoirs, accelerating production decline rates and the focus on complex deepwater prospects, technology has become increasingly critical to the marketplace. Clients continue to seek, test and prove production-enabling technologies at an increasing rate. Technology is an important aspect of our products and services, as it helps us provide our clients with more efficient tools to find and produce oil and natural gas. We have invested a substantial amount of our time and resources in building our technology offerings. We believe our products and services are among the best in the industry and enable our clients to reduce their costs of drilling and production and/or increase production rates. Furthermore, these offerings afford us additional opportunities to sell our traditional core products and services to our clients.

 

Evaluation, Drilling & Intervention Services Division

 

Our Evaluation, Drilling & Intervention Services Division provides products and services used by oil and natural gas companies, drilling contractors and other service companies to explore for, drill for, and produce oil and natural gas, as well as work over wells. The division is a combination of Weatherford’s former Drilling Services division, Precision Energy Services and Precision Drilling International. As discussed above, Precision Energy Services and Precision Drilling International were significant acquisitions in 2005 that strengthened our offering and expertise in directional drilling, open hole and cased hole wireline services, and controlled pressure drilling and testing. The acquisition also added land rigs to our portfolio, primarily in the Eastern Hemisphere.

 

Many of the products and services offered by this division are used in the initial drilling and completion of oil and natural gas wells. The remainder of the products and services are used in connection with the production phases of wells, including maintenance, re-drilling, re-completion and other remediation and well intervention operations.

 

The division comprises three primary business units: 1) Performance Drilling & Evaluation Services, 2) Well Construction & Intervention Services, and 3) Integrated Drilling Services.

 

Performance Drilling & Evaluation Services

 

This business unit concentrates on directional drilling services, drilling-with-casing, Controlled Pressure Drilling^® (CPD^®) & well testing, wireline services and geoscience services.

 

Drilling Services — These capabilities include directional drilling and drilling-with-casing (DwC^tm) and drilling-with-liner (DwL^tm) systems. Directional drilling involves the personnel, equipment and engineering required to control the direction of a wellbore. Directional drilling allows drilling of multiple wells from a single offshore platform or a land-based pad site. It also allows drilling of horizontal wells and penetration of multiple reservoir pay zones from a single wellbore. Directional drilling services are necessary for the industry’s increasing trends toward deviated wells, multilateral completions, re-entry and infill drilling. Through the acquisition of Precision Energy Services in 2005, we now supply a range of specialized, patented equipment for directional drilling, including:

 

 

 

The Precision acquisition added the Advantage Engineering facility, which supports our directional drilling capabilities. This state-of-the-art facility houses many of the industry’s most qualified engineers, scientists and technicians, all focused on developing technologies for the MWD/LWD and directional drilling markets, both land based and offshore. We also acquired a portfolio of patents and patent applications directed at key aspects of technology in LWD nuclear and resistivity measurements, electromagnetic telemetry and the Revolution RSS. We also now hold a worldwide, exclusive license to electromagnetic telemetry patents and patent applications for use in MWD services.

 

 

Controlled Pressure Drilling & Well Testing — This business unit helps clients increase the profitability of their reservoirs’ assets at less lifecycle cost by enhancing drilling performance and reservoir recovery through a portfolio of products and services. Well testing uses specialized equipment and procedures to obtain essential information about oil and gas wells after the drilling process has been completed.

 

Weatherford’s Controlled Pressure Drilling & Well Testing offerings are provided through three disciplines: 1) Managed Pressure Drilling, 2) Underbalanced Drilling and 3) Air Drilling.

 

 

 

A full range of downhole equipment, such as high temperature motors, wireline steering tools, drillpipe, air rotary hammer drills, casing exit systems, downhole deployment valves and downhole data acquisition equipment, make our product offering unique. Another differentiator is our range of surface equipment, such as: specifically designed, self-contained mobile or skid-mounted compression and nitrogen membrane or passive exhaust gas generation systems; rotating control devices for controlling well pressure while circulating drilling media during drilling; skid-mounted separators for separating oil, natural gas, drilling media and cuttings; choke manifolds; and solids recovery systems.

 

In our well testing business, typical information derived may include reservoir performance, reservoir pressure, formation permeability, formation porosity and formation fluid composition.

 

A related application is our separation business, which supplies personnel and equipment on a wellsite to recover a mixture of solids, liquids and gases from oil and gas wells. These services are used during drilling, after stimulation or after re-completion to clean up wells. The operator requires that a well be properly cleaned before undertaking a well test to ensure that the true deliverability of the well is attained and that debris and spent stimulation chemicals do not ultimately flow to the process plant.

 

Wireline Services — This business unit measures the physical properties of underground formations to help determine the location and potential deliverability of oil and gas from a reservoir. Wireline services are provided from surface logging units, which lower tools and sensors into the wellbore mainly on a single or multiple conductor wireline; however, other conveyance methods are also available. In fact, Weatherford offers the most comprehensive suite of logging tool conveyance options in the industry. This unmatched flexibility of options provides opportunities for substantial savings in rig costs and significant risk reduction during the formation evaluation process. The provision of wireline services is divided into three categories: open hole, cased hole and slickline services.

 

 

The log data is then used to characterize the reservoir and describe it in terms of porosity, permeability, oil, gas or water content and an estimation of productivity. This information can be further refined at a later time in one of our log interpretation centers. Wireline services can relay this information from the wellsite on a real-time basis via a secure satellite transmission network and secure Internet connection to the client’s office for faster evaluation and decision making.

 

Most of our open hole tools and sensors are proprietary. Our unique offering is a reliable, cost-effective system known as the Compact^tm suite of tools. The system’s design, which is smaller, slimmer and easier to handle, enables acquisition of high quality logging data more efficiently and in a broader range of well conditions than possible with the current offerings of our competitors. As a result, the focus of open hole research and engineering has been on developing new and/or improved downhole sensors for the Compact and standard logging suites. Compact tools can be conveyed on wireline or using an array of conveyance alternatives, such as the well shuttle, tractors or coiled tubing.

 

 

In addition, cased hole services may involve wellbore remediation, which could include the positioning and installation of various plugs and packers to maintain production or repair well problems, and casing inspection for internal or external abnormalities in the casing string. Some of our cased hole tools are proprietary.

 

 

Through the acquisition of Precision Energy Services, we now have a total of more than 540 wireline units that can be deployed from our service centers in Canada, the U.S. and other locations around the world.

 

GeoScience Services — This business unit, consisting of geologists, geophysicists, and drilling, completion, production and reservoir engineers, serves as the interdisciplinary bridge across our diverse product lines to support client efforts to maximize their oil and gas assets for the life of the well — from well planning through drilling, evaluation, completion, production, intervention and, finally, abandonment.

 

Major computing centers in Calgary and Houston, along with branches in Europe, the Middle East and South America, use the latest technology to deliver data to our clients — from real-time (LWD) “geosteering” for critical well placement decisions to ongoing reservoir monitoring with permanent “intelligent completion” sensors. We provide advanced reservoir solutions by incorporating open hole, cased hole and production data.

 

One of our businesses, Hycal Energy Research Laboratories, Ltd., specializes in advanced core and fluid analysis, formation damage and phase behavior to optimize production. Another business, our proprietary SURE^SM process, is a systematic evaluation for determining whether candidate wells are suited for special controlled pressure drilling and testing and multilateral drilling techniques to reduce formation damage and improve deliverability before the prospect is drilled.

 

The recent addition of OMNI Labs adds several important components to our multi-disciplined geoscience and engineering capability, including one of the industry’s most experienced teams of geologists, engineers and technicians. OMNI is known for pioneering wellsite stabilization procedures for unconsolidated cores and continues to set the standard for analysis and evaluation of unconsolidated reservoirs. OMNI also has been the leader in developing secured client Web access to core data for faster delivery of analysis results and intermediate and final reports.

 

Well Construction & Intervention Services

 

This business unit focuses on our more traditional mechanical capabilities and spans tubular running services, cementation tools, liner systems, solid tubular expandable technologies, drilling tools, intervention services and decommissioning.

 

Tubular Running Services — These services consist of a wide variety of tubular connection and installation services for the drilling, completion and workover of an oil or natural gas well. We are a significant market leader in tubular running services worldwide. Offering an integrated package of total tubular services management, we provide tubular handling, preparation, inspection and wellsite installation services from a single source. As the leader in rig mechanization technology used for the installation of tubing, casing and production risers, we offer a suite of products and services for improving rig floor operations by reducing personnel exposure, increasing operational efficiency and improving safety. We offer computerized torque monitoring and testing services to ensure the integrity of tubular connection makeup. We also specialize in critical-service installations where operating conditions, such as downhole conditions and/or metallurgical characteristics, call for specific handling technology. Finally, our tubular running services integrate with other product/service lines, such as high-grade completion equipment installation services and cementation engineering services.

 

Cementation Tools — Cementing operations comprise one of the most important and expensive phases of well completion. According to Spears & Associates, we are the world’s leading producer of specialized equipment that allows operators to centralize the casing throughout the wellbore and control the displacement of cement and other fluids. Our cementing engineers also analyze complex wells and provide detailed recommendations to help optimize cementing results. Our cementing products group also works closely with our Completion & Production Systems Division in designing integrated completion systems. Our cementing product line includes the following:

 

 

Liner Systems — Liner hangers allow suspension of strings of casing within a wellbore without the need to extend the casing to the surface. Most directional wells include one or more liners to optimize casing programs. We offer both drilling and production liner hangers. Drilling liners are used to isolate areas within the well during drilling operations. Production liners are used in the producing area of the well to support the wellbore and to isolate various sections of the well. In the Gulf of Mexico alone, Weatherford runs 500 to 600 liner jobs a year, of which approximately 150 are deepwater. Our inflatable packer product line services liner systems and includes annulus casing packers, inflatable production packers and inflatable straddle packer assemblies. We also offer specialized high-pressure, high-temperature, high-performance inflatable thru-tubing and completion packers.

 

Solid Tubular Expandable Technologies — Proprietary expandable tools are being developed for downhole solid tubular applications in well remediation, well completion and well construction. Our solid tubular expandable products include the MetalSkin^® line, used for well cladding to shut off zones, retro-fit corroded sections of casing and strengthen existing casing. Solid expandable systems use fixed-cone expansion technology. We have commercialized and completed successful jobs in 2006 for well construction purposes, using MetalSkin open-hole clad systems for controlling unwanted fluid loss or influx and slim-bore drilling liners. Slim-bore and, ultimately, monobore liner systems are designed to allow significant cost reductions by reducing consumables for drilling and completion of wells, allowing use of smaller rigs and reducing cuttings removal needs. The benefits are derived because of the potential of expandable technologies to significantly reduce or eliminate the reverse-telescoping architecture inherent in traditional well construction.

 

Drilling Tools — We design and manufacture patented tools, including our drilling jars, rotating control devices and other pressure-control equipment. We also offer a broad selection of in-house or third-party manufactured equipment for the drilling, completion and workover of oil and natural gas wells. We offer these proprietary and nonproprietary drilling tools to our clients — primarily operators and drilling contractors — on a rental basis, allowing the clients to use unique equipment without the cost of holding that equipment in inventory.

 

The rental of our proprietary and nonproprietary tools permits more efficient use of the equipment and allows us to receive value-added returns on the equipment. The breadth of our operations and locations allows us to manage and re-deploy our equipment to locations where it is most needed. Our drilling tools include the following:

 

 

 

Intervention Services — Our intervention services help clients repair wells that have mechanical problems or that need work to prolong production of oil and natural gas reserves. Our intervention products and services span the spectrum of fishing services, re-entry services, and thru-tubing products and services.

 

Fishing Services — Fishing services are provided through teams of experienced fishing tool supervisors and a comprehensive line of fishing and milling tools, including several proprietary technologies. Our teams provide conventional fishing services, such as removing wellbore obstructions, including stuck or dropped equipment, tools, drillstring components and other debris, that have been left behind unintentionally during the drilling, completion or workover of new and old wells. Specialty fishing tools required in these activities include fishing jars, milling tools, casing cutters, overshots and spears. Our Fishing Services business unit also provides well patches and extensive plug-and-abandonment products. Proprietary technologies include our PowerStroke^tm milling system. The PowerStroke system helps operators remediate wells using existing wellbore infrastructure, a benefit that can reduce customer cost by up to 70% compared to the cost of drilling a new well.

 

Re-entry Services — Our re-entry services include casing exit services and advanced multilateral systems. Conventional and advanced casing exit systems allow sidetrack and lateral drilling solutions for clients who either cannot proceed down the original well track or want to drill lateral wells from the main or parent wellbore. An example is Weatherford’s QuickCut^tm single-trip casing exit system, which mills windows in half the conventional time and reduces drilling time in difficult-to-drill formations. As of December 2006, we had run more than 1,700 QuickCut systems around the world. In addition, advanced multilateral systems, including selective re-entry systems (SRS), StarBurst^tm and MillThru^tm Level 4 patented technology and advanced multilateral junction solutions, allow numerous sidetracks from parent wellbores.

