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FORM 10-Q   (Mark One) [X]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2004 OR [  ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
 For the transition period fromto Commission file number 000-31579 HYDRIL COMPANY   DELAWARE
    
    95-2777268(State or other jurisdiction of
incorporation or organization)
    
    (IRS Employer
Identification No.)
 3300 North Sam Houston Parkway East Houston, Texas
    
    77032-3411(Address of principal executive offices)
    
    (Zip Code)
 Registrants telephone number, including area code (281) 449-2000 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 registrant is an accelerated filer (as
defined in Rule 12b-2 of the 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. Shares outstanding at August 2, 2004: Common stock, $.50 par value, 16,473,391 shares outstanding Class B common stock, $.50 par value,6,546,913 shares outstanding




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HYDRIL COMPANY INDEX PagePART IFINANCIAL INFORMATIONItem 1. Financial StatementsConsolidated Balance SheetsJune 30, 2004 (unaudited) and December 31, 2003
    
    
    3Unaudited Consolidated Statements of OperationsFor the Three and Six Months Ended
June 30, 2004 and 2003
    
    
    5Unaudited Consolidated Statements of Cash FlowsFor the Six Months Ended
June 30, 2004 and 2003
    
    
    6Notes to Unaudited Consolidated Financial Statements
    
    
    7Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations
    
    
    14Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    36Item 4. Controls and Procedures
    
    
    36PART IIOTHER INFORMATIONItem 4. Submission of Matters to a Vote of Security Holders
    
    
    37Item 6. Exhibits and Reports on Form 8-K
    
    
    37Form of 2004 Director's Deferred Share Unit AgmtCertification of CEO Pursuant to Section 302Certification of CFO Pursuant to Section 302Certification of CEO Pursuant to Section 906Certification of CFO Pursuant to Section 906
  * * * Cautionary Statement Regarding Forward-Looking Information This Quarterly Report on Form 10-Q contains forward-looking statements.
These statements relate to future events or our future financial performance,
including our business strategy and product development plans, and involve
known and unknown risks and uncertainties. These risks and uncertainties and
assumptions, which are more fully described under RISK FACTORS in Item 2 of
this report and in Hydril Companys Annual Report on Form 10-K for the year
ended December 31, 2003 filed with the Securities and Exchange Commission,
include, but are not limited to, the impact of changes in oil and natural gas
prices and worldwide and domestic economic conditions on drilling activity and
demand for and pricing of Hydrils products, the impact of geo-political and
other events affecting international markets and trade, Hydrils ability to
remain on the leading edge of technology in its products and maintain and
increase its market share, the impact of international and domestic trade laws,
the loss of or change to distribution methods of premium connections in the
U.S. and Canada, overcapacity in the pressure control industry, and high fixed
costs that could affect the pricing of Hydrils products. These factors may
cause our companys or our industrys actual results, levels of activity,
performance or achievements to be materially different from those expressed or
implied by the forward-looking statements. In some cases, you can identify
forward-looking statements by terminology such as may, will, should,
could, expects, intends, plans, anticipated, believes, estimated,
potential, or the negative of these terms or other comparable terminology. These statements are only projections, based on anticipated industry
activity. Although we believe that the expectations reflected in the
forward-looking statements are reasonable, we cannot guarantee future results,
levels of activity, performance or achievements.




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HYDRIL COMPANY 
 Part I, Item 1: Consolidated Balance Sheets
 June 30,
    
    December 31,2004
    
    2003(unaudited)CURRENT ASSETS:Cash and cash equivalents
    
    $
    73,250
    
    
    $
    54,139Investments
    
    
    12,055
    
    
    
    6,831Receivables:Trade, less allowance for doubtful
accounts: 2004, $1,058; 2003, $1,127
    
    
    38,329
    
    
    
    34,886Contract costs and estimated earnings in excess of billings
    
    
    4,081
    
    
    
    4,366Other
    
    
    3,130
    
    
    
    1,842Total receivables
    
    
    45,540
    
    
    
    41,094Inventories:Finished goods
    
    
    21,156
    
    
    
    24,190Work-in-process
    
    
    6,527
    
    
    
    5,320Raw Materials
    
    
    6,044
    
    
    
    6,906Total inventories
    
    
    33,727
    
    
    
    36,416Deferred tax asset
    
    
    7,491
    
    
    
    9,095Other current assets
    
    
    3,503
    
    
    
    4,422Total current assets
    
    
    175,566
    
    
    
    151,997PROPERTY:Land and improvements
    
    
    21,150
    
    
    
    21,021Buildings and equipment
    
    
    53,583
    
    
    
    53,217Machinery and equipment
    
    
    162,882
    
    
    
    163,574Construction-in-progress
    
    
    3,417
    
    
    
    2,106Total
    
    
    241,032
    
    
    
    239,918Less accumulated depreciation and amortization
    
    
    (139,493
    )
    
    
    (134,871
    )Property, net
    
    
    101,539
    
    
    
    105,047OTHER LONG-TERM ASSETS:Investments
    
    
    
    
    
    
    958Deferred tax asset
    
    
    1,820
    
    
    
    901Other assets
    
    
    7,030
    
    
    
    5,649TOTAL
    
    $
    285,955
    
    
    $
    264,552
 See notes to unaudited consolidated financial statements 3




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HYDRIL COMPANY
Part I, Item 1: Consolidated Balance Sheets
(In Thousands, Except Share and Per Share Information) June 30,
    
