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UNITED STATES SECURITIES AND EXCHANGE COMMISSION  Form 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934 For the Quarterly Period Ended June 30, 2004 Commission file number 001-15423 Grant Prideco, Inc.  Delaware
    
    76-0312499(State or Other Jurisdiction of
    
    (I.R.S. EmployerIncorporation or Organization)
    
    Identification No.)1330 Post Oak Blvd.Suite 2700Houston, Texas
    
    77056(Address of Principal Executive Offices)
    
    (Zip Code)
 (832) 681-8000
(Registrants telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ] Indicate by check mark whether the issuer is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuers classes
of common stock, as of the latest practicable date: Title of Each Class
    
    Outstanding at August 2, 2004Common Stock, par value $0.01 per share
    
    122,725,494




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TABLE OF CONTENTS  PART I. FINANCIAL INFORMATIONITEM 1. Financial StatementsConsolidated Statements of OperationsConsolidated Balance SheetsConsolidated Statements of Cash FlowsNotes to Consolidated Financial StatementsCONDENSED CONSOLIDATING STATEMENT OF OPERATIONSCONDENSED CONSOLIDATING BALANCE SHEETCONDENSED CONSOLIDATING STATEMENT OF CASH FLOWSITEM 2. Managements Discussion and Analysis of Financial Condition and Results of OperationsITEM 3. Quantitative and Qualitative Market Risk DisclosuresITEM 4. Controls and ProceduresPART IIITEM 4. Submission of Matters to a Vote of Security HoldersITEM 6. Exhibits and Reports on Form 8-KSIGNATURESEXHIBIT INDEXCertification of Michael McShaneCertification of Matthew D. FitzgeraldSection 906 Certification    Table of Contents  
 PART I. FINANCIAL INFORMATION 
 ITEM 1.Financial Statements 
 GRANT PRIDECO, INC.
Consolidated Statements of Operations
(Unaudited)
(In thousands, except per share data) Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Revenues
    
    $
    225,214
    
    
    $
    181,243
    
    
    $
    444,772
    
    
    $
    364,128Costs and Expenses:Cost of sales
    
    
    136,603
    
    
    
    128,375
    
    
    
    273,383
    
    
    
    251,844Sales and marketing
    
    
    30,717
    
    
    
    23,607
    
    
    
    59,847
    
    
    
    45,994General and administrative
    
    
    19,950
    
    
    
    15,543
    
    
    
    39,375
    
    
    
    31,949Research and engineering
    
    
    4,965
    
    
    
    4,325
    
    
    
    10,314
    
    
    
    8,063Other charges
    
    
    2,498
    
    
    
    78
    
    
    
    5,232
    
    
    
    78194,733
    
    
    
    171,928
    
    
    
    388,151
    
    
    
    337,928Operating Income
    
    
    30,481
    
    
    
    9,315
    
    
    
    56,621
    
    
    
    26,200Interest Expense
    
    
    (10,495
    )
    
    
    (10,866
    )
    
    
    (20,990
    )
    
    
    (21,874
    )Equity Income (Loss) in Unconsolidated Affiliates
    
    
    (481
    )
    
    
    1,037
    
    
    
    (287
    )
    
    
    1,671Other Income, Net
    
    
    337
    
    
    
    7,140
    
    
    
    2,362
    
    
    
    8,284Income from Continuing Operations Before Income Taxes
    
    
    19,842
    
    
    
    6,626
    
    
    
    37,706
    
    
    
    14,281Income Tax Expense
    
    
    (6,186
    )
    
    
    (2,351
    )
    
    
    (12,759
    )
    
    
    (4,994
    )Income from Continuing Operations Before Minority Interests
    
    
    13,656
    
    
    
    4,275
    
    
    
    24,947
    
    
    
    9,287Minority Interests
    
    
    (1,521
    )
    
    
    (798
    )
    
    
    (2,781
    )
    
    
    (1,456
    )Income from Continuing Operations
    
    
    12,135
    
    
    
    3,477
    
    
    
    22,166
    
    
    
    7,831Income (Loss) from Discontinued Operations, Net of Tax
    
    
    (9,885
    )
    
    
    349
    
    
    
    (9,243
    )
    
    
    29Net Income
    
    $
    2,250
    
    
    $
    3,826
    
    
    $
    12,923
    
    
    $
    7,860Basic Net Income Per Share:Income from continuing operations
    
    $
    0.10
    
    
    $
    0.03
    
    
    $
    0.18
    
    
    $
    0.06Income (loss) from discontinued operations
    
    
    (0.08
    )
    
    
    0.00
    
    
    
    (0.07
    )
    
    
    0.00Net Income
    
    $
    0.02
    
    
    $
    0.03
    
    
    $
    0.11
    
    
    $
    0.06Diluted Net Income Per Share:Income from continuing operations
    
    $
    0.10
    
    
    $
    0.03
    
    
    $
    0.18
    
    
    $
    0.06Income (loss) from discontinued operations
    
    
    (0.08
    )
    
    
    0.00
    
    
    
    (0.08
    )
    
    
    0.00Net Income
    
    $
    0.02
    
    
    $
    0.03
    
    
    $
    0.10
    
    
    $
    0.06Weighted Average Shares Outstanding:Basic
    
    
    122,767
    
    
    
    121,636
    
    
    
    122,405
    
    
    
    121,507Diluted
    
    
    125,383
    
    
    
    123,576
    
    
    
    124,863
    
    
    
    123,256
 The accompanying notes are an integral part of these consolidated financial statements. 2




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GRANT PRIDECO, INC.
Consolidated Balance Sheets
(In thousands, except par value amount) June 30,
    
    December 31,2004
    
    2003(Unaudited)AssetsCurrent Assets:Cash
    
    $
    34,398
    
    
    $
    19,230Restricted cash
    
    
    4,172
    
    
    
    283Accounts receivable, net of allowance for uncollectible
accounts of $5,092 and $3,539, respectively
    
    
    196,793
    
    
    
    212,285Inventories
    
    
    238,676
    
    
    
    231,994Current deferred tax assets
    
    
    26,913
    
    
    
    30,283Prepaid expenses
    
    
    13,928
    
    
    
    12,924Other current assets
    
    
    4,825
    
    
    
    3,864519,705
    
    
    
    510,863Property, Plant, and Equipment, Net
    
    
    249,557
    
    
    
    251,236Goodwill
    
    
    389,224
    
    
    
    396,944Intangible Assets, Net
    
    
    41,918
    
    
    
    36,250Investments In and Advances to Unconsolidated Affiliates
    
    
    44,028
    
    
    
    47,786Other Assets
    
    
    16,519
    
    
    
    18,982$
    1,260,951
    
    
    $
    1,262,061Liabilities and Stockholders EquityCurrent Liabilities:Short-term borrowings and current portion of long-term debt
    
    $
    13,115
    
    
    $
    11,073Accounts payable
    
    
    73,042
    
    
    
    74,408Current deferred tax liabilities
    
    
    3,742
    
    
    
    3,763Accrued labor and benefits
    
    
    31,979
    
    
    
    30,406Federal income taxes payable
    
    
    11,408
    
    
    
    14,401Other accrued liabilities
    
    
    36,529
    
    
    
    32,204169,815
    
    
    
    166,255Long-Term Debt
    
    
    404,829
    
    
    
    426,853Deferred Tax Liabilities
    
    
    25,479
    
    
    
    26,965Other Long-Term Liabilities
    
    
    13,280
    
    
    
    23,843Commitments and Contingencies
    
    
    
    
    
    
    Minority Interests
    
    
    14,692
    
    
    
    12,031Stockholders Equity:Preferred stock, $0.01 par value
    
    
    
    
    
    
    Common stock, $0.01 par value
    
    
    1,227
    
    
    
    1,212Capital in excess of par value
    
    
    498,963
    
    
    
    482,122Treasury stock, at cost
    
    
    (7,957
    )
    
    
    (6,692
    )Retained earnings
    
    
    149,946
    
    
    
    137,023Deferred compensation obligation
    
    
    10,363
    
    
    
    9,366Accumulated other comprehensive loss
    
    
    (19,686
    )
    
    
    (16,917
    )632,856
    
    
    
    606,114$
    1,260,951
    
    
    $
    1,262,061
 The accompanying notes are an integral part of these consolidated financial statements. 3




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GRANT PRIDECO, INC.
Consolidated Statements of Cash Flows
(Unaudited)
(In thousands) Six Months EndedJune 30,2004
    
    2003Cash Flows From Operating Activities:Net income
    
    $
    12,923
    
    
    $
    7,860Adjustments to reconcile net income to net cash
provided by operating activities:Gain on sale of businesses, net
    
    
    (774
    )
    
    
    (1,305
    )Loss on sale of discontinued operations
    
    
    11,446
    
    
    
    Depreciation and amortization
    
    
    21,761
    
    
    
    21,129Non-cash portion of other charges
    
    
    2,447
    
    
    
    (73
    )Deferred income tax
    
    
    5,464
    
    
    
    3,919Deferred compensation expense
    
    
    3,047
    
    
    
    2,511Minority interests in consolidated subsidiaries
    
    
    2,781
    
    
    
    1,456Equity (income) loss in unconsolidated affiliates, net of dividends
    
    
    5,051
    
    
    
    11,978(Gain)/Loss on sale of assets
    
    
    (2,621
    )
    
    
    229Change in operating assets and liabilities, net of effects of
businesses acquired:Accounts receivable, net
    
    
    8,140
    
    
    
    8,581Inventories
    
    
    (15,784
    )
    
    
    (12,225
    )Other current assets
    
    
    (2,117
    )
    
    
    13,133Other assets
    
    
    1,540
    
    
    
    1,709Accounts payable
    
    
    1,183
    
    
    
    6,366Other accrued liabilities
    
    
    (1,151
    )
    
    
    (3,733
    )Other, net
    
    
    (5,206
    )
    
    
    (11,301
    )Net cash provided by operating activities
    
    
    48,130
    
    
    
    50,234Cash Flows From Investing Activities:Acquisition of businesses, net of cash acquired
    
    
    (17,312
    )
    
    
    (8,439
    )Proceeds from sale of businesses, net of cash disposed
    
    
    2,180
    
    
    
    11,000Proceeds from sale of discontinued operations, net of cash disposed
    
    
    20,159
    
    
    
    Investments in and advances to unconsolidated affiliates
    
    
    (1,561
    )
    
    
    (2,543
    )Capital expenditures for property, plant, and equipment
    
    
    (20,733
    )
    
    
    (19,813
    )Proceeds from sale of fixed assets
    
    
    3,290
    
    
    
    102Net cash used in investing activities
    
    
    (13,977
    )
    
    
    (19,693
    )Cash Flows From Financing Activities:Repayments on debt, net
    
    
    (27,558
    )
    
    
    (30,488
    )Purchases of treasury stock
    
    
    (1,545
    )
    
    
    (1,354
    )Proceeds from stock option exercises
    
    
    9,984
    
    
    
    357Net cash used in financing activities
    
    
    (19,119
    )
    
    
    (31,485
    )Effect of Exchange Rate Changes on Cash
    
    
    134
    
    
    
    903Net Increase (Decrease) in Cash
    
    
    15,168
    
    
    
    (41
    )Cash at Beginning of Year
    
    
    19,230
    
    
    
    21,878Cash at End of Period
    
    $
    34,398
    
    
    $
    21,837Non-Cash Activities:Non-interest bearing note issued in conjunction with an acquisition
    
    $
    3,961
    
    
    
    
 The accompanying notes are an integral part of these consolidated financial statements. 4




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GRANT PRIDECO, INC.
Notes to Consolidated Financial Statements
(Unaudited)  1.
    
    General Basis of Presentation The accompanying consolidated financial statements of Grant Prideco, Inc.
(the Company or Grant Prideco) have been prepared in accordance with
accounting principles generally accepted in the United States for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all disclosures required by
generally accepted accounting principles for complete financial statements. All
significant transactions between Grant Prideco and its consolidated
subsidiaries have been eliminated. The interim financial statements have not
been audited. However, in the opinion of management, all adjustments,
consisting only of normal recurring adjustments, necessary for a fair
presentation of the financial statements have been included. Results of
operations for interim periods are not necessarily indicative of the results of
operations that may be expected for the entire year. The balance sheet at
December 31, 2003 has been derived from the audited financial statements at
that date but does not include all of the information and footnotes required by
generally accepted accounting principles for complete financial statements.
These interim financial statements should be read in conjunction with the
audited financial statements and notes thereto included in the Companys Annual
Report on Form 10-K for the year ended December 31, 2003. The Annual Report on Form 10-K for the year ended December 31, 2003
includes disclosures related to significant accounting policies including
revenue recognition, inventory valuation, business combinations, impairment of
long-lived assets, goodwill and intangible assets, deferred tax asset
valuation, estimates related to contingent liabilities and future claims, and
pension liabilities. The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported amounts
of certain assets and liabilities and disclosures of contingent assets and
liabilities at the date of the consolidated financial statements, and the
related reported amounts of revenues and expenses during the reporting period.
The significant estimates made by management in the accompanying consolidated
financial statements include reserves for inventory obsolescence,
restructuring, self-insurance, valuation of goodwill and long-lived assets,
allowance for doubtful accounts, determination of income taxes, contingent
liabilities, and purchase accounting allocations. Actual results could differ
from those estimates. Certain reclassifications of prior year balances have been made to conform
such amounts to corresponding 2004 classifications. These reclassifications
have no impact on net income. As explained in Note 15, during the second
quarter of 2004, the Company completed the sale of its Texas Arai division.
Prior year results of operations of Texas Arai have been reclassified as discontinued
operations.  2.
    