 

Thru-tubing Services — Thru-tubing services are used in well re-entry activity to allow operators to perform complex drilling, completion and cementing activities from existing wellbores without removing existing production systems. We provide a full range of thru-tubing services and products, including drilling motors, casing exits, fishing and milling, zonal isolation packers and other well remediation services.

 

Decommissioning — Decommissioning is the process of safely sealing and abandoning wellbores. In 2006, we completed the world’s first hydromechanical (non-explosive) wellhead removal program in the North Sea. Using this non-explosive technique resulted in significant reductions in health, safety and environmental risks compared to traditional decommissioning techniques.

 

Integrated Drilling Services

 

In 2006, our land drilling business was owned and operated under the name Precision Drilling International. This business consists of a total of 42 rigs; of these, 21 are heavy-duty land rigs and 21 are light-and-medium drilling rigs. The majority of our rigs are located in the Eastern Hemisphere. We have the ability to offer project management services to our customers, whereby we would provide a number of products and services needed to drill and complete a well, including the rig.

 

Competition

 

We provide our Evaluation, Drilling & Intervention Services Division’s products and services worldwide, and we compete in a variety of distinct segments with a number of competitors. Our major competitors are Baker Hughes, Halliburton, Schlumberger, Smith International and BJ Services. We also compete with other regional suppliers that provide a limited range of equipment and services tailored for local markets. Competition is based on a number of factors, including performance, safety, quality, reliability, service, price, response time and, in some cases, breadth of products. We believe we are the industry leader in a number of the Evaluation, Drilling and Intervention Division’s product and service offerings, including Controlled Pressure Drilling (CPD). We currently do not have a high share of the global market in our directional drilling and wireline offerings. We do, however, have

strong shares in the markets where the technology of these product lines was originally developed, and we believe our global market shares for these product lines will increase as we introduce them into new geographic markets.

 

Completion & Production Systems Division

 

Our Completion & Production Systems Division provides conventional and intelligent completion systems, all forms of artificial-lift systems, reservoir stimulation, production optimization and pipeline services. In addition, this division provides a variety of pumping systems for the energy, industrial, chemical and municipal markets.

 

Completion Systems

 

We offer our clients a comprehensive line of completion products as well as engineered and integrated completion systems for oil and natural gas fields. These products and services include the following:

 

Cased Hole Completion Systems — These systems are incorporated into the tubing string used to transport hydrocarbons from the reservoir to the surface. We offer a wide range of devices for enhancing the safety and functionality of the production string, including permanent and retrievable packer systems, subsurface safety systems, flow controls and tool string, specialized downhole isolation valves and associated servicing equipment. During the past 10 years, we have evolved our portfolio from one of basic cased-hole commodity products to one that focuses more heavily on premium offerings for deepwater and high-pressure/high-temperature environments.

 

Sand Screens — Sand production often results in premature failure of artificial-lift and other downhole and surface equipment and can obstruct the flow of oil and natural gas. Conventional sand screen products are used in the fluid-solid separation processes and have a variety of product applications. Our primary application of well screens is for the control of sand in unconsolidated formations. We offer premium, pre-pack and wire-wrap sand screens. We also offer a FloReg^tm line of inflow control devices that balance horizontal wellbore production, ultimately maximizing reservoir drainage.

 

We also operate the water well and industrial screen business of Johnson Screens, acquired in 2001. Served markets include water well, petrochemical, wastewater treatment and surface water intake, mining and general industrial applications.

 

Expandable Sand Screens (ESS) — Our ESS^® systems are proprietary step-change sand-control devices that reduce cost and improve production. An ESS system consists of three layers, including slotted base pipe, filtration screens and an outer protective shroud. The system can be expanded using a fixed cone and/or compliantly using our proprietary axial and rotary expansion system. This system aids productivity because it stabilizes the wellbore, prevents sand migration and has a larger inner diameter.

 

ESS technology can replace complex gravel-packing techniques in many sand-control situations. In 2006, we commercialized our ERC^tm expandable reservoir completion system, which encompasses the ESS system and the EZI^tm expandable zonal isolation system, a product evolved from our MetalSkin solid expandable technology, to apply expandable reservoir completions to multizone factors, combining open-hole productivity with cased-hole functionality. At the end of 2006, we had installed 450 expandable completions, which equates to more than 270,000 installed feet.

 

Industrial Pumps — In today’s industrial markets there exists an endless variety of applications and special product needs. With a proven history of providing cost-effective pumping solutions for optimal performance and operating efficiencies, we are uniquely positioned to address and enhance specific service and product requirements in a number of industrial applications. Our technical expertise, experience and capabilities plus proven products support our ability to provide clients with pumps designed for a wide variety of conditions and applications. Weatherford’s comprehensive line of industrial products includes specialty and multiplex pumps, progressing cavity pumps and horizontal surface pumping units, each offering an array of capabilities that cover pumping applications across the major industries.

 

Artificial Lift Systems

 

Artificial lift systems are installed in oil wells and, to a lesser extent, natural gas wells that do not have sufficient reservoir pressure to raise the produced hydrocarbon to the surface. These systems supplement the natural reservoir pressures to produce oil or natural gas from the well. There are six principal types of artificial lift technologies used in the industry. We are the leading producer of artificial lift systems and the only company in the world able to provide all forms of lift, including progressing cavity pumps, reciprocating rod systems, gas lift systems, electrical submersible pumps, hydraulic lift systems, plunger lift systems and hybrid lift systems. We are always looking to develop new and innovative lift systems.

 

Progressing Cavity Pumps — A progressing cavity pump (PCP) is a downhole pump driven by an above-ground electric motor system connected to it by a coupled rod or continuous rod string. These pumps are among the most operationally efficient and are designed to work in wells of depths up to 6,000 feet with production between 10 and 4,500 barrels of oil per day. We are also developing PCP solutions for higher temperatures and special applications. PCPs have had particular success in heavy-oil-producing basins around the world.

 

Reciprocating Rod Lift Systems — A reciprocating rod lift system is an artificial lift pumping system that uses an above-ground mechanical unit connected to a sucker rod and a downhole pump. It uses an up-and-down suction process to lift the oil from the reservoir. Reciprocating rod lift is used primarily for the production of oil from wells of depths up to 14,000 feet and production rates from 20 to 8,000 barrels per day. Reciprocating rod-lift systems are generally more expensive to install than other systems but less costly to operate. We offer a complete package of products for rod-lift applications ranging from traditional pump jacks to the state-of-the-art Rotaflex^® long-stroke pumping unit, as well as all downhole components, including the COROD^® continuous rod, traditional sucker rods and tubing anchors.

 

Gas Lift Systems — Gas lift is a form of artificial lift that uses natural gas to lift oil in a producing reservoir to the surface. The process of gas lift involves the injection of natural gas into the well through an above-ground injection system and a series of downhole mandrels and gas lift valves in the production tubing string. The gas injected into the system is either produced from and re-injected into the well, or is injected from gas produced from nearby wells. The injected gas acts as the lifting agent for the oil. Gas lift systems are used primarily for offshore wells (including deepwater and ultra-deepwater) and for wells that have a high component of gas in the produced fluid or have a gas supply near the well. Gas lift systems are designed to operate at depths up to 15,000 feet with volumes up to 20,000 barrels of oil per day.

 

Electric Submersible Pumps — An electric submersible pump (ESP) is an electrically powered downhole pumping system that is typically landed near the perforations of the producing reservoir. To lift fluid to the surface, the system converts electrical power to centrifugal motion via the rotating motor and pump shafts. Electrical power is transmitted downhole through a power cable that runs the length of the production tubing. Power is provided by a surface supply system and controlled by either surface electrical switchgear or a variable frequency drive. ESPs are designed to operate at depths of up to 13,500 feet with produced fluid volumes ranging from 100 to 60,000 barrels per day. Before 1999, we did not provide ESPs to the oil industry. In 2002, we began manufacturing and distributing our own proprietary line of ESP systems.

 

Hydraulic Lift Systems — A hydraulic lift oil pumping system uses an above-ground surface power unit to operate a downhole hydraulic pump (jet or piston) to lift oil from the reservoir. These systems are designed for wells of depths up to 20,000 feet and volumes up to 15,000 barrels per day. Hydraulic pumps are well suited for wells with high volumes and low solids.

 

Plunger Lift Systems — Plunger lift is the only artificial lift method that requires no assistance from outside energy sources. The typical system consists of a plunger (or piston), top and bottom bumper springs, a lubricator and a surface controller. The plunger cycles between the top and bottom bumper springs. As it travels to the surface, it creates a solid interface between the lifted gas below and produced fluid above to maximize lift energy. The travel cycle is controlled by a surface controller. Plunger lift is a low-cost, easily maintained method of lift. It is particularly useful for dewatering gas wells and increasing production from wells with emulsion problems. Plunger lift also keeps wells free of paraffin and other tubing deposits and can be used to produce a well to depletion.

 

Hybrid Lift Systems — We offer a variety of hybrid artificial lift systems which are engineered for special applications and may incorporate two or more of the artificial lift methods described above. As the leading supplier of lift systems, we are continuously looking for and developing new and innovative means of lifting conventional and unconventional hydrocarbons.

 

Wellhead Systems — We offer a line of conventional wellhead equipment and valves manufactured to the latest API industry specifications and client requirements, including conventional surface wellheads through 20,000 psi; gate valves from 2,000 to 20,000 psi; complete wellhead systems (drill-through, multi-bowl, unitized and mud-line); and all the accessories and aftermarket services to go with them.

 

Stimulation and Chemicals

 

We offer our clients advanced chemical technology and services for safer and more effective production enhancement. These products and services include the following:

 

Production Chemical Systems — Our Engineered Chemistry^® business combines proprietary chemical solutions with internally developed oilfield equipment technologies. Our high-performance chemistry solutions include: customized chemical solutions for production, refining, completion, water treatment and other industrial processes; a total service package (product selection, application and optimization); and precise formulations and multi-functional chemical formulations that include the only formulas certified for capillary injection.

 

Capillary Injection Technology and Services — We formed our capillary technology group by combining our in-depth artificial-lift experience with our oilfield production chemical expertise to provide safer and more effective production enhancement. Capillary technology maximizes well production while protecting tubular goods. With systems easily installed in live wells in just three to four hours, reservoir production is not interrupted. Our specialists are trained in all aspects of injection services and chemical handling to provide each worksite with expedient service in the safest environment possible.

 

Fracturing Technologies — Hydraulic reservoir fracturing (“fracturing”) is a stimulation method routinely performed on oil and natural gas wells in low-permeability reservoirs to increase productivity and oil and gas recovery. Current operations are located in most major fracturing markets within the U.S. Our three differentiators are: 1) cutting-edge equipment standardized to control inventory, maintenance and training costs; 2) robust chemical product portfolio with a focused research and development approach; and 3) a premier workforce with a shared focus on providing the most efficient and effective operations.

 

In 2006, we also added the FracMap^tm reservoir management and characterization tool for helping to determine whether a stimulation is staying in the productive zone. Our capabilities use multiple technologies to produce real-time, three-dimensional videos of fractures as they occur.

 

Production Optimization

 

Production optimization is the process of increasing production, reducing production costs, or both, of oil and natural gas fields. The ultimate goal is to assist operators in making better decisions that maximize profits through improved well productivity management. One of the major benefits of production optimization is that more production can be achieved through the existing infrastructure, deferring capital spending on the de-bottlenecking processes.

 

We were one of the first companies to provide complete artificial-lift well optimization services and products. We now offer proprietary software that works with artificial-lift and intelligent completion systems to remotely monitor and control wells, as well as optimize field production, from a central location. Our systems are used in more than 40,000 wells worldwide.

 

Well Optimization — By providing intelligence at the wellsite and intelligence at the desktop, we provide the operator with a unique solution for optimizing each well individually. For wellsite intelligence, we offer specific controllers for each type of artificial lift. These controllers contain computers with specific logic to control the well during changes in the reservoir, artificial-lift equipment or well components. The operational changes are based on the parameters set by the well operator, either at the wellsite or at a desktop computer. The desktop software

provides advanced analytical tools that allow the operator to make changes by controlling the well directly or by changing the parameters that the controller is using to operate the well.

 

Flow Metering — Weatherford’s Production Optimization group develops metering and software solutions to supply real-time production information to the operator, allowing accurate production measurements as a part of asset optimization. The family of new products includes the revolutionary Red Eye^® 2G watercut meter, which delivers superior accuracy across the full range (1% to 99%) of water cuts. The Red Eye^® multiphase metering systems (REMMS) are well-testing skids that allow the operator to perform well tests on demand without the errors and long purge times of traditional three-phase test separators. In 2006, Weatherford began offering electronic flow measurement (EFM) solutions to accurately measure flowing wells. The EFM devices are used mainly for natural gas and coalbed methane wells.

 

Reservoir Optimization — Our intelligent completion technology (ICT) uses optical sensing to allow operators to remotely monitor the downhole pressure, temperature, flow rate, phase fraction and seismic activity of each well and the surrounding reservoir. This advanced monitoring capability allows the operator to monitor the reaction of the reservoir to the production of the well. Combining this monitoring with multiple-zone downhole flow control allows field pressure management and shutoff of unwanted flows of water or gas.

