UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
SCHEDULE 14A
(RULE 14a-101)
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SMITH INTERNATIONAL, INC.
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(SMITH INTERNATIONAL, INC. LOGO)
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NOTICE OF ANNUAL MEETING OF STOCKHOLDERS
APRIL 22, 2003
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To Our Stockholders:
The Annual Meeting of Stockholders (the "Annual Meeting") of Smith
International, Inc. (the "Company") will be held on TUESDAY, APRIL 22, 2003, at
9:00 a.m., at 700 King Street, Wilmington, Delaware, to consider and take action
on the following:
1. Re-election of two directors: Benjamin F. Bailar and Doug Rock, each
for a term of three years;
2. Approval of an amendment to the Smith International, Inc. 1989
Long-Term Incentive Compensation Plan;
3. Approval of an amendment to the Smith International, Inc. Stock Plan
for Outside Directors;
4. Ratification of Deloitte & Touche LLP as auditors for 2003; and
5. Transaction of any other business properly before the Annual Meeting.
YOUR BOARD OF DIRECTORS RECOMMENDS A VOTE "IN FAVOR OF" PROPOSALS 1, 2, 3
AND 4.
The Board of Directors has fixed the close of business on March 1, 2003 as
the record date for determining stockholders who are entitled to notice of and
to vote at the meeting.
This Proxy Statement, voting instruction card and Smith International, Inc.
2002 Annual Report are being distributed on or about March 26, 2003.
This year we are again offering three ways to vote your shares. In addition
to the traditional paper proxy card, you may vote via the Internet or by
telephone by following the instructions included in this package. If you vote
via the Internet or by telephone, you will need the Control Number that is
imprinted on your personalized proxy card.
By Order of the Board of Directors
-s- Neal S. Sutton
Neal S. Sutton
Secretary
PROXY STATEMENT
TABLE OF CONTENTS
PAGE
----
GENERAL INFORMATION ABOUT VOTING............................ 1
PROPOSAL 1: ELECTION OF DIRECTORS........................... 2
Nominees.................................................. 3
Directors Continuing in Office............................ 4
Stock Ownership of Directors and Executive Officers....... 6
Information about the Board of Directors and its
Committees............................................. 7
Audit Committee Report.................................... 8
Executive Compensation.................................... 10
Compensation and Benefits Committee Report on Executive
Compensation.......................................... 10
Comparison of Five-Year Cumulative Total Return........ 13
Executive Compensation Tables.......................... 14
I. Summary Compensation Table........................ 14
II. Option/SAR Grants in 2002......................... 15
III. Aggregated Option Exercises in 2002 and December
31, 2002 Option Values................................ 15
Retirement Benefits and Employment Contracts........... 15
Additional Information about Our Directors and Executive
Officers............................................... 17
Stock Ownership of Certain Beneficial Owners.............. 18
PROPOSAL 2: APPROVAL OF AN AMENDMENT TO THE SMITH
INTERNATIONAL, INC.
1989 LONG-TERM INCENTIVE COMPENSATION PLAN................ 19
PROPOSAL 3: APPROVAL OF AN AMENDMENT TO THE SMITH
INTERNATIONAL, INC. STOCK PLAN FOR OUTSIDE DIRECTORS...... 22
PROPOSAL 4: APPROVAL OF DELOITTE & TOUCHE LLP AS AUDITORS... 23
OTHER BUSINESS.............................................. 24
STOCKHOLDERS' PROPOSALS..................................... 24
ANNUAL REPORT AND FINANCIAL INFORMATION..................... 25
Appendix A -- Smith International, Inc. Audit Committee
Charter................................................... A-1
Appendix B -- Form of Seventh Amendment to the Smith
International, Inc.
1989 Long-Term Incentive Compensation Plan................ B-1
(SMITH INTERNATIONAL, INC. LOGO)
P. O. Box 60068
Houston TX 77205-0068
PROXY STATEMENT
YOUR VOTE IS VERY IMPORTANT. For this reason, the Board of Directors is
soliciting proxies to be used at the 2003 Annual Meeting. This Proxy Statement
is being sent to you in connection with this request and has been prepared for
the Board by our management. "We," "our," "Smith" and the "Company" each refers
to Smith International, Inc. This Proxy Statement is first being sent to our
stockholders on or about March 26, 2003. IT IS IMPORTANT THAT YOUR SHARES BE
REPRESENTED AT THIS MEETING. EVEN IF YOU PLAN TO ATTEND THE MEETING, PLEASE VOTE
(1) BY COMPLETING, SIGNING, DATING AND MAILING THE PROXY CARD IN THE ENCLOSED
POSTAGE PRE-PAID ENVELOPE, (2) VIA THE INTERNET AS INDICATED ON THE PROXY CARD
OR (3) BY CALLING THE TOLL-FREE TELEPHONE NUMBER LISTED ON THE PROXY CARD.
GENERAL INFORMATION ABOUT VOTING
WHO CAN VOTE.
You are entitled to vote your shares of our common stock ("Common Stock")
if our records show that you held your shares as of March 1, 2003. At the close
of business on March 1, 2003, a total of 101,745,385 shares of Common Stock were
outstanding and entitled to vote. Each share of Common Stock has one vote. The
enclosed proxy card shows the number of shares that you are entitled to vote.
HOW YOU CAN VOTE.
If you return your signed proxy card to us, or if you vote by the Internet
or by telephone before the Annual Meeting, we will vote your shares as you
direct. You can specify on your proxy card whether your shares should be voted
for both, one or neither of the nominees for director. You can also specify
whether you approve, disapprove or abstain from the other three proposals. If
your Common Stock is held by a broker, bank or other nominee, you will receive
instructions from them that you must follow in order to have your shares voted.
If the meeting is adjourned, your Common Stock will be voted as specified on
your proxy card on the new meeting date, unless you have revoked your proxy
instructions.
IF YOU RETURN YOUR PROXY CARD BUT DO NOT SPECIFY ON YOUR PROXY CARD HOW YOU
WANT TO VOTE YOUR SHARES, WE WILL VOTE THEM "FOR" THE ELECTION OF BOTH NOMINEES
FOR DIRECTOR AS SET FORTH UNDER "ELECTION OF DIRECTORS" BELOW AND "FOR"
PROPOSALS 2, 3 AND 4.
HOW YOU MAY REVOKE YOUR PROXY INSTRUCTIONS.
You can revoke your proxy at any time before it is exercised in any of four
ways:
(1) by submitting written notice of revocation to our Secretary;
(2) by submitting another proxy card that is properly signed and later
dated;
(3) by submitting another proxy via the Internet or by telephone on a
date after the date of your last proxy; or
(4) by voting in person at the meeting.
1
NUMBER OF VOTES REQUIRED.
Directors must be elected by a plurality of the votes cast at the meeting.
This means that the two nominees receiving the greatest number of votes will be
elected. A majority of the shares represented at the meeting is required to
approve each of Proposals 2, 3 and 4. The Annual Meeting will be held if the
holders of a majority of the outstanding shares of Common Stock entitled to vote
(a "quorum") are present at the meeting in person or by proxy. If you have
returned valid proxy instructions or attend the meeting in person, your Common
Stock will be counted for the purpose of determining whether there is a quorum,
even if you wish to abstain from voting on some or all matters introduced at the
meeting. "Broker non-votes" also count for quorum purposes. If you hold your
Common Stock through a broker, bank or other nominee, generally the nominee may
only vote the Common Stock that it holds for you in accordance with your
instructions. However, if the broker, bank or nominee has not received your
instructions within ten days of the meeting, it may vote on matters that the New
York Stock Exchange determines to be routine. If the broker, bank or nominee
cannot vote on a particular matter because it is not routine, there is a "broker
non-vote" on that matter. Broker non-votes do not count as votes for or against
any proposal; however, an abstention counts as a vote against a proposal.
Abstentions and broker non-votes have no effect on the outcome of the election
of directors.
OTHER MATTERS TO BE ACTED UPON AT THE MEETING.
We do not know of any matters to be presented or acted upon at the meeting,
other than those mentioned in this document. If any other matter is presented at
the meeting on which a vote may properly be taken, your signed proxy card gives
authority to Doug Rock and Neal S. Sutton to vote on those matters.
COST OF THIS PROXY SOLICITATION.
We will pay the cost of this proxy solicitation. In addition to soliciting
proxies by mail, some of our employees may solicit stockholders for the same
type of proxy, personally and by telephone. None of these employees will receive
any additional or special compensation for doing this. We have retained Morrow &
Co. to assist in the solicitation of proxies for a fee of $7,000, plus
reasonable out-of-pocket costs and expenses. We will, upon request, reimburse
brokers, banks and other nominees for their expenses in sending proxy material
to their principals and obtaining their proxies.
PROPOSAL 1: ELECTION OF DIRECTORS
At the 2003 Annual Meeting, stockholders will elect two persons as Class II
directors to hold office until the 2006 Annual Meeting, or until they are
succeeded by other qualified directors who have been elected. The nominees are
Benjamin F. Bailar and Doug Rock.
Directors must be elected by a plurality of the votes cast at the meeting.
This means that the two nominees receiving the greatest number of votes will be
elected. Votes withheld for any director will not be counted.
We will vote your shares as you specify on your proxy card. If you properly
execute and return your proxy card (in paper form, electronically via the
Internet or by telephone), but don't specify how you want your shares voted, we
will vote them for the election of both the nominees listed below. If
unforeseen circumstances (such as death or disability) make it necessary for the
Board of Directors to substitute another person for any of the nominees, and you
have either voted for the substituted nominee or not specified your vote, we
will vote your shares for that other person.
2
Both nominees are current members of the Board of Directors. A brief
biography of all directors is presented below:
NOMINEES
Directors to be elected to Class II for a term expiring in 2006:
BENJAMIN F. BAILAR (Picture)
Age: 68
Director Since: 1993
Recent Business Experience: Mr. Bailar is the Dean and H. Joe Nelson,
III Professor of Administration Emeritus of
Jesse H. Jones Graduate School of
Administration of Rice University, where he
held that position from September 1, 1987
through June 1997.
Committee Membership: Chairman, Audit Committee; Nominating and
Corporate Governance Committee.
Other Directorships: Dana Corporation; Trustee of the Philatelic
Foundation.
DOUG ROCK (Picture)
Age: 56
Director Since: 1987
Recent Business Experience: Mr. Rock was elected Chairman of the Board
of Directors on February 26, 1991. Mr. Rock
has been with the Company since 1974 and
has been Chief Executive Officer, President
and Chief Operating Officer since March 31,
1989.
Committee Membership: Executive Committee.
Other Directorships: VIAD CORP.
THE BOARD OF DIRECTORS RECOMMENDS THAT YOU VOTE FOR THE ELECTION OF BOTH
NOMINEES FOR DIRECTOR.
3
DIRECTORS CONTINUING IN OFFICE
Directors of Class III to continue in office until 2004:
JAMES R. GIBBS (PICTURE)
Age: 58
Director Since: 1990
Recent Business Experience: Mr. Gibbs is the Chairman of the Board,
President & Chief Executive Officer of
Frontier Oil Corporation (formerly Wainoco
Oil Corporation). He was President and
Chief Operating Officer of Frontier from
January 1, 1987 to April 1, 1992, at which
time he assumed the additional position of
Chief Executive Officer. He was elected
Chairman of the Board of Frontier in April
1999. He joined Frontier Oil Corporation in
February 1982 as Vice President of Finance
and Administration, and was appointed
Executive Vice President in September 1985.
Committee Membership: Audit Committee; Chairman, Compensation and
Benefits Committee; Executive Committee;
Chairman, Nominating and Corporate
Governance Committee.
Other Directorships: Frontier Oil Corporation; Veritas DGC Inc.;
Gundle/SLT Environmental Inc.; advisory
director of Frost Bank-Houston.
JERRY W. NEELY (PICTURE)
Age: 66
Director Since: 1977
Recent Business Experience: Mr. Neely held a number of positions with
the Company from 1965 to 1987. He was
President from February 1976 to December
1977, at which time he assumed the
additional positions of Chairman of the
Board and Chief Executive Officer and
served in those capacities until December
1987. Since that time, Mr. Neely has been a
private investor.
Committee Membership: Audit Committee; Compensation and Benefits
Committee; Chairman, Executive Committee.