    Stock-Based Compensation Pro Forma Stock Option Compensation Expense The Company has elected to account for its stockbased compensation using
the intrinsic value method of accounting in accordance with Accounting
Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, as
allowed under Statement of Financial Accounting Standards (SFAS) No. 123,
Accounting for StockBased Compensation. Under this method, no compensation
expense is recognized when the number of shares granted is known and the
exercise price of the stock option at the time of grant is equal to or greater
than the market price of the Companys common stock. Reported net income does include
compensation expense associated with restricted stock awards and accelerated
vesting of certain stock awards related to severance. Had compensation expense for stock options been determined based on the
fair value at the grant dates for awards under the Companys incentive
compensation plans, the Companys net income and net income per share would
have been 5




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reduced to the pro forma amounts indicated as follows: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(In thousands)Net Income as Reported
    
    $
    2,250
    
    
    $
    3,826
    
    
    $
    12,923
    
    
    $
    7,860Add: Stock-based
employee
compensation
expense included in
reported net
income, net of
related tax effects
    
    
    2,214
    
    
    
    1,461
    
    
    
    3,128
    
    
    
    2,006Deduct: Total
stock-based
employee
compensation
expense determined
under the fair
value method for
all awards, net of
related tax
effects
    
    
    (3,826
    )
    
    
    (4,144
    )
    
    
    (6,180
    )
    
    
    (8,604
    )Pro Forma Net Income
    
    $
    638
    
    
    $
    1,143
    
    
    $
    9,871
    
    
    $
    1,262Net Income Per Share:Basic as reported
    
    $
    0.02
    
    
    $
    0.03
    
    
    $
    0.11
    
    
    $
    0.06Basic pro forma
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.08
    
    
    $
    0.01Diluted as reported
    
    $
    0.02
    
    
    $
    0.03
    
    
    $
    0.10
    
    
    $
    0.06Diluted pro forma
    
    $
    0.01
    
    
    $
    0.01
    
    
    $
    0.08
    
    
    $
    0.01
 The weighted average fair value of each stock option included in the
preceding pro forma amounts was estimated using the Black-Scholes option
pricing model and was amortized over the vesting period of the underlying
options. Restricted Stock In February 2004, the Company awarded 341,950 shares of restricted stock
to officers and other key employees under the Companys 2000 Employee Stock
Option and Restricted Stock Plan (2000 Plan). The restricted shares vest
on the ninth anniversary of the date of grant (February 2013), however there is an accelerated vesting schedule based on
the achievement of certain predetermined performance metrics.
Beginning with the third anniversary date of the grant through the
eighth anniversary date, the performance metrics are evaluated
annually and early vesting will occur for meeting the performance
goals. Restricted shares are subject
to certain restrictions on ownership and transferability when granted.
Unearned compensation on the February 2004 award of restricted shares of $4.7
million was recorded based on the market value of the shares on the
date of grant and is being amortized ratably over the expected vesting period. In addition, related to the February 2004 restricted stock award, there is
also a tax gross up bonus component at the time of vesting based on an incremental tax
rate to reimburse the employees for the tax related to the vesting of the
restricted shares. As the tax gross up bonus will change based on the share
price at the vesting date, the estimated cash liability to the employees is
variable. During the first six months of 2004, the Company recorded an
additional expense of $0.3 million associated with this potential
liability.  3.
    
    Comprehensive Income (Loss) Comprehensive income (loss) includes changes in stockholders equity
during the periods that do not result from transactions with stockholders. The
Companys total comprehensive income (loss) was as follows: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(In thousands)Net Income
    
    $
    2,250
    
    
    $
    3,826
    
    
    $
    12,923
    
    
    $
    7,860Foreign currency translation adjustments
    
    
    (3,465
    )
    
    
    7,413
    
    
    
    (2,769
    )
    
    
    3,141Total Comprehensive Income (Loss)
    
    $
    (1,215
    )
    
    $
    11,239
    
    
    $
    10,154
    
    
    $
    11,001
 6




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4.
    
    InventoriesInventories by category are as follows: June 30,
    
    December 31,2004
    
    2003(In thousands)Raw Materials, Components and Supplies
    
    $
    82,210
    
    
    $
    96,528Work in Process
    
    
    49,121
    
    
    
    36,889Finished Goods
    
    
    107,345
    
    
    
    98,577Total
    
    $
    238,676
    
    
    $
    231,994
  5.
    
    Property, Plant and Equipment Property, plant and equipment, net consisted of the following: June 30,
    
    December 31,2004
    
    2003(In thousands)Land
    
    $
    21,753
    
    
    $
    22,715Buildings and Improvements
    
    
    81,728
    
    
    
    85,322Machinery and Equipment
    
    
    261,992
    
    
    
    255,788Furniture and Fixtures
    
    
    29,163
    
    
    
    23,479Construction in Progress
    
    
    16,972
    
    
    
    19,856411,608
    
    
    
    407,160Less: Accumulated Depreciation
    
    
    (162,051
    )
    
    
    (155,924
    )Net
    
    $
    249,557
    
    
    $
    251,236
  6.
    
    Other Charges 2004 Charges Results for the three- and six-month periods ended June 30, 2004 include
other charges of $2.5 million ($1.7 million net of tax) and $5.2 million ($3.4
million net of tax), respectively. The year to date charges include $2.0
million due to lease termination, severance and other exit costs related to the
Drilling Products rationalization program and $3.2 million of severance costs
related to the Tubular Technology and Services organizational restructuring.
These charges are summarized in the following chart (in thousands): Drilling
    
    TubularProducts
    
    Technology
    
    
    
    
    
    
    
    
    
    Liabilityand
    
    and
    
    Total
    
    
    
    
    
    BalanceServices
    
    Services
    
    Charges
    
    Utilized
    
    6/30/04Drilling Products Rationalization Program:Lease termination costs (a)
    
    $
    1,430
    
    
    $
    
    
    
    $
    1,430
    
    
    $
    107
    
    
    $
    1,323Severance costs (b)
    
    
    246
    
    
    
    
    
    
    
    246
    
    
    
    246
    
    
    
    Other exit costs (c)
    
    
    349
    
    
    
    
    
    
    
    349
    
    
    
    349
    
    
    
    2,025
    
    
    
    
    
    
    
    2,025
    
    
    
    702
    
    
    
    1,323Severance Costs (d)
    
    
    
    
    
    
    3,207
    
    
    
    3,207
    
    
    
    3,207
    
    
    
    Total
    
    $
    2,025
    
    
    $
    3,207
    
    
    $
    5,232
    
    
    $
    3,909
    
    
    $
    1,323
  (a)
    
    The lease termination costs of $1.4 million are for a long-term lease which is expected to be
repaid over the next year relating to an operating lease for equipment located at the Companys
Canadian facility. Due to the downsizing of the Companys Canadian operations, this equipment
will no longer be utilized. This amount was included in Other
Accrued Liabilities in the
accompanying Consolidated Balance Sheets.(b)
    
    Severance costs of $0.2 million relate to employees that were terminated in connection with the
downsizing of the Companys Canadian operations. These costs related to 79 employees and were
paid in April 2004.(c)
    
    Other exit costs of $0.3 million are associated with the downsizing of the Canadian operations
and the closing of the Companys manufacturing facility.(d)
    
    Severance costs of $3.2 million relate to the organizational restructuring of the Companys
Tubular Technology and Services segment. 7




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7.
    
    Net Income Per Share Basic net income per share is computed by dividing net income by the
weighted average number of common shares outstanding for the period. Diluted
earnings per share reflect the potential dilution from the exercise or
conversion of securities into common stock. Common stock equivalent shares are
excluded from the computation if their effect was antidilutive. The
computation of diluted earnings per share for the three- and six-month periods
ended June 30, 2004 did not include options to purchase 3.9 million and 4.0
million shares, respectively, of common stock because their exercise prices
were greater than the average market price of the common stock for the
applicable period. The computation of diluted earnings per share for the
three- and six-month periods ended June 30, 2003 did not include options to
purchase 4.6 million shares of common stock because their exercise prices were
greater than the average market price of the common stock for the applicable
period.  8.
    
    Senior Credit Facility As of June 30, 2004, the Company had outstanding borrowings of $34.3
million under its $240 million Senior Credit Facility (Senior Credit Facility),
which related to the term loan portion of the Senior Credit Facility.
Additionally, the Company had $6.8 million of revolver availability reserved to
support outstanding letters of credit. At June 30, 2004, the Company had no
outstanding balances under the revolver portion of its Senior Credit Facility.
Net borrowing availability was $128.9 million. As of December 31, 2003, the
Company had borrowed $57.2 million under the Senior Credit Facility, of which
$42.9 million related to the term loan, $14.3 million
related to the revolving
credit facility, and $5.9 million had been used to support outstanding letters
of credit. Net borrowing availability was $122.3 million.  9.
    
    Goodwill and Other Intangible Assets The carrying amount of goodwill by reporting unit is as follows: TubularDrilling
    
    
    
    
    
    TechnologyProducts
    
    
    
    
    
    andand Services
    
    Drill Bits
    
    Services
    
    Other
    
    Total(In thousands)Balance at December 31, 2002
    
    $
    125,199
    
    
    $
    155,983
    
    
    $
    111,367
    
    
    $
    1,534
    
    
    $
    394,083Acquisitions
    
    
    
    
    
    
    5,823
    
    
    
    3,047
    
    
    
    
    
    
    
    8,870Dispositions
    
    
    
    
    
    
    
    
    
    
    (6,443
    )
    
    
    (1,534
    )
    
    
    (7,977
    )Translation and Other Adjustments
    
    
    4,259
    
    
    
    509
    
    
    
    (2,800
    )
    
    
    2,500
    
    
    
    4,468Impairment Loss
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,500
    )
    
    
    (2,500
    )Balance at December 31, 2003
    
    $
    129,458
    
    
    $
    162,315
    
    
    $
    105,171
    
    
    $
    
    
    
    $
    396,944Acquisitions
    
    
    
    
    
    
    548
    
    
    
    
    
    
    
    
    
    
    
    548Dispositions
    
    
    
    
    
    
    
    
    
    
    (8,038
    )
    
    
    
    
    
    
    (8,038
    )Translation and Other Adjustments
    
    
    (139
    )
    
    
    (91
    )
    
    
    
    
    
    
    
    
    
    
    (230
    )Balance at June 30, 2004
    
    $
    129,319
    
    
    $
    162,772
    
    
    $
    97,133
    
    
    $
    
    
    
    $
    389,224
 During the second quarter of 2004, the Company sold its Texas Arai
operations. Goodwill allocated to this sale of $8.0 million was based upon the
proportional relative fair market value of Texas Arai to the Tubular Technology
and Services reporting unit that was retained. See Note 15 for further
discussion of this discontinued operation. Intangible assets of $41.9 million and $36.3 million, net of accumulated
amortization of $8.1 million and $7.3 million, as of June 30, 2004 and December
31, 2003, respectively, are recorded at cost and are amortized on a
straight-line basis. The Companys intangible assets primarily consist of
patents, technology licenses, customer relationships, trademarks and
covenants not to compete that are amortized over the definitive terms of
the related agreement or the Companys estimate of 8




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##### Table of Contents



their useful lives if there
are no definitive terms. The following table shows the Companys intangible assets by asset
category: June 30, 2004
    
    December 31, 2003Gross
    
    Accumulated
    
    Net
    
    Gross
    
    Accumulated
    
    NetIntangibles
    
    Amortization
    
    Intangibles
    
    Intangibles
    
    Amortization
    
    Intangibles(In thousands)Patents
    
    $
    40,360
    
    
    $
    (4,212
    )
    
    $
    36,148
    
    
    $
    33,160
    
    
    $
    (2,877
    )
    
    $
    30,283Technology Licenses
    
    
    1,439
    
    
    
    (436
    )
    
    
    1,003
    
    
    
    1,288
    
    
    
    (373
    )
    
    
    915Customer Relationships
    
    
    3,300
    
    
    
    (251
    )
    
    
    3,049
    
    
    
    3,300
    
    
    
    (167
    )
    
    
    3,133Trademarks
    
    
    1,610
    
    
    
    (620
    )
    
    
    990
    
    
    
    1,610
    
    
    
    (424
    )
    
    
    1,186Covenants Not to Compete
    
    
    3,300
    
    
    
    (2,572
    )
    
    
    728
    
    
    
    4,150
    
    
    
    (3,417
    )
    
    
    733$
    50,009
    
    
    $
    (8,091
    )
    
    $
    41,918
    
    
    $
    43,508
    
    
    $
    (7,258
    )
    
    $
    36,250
 Amortization expense related to intangible assets for the six-month
periods ended June 30, 2004 and 2003 was $2.2 million and $2.0 million,
respectively, and is recorded in General and Administrative and Research and
Engineering expenses in the Consolidated Statements of Operations.
Amortization expense related to existing intangible assets for the remainder of
2004 is estimated to be $2.1 million and for each of the years 2005 through
2009 is estimated to be approximately $4.0 million, $3.6 million, $3.3 million,
$2.9 million, and $2.7 million, respectively.  10.
    
    Restricted Cash At June 30, 2004, the Company had $4.2 million of restricted cash. The
restricted cash relates to the Companys 60% interest in Tianjin Pipe Company
(TPCO) and is subject to dividend and distribution restrictions, however is
available to fund the local operations in China.  11.
    