 

Optical Sensing — In 2006, the use of optical sensing technology continued to expand in the market. Downhole optical flowmeter and seismic technologies were deployed on a more widespread basis. Overall, installations increased by 60%, and the number of optical pressure/temperature (P/T) gauges installed was up 76% from 2005. Cumulative optical sensing system operation has now exceeded 1.8 million hours, with almost 1.5 million feet of optical cable installed. This represents about 4.5 million feet of fiber deployed in oil and gas wells. It also represents more than 300 optical sensors, including P/T gauges, distributed temperature sensors, flowmeters and seismic stations.

 

Life of Well Information Software (LOWIS) — We provide tools for optimizing workflow. These software tools assist the operator in tracking the operations needed for optimal field management. Tasks such as chemical injection, well workovers and injection allocation can easily generate unnecessary expenses by inefficient prioritization of tasks, poor recordkeeping and lack of analysis of the effectiveness of the total field operations. The combination of our experienced consultants and advanced software tools help the operator optimize operations for entire fields.

 

Pipeline and Specialty Services

 

We provide a range of services used throughout the life cycle of pipelines and process facilities, onshore and offshore. Our pipeline group can meet all the requirements of the pipeline, process, industrial and energy markets worldwide. We also can provide any service (or package of services) carried out on permanently installed client equipment that involves inspecting, cleaning, drying, testing, improving production, running or establishing integrity from the wellhead out. We maintain the largest global fleet of onsite generated membrane nitrogen equipment, which provides the safe production of a continuous supply of nitrogen at a lower cost with no cryogenic hazards.

 

Competition

 

In our Completion & Production Systems Division, our principal competitors include Baker Hughes, Halliburton, Schlumberger and BJ Services. We also compete with various smaller providers of completion equipment. In the area of intelligent wells, our main competitors are Schlumberger, Baker Hughes and WellDynamics. Robbins & Myers, Harbison Fischer, Lufkin, National Oilwell Varco and Dover Corporation are competitors exclusive to our artificial-lift products. Competition in hydraulic reservoir fracturing includes principal competitors noted above and several regional companies. The principal methods of competition are performance, quality of products and services, reliability, price, technological innovation and industry reputation. According to Spears & Associates, we are a leading provider of completion equipment in the world and the world’s largest provider of progressing cavity pumps, reciprocating rod-lift pump systems and hydraulic-lift systems and are the only fully integrated provider of all lift systems.

 

Properties

 

Our operations are conducted in approximately 100 countries. We currently have 90 manufacturing facilities and approximately 730 sales, service and distribution locations throughout the world. The following table describes the material facilities we owned or leased as of December 31, 2006:

 

 

Other Business Data

 

Raw Materials

 

We purchase a wide variety of raw materials as well as parts and components made by other manufacturers and suppliers for use in our manufacturing. Many of the products sold by us are manufactured by other parties. We are not dependent on any single source of supply for any of our raw materials or purchased components; however, the loss of one or more of our suppliers in our Completion & Production Systems Division could disrupt production.

 

Customers and Backlog

 

Our principal customers consist of major and independent oil and natural gas producing companies. During 2006, 2005 and 2004, none of our customers individually accounted for more than 10% of consolidated revenues.

 

Our backlog consists of customer orders for which a purchase order has been received, satisfactory credit arrangements exist and delivery is scheduled. The respective sales backlog was approximately $349 million as of December 31, 2006 and approximately $294 million for the comparable period in the prior year. All backlog is expected to be shipped during 2007.

 

Research and Development and Patents

 

We maintain world-class technology and training centers throughout the world. Our 29 research, development and engineering facilities are focused on improving existing products and services and developing new technologies to meet customer demands for improved drilling performance and enhanced reservoir productivity. Our expenditures for research and development totaled $149.4 million in 2006, $107.4 million in 2005 and $83.6 million in 2004.

 

As many areas of our business rely on patents and proprietary technology, we have followed a policy of seeking patent protection both inside and outside the U.S. for products and methods that appear to have commercial significance. In the U.S., we currently have 965 patents issued and over 450 pending. We have 1,485 patents issued in international jurisdictions and over 1,590 pending. We amortize patents over the years expected to be benefited, ranging from 3 to 20 years.

 

Many of our patents provide us with competitive advantages in our markets. Important patented products and technologies include:

 

(1) LWD and MWD systems, such as our “MFR” multi-frequency resistivity logging tool, our density- neutron combination logging tool, and our electro-magnetic telemetry tool;

 

(2) our controlled pressure drilling and testing drilling products and services, including our “Virtual Riser” offshore pressure control system, Williams high pressure rotating heads, internal riser rotating control heads for deepwater drilling, and our Clearwater chemicals and foam technology;

 

(3) new generation wireline magnetic casing inspection tool and wireline oil-based borehole imager;

 

(4) our expandable slotted and solid tubular products, such as our “ESS” expandable sand screens, many of such products are sold pursuant to a license from Shell;

 

(5) tubular running systems, including our “PowerScope” tong positioning system and our “StabMaster” tubular positioning system;

 

(6) casing exit systems, including our “QuickCut” casing window milling system;

 

(7) drilling with casing equipment and services including the “DrillShoe” and “ReamerShoe” casing shoes, and our new suite of drilling hazard mitigation services;

 

(8) sensing systems for intelligent completion systems, such as our fiber optic flow meter, our “Clarion” fiber optic seismic sensing system, and our “Red Eye” water/oil ratio meter; and

 

(9) wellbore completion products, such as our “Optimax” subsurface safety valve and “FracGuard” composite bridge plug.

 

Although in the aggregate our patents are of considerable importance to the manufacturing and marketing of many of our products, we do not believe that the loss of any one of our patents would have a material adverse effect on our business.

 

Seasonality

 

Weather and natural phenomena can temporarily affect level of demand for our products and services. Spring months in Canada and winter months in the North Sea tend to negatively affect operations. In the summer of 2005, the Gulf of Mexico suffered an unusually high number of hurricanes with unusual intensity that adversely impacted our operations. The widespread geographical locations of our operations serve to mitigate the impact of the seasonal nature of our business.

 

Insurance

 

We currently carry a variety of insurance for our operations. We are partially self-insured for certain claims in amounts we believe to be customary and reasonable.

 

Although we believe we currently maintain insurance coverage adequate for the risks involved, there is always a risk our insurance may not be sufficient to cover any particular loss or that our insurance may not cover all losses. For example, while we maintain product liability insurance, this type of insurance is limited in coverage and it is possible an adverse claim could arise in excess of our coverage. Finally, insurance rates have in the past been subject to wide fluctuation. Changes in coverage, insurance markets and our industry may result in further increases in our cost and higher deductibles and retentions.

 

Federal Regulation and Environmental Matters

 

Our operations are subject to federal, state and local laws and regulations relating to the energy industry in general and the environment in particular. While we are not currently aware of any situation involving an environmental claim that would likely have a material adverse effect on our business, it is always possible that an environmental claim with respect to one or more of our current businesses or a business or property that one of our predecessors owned or used could arise that could have a material adverse effect.

 

In October 2002, we were notified by a third party that we may be a potentially responsible party to the Force Road Oil and Vacuum Truck Company Superfund site in Brazoria County, Texas. This matter is in the preliminary stages, and based on the information provided, if we are named as a party by the Texas Commission on Environmental Quality (“TCEQ”), it appears we will be a de minimus party. In January 2003, a subsidiary of Precision Energy Services was notified by the U.S. Environmental Protection Agency (“EPA”) that they were a potentially responsible party to the Gulf Nuclear Superfund Sites in Odessa, Tavenor and Webster, Texas. Based upon the information provided, it appears they will be classified as a de minimus party. In August 2004, we were notified by the U.S. Environmental Protection Agency (“EPA”) that we were a potentially responsible party to the Malone Services Co. Superfund Site in Texas City, Texas. We were classified as a de minimus party and paid a settlement payment of approximately $28,000. We are currently awaiting the EPA’s acceptance of our settlement payment.

 

Our 2006 expenditures to comply with environmental laws and regulations were not material, and we currently expect the cost of compliance with environmental laws and regulations for 2007 also will not be material.

 

Employees

 

We currently employ approximately 33,000 employees. Certain of our operations are subject to union contracts. These contracts, however, cover less than one percent of our employees. We believe that our relationship with our employees is generally satisfactory.

 

Forward-Looking Statements

 

This report, as well as other filings made by us with the Securities and Exchange Commission (“SEC”), and our releases issued to the public contain various statements relating to future results, including certain projections

and business trends. We believe these statements constitute “Forward-Looking Statements” as defined in the Private Securities Litigation Reform Act of 1995.

 

From time to time, we update the various factors we consider in making our forward-looking statements and the assumptions we use in those statements. However, we undertake no obligation to publicly update or revise any forward-looking events or circumstances that may arise after the date of this report. The following sets forth the various assumptions we use in our forward-looking statements, as well as risks and uncertainties relating to those statements. Certain of the risks and uncertainties may cause actual results to be materially different from projected results contained in forward-looking statements in this report and in our other disclosures. These risks and uncertainties include, but are not limited to, the following:

 

 

 

Finally, our future results will depend upon various other risks and uncertainties, including, but not limited to, those detailed in our other filings with the SEC. For additional information regarding risks and uncertainties, see our other filings with the SEC under the Securities Exchange Act of 1934, as amended, and the Securities Act of 1933, as amended, available free of charge at the SEC’s website at www.sec.gov. We will generally update our assumptions in our filings as circumstances require.

 

 

An investment in our common shares involves various risks. When considering an investment in our company, you should consider carefully all of the risk factors described below, as well as other information included and incorporated by reference in this report.

 

We conduct significant foreign operations that subject us to numerous risks

 

Like most multinational oilfield service companies, we have operations in certain international areas, including parts of the Middle East, North and West Africa, Latin America, the Asia Pacific region and the Commonwealth of Independent States, that are subject to risks of war, political disruption, civil disturbance, economic and legal sanctions (such as restrictions against countries that the U.S. government may deem to sponsor terrorism) and changes in global trade policies. We participated in the United Nations oil-for-food program governing sales of goods and services into Iraq. The SEC has asked us to provide them copies of certain documents relating to our participation in that program in connection with a fact-finding inquiry related to that program. We are complying with that request. Our operations may be restricted or prohibited in any country in which the foregoing risks occur.

 

In particular, the occurrence of any of these risks could result in the following events, which in turn, could materially and adversely impact our results of operations:

 

 

Currency Exposure

 

Approximately 38.9% of our net assets are located outside the U.S. and are carried on our books in local currencies. Changes in those currencies in relation to the U.S. dollar result in translation adjustments, which are reflected as accumulated other comprehensive income in the shareholders’ equity section in our Consolidated Balance Sheets. We recognize remeasurement and transactional gains and losses on currencies in our Consolidated Statements of Income, which may adversely impact our results of operations. We enter into foreign currency forward contracts and other derivative instruments as an effort to reduce our exposure to currency fluctuations; however, there can be no assurance that these hedging activities will be effective in reducing or eliminating foreign currency risks.

 

In certain foreign countries, a component of our cost structure is U.S. dollar denominated, whereas our revenues are partially local currency based. In those cases, a devaluation of the local currency would adversely impact our operating margins.

 

Litigation and Environmental Exposure

 

In the ordinary course of business, we become the subject of various claims and litigation. We maintain insurance to cover many of our potential losses and we are subject to various self-retentions and deductibles with respect to our insurance. Although we are subject to various ongoing items of litigation, we do not believe any of our current items of litigation will result in any material uninsured losses to us. However, it is possible an unexpected judgment could be rendered against us in cases in which we could be uninsured and beyond the amounts we currently have reserved or anticipate incurring.

 

We are also subject to various federal, state and local laws and regulations relating to the energy industry in general and the environment in particular. Environmental laws have in recent years become more stringent and have generally sought to impose greater liability on a larger number of potentially responsible parties. While we are not currently aware of any situation involving an environmental claim that would be likely to have a material adverse effect on our business, it is always possible that an environmental claim with respect to one or more of our current businesses or a business or property that one of our predecessors owned or used could arise and could involve material expenditures.

 

Industry Exposure

 

The concentration of our customers in the energy industry may impact our overall exposure to credit risk as customers may be similarly affected by prolonged changes in economic and industry conditions. Further, laws in some jurisdictions in which we operate could make collection difficult or time consuming. We perform ongoing credit evaluations of our customers and do not generally require collateral in support of our trade receivables. While we maintain reserves for potential credit losses, we cannot assure such reserves will be sufficient to meet write-offs of uncollectible receivables or that our losses from such receivables will be consistent with our expectations.

 

Terrorism Exposure

 

The terrorist attacks that took place in the U.S. on September 11, 2001 and the subsequent ongoing war on terror have created many global economic and political uncertainties. The potential for future terrorist attacks, the

national and international responses to terrorist attacks, and other acts of war or hostility have created many economic and political uncertainties that could adversely affect our businesses.