Other Directorships: Member of the Board of Trustees of the
University of Southern California.
4
Directors of Class I to continue in office until 2005:
G. CLYDE BUCK [PICTURE]
65
Age:
1992
Director Since:
Mr. Buck has had extensive experience in
Recent Business Experience: energy-related matters. He received a B.A.
in economics from Williams College and a
M.B.A. from Harvard. He is currently Senior
Vice President and Managing Director
Corporate Finance of the investment banking
firm of Sanders Morris Harris Inc., a
position he has held since April 1998. From
1983 to 1998, Mr. Buck was a Managing
Director in the Houston corporate finance
office of Dain Rauscher Incorporated.
Committee Membership: Compensation and Benefits Committee;
Nominating and Corporate Governance
Committee.
Other Directorships: Frontier Oil Corporation
LOREN K. CARROLL [PICTURE]
Age: 59
Director Since: 1987
Recent Business Experience: Mr. Carroll joined the Company in December
1984 as Vice President and Chief Financial
Officer. In January 1988 he was appointed
Executive Vice President and Chief Financial
Officer and served in that capacity until
March 1989. Mr. Carroll rejoined the Company
in 1992 as Executive Vice President and
Chief Financial Officer and continues to
hold the office of Executive Vice President
of the Company. On March 16, 1994, Mr.
Carroll was named the President and Chief
Executive Officer of M-I, a company in which
the Company holds a 60% interest.
Committee Membership: Executive Committee.
Other Directorships: Fleetwood Enterprises, Inc.
5
WALLACE S. WILSON [PICTURE]
Age:
73
Director Since:
1998
Recent Business Experience:
Mr. Wilson was President of Wilson
Industries, Inc. from 1964 to 1980, at which
time he assumed the additional position of
Chairman of the Board and Chief Executive
Officer. He served as Chairman of the Board,
President and Chief Executive Officer of
Wilson Industries until April 30, 1998, when
Wilson Industries was purchased by the
Company. Mr. Wilson became a director of the
Company on May 15, 1998 and he will be
retiring as a director on April 22, 2003.
Committee Membership: Compensation and Benefits Committee.
STOCK OWNERSHIP OF DIRECTORS AND EXECUTIVE OFFICERS
The following table shows the number of shares of Common Stock beneficially
owned as of March 1, 2003 by each director or nominee for director, the
executive officers named in the Summary Compensation Table included later in
this Proxy Statement and all directors and executive officers as a group. Except
as otherwise indicated, the persons listed below have sole voting power and
investment power relating to the shares shown.
SECURITY OWNERSHIP OF DIRECTORS AND EXECUTIVE OFFICERS
COMMON STOCK
BENEFICIALLY OWNED
--------------------
NO. OF PERCENT
NAME OF INDIVIDUAL SHARES OF CLASS
------------------ --------- --------
Benjamin F. Bailar(1)............................ 10,800 *
G. Clyde Buck(1)................................. 28,000 *
Loren K. Carroll(2).............................. 433,250 *
Margaret K. Dorman(2)(3)......................... 87,530 *
James R. Gibbs(1)(4)............................. 10,000 *
Jerry W. Neely(1)(5)............................. 597,817 *
Doug Rock(2)..................................... 706,600 *
Neal S. Sutton(2)................................ 130,100 *
Richard A. Werner(2)(3).......................... 174,821 *
Wallace S. Wilson(6)............................. 2,479,466 2.4
All directors and executive officers as a group
(16 persons)(1)(2)(3)(4)(5)(6)................. 5,058,478 4.9
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* Less than 1%
(1) The amounts reported do not include the shares of Common Stock to be issued
to each outside director on or about April 22, 2003 under the Smith
International, Inc. Stock Plan for Outside Directors (the "Stock Plan"),
assuming the proposed amendment to the Stock Plan is approved by the
stockholders. The shares to be issued will be based on the closing price of
the Company's Common Stock on April 22, 2003 and will be a number of shares
to give each outside director equity compensation of approximately $45,000.
6
(2) The amounts reported include shares of Common Stock that could be acquired
on or before May 1, 2003 through the exercise of stock options as follows:
Mr. Rock: 706,600 shares; Mr. Carroll: 384,250 shares; Mr. Sutton: 130,100
shares; Ms. Dorman: 85,500 shares; Mr. Werner: 171,600 shares; and all
executive officers as a group: 1,878,144 shares.
(3) The amounts reported include shares of Common Stock allocated to accounts
under a 401(k) plan as follows: Ms. Dorman: 2,030 shares; Mr. Werner: 3,221
shares; and all directors and executive officers as a group: 5,251 shares.
(4) The amounts reported include 1,000 shares held by Mrs. Gibbs and 800 shares
held in a trust for the benefit of their child where Mrs. Gibbs is a
co-trustee.
(5) The amounts reported include 345,383 shares held by Mrs. Neely.
(6) The amounts reported include 752,118 shares held by Mrs. Wilson.
INFORMATION ABOUT THE BOARD OF DIRECTORS AND ITS COMMITTEES
THE BOARD. During 2002, the Board of Directors held eight meetings. All
directors attended at least 75% of the meetings of the Board of Directors and of
all committees on which they served.
COMMITTEES OF THE BOARD. The Company has an Audit Committee and its
members are Messrs. Bailar, Gibbs and Neely. The Audit Committee reviews the
Company's auditing, accounting, financial reporting and internal control
functions. This committee also recommends the firm that the Company should
retain as its independent accountant. All members of the Audit Committee are
non-employee directors. During 2002, the Audit Committee held eight meetings.
The Company has a Compensation and Benefits Committee, and its members are
Messrs. Gibbs, Buck, Neely and Wilson. The Compensation and Benefits Committee
reviews the Company's executive compensation and employee benefit plans and
programs, including their establishment, modification and administration. It
also administers the Company's stock option plan. During 2002, this committee
held two meetings. The Executive Compensation Subcommittee of this committee,
comprised of Messrs. Gibbs and Buck, held two meetings during 2002. The
Committee is currently considering a written charter which it anticipates
approving during 2003. Among other things, the proposed charter contains
provisions requiring that Committee members meet the independence requirements
of the New York Stock Exchange, giving the Committee the sole authority to
retain and terminate any compensation consultant and permitting the Committee to
obtain advice and assistance from outside legal, accounting, compensation and
other consultants as it deems necessary.
The Company has an Executive Committee and its members are Messrs. Neely,
Carroll, Gibbs and Rock. The Executive Committee, between meetings of the Board
of Directors, has limited power to act on behalf of the Board. This committee
meets only as needed and did not meet in 2002. Since the size of the Company's
Board of Directors is small, and since all directors have generally been
available for full Board meetings and this Committee has not met in many years,
the Company does not intend to reappoint the Executive Committee at its April
2003 Board of Directors meeting.
The Company has a Nominating and Corporate Governance Committee and its
members are Messrs. Gibbs, Bailar and Buck. The Nominating Committee was formed
on February 6, 2002 and renamed the Nominating and Corporate Governance
Committee on October 23, 2002. The Nominating and Corporate Governance Committee
did not meet in 2002 as the entire Board of Directors considered nominees for
the Board and corporate governance matters during 2002. The Committee met on
February 4, 2003 to recommend nominees for director at the 2003 Annual Meeting
of Stockholders and to consider certain corporate governance matters. The
Committee is scheduled to meet a total of four times during 2003. The Nominating
and Corporate Governance Committee is responsible for assisting the Board of
Directors and management in developing and maintaining best practices in
corporate governance. In this role, the Nominating and Corporate Governance
Committee serves as the nominating committee, administers a process to measure
the effectiveness of the Board of Directors, and recommends to the Board of
Directors the criteria by which directors will be held accountable. The
Nominating and Corporate Governance Committee will consider
7
recommendations for nominees for directorships submitted by stockholders.
Stockholders who wish the Nominating and Corporate Governance Committee to
consider their recommendations for nominees for the position of director should
submit their recommendations in writing to the Nominating and Corporate
Governance Committee in care of the Secretary of the Company at our principal
executive offices. In addition, the Nominating and Corporate Governance
Committee makes recommendations to the Board regarding the agenda for the
Company's annual meetings of stockholders and reviews stockholder proposals and
makes recommendations to the Board regarding action on such proposals. The
Nominating and Corporate Governance Committee is currently considering a written
charter which it anticipates approving in 2003. Among other things, the proposed
charter would require that members of the Committee meet the independence
requirements of the New York Stock Exchange and would give the Committee the
authority to seek advice and assistance from outside legal, accounting and other
consultants as it deems necessary.
DIRECTORS' COMPENSATION. Employee directors receive no additional
compensation other than their normal salary for serving on the Board or its
committees. Non-employee directors receive $30,000 annually and $1,500 for each
Board meeting attended. In addition, they are paid $8,000 per year for chairing
a committee and $1,250 for each committee meeting attended. Beginning in 2003,
subject to the approval of the Company's stockholders, non-employee directors
will receive an annual grant of shares of Common Stock with a value of
approximately $45,000. Previously, outside directors had received an annual
grant of 400 shares of Common Stock.
NON-EMPLOYEE DIRECTOR PROGRAMS. The Company terminated its Directors'
Retirement Plan in 1998. The Company issued restricted stock grants to each of
the non-employee directors to fund the actuarial value of their accrued benefits
under the retirement plan. These grants will "cliff-vest" upon retirement after
ten years of service as a director. This means the grants will all vest at once
upon retirement after ten years of service.
COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION. During 2002,
Messrs. Buck, Gibbs, Neely and Wilson served as members of the Company's
Compensation and Benefits Committee. During 2002, none of Messrs. Buck, Gibbs,
Neely and Wilson was an officer or employee of the Company or any of its
subsidiaries, nor did any of them have any other relationship with the Company
that requires further disclosure under requirements of the U.S. Securities and
Exchange Commission (the "SEC"). From December 1977 to December 1987, Mr. Neely
was Chief Executive Officer and Chairman of the Board of Directors of the
Company. From 1964 to 1980, Mr. Wilson was President of Wilson Industries, Inc.,
at which time he assumed the additional position of Chairman of the Board and
Chief Executive Officer. Mr. Wilson served as Chairman of the Board, President
and Chief Executive Officer of Wilson Industries until April 30, 1998, when
Wilson Industries was purchased by the Company.
AUDIT COMMITTEE REPORT
In accordance with its written charter, the Audit Committee assists the
Board of Directors in oversight of the accounting, auditing, and financial
reporting practices of the Company. On February 5, 2003, the Audit Committee
approved and the Board of Directors adopted a revised Audit Committee Charter, a
copy of which is attached to this Proxy Statement as Appendix A.
The Audit Committee consists of three independent members, as independence
is defined by the listing standards of the New York Stock Exchange.
Management is responsible for the financial reporting process, the
preparation of consolidated financial statements in accordance with generally
accepted accounting principles, the system of internal controls, and procedures
designed to insure compliance with accounting standards and applicable laws and
regulations. The Company's independent auditors are responsible for auditing the
financial statements. The Audit Committee's responsibility is to monitor and
review these processes and procedures. Although the members of the Audit
Committee satisfy the composition and expertise requirements of the New York
Stock Exchange for qualified members of the Audit Committee, none of the members
of the Audit Committee are professionally engaged in the practice of accounting
or auditing. The Audit Committee relies, without independent verification, on
the information provided to it and on the representations made by management and
the independent auditors that the financial statements have been prepared in
conformity with generally accepted accounting principles.
8
Upon the recommendation of the Company's Audit Committee and approval of
the Board of Directors, the Company dismissed Arthur Andersen LLP on April 15,
2002 and appointed Deloitte & Touche LLP to serve as the Company's independent
auditors. The appointment of Deloitte & Touche was made after careful
consideration by the Board of Directors, the Audit Committee and management of
the Company and concluded an extensive evaluation process. The decision to
change auditors was not the result of any disagreement between the Company and
Arthur Andersen on any matter, including accounting principles or practices,
financial statement disclosures, or auditing scopes or procedures.
The Audit Committee met eight times during the last fiscal year. The Audit
Committee's regularly scheduled meetings were conducted with members of
management, the internal auditors and the Company's independent auditors. During
these meetings, the Audit Committee discussed with the Company's internal and
independent auditors the overall scope and plans for their respective audits.