    Segment Information Business Segments The Company now operates through three primary business segments: Drilling
Products and Services, Drill Bits and Tubular Technology and Services. In the
first quarter of 2004, the Company announced an organizational restructuring
which collapsed the Marine Products and Services segment into the Tubular
Technology and Services segment. This segment reporting change was made as
these combined operations have similar economic characteristics and will be
managed by one chief operating decision maker. Prior periods have been
restated for current year presentation. The Companys Drilling Products and Services segment manufactures and
sells a full range of proprietary and API drill pipe, drill collars,
heavyweight drill pipe and accessories. The Drill Bits segment designs,
manufactures, and distributes fixed-cutter and roller-cone drill bits. The
Companys Tubular Technology and Services segment designs, manufactures, and
sells a line of premium connections and associated premium tubular products and
accessories for oil country tubular goods and offshore applications. The
Company also has an Other segment, that prior to the first quarter of 2003,
included our industrial drill pipe operations and our construction casing and
water well operations. The Company exited the industrial drill pipe business
in the second quarter of 2003 and the construction casing and water well
business in the first quarter of 2003. This segment now only includes the
remaining industrial product inventories and operations from three of the
Companys technology joint ventures, of which two of the joint ventures were
either sold or terminated in the first quarter of 2004. See Note 14 for
further discussion on dispositions. 9




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##### Table of Contents



Drilling
    
    
    
    
    
    TubularProducts
    
    
    
    
    
    Technologyand
    
    
    
    
    
    andTHREE MONTHS ENDED:
    
    Services
    
    Drill Bits
    
    Services
    
    Other
    
    Corporate
    
    Total(In thousands)June 30, 2004Revenues from Unaffiliated Customers
    
    $
    90,702
    
    
    $
    76,585
    
    
    $
    57,054
    
    
    $
    873
    
    
    $
    
    
    
    $
    225,214Operating Income (Loss)
    
    
    19,531
    
    
    
    16,655
    
    
    
    2,365
    
    
    
    (528
    )
    
    
    (7,542
    )
    
    
    30,481June 30, 2003Revenues from Unaffiliated Customers
    
    $
    68,614
    
    
    $
    56,721
    
    
    $
    53,305
    
    
    $
    2,603
    
    
    $
    
    
    
    $
    181,243Operating Income (Loss)
    
    
    6,718
    
    
    
    13,166
    
    
    
    680
    
    
    
    (6,776
    )
    
    
    (4,473
    )
    
    
    9,315
 Drilling
    
    
    
    
    
    TubularProducts
    
    
    
    
    
    Technologyand
    
    
    
    
    
    andSIX MONTHS ENDED:
    
    Services
    
    Drill Bits
    
    Services
    
    Other
    
    Corporate
    
    Total(In thousands)June 30, 2004Revenues from Unaffiliated Customers
    
    $
    175,924
    
    
    $
    155,843
    
    
    $
    111,245
    
    
    $
    1,760
    
    
    $
    
    
    
    $
    444,772Operating Income (Loss)
    
    
    32,274
    
    
    
    35,908
    
    
    
    4,175
    
    
    
    (1,707
    )
    
    
    (14,029
    )
    
    
    56,621June 30, 2003Revenues from Unaffiliated Customers
    
    $
    133,211
    
    
    $
    109,975
    
    
    $
    113,175
    
    
    $
    7,767
    
    
    $
    
    
    
    $
    364,128Operating Income (Loss)
    
    
    14,713
    
    
    
    23,118
    
    
    
    4,453
    
    
    
    (7,321
    )
    
    
    (8,763
    )
    
    
    26,200
  12.
    
    Recent Accounting Pronouncements In January 2003, the FASB Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN No. 46) was issued. FIN No. 46 clarifies the
application of Accounting Research Bulletin No. 51, Consolidated Financial
Statements, to variable interest entities, which are certain entities in which
equity investors do not have the characteristics of a controlling financial
interest or do not have sufficient equity at risk for the entity to finance its
activities without additional subordinated support from other parties. The
Company is not a primary beneficiary of a variable interest entity (VIE) nor
does it hold any significant interests or involvement in a VIE. The adoption of
this interpretation did not have a material effect on the Companys results of
operations or financial position. In December 2003, the FASB revised SFAS No. 132, Employers Disclosures
about Pensions and Other Post-Retirement Benefits. The revised standard
requires new disclosures in addition to those required by the original standard
about the assets, obligations, cash flows and net periodic benefit costs of
defined benefit pension plans and other defined benefit post-retirement plans.
As revised, SFAS No. 132R is effective for financial statements with fiscal
years ending after December 15, 2003. The interim-period disclosures required
by this standard are effective for interim periods beginning after December 15,
2003. However, disclosure of the estimated future benefit payments is
effective for fiscal years ending after June 14, 2004. See Note 16 for
disclosures regarding our defined benefit pension plans.  13.
    
    Acquisitions On June 21, 2004, the Company acquired the polycrystalline diamond compact
(PDC) manufacturing business of Novatek, International, Inc. (Novatek) for
$17.3 million in cash plus a non-interest bearing note payable of $4.2 million,
with $3.0 million due June 2005 and $1.2 million due June 2006, which has been
discounted to $4.0 million based on the Companys incremental borrowing rate.
The Companys management believes that this acquired PDC technology will
provide the Companys Drill Bits segment with certain manufacturing
capabilities to ensure a high quality supply of PDC cutters and better control
over cutter technologies. Goodwill recognized in this acquisition was
approximately $0.5 million. The purchase price for the PDC acquisition has
been allocated to the fair values of assets acquired. The preliminary purchase
price allocation is based upon the Companys current estimates of respective
fair values. The Company expects to finalize the determination of the fair
value of assets acquired in 2004. This acquisition is included in the
Companys Drill Bits segment and its results of operations have been included
in the financial statements from the date acquired. This acquisition is not
material to the Company, therefore pro forma information is not presented. 10




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##### Table of Contents



14.
    
    Dispositions On March 4, 2004, the Company sold its Plexus Ocean Systems (POS) rental
wellhead business for $1.3 million in net cash. The POS operations were
included in the Companys Other segment. The Company recognized a pre-tax
loss of $0.1 million on the sale, which is recorded in the Consolidated
Statement of Operations in Other Income, Net. Revenue related to POS
included in the Other segments results for the three- and six-month periods
ended June 30, 2004 and 2003 was $0.0 million and $0.2 million and $0.6 million
and $0.7 million, respectively. Operating loss related to POS for the
three- and six-month periods ended June 30, 2004 and 2003 was not material. On September 2, 2003, the Company sold Rotator AS (Rotator) for $14.3
million in cash, which included a post-closing working capital adjustment of
$0.8 million that was recorded in the first quarter of 2004 in the Consolidated
Statement of Operations in Other Income, Net. Revenue related to Rotator
included in the Tubular Technology Services segments results for the three-
and six-month periods ended June 30, 2003 were $3.1 million and $6.5 million,
respectively. Operating income related to Rotator included in the Tubular
Technology Services segments results for the three- and six-month periods
ended June 30, 2003 was $0.3 million and $0.5 million, respectively. On March 25, 2003, the Company sold Star Iron Works, Inc. (Star), a
manufacturer of drilling tools for the water well, construction, and utility
boring industries, for $11.0 million in cash and a note valued at approximately
$0.9 million. The gain recognized on the sale of Star was $1.3 million, $0.8
million net of tax, and is recorded in the Consolidated Statements of
Operations in Other Income, Net. Revenue and operating income related to
Star included in the Other segments results for the three months ended March
31, 2003 were $3.6 million and $0.1 million, respectively.  15.
    
    Discontinued Operations On April 23, 2004, the Company sold substantially all of the assets and
business of its Texas Arai division for approximately $20.2 million in cash,
subject to final working capital adjustments, and recognized a loss on sale of
approximately $11.4 million, $10.1 million net of tax, which primarily related
to the goodwill allocated to this operation. Texas Arai was included in the
Companys Tubular Technology and Services segment. Following are the condensed statement of operations from discontinued
operations related to Texas Arai (in thousands): Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003Revenues
    
    $
    2,594
    
    
    $
    8,874
    
    
    $
    12,833
    
    
    $
    16,471Income Before Income Taxes
    
    
    358
    
    
    
    543
    
    
    
    1,346
    
    
    
    51Income Tax Expense
    
    
    (125
    )
    
    
    (194
    )
    
    
    (471
    )
    
    
    (22
    )Income from Operations, Net of Tax
    
    
    233
    
    
    
    349
    
    
    
    875
    
    
    
    29Loss on Disposal, Net of Tax
    
    
    (10,118
    )
    
    
    
    
    
    
    (10,118
    )
    
    
    Income (Loss) from Discontinued Operations
    
    $
    (9,885
    )
    
    $
    349
    
    
    $
    (9,243
    )
    
    $
    29
 Intercompany sales and profit related to Texas Arai, which were eliminated
from the condensed statement of operations above, were not material for the
periods presented. Following is a condensed summary balance sheet of discontinued operations
for the assets and liabilities sold related to Texas Arai, along with the
goodwill allocated (see Note 9 for further discussion), which were included in
the accompanying Consolidated Balance Sheet as of December 31, 2003 (in
thousands): Accounts Receivable
    
    $
    4,116Inventories
    
    
    13,654Total Current Assets
    
    
    17,770Property, Plant, and Equipment, Net
    
    
    8,287Goodwill
    
    
    8,038Total Assets
    
    
    34,095Accounts Payable
    
    $
    3,750Other Current Liabilities
    
    
    102Total Liabilities
    
    
    3,852
 11




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##### Table of Contents



16.
    
    Pension Plans U.S. Pension Plan The following table shows the components of Net Periodic Benefit Cost for the
Companys Reed Hourly Pension Plan: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(In thousands)Service Cost
    
    $
    72
    
    
    $
    82
    
    
    $
    168
    
    
    $
    82Interest Cost
    
    
    134
    
    
    
    164
    
    
    
    348
    
    
    
    164Expected Return on Plan Assets
    
    
    (106
    )
    
    
    (150
    )
    
    
    (247
    )
    
    
    (150
    )Amortization of Initial Net Obligation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Amortization of Prior Service Cost
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Amortization of Net Actuarial Gain
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Administration Expenses
    
    
    10
    
    
    
    18
    
    
    
    23
    
    
    
    18Settlements, Curtailment, and Special
Termination Benefits
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net Periodic Benefit Cost
    
    $
    110
    
    
    $
    114
    
    
    $
    292
    
    
    $
    114
 Minimum funding requirements for 2004 related to this plan are expected to
be approximately $0.5 million. Non-U.S. Pension Plan The following table shows the components of Net Periodic Benefit Cost for
the Companys UK Hycalog Retirement Death Benefit Scheme: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(In thousands)Service Cost
    
    $
    
    
    
    $
    
    
    
    $
    
    
    
    $
    Interest Cost
    
    
    420
    
    
    
    
    
    
    
    420
    
    
    
    Expected Return on Plan Assets
    
    
    (451
    )
    
    
    
    
    
    
    (451
    )
    
    
    Amortization of Initial Net Obligation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Amortization of Prior Service Cost
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Amortization of Net Actuarial Loss (Gain)
    
    
    47
    
    
    
    
    
    
    
    47
    
    
    
    Administration Expenses
    
    
    203
    
    
    
    
    
    
    
    203
    
    
    
    Settlements, Curtailment, and Special
Termination Benefits
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net Periodic Benefit Cost
    
    $
    219
    
    
    $
    
    
    
    $
    219
    
    
    $
    
 The Company does not expect to make any contributions in 2004 related to
this plan.  17.
    
    Investments in Unconsolidated Affiliates The Companys 50.01% owned joint venture, Voest-Alpine, is accounted for
under the equity method of accounting due to the minority owner having
substantive participating rights. Summarized financial information for
Voest-Alpine is as follows (in thousands): Three Months Ended June 30,
    
    Six Months Ended June 30,2004
    
    2003
    
    2004
    
    2003Net Sales
    
    $
    74,942
    
    
    $
    57,508
    
    
    $
    138,034
    
    
    $
    115,542Gross Profit
    
    
    5,968
    
    
    
    6,498
    
    
    
    11,012
    
    
    
    15,251Net Income
    
    $
    2,223
    
    
    $
    3,068
    
    
    $
    3,072
    
    
    $
    6,121Companys Equity Income
    
    $
    1,071
    
    
    $
    1,998
    
    
    $
    1,593
    
    
    $
    3,806Dividends Received
    
    $
    4,764
    
    
    $
    13,649
    
    
    $
    4,764
    
    
    $
    13,649
 The Companys equity in earnings differs from its proportionate share of
net income due to the elimination of intercompany profit on Voest-Alpine sales
to the Company. 12




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##### Table of Contents



18.
    
    Preferred Supplier Credit Agreement In April 2000, Weatherford spun off Grant Prideco to its stockholders as
an independent, publicly traded company (the Distribution). In connection
with the initial capitalization of the Company, and in consideration of amounts
due from the Company to Weatherford at the time of the Distribution, the
Company entered into a preferred supplier agreement with Weatherford. Pursuant
to this agreement Weatherford agreed for at least a three-year period from the
Distribution date to purchase a minimum of 70% of its requirements of certain
products from the Company; and the Company agreed to a $30 million credit,
subject to a limitation of the application of the credit to no more than 20% of
any purchase. In April 2003, the agreement was extended for two additional
years and the unused preferred supplier credit balance was reduced by $6.6
million and was treated as a reduction in the accrued liability as a credit to
other income. At June 30, 2004, the remaining credit balance of $5.5 million
was classified as Other Accrued Liabilities in the accompanying Consolidated
Balance Sheets.  19.
    