 

Tax Exposure

 

On June 26, 2002, the stockholders and Board of Directors of Weatherford International, Inc. (“Weatherford Inc.”) approved our corporate reorganization, and Weatherford International Ltd. (“Weatherford Limited”), a newly formed Bermuda company, became the parent holding company of Weatherford International, Inc. The realization of the tax benefit of this reorganization could be impacted by changes in tax laws, tax treaties or tax regulations or the interpretation or enforcement thereof or differing interpretation or enforcement of applicable law by the U.S. Internal Revenue Service or other taxing jurisdictions. The inability to realize this benefit could have a material impact on our financial statements.

 

Acquisition Exposure

 

In August of 2005, we acquired Precision Energy Services and Precision Drilling International. In association with the acquisition, we identified pre-acquisition contingencies related to duties and taxes associated with the importation of certain equipment assets to foreign jurisdictions. We calculated a range of reasonable estimates of the costs associated with these duties. As no amount within the range appeared to be a better estimate than any other, we used the amount that is the low end of the range in accordance with Statement of Financial Accounting Standards No. 5, Accounting for Contingencies, and its interpretations. At December 31, 2006, we have recorded a liability in the amount of approximately $20 million for this matter. If we used the high end of the range, the aggregate potential liability would be approximately $27 million higher. It is reasonably possible that the actual amount paid to settle these items could be materially different from our estimate and could have a material adverse effect on our consolidated financial statements.

 

Bermuda Governance Risks

 

We are a Bermuda exempt company, and it may be difficult for you to enforce judgments against us or our directors and executive officers. The rights of holders of our shares will be governed by Bermuda law and our memorandum of association and bye-laws. The rights of shareholders under Bermuda law may differ from the rights of shareholders of companies incorporated in other jurisdictions. One of our directors is not a resident of the U.S., and a substantial portion of our assets are located outside the U.S. As a result, it may be difficult for investors to effect service of process on those persons in the U.S. or to enforce in the U.S. judgments obtained in U.S. courts against us or those persons based on the civil liability provisions of the U.S. securities laws. Uncertainty exists as to whether courts in Bermuda will enforce judgments obtained in other jurisdictions, including the U.S., against us or our directors or officers under the securities laws of those jurisdictions or entertain actions in Bermuda against us or our directors or officers under the securities laws of other jurisdictions.

 

Our bye-laws restrict shareholders from bringing legal action against our officers and directors.

 

Our bye-laws contain a broad waiver by our shareholders of any claim or right of action, both individually and on our behalf, against any of our officers or directors. The waiver applies to any action taken by an officer or director, or the failure of an officer or director to take any action, in the performance of his or her duties, except with respect to any matter involving any fraud or dishonesty on the part of the officer or director. This waiver limits the right of shareholders to assert claims against our officers and directors unless the act or failure to act involves fraud or dishonesty.

 

Our bye-laws have anti-takeover provisions that may discourage a change of control. These anti-takeover provisions could result in a lower market price for our shares and may limit a shareholder’s ability to obtain a premium for our shares.

 

Our bye-laws contain provisions that could make it more difficult for a third party to acquire us without the consent of our board of directors, even if the third party’s offer may be considered beneficial by many shareholders.

As a result, shareholders may be limited in their ability to obtain a premium for their shares and this may cause the market price of our shares to decrease significantly. These provisions also provide for:

 

 

Our board of directors may issue preference shares and determine their powers, preferences and rights and their qualifications, limitations and restrictions. The issuance of preference shares may delay, defer or prevent a merger, amalgamation, tender offer or proxy contest involving us.

 

 

None.

 

 

See “Item 1. Business — Properties” on page 13 of this report, which is incorporated by reference into this item.

 

 

In the ordinary course of business, we become the subject of various claims and litigation. We maintain insurance to cover many of our potential losses, and we are subject to various self-retention limits and deductibles with respect to our insurance.

 

See “Item 1. Business — Other Business Data — Federal Regulation and Environmental Matters” on page 16 of this report, which is incorporated by reference into this item.

 

Although we are subject to various ongoing items of litigation, we do not believe any of the items of litigation to which we are currently subject will result in any material uninsured losses to us. It is possible, however, an unexpected judgment could be rendered against us in the cases in which we are involved that could be uninsured and beyond the amounts we currently have reserved.

 

 

No matters were submitted to a vote of shareholders of the Company during the fourth quarter of the year ended December 31, 2006.

 

PART II

 

 

Our common shares are traded on the New York Stock Exchange under the symbol “WFT.” As of February 20, 2007, there were 2,099 shareholders of record. Additionally, there were 278 stockholders of Weatherford International, Inc. as of the same date who had not yet exchanged their shares. The following table sets forth, for the periods indicated, the range of high and low sales prices per common share as reported on the New York Stock Exchange. In 2005, our Board of Directors approved a two-for-one split of our common shares. As a result, all prices have been restated to reflect the two-for-one share split.

 

 

On February 20, 2007, the closing sales price of our common shares as reported by the New York Stock Exchange was $39.24 per share. We have not declared or paid cash dividends on our common shares since 1984.

 

In December 2005, our Board of Directors approved a share repurchase program under which up to $1 billion of our outstanding common shares could be purchased. Future purchases of our shares can be made in the open market or privately negotiated transactions, at the discretion of management and as market conditions warrant. During the quarter ended December 31, 2006, we purchased our common shares in the following amounts at the following average prices:

 

 

In addition, under our restricted share plan, employees may elect to have us withhold common shares to satisfy minimum statutory federal, state and local tax withholding obligations arising on the vesting of restricted stock awards and exercise of options. When we withhold these shares, we are required to remit to the appropriate taxing authorities the market price of the shares withheld, which could be deemed a purchase of the common shares by us on the date of withholding.

 

During the quarter ended December 31, 2006, we withheld common shares to satisfy these tax withholding obligations as follows:

 

 

On February 28, 2002, we issued a warrant to purchase up to 6.5 million of our common shares at $30.00 per share as part of the consideration given to obtain a worldwide license to Shell Technology Ventures Inc.’s expandable technology. Effective July 12, 2006, we and Shell Technology Ventures Inc. amended and restated this warrant. The amendments reflect, among other things, changes in our capital and organizational structure since the original warrant was issued in February 2002. The warrant is exercisable until February 28, 2012 and is subject to adjustment for changes in our capital structure or our issuance of dividends in cash, securities or property. To the extent that the amendment and restatement of the warrant constitutes the issuance of a new security, that new security was issued solely in exchange for the original warrant. There were no cash proceeds from the exchange. That new security was an exempted security not subject to registration as provided by Section 3(a)(9) of the Securities Act of 1933.

 

On August 31, 2005, in connection with our acquisition of Precision Energy Services and Precision Drilling International, we issued 52.0 million of our common shares to Precision Drilling Corporation in a private placement exempt from registration under Section 4(2) of the Securities Act of 1933, as amended.

 

Information concerning securities authorized for issuance under equity compensation plans is set forth in Part III of this report under “Item 12. Security Ownership of Certain Beneficial Owners and Management — Equity Compensation Plan Information,” which is incorporated herein by reference.

 

 

The following table sets forth certain selected historical consolidated financial data and should be read in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and Notes thereto included elsewhere herein. The following information may not be deemed indicative of our future operating results. The information presented has been restated to reflect our fourth quarter 2005 two-for-one share split, and the years ended December 31, 2003 and 2002 have been restated to reflect Gas Services International compression fabrication business as a discontinued operation.

 

 

 

Our Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) begins with an executive overview which provides a general description of our company today, a synopsis of industry market trends, insight into management’s perspective of the opportunities and challenges we face and our outlook for 2007 and 2008. Next, we analyze the results of our operations for the last three years, including the trends in our business and a summary of our severance, restructuring and asset impairment charges. Then we review our cash flows and liquidity, capital resources and contractual commitments. We conclude with an overview of our critical accounting judgments and estimates and a summary of recently issued accounting pronouncements.

 

The following discussion should be read in conjunction with our Consolidated Financial Statements and Notes thereto included in “Item 8. Financial Statements and Supplementary Data.” Our discussion includes various forward-looking statements about our markets, the demand for our products and services and our future results. These statements are based on certain assumptions we consider reasonable. For information about these assumptions, you should refer to the section entitled “Item 1. Business — Forward-Looking Statements.”

 

Overview

 

General

 

Weatherford provides equipment and services used for drilling, completion and production of oil and natural gas wells throughout the world. We conduct operations in approximately 100 countries and have service and sales locations in nearly all of the oil and natural gas producing regions in the world. Our offerings include drilling and evaluation services, including directional drilling, measurement while drilling and logging while drilling, well installation services, fishing and intervention services, drilling equipment including land rigs, completion systems, production optimization and all forms of artificial lift. We operate under two segments: Evaluation, Drilling & Intervention Services and Completion & Production Systems.

 

In July 2005, we sold our Gas Services International compression fabrication business. Results of this business were formerly reported within our Completion & Production Systems business segment and have been reclassified as a discontinued operation for all periods presented.

 

Industry Trends

 

Changes in the current price and expected future prices of oil and natural gas influence the level of energy industry spending. Changes in expenditures result in an increased or decreased demand for our products and services. Rig count is an indicator of the level of spending for the exploration for and production of oil and natural gas reserves.

 

The following chart sets forth certain statistics that reflect historical market conditions:

 

 

 

Although oil and natural gas prices have continued to fluctuate over the last several years, the average annual price of oil and natural gas has continued to increase. Oil prices ranged from a high of $77.03 per barrel in July of 2006 to a low of $17.97 per barrel in January of 2002. Natural gas prices ranged from a high of $15.42 per MM/BTU in December of 2005 to a low of $1.91 per MM/BTU in January of 2002. Factors influencing oil and natural gas prices during the three-year period include persistent hydrocarbon inventory levels, realized and expected economic growth, levels of spare production capacity within the Organization of Petroleum Exporting Countries (“OPEC”), weather and geopolitical uncertainty, including the uncertainty of Iraqi oil production.

 

Historically, the majority of worldwide drilling activity has been concentrated in North America. From mid-1999 through mid-2001, North American rig count improved steadily, peaking in the first quarter of 2001 at a quarterly average of 1,636 rigs. The level of drilling and completion spending in North America also improved steadily for this same time period with an overall improvement greater than 100%. During the latter part of 2001, the rig count started to decline, and the decline continued through mid-2002. Since mid-2002, the North American rig count has improved to a fourth quarter 2006 rig count average of 2,160 rigs. Traditionally, the international rig count has not been as volatile as the North American rig count. The international market experienced a 10% improvement in the 2006 average annual rig count as compared to the previous year and 20% improvement as compared to 2004.

 

During 2006, drilling and completion spending has continued to increase in both North America and the international markets. According to Spears & Associates, 2006 drilling and completion spending increased 42% in North America and 24% in international markets as compared to 2005 levels. Drilling and completion spending growth during 2007 is anticipated to be driven by the international markets. According to Spears & Associates, drilling and completion spending during 2007 is anticipated to increase approximately 16% in international markets while declining approximately 3% in North America markets as compared to 2006 levels.

 

Opportunities and Challenges

 

The nature of our industry offers many opportunities and challenges. We have created a long-term strategy aimed at growing our business, servicing our customers, and most importantly, creating value for our shareholders. The success of our long-term strategy will be determined by our ability to manage effectively any industry cyclicality, respond to industry demands and successfully maximize the benefits from our acquisitions.

 

The cyclicality of the energy industry impacts the demand for our products and services. Certain of our products and services, such as our drilling and evaluation services, well installation services and well completion services, depend on the level of exploration and development activity and the completion phase of the well life cycle. Other products and services, such as our production optimization and artificial lift systems, are dependent on production activity. We believe that decline rates, a measure of the fall in production from a well over time, are accelerating. We also believe that there has been, and will continue to be, a deterioration in the quality of incremental hydrocarbon formations that our customers develop and that these formations will require more of our products and services than higher quality formations. The market for oilfield services will grow year on year relative to the decline rates and the implicit rate of demand growth. We are aggressively, but methodically, expanding our people, manufacturing and equipment capacity to meet the demands of the industry.

 

In the third quarter of 2005, we acquired Precision Energy Services and Precision Drilling International. This acquisition significantly strengthens and expands our service offering. Opportunities exist to accelerate the market penetration of the acquired products in the Eastern Hemisphere by utilizing our established infrastructure and to increase pull through sales with our expanded portfolio of technologies.

 

2007 and 2008 Outlook

 

We believe the outlook for our businesses is favorable. As decline rates accelerate and reservoir productivity complexities increase, our clients will face growing challenges securing desired rates of production growth. Assuming the demand for hydrocarbons does not weaken, these phenomena provide us with a robust outlook. The acceleration of decline rates and the increasing complexity of the reservoirs increase our customers’ requirements for technologies that improve productivity.

 

In particular, the international markets are experiencing a multi-year expansion, with the Eastern Hemisphere standing out as the strongest market. The dynamics in North America are different. Near term, the climate will dictate activity in North America. Weather-related activity decreases were experienced in North America during the fourth quarter of 2006, particularly in Canada. Aside from seasonal swings, further declines in the 2007 Canadian market are likely. High natural gas storage levels could also impact near-term activity; however we believe any activity declines would be short lived, if they were to occur.