The Audit Committee also discussed the results of their examinations and their
evaluation of the Company's internal controls, with certain matters discussed in
the absence of Company management. In addition to the regularly scheduled
meetings, the Committee conducted special teleconference meetings to discuss
relevant financial accounting, internal control and financial reporting matters
with Company management and the independent auditors. The majority of these
meetings were held to discuss interim financial information of the Company prior
to its release to the public and, accordingly, included a discussion of the
results of the independent auditors' Statement on Auditing Standards ("SAS") No.
71 reviews. During the year, the Audit Committee also discussed with the
Company's independent auditors all matters required by generally accepted
auditing standards, including those described in Statement on Auditing Standards
("SAS") No. 61, as amended, "Communication with Audit Committees".
The Audit Committee obtained a formal written statement from Deloitte &
Touche disclosing that they are independent with respect to the Company within
the meaning of the Securities Act administered by the Securities and Exchange
Commission and the requirements of the Independence Standards Board. The Audit
Committee discussed with Deloitte & Touche any relationships that may have an
impact on their objectivity and independence and satisfied itself as to Deloitte
& Touche's independence. The Audit Committee also approved, among other things,
the amount of fees to be paid to Deloitte & Touche for audit and non-audit
services and considered whether the provision of non-audit services by Deloitte
& Touche is compatible with maintaining Deloitte & Touche's independence. In
response to public concerns about the integrity of independent audits, the
Company has expanded the role of other firms in providing non-audit services.
Deloitte & Touche did not provide any financial information systems design or
implementation services to the Company during the fiscal year ended December 31,
2002.
The Audit Committee reviewed and discussed the Company's audited
consolidated financial statements as of and for the year ended December 31, 2002
with management and the independent auditors. Based on the above-mentioned
review and discussions, and subject to the limitations on the Audit Committee's
role and responsibilities described above and in the Audit Committee charter,
the Audit Committee recommended to the Board of Directors that the Company's
audited consolidated financial statements be included in its Annual Report on
Form 10-K for the fiscal year ended December 31, 2002 for filing with the
Securities and Exchange Commission.
Audit Committee
Benjamin F. Bailar, Chairman
James R. Gibbs
Jerry W. Neely
9
EXECUTIVE COMPENSATION
COMPENSATION AND BENEFITS COMMITTEE REPORT ON EXECUTIVE COMPENSATION
COMPENSATION POLICIES
The Company's executive compensation program is designed to help the
Company attract, motivate and retain the executive resources that the Company
needs to maximize its return to stockholders. The objective of the Company's
compensation program for key management positions is to provide compensation
packages that are consistent with competitive market norms for companies similar
in size, activity and complexity to the Company.
The Compensation and Benefits Committee (the "Compensation Committee"),
which consists solely of non-employee directors, administers the executive
compensation programs of the Company and determines the compensation of senior
management. An independent compensation consultant, Towers Perrin, advises the
Compensation Committee on all compensation matters. Towers Perrin has been
advising the Compensation Committee with respect to such matters since April
2001.
The Company's executive compensation program is structured and implemented
to provide competitive compensation opportunities and various incentive award
payments based on Company and individual performance, as well as to link
compensation to financial targets that affect short and long term share price
performance. The Compensation Committee administers all of the Company's
executive compensation programs, including the design of the programs and the
measurement of their effectiveness. The Compensation Committee also reviews and
approves all salary arrangements and other payments to executives, evaluates
their performance and considers other related matters.
TAX CONSIDERATIONS
Section 162(m) of the Internal Revenue Code limits the allowable tax
deduction that may be taken by the Company for compensation paid to the Chief
Executive Officer and the four other highest paid executive officers named in
the Summary Compensation Table. The limit is $1 million per executive per year,
but compensation payable solely upon the attainment of performance goals is
excluded from the limitation. The Compensation Committee has established an
Executive Compensation Subcommittee (the "Subcommittee") to review and establish
compensation for any executive officer whose compensation might exceed $1
million in any year. The Subcommittee consists of two members of the
Compensation Committee, Messrs. Gibbs and Buck, who are independent directors as
defined in the Internal Revenue Code and its regulations. The Compensation
Committee and the Subcommittee will continue to analyze its executive
compensation practices and plans on an ongoing basis with respect to Section
162(m) of the Internal Revenue Code. Where it deems advisable, the Compensation
Committee will take appropriate action to maintain the tax deductibility of its
executive compensation.
TYPES OF COMPENSATION
There are two main types of compensation:
(1) Annual Compensation. This includes base salary and annual
incentives in the form of bonuses. The Company awards bonuses only when the
Company's financial performance during the year meets a certain level
required under the annual incentive plan.
(2) Long-Term Compensation. This includes stock options and other
long-term incentive awards based on Common Stock. The value of these awards
depends upon the Company's performance and future stock value.
FACTORS CONSIDERED IN DETERMINING COMPENSATION
The Compensation Committee wants the compensation of the Company's
executives to be competitive in the worldwide energy industry. The Compensation
Committee estimates an executive's competitive level of
10
total compensation based on information from a variety of sources, including
proxy statements, special surveys and the Committee's compensation consultant.
The companies that are part of the Peer Group described in the Performance Graph
are some of the companies used by the Compensation Committee in establishing
both base salary and performance-based targeted incentive compensation. The
sources used by the Compensation Committee are larger than the Peer Group, but
are all in the energy industry. The Compensation Committee then compares the
industry information with the Peer Group and with the Company's compensation
levels to determine both base salary and incentive compensation.
Annual Compensation
Annual compensation for the Company's executives includes salary and bonus.
This is similar to the compensation programs of most leading companies.
The Compensation Committee annually reviews each executive's base salary.
The Compensation Committee aims to pay salaries slightly above the median of the
range of compensation paid by similar companies. The Compensation Committee also
looks at the specific job duties, the person's achievements and other criteria.
Increases in base salary are primarily the result of individual performance,
which includes meeting specific goals established by the Compensation Committee.
The criteria used in evaluating individual performance vary depending on the
executive's function, but generally include leadership inside and outside the
Company; advancing the Company's interests with customers, vendors and in other
business relationships; product quality and development; and advancement in
skills and responsibility. In 2002, seven executive officers received merit
increases.
Annual Incentive Compensation
The annual incentive plan promotes the Company's pay-for-performance
philosophy by providing executives with direct financial incentives in the form
of cash awards that are paid based on the achievement of performance objectives
established for the fiscal year. Each year, the Compensation Committee sets
corporate goals based upon financial objectives deemed appropriate by the
Compensation Committee. These objectives may include earnings per share, profit
after tax, return on assets, return on net capital employed and other financial
objectives for the year. Where executives have strategic business unit
responsibilities, their goals are based on financial performance measures of
that business unit. No bonus is paid to corporate executives unless certain
threshold company performance levels set by the Compensation Committee are
reached. Business unit executives must meet certain threshold performance levels
in their business unit's annual incentive plan in order to receive a bonus.
Each year the Compensation Committee sets targets for each executive
relating to annual incentive compensation. The target incentive awards for 2002
for eligible Company executives were based on various company, business unit and
individual performance measures. The Compensation Committee does not use a
specific formula for weighing individual performance. Instead, individuals are
assessed based upon how they contributed to the Company's business success in
their respective areas of responsibility. Awards were made in 2002 under the
annual incentive plan for fiscal year 2001 to eligible executives.
Stock Option Program
The Compensation Committee strongly believes that the grant of significant
annual equity awards further links the interests of senior management and the
Company's stockholders. Each year, the Compensation Committee determines the
total amount of options to be made available to the Company's executives. These
amounts vary each year and are based upon what the Compensation Committee
believes is appropriate. The Compensation Committee considers an executive's
total compensation package, including the amount of stock options previously
awarded. Other important factors are the desire to create stockholder value,
encourage equity ownership, provide an appropriate link to stockholder interests
and provide long-term incentive award opportunities in the same range as similar
companies in the Company's industry.
11
Chief Executive Officer Compensation
The Subcommittee determines the pay level for the Chief Executive Officer,
considering both a pay-for-performance philosophy and market rates of
compensation for similar positions. A significant portion of compensation for
the Chief Executive Officer is based upon the Company's performance. Mr. Rock's
compensation is determined using substantially the same criteria utilized to
determine compensation for other executive officers, as discussed earlier in
this report. Specific actions taken by the Subcommittee regarding Mr. Rock's
compensation are summarized below.
Base Salary -- The Subcommittee reviewed the base salary for Mr. Rock at
its December 2001 meeting and increased it to $875,000. In setting Mr. Rock's
base salary for fiscal year 2002, the Subcommittee reviewed the recommendations
by the independent compensation consultant, Towers Perrin, and market
comparisons as well as the Company's acquisition activities and expense control
during fiscal year 2001.
Annual Incentive -- The Subcommittee reviewed the predetermined bonus
objectives set by the Compensation Committee based on the Company's fiscal year
financial performance. For fiscal year 2001, Mr. Rock earned an annual bonus in
the amount of $1,222,031, which was paid in 2002.
Stock Options -- The Company granted Mr. Rock non-qualified stock options
to purchase 247,000 shares of Common Stock on December 3, 2002, at the
recommendation of the Subcommittee. The award of stock options to Mr. Rock was
approximately 19.6% of the total stock options granted to all employees of the
Company in 2002. The options were granted at 100% of fair market value on the
date of grant. The performance sensitivity of the grant is built into the option
concept, since the options produce no gain unless the Company's share price
rises over the initial grant price.
SUMMARY
The Compensation Committee believes that the compensation program for the
executives of the Company is comparable with compensation programs provided by
other companies in the energy industry and serves the best interests of the
Company's stockholders. The Compensation Committee also believes that annual
performance pay is appropriately linked to individual performance, annual
financial performance of the Company and stockholder value.
Compensation and Benefits Committee
James R. Gibbs, Chairman
G. Clyde Buck
Jerry W. Neely
Wallace S. Wilson
12
COMPARISON OF FIVE-YEAR CUMULATIVE TOTAL RETURN
The following line graph compares the cumulative total stockholder return
of the Company's Common Stock against the cumulative total return of the S&P 500
Index and our Peer Group for each of the five years in the period starting
December 31, 1997 and ending December 31, 2002. Our Peer Group consists of the
following companies in the same general line of business as the Company: Baker
Hughes, Inc., BJ Services Company, Cooper Cameron Corporation, Halliburton
Company, Schlumberger Limited, Varco International Inc. and Weatherford
International, Inc.
The results are based on an assumed $100 investment on December 31, 1997
and reinvestment of dividends (if applicable). For each index, total return is
based on market capitalization of its components.
(PERFORMANCE GRAPH)
--------------------------------------------------------------------------------------------
Dec. 1997 Dec. 1998 Dec. 1999 Dec. 2000 Dec. 2001 Dec. 2002
--------------------------------------------------------------------------------------------
Smith $100.00 $ 41.04 $ 80.96 $121.49 $ 87.36 $106.30
S&P 500 $100.00 $128.58 $155.63 $141.46 $124.65 $ 97.10
Peer Group $100.00 $ 53.96 $ 77.04 $106.34 $ 72.82 $ 67.46
13
EXECUTIVE COMPENSATION TABLES
The following table shows compensation for services to the Company of the
persons who during 2002 were the Chief Executive Officer and the other four most
highly compensated executive officers (the "Named Officers"):
SUMMARY COMPENSATION TABLE
LONG TERM
COMPENSATION
AWARDS
------------
ANNUAL COMPENSATION SECURITIES
------------------------ UNDERLYING ALL OTHER
NAME OF INDIVIDUAL AND SALARY BONUS OPTIONS COMPENSATION
PRINCIPAL POSITION YEAR $(1) $ (#)(2) $(3)
---------------------- ---- ------------ --------- ------------ ------------
Doug Rock.................................. 2002 874,808 1,222,031 247,000 255,197
Chairman of the Board, Chief Executive 2001 825,000 900,000 322,000 210,576
Officer, President and Chief Operating
Officer.................................. 2000 749,996 429,000 194,000 140,792(4)
Loren K. Carroll........................... 2002 559,889 628,050 117,000 145,373
Executive Vice President, President and 2001 530,004 468,000 138,000 122,580
Chief Executive Officer of M-I 2000 468,000 250,000 110,000 84,774
Neal S. Sutton............................. 2002 359,942 340,688 52,000 86,320
Senior Vice President -- Administration, 2001 345,000 262,400 62,000 75,132
General Counsel and Secretary 2000 327,990 126,000 44,000 52,524
Margaret K. Dorman......................... 2002 344,827 296,250 52,000 79,173
Senior Vice President, Chief Financial 2001 300,000 200,000 62,000 62,244
Officer and Treasurer 2000 249,990 85,000 44,000 42,395
Richard A. Werner.......................... 2002 319,889 290,000 52,000 75,431
President, Smith Services 2001 290,004 140,800 62,000 53,940
2000 275,002 60,000 44,000 38,246
---------------
(1) The amounts in this column include compensation deferred by the Named
Officers in 2000, 2001 and 2002 under the Smith International, Inc.