    Subsidiary Guarantor Financial Information The following unaudited condensed consolidating balance sheet as of June
30, 2004, condensed consolidating statements of operations for the three- and
six-month periods ended June 30, 2004 and 2003 and condensed consolidating
statements of cash flows for the six-month periods ended June 30, 2004 and 2003
are provided for the Companys domestic subsidiaries that are guarantors of
debt securities issued by the Company. The Companys obligations to pay
principal and interest under the 9% and 9 5/8% Senior Notes are guaranteed on a
joint and several basis by all of the Companys domestic subsidiaries. The
guarantees are full and unconditional and the guarantor subsidiaries are 100%
owned by Grant Prideco, Inc. 13




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##### Table of Contents



CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Three Months Ended June 30, 2004
(In thousands) Non-Parent
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    TotalRevenues
    
    $
    
    
    
    $
    159,601
    
    
    $
    65,613
    
    
    $
    
    
    
    $
    225,214Costs and Expenses:Cost of sales
    
    
    
    
    
    
    100,897
    
    
    
    35,706
    
    
    
    
    
    
    
    136,603Selling, general, and administrative
    
    
    
    
    
    
    38,608
    
    
    
    17,024
    
    
    
    
    
    
    
    55,632Other charges
    
    
    
    
    
    
    2,289
    
    
    
    209
    
    
    
    
    
    
    
    2,498
    
    
    
    141,794
    
    
    
    52,939
    
    
    
    
    
    
    
    194,733Operating Income
    
    
    
    
    
    
    17,807
    
    
    
    12,674
    
    
    
    
    
    
    
    30,481Interest Expense
    
    
    (8,816
    )
    
    
    (1,504
    )
    
    
    (175
    )
    
    
    
    
    
    
    (10,495
    )Equity Loss in Unconsolidated Affiliates
    
    
    
    
    
    
    (481
    )
    
    
    
    
    
    
    
    
    
    
    (481
    )Other Income (Expense), Net
    
    
    
    
    
    
    1,007
    
    
    
    (670
    )
    
    
    
    
    
    
    337Equity in Subsidiaries, Net of Taxes
    
    
    8,399
    
    
    
    
    
    
    
    
    
    
    
    (8,399
    )
    
    
    Income from Continuing Operations Before Income Taxes
    
    
    (417
    )
    
    
    16,829
    
    
    
    11,829
    
    
    
    (8,399
    )
    
    
    19,842Income Tax (Provision) Benefit
    
    
    2,667
    
    
    
    (4,897
    )
    
    
    (3,956
    )
    
    
    
    
    
    
    (6,186
    )Income from Continuing Operations Before Minority Interests
    
    
    2,250
    
    
    
    11,932
    
    
    
    7,873
    
    
    
    (8,399
    )
    
    
    13,656Minority Interests
    
    
    
    
    
    
    
    
    
    
    (1,521
    )
    
    
    
    
    
    
    (1,521
    )Income from Continuing Operations
    
    
    2,250
    
    
    
    11,932
    
    
    
    6,352
    
    
    
    (8,399
    )
    
    
    12,135Loss from Discontinued Operations, Net of Tax
    
    
    
    
    
    
    (9,885
    )
    
    
    
    
    
    
    
    
    
    
    (9,885
    )Net Income
    
    $
    2,250
    
    
    $
    2,047
    
    
    $
    6,352
    
    
    $
    (8,399
    )
    
    $
    2,250
 CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Three Months Ended June 30, 2003
(In thousands) Non-Parent
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    TotalRevenues
    
    $
    
    
    
    $
    106,864
    
    
    $
    74,379
    
    
    $
    
    
    
    $
    181,243Costs and Expenses:Cost of sales
    
    
    
    
    
    
    86,842
    
    
    
    41,533
    
    
    
    
    
    
    
    128,375Selling, general, and administrative
    
    
    
    
    
    
    25,113
    
    
    
    18,362
    
    
    
    
    
    
    
    43,475Other charges
    
    
    
    
    
    
    78
    
    
    
    
    
    
    
    
    
    
    
    78
    
    
    
    112,033
    
    
    
    59,895
    
    
    
    
    
    
    
    171,928Operating Income (Loss)
    
    
    
    
    
    
    (5,169
    )
    
    
    14,484
    
    
    
    
    
    
    
    9,315Interest Expense
    
    
    (9,136
    )
    
    
    (1,538
    )
    
    
    (192
    )
    
    
    
    
    
    
    (10,866
    )Equity Income in Unconsolidated Affiliates
    
    
    1,037
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,037Other Income (Expense), Net
    
    
    
    
    
    
    8,352
    
    
    
    (1,212
    )
    
    
    
    
    
    
    7,140Equity in Subsidiaries, Net of Taxes
    
    
    9,048
    
    
    
    
    
    
    
    
    
    
    
    (9,048
    )
    
    
    Income from Continuing Operations Before Income Taxes
    
    
    949
    
    
    
    1,645
    
    
    
    13,080
    
    
    
    (9,048
    )
    
    
    6,626Income Tax (Provision) Benefit
    
    
    2,877
    
    
    
    (1,363
    )
    
    
    (3,865
    )
    
    
    
    
    
    
    (2,351
    )Income from Continuing Operations Before Minority
Interests
    
    
    3,826
    
    
    
    282
    
    
    
    9,215
    
    
    
    (9,048
    )
    
    
    4,275Minority Interests
    
    
    
    
    
    
    
    
    
    
    (798
    )
    
    
    
    
    
    
    (798
    )Income from Continuing Operations
    
    
    3,826
    
    
    
    282
    
    
    
    8,417
    
    
    
    (9,048
    )
    
    
    3,477Income from Discontinued Operations, Net of Tax
    
    
    
    
    
    
    349
    
    
    
    
    
    
    
    
    
    
    
    349Net Income
    
    $
    3,826
    
    
    $
    631
    
    
    $
    8,417
    
    
    $
    (9,048
    )
    
    $
    3,826
 14




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##### Table of Contents



CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Six Months Ended June 30, 2004
(In thousands) Non-Parent
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    TotalRevenues
    
    $
    
    
    
    $
    302,166
    
    
    $
    142,606
    
    
    $
    
    
    
    $
    444,772Costs and Expenses:Cost of sales
    
    
    
    
    
    
    197,829
    
    
    
    75,554
    
    
    
    
    
    
    
    273,383Selling, general, and administrative
    
    
    
    
    
    
    75,009
    
    
    
    34,527
    
    
    
    
    
    
    
    109,536Other Charges
    
    
    
    
    
    
    3,207
    
    
    
    2,025
    
    
    
    
    
    
    
    5,232
    
    
    
    276,045
    
    
    
    112,106
    
    
    
    
    
    
    
    388,151Operating Income
    
    
    
    
    
    
    26,121
    
    
    
    30,500
    
    
    
    
    
    
    
    56,621Interest Expense
    
    
    (18,006
    )
    
    
    (2,676
    )
    
    
    (308
    )
    
    
    
    
    
    
    (20,990
    )Equity Loss in Unconsolidated Affiliates
    
    
    
    
    
    
    (287
    )
    
    
    
    
    
    
    
    
    
    
    (287
    )Other Income (Expense), Net
    
    
    
    
    
    
    5,251
    
    
    
    (2,889
    )
    
    
    
    
    
    
    2,362Equity in Subsidiaries, Net of Taxes
    
    
    24,807
    
    
    
    
    
    
    
    
    
    
    
    (24,807
    )
    
    
    Income from Continuing Operations Before Income Taxes
    
    
    6,801
    
    
    
    28,409
    
    
    
    27,303
    
    
    
    (24,807
    )
    
    
    37,706Income Tax (Provision) Benefit
    
    
    6,122
    
    
    
    (9,958
    )
    
    
    (8,923
    )
    
    
    
    
    
    
    (12,759
    )Income from Continuing Operations Before Minority
Interests
    
    
    12,923
    
    
    
    18,451
    
    
    
    18,380
    
    
    
    (24,807
    )
    
    
    24,947Minority Interests
    
    
    
    
    
    
    
    
    
    
    (2,781
    )
    
    
    
    
    
    
    (2,781
    )Income from Continuing Operations
    
    
    12,923
    
    
    
    18,451
    
    
    
    15,599
    
    
    
    (24,807
    )
    
    
    22,166Loss from Discontinued Operations, Net of Tax
    
    
    
    
    
    
    (9,243
    )
    
    
    

    
    
    
    



    
    
    
    (9,243
    )Net Income
    
    $
    12,923
    
    
    $
    9,208
    
    
    $
    15,599
    
    
    $
    (24,807
    )
    
    $
    12,923
 CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS
Six Months Ended June 30, 2003
(In thousands) Non-Parent
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    TotalRevenues
    
    $
    
    
    
    $
    214,991
    
    
    $
    149,137
    
    
    $
    
    
    
    $
    364,128Costs and Expenses:Cost of sales
    
    
    
    
    
    
    175,436
    
    
    
    76,408
    
    
    
    
    
    
    
    251,844Selling, general, and administrative
    
    
    
    
    
    
    50,103
    
    
    
    35,903
    
    
    
    
    
    
    
    86,006Other charges
    
    
    
    
    
    
    78
    
    
    
    
    
    
    
    
    
    
    
    78
    
    
    
    225,617
    
    
    
    112,311
    
    
    
    
    
    
    
    337,928Operating Income (Loss)
    
    
    
    
    
    
    (10,626
    )
    
    
    36,826
    
    
    
    
    
    
    
    26,200Interest Expense
    
    
    (18,267
    )
    
    
    (3,199
    )
    
    
    (408
    )
    
    
    
    
    
    
    (21,874
    )Equity Income in Unconsolidated Affiliates
    
    
    1,671
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,671Other Income (Expense), Net
    
    
    
    
    
    
    11,680
    
    
    
    (3,396
    )
    
    
    
    
    
    
    8,284Equity in Subsidiaries, Net of Taxes
    
    
    18,647
    
    
    
    
    
    
    
    
    
    
    
    (18,647
    )
    
    
    Income (Loss) from Continuing Operations
Before Income Taxes
    
    
    2,051
    
    
    
    (2,145
    )
    
    
    33,022
    
    
    
    (18,647
    )
    
    
    14,281Income Tax (Provision) Benefit
    
    
    5,809
    
    
    
    397
    
    
    
    (11,200
    )
    
    
    
    
    
    
    (4,994
    )Income (Loss) from Continuing Operations
Before Minority Interests
    
    
    7,860
    
    
    
    (1,748
    )
    
    
    21,822
    
    
    
    (18,647
    )
    
    
    9,287Minority Interests
    
    
    
    
    
    
    
    
    
    
    (1,456
    )
    
    
    
    
    
    
    (1,456
    )Income (Loss) from Continuing Operations
    
    
    7,860
    
    
    
    (1,748
    )
    
    
    20,366
    
    
    
    (18,647
    )
    
    
    7,831Income from Discontinued Operations, Net of Tax
    
    
    
    
    
    
    29
    
    
    
    
    
    
    
    
    
    
    
    29Net Income (Loss)
    
    $
    7,860
    
    
    $
    (1,719
    )
    
    $
    20,366
    
    
    $
    (18,647
    )
    
    $
    7,860
 15




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##### Table of Contents



CONDENSED CONSOLIDATING BALANCE SHEET
As of June 30, 2004
(In thousands) Non-Parent
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    ConsolidatedAssetsCurrent Assets:Cash
    
    $
    
    
    
    $
    15,807
    
    
    $
    18,591
    
    
    $
    
    
    
    $
    34,398Restricted cash
    
    
    
    
    
    
    
    
    
    
    4,172
    
    
    
    
    
    
    
    4,172Accounts receivable, net
    
    
    
    
    
    
    111,965
    
    
    
    84,828
    
    
    
    
    
    
    
    196,793Inventories
    
    
    
    
    
    
    132,394
    
    
    
    106,282
    
    
    
    
    
    
    
    238,676Current deferred tax assets
    
    
    
    
    
    
    24,980
    
    
    
    1,933
    
    
    
    
    
    
    
    26,913Other current assets
    
    
    
    
    
    
    9,541
    
    
    
    9,212
    
    
    
    
    
    
    
    18,753
    
    
    
    294,687
    
    
    
    225,018
    
    
    
    
    
    
    
    519,705Property, Plant, and Equipment, Net
    
    
    
    
    
    
    153,703
    
    
    
    95,854
    
    
    
    
    
    
    
    249,557Goodwill
    
    
    
    
    
    
    201,462
    
    
    
    187,762
    
    
    
    
    
    
    
    389,224Investments In and Advances to
Subsidiaries
    
    
    1,008,154
    
    
    
    
    
    
    
    
    
    
    
    (1,008,154
    )
    
    
    Investments In and Advances to
Unconsolidated Affiliates
    
    
    
    
    
    
    44,028
    
    
    
    
    
    
    
    
    
    
    
    44,028Other Assets
    
    
    6,892
    
    
    
    35,138
    
    
    
    16,407
    
    
    
    
    
    
    
    58,437$
    1,015,046
    
    
    $
    729,018
    
    
    $
    525,041
    
    
    $
    (1,008,154
    )
    
    $
    1,260,951Liabilities And Stockholders EquityCurrent Liabilities:Short-term borrowings and current
portion of long-term debt
    
    $
    
    
    
    $
    12,643
    
    
    $
    472
    
    
    $
    
    
    
    $
    13,115Accounts payable
    
    
    
    
    
    
    37,126
    
    
    
    35,916
    
    
    
    
    
    
    
    73,042Current deferred tax liabilities
    
    
    
    
    
    
    10
    
    
    
    3,732
    
    
    
    
    
    
    
    3,742Other accrued liabilities
    
    
    7,795
    
    
    
    35,843
    
    
    
    36,278
    
    
    
    
    
    
    
    79,9167,795
    
    
    
    85,622
    
    
    
    76,398
    
    
    
    
    
    
    