 

Looking into 2007 and 2008, we expect average worldwide rig activity to grow as compared to fourth quarter 2006 levels, and we expect our business to continue to grow at a faster rate than the underlying rig count. We expect the Eastern Hemisphere to be our highest growth market during 2007, followed by the Latin America market. We expect our growth in 2007 and 2008 to be broad based, with all of our product and service lines continuing to build on 2006 achievements. These improvements should be driven by the strength of our technology and our global infrastructure. We expect our newer technologies to continue to gain traction across a wider breadth of geographic markets, similar to our performance in 2006.

 

Geographic Markets.  Climate, natural gas storage levels and commodity prices will dictate the rate of oilfield service activity growth in North America during 2007 and 2008. While these factors are difficult to predict with any certainty over short periods of time, we believe that the North American market has positive secular growth attributes over the longer term. Over the next 12 to 18 months, North America activity is likely to remain at or around current levels, on average. We expect most of our growth in 2007 and 2008 will come out of the international markets. Eastern Hemisphere growth will be driven by year over year increases in the Middle East, North Africa, West Africa, China, Russia and Central Europe. In addition, we expect volume increases in Latin America with improvements stemming from Brazil, Mexico and Argentina. The North Sea is expected to show modest growth throughout 2007. In the course of 2007, we anticipate the Eastern Hemisphere will surpass the U.S. market as our largest market.

 

Pricing.  The overall pricing outlook is positive. Pricing is trending upwards, concurrently with raw material and labor cost inflation. We expect pricing to remain positive throughout 2007, net of cost increases. Price improvements are being realized on a contract-by-contract basis and are occurring in different classes of products and service lines depending upon the region.

 

Overall, the level of market improvements for our businesses for 2007 will continue to depend heavily on our ability to gain market share, primarily in the Eastern Hemisphere, recruit and retain personnel and secure further acceptance of our new technologies. The continued strength of the industry will be highly dependent on many external factors, such as world economic and political conditions, member country quota compliance within OPEC and weather conditions. The extreme volatility of our markets makes predictions regarding future results difficult.

 

Results of Operations

 

In connection with our integration plan relating to the acquisition of divisions of Precision Drilling Corporation and the operational realignment of our Pipeline and Specialty Services businesses, we undertook a review of our presentation of segment information in the second quarter of 2006. In addition to their former businesses,

Evaluation, Drilling & Intervention Services now includes the operations of Precision Drilling International, and Completion & Production Services includes the operations of Pipeline and Specialty Services.

 

The following charts contain selected financial data comparing our consolidated and segment results from operations for 2006, 2005 and 2004. On August 31, 2005, we completed the acquisition of Precision Energy Services and Precision Drilling International, divisions of Precision Drilling Corporation. The results of operations from the acquired businesses are included in our results of operations from the date of acquisition; therefore, the year ended December 31, 2005 includes four months of activity from these acquired businesses. We are unable to provide certain information regarding our current period results excluding the impact of acquisitions due to the integration of these acquisitions into our operations.

  Comparative Financial Data

 

 

Consolidated Revenues by Geographic Region

 

 

Company Results

 

Revenues

 

Consolidated revenues increased $2,245.7 million, or 51.8%, in 2006 as compared to 2005. The 2005 acquisition of Precision Energy Services and Precision Drilling International contributed approximately $1,040 million of the increase. The remaining increase was due primarily to market activity, share gains and pricing initiatives. North America generated revenue growth of 53.0%, and included revenue increases of 56.2% and 46.5% in the U.S. and Canada, respectively. Excluding revenues from acquisitions, North America revenues increased approximately $700 million, or 33%. This region’s increase outpaced the North America rig count increase of 15.3%. The increase in activity and pricing in the U.S. and Canadian markets were the key contributors to revenue growth during 2006. Internationally, revenues increased $973.8 million, 50.4%, or approximately $510 million, 29%, excluding acquisitions, as compared to the 10.4% increase in the average annual international rig count. Excluding our acquisitions, the revenue increase was generated by increased volume through market share and activity improvement and increased pricing obtained through the renewal of long-term contracts. Our international revenue growth, excluding acquisitions, was led by increases of approximately 41%, 30% and 24% in the Middle East and North Africa region, the Latin America region and the Europe, CIS and West Africa region, respectively.

 

Consolidated revenues increased $1,201.5 million, or 38.4%, in 2005 as compared to 2004. The acquisition of Precision Energy Services and Precision Drilling International contributed $448.3 million of the increase. Organic growth of $753.2 million was due primarily to market activity, share gains and pricing initiatives. North America generated revenue growth of 43.8%, and included revenue increases of 41.0% and 49.7% in the U.S. and Canada, respectively. Excluding acquisitions, North America revenues increased $481.1 million, or 28.8%. This increase is compared to an average annual North America rig count increase of 18.1%, and was due to product specific market share gains, activity increases and pricing improvement. Although our U.S. operations generated substantial revenue growth during 2005, certain of our U.S. manufacturing and distribution facilities were negatively impacted by devastating hurricane activity in the Gulf Coast region. Internationally, revenues increased $470.3 million, 32.2%, or $272.1 million, 18.6%, excluding acquisitions, as compared to the 8.6% increase in the average annual international rig count. Excluding our acquisitions, the revenue increase was generated by increased volume through market share and activity improvement and increased pricing obtained through the renewal of long-term contracts. Our international revenue growth, excluding acquisitions, was led by increases of 29.8%, 19.6% and 15.8% in the Asia Pacific, Middle East and North Africa and Europe, CIS and West Africa regions, respectively.

 

Gross Profit

 

Our gross profit as a percentage of revenues increased from 31.9% in 2005 to 35.9% in 2006. This increase was primarily the result of the positive impact of higher base revenues to cover fixed costs, with additional contributions from stronger North America and international pricing. In addition, the year ended December 31, 2005 included inventory write downs of $20.7 million associated with our 2005 integration/reorganization plan.

 

Our gross profit as a percentage of revenues increased from 31.1% in 2004 to 31.9% in 2005. The increase in our gross profit percentage in 2005 was primarily volume related, with additional contributions from stronger

pricing increases. This increase was offset by increasing labor costs, inventory write downs of $20.7 million associated with our 2005 integration/reorganization plan and the lower margins of businesses acquired in 2005.

 

Research and Development

 

Research and development expenses increased $42.1 million, or 39.2%, in 2006 as compared to 2005 and $23.8 million, or 28.5%, in 2005 as compared to 2004. Research and development expenses as a percentage of revenues were 2.3%, 2.5% and 2.7% in 2006, 2005 and 2004, respectively. Our 2005 acquisition accounted for approximately $40 million of the current year’s increase and approximately $15 million of the increase experienced during 2005. The remaining increases of research and development expenditures reflect our continued focus on developing and commercializing new technologies as well as investing in our core product offerings.

 

Corporate General and Administrative

 

Corporate general and administrative expenses increased $38.4 million, or 49.8%, from 2005 to 2006. Approximately $17 million of the increase is due to severance charges. The remainder of the increase is primarily due to increased costs associated with higher employee compensation expense and professional services fees. Corporate general and administrative expenses increased $21.3 million, or 38.0%, from 2004 to 2005 due primarily to increases in stock-based compensation, severance, increases in professional fees and increased costs associated with our 2005 acquisition.

 

Exit Costs and Restructuring Charges

 

During 2005, we underwent both a restructuring related to our acquisition of Precision and reorganization activities related to our historical businesses, including a change in management, a change in regional structure and an evaluation of product lines. We incurred exit costs of $114.2 million related to this exit and reorganization. The charge included an inventory write-down of $20.7 million which has been recorded in Cost of Products and a remaining amount of $93.6 million which has been recorded as Exit Costs and Restructuring Charges in the accompanying Consolidated Statements of Income.

 

The exit plan related to the Precision acquisition resulted in exit costs and restructuring charges of $105.5 million. We initiated an integration plan to combine worldwide operations, rationalize product lines, and eliminate certain products, services and locations. Product line rationalization included wireline, controlled pressure drilling and testing and directional product and service offerings. Inventory totaling $20.7 million was written-down. Asset impairment charges included $20.9 million for fixed assets, $12.9 million related to information technology and $1.7 million related to investments. Employee severance and termination benefits totaled $33.0 million. Contract terminations and facility closures of $7.3 million were also recorded. In connection with the valuation of the Precision assets, $9.0 million was identified as purchased in process research and development and was written-off.

 

The exit plan related to the reorganization activities surrounding our historical businesses resulted in exit costs and restructuring charges of $8.7 million. We incurred severance and termination benefits of $3.6 million and recorded $2.6 million of facility termination charges related to the rationalization of two facilities in the United Kingdom and the U.S. The remaining $2.5 million charge related to the write-off of other assets.

 

The 2005 integration and reorganization plans are substantially complete as of December 31, 2006. No additional costs were recorded during the year ended December 31, 2006, and we do not anticipate future charges, relating to these activities. A summary of the exit costs and restructuring charges by segment is as follows:

 

 

As of December 31, 2006, the remaining accrual was comprised primarily of severance benefits. The length of time we are obligated to make severance payments varies, with the longest obligation continuing through 2018.

 

Gain on Sale of Universal Common Stock

 

We sold our remaining 6.75 million shares of Universal Compression common stock during 2005 for net proceeds of $276.8 million and recognized a gain of $115.5 million with no related tax impact. During 2004, we sold 7.0 million shares of Universal Compression common stock for net proceeds of $231.8 million and recognized a gain of $77.6 million with no related tax impact.

 

Debt Redemption Expense

 

During the third quarter of 2005, we settled our Zero Coupon Convertible Senior Debentures and expensed $4.7 million, $3.3 million net of taxes, of unamortized issuance costs.

 

Interest Expense

 

Interest expense increased $29.2 million, or 36.4%, in 2006 as compared to 2005. This increase was due primarily to our additional long-term debt issuances during 2006 used to fund our acquisition of shares under our share repurchase program and to fund current year acquisitions. The increase was partially offset by the settlement of our Zero Coupon Convertible Senior Debentures and the reduction of our outstanding debt balance with the proceeds received from the sale of our remaining investment in Universal Compression, which occurred in the third and fourth quarters of 2005, respectively. Interest expense increased $16.8 million, or 26.4%, in 2005 as compared to 2004. This increase was due primarily to the incremental borrowings used to fund the cash portion of our 2005 acquisition, offset by the settlement of our Zero Coupon Convertible Senior Debentures during the third quarter of 2005.

 

Other, Net

 

Other, net decreased $32.8 million from 2005 to 2006 primarily as a result of unfavorable changes in foreign exchange rates experienced during the current year. In addition, the year ended December 31, 2005 included equity in earnings of $9.5 million from our investment in Universal Compression. Our remaining interest in Universal Compression was sold in December of 2005. Our other, net increased approximately $9.2 million from 2004 to 2005 primarily due to the favorable impact of fair value changes in foreign exchange and interest rate derivatives not accounted for as hedging instruments.

 

Income Taxes

 

Our effective tax rates were 25.9% in 2006, 25.4% in 2005, and 21.5% in 2004. During 2006, we realized a tax benefit of $26.4 million related to the favorable settlement of certain foreign tax exposures, which lowered our effective rate for the period.

 

During 2005, we incurred exit and restructuring charges and debt redemption expense of $119.0 million, $81.9 million net of tax, and a gain on our sale of Universal Compression common stock of $115.5 million with no related tax impact. We also incurred additional tax expense of $23.9 million associated with the impairment of certain foreign tax credits resulting from the integration of the Precision acquisition into our tax structure. These items and their associated income tax impact reduced our 2005 effective income tax rate.

 

Our 2004 effective tax rate was reduced due to our sale of Universal common stock which generated a $77.6 million gain with no related tax impact.

 

Segment Results

 

Evaluation, Drilling & Intervention Services

 

Evaluation, Drilling & Intervention Services revenues increased $1,705.3 million, or 67.4%, in 2006 as compared to 2005. All of our product lines generated substantial growth. Our third quarter 2005 acquisition of Precision Energy Services provided significant top-line growth in our controlled pressure drilling and testing systems, cased and open hole wireline and directional drilling product line offerings. Geographically, the North America revenue increase of $849.5 million, or 69.1%, included approximately $570 million of revenues from acquisitions. The increase of approximately 28% before acquisitions was due to volume growth above the 15.3% increase in the average annual North America rig count and price increases in the U.S. market implemented during the first half of 2006. International revenues increased $855.7 million, or 65.8%, from 2005 to 2006. The most significant organic international growth was in the Middle East and North Africa region, the Asia Pacific region, and the Europe, CIS and West Africa region, where revenues increased approximately 43%, 40% and 31%, respectively. Our international revenue growth, excluding acquisitions, increased approximately $390 million, or 35% as compared to a 10.4% increase in the average international rig count. This increase reflects our continued investment in the Eastern Hemisphere and new, technologically advanced product offerings.