Supplemental Executive Retirement Plan ("SERP") and the Smith International,
Inc. 401(k) Retirement Plan (the "401(k) Plan").
(2) The option numbers for 2000 and 2001 have been adjusted to reflect the 2-1
stock split on June 20, 2002.
(3) The amounts in this column include the Company's contribution to each Named
Officer's account in the SERP for the 2000, 2001 and 2002 plan years,
excluding interest (at 120% of the applicable Federal long-term rate). For
2002, SERP contributions to each Named Officer's account are as follows: Mr.
Rock: $242,197; Mr. Carroll: $133,627; Mr. Sutton: $73,320; Ms. Dorman:
$72,263 and Mr. Werner: $60,003. In addition, this column also reflects the
Company's contributions to the 401(k) Plan. The 2002 plan year contributions
to each Named Officer's 401(k) account are as follows: Mr. Rock: $13,000;
Mr. Carroll: $11,746; Mr. Sutton: $13,000; Ms. Dorman: $6,910 and Mr.
Werner: $15,428.
(4) Mr. Rock received a lump sum cash payment of $9,694 in January 2001 for the
actuarial present value of his vested accrued benefits under the Smith
International, Inc. Supplemental Pension Plan, which was terminated
effective December 31, 2000.
14
OPTION/SAR GRANTS IN 2002
The following table shows all grants of options to the Named Officers in
2002. No stock appreciation rights were granted in 2002.
INDIVIDUAL GRANTS
--------------------------------------------------------------------------------
NUMBER OF
SECURITIES % OF TOTAL
UNDERLYING OPTIONS GRANTED EXERCISE OR
OPTIONS TO EMPLOYEES BASE PRICE EXPIRATION GRANT DATE
NAME GRANTED(#)(1) IN 2002 ($/SHARE) DATE PRESENT VALUE($)(2)
---- ------------- --------------- ----------- ---------- -------------------
Doug Rock....................... 247,000 19.6 34.73 12-03-12 3,793,920
Loren K. Carroll................ 117,000 9.3 34.73 12-03-12 1,797,120
Neal S. Sutton.................. 52,000 4.1 34.73 12-03-12 798,720
Margaret K. Dorman.............. 52,000 4.1 34.73 12-03-12 798,720
Richard A. Werner............... 52,000 4.1 34.73 12-03-12 798,720
---------------
(1) Options were granted to the Named Officers on December 3, 2002 at an
exercise price of $34.73. The exercise price per share is equal to the
closing price of the Common Stock on the New York Stock Exchange Composite
Tape on the date of grant. Options granted vest at a rate of 25% per year
and will not begin to become exercisable until December 3, 2003. If a change
of control of the Company occurs, all outstanding options would become
exercisable immediately.
(2) Present value was calculated using the Black-Scholes option pricing model.
Use of this model should not be viewed in any way as a forecast of the
future performance of the Common Stock, which will be determined by future
events and unknown factors. The estimated values under the Black-Scholes
model are based upon certain assumptions as to variables such as interest
rate and stock price volatility. Assumptions used for the Black-Scholes
option pricing model include a risk-free rate of return of 3.2% and a
volatility factor of 46%. A dividend yield during the option life is not
applicable. The ultimate value of the options will depend on the future
market price of the Company's Common Stock.
AGGREGATED OPTION EXERCISES IN 2002 AND DECEMBER 31, 2002 OPTION VALUES
The following table provides information on options exercised by the Named
Officers during 2002 and the value of options held by those officers on December
31, 2002.
NUMBER OF SECURITIES UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS AT IN-THE-MONEY OPTIONS AT
SHARES DECEMBER 31, 2002 DECEMBER 31, 2002($)(1)
ACQUIRED ON VALUE ------------------------------- -------------------------
NAME EXERCISE(#) REALIZED($) EXERCISABLE/UNEXERCISABLE EXERCISABLE/UNEXERCISABLE
---- ----------- ----------- ------------------------------- -------------------------
Doug Rock.................... 0 0 731,600/635,200 8,137,732/3,030,964
Loren K. Carroll............. 0 0 384,250/295,750 4,478,975/1,310,425
Neal S. Sutton............... 0 0 155,100/130,600 1,831,216/ 596,722
Margaret K. Dorman........... 0 0 85,500/130,600 839,146/ 596,722
Richard A. Werner............ 0 0 171,600/130,600 2,030,206/ 596,722
---------------
(1) Value based on the closing price on the New York Stock Exchange Composite
Tape for the Common Stock on December 31, 2002 ($32.62).
RETIREMENT BENEFITS AND EMPLOYMENT CONTRACTS
PENSION PLAN
Smith International, Inc. Restated Pension Plan. The Company has a defined
benefit pension plan (the "Restated Pension Plan"), which is currently frozen.
The benefit accruals were frozen effective March 1, 1987, and the amount of the
pension benefit was fixed for all eligible employees based only upon benefit
15
accruals from September 1, 1985 to March 1, 1987. Any benefits under the
Restated Pension Plan are offset by benefits paid under a previous pension plan
of the Company.
The following table illustrates the estimated annual retirement benefit
payable as a life annuity under the Restated Pension Plan to any employee
retiring at normal retirement age in various compensation levels and certain
years-of-service classifications.
PENSION PLAN TABLE
ESTIMATED ANNUAL PENSION FOR YEARS
OF SERVICE
------------------------------------
COMPENSATION 20 25 30
------------ ---------- ---------- ----------
$ 125,000.............................................. $ 3,280 $ 3,280 $ 3,280
200,000.............................................. 5,250 5,250 5,250
300,000.............................................. 7,875 7,875 7,875
400,000.............................................. 10,500 10,500 10,500
500,000.............................................. 13,125 13,125 13,125
700,000.............................................. 18,375 18,375 18,375
800,000.............................................. 21,000 21,000 21,000
900,000.............................................. 23,625 23,625 23,625
1,000,000.............................................. 26,250 26,250 26,250
Since benefit accruals under the Restated Pension Plan have been frozen
since March 1, 1987, the years of service for the Named Officers include only
the period from September 1, 1985 to March 1, 1987. The annual pension benefits
that would be payable at age 65 under the Restated Pension Plan to the Named
Officers are as follows: Mr. Rock: $8,150; Mr. Carroll: $4,282; Mr. Sutton:
$-0-; Ms. Dorman: $-0-; and Mr. Werner: $-0-. The benefits are not subject to
any reduction for Social Security.
SMITH INTERNATIONAL, INC. SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN ("SERP")
The Company adopted the SERP effective October 1, 1993. It is a
non-qualified, deferred compensation plan covering all of the executive officers
and certain other participants. The primary purpose of the SERP is to provide
executives who are affected by the Internal Revenue Code limitations under the
Company's 401(k) Retirement Plan (the "401(k) Plan") with the opportunity to
defer a portion of their current compensation. Distributions will generally be
made following a participant's termination of employment, although in-service
withdrawals are permitted in certain circumstances. A participant in the SERP
may defer up to 100% of his or her salary or bonus paid during a plan year. The
Company may also make contributions to the SERP on behalf of its participants.
Age-Weighted Contributions. Effective as of the last day of each quarter
during the year, a contribution by the Company may be allocated under the SERP
based on the participant's age-weighted contribution percentage ("AWCP") ranging
from 2 to 6%. The difference between a participant's (i) "Total 401(k)
Compensation" and his or her (ii) "Net 401(k) Compensation" is multiplied by the
AWCP to compute the age-weighted contribution for the year. "Total 401(k)
Compensation" generally means the total of all cash amounts paid by the Company
to a participant, including deferred amounts. "Net 401(k) Compensation"
generally means Total 401(k) Compensation less participant contributions to the
SERP, but not to exceed $200,000 for any year. Effective January 1, 1995, the
SERP was amended to fix the AWCP for the executive officers at 6%.
Matching Contributions. The SERP contains matching provisions that mirror
the matching formulas in effect for the 401(k) Plan, but without regard to
certain Internal Revenue Code limits applicable to the 401(k) Plan. Matching
contributions for a plan year in both the SERP and the 401(k) Plan combined
cannot exceed 6% of a participant's Total 401(k) Compensation net of any
incentive bonus. Effective January 1,
16
1995, the SERP was amended so that executive officers will receive matching
contributions up to 6% of their Total 401(k) Compensation.
Discretionary Profit Sharing Contributions. The Compensation Committee
may, in its discretion, determine the amount of any profit sharing contribution
for a plan year and how that amount is to be allocated among the SERP
participants.
EMPLOYMENT AGREEMENTS
The Company has employment agreements with Messrs. Rock, Sutton and Werner
dated December 10, 1987, January 2, 1991 and May 1, 1991, respectively. These
agreements have an initial term of three years and are automatically extended
for an additional year at each anniversary date. Each of the employment
agreements with Messrs. Rock, Sutton and Werner contains the employee's salary
and other conditions of employment and entitles the employee to participate in
the Company's bonus program and other benefit programs. If Messrs. Rock, Sutton
or Werner are terminated by the Company (other than for cause, death or
disability) or if for any reason their positions are eliminated or otherwise
become redundant, Messrs. Rock, Sutton or Werner would be entitled to receive a
lump sum payment in cash equal to their current annual base salary and bonus
through the date of termination; provided, however, that in the event of a
change in control, the Change of Control Agreements (as discussed below) would
control, except with respect to any accrued obligations under the employment
agreement that were not fully accrued under their Change of Control Agreements.
CHANGE OF CONTROL AGREEMENTS
On January 4, 2000, the Company entered into Change-of-Control Employment
Agreements ("Agreements") with seven executive officers, including Messrs. Rock,
Carroll, Sutton, Werner and Ms. Dorman. In the event of a "change of control" of
the Company (as defined in the Agreements), the Agreements provide for the
continued employment of the seven executive officers for a period of three years
and provide for the continuation of salary and benefits. If the executive is
terminated by the Company (other than for cause, death or disability), or if the
executive elects to terminate his or her employment for "Good Reason" (as
defined in the Agreements), the executive is entitled to receive a lump sum
payment in cash equal to the aggregate of the following amounts: (i) current
annual base salary and pro rata bonus through the date of termination; (ii) any
compensation previously deferred by the executive and any accrued vacation pay;
(iii) three times the executive's annual base salary and Highest Annual Bonus
(as defined in the Agreements); and (iv) any actuarial difference in the SERP
benefit the executive would have received had the executive's employment
continued for three years after the date of the executive's termination.
The executive would also receive continued coverage under applicable
welfare and benefit plans for three years. The Agreements also provide for an
additional payment to the executive of an amount equal to any Excise Tax (as
defined in the Agreements), imposed on the aggregate cash payment described
above and any income taxes imposed on such additional payment, so that the
executive receives the amount that would have been received had any Excise Tax
not been imposed. The determination of whether and when the additional payment
is required and the amount of such payment will be made by a certified public
accounting firm designated by the executive.
ADDITIONAL INFORMATION ABOUT OUR
DIRECTORS AND EXECUTIVE OFFICERS
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934 requires the Company's
officers and directors, and persons who own more than 10% of the Company's
outstanding shares of Common Stock (collectively, "Section 16 Persons"), to file
with the Securities and Exchange Commission initial reports of ownership and
17
reports of changes in ownership of Common Stock and other equity securities.
Section 16 Persons are required by Commission regulations to furnish the Company
with copies of all Section 16(a) reports they file.