    169,815Long-Term Debt
    
    
    374,395
    
    
    
    28,505
    
    
    
    1,929
    
    
    
    
    
    
    
    404,829Deferred Tax Liabilities
    
    
    
    
    
    
    4,288
    
    
    
    21,191
    
    
    
    
    
    
    
    25,479Other Long-Term Liabilities
    
    
    
    
    
    
    9,563
    
    
    
    3,717
    
    
    
    
    
    
    
    13,280Commitments and Contingencies
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Minority Interests
    
    
    
    
    
    
    
    
    
    
    14,692
    
    
    
    
    
    
    
    14,692Stockholders Equity
    
    
    632,856
    
    
    
    601,040
    
    
    
    407,114
    
    
    
    (1,008,154
    )
    
    
    632,856$
    1,015,046
    
    
    $
    729,018
    
    
    $
    525,041
    
    
    $
    (1,008,154
    )
    
    $
    1,260,951
 16




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##### Table of Contents



CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Six Months Ended June 30, 2004
(In thousands) Non-Parent
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    ConsolidatedCash Flows From Operating Activities:Net cash (used in) provided by operating activities
    
    $
    (8,439
    )
    
    $
    42,001
    
    
    $
    14,568
    
    
    $
    
    
    
    $
    48,130Cash Flows From Investing Activities:Acquisition of businesses, net of cash acquired
    
    
    
    
    
    
    (17,312
    )
    
    
    
    
    
    
    
    
    
    
    (17,312
    )Proceeds from sale of business, net of cash disposed
    
    
    
    
    
    
    1,349
    
    
    
    831
    
    
    
    
    
    
    
    2,180Proceeds from sale of discontinued operations, net of cash disposed
    
    
    
    
    
    
    20,159
    
    
    
    
    
    
    
    
    
    
    
    20,159Investments in and advances to unconsolidated affiliates
    
    
    
    
    
    
    (1,561
    )
    
    
    
    
    
    
    
    
    
    
    (1,561
    )Capital expenditures for property, plant & equipment
    
    
    
    
    
    
    (8,698
    )
    
    
    (12,035
    )
    
    
    
    
    
    
    (20,733
    )Proceeds from the sale of fixed assets
    
    
    
    
    
    
    3,103
    
    
    
    187
    
    
    
    
    
    
    
    3,290Net cash used in investing activities
    
    
    
    
    
    
    (2,960
    )
    
    
    (11,017
    )
    
    
    
    
    
    
    (13,977
    )Cash Flows From Financing Activities:Repayments on debt, net
    
    
    
    
    
    
    (25,854
    )
    
    
    (1,704
    )
    
    
    
    
    
    
    (27,558
    )Purchases of treasury stock
    
    
    (1,545
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,545
    )Proceeds from stock option exercises
    
    
    9,984
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,984Net cash provided by (used in) financing activities
    
    
    8,439
    
    
    
    (25,854
    )
    
    
    (1,704
    )
    
    
    
    
    
    
    (19,119
    )Effect of Exchange Rate Changes on Cash
    
    
    
    
    
    
    
    
    
    
    134
    
    
    
    
    
    
    
    134Net Increase in Cash
    
    
    
    
    
    
    13,187
    
    
    
    1,981
    
    
    
    
    
    
    
    15,168Cash at Beginning of Year
    
    
    
    
    
    
    2,620
    
    
    
    16,610
    
    
    
    
    
    
    
    19,230Cash at End of the Period
    
    $
    
    
    
    $
    15,807
    
    
    $
    18,591
    
    
    $
    
    
    
    $
    34,398
 CONDENSED CONSOLIDATING STATEMENT OF CASH FLOWS
Six Months Ended June 30, 2003
(In thousands) Non-Parent
    
    Guarantors
    
    Guarantors
    
    Eliminations
    
    ConsolidatedCash Flows From Operating Activities:Net cash (used in) provided by operating activities
    
    $
    (5,432
    )
    
    $
    46,461
    
    
    $
    9,205
    
    
    $
    
    
    
    $
    50,234Cash Flows From Investing Activities:Acquisition of businesses, net of cash acquired
    
    
    (2,028
    )
    
    
    (1,250
    )
    
    
    (5,161
    )
    
    
    
    
    
    
    (8,439
    )Proceeds from sale of business
    
    
    11,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11,000Investments in and advances to unconsolidated affiliates
    
    
    (2,543
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (2,543
    )Capital expenditures for property, plant & equipment
    
    
    
    
    
    
    (14,619
    )
    
    
    (5,194
    )
    
    
    
    
    
    
    (19,813
    )Proceeds from the sale of fixed assets
    
    
    
    
    
    
    74
    
    
    
    28
    
    
    
    
    
    
    
    102Net cash provided by (used in) investing activities
    
    
    6,429
    
    
    
    (15,795
    )
    
    
    (10,327
    )
    
    
    
    
    
    
    (19,693
    )Cash Flows From Financing Activities:Repayments on debt, net
    
    
    
    
    
    
    (27,556
    )
    
    
    (2,932
    )
    
    
    
    
    
    
    (30,488
    )Purchases of treasury stock
    
    
    (1,354
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (1,354
    )Proceeds from stock option exercises
    
    
    357
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    357Net cash used in financing activities
    
    
    (997
    )
    
    
    (27,556
    )
    
    
    (2,932
    )
    
    
    
    
    
    
    (31,485
    )Effect of Exchange Rate Changes on Cash
    
    
    
    
    
    
    
    
    
    
    903
    
    
    
    
    
    
    
    903Net Increase (Decrease) in Cash
    
    
    
    
    
    
    3,110
    
    
    
    (3,151
    )
    
    
    
    
    
    
    (41
    )Cash at Beginning of Year
    
    
    
    
    
    
    2,690
    
    
    
    19,188
    
    
    
    
    
    
    
    21,878Cash at End of the Period
    
    $
    
    
    
    $
    5,800
    
    
    $
    16,037
    
    
    $
    
    
    
    $
    21,837
 17




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##### Table of Contents



ITEM 2.Managements Discussion and Analysis of Financial Condition and Results
of Operations The following discussion is intended to assist you in understanding our
financial condition as of June 30, 2004, and our results of operations for the
three- and six-month periods ended June 30, 2004 and 2003. This discussion
should be read with our financial statements and their notes included elsewhere
in this report as well as our financial statements and their related notes and
related Managements Discussion and Analysis of Financial Condition and Results
of Operations for the year ended December 31, 2003, previously filed with the
Securities and Exchange Commission in our Annual Report on Form 10-K. Our discussion of our results of operations and financial condition
contains statements relating to our future results, including certain
projections and trends, which constitute forward-looking statements. Certain
risks and uncertainties may cause actual results to be materially different
from projected results contained in these forward-looking statements and other
disclosures. These risks and uncertainties are more fully described under
Forward-Looking Statements and Exposures below. As used herein, unless
otherwise required by the context, the term Grant Prideco refers to Grant
Prideco, Inc. and the terms we, our, and similar words refer to Grant
Prideco and its subsidiaries. The use herein of such terms as group,
organization, we, us, our, and its, or references to specific
entities, are not intended to be a precise description of corporate
relationships. General We are the world leader in drill stem technology development and drill
pipe manufacturing, sales and service; a global leader in drill bit technology,
manufacturing, sales and service; and a leading provider of high-performance
engineered connections and premium tubular products and services. We operate
primarily through three business segments: (1) Drilling Products and Services,
(2) Drill Bits, and (3) Tubular Technology and Services. In the first quarter
of 2004, the Company announced an organizational restructuring that resulted in
the former Marine Products and Services businesses now being reflected in the
Tubular Technology and Services segment. Prior periods have been restated for
comparability. Critical Accounting Policies and Estimates In our annual report on Form 10-K for the year ended December 31, 2003, we
identified our most critical accounting policies upon which our financial
condition depends as those relating to revenue recognition and accounts
receivable valuation, inventory valuation, business combinations, impairment of
long-lived assets, goodwill and intangible assets, valuation allowance for
deferred tax assets, estimates related to contingent liabilities and future
claims, and pension liabilities. Exited Product Lines During the first quarter of 2003, we made a strategic decision to exit the
manufacture and sale of industrial drilling products and oil and gas tubing
product lines. Pursuant to this decision, we sold our Star Iron Works, Inc.
(Star) subsidiary, shut-down operations at our Bryan, Texas facility, and we
are in the process of liquidating our remaining inventory related to this
business. As a result of this decision, we recognized a $1.3 million pre-tax,
$0.8 million after tax, gain on the sale of our Star operation during the first
quarter of 2003. During the third quarter of 2003, we sold our Rotator control
value business for $14.3 million in cash, which included a working capital
adjustment of $0.8 million in the first quarter of 2004. Additionally, in
March 2004 we sold our Plexus Ocean Systems (POS) business for $1.3 million in
net cash and recorded a pre-tax loss on the sale of approximately $0.1 million.
Gains (losses) on the above mentioned dispositions were recorded in Other
Income, Net in the accompanying Statements of Operations. Discontinued Operations On April 23, 2004, we sold substantially all of the assets and business of
Texas Arai, Inc., our API coupling business, for approximately $20.2 million in
cash. This sale reflects our continuing efforts to improve long-term
profitability by focusing on our premium product lines within the Tubular
Technology and Services segment. Due primarily to the write-off of goodwill
associated with this business, we recorded an after-tax loss of approximately
$10.1 million associated with this sale. The results from Texas Arai and the
loss on sale are reported as discontinued operations. Accordingly, prior-year
amounts have been reclassified to conform to current year presentation. 18




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Acquisition of PDC Technology In June 2004, we acquired the polycrystalline diamond compact (PDC)
manufacturing business of Novatek, International, Inc. We believe that this
acquired PDC technology will provide our Drill Bits segment with certain
manufacturing capabilities to ensure a high quality supply of PDC cutters and
better control over cutter technologies. Market Trends and Outlook Our business is materially dependent on the level of oil and gas drilling
activity worldwide, which, in turn, depends on the level of capital spending by
major, independent, and state-owned exploration and production companies. This
capital spending is driven by current prices for oil and gas and the perceived
stability and sustainability of those prices. All of our business segments
generally track the level of domestic and international drilling activity,
however their revenues, cash flows, and profitability follow the rig count at
different stages within the market cycles. Drill pipe demand is also a
function of customer inventory levels and typically lags changes in the
worldwide rig count until customers no longer have sufficient inventory to
sustain current and near-term expected future activity. Drill bit demand and
our Drill Bits segments earnings and cash flows have closely tracked the
worldwide rig count. Results from our premium connections and accessories
product lines in our Tubular Technology and Services segment predominately
follow changes in North American offshore drilling, deep drilling, and natural
gas drilling rig counts; but short-term demand is also affected by inventories
held by oil country tubular goods (OCTG) distributors. Demand for other product
lines in this segment can also follow the level of worldwide offshore drilling
activity. For the periods below, the revenues, profitability, and cash flows from
each of our business segments have been impacted by changes in oil and gas
prices and rig counts. The following table sets forth certain information with
respect to oil and gas prices at the dates indicated and the North American
(U.S. and Canadian) and international rig counts for the periods reflected: Three Months EndedJune 30, 2004
    
    December 31, 2003
    
    June 30, 2003WTI Oil(a)Average
    
    $
    38.32
    
    
    $
    31.18
    
    
    $
    29.02Ending
    
    
    37.05
    
    
    
    32.52
    
    
    
    30.19Henry Hub Gas(b)Average
    
    $
    6.10
    
    
    $
    5.09
    
    
    $
    5.64Ending
    
    
    6.03
    
    
    
    5.80
    
    
    
    5.35North American Rig Count(c)Average
    
    
    1,360
    
    
    
    1,517
    
    
    
    1,231Ending
    
    
    1,510
    
    
    
    1,531
    
    
    
    1,375International Rig Count(c)Average
    
    
    837
    
    
    
    791
    
    
    
    765Ending
    
    
    841
    
    
    
    803
    
    
    
    769
   (a)
    
    Price per barrel of West Texas Intermediate
(WTI) crude. Source: Bloomberg Energy/Commodity Service.(b)
    
    Price per MMBtu. Source: Bloomberg Energy/Commodity Service.(c)
    
    Source: Baker Hughes Rig Count (International Rig Count excludes China and the former Soviet Union). Future Market Trends and Expectations Looking forward, we anticipate that our results will be based on the level
of drilling activity and our customers views regarding the sustainability of
that activity. These perceptions, in turn, will depend on their views
regarding the sustainability of oil and natural gas prices. Commodity prices
have been particularly strong during the first half of 2004, and this has
resulted in increased drilling activity. This activity contributed to the
increase in our June 30, 2004 backlog to $191.5 million, which is our highest
company backlog level since November 2001. For the balance of the year, we
forecast a stable drilling environment, except for Canada where we anticipate
strong seasonal improvement over the second half of 19