 

Evaluation, Drilling & Intervention Services revenues increased $831.1 million, or 49.0%, in 2005 as compared to 2004. Excluding the impact of acquisitions, the increase was $382.8 million, or 22.6%. Our controlled pressure drilling and testing systems, proprietary drilling tools, well installation systems and intervention services all posted significant growth during 2005, excluding the impact of acquisitions. Our 2005 acquisition provided significant top-line growth to our cased and open hole wireline and directional drilling product line offerings. Geographically, the North America revenue increase of $446.9 million, or 57.2%, included $250.1 million of revenues from the Precision Energy Services acquisition. The increase of 25.2% before acquisitions was due to volume growth above the 18.1% increase in the average annual North America rig count and price increases in the U.S. market implemented throughout 2005. International revenues increased $384.2 million, or 41.9%, from 2004 to 2005. Precision Energy Services contributed $198.2 million of international revenue of which approximately 41% was derived in Latin America. Excluding acquisitions, the international revenue increase of $186.0 million, or 20.3%, was generated primarily by increases of 25.0%, 20.6%, and 20.2% in the Latin America region, the Europe, CIS and West Africa region and the Asia Pacific region, respectively. This increase in international revenues was over two times the increase in activity as measured by the average annual international rig count, which increased 8.6%, and reflects our continued investment in the Eastern Hemisphere and new, technologically advanced product offerings.

 

Our gross profit as a percentage of revenue was 38.0% in 2006, 34.2% in 2005, and 34.1% in 2004. The increase in our gross profit percentage in 2006 was primarily volume driven, with additional benefits realized from the North America and international price increases. The year ended 2005 included $20.7 million of inventory write downs associated with our 2005 integration/reorganization plan. The increase in our gross profit percentage in 2005 over 2004 levels was due primarily to increases in pricing and volume, offset by increasing labor and raw material costs, the impact of the 2005 hurricanes on our U.S. operations, an inventory write down of $20.7 million associated

with our 2005 integration/reorganization plan and the impact of the 2005 acquisition. Although the acquired product lines have similar margins to our historical divisional margins in North America, the start-up nature of the operations in the Eastern Hemisphere had a negative impact on overall gross profit margins of the acquired business during 2005.

 

Research and development expenses increased $39.4 million, or 69.3%, from 2005 to 2006 and $17.7 million, or 45.0%, from 2004 to 2005. Our late 2005 acquisition of Precision was the primary cause of the increase in expenditures year over year. As a percentage of revenues, research and development expenses for each of the three years ended 2006, 2005 and 2004 were 2.3%.

 

Selling, general and administrative expenses as a percentage of revenues were 11.5%, 11.9%, and 12.7% in 2006, 2005 and 2004, respectively. The decline as a percentage of revenues was due primarily to our higher revenue base to absorb certain inherent fixed costs included in our selling, general and administrative expenses, such as intangible asset amortization.

 

Completion & Production Systems

 

Completion & Production Systems revenues increased $540.4 million, or 29.9%, in 2006 as compared to 2005. This increase was driven primarily by higher demand across all product lines. On a geographic basis, North America revenues increased $422.4 million, or 36.0%, and included increases of 48.0% and 16.3% in the U.S. and Canada, respectively. Improvements in the region, beyond increases in activity, were primarily due to North America price increases and product specific U.S. market share gains. International revenues improved $118.0 million, or 18.7%, and were led by revenue growth of 35.7% in the Middle East and North Africa region and 31.2% in the Latin America region.

 

Completion & Production Systems revenues increased $370.3 million, or 25.8%, in 2005 as compared to 2004. Significant revenue growth was generated by our portfolio of artificial lift products and services and our continued introduction of our fracturing technologies. We also realized revenue growth in our sand screen applications, including expandable sand screens. North America revenues increased $284.2 million, or 32.0%, and included increases of 42.9% and 17.3% in the U.S. and Canada, respectively. In addition to an increase in activity, as indicated by an 18.1% increase in the average annual North America rig count, increases in pricing and product specific U.S. market share gains attributed to the increase in revenue. Our international operations realized revenue growth of $86.1 million, or 15.8%. The Eastern Hemisphere fueled this robust growth with increases of 40.4%, 27.6% and 8.6% in the Asia Pacific region, the Middle East and North Africa region and the Europe, CIS and West Africa region, respectively.

 

Gross profit as a percentage of revenue was 32.1% in 2006, 28.6% in 2005, and 27.6% in 2004. The continued increase in this segment’s gross profit percentages was due primarily to the higher revenue base, increases in pricing in the U.S. market and changes in product mix.

 

Selling, general and administrative expenses as a percentage of revenues were 11.7%, 13.7% and 15.3% in 2006, 2005 and 2004, respectively. The percentage decline was due primarily to our higher revenue base and certain inherent fixed costs included in our selling, general and administrative expenses such as intangible asset amortization. In addition, the year ended 2006 includes the effect from the divestiture of a portion of our minority interest in a subsidiary. This transaction represents approximately 7% of selling, general and administrative expenses for the year ended 2006.

 

Discontinued Operation

 

Our discontinued operation consists of our Gas Services International compression fabrication business. We generated a gain from our discontinued operation of $1.2 million, net of taxes, for the year ended December 31, 2005 and incurred a loss from our discontinued operation, net of taxes, of $7.2 million for the year ended December 31, 2004. The sale of this business was finalized in July 2005 for a gain of approximately $0.6 million. Included in the 2004 loss were non-cash charges related to goodwill and asset impairments of $3.1 million and an income tax provision of $2.4 million to record a valuation allowance against unrealized deferred tax assets.

 

Liquidity and Capital Resources

 

Historical Cash Flows

 

Our historical cash flows for the years ended December 31, 2006 and 2005 were as follows:

 

 

Sources of Liquidity

 

Our sources of liquidity include current cash and cash equivalent balances, cash generated from operations, and committed availabilities under bank lines of credit. In 2005, we also generated cash proceeds from the sale of our investment in Universal Compression Holdings, Inc. and non-core businesses. We also historically have accessed banks for short-term loans from uncommitted borrowing arrangements and the capital markets with debt, equity and convertible offerings. We maintain a shelf registration statement covering the future issuance of various types of securities, including debt, common shares, preferred shares and warrants.

 

Committed Borrowing Facilities

 

The following summarizes our short-term committed financing facilities and our usage and availability of committed facilities as of December 31, 2006 (in millions):

 

 

In August 2005, we entered into a 364-Day Revolving Credit Agreement (“364-Day Facility”). Under this agreement, we were allowed to borrow up to $1.2 billion to fund the redemption of our zero coupon convertible senior debentures and the acquisition of Precision Energy Services and Precision Drilling International, and were allowed to fund certain refinancings, including commercial paper repayments or common share repurchases. The 364-Day Facility was terminated on August 10, 2006 in connection with the completion of our debt issuance of $600.0 million.

 

On May 2, 2006, we amended and restated our revolving credit agreement with a syndicate of banks of which JPMorgan Chase Bank is the Administrative Agent (“Revolving Credit Facility”). As restated, the Revolving Credit Facility provided us a $750.0 million, five-year multi-currency senior unsecured revolving credit facility. The

Revolving Credit Facility provided that, with the consent of the lenders, we could increase the size of the facility up to $1.5 billion. Effective November 14, 2006, we increased the aggregate lending commitment available under this facility to $1.5 billion. Based on our current debt ratings, we will pay a commitment fee of 0.08% per year, and borrowings under the facility will bear interest at variable annual rates based on LIBOR plus 0.27%, plus an additional 0.05% for any period in which more than half of the total commitment is utilized. The Revolving Credit Facility superceded our previous $500.0 million facility that was scheduled to mature May 12, 2006. The weighted average interest rate on the outstanding borrowing under this facility was 5.4% at December 31, 2006.

 

The Revolving Credit Facility requires us to maintain a debt-to-capitalization ratio of less than 60% and contains other covenants and representations customary for investment-grade commercial credit. We were in compliance with these covenants at December 31, 2006. The Revolving Credit Facility is guaranteed by our wholly-owned indirect subsidiary, Weatherford International, Inc., subject to certain conditions. The Revolving Credit Facility does not contain any provisions that make its availability dependent upon our credit ratings; however, the interest rate is dependent upon the credit rating of our long-term senior debt.

 

We also maintain a Canadian dollar committed facility (“Canadian Facility”) to support our operations in that country. The Canadian Facility provides for borrowings or letters of credit under the facility up to an aggregate of 25.0 million Canadian dollars, or $21.5 million as of December 31, 2006. The weighted average interest rate of the outstanding borrowings of this facility was 6.7% at December 31, 2006.

 

Commercial Paper

 

In October 2005, we initiated a commercial paper program under which we may from time to time issue short-term unsecured notes. In connection with this program, we entered into agreements with third-party lending institutions under which each of these lending institutions may act as dealers of this commercial paper. Also in connection with the program, Weatherford International, Inc., one of our wholly-owned indirect subsidiaries, provides a guarantee of any commercial paper notes that we may issue. Our commercial paper issuances are supported by the Revolving Credit Facility. In connection with the increase in the aggregate lending commitments under our Revolving Credit Facility, the size of our commercial paper program was increased to $1.5 billion on November 15, 2006. As of December 31, 2006, we had $490.8 million of outstanding commercial paper issuances with maturities ranging from 3 to 26 days. The weighted average interest rate related to outstanding commercial paper issuances at December 31, 2006 was 5.4%.

 

Cash Requirements

 

During 2007, we anticipate our cash requirements to include working capital needs, capital expenditures, and the repurchase of our common shares.

 

Capital expenditures for 2007 are projected to be approximately $1.0 billion. The expenditures are expected to be used primarily to support the growth of our business and operations. Capital expenditures during the year ended December 31, 2006 were $999.3 million, net of proceeds from tools lost down hole of $71.8 million.

 

In December 2005, our board authorized us to repurchase up to $1.0 billion of our outstanding common shares. We may from time to time repurchase our common shares depending upon the price of our common shares, our liquidity and other considerations. During the year ended December 31, 2006, we repurchased 12.5 million of our common shares at an aggregate price of $548.6 million.

 

From time to time we acquire businesses or technologies that increase our range of products and services, expand our geographic scope or are otherwise strategic to our businesses. During the year ended December 31, 2006, we used approximately $194.3 million in cash, net of cash acquired, in business acquisitions.

 

Contractual Obligations

 

The following summarizes our contractual obligations and contingent commitments by period. The obligations we pay in future periods may vary from those reflected here due to certain assumptions including the duration of our obligations and anticipated actions by third parties.

 

 

 

 

Short-term Debt

 

We have short-term borrowings with various domestic and international institutions pursuant to uncommitted facilities. At December 31, 2006, we had $60.0 million in short-term borrowings outstanding under these arrangements with a weighted average interest rate of 6.5%.

 

Senior Notes

 

On August 7, 2006, we completed an offering of $600.0 million senior notes at a coupon rate of 6.50% (“6.50% Senior Notes”) with a maturity in August 2036. Net proceeds of $588.3 million were used to partially repay outstanding borrowings on our commercial paper program. Interest on the notes is payable semi-annually in arrears on February 1 and August 1 of each year. The notes are fully and unconditionally guaranteed by Weatherford International, Inc. In connection with the issuance, we elected to notify our administrative agent under our 364-Day Facility to terminate the commitments under that agreement. In addition, the size of our commercial paper program was reduced to correspond to the availability under the Revolving Credit Facility.

 

On May 15, 2006, the stated maturity date, we repaid in full the outstanding $200.0 million of 71/4% Senior Notes plus all accrued interest.

 

On February 17, 2006, we completed an offering of $350.0 million of 5.50% senior notes due 2016 (“5.50% Senior Notes”). The notes are fully and unconditionally guaranteed by Weatherford International, Inc. Interest on the notes is payable semi-annually in arrears on February 15 and August 15 of each year. Net proceeds from the offering were $346.2 million and were used to reduce borrowings on our commercial paper program.

 

On October 7, 2003, we issued $250.0 million of 4.95% senior notes due 2013 (“4.95% Senior Notes”). The notes are fully and unconditionally guaranteed by Weatherford International, Inc. Interest on the notes is payable semi-annually in arrears on April 15 and October 15 of each year.

 

On November 16, 2001, we issued $350.0 million of 65/8% senior notes due 2011 (“65/8% Senior Notes”). Interest on the 65/8% Senior Notes is payable semi-annually on May 15 and November 15. The notes were issued by our wholly-owned indirect subsidiary, Weatherford International, Inc., and are fully and unconditionally guaranteed by Weatherford International Ltd.

 

Other Long-term Debt

 

We have long-term borrowings with various domestic and international institutions, primarily related to capital leases and foreign and other bank debt. At December 31, 2006, we had $23.8 million in other long-term borrowings outstanding under these arrangements with a weighted average interest rate of 6.2%.

 

Derivative Instruments

 

From time to time, we enter into derivative transactions to hedge existing or projected exposures to changes in interest rates and foreign currency exchange rates. We do not enter into derivative transactions for speculative or trading purposes.

 

Interest Rate Swaps

 

We use interest rate swap agreements to take advantage of available short-term interest rates. Amounts received upon termination of the swap agreements represent the fair value of the agreements at the time of termination and are recorded as an adjustment to the carrying value of the related debt. These amounts are being amortized as a reduction to interest expense over the remaining term of the debt.