Based solely on its review of the copies of such reports received by it, or
written representations from certain Section 16 Persons that all Section 16(a)
reports required to be filed for such persons had been filed, the Company
believes that during 2002 the Section 16 Persons complied with all Section 16(a)
filing requirements applicable to them except that Mr. Gibbs filed a late report
disclosing one transaction and Mr. Neely filed a late report disclosing two
transactions.
STOCK OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
The following table shows certain information about stock ownership of all
persons known to the Company to own of record or beneficially more than 5% of
the outstanding Common Stock of the Company as of March 1, 2003. This
information is based upon information furnished to the Company by these persons
and statements filed with the SEC:
NAME AND ADDRESS AMOUNT AND NATURE OF PERCENT OF
OF BENEFICIAL OWNER BENEFICIAL OWNERSHIP CLASS
------------------- -------------------- ----------
FMR Corp.................................................... 15,203,550(1) 14.94%
82 Devonshire Street
Boston, Massachusetts 02109
Morgan Stanley.............................................. 6,070,871(2) 5.96%
1585 Broadway
New York, NY 10036
T. Rowe Price Associates, Inc............................... 5,973,500(3) 5.87%
100 East Pratt Street
Baltimore, Maryland 21202
Janus Capital Management LLC................................ 5,112,182(4) 5.02%
100 Fillmore Street
Denver, Colorado 80206
---------------
(1) Fidelity Management & Research Company ("Fidelity"), a wholly owned
subsidiary of FMR Corp. ("FMR") and an investment adviser, is the beneficial
owner of 10,846,308 shares as a result of acting as investment adviser to
various registered investment companies (the "Funds"). Edward C. Johnson 3d,
FMR's Chairman, through its control of Fidelity, and the Funds each has sole
power to dispose of the 10,846,308 shares owned by the Funds. Neither FMR
nor Mr. Johnson has the sole power to vote or direct the voting of the
shares owned directly by the Fidelity Funds, which power resides with the
Funds' Boards of Trustees. Fidelity carries out the voting of the shares
under written guidelines established by the Funds' Boards of Trustees.
Fidelity Management Trust Company ("FMTC"), a wholly owned subsidiary of
FMR, is the beneficial owner of 2,689,490 shares as a result of its serving
as investment manager of various institutional accounts. Mr. Johnson and
FMR, through its control of FMTC, each has sole dispositive power over
2,689,490 shares and sole power to vote or to direct the voting of 2,682,090
shares and no power to vote or to direct the voting of 7,400 shares owned by
the institutional accounts. Geode Capital Management LLC ("Geode LLC"), a
wholly owned subsidiary of Fidelity Investors III Limited Partnership ("FILP
III"), is the beneficial owner of 352 shares. Fidelity Investors Management,
LLC ("FIML") is the general partner and investment manager of FILP III. The
managers of Geode LLC, the members of FIML and the limited partners of FILP
III are certain shareholders and employees of FMR Corp. Members of the
Edward C. Johnson 3d family are the predominant owners of Class B shares of
common stock of FMR, representing approximately 49% of the voting power of
FMR. Mr. Johnson owns 12.0% and Abigail P. Johnson, a Director of FMR, owns
24.5% of the voting stock of FMR. The Johnson family group and all other
Class B shareholders have entered into a shareholders' voting agreement
under which all Class B shares will be voted in accordance with the majority
vote of Class B shares. Through their ownership of voting common stock and
the shareholders'
18
voting agreement, members of the Johnson family may be deemed, under the
Investment Company Act of 1940, to form a controlling group with respect to
FMR. Fidelity International Limited ("FIL") beneficially owns 1,667,400
shares. FIL has sole power to vote and to dispose of such shares.
(2) Morgan Stanley is the parent company of, and indirect beneficial owner of
securities held by, one of its business units.
(3) These securities are owned by various individual and institutional investors
for which T. Rowe Price Associates, Inc. ("Price Associates") serves as
investment adviser with power to direct investments and/or sole power to
vote the securities. For purposes of the reporting requirements of the
Securities Exchange Act of 1934, Price Associates is deemed to be a
beneficial owner of such securities; however, Price Associates expressly
disclaims that it is, in fact, the beneficial owner of such securities.
(4) Janus Capital has an indirect 100% ownership stake in Bay Isle Financial LLC
("Bay Isle") and an indirect 50.1% ownership stake in Enhanced Investment
Technologies LLC ("INTECH"). Due to this ownership structure, holdings for
Janus Capital, Bay Isle and INTECH are aggregated for purposes of this
beneficial ownership reporting. Janus Capital, Bay Isle and INTECH are
registered investment advisers, each furnishing investment advice to various
investment companies registered under Section 8 of the Investment Company
Act of 1940 and to individual and institutional clients (collectively
referred to herein as "Managed Portfolios").
As a result of its role as investment adviser or sub-adviser to the Managed
Portfolios, Janus Capital may be deemed to be the beneficial owner of
5,112,182 shares of the shares outstanding of the Company's Common Stock
held by such Managed Portfolios. However, Janus Capital does not have the
right to receive any dividends from, or the proceeds from the sale of, the
securities held in the Managed Portfolios and disclaims any ownership
associated with such rights.
As a result of its role as investment adviser or sub-adviser to the managed
Portfolios, INTECH may be deemed to be the beneficial owner of 43,100
shares of the shares outstanding of the Company's Common Stock held by such
Managed Portfolios. However, INTECH does not have the right to receive any
dividends from, or the proceeds from the sale of, the securities held in
the Managed Portfolios and disclaims any ownership associated with such
rights.
PROPOSAL 2: APPROVAL OF AN AMENDMENT TO THE
SMITH INTERNATIONAL, INC. 1989 LONG-TERM
INCENTIVE COMPENSATION PLAN
GENERAL
At the meeting, you will be asked to approve an amendment, attached to this
Proxy Statement as Appendix B, to the Smith International, Inc. 1989 Long-Term
Incentive Compensation Plan (the "1989 Plan") to (i) clarify the stock
adjustment provisions with respect to stock splits, stock dividends and other
capital readjustments; and (ii) clarify that awards granted to executive
officers pursuant to the 1989 Plan are intended to qualify for the
performance-based exception to the federal income tax deduction limit under
Section 162(m) of the Internal Revenue Code. The amendment also includes a
provision that incorporates the increase in the aggregate number of shares of
the Company's Common Stock reserved for issuance under the 1989 Plan that
occurred as a result of the 2-1 stock split on June 20, 2002. You are not being
asked to approve the increase and your vote on this Proposal 2 will not affect
the aggregate number of shares of the Company's Common Stock currently reserved
for issuance under the 1989 Plan.
The 1989 Plan was originally approved by the stockholders at the May 9,
1989 annual meeting. Since 1989, as adjusted to reflect the 2-1 stock split, a
total of 14,400,000 shares of Common Stock have been reserved for issuance under
the 1989 Plan. On December 4, 2002, the Board of Directors approved an amendment
to the 1989 Plan as attached to this Proxy Statement as Appendix B. At the
Annual Meeting, the Company's stockholders will be asked to approve the proposed
amendment to the 1989 Plan described above.
19
TERMS OF THE AMENDMENT
The amendment includes two material provisions: (1) the amendment clarifies
the stock adjustment provisions with respect to stock splits, stock dividends
and other capital readjustments; and (2) the amendment clarifies that awards
granted to executive officers pursuant to the 1989 Plan are intended to qualify
for the performance-based exception to the federal income tax deduction limit
under Section 162(m) of the Internal Revenue Code. The Company intends that the
1989 Plan comply with the applicable requirements so that any incentive award
subject to Section 162(m) of the Internal Revenue Code that is granted to
executive officers will qualify for the performance-based exception, except for
grants of options with an option price set at less than the fair market value of
a share of Common Stock on the date of grant. The 1989 Plan currently prohibits
the grant of options at option prices set at less than the fair market value of
a share of Common Stock on the date of grant. If any provision of the 1989 Plan
or an incentive award would not permit the 1989 Plan or the incentive award to
comply with the performance-based exception as intended, then such provision
would be construed or deemed to be amended to conform to the requirements of the
performance-based exception to the extent permitted by applicable law and deemed
advisable by the Compensation Committee.
The proposed amendment does not affect either the shares of Common Stock
currently reserved for issuance or the number of shares of Common Stock to be
issued upon exercise of outstanding options, and the Company intends to continue
to award stock options at the same levels and on the same criteria as it has
done since the inception of the 1989 Plan.
The Board of Directors has found that stock options granted to employees
have been highly effective in recruiting and retaining competent personnel. The
Board of Directors believes that the growth of the Company is dependent upon its
ability to attract, employ and retain executives and employees of outstanding
ability who will dedicate their maximum productive efforts toward the
advancement of the Company. The growing competition among companies for capable
managers makes it necessary for the Company to maintain a strong and competitive
incentive program.
EQUITY COMPENSATION PLAN INFORMATION
The following table shows information as of December 31, 2002, with respect
to the 1989 Plan and the Smith International, Inc. Stock Plan for Outside
Directors under which equity securities of the Company are authorized for
issuance, aggregated as follows:
(A) (B) (C)
--- --- ---
NUMBER OF SECURITIES
NUMBER OF SECURITIES REMAINING AVAILABLE FOR
TO BE ISSUED UPON FUTURE ISSUANCE UNDER
EXERCISE OF WEIGHTED-AVERAGE EXERCISE EQUITY COMPENSATION PLANS
OUTSTANDING OPTIONS, PRICE OF OUTSTANDING OPTIONS, (EXCLUDING SECURITIES
PLAN CATEGORY WARRANTS AND RIGHTS WARRANTS AND RIGHTS REFLECTED IN COLUMN(A))
------------- -------------------- ----------------------------- -------------------------
Equity compensation plans 3,353,574(1)
approved by security
holders:..................... 6,270,264 $ 25.04
Equity compensation plans not Not applicable
approved by security
holders...................... Not applicable Not applicable
-------------- -------------- --------------
Total.......................... 6,270,264 $ 25.04 3,353,574
============== ============== ==============
---------------
(1) Includes 32,000 shares available for issuance pursuant to the Stock Plan for
Outside Directors.
AWARDS UNDER THE 1989 PLAN
As of March 1, 2003, 6,024,863 stock options were outstanding under the
1989 Plan, having exercise prices of $6.56 to $36.52 and expiring from December
6, 2004 to December 3, 2012. The outstanding figure includes stock options for
1,259,000 shares which were issued on December 3, 2002. All stock options
granted under the 1989 Plan are conditioned upon continued employment. The last
reported sales price, as reported by the New York Stock Exchange, of the
Company's Common Stock on March 14, 2003 was $32.61 per share.
20
Under the 1989 Plan, the Named Officers have been granted, in the
aggregate, options exercisable into the following number of shares of Common
Stock: Mr. Rock: 1,803,300; Mr. Carroll: 840,100; Mr. Sutton: 395,390; Ms.
Dorman: 219,600; and Mr. Werner: 383,520. All current executive officers as a
group have been granted, in the aggregate, options exercisable into 4,474,700
shares of Common Stock. All employees, other than executive officers, as a
group, have been granted, in the aggregate, options exercisable into 7,756,038
shares of Common Stock. Non-employee directors are not eligible to receive
options under the 1989 Plan.
SUMMARY OF THE 1989 PLAN
The following is a summary of the 1989 Plan and is qualified in its
entirety by the full text of the 1989 Plan. Any shareholder may obtain a copy of
the 1989 Plan by writing to Smith International, Inc., 16740 Hardy Street,
Houston, Texas 77032, Attention: Corporate Secretary. Requests may also be made
by fax to (281) 233-5996 or to the Company's website at (www.smith.com).
PLAN ADMINISTRATION
The 1989 Plan is administered by the Compensation Committee. All full-time
salaried employees of the Company who are performing management, supervisory,
sales, scientific or engineering services or who the Compensation Committee
decides are key employees are eligible to receive awards under the 1989 Plan.
The Compensation Committee determines awards based upon an employee's
ability to influence the Company's performance. Future awards are based on
future performance and cannot, therefore, be determined in advance. Nonqualified
stock options have been granted to all Named Officers, six executive group
employees and approximately 399 non-executive officer employees, for a total of
approximately 410 current employees. No directors of the Company, in their
capacity as a director, have been granted awards under the 1989 Plan. Please see
the section entitled "Executive Compensation" earlier in this document for more
information about stock options granted to executive officers.