    December, 31,2004
    
    2003(unaudited)CURRENT LIABILITIES:Accounts payable
    
    $
    13,733
    
    
    $
    13,481Billings in excess of contract costs and estimated earnings
    
    
    709
    
    
    
    487Accrued liabilities
    
    
    17,752
    
    
    
    17,184Income taxes payable
    
    
    4,124
    
    
    
    4,350Total current liabilities
    
    
    36,318
    
    
    
    35,502LONG-TERM LIABILITIES:Deferred tax liability
    
    
    135
    
    
    
    140Other
    
    
    12,410
    
    
    
    11,900Total long-term liabilities
    
    
    12,545
    
    
    
    12,040CONTINGENCIES (Note 4)STOCKHOLDERS EQUITY:Capital stock:Preferred stock-authorized, 10,000,000 shares of $1 par
value; none issued or outstanding
    
    
    
    
    
    
    Common stock-authorized 75,000,000 shares of $.50 par
value; 16,422,226 and 16,058,792 shares issued and
outstanding at June 30, 2004 and December 31, 2003,
respectively
    
    
    8,211
    
    
    
    8,029Class B common stock-authorized, 32,000,000 shares of
$.50 par value; 6,560,913 and 6,757,721 shares issued
and outstanding at June 30, 2004 and December 31, 2003,
respectively
    
    
    3,280
    
    
    
    3,379Additional paid in capital
    
    
    54,549
    
    
    
    49,312Retained earnings
    
    
    176,956
    
    
    
    160,059Deferred compensation
    
    
    (3,936
    )
    
    
    (1,801
    )Accumulated other comprehensive loss
    
    
    (1,968
    )
    
    
    (1,968
    )Total stockholders equity
    
    
    237,092
    
    
    
    217,010TOTAL
    
    $
    285,955
    
    
    $
    264,552
 See notes to unaudited consolidated financial statements 4




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HYDRIL COMPANY 
 Part I, Item 1: Unaudited Consolidated Statements of Operations
 Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003REVENUE
    
    $
    62,905
    
    
    $
    54,551
    
    
    $
    120,402
    
    
    $
    111,889COST OF SALES
    
    
    36,834
    
    
    
    32,941
    
    
    
    71,981
    
    
    
    67,980GROSS PROFIT
    
    
    26,071
    
    
    
    21,610
    
    
    
    48,421
    
    
    
    43,909SELLING, GENERAL &
ADMINISTRATION EXPENSES:Engineering
    
    
    2,871
    
    
    
    3,349
    
    
    
    5,788
    
    
    
    7,015Sales and marketing
    
    
    4,582
    
    
    
    4,168
    
    
    
    8,697
    
    
    
    8,166General and administration
    
    
    5,250
    
    
    
    4,405
    
    
    
    10,111
    
    
    
    8,712Total
    
    
    12,703
    
    
    
    11,922
    
    
    
    24,596
    
    
    
    23,893OPERATING INCOME
    
    
    13,368
    
    
    
    9,688
    
    
    
    23,825
    
    
    
    20,016INTEREST EXPENSE
    
    
    
    
    
    
    (546
    )
    
    
    
    
    
    
    (1,101
    )INTEREST INCOME
    
    
    170
    
    
    
    226
    
    
    
    354
    
    
    
    476OTHER INCOME (EXPENSE)
    
    
    132
    
    
    
    112
    
    
    
    27
    
    
    
    32INCOME BEFORE INCOME
TAXES
    
    
    13,670
    
    
    
    9,480
    
    
    
    24,206
    
    
    
    19,423PROVISION FOR INCOME
TAXES
    
    
    4,647
    
    
    
    3,317
    
    
    
    7,309
    
    
    
    6,797NET INCOME
    
    $
    9,023
    
    
    $
    6,163
    
    
    $
    16,897
    
    
    $
    12,626NET INCOME PER SHARE:BASIC
    
    $
    0.39
    
    
    $
    0.27
    
    
    $
    0.74
    
    
    $
    0.56DILUTED
    
    $
    0.39
    
    
    $
    0.27
    
    
    $
    0.73
    
    
    $
    0.55WEIGHTED AVERAGE SHARES
OUTSTANDING:BASIC
    
    
    22,913,096
    
    
    
    22,685,637
    
    
    
    22,880,553
    
    
    
    22,637,244DILUTED
    
    
    23,258,520
    
    
    
    23,019,217
    
    
    
    23,190,522
    
    
    
    22,969,513
 See notes to unaudited consolidated financial statements 5




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HYDRIL COMPANY 
 Part I, Item 1: Unaudited Consolidated Statements of Cash Flows
 Six Months EndedJune 30,2004
    
    2003CASH FLOWS FROM OPERATING ACTIVITIES:Net income
    
    $
    16,897
    
    
    $
    12,626Adjustments to reconcile net income to net cash used in
operating activities:Amortization of deferred compensation
    
    
    238
    
    
    
    35Depreciation
    
    
    6,205
    
    
    
    5,814Deferred income taxes
    
    
    685
    
    
    
    325Provision for doubtful accounts
    
    
    (85
    )
    
    
    45Gain on sale of real estate not used in operations
    
    
    
    
    
    
    (104
    )Change in operating assets and liabilities:Receivables
    
    
    (4,646
    )
    
    
    1,730Contract costs and estimated earnings in excess of billings
    
    
    285
    
    
    
    (1,656
    )Inventories
    
    
    2,689
    
    
    
    3,031Other current and noncurrent assets
    
    
    489
    
    
    
    973Accounts payable
    
    
    252
    
    
    
    (1,130
    )Billings in excess of contract costs