 

As of December 31, 2006 and 2005, we had net unamortized gains of $14.3 million and $18.3 million, respectively, associated with interest rate swap terminations. These gains have been deferred and recorded as an adjustment to the carrying value of the related debt and are amortized against interest expense over the remaining term of the debt issuance against which they were hedged. Our interest expense was reduced by $4.0 million, $6.8 million and $12.3 million for 2006, 2005 and 2004, respectively, as a result of our interest rate swap activity. There were no interest rate swap agreements outstanding as of December 31, 2006 and 2005.

 

Cash Flow Hedges

 

During December 2005, we recorded a $4.2 million loss in Other Comprehensive Income on interest rate derivatives entered into and terminated in 2005; this loss is being amortized to interest expense over the life of the 5.50% Senior Notes.

 

In January 2006 we entered into interest rate derivative instruments for a notional amount of $350.0 million to hedge projected exposures to interest rates in anticipation of a future debt issuance. Those hedges were terminated at the time of issuance of the 5.50% Senior Notes. We received cash proceeds of $6.2 million at termination, and the gain on these hedges is being amortized to interest expense over the life of the 5.50% Senior Notes.

 

In July 2006 we entered into interest rate derivative instruments for a notional amount of $500.0 million to hedge projected exposures to interest rates in anticipation of a future debt issuance. Those hedges were terminated at the time of issuance of the 6.50% Senior Notes. We paid a cash settlement of $1.5 million at termination, and the loss on these hedges is being amortized to interest expense over the life of the 6.50% Senior Notes.

 

Other Derivative Instruments

 

As of December 31, 2006 and 2005, we had several foreign currency forward contracts and one option contract with notional amounts aggregating $271.0 million and $88.9 million, respectively, which were entered into to hedge exposure to currency fluctuations in various foreign currencies, including the euro, the Australian dollar, the Canadian dollar, the Norwegian kroner, the Brazilian reais, the Mexican peso, the Thai bhat and the pound sterling. The total estimated change in fair value of these contracts compared to the original notional amount at December 31, 2006 and 2005 resulted in a liability of $1.0 million and $0.1 million, respectively. These derivative instruments were not designated as hedges and the changes in fair value of the contracts are recorded each period in current earnings.

 

In addition, after the closing of the acquisition of Precision Energy Services and Precision Drilling International, we entered into a series of cross-currency swaps between the U.S. dollar and Canadian dollar with notional amounts at execution totaling $588.9 million. On March 31, 2006, cross-currency swaps with an original notional value of $140.4 million were terminated and we paid a net settlement in April 2006 of $3.5 million. On

September 11, 2006, a cross-currency swap with an original notional value of $84.2 million was terminated and we paid a net settlement of $6.3 million. At December 31, 2006, we had notional amounts outstanding of $364.3 million. The total estimated change in fair value of these contracts compared to the original notional amount at December 31, 2006 resulted in a liability of $11.1 million. These derivative instruments were not designated as hedges and the changes in fair value of the contracts are recorded each period in current earnings. During the year ended December 31, 2006, net cash proceeds of $3.2 million were received from the cross-currency swaps, which were the net settlements of quarterly interest rate payments on the two currencies swapped. These quarterly net interest rate settlements are based on the variable interest rates of both the Canadian dollar and the U.S. dollar.

 

We also have the following cash commitments and contractual obligations:

 

Warrant

 

On February 28, 2002, we issued Shell Technology Ventures Inc. a warrant to purchase up to 6.5 million common shares at a price of $30.00 per share. Effective July 12, 2006, this agreement was amended and restated to reflect, among other things, changes in our capital structure. The warrant remains exercisable until February 28, 2012 and is subject to adjustment for changes in our capital structure or the issuance of dividends in cash, securities or property. Upon exercise by the holder, settlement may occur through physical delivery, net share settlement, net cash settlement or a combination of those methods. The net cash settlement option upon exercise is at our sole discretion. In addition, the amended and restated warrant no longer contains a conversion feature, which previously allowed the warrant holder to convert the warrant into common shares. The amendment did not affect the accounting or classification of the warrant.

 

Pension Plans

 

We have defined benefit pension plans covering certain of our U.S. and international employees that provide various pension benefits. During 2006, we contributed $9.6 million towards those plans, and for 2007, we anticipate funding approximately $10.8 million through cash flows from operating activities.

 

Our nonqualified supplemental executive retirement plan is unfunded; however, we maintain life insurance policies on the participants with the intent to use the proceeds from such policies to meet the plan’s benefit requirements.

 

Zero Coupon Convertible Senior Debentures

 

On June 30, 2000, we completed the private placement of $910.0 million face amount of Zero Coupon Debentures. These debentures were issued at $501.6 million, providing the holders with an annual 3% yield to maturity. At June 30, 2005, the holders had the option to require us to repurchase the Zero Coupon Debentures at the accreted amount which was $582.2 million. In total, $11.0 million of face value for an aggregate accreted value of $7.1 million was put to us. We settled this obligation during July 2005 with cash on hand.

 

On July 28, 2005, we called for redemption on August 29, 2005 of all of the outstanding Zero Coupon Debentures. At their option, certain holders tendered for conversion an aggregate of $367.4 million principal amount at maturity. The debentures were converted to an aggregate of approximately 7.3 million of our common shares. We redeemed the remaining $531.6 million aggregate principal amount at maturity for a cost of $341.8 million. We funded $240.0 million of that amount at that time through a borrowing on our 364-Day Facility and the remaining $101.8 million with available cash.

 

Off Balance Sheet Arrangements

 

Guarantees

 

The 65/8% Senior Notes of Weatherford International, Inc. were guaranteed by Weatherford International Ltd. as of December 31, 2006. The following obligations of Weatherford International Ltd. were guaranteed by Weatherford International, Inc. as of December 31, 2006: (i) the Revolving Credit Facility, (ii) the Canadian Facility, (iii) the 4.95% Senior Notes, (iv) the 5.50% Senior Notes, (v) the 6.50% Senior Notes and (vi) issuances of commercial paper.

 

Letters of Credit

 

We execute letters of credit in the normal course of business. While these obligations are not normally called, these obligations could be called by the beneficiaries at any time before the expiration date should we breach certain contractual or payment obligations. As of December 31, 2006, we had $159.1 million of letters of credit and bid and performance bonds outstanding, consisting of $133.0 million outstanding under various uncommitted credit facilities and $26.1 million letters of credit outstanding under our committed facilities. If the beneficiaries called these letters of credit, the called amount would become an on-balance sheet liability, and our available liquidity would be reduced by the amount called.

 

Operating Leases

 

We are committed under various operating lease agreements primarily related to office space and equipment. Generally, these leases include renewal provisions as well as provisions which permit the adjustment of rental payments for taxes, insurance and maintenance related to the property.

 

Related Party Agreements

 

See “Item 8. Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements — Note 20” for additional discussion of related party transactions.

 

Critical Accounting Policies and Estimates

 

Our discussion and analysis of our financial condition and results of operation is based upon our consolidated financial statements. We prepare these financial statements in conformity with U.S. generally accepted accounting principles. As such, we are required to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. We base our estimates on historical experience, available information and various other assumptions we believe to be reasonable under the circumstances. On an on-going basis, we evaluate our estimates; however, actual results may differ from these estimates under different assumptions or conditions. The accounting policies we believe require management’s most difficult, subjective or complex judgments and are the most critical to our reporting of results of operations and financial position are as follows:

 

Business Combinations and Goodwill and Indefinite-Lived Intangible Assets

 

Goodwill and intangible assets acquired in connection with business combinations represent the excess of consideration over the fair value of tangible net assets acquired. Certain assumptions and estimates are employed in determining the fair value of assets acquired, the fair value of liabilities assumed, as well as in determining the allocation of goodwill to the appropriate reporting unit.

 

We perform an impairment test for goodwill and indefinite-lived intangible assets annually as of October 1, or earlier if indicators of potential impairment exist. Our goodwill impairment test involves a comparison of the fair value of each of our reporting units with their carrying value. Our impairment test for indefinite-lived intangible assets involves the comparison of the fair value of the intangible asset and its carrying value. The fair value is determined using discounted cash flows and other market-related valuation models, including earnings multiples and comparable asset market values. Certain estimates and judgments are required in the application of these fair value models. The discounted cash flow analysis consists of estimating the future cash flows that are directly associated with each of our reporting units. These cash flows, in addition to the earnings multiples and comparable asset market values, are inherently subjective and require significant estimates based upon historical experience and future expectations such as budgets and industry projections. We have determined no impairment exists; however, if for any reason the fair value of our goodwill or that of any of our reporting units or the fair value of our intangible assets with indefinite lives declines below the carrying value in the future, we may incur charges for the impairment. The amount of the impairment, if any, is then determined based on an allocation of the reporting unit fair values to individual assets and liabilities.

 

Long-Lived Assets

 

Long-lived assets, which includes property, plant and equipment and definite-lived intangibles, comprise a significant amount of our total assets. In accounting for long-lived assets, we must make estimates about the expected useful lives of the assets and the potential for impairment based on the fair value of the assets and the cash flows they are expected to generate. The value of the long-lived assets is then amortized over its expected useful life. A change in the estimated useful lives of our long-lived assets would have an impact on our results of operations. We estimate the useful lives of our long-lived asset groups as follows:

 

 

In estimating the useful lives of our property, plant and equipment, we rely primarily on our actual experience with the same or similar assets. The useful lives of our intangible assets are determined by the years over which we expect the assets to generate a benefit based on legal, contractual or regulatory terms.

 

Long-lived assets to be held and used by us are reviewed to determine whether any events or changes in circumstances indicate that we may not be able to recover the carrying amount of the asset. Factors that might indicate a potential impairment may include, but are not limited to, significant decreases in the market value of the long-lived asset, a significant change in the long-lived asset’s physical condition, the introduction of competing technologies, legal challenges, a change in industry conditions or a reduction in cash flows associated with the use of the long-lived asset. If these or other factors exist that indicate the carrying amount of the asset may not be recoverable, we determine whether an impairment has occurred through the use of an undiscounted cash flow analysis. The undiscounted cash flow analysis consists of estimating the future cash flows that are directly associated with and expected to arise from the use and eventual disposition of the asset over its remaining useful life. These cash flows are inherently subjective and require significant estimates based upon historical experience and future expectations such as budgets and internal projections. If the undiscounted cash flows do not exceed the carrying value of the long-lived asset, an impairment has occurred, and we recognize a loss for the difference between the carrying amount and the estimated fair value of the asset. The fair value of the asset is measured using market prices, or in the absence of market prices, is based on an estimate of discounted cash flows. Cash flows are generally discounted at an interest rate commensurate with our weighted average cost of capital for a similar asset.

 

Employee Stock-Based Compensation

 

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (Revised 2004) Share-Based Payment (“SFAS No. 123R”). SFAS No. 123R addresses the accounting for all share-based payment awards, including shares issued under employee stock purchase plans, stock options, restricted stock and stock appreciation rights. Under the new standard, companies are no longer able to account for share-based compensation transactions using the intrinsic value method in accordance with Accounting Principles Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees. Under the intrinsic method, no compensation expense is recognized when the exercise price of an employee stock option is equal to the common share market price on the grant date and all other factors of the grant are fixed. Under SFAS No. 123R, companies must account for share-based compensation transactions using a fair-value method and recognize the expense in the consolidated statement of income. Effective January 1, 2006, we adopted SFAS No. 123R using the modified-prospective transition method. Under this method, compensation cost is recognized for all awards granted, modified or settled after the adoption date as well as for any awards that were granted prior to the adoption date for which the requisite service has not yet been rendered.

 

Previously on January 1, 2003, we adopted SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), to expense the fair value of employee stock-based compensation for awards granted, modified or settled subsequent to December 31, 2002. We elected the prospective method of adoption, and under this method, the fair value of employee stock-based awards granted or modified subsequent to adoption is measured at the grant

date and is recognized as an expense over the service period, which is usually the vesting period. Accordingly, the adoption of SFAS No. 123R’s fair value method does not have a significant impact on our reported results of operations for the year ended December 31, 2006 as all of the grants issued prior to the adoption of SFAS No. 123 were fully vested in the prior year and the grants issued subsequent to January 1, 2003 are currently being expensed at their estimated fair value.

 

The fair value of each option is estimated using the Black-Scholes option pricing model. Key assumptions in the Black-Scholes option pricing model, some of which are based on subjective expectations, are subject to change. A change in one or more of these assumptions would impact the expense associated with future grants. These key assumptions include the volatility of our common shares, the risk-free interest rate and the expected life of options.

 

We used the following weighted average assumptions in the Black-Scholes option pricing model for determining the fair value of our 2005 and 2006 stock option grants:

 

 

We calculated the expected volatility by measuring the volatility of our historical stock price for a period equal to the expected life of the option and ending at the time the option was granted. We determined the risk-free interest rate based upon the interest rate on a U.S. Treasury Bill with a term equal to the expected life of the option at the time the option was granted. In estimating the expected lives of our stock options, we have relied primarily on our actual experience with our previous stock option grants. The expected life is less than the term of the option as option holders, in our experience, exercise or forfeit the options during the term of the option.