The 1989 Plan provides for the following types of awards: (a) nonqualified
stock option; (b) stock appreciation right related to an option; (c) stock
appreciation right not related to an option; (d) stock award; (e) restricted
stock; (f) cash award; and (g) any combination of the foregoing. As of March 1,
2003, only nonqualified stock options and restricted stock have been awarded
under the 1989 Plan.
GENERAL TERMS AND CONDITIONS OF AWARDS
Exercise of Stock Options and Termination of Awards. The purchase price
for a nonqualified stock option is payable in cash or in shares of Common Stock
and may be exercised only by the employee. If an employee voluntarily resigns or
is terminated for cause, all of the awards immediately terminate. If an employee
retires, the award expires three years after termination unless it expires
sooner by its terms. If an employee is terminated by the Company for any other
reason, then the award expires one year after termination unless it expires
sooner by its terms. An award may not be exercised after ten years from the date
the award is granted.
Adjustment of Awards. If any change occurs in the capitalization of the
Company, such as a stock dividend or stock split, or if a merger takes place in
which the Company is the surviving corporation, the Board of Directors or the
Committee may take such action as it deems appropriate so that the value of each
outstanding award shall not be adversely affected by such corporate event. In
the event of a takeover bid or tender offer for 25% or more of the outstanding
securities of the Company, the restrictions on any restricted stock would lapse
immediately, all outstanding options and stock appreciation rights become
exercisable immediately, and all performance objectives are deemed to be met and
payment made immediately.
Federal Income Tax Consequences. The 1989 Plan permits the Compensation
Committee to grant nonqualified stock options ("NQSOs") to certain key employees
of the Company. The following discussion is
21
intended only as a summary of the effect of federal income taxation upon the
optionee and the Company with respect to the grant and exercise of NQSOs under
the 1989 Plan.
Upon the grant of a NQSO, the optionee will not recognize any taxable
income, and the Company will not be entitled to a federal income tax deduction.
Upon the exercise of an NQSO, the excess of the fair market value of the shares
acquired on the exercise of the option over the purchase price (the "spread")
will be compensation that is taxable to the optionee as ordinary income. To
determine the amount of the spread, the fair market value of the stock on the
date of exercise is used; however, if an optionee is subject to the six month
short-swing profit recovery provisions of Section 16(b) of the Securities
Exchange Act of 1934 (generally executive officers), the fair market value will
generally be determined at the end of the six-month period, unless such optionee
elects to be taxed based on the fair market value at the date of exercise. Any
such election must be made and filed with the Internal Revenue Service within 30
days after exercise in accordance with the regulations under Section 83(b) of
the Internal Revenue Code. The Company, in computing its federal income tax,
will generally be entitled to a deduction, subject to limitations under Section
162(m) of the Internal Revenue Code, in an amount equal to the compensation
taxable to the optionee in the Company's taxable year in which the amount is
taxable to the optionee.
Amendment of the 1989 Plan. The Board of Directors may terminate, modify
or amend the 1989 Plan at any time without stockholder approval, except for
amendments that (a) change the class of persons eligible to receive awards; (b)
materially increase benefits; (c) transfer the administration of the 1989 Plan
to anyone who is not a "disinterested person" under the federal securities law;
or (d) increase the number of shares subject to the 1989 Plan.
The affirmative vote of a majority of the votes represented at the annual
meeting will be sufficient to approve the amendment to the 1989 Plan.
THE BOARD OF DIRECTORS RECOMMENDS THAT YOU VOTE FOR APPROVAL OF THE
AMENDMENT TO THE 1989 PLAN.
PROPOSAL 3: APPROVAL OF AN AMENDMENT TO THE
SMITH INTERNATIONAL, INC. STOCK PLAN FOR OUTSIDE DIRECTORS
At the meeting, you will be asked to approve an amendment to the Smith
International, Inc. Stock Plan for Outside Directors (the "Stock Plan") to
change the number of shares of Common Stock each non-employee director will
receive annually under the Stock Plan to that number equal to a value of
approximately $45,000. Upon your approval, the term of the Stock Plan would be
extended until April 22, 2013.
The Stock Plan provides equity compensation to the Company's non-employee
directors. Four members of the Company's Board of Directors are eligible to
receive grants under the Stock Plan. The Stock Plan provides for awards of
common stock and restricted stock. Since 1992, a total of 120,000 shares have
been reserved for issuance under the Stock Plan. The Stock Plan currently
provides that non-employee directors receive 800 shares of Common Stock per
year. The proposed amendment would provide that non-employee directors receive
equity compensation of approximately $45,000 per year.
The following table shows the approximate value of shares of Common Stock
the Board of Directors expects to issue under the Stock Plan on or about April
22, 2003, assuming the proposed amendment to the Stock Plan is approved by the
stockholders:
NAME OF NON-EMPLOYEE DIRECTOR DOLLAR VALUE NUMBER OF SHARES(1)
----------------------------- ------------ --------------------
Benjamin F. Bailar(2)....................................... $ 45,002 1,380
G. Clyde Buck............................................... $ 45,002 1,380
James R. Gibbs.............................................. $ 45,002 1,380
Jerry W. Neely.............................................. $ 45,002 1,380
-------- -----
Non-Executive Director Group................................ $180,008 5,520
22
---------------
(1) Based upon the last reported sales price of the Common Stock as of March 14,
2003 ($32.61). The actual number of shares to be issued will be based on the
price of our Common Stock on the grant date.
(2) Award contingent upon Mr. Bailar being re-elected to the Board of Directors
at the annual meeting.
It is important for the Company to attract outstanding directors and to
retain their services. In order to do that, the Company believes it should
provide total compensation to its non-employee directors at or slightly above
market. In 2002 the Compensation and Benefit Committee's independent
compensation consultant, Towers Perrin, reported on the then current level of
cash and equity compensation paid to non-employee members of the Company's Board
of Directors. Towers Perrin concluded, and the Compensation Committee agreed,
that cash compensation, other than that of Committee Chairs, was close to market
but that the equity component of non-employee director's compensation was
substantially below market. Towers Perrin recommended that the equity component
be increased in value to approximately $45,000 and targeted at an approximate
dollar amount rather than a specific number of shares of Common Stock. In
today's climate, the Board of Directors believes this additional equity
compensation for non-employee directors is necessary to secure and retain
qualified non-employee individuals to serve on the Board of Directors of the
Company.
This summary of the Stock Plan is qualified in its entirety by the full
text of the Stock Plan. Any stockholder may obtain a copy of the Stock Plan by
writing to Smith International, Inc., 16740 Hardy Street, Houston, Texas 77032,
Attention: Corporate Secretary. Requests may also be made by fax to (281)
233-5996 or to the Company's website at (www.smith.com).
The Board of Directors may modify, revise or terminate the Stock Plan at
any time. If any amendment to the Stock Plan requires the approval of our
stockholders in order to assure that it complies with the rules of the SEC or
the New York Stock Exchange, then an amendment would only be made after
obtaining the required stockholder vote.
The affirmative vote of a majority of the shares represented at the annual
meeting will be sufficient to approve the amendment to the Stock Plan.
THE BOARD OF DIRECTORS RECOMMENDS THAT YOU VOTE FOR APPROVAL OF THE
AMENDMENT TO THE STOCK PLAN.
PROPOSAL 4: APPROVAL OF DELOITTE & TOUCHE LLP AS AUDITORS
The Board of Directors has selected Deloitte & Touche LLP to audit the
books and records of the Company for its fiscal year ending December 31, 2003.
The Company has been advised by Deloitte & Touche that the firm has no
relationship with the Company or its subsidiaries other than that arising from
the firm's engagement as auditors and, in limited circumstances, tax advisors.
Upon the recommendation of the Company's Audit Committee and approval of
the Board of Directors, the Company dismissed Arthur Andersen LLP on April 15,
2002 and appointed Deloitte & Touche to serve as its independent auditors. The
appointment of Deloitte & Touche was made after careful consideration by the
Board of Directors, its Audit Committee and management of the Company after an
extensive evaluation process. Deloitte & Touche has offices in or convenient to
most of the locations in the world where the Company and its subsidiaries
operate. Representatives of Deloitte & Touche are not expected to be present at
the Annual Meeting, will not have the opportunity to make a statement and will
not be available to respond to questions.
Change of Independent Public Accountants
As previously disclosed, on April 15, 2002 we dismissed Arthur Andersen and
appointed Deloitte & Touche as our new independent auditors. The decisions were
recommended by the Audit Committee and approved by the Board of Directors.
23
Arthur Andersen's reports on our consolidated financial statements for each
of the years ended December 31, 2001 and 2000 did not contain any adverse
opinion or disclaimer of opinion, nor were they qualified or modified as to
uncertainty, audit scope, or accounting principles.
During the years ended December 31, 2001 and 2000, and the subsequent
interim period through April 15, 2002, there were no disagreements between us
and Arthur Andersen on any matter of accounting principles or practices,
financial statement disclosure, or auditing scope or procedure, which
disagreements, if not resolved to Arthur Andersen's satisfaction, would have
caused them to make reference to the subject matter of the disagreement in
connection with their report.
None of the reportable events described in Item 304(a)(1)(v) of Regulation
S-K occurred during the years ended December 31, 2001 and 2000 or during the
subsequent interim period through April 15, 2002.
We provided Arthur Andersen with a copy of the foregoing disclosures. A
copy of Arthur Andersen's letter, dated April 15, 2002, stating their agreement
with such statements is attached as Exhibit 16.1 to our Current Report on Form
8-K filed April 18, 2002 with the Securities and Exchange Commission.
During the years ended December 31, 2001 and 2000, and the subsequent
interim period through April 15, 2002, we did not consult with Deloitte & Touche
regarding any of the matters or events set forth in Item 302(a)(2)(i) and (ii)
of Regulation S-K.
FEES PAID TO DELOITTE & TOUCHE LLP
Audit Fees. Fees related to the audit of the Company's 2002 consolidated
financial statements and the review of the Company's interim financial
statements included in its quarterly reports on Form 10-Q were $960,000. These
fees also include the audit of the combined financial statements of M-I, the
Company's majority-owned joint venture.
Financial Information Systems Design and Implementation. During fiscal
year 2002, the Company did not engage Deloitte & Touche to render financial
information systems design and implementation services.
All Other Fees. The Company incurred an aggregate of $525,000 in fees to
Deloitte & Touche during fiscal year 2002 for all non-audit services. These fees
primarily relate to auditing statutory accounts of certain non-U.S. operations
and various U.S. employee benefit plans, which were not directly related to the
audit of the 2002 consolidated financial statements.
Although ratification by stockholders is not required by law, the Board of
Directors has determined that it is desirable to request approval of this
selection by the stockholders. Notwithstanding its selection, the Board of
Directors, in its discretion, may appoint new independent auditors at any time
during the year if the Board believes that such a change would be in the best
interest of the Company and its stockholders. If the stockholders do not ratify
the appointment of Deloitte & Touche LLP, the Board may reconsider its
selection.
THE BOARD OF DIRECTORS RECOMMENDS THAT YOU VOTE FOR THE CONTINUED
ENGAGEMENT OF DELOITTE & TOUCHE LLP TO AUDIT THE BOOKS AND RECORDS OF THE
COMPANY FOR THE FISCAL YEAR ENDING DECEMBER 31, 2003.
OTHER BUSINESS
The Board of Directors does not intend to present any other business for
action at the meeting, and the Company has not been advised of any other
business intended to be presented by others.
STOCKHOLDERS' PROPOSALS
In order to be considered for inclusion in next year's Proxy Statement,
stockholder proposals must be submitted to the Company in writing by no later
than November 27, 2003. In addition, in order for a stockholder to bring any
business before a stockholder meeting, timely notice must be received by the
Company in writing by no later than November 27, 2003, in accordance with the
Company's Restated Bylaws.