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2004. This strong environment and improved backlog should result in
steady improvement in revenues from our Drilling Products segments in the
second half of the year, and it should drive continued strong performance from
our Drill Bits Segment. Unfortunately, high oil and natural gas prices have
not translated into the level of increased demand historically experienced by
our Tubular Technology and Services segment due to its strong leverage to the
Gulf of Mexico rig count, which has declined despite the overall increase in
the U.S. rig count. We are in the process of restructuring portions of this
segment, and we anticipate it will improve marginally over the remainder of the
year. Steel prices and availability could also affect our future results. Steel
prices have significantly increased since the end of 2003. This increase was
caused primarily by increases in the prices paid by our suppliers for scrap and
coke utilized in their operations. As a result, the costs for tubulars
utilized to manufacture tool joints, drill collars, and heavy weight drill pipe
have increased. Rising steel costs could offset some of the anticipated
benefits from our vertical integration in China. So far, we have been fairly
successful in charging higher prices by imposing surcharges to our customer
base to offset any cost increases borne by us as a result of these changes in
steel prices. We anticipate that we will continue to be successful in passing
on these increased costs through surcharges. However, there is no assurance
that we will continue to be able to successfully accomplish this in all regions
in which we operate. To the extent we are unable to do so, our results of
operations would be adversely affected. When forecasting our operations for the balance of 2004, we relied on
various assumptions, including stable drilling activity, except for strong
seasonal improvement in Canada, and steady improvement in drill pipe demand.
We also anticipated benefits from pricing increases implemented at our Drilling
Products and Services and Drill Bits Segments earlier in the year. Using these
assumptions, we expect to earn between $0.45 and $0.50 per share from
continuing operations during 2004. 20




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##### Table of Contents



Results of Operations Three Months Ended June 30, 2004 Compared to the Three Months Ended June 30,
2003 The following table summarizes the results of the Company (in thousands): Three Months Ended June 30,2004
    
    2003
    
    % ChangeRevenues:Drilling Products and Services
    
    $
    90,702
    
    
    $
    68,614
    
    
    
    32
    %Drill Bits
    
    
    76,585
    
    
    
    56,721
    
    
    
    35
    %Tubular Technology and Services
    
    
    57,054
    
    
    
    53,305
    
    
    
    7
    %Other
    
    
    873
    
    
    
    2,603
    
    
    
    (66
    %)Total Revenues
    
    
    225,214
    
    
    
    181,243
    
    
    
    24
    %Operating Income (Loss):Drilling Products and Services
    
    
    19,531
    (a)
    
    
    6,718
    
    
    
    191
    %Drill Bits
    
    
    16,655
    
    
    
    13,166
    (c)
    
    
    27
    %Tubular Technology and Services
    
    
    2,365
    (b)
    
    
    680
    (d)
    
    
    248
    %Other
    
    
    (528
    )
    
    
    (6,776
    ) (e)
    
    
    (92
    %)Corporate
    
    
    (7,542
    )
    
    
    (4,473
    ) (f)
    
    
    69
    %Total Operating Income
    
    
    30,481
    
    
    
    9,315
    
    
    
    227
    %
   (a)
    
    Includes other charges of $0.2 million related to the Drilling Products rationalization program.(b)
    
    Includes other charges of $2.3 million related to severance due to the Tubular Technology and Services organizational
restructuring.(c)
    
    Includes transition costs of $0.5 million related to the ReedHycalog acquisition in December 2002.(d)
    
    Includes other charges of $0.4 million related to inventory reserves for exited product lines which were classified
as cost of sales.(e)
    
    Includes other charges of $6.0 million related to inventory reserves for exited product lines which were classified
as cost of sales.(f)
    
    Includes other charges of $1.5 million for stock compensation expense and a $1.4 million credit for a previously
recorded contingent liability. Consolidated revenues increased by $44.0 million, or 24%, in the second
quarter of 2004 compared to last years second quarter. Consolidated operating
income increased $21.2 million, or 227%, in the second quarter of 2004 compared
to last years second quarter, which included charges and transition costs
mentioned above. These increases were primarily due to increased activity
across all of our segments, reflecting the 10% increase in worldwide active
rigs and increased drill stem sales to U.S. land drilling contractors. Drilling Products and Services Revenues for the Drilling Products and Services segment increased 32% in
the second quarter of 2004, to $90.7 million, compared to last years second
quarter. Operating income margins increased from 10% in last years second
quarter to 22% in the second quarter of 2004. These improvements reflect a 24%
increase in drill pipe footage sold and increased sales of other products,
which include heavyweight drill pipe, tool joints and drill pipe processing.
During the second quarter of 2004, this segments results also benefited from
increased operating efficiencies resulting from the rationalization program
implemented at the beginning of the year. Drill Bits Revenues for the Drill Bits segment increased 35% in the second quarter of
2004, to $76.6 million, compared to last years second quarter. This reflects
the 10% increase in worldwide active rigs and strong year-over-year growth
driven by the continued success of ReedHycalogs rotary steerable bit
technologies and directional products, as well as the outstanding
performance of ReedHycalogs TReX diamond technology. More recently, the
introduction of the TuffCutter, TuffDuty and Titan lines of roller-cone
products has added to the revenue growth as those products were 21




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##### Table of Contents



deployed
worldwide. Operating income margins decreased slightly from 23% in last years
second quarter to 22% in the second quarter of 2004 due to higher incremental
sales and marketing expenses resulting from international expansion efforts. Tubular Technology and Services Revenues for the Tubular Technology and Services segment increased 7% in
the second quarter of 2004, to $57.0 million, compared to last years second
quarter. Operating income margins increased from 1% in last years second
quarter, which included an inventory reserve charge of $0.4 million, to 4% in
the second quarter of 2004, which included a severance charge of $2.3 million
related to this segments organizational restructuring. These increases reflect
improved results in our TCA and XL Systems divisions due to increased drilling
activity. The second quarter of 2003 also includes the results from our
Rotator division which we sold in the third quarter of 2003. Other Segment Revenues for the Other segment in the second quarter of 2004 were $0.9
million compared to $2.6 million in last years second quarter. The decrease
in revenues was due to the exiting of our industrial product lines during 2003,
coupled with the sale of our POS business in the first quarter of 2004. Operating loss was $0.5 million in the second quarter of 2004 compared to
an operating loss of $6.8 million in last years second quarter. The 2003
operating loss included an inventory reserve charge of $6.0 million related to
the exiting of the industrial product lines. Corporate Corporate operating loss for the second quarter of 2004 was $7.5 million
compared to $4.5 million in last years second quarter. The year-over-year
increase was primarily due to higher professional fees and incentive
compensation costs. Other Items Our interest expense decreased $0.4 million in the second quarter of 2004
compared to the same period in 2003. This decrease was due to lower debt
balances year-over-year. Equity income (loss) in unconsolidated affiliates decreased to a loss of
$0.5 million from income of $1.0 million in last years second quarter. This
decrease reflects increased development spending in our IntelliServ joint
venture, coupled with decreased equity income from our investment in
Voest-Alpine due to increased steel prices. Other income decreased by $6.8 million, from income of $7.1 million in
last years second quarter to income of $0.3 million in the second quarter of
2004. The second quarter of 2003 reflects a $6.6 million gain from favorably
renegotiating a liability to our former parent. The year to date effective tax rate was 34%; however, the effective tax
rate in the second quarter of 2004 was 31% due to the cumulative effect of a
reduction from the first quarter of 2004 tax rate of 37%. The rate decrease
resulted from higher forecasted profitability at Voest-Alpine and increased
permanent differences. 22




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Results of Operations Six Months Ended June 30, 2004 Compared to the Six Months Ended June 30, 2003 The following table summarizes the results of the Company (in thousands): Six Months Ended June 30,2004
    
    2003
    
    % ChangeRevenues:Drilling Products and Services.
    
    $
    175,924
    
    
    $
    133,211
    
    
    
    32
    %Drill Bits
    
    
    155,843
    
    
    
    109,975
    
    
    
    42
    %Tubular Technology and Services
    
    
    111,245
    
    
    
    113,175
    
    
    
    (2
    %)Other
    
    
    1,760
    
    
    
    7,767
    
    
    
    (77
    %)Total Revenues
    
    
    444,772
    
    
    
    364,128
    
    
    
    22
    %Operating Income (Loss):Drilling Products and Services
    
    
    32,274
    (a)
    
    
    14,713
    
    
    
    119
    %Drill Bits
    
    
    35,908
    
    
    
    23,118
    (c)
    
    
    55
    %Tubular Technology and Services
    
    
    4,175
    (b)
    
    
    4,453
    (d)
    
    
    (6
    %)Other
    
    
    (1,707
    )
    
    
    (7,321
    ) (e)
    
    
    (77
    %)Corporate
    
    
    (14,029
    )
    
    
    (8,763
    ) (f)
    
    
    60
    %Total Operating Income
    
    
    56,621
    
    
    
    26,200
    
    
    
    116
    %
   (a)
    
    Includes other charges of $2.0 million related to the Drilling Products rationalization program, which includes lease termination,
severance and other exit costs.(b)
    
    Includes other charges of $3.2 million related to severance due to the Tubular Technology and Services organizational restructuring.(c)
    
    Includes transition costs of $2.1 million related to the ReedHycalog acquisition in December 2002.(d)
    
    Includes other charges of $0.4 million related to inventory reserves for exited product lines which were classified as cost of sales.(e)
    
    Includes other charges of $6.0 million related to inventory reserves for exited product lines which were classified as cost of sales.(f)
    
    Includes other charges of $1.5 million for stock compensation expense and a $1.4 million credit for a previously recorded contingent
liability. Consolidated revenues increased $80.6 million, or 22%, for the six months
ended June 30, 2004 compared to the same period last year. Consolidated
operating income increased $30.4 million, or 116%, for the six months ended
June 30, 2004 compared to the same period last year, which included charges and
transition costs mentioned above. These increases were primarily due to
increased activity in our Drilling Products and Services and Drill Bits
segments, reflecting the 12% increase in worldwide active rigs and increased
drill stem sales to U.S. land drilling contractors. Also, efficiencies and
costs reductions were being realized during the six months ended June 30, 2004
from our Drilling Products rationalization program and our Tubular Technology
and Services organizational restructuring. Drilling Products and Services Revenues for the Drilling Products and Services segment increased 32% for
the six months ended June 30, 2004, to $175.9 million, compared to the same
period in 2003. Operating income margins increased to 18% for the six months
ended June 30, 2004, which includes other charges of $2.0 million related to
the rationalization program, from 11% for the same period in 2003. These
improvements reflect a 32% increase in drill pipe footage sold due to increased
drilling activity. Also, this segments 2004 results benefited from increased
operating efficiencies resulting from the rationalization program implemented
at the beginning of the year. 23




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##### Table of Contents



Drill Bits Revenues for the Drill Bits segment increased 42% for the six months ended
June 30, 2004, to $155.8 million, compared to the same period in 2003.
Operating income margins increased to 23% for the six months ended June 30,
2004 from 21% for the same period in 2003. These increases reflect the 12%
increase in worldwide active rigs and strong year-over-year growth driven by
the continued success of ReedHycalogs rotary steerable bit technologies and
directional products, ReedHycalogs TReX diamond technology, as well as the
recently introduced TuffCutter, TuffDuty and Titan lines of roller-cone
products. Tubular Technology and Services Revenues for the Tubular Technology and Services segment decreased 2% for
the six months ended June 30, 2004, to $111.2 million, compared the same period
in 2003. The year-over-year decrease was primarily due to the sale of our
Rotator division in the third quarter of 2003 along with decreased sales in our
premium threading and accessories businesses. These decreases were partially
offset by improved results at our TCA and XL Systems divisions. Operating
income margins of 4% were flat year-over year, which included an inventory
reserve charge of $0.4 million for the six months ended June 20, 2003 and, for
the same period in 2004, a severance charge of $3.2 million related to this
segments organizational restructuring. Other Segment Revenues for the Other segment for the six months ended June 30, 2004 were
$1.8 million compared to $7.8 million for the same period in 2003. The
decrease in revenues was due to the exiting of our industrial product lines
during 2003, coupled with the sale of our POS business in the first quarter of
2004. Operating loss was $1.7 million for the six months ended June 30, 2004
compared to an operating loss of $7.3 million for the same period in 2003. The
2003 operating loss included an inventory reserve charge of $6.0 million
related to the exiting of the industrial product lines. Corporate Corporate operating loss for the six months ended June 30, 2004 was $14.0
million compared to $8.8 million for the same period in 2003. This increase
was primarily due to higher professional fees and incentive compensation costs. Other Items Our interest expense decreased $0.9 million for the six months ended June
30, 2004 compared to the same period in 2003. This decrease was due to lower
debt balances year-over-year. Our equity income (loss) in unconsolidated affiliates decreased $2.0
million, from income of $1.7 million for the six months ended June 30, 2003 to
a loss of $0.3 million for the same period in 2004. Equity income contributed
by our investment in Voest-Alpine decreased by $2.2 million due to increased
steel prices. Also, 2003 includes equity losses related to Jiangsu Shuguang
Grant Prideco Tubular Limited (JSG), which we acquired a majority interest in
March 2003. Other income decreased $5.9 million, from income of $8.3 million for the
six months ended June 30, 2004 to income of $2.4 million for the same period in
2003. The decrease primarily relates to a $6.6 million gain in 2003 from
favorably renegotiating a liability to our former parent. The effective tax rate for the six months ended June 30, 2004 was 34%
compared to 35% for the same period in 2003. 24




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##### Table of Contents



Liquidity and Capital Resources Overview At June 30, 2004, we had cash of $34.4 million, working capital of $349.9
million, and unused borrowing availability of $128.9 million under our
revolving credit facility, compared to cash of $19.2 million, working capital
of $344.6 million, and unused borrowing availability of $122.3 million at
December 31, 2003. The following table summarizes our cash flows provided by operating
activities, net cash used in investing activities and net cash used in
financing activities for the periods presented (in thousands): Six Months EndedJune 30,2004
    
    2003Net Cash Provided by Operating Activities
    
    $
    48,130
    
    
    $
    50,234Net Cash Used in Investing Activities
    
    
    (13,977
    )
    
    
    (19,693
    )Net Cash Used in Financing Activities
    
    
    (19,119
    )
    