 

We are not required to recalculate the fair value of our stock option grants estimated using the Black-Scholes option pricing model after the initial calculation under the related option terms as modified. However, a 100 basis point increase in our expected volatility and risk-free interest rate at the grant date would have had the following impact on our compensation expense for the year ended December 31, 2006:

 

 

Pension and Other Postretirement Benefits

 

In September 2006, the FASB issued Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R) (“SFAS No. 158”). Among other items, SFAS No. 158 requires recognition of the overfunded or underfunded status of an entity’s defined benefit or postretirement plan as an asset or liability in the financial statements, requires the measurement of defined benefit or postretirement plan assets and obligations as of the end of the employer’s fiscal year, and requires recognition of the previously deferred portion of defined benefit or postretirement plans in other comprehensive income.

 

Amounts recognized in the financial statements must be determined on an actuarial basis. Two of the more critical assumptions in the actuarial calculations are the discount rate for determining the current value of plan benefits and the expected rate of return on plan assets. Discount rates are based on the yields of government bonds or high quality corporate bonds in the respective country or economic market. The expected long-term rates of return on plan assets are based on a combination of historical experience and anticipated future returns in each of the asset categories. As we have both domestic and international plans, the assumptions, though the same in nature, are based on varying factors specific to each particular country or economic environment. Changes in any of the assumptions used could impact our projected benefit obligations and benefit costs as well as other pension and postretirement benefit calculations.

 

Due to the significance of the discount rates and expected long-term rates of return, the following sensitivity analysis demonstrates the effect that a 50 basis point change in those assumptions will have on annual pension expense:

 

 

Income Taxes

 

We provide for income taxes in accordance with SFAS No. 109, Accounting for Income Taxes. This standard takes into account the differences between the financial statement treatment and tax treatment of certain transactions. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates is recognized as income or expense in the period that includes the enactment date. Our effective tax rates for 2006, 2005 and 2004 were 25.9%, 25.4% and 21.5%, respectively.

 

We operate in approximately 100 countries through various legal entities. As a result, we are subject to numerous domestic and foreign tax jurisdictions and tax agreements and treaties among the various taxing authorities. Our operations in these jurisdictions are taxed on various bases: income before taxes, deemed profits (which is generally determined using a percentage of revenues rather than profits) and withholding taxes based on revenue. The calculation of our tax liabilities involves consideration of uncertainties in the application and interpretation of complex tax regulations in a multitude of jurisdictions across our global operations. We recognize potential liabilities and record tax liabilities for anticipated tax audit issues in the U.S. and other tax jurisdictions based on our estimate of whether, and the extent to which, additional taxes will be due. The tax liabilities are reflected net of realized tax loss carryforwards. We adjust these reserves upon specific events; however, due to the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is different from our current estimate of the tax liabilities. If our estimate of tax liabilities proves to be less than the ultimate assessment, an additional charge to expense would result. If payment of these amounts ultimately proves to be less than the recorded amounts, the reversal of the liabilities would result in tax benefits being recognized in the period when the contingency has been resolved and the liabilities are no longer necessary. If the tax liabilities relate to tax uncertainties existing at the date of the acquisition of a business, the adjustment of such tax liabilities will result in an adjustment to the goodwill recorded at the date of acquisition. Changes in tax laws, regulations, agreements and treaties, foreign currency exchange restrictions or our level of operations or profitability in each taxing jurisdiction could have an impact upon the amount of income taxes that we provide during any given year.

 

Valuation Allowance for Deferred Tax Assets

 

We record a valuation allowance to reduce the carrying value of our deferred tax assets when it is more likely than not that a portion or all of the deferred tax assets will expire before realization of the benefit or that future deductibility is not probable. The ultimate realization of the deferred tax assets depends on the ability to generate sufficient taxable income of the appropriate character and in the related jurisdiction in the future. In evaluating our ability to recover our deferred tax assets, we consider all reasonably available positive and negative evidence, including our past operating results, the existence of cumulative losses in the most recent years and our forecast of future taxable income. In estimating future taxable income, we develop assumptions, including the amount of future state, federal and international pretax operating income, the reversal of temporary differences and the implementation of feasible and prudent tax planning strategies. These assumptions require significant judgment.

 

We have identified various domestic and international tax planning strategies that we would implement, if necessary, to enable the realization of our deferred tax assets; however, when the likelihood of the realization of

existing deferred tax assets changes, adjustments to the valuation allowance are charged to our income tax provision in the period in which the determination is made.

 

As of December 31, 2006, our net deferred tax assets were $90.5 million before a related valuation allowance of $51.8 million. As of December 31, 2005, our net deferred tax assets were $159.7 million excluding a related valuation allowance of $44.0 million.

 

For a more comprehensive list of our accounting policies, see “Item 8. Financial Statements and Supplementary Data — Notes to Consolidated Financial Statements — Note 1.”

 

New Accounting Pronouncements

 

In September 2006, the FASB issued Statement No. 157, Fair Value Measurements (“SFAS No. 157”), which defines fair value, establishes a framework for measuring fair value under GAAP, and expands disclosures about fair value measurements. SFAS No. 157 applies to other accounting pronouncements that require or permit fair value measurements. The new guidance is effective for financial statements issued for fiscal years beginning after November 15, 2007, and for interim periods within those fiscal years. We are currently evaluating the potential impact, if any, of the adoption of SFAS No. 157 on our consolidated financial position, results of operations and cash flows.

 

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an Interpretation of FASB Statement No. 109 (“FIN No. 48”). FIN No. 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. In addition, it provides guidance on the measurement, derecognition, classification and disclosure of tax positions, as well as the accounting for related interest and penalties. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. We do not expect the Interpretation to have a material impact on our results from operations or financial position.

 

 

We are currently exposed to market risk from changes in foreign currency and changes in interest rates. From time to time, we may enter into derivative financial instrument transactions to manage or reduce our market risk, but we do not enter into derivative transactions for speculative purposes. A discussion of our market risk exposure in these financial instruments follows.

 

Foreign Currency Exchange Rates

 

We operate in virtually every oil and natural gas exploration and production region in the world. In some parts of the world, such as the Middle East and Southeast Asia, the currency of our primary economic environment is the U.S. dollar. We use this as our functional currency. In other parts of the world, we conduct our business in currencies other than the U.S. dollar and the functional currency is the applicable local currency. In those countries in which we operate in the local currency, the effects of foreign currency fluctuations are largely mitigated because local expenses of such foreign operations are also generally denominated in the same currency.

 

Assets and liabilities of which the functional currency is the local currency are translated into U.S. dollars using the exchange rates in effect at the balance sheet date, resulting in translation adjustments that are reflected as Accumulated Other Comprehensive Income in the shareholders’ equity section on our Consolidated Balance Sheets. At December 31, 2006, approximately 38.9% of our net assets are impacted by changes in foreign currencies in relation to the U.S. dollar. We recorded a $45.4 million adjustment to increase our equity account for the year ended December 31, 2006 to reflect the net impact of the strengthening of various foreign currencies against the U.S. dollar.

 

As of December 31, 2006, we had entered into several foreign currency forward contracts with notional amounts aggregating $271.0 million to hedge exposure to currency fluctuations in various foreign currencies, including the euro, the Australian dollar, the Canadian dollar, the Norwegian kroner, the Mexican peso, and the pound sterling. The total estimated change in fair value of these contacts compared to the original notional amount

at December 31, 2006 resulted in a liability of $1.0 million. These derivative instruments were not designated as hedges and the changes in fair value of the contracts are recorded each period in current earnings.

 

In addition, after the closing of the acquisition of Precision Energy Services and Precision Drilling International, we entered into a series of cross-currency swaps between the U.S. dollar and Canadian dollar with notional amounts at execution totaling $588.9 million. On March 31, 2006, cross-currency swaps with an original notional value of $140.4 million were terminated and we paid a net settlement in April 2006 of $3.5 million. On September 11, 2006, a cross-currency swap with an original notional value of $84.2 million was terminated and we paid a net settlement of $6.3 million. At December 31, 2006, we had notional amounts outstanding of $364.3 million. The estimated change in fair value of these contracts compared to the original notional amount at December 31, 2006 resulted in a liability of $11.1 million. These derivative instruments were not designated as hedges and the changes in fair value of the contracts are recorded each period in current earnings. During the year ended December 31, 2006, net cash proceeds of $3.2 million were received from the cross-currency swaps, which were the net settlement of quarterly interest rate payments on the two currencies swapped. These quarterly net interest rate settlements are based on the variable interest rates of both the Canadian dollar and the U.S. dollar.

 

Interest Rates

 

We are subject to interest rate risk on our long-term fixed-interest rate debt and variable-interest rate borrowings. Variable rate debt, where the interest rate fluctuates periodically, exposes us to short-term changes in market interest rates. Fixed rate debt, where the interest rate is fixed over the life of the instrument, exposes us to changes in market interest rates reflected in the fair value of the debt and to the risk that we may need to refinance maturing debt with new debt at a higher rate. All other things being equal, the fair value of our fixed rate debt will increase or decrease as interest rates change.

 

Our long-term borrowings that were outstanding at December 31, 2006 subject to interest rate risk consist of the following:

 

 

We have various other long-term debt instruments of $12.5 million, but believe the impact of changes in interest rates in the near term will not be material to these instruments. Short-term borrowings of $633.0 million at December 31, 2006 and $741.5 million at December 31, 2005 approximate fair value.

 

As it relates to our variable rate debt, if market interest rates average 1.0% more in 2007 than the rates as of December 31, 2006, interest expense for 2007 would increase by $6.4 million. This amount was determined by calculating the effect of the hypothetical interest rate on our variable rate debt. This sensitivity analysis assumes there are no changes in our financial structure.

 

Interest Rate Swaps

 

We manage our debt portfolio to achieve an overall desired position of fixed and floating rates and may employ interest rate swaps as a tool to achieve that goal. The major risks from interest rate derivatives include changes in the interest rates affecting the fair value of such instruments, potential increases in interest expense due to market increases in floating interest rates and the creditworthiness of the counterparties in such transactions. The counterparties to our interest rate swaps are creditworthy multinational commercial banks. We believe that the risk of counterparty nonperformance is immaterial.

 

We have used interest rate swap agreements to take advantage of available short-term interest rates. Amounts received upon termination of the swap agreements represent the fair value of the agreements at the time of termination and are recorded as an adjustment to the carrying value of the related debt. These amounts are being amortized as a reduction to interest expense over the remaining term of the debt.

 

As of December 31, 2006 and 2005, we had net unamortized gains of $14.3 million and $18.3 million, respectively, associated with interest rate swap terminations. These gains have been deferred and recorded as an adjustment to the carrying value of the related debt and are amortized against interest expense over the remaining term of the debt issuance against which they were hedged. Our interest expense was reduced by $4.0 million and $6.8 million for the years ended December 31, 2006 and 2005, respectively. There were no interest rate swap agreements outstanding as of December 31, 2006.

 

 

INDEX TO FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE

 

 

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

 

Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in the Securities Exchange Act of 1934 Rule 13a-15(f). The Company’s internal controls were designed to provide reasonable assurance as to the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006. In making its assessment, management has utilized the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control-Integrated Framework.

 

Based on this assessment, management concluded that as of December 31, 2006 the company’s internal control over financial reporting is effective.

 

Our assessment of the effectiveness of the Company’s internal control over financial reporting has been audited by Ernst & Young LLP, an independent registered public accounting firm, as stated in their report, which is included herein. This report appears on page 48.

 

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Shareholders of

Weatherford International Ltd. and Subsidiaries

 

We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control over Financial Reporting, that Weatherford International Ltd. maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Weatherford International Ltd.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, management’s assessment that Weatherford International Ltd. maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Weatherford International Ltd. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the COSO criteria.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Weatherford International Ltd. and Subsidiaries as of December 31, 2006 and 2005 and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006, and our report dated February 22, 2007 expressed an unqualified opinion thereon.

 

/s/ Ernst & Young LLP

 

Houston, Texas

February 22, 2007

 

Report of Independent Registered Public Accounting Firm

 

The Board of Directors and Shareholders of

Weatherford International Ltd. and Subsidiaries

 

We have audited the accompanying consolidated balance sheets of Weatherford International Ltd. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2006. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Weatherford International Ltd. and subsidiaries at December 31, 2006 and 2005, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

 

As discussed in Note 1 to the consolidated financial statements, effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment and, as discussed in Note 16, effective December 31, 2006 the Company adopted Statement of Financial Accounting Standards No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R).

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Weatherford International Ltd.’s internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 22, 2007 expressed an unqualified opinion thereon.

 

/s/ Ernst & Young LLP

 

Houston, Texas

February 22, 2007

WEATHERFORD INTERNATIONAL LTD. AND SUBSIDIARIES

 

CONSOLIDATED BALANCE SHEETS

 

The accompanying notes are an integral part of these consolidated financial statements.

WEATHERFORD INTERNATIONAL LTD. AND SUBSIDIARIES

 

CONSOLIDATED STATEMENTS OF INCOME