24
ANNUAL REPORT AND FINANCIAL INFORMATION
A COPY OF THE COMPANY'S 2002 ANNUAL REPORT TO STOCKHOLDERS ACCOMPANIES THIS
PROXY STATEMENT. WE WILL PROVIDE WITHOUT CHARGE THE COMPANY'S ANNUAL REPORT ON
FORM 10-K FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002, TO ANY PERSON REQUESTING
A COPY IN WRITING AND STATING THAT HE OR SHE WAS A BENEFICIAL HOLDER OF THE
COMPANY'S COMMON STOCK ON MARCH 1, 2003. THE COMPANY WILL ALSO FURNISH COPIES OF
ANY EXHIBITS TO THE FORM 10-K AT $0.50 PER PAGE, PAID IN ADVANCE. REQUESTS AND
INQUIRIES SHOULD BE ADDRESSED TO:
INVESTOR RELATIONS
SMITH INTERNATIONAL, INC.
P. O. BOX 60068
HOUSTON TX 77205-0068
The Company's 2002 Annual Report to Stockholders should not be regarded as
proxy soliciting material or as a communication for which a solicitation of
proxies is to be made.
By Order of the Board of Directors
-s- Neal S. Sutton
Neal S. Sutton
Secretary
25
APPENDIX A
SMITH INTERNATIONAL, INC.
AUDIT COMMITTEE CHARTER
(EFFECTIVE FEBRUARY 5, 2003)
The primary responsibility for the Company's financial reporting and
internal operating controls is vested in senior management as overseen by the
Board of Directors ("Board"). The Audit Committee ("Committee") is a standing
committee appointed by the Board to assist it in monitoring (1) the integrity of
the financial statements of the Company, (2) the compliance by the Company with
legal and regulatory requirements, (3) the independent auditor's qualifications
and independence and (4) the performance of the Company's internal audit
function and independent auditors.
The Committee shall be composed of such number of independent directors as
shall be determined, from time to time, by the Board, but shall consist of no
fewer than three members. Each member of the Committee shall meet the
independence and experience requirements of the New York Stock Exchange, Section
10A(m)(3) of the Securities and Exchange Act of 1934 (the "Act") and the rules
and regulations of the Securities and Exchange Commission (the "Commission"). At
least one member of the Committee shall be an "audit committee financial expert"
as defined by the Commission. Committee members shall not simultaneously serve
on the audit committee of more than two other public companies.
The Committee may form and delegate authority to subcommittees consisting
of one or more members, when appropriate, including the authority to grant
preapprovals of audit and permitted non-audit services, provided that decisions
of such subcommittee to grant preapprovals shall be presented to the full
Committee at its next scheduled meeting. The Company shall provide for
appropriate funding, as determined by the Committee, for payment of compensation
to the independent auditor for the purpose of rendering or issuing an audit
report and to any advisors employed by the Committee.
The Committee will meet at least quarterly and at such other times as it
determines. The Committee shall have unrestricted access to Company personnel
and documents and will be given the resources necessary to discharge its
responsibilities. The Committee shall meet periodically with management, the
internal auditors and the independent auditor in separate executive sessions.
The Committee shall have the authority to retain independent legal, accounting
or other consultants to advise the Committee. The Committee may request any
officer or employee of the Company or the Company's outside legal counsel or
independent auditor to attend a meeting of the Committee or to meet with any
members of, or consultants to, the Committee.
The members of the Committee, including its Chair, shall be appointed by
the Board on the recommendation of the Nominating and Corporate Governance
Committee. Committee members may be replaced by the Board.
The Committee shall make regular reports to the Board.
The Committee shall review and assess the adequacy of this Charter annually
and recommend any proposed changes to the Board for approval. The Committee
shall annually review the Committee's own performance.
The Committee shall have the following duties and responsibilities, which
may be changed from time to time by the Board:
I. FINANCIAL REPORTING
To accomplish its responsibilities to the Board in the area of financial
reporting, the Committee will:
1. Oversee the independent audit coverage, including
(i) Recommend annually to the Board the appointment of the
independent auditor, which firm will report directly to the Committee.
The Committee shall be directly responsible for the
A-1
compensation and oversight of the work of the independent auditor,
including resolution of any disagreement between management and the
independent auditor regarding financial reporting, for the purpose of
preparing or issuing an audit report or related work.
(ii) Meet with the independent auditor prior to the audit to review
the changes in audit procedures, planned scope and staffing of the audit
and the estimated fees.
(iii) Review and discuss with management and the independent
auditor significant financial reporting issues and judgment made in
connection with the preparation of the Company's financial statements,
including any significant changes in the Company's selection or
application of accounting principles, any major issues as to the
adequacy of the Company's internal controls and any material steps
adopted in light of special control deficiencies.
(iv) Review and preapprove all auditing services and permitted
non-audit services (including the fees and terms thereof) to be
performed for the Company by the independent auditor, subject to the de
minimus exceptions for non-audit services described in Section
10A(i)(1)(B) of the Exchange Act which are approved by the Committee
prior to the completion of the audit.
(v) Approve the fees to be paid to the independent auditor.
2. Review and discuss with management and the independent auditor any
proposed significant changes to the Company's accounting principles and
practices required by professional accounting standards or as suggested by
management. Discuss with management and the independent auditor the effect
of regulatory and accounting initiatives as well as off-balance sheet
structures, if any, on the Company's financial statements.
3. Review the financial statements, including
(i) Review and discuss with management and the independent auditor
the annual audited financial statements, including discussions made in
management's discussion and analysis, and recommend to the Board whether
the audited financial statements should be included in the Company's
annual report on Form 10-K.
(ii) Review and discuss with management and the independent auditor
the Company's quarterly financial statements prior to the filing of the
Company's quarterly report on Form 10-Q.
(iii) Review and discuss other financial reports requiring approval
by the Board before submission to the Securities and Exchange Commission
or other government agencies.
4. Inquire about the existence and substance of any significant
accounting accruals, reserves or estimates made by management that had or
may have a material impact on the financial statements.
5. Review and discuss reports from the independent auditors on:
(i) All critical accounting policies and practices to be used.
(ii) All alternative treatments of financial information within
generally accepted accounting principles that have been discussed with
management, the ramifications of the use of such alternative disclosures
and treatments and the treatment preferred by the independent auditor.
(iii) Other material written communications between the independent
auditor and management, such as any management letter or schedule of
unadjusted differences.
6. Discuss with management the Company's earnings press releases,
including the use of "pro forma" or "adjusted" non-GAAP information, as
well as financial information and earnings guidance provided to analysts
and ratings agencies. Such discussions may be done generally, consisting of
discussing the types of information to be disclosed and the types of
presentations to be made.
7. Discuss with the independent auditor the matters required to be
discussed by Statement on Auditing Standards No. 61 relating to the conduct
of the audit, including any difficulties encountered in
A-2
the course of the audit work, any restrictions on the scope of activities
or access to required information and any significant disagreements with
management.
8. Obtain from management a notification of issues and responses prior
to seeking a second opinion from an independent public accountant.
9. Review disclosures made by the Company's CEO and CFO in connection
with their certification process for Form 10-K and Form 10-Q about any
significant deficiencies in the design or operation of internal controls or
material weaknesses therein and any fraud involving management or other
employees who have a significant role in the Company's internal controls.
10. Obtain and review a report from the independent auditor at least
annually regarding (a) the independent auditor's internal quality control
review, (b) any material issues raised by the most recent internal quality
control review, or peer review, of the firm, or by any inquiry or
investigation by governmental or professional authorities within the
preceding five years respecting one or more independent audits carried out
by the firm, (c) any steps taken to deal with any such issues and (d) all
relationships between the independent auditor and the Company. Evaluate the
qualifications, performance and independence of the independent auditor,
including considering whether the independent auditor's quality controls
are adequate and the provision of permitted non-audit services is
compatible with maintaining the auditor's independence, and taking into
account the opinions of management and internal auditors. The Committee
shall present its conclusions with respect to the independent auditor to
the Board.
11. Review and evaluate the lead partner of the independent auditor
team.
12. Ensure the rotation of the lead (or coordinating) audit partner
having primary responsibility for the audit and the audit partner
responsible for reviewing the audit as required by law.
13. Recommend to the Board policies for the Company's hiring of
employees or former employees of the independent auditor who participated
in any capacity in the audit of the Company.
14. Discuss with the independent auditor any communications with its
national office concerning auditing or accounting issues presented by the
engagement.
II. CORPORATE GOVERNANCE
The responsibility of the Committee to the Board in the area of corporate
governance is to review whether the Company is in reasonable compliance with
pertinent laws and regulations and is maintaining effective controls with
respect to the assets and the books and records of the Company. To accomplish
this, the Committee will:
1. Review corporate policies relating to compliance with laws and
regulations, ethics, conflict of interest and the investigation of
misconduct or fraud. Establish procedures for the receipt, retention and
treatment of complaints received by the Company regarding accounting,
internal accounting controls or auditing matters and the confidential,
anonymous submission by employees of concerns regarding questionable
accounting or auditing matters.
2. Advise the Board with respect to the Company's compliance, and that
of its subsidiaries and foreign affiliate entities, with applicable legal
requirements and the Company's corporate policies and with respect to the
Company's policies and procedures regarding compliance.
3. Discuss with management and the independent auditor any
correspondence with regulators or governmental agencies and any published
reports which raise material issues regarding the Company's financial
statements or accounting policies.
4. Discuss with management the Company's major financial risk
exposures and the steps management has taken to monitor and control such
exposures, including the Company's risk assessment and risk management
policies.
A-3
5. Obtain from the independent auditor assurance that Section 10A(b)
of the Exchange Act has not been implicated.
6. Discuss with the Company's General Counsel:
(i) Any questionable or possible illegal activities or payments
reported to the Committee. (ii) Any legal matters that may have a
material impact on the financial statements of the Company.
(iii) The Company's compliance policies.
(iv) Any material reports or inquiries received from regulators or
governmental agencies.
III. INTERNAL CONTROL
It is incumbent on the Committee to fulfill its oversight responsibilities
to the Board without unnecessary or inappropriate intervention with the
prerogatives of corporate management. Nevertheless, to carry out its
responsibility, the Committee should:
1. Review the appointment and replacement of the Director of Internal
Audit.
2. Discuss with the independent auditor and management the internal
audit department responsibilities, budget and staffing and any recommended
changes in the planned scope of the internal audit.
3. Review the work and performance of the Company's internal audit
function including the results of significant audits and management's
response. Determine from the internal auditors whether there is a need for
any significant change in the Company's system of internal controls.
While the Committee has the responsibilities and powers set forth in this
Charter, it is not the duty of the Committee to plan or conduct audits or to
determine that the Company's financial statements are complete and accurate and
are in accordance with generally accepted accounting principles and applicable
rules and regulations. These are the responsibilities of management and the
independent auditor.
A-4
APPENDIX B
SEVENTH AMENDMENT TO THE SMITH INTERNATIONAL, INC.
1989 LONG-TERM INCENTIVE COMPENSATION PLAN
(AS AMENDED AS OF FEBRUARY 2, 2000)
WITNESSETH
WHEREAS, Smith International, Inc. (the "Company") maintains the Smith
International, Inc. 1989 Long-Term Incentive Compensation Plan (the "Plan") for
the purpose of providing additional incentives to officers and other valued
employees of the Company; and
WHEREAS, in Section 14 of the Plan, the Board of Directors of the Company
(the "Board") reserved the discretionary right to amend the Plan at any time;
and
WHEREAS, the Board now desires to amend the Plan to increase the aggregate
number of shares of the Company's Common Stock which are reserved under the Plan
to reflect a 2-1 stock split; and
WHEREAS, the Board desires to amend the Plan to incorporate certain
provisions relating to the stock adjustment provisions in the event of another
stock split or other designated corporate event; and
WHEREAS, the Board desires to amend the Plan to clarify and expand certain
provisions related to the performance-based exception to the federal income tax
deduction limit under Section 162(m) of the Internal Revenue Code;
NOW, THEREFORE, the Plan is hereby amended by this Seventh Amendment
thereto, as follows:
1. Section 3(a) of the Plan is hereby amended in its entirety to provide as
follows:
3. SHARES OF COMMON STOCK SUBJECT TO THE PLAN
(a) Effective as of June 20, 2002, subject to Section 3(c) and
Section 12 of the Plan, the aggregate number of shares of Common Stock
that may be issued or transferred or as to which Stock Appreciation
Rights may be exercised pursuant to Incentive Awards under the Plan
shall not exceed 14,400,000 shares.