    
    (31,485
    )
 Operating Activities Net cash flows provided by operating activities decreased by $2.1 million
for the six months ended June 30, 2004 compared to the same period in 2003.
Cash flow before changes in operating assets and liabilities increased by $13.8
million reflecting the $14.3 million increase in income from continuing
operations, which was offset by a use of cash of $15.9 million related to net
increases in operating assets and liabilities primarily related to utilization
of advances and recovery of value-added taxes. Investing Activities Net cash used in investing activities decreased by $5.7 million for the
six months ended June 30, 2004 compared to the same period in 2003. This
change includes an increase in net cash provided by acquisition and divestiture
activity of $2.5 million for the six months ended June 30, 2004 compared to the
same period in 2003, coupled with an increase in proceeds from the sale of
fixed assets of $3.2 million year-over-year. Payments for business
acquisitions for the six months ended June 30, 2003 of $8.4 million includes
post-closing purchase price payments of $3.2 million related to ReedHycalog and
POS and $5.2 million related to an additional 35% interest of Rotator in
January 2003, compared to payments for the same period in 2004 of $17.3 million
which includes the purchase of the PDC business in June 2004. Proceeds from
divestitures for the six months ended June 30, 2003 includes the sale of Star
of $11.0 million, compared to proceeds for the same period in 2004 of $22.3
million, which primarily includes the sale of our Texas Arai business in April
2004. Financing Activities Net cash used in financing activities decreased $12.4 million for the six
months ended June 30, 2004 compared to the same period in 2003. This change
primarily reflects increased proceeds from stock options exercised in 2004 and
decreased repayments on our debt due to less outstanding under our revolving
credit facility year-over-year. As of June 30, 2004, there were no borrowings
outstanding under the revolver portion of our Senior Credit Facility. Capital Expenditures Our capital expenditures for property, plant, and equipment totaled $20.7
million and $19.8 million for the six months ended June 30, 2004 and 2003,
respectively. We currently expect to expend approximately $45 million for
capital expenditures for property, plant, and equipment during 2004. Much of
this spending will be related to our capital improvement program to reduce
production costs and improve efficiencies and our capital expansion programs in
China and Singapore. 25




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##### Table of Contents



Senior Credit Facility and Other Long-Term Debt Our debt balances are primarily comprised of: (1) borrowings under our
Senior Credit Facility, (2) our 9 5/8% Senior Notes due 2007, and (3) our 9%
Senior Notes due 2009. As of June 30, 2004, we had outstanding borrowings of $34.3 million under
our $240 million Senior Credit Facility (Senior Credit Facility), which related
to the term loan portion of the facility. Additionally, we had $6.8 million of
revolver availability reserved to support outstanding letters of credit. At
December 31, 2003, we had outstanding borrowings of $57.2 million under the
Senior Credit Facility, of which $42.9 million related to the term loan portion
and $14.3 million related to the revolving credit facility. Additionally, we
had $5.9 million of revolver availability reserved to support outstanding
letters of credit. Currently, required principal and interest payments for our outstanding
debt are approximately $23.8 million for the remainder of 2004. We currently
expect to satisfy all capital expenditures and debt service requirements during
2004 from operating cash flows, with any shortfall utilizing existing cash
balances and the revolver portion of our Senior Credit Facility. Based on our current projected capital expenditures, required principal
and interest payments, operating cash flows, existing cash balances, and
estimated availability under the Senior Credit Facility, we believe we can
satisfy all of our expected commitments during the next 12 months and will have
sufficient liquidity to not only maintain our existing operations but to take
advantage of strategic opportunities that may present themselves during such
period. Acquisitions and expansions will be financed from cash flow from
operations, borrowings under our Senior Credit Facility, or through the
issuance of additional debt and equity financing, as appropriate. Any future
financing will be arranged to meet our requirements, with the timing, amount,
and form of issue dependent on the prevailing market and general economic
conditions. Other Commitments As part of our investment in Voest-Alpine, we entered into a supply
contract with Voest-Alpine under which we agreed to purchase a minimum of
57,000 metric tons of green tubulars during 2003 and 52,000 metric tons per
year thereafter through July 2007. Because this agreement requires us to
purchase tubulars regardless of our needs, our purchases under this agreement
may be made for inventory during periods of low customer demand. These types
of purchases would require us to use our working capital and expose us to risks
of excess inventory during those periods. Although these purchases could
require us to expend a material amount of money, we expect that we will be able
to eventually use or sell all of the tubular products we are required to
purchase from Voest-Alpine. We currently believe we will meet our contractual
commitments for 2004 without incurring unnecessary penalties or material
unnecessary inventory positions. In connection with our spinoff from Weatherford in April 2000, we entered
into a preferred supplier agreement with Weatherford in which Weatherford
agreed for at least a three-year period from April 2000 to purchase at least
70% of its requirements for certain products from us. In return, we agreed to
sell those products at prices not greater than the price that we sell to
similarly situated customers, and, as partial consideration for amounts due to
Weatherford at that time, we provided Weatherford a $30 million credit towards
20% of the purchase price of those products. In the second quarter of 2003, we
renegotiated this contract with Weatherford, which extended this contract until
March 2005 and reduced the unused preferred supplier credit balance by $6.6
million. At June 30, 2004, the remaining credit balance was $5.5 million and
was included in Other Accrued Liabilities in the accompanying Consolidated
Balance Sheets. Recent Accounting Pronouncements For recent accounting pronouncements, see Note 12 of the unaudited
consolidated financial statements included herein. Forward-Looking Statements and Exposures In light of the SECs Regulation FD, we have elected to provide in this
report various forward-looking statements and operational details. We have done
so to assure full market disclosure of information that we generally make
available to our 26




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##### Table of Contents



investors and securities analysts. We expect to provide updates to this
information on a regular basis in our periodic and current reports filed with
the SEC. We have also made our investor conference calls open to all investors
and encourage all investors to listen in on these calls. We will publicly
announce the call-in information in a press release before such calls. We are
providing this information to assist our stockholders in better understanding
our business. These expectations reflect only our current view on these matters
as of the date of this report and are subject to change based on changes of
facts and circumstances. There can be no assurance that these expectations will
be met and our actual results will likely vary (up or down) from those
currently projected. These estimates speak only of our expectations as of the
date of this report and we make no undertaking to update this information. The
absence of an update should not be considered as an affirmation of our current
expectations or that facts have not changed during the quarter that would
impact our expectations. In modeling our earnings for all of 2004, we have made numerous
assumptions regarding our operations that are more fully described in our
Annual Report on Form 10-K. Risk Factors and Exposures The businesses in which we operate are subject to various risks and
uncertainties that could have adverse consequences on our results of operations
and financial condition and that could cause actual results to be materially
different from projected results contained in the forward-looking statements in
this report and in our other disclosures. Investors should carefully consider
these risks and uncertainties when evaluating our company and the
forward-looking statements that we make. These risks and uncertainties
include, but are not limited to, the following: A decline in domestic and worldwide oil and gas drilling activity would
adversely affect our results of operations. Our forward-looking statements and projections of future results assume
stable to moderately increasing demand for our products and services. However,
our businesses are materially dependent on the level of oil and gas drilling
activity in North America and worldwide, which in turn depends on the level of
capital spending by major, independent and state-owned exploration and
production companies. This capital spending is driven by current prices for oil
and gas and the perceived stability and sustainability of those prices. Oil and
gas prices have been subject to significant fluctuation in recent years in
response to changes in the supply and demand for oil and gas, market
uncertainty, world events, governmental actions, and a variety of additional
factors that are beyond our control, including:  
    
    the level of North American and worldwide oil and gas exploration and production activity;
    
    worldwide economic conditions, particularly economic conditions in North America;
    
    oil and gas production costs;
    
    the expected costs of developing new reserves;
    
    national government political requirements and the policies of the OPEC;
    
    the price and availability of alternative fuels;
    
    environmental regulation; and
    
    tax policies. Decreased demand for our products results not only from periods of lower
drilling activity, but also from the resulting build up of customer inventory
of drill pipe associated with idle rigs, which can be used on active rigs in
lieu of new purchases. The time period during which drill pipe inventory is
used is a function of the number of rigs actively drilling and the expected
level of drilling activity. A decrease in the number of rigs actively drilling
results in a large amount of unused drill pipe on idle rigs and a decrease in
demand for new drill pipe. 27




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An economic downturn could adversely affect demand for our products and
services and our results of operations. The U.S. and worldwide economies have been very volatile, and their future
directions are uncertain. If North American or international economies decline
unexpectedly, our results of operations and financial condition could be
materially adversely affected. Increases in the prices of our raw materials could affect our results of
operations. We use large amounts of steel tubulars and bars in the manufacture of our
products. The price of these raw materials has a significant impact on our cost
of producing products. If we are unable to pass future raw material price
increases on to our customers, our margins and results of operations could be
adversely affected. Steel prices have increased significantly since the end of 2003, caused
primarily by significant increases in the prices paid by our suppliers for
scrap and coke utilized in their operations. Although we have a long-term
supply contract with our Voest-Alpine affiliate relating to our supply of green
tubes utilized in our drill pipe operations, we do not have such supply
contracts in place for our suppliers of bars and billets utilized to
manufacture our tool joints, drill collars and heavyweight drill pipe. Our
partner in our Austrian joint venture also is seeking to renegotiate its supply
contract for billets to our Voest-Alpine affiliate. Our forward-looking
statements assume that we will be able to pass on to our customers any cost
increases we may experience as a result of the current shortages being
experienced in the worldwide steel markets. If we are unable to, our results of
operations could be materially adversely affected. With respect to our Chinese operations, we purchase green tubes from our
supplier on a cost-plus basis. As such, any increase in our raw material costs
that we cannot pass on to our customers could have an adverse impact on our
operations. In addition, certain of the benefits forecasted from our joint
venture to manufacture upset-to-grade tubulars in China are based upon price
differentials between our Chinese supplier and our Voest-Alpine affiliate,
which may not materialize if steel prices continue to rise. In addition, rising steel costs also have the potential to delay increases
in demand for our drill stem components and premium casing products. As drill
stem products are not consumables, our customers could elect to defer purchases
until such time as they determine that steel prices have stabilized or returned
to more normalized conditions. Our forward-looking statements do not assume
that there will be any reduced demand for our drill stem products or premium
casing as a result of increased prices caused by the current shortages being
experienced in the worldwide steel markets. Reduced demand could adversely
affect our results of operations. Interruptions of supply of raw materials could materially adversely affect
our results of operations. We rely on various suppliers to supply the components utilized to
manufacture our drilling products and premium casing. The availability of the
raw materials is not only a function of the availability of steel, but also the
alloy materials that are utilized by our suppliers in manufacturing tubulars
that meet our proprietary chemistries. Currently, there is a worldwide
shortage of scrap, coke and alloys that has caused raw material prices to
increase for steel tubulars, billets and bars utilized in our manufacturing
operations. To date, these shortages have not caused a material disruption in
availability or our manufacturing operations, however, there can be no
assurance that material disruptions could not occur in the future. If material
disruptions to raw materials availability occur, it could adversely affect our
results of operations and our ability to increase or manufacturing operations
to meet the increased revenues upon which our forward-looking statements are
based. Due to intense competition in our industry, our revenues may decline if we do
not develop, produce, and commercialize new competitive technologies and
products or if we are unable to adequately protect our current and future
intellectual property rights relating to our technologies and products. The markets for our premium products and services are characterized by
continual developments. Substantial improvements in the scope and quality of
product function and performance can occur over a short period of time. In
order to remain competitive, we must be able to develop commercially
competitive products in a timely manner in response to changes in technology.
Our ability to develop new products and maintain competitive advantages depends
on our ability to 28




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design and commercially market products that meet the needs
of our customers, including delivery schedules and product
specifications. Additionally, the time and expense invested in product development may not
result in commercially feasible applications that provide revenues. We could be
required to write-off our entire investment in a new product that does not
reach commercial viability. Moreover, we may experience operating losses after
new products are introduced and commercialized because of high start-up costs,
unexpected manufacturing costs or problems, or lack of demand. Many of our products and the processes we use to manufacture them have
been granted U.S. and international patent protection, or have patent
applications pending. Nevertheless, patents may not be granted for our
applications and, if patents are issued, the claims allowed may not be
sufficient to protect our technology. If our patents are not enforceable, or if
any of our products infringe patents held by others, our financial results may
be adversely affected. Our competitors may be able to independently develop
technology that is similar to ours without infringing on our patents, which is
especially true internationally where the protection of intellectual property
rights may not be as effective. In addition, obtaining and maintaining
intellectual property protection internationally may be significantly more
expensive than doing so domestically. We may have to spend substantial time and
money defending our patents and, after our patents expire, our competitors will
not be legally constrained from developing products substantially similar to
ours. In addition, we are in the process of developing new products that we
intend to introduce to the market during 2004. These products include 1) large
diameter premium connectors for our Tubular Technology and Services segment and
2) new drill bits. If we are unable to introduce such products as a result of
delays in our development activities, such introductions not being accepted by
our end-users, or delays or abandonment for other reasons, our projected
results could be adversely affected. Our results of operations and financial condition are dependent upon our
ability to successfully increase and decrease, without material disruption,
our manufacturing capacity and expense in response to changes in demand and
to maintain prices for our products, which can be adversely affected by
changes in industry conditions and competitive forces. Our projections assume steady demand for our products and services during
2004, in particular our drill stem products. In the event demand for these
products increases, we will be required to increase our production during peak
demand periods with minimal operational disruption and inefficiency. If this
does not happen, or we experience difficulties in this regard, our results of
operations during this ramp-up for high demand periods could be adversely
affected. Our international operations may experience severe interruptions due to
political, economic, or other risks, which could adversely affect our results
of operations and financial condition. During the first half of 2004, we derived approximately 40% of our total
revenues from our facilities outside the U.S. In addition, a large part of
sales from our domestic locations were for use in foreign countries. In
addition, many of our key manufacturing operations are outside of the U.S.,
including Mexico, Austria, Italy, China, Indonesia, and Singapore. Our
operations in certain international locations are subject to various political
and economic conditions existing in those countries that could disrupt
operations. These risks include:  
    
    changes in foreign tax laws;
    
    changes in regulations and labor practices;
    
    currency fluctuations and devaluations;
    
    currency restrictions, banking crises, and limitations on repatriation of profits; and
    
    political instability or military conflict. Our foreign operations may suffer disruptions, and we may incur losses
that will not be covered by insurance. We have not historically carried
political risk insurance. In particular, terrorist attacks and other threats to
U.S. national security and 29