2. Section 12(a) of the Plan is hereby amended in its entirety to provide
as follows:
12. ADJUSTMENT PROVISIONS
(a) Effective as of June 20, 2002, subject to Section 12(b), if the
Company should effect any subdivision or consolidation of shares of
Common Stock or other capital readjustment, the payment of a stock
dividend, stock split, combination of shares, recapitalization,
reclassification, or other increase or reduction in the number or kind
of shares outstanding, without receiving compensation therefor in money,
services or property, then an appropriate and proportionate adjustment
shall be made in (i) the maximum number and kind of shares provided in
Section 3 of the Plan, (ii) the number and kind of shares or other
securities subject to the then outstanding Options and Stock
Appreciation Rights, (iii) the number of unvested shares of Common Stock
granted pursuant to awards of Restricted Stock or a Stock Award, and
(iv) the price for each share or other unit of any other securities
subject to then outstanding Options and the value of any then
outstanding Stock Appreciation Rights without change in the aggregate
purchase price or value as to which such Options or Stock Appreciation
Rights remain exercisable. The Board of Directors or Committee shall
take such action that it deems appropriate, in its discretion, so that
the value of each outstanding Incentive Award to its Holder shall not be
adversely affected by a corporate event described in this Section 12(a).
The existence of the Plan or outstanding Incentive Awards hereunder
shall not affect in any way the right or power of the Company or its
stockholders to make or authorize any or all adjustments,
B-1
recapitalization, reorganization or other changes in the Company's
capital structure or its business or any merger or consolidation of the
Company, or any issue of bonds, debentures, preferred or prior
preference stocks ahead of or affecting the Common Stock or the rights
thereof, or the dissolution or liquidation of the Company, or any sale
or transfer of all or any part of its assets or business, or any other
corporate act or proceeding whether of a similar character or otherwise.
The following amendments to the Plan are referred to as the "Section 162(m)
Amendments":
3. Section 2 of the Plan is hereby amended by replacing the definition of
"Committee" used therein with the following new definition:
"Committee" shall mean the Compensation and Benefits Committee of the
Board of Directors, unless the Board of Directors appoints another
committee to administer the Plan. The Committee shall consist of not less
than two directors who fulfill the "nonemployee director" requirements of
Rule 16b-3 under the Securities Exchange Act of 1934 and the "outside
director" requirements of Section 162(m) of the Internal Revenue Code.
The Board of Directors shall have the power to fill vacancies on the
Committee arising by resignation, death, removal or otherwise. The Board of
Directors, in its discretion, may bifurcate the powers and duties of the
Committee among one or more separate committees, or retain all powers and
duties of the Committee in a single Committee.
4. Section 2 of the Plan is hereby amended by adding the following new
definitions within Section 2 as follows:
"Covered Employee" shall mean a named executive officer who is one of
the group of covered employees, as defined in Section 162(m) of the
Internal Revenue Code and Treasury Regulation sec. 1.162-27(c) (or its
successor).
"Performance-Based Exception" shall mean the exception from the tax
deductibility limitations of Section 162(m) of the Internal Revenue Code,
as prescribed in Section 162(m) and Treasury Regulation sec. 1.162-27(e)
(or its successor).
5. Section 3(a) of the Plan is hereby amended to add the following new
paragraph following the first paragraph of Section 3(a), as follows:
Unless the Committee determines that a particular Incentive Award granted
to a Covered Employee is not intended to comply with the Performance-Based
Exception, the following rules shall apply to grants of Incentive Awards to
Covered Employees:
(1) Subject to adjustment as provided in Section 12, the maximum
aggregate number of shares of Common Stock that may be granted or that may
vest, as applicable, in any calendar year pursuant to any Incentive Award
held by any individual Covered Employee shall be One Million (1,000,000)
shares.
(2) The maximum aggregate cash payout with respect to any Incentive
Awards granted in any calendar year which may be made to any Covered
Employee shall be Ten Million dollars ($10,000,000).
(3) With respect to any Incentive Award granted to a Covered Employee
that is canceled or repriced, the number of shares subject to such
Incentive Award shall continue to count against the maximum number of
shares that may be the subject of Incentive Awards granted to such Covered
Employee and, in this regard, such maximum number shall be determined in
accordance with Section 162(m) of the Internal Revenue Code.
(4) The limitations of subsections (1), (2) and (3) above shall be
construed and administered so as to comply with the Performance-Based
Exception.
B-2
6. Section 13 of the Plan is hereby amended by adding the following new
paragraph (l) at the end thereof, as follows:
(l) Unless otherwise determined by the Committee with respect to any
particular Incentive Award, it is intended that the Plan shall comply with
the applicable requirements so that any Incentive Award subject to Section
162(m) of the Internal Revenue Code that is granted to a Covered Employee
shall qualify for the Performance-Based Exception, except for grants of
Options with an Option price set at less than the fair market value of a
share of Common Stock on the date of grant. If any provision of the Plan or
an Incentive Award would not permit the Plan or Incentive Award to comply
with the Performance-Based Exception as so intended, such provision shall
be construed or deemed to be amended to conform to the requirements of the
Performance-Based Exception to the extent permitted by applicable law and
deemed advisable by the Committee; provided, however, no such construction
or amendment shall have an adverse effect to the grantee of a prior grant
of an Incentive Award or on the economic value to a grantee of any
outstanding Incentive Award.
IN WITNESS WHEREOF, this Seventh Amendment to the Plan is hereby executed
on this 4th day of December, 2002, to be effective as of June 20, 2002, except
as otherwise expressly stated herein.
SMITH INTERNATIONAL, INC.
By: /s/ NEAL S. SUTTON
------------------------------------
Name: Neal S. Sutton
Title: Sr. VP Admin., General Counsel
and Secretary
Date: December 4, 2002
ATTEST:
By: /s/ VIVIAN M. CLINE
------------------------------------
Name: Vivian M. Cline
Title: Assistant Secretary
Date: December 4, 2002
B-3
P THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS OF
SMITH INTERNATIONAL, INC.
R This undersigned hereby appoints Doug Rock and Neal S. Sutton, and
each of them, as his or her Proxy with full power of substitution in each,
to represent the undersigned at the Annual Meeting of Stockholders of SMITH
O INTERNATIONAL, INC. to be held at 700 King Street, Wilmington, Delaware on
April 22, 2003 at 9:00 a.m., and at any adjournments thereof, on all
matters that may properly come before the meeting.
X
YOUR SHARES WILL BE VOTED AS DIRECTED ON THIS CARD. IF SIGNED AND
NO DIRECTION IS GIVEN FOR ANY ITEM, IT WILL BE VOTED IN FAVOR OF ITEMS 1,
Y 2, 3 AND 4.
To vote by telephone or internet, please see the reverse of this
card. To vote by mail, please sign and date this card on the reverse, tear
off at the perforation, and mail promptly in the enclosed postage-paid
envelope.
Comments/Address Change:
-------------------------------------------------
--------------------------------------------------------------------------
--------------------------------------------------------------------------
--------------------------------------------------------------------------
YOUR VOTE IS VERY IMPORTANT. THANK YOU FOR VOTING.
O IF YOU ARE VOTING BY MAIL, DETACH PROXY CARD HERE, O
SIGN, DATE AND MAIL IN POSTAGE-PAID ENVELOPE PROVIDED
_ _ _ |
[ ] PLEASE MARK YOUR | | 7551
VOTES AS IN THIS | | _ _ _
EXAMPLE |
THIS PROXY WILL BE VOTED AS DIRECTED BELOW, OR IF SIGNED AND NO DIRECTION
IS GIVEN, WILL BE VOTED "FOR" ITEMS 1, 2, 3 AND 4 AND AS RECOMMENDED BY THE
BOARD OF DIRECTORS OF SMITH INTERNATIONAL, INC. ON ALL OTHER MATTERS.
--------------------------------------------------------------------------------
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR PROPOSALS 1, 2, 3 AND 4.
--------------------------------------------------------------------------------
FOR WITHHELD NOMINEES:
1. Election of [ ] [ ] 01. Benjamin F. Bailar
Directors. 02. Doug Rock
For, except vote withheld from the following nominee(s):
----------------------------------------------------------------------
FOR AGAINST ABSTAIN
2. Approval of amendment to 1989 [ ] [ ] [ ]
Long-Term Incentive Compensation
Plan.
3. Approval of amendment to Stock [ ] [ ] [ ]
Plan for Outside Directors.
4. Approval of Deloitte & Touche LLP [ ] [ ] [ ]
as independent auditors of the
Company
5. In the discretion of the proxies on any other matters that may properly come
before the meeting or any adjournment thereof.
--------------------------------------------------------------------------------
SIGNATURE(S) DATE
--------------------------------------- ------------
NOTE: Signature(s) should agree with name(s) as printed on this proxy.
-- PLEASE CAREFULLY DETACH HERE AND RETURN THIS PROXY IN THE
ENCLOSED REPLY ENVELOPE --
VOTING INSTRUCTIONS
SMITH INTERNATIONAL, INC.
ANNUAL MEETING OF STOCKHOLDERS -- APRIL 22, 2003
TO: ALL SMITH AND M-I EMPLOYEES PARTICIPATING IN THE SMITH STOCK FUND:
We have been requested to forward to you the enclosed proxy material with
respect to securities held by Vanguard in your 401(k) account but not
registered in your name. These securities can be voted only by Vanguard's
nominee as the holder of record. We urge you to send in your instructions so
that your securities may be voted in accordance with your wishes.
The Annual Meeting of Stockholders of SMITH INTERNATIONAL, INC. will be held at
700 King Street, Wilmington, Delaware on April 22, 2003 at 9:00 A.M.
YOUR SHARES WILL BE VOTED AS DIRECTED ON THIS CARD. IF SIGNED AND NO
DIRECTION IS GIVEN FOR ANY ITEM, YOUR SHARES WILL BE VOTED IN FAVOR OF ITEMS
1, 2, 3 AND 4.
To vote by telephone or internet, please see the reverse of this card.
To vote by mail, please sign and date this card on the reverse, tear off at the
perforation, and mail promptly in the enclosed postage-paid envelope.
-------------
YOUR VOTE IS VERY IMPORTANT. THANK YOU FOR VOTING. SEE
REVERSE SIDE
-------------
O IF YOU ARE VOTING BY MAIL, DETACH PROXY CARD HERE, O
SIGN, DATE AND MAIL IN POSTAGE-PAID ENVELOPE PROVIDED
_ _ _ |
[ ] PLEASE MARK YOUR | | 7551
VOTES AS IN THIS | | _ _ _
EXAMPLE |
THIS PROXY WILL BE VOTED AS DIRECTED BELOW, OR IF SIGNED AND NO DIRECTION
IS GIVEN, WILL BE VOTED "FOR" ITEMS 1, 2, 3 AND 4 AND AS RECOMMENDED BY THE
BOARD OF DIRECTORS OF SMITH INTERNATIONAL, INC. ON ALL OTHER MATTERS.
--------------------------------------------------------------------------------
THE BOARD OF DIRECTORS RECOMMENDS A VOTE FOR PROPOSALS 1, 2, 3 AND 4.
--------------------------------------------------------------------------------
FOR WITHHELD NOMINEES:
1. Election of [ ] [ ] 01. Benjamin F. Bailar
Directors. 02. Doug Rock
For, except vote withheld from the following nominee(s):
----------------------------------------------------------------------
FOR AGAINST ABSTAIN
2. Approval of amendment to 1989 [ ] [ ] [ ]
Long-Term Incentive Compensation
Plan.
3. Approval of amendment to Stock [ ] [ ] [ ]
Plan for Outside Directors.
4. Approval of Deloitte & Touche LLP [ ] [ ] [ ]
as independent auditors of the
Company
5. In the discretion of the proxies on any other matters that may properly come
before the meeting or any adjournment thereof.
--------------------------------------------------------------------------------
SIGNATURE(S) DATE
--------------------------------------- ------------
NOTE: Signature(s) should agree with name(s) as printed on this proxy.
-- PLEASE CAREFULLY DETACH HERE AND RETURN THIS PROXY IN THE
ENCLOSED REPLY ENVELOPE --