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resulting U.S. military activity throughout the
world increase the possibility that our operations could be interrupted or
adversely affected. Such disruption could result in our inability to ship
products in a timely and cost-effective manner or our inability to place
contractors and employees in various countries or regions. Any material currency fluctuations or devaluations, or political events
that disrupt oil and gas exploration and production or the movement of funds
and assets could materially adversely affect our results of operations and
financial position. During the first half of 2004, approximately $34.8 million of our revenues
were earned by our Chinese operations. As is customary in this country, it is
common for our Chinese operations to settle receivables and payables through
bearer bonds and notes. Recently, Chinese banks have been experiencing a
shortage of currencies, which could affect our ability to fully realize these
notes. At June 30, 2004, we were not holding any such notes. To date, our
Chinese operations have not experienced significant losses as a result of such
practice; however, there can be no assurance that such losses could not occur
in the future. Any such losses could have a materially adverse affect on our
results of operations in the period in which they occur. We have renewed an agreement with Voest-Alpine, an entity of which we own
50.01%, to purchase green tubulars through September 2007. Our future results
could be adversely affected if we are unable to use or resell these tubulars.
In addition, we have agreed to be responsible for paying any anti-dumping
duties in the U.S. on the resale of these tubulars, which could affect our
ability to resell the tubulars in the U.S. Further, our long-term supply
contract with Voest-Alpine is denominated in Euros. We have no significant
offset for revenues in Euros and we have not hedged for currency risk with
respect to this contract. Thus, a material long-term strengthening of the Euro
versus the U.S. dollar could materially adversely affect our results of
operations. In connection with our business operations, we could be subject to
substantial liability claims that adversely affect our results of operations. Our products are complex, and the failure of this equipment to operate
properly or to meet specifications may greatly increase our customers costs of
drilling a well. In addition, many of these products are used in hazardous
drilling and production applications where an accident or product failure can
cause personal injury or loss of life; damage to property, equipment, or the
environment; regulatory investigations and penalties; and the suspension of the
end-users operations. If our products or services fail to meet specifications
or are involved in accidents or failures, we could face warranty, contract, or
other litigation claims for which we may be held responsible and our reputation
for providing quality products may suffer. Our insurance may not be adequate in risk coverage or policy limits to
cover all losses or liabilities that we may incur or be responsible. Moreover,
in the future we may not be able to maintain insurance at levels of risk
coverage or policy limits that we deem adequate or at premiums that are
reasonable for us, particularly in the recent environment of significant
insurance premium increases. Further, any claims made under our policies will
likely cause our premiums to increase. Any future damages deemed to be caused by our products or services that
are assessed against us and that are not covered by insurance, or that are in
excess of policy limits or subject to substantial deductibles, could have a
material adverse effect on our results of operations and financial condition.
Litigation and claims for which we are not insured can occur, including
employee claims, intellectual property claims, breach of contract claims, and
warranty claims. Our forward-looking statements assume that such uninsured
claims or issues will not occur. We account for warranty reserves on a specific
identification basis. As a result, a significant unexpected warranty issue
during a particular quarter or year could cause a material reduction in our
results of operations in the quarter or year that the reserve for such warranty
is made. We are subject to environmental, health, and safety laws and regulations that
expose us to potential financial liability. Our operations are regulated under a number of federal, state, local, and
foreign environmental laws and regulations, which govern, among other things,
the discharge of hazardous materials into the air and water, as well as the
handling, storage, and disposal of hazardous materials and the remediation of
contaminated sites. Compliance with these 30




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environmental laws is a major
consideration in the manufacturing of our products. Because we use and generate
hazardous substances and wastes in our manufacturing operations, we may be
subject to material financial liability for any investigation and clean up of
such hazardous materials, and any related personal injury damages or toxic tort
claims. We have not historically carried insurance for such matters. In addition, many of our current and former properties are or have been
used for industrial purposes. Accordingly, we also may be subject to financial
liabilities relating to the investigation and remediation of hazardous
materials resulting from the action of previous owners or operators of
industrial facilities on those sites. Liability in many instances may be
imposed on us regardless of the legality of the original actions relating to
the hazardous or toxic substances or whether or not we knew of, or were
responsible for, the presence of those substances. Liabilities we have assumed
in connection with the ReedHycalog acquisition include, subject to certain
exceptions, certain obligations, liabilities, costs, and expenses for
violations of health, safety and environmental laws relating to the assets and
include certain unknown, as well as known, obligations, liabilities, costs, and
expenses arising or incurred prior to, on or after the closing date.
Furthermore, with certain exceptions, we may be required to indemnify
Schlumberger against losses incurred in connection with or related to these
assumed liabilities. We are also subject to various federal, state, local, and foreign laws and
regulations relating to safety and health conditions in our manufacturing
facilities. Those laws and regulations may subject us to material financial
penalties or liabilities for any noncompliance, as well as potential business
disruption if any of our facilities or a portion of any facility is required to
be temporarily closed as a result of any violation of those laws and
regulations. Any such financial liability or business disruption could have a
material adverse effect on our financial condition and results of operations. Our results of operations could be adversely affected by actions under U.S.
trade laws and new foreign entrants into U.S. markets. Although we are a U.S.-based manufacturing company, we do own and operate
international manufacturing operations that support our U.S.-based business. If
actions under U.S. trade laws were instituted that limited our access to these
products, our ability to meet our customer specifications and delivery
requirements would be reduced. Any adverse effects on our ability to import
products from our foreign subsidiaries could have a material adverse effect on
our results of operations. Additionally, foreign producers of tubular goods have been found to have
sold their products, which may include premium connections, for export to the
U.S. at prices that are lower than the cost of production, or their prices in
their home market, or a major third-country market. Anti-dumping orders
restricting the manner and price at which tubular goods from certain countries
can be imported are currently in effect. If such orders are revoked or changed,
we could be exposed to increased competition from imports that could reduce our
sales and market share. In addition, the premium connections market served by
our Atlas Bradford product line is highly competitive. The level of
competition could further increase if foreign steel mills, with their own lines
of internationally accepted premium connections, more successfully penetrate
the U.S. market, which could adversely affect our results of operations. Our results of operations could be materially and adversely affected by
charges associated with future operational changes implemented by management
of our company. At the end of 2003, our management completed a review and assessment of
our drill stem manufacturing operations that resulted in a downsizing of
certain of our operations, primarily in Canada. As a result of this
downsizing, during 2003 we wrote-off various equipment and assets that were no
longer useful in our business and incurred approximately $2.0 million in lease
termination, severance, and other exit costs during the first half of 2004. At the beginning of 2004, we also announced the combination of our Marine
Products and Services businesses into our Tubular Technology and Services
segment. As a result of this combination, we incurred approximately $3.2
million in severance and related costs during the first six months of 2004. In April 2004, as part of our ongoing review of our operations to focus on
our key product lines, we sold our API coupling business and recognized an
after-tax loss on sale of approximately $10.1 million, subject to final working
capital adjustments and standard closing requirements that have not yet been
determined. 31




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In addition to these activities, management continues to conduct
company-wide assessments of all of our related manufacturing strategies and
practices and of our under-performing product lines to determine possible
improvements to manufacturing efficiencies and future profitability. Such
assessment could in the future result in divestitures or operational
rationalizations that result in write-downs or other losses during any
particular accounting period. Our forward-looking statements assume that none
of the results of these reviews or activities will adversely affect our results
of operations in any period. Our results of operations could be adversely impacted by write-offs
associated with international receivables that are invoiced and collected
through third parties. In the ordinary course of business, Grant Prideco utilizes third-party
agents to assist in the sale of its products in various countries. For certain
countries and customers, the agent is actually the contracting party with the
ultimate end-user of the product. Also, in connection with the Companys
purchase of its ReedHycalog drill bit business in December 2002, the Company
was required to operate through a transition structure in various international
locations until the Company was able to create the necessary legal and
operating structure to operate on a stand-alone basis. During this transition
period, sales in these countries were invoiced and are being collected through
the seller of the ReedHycalog business, who was acting as the Companys agent
or nominee in those countries. As of June 30, 2004, the Company had
approximately $15 million of receivables outstanding that relate to sales made
through this transition structure. For all sales made through third-party
agents, Grant Prideco is not only subject to the credit risk associated with
the end-user of the product, but also the third-party agent as well, and
collecting such receivables often requires additional Company effort, and most
importantly, can extend the receivable collection period. Any write-offs
associated with such receivables could have an adverse impact on the Companys
results of operations during the period in which any such write-off occurs. Our results of operations could be adversely affected due to an
implementation of a new enterprise-wide resource planning (ERP) system. We currently are implementing a new management ERP system that we believe
will, in the long term, significantly enhance our information systems, internal
processes and controls. This implementation is ongoing and includes a
significant amount of managements time and dedication and may distract
management in unpredictable ways from our core businesses. ERP
implementations that occur during the second half of the year, although
designed to enhance controls and procedures, could delay and adversely affect
the ability of the Company and its auditors to timely test such systems in
connection with the year-end 404 certifications. Additionally, the ERP system
might not result in the anticipated benefits and may actually cause disruptions
and inefficiencies in our businesses which could result in increases in our
operating and other cost that could adversely affect our results of operations. 
 ITEM 3.Quantitative and Qualitative Market Risk Disclosures Interest Rates Currently, we have variable interest rate debts totaling approximately
$34.3 million. These variable rate debts expose us to the risk of increased
interest expense in the event of increases in short-term interest rates. If
the variable interest rates were to increase by 1% from March 2004 levels, our
combined interest expense would increase by approximately $0.3 million
annually. 
 ITEM 4.Controls and Procedures Evaluation of Disclosure Controls and Procedures The Companys management, with the participation of the Companys
principal executive officer and principal financial officer, evaluated the
effectiveness of the Companys disclosure controls and procedures (as defined
in Rules 13a-15(e) and 15d-15(e) promulgated under the Securities Exchange Act
of 1934, as amended (the Exchange Act)) as of the end of the fiscal quarter
ended June 30, 2004. Based on this evaluation, the Companys principal
executive officer and principal financial officer have concluded that the
Companys disclosure controls and procedures were effective as of the end of
the fiscal quarter ended June 30, 2004, to ensure that information that is
required to be disclosed by the Company in the reports it files or submits
under the Exchange Act is recorded, processed, summarized, and reported, within
the time periods specified in the SECs rules and forms. Changes in Internal Controls There were no changes in the Companys internal control over financial
reporting that occurred during the fiscal quarter ended June 30, 2004 that have
materially affected, or are reasonably likely to materially affect, the
Companys internal control over financial reporting. 32




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PART II 
 ITEM 4.Submission of Matters to a Vote of Security Holders On May 11, 2004, the Company held its Annual Meeting of Shareholders. At
the meeting, shareholders voted on the election of directors to serve until the
next annual meeting of shareholders. The following is a summary of the votes
on this item: Votes For
    
    Votes WithheldDavid Butters
    
    
    109,773,180
    
    
    
    3,849,740Eliot M. Fried
    
    
    112,052,236
    
    
    
    1,570,684Dennis R. Hendrix
    
    
    112,281,729
    
    
    
    1,341,191Harold E. Layman
    
    
    109,928,706
    
    
    
    3,694,214Sheldon B. Lubar
    
    
    110,587,093
    
    
    
    3,035,827Michael McShane
    
    
    111,269,507
    
    
    
    2,353,413Robert K. Moses, Jr.
    
    
    112,352,946
    
    
    
    1,269,974Joseph E. Reid
    
    
    112,273,373
    
    
    
    1,349,547David A. Trice
    
    
    109,850,395
    
    
    
    3,772,525
 
 ITEM 6.Exhibits and Reports on Form 8-K  (a)
    
    Exhibits -  31.1
    
    Certification of Michael McShane31.2
    
    Certification of Matthew D. Fitzgerald32.1
    
    Section 906 Certification  (b)
    
    Reports filed onForm 8-Kduring the three months ended June 30, 2004 -  1.
    
    Report on Form 8-K dated April 29, 2004, filing the
Companys press release related to its first quarter 2004 results
of operations.2.
    
    Report on Form 8-K, dated June 4, 2004, filing the
Companys presentation to investors at the UBS Warburg, 2004
Global Oil and Gas Conference. 33




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SIGNATURES Pursuant to the requirements of Section 12 of the Securities Exchange Act
of 1934, the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized. GRANT PRIDECO, INC.By:
    
    /s/ MATTHEW D. FITZGERALDMatthew D. FitzgeraldSr. Vice President and Chief Financial OfficerBy:
    
    /s/ GREG L. BOANEGreg L. BoaneCorporate Controller and Principal Accounting Officer
 Date: August 9, 2004 34




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EXHIBIT INDEX Exhibit Number
    
    Description31.1
    
    Certification of Michael McShane31.2
    
    Certification of Matthew D. Fitzgerald32.1
    
    Section 906 Certification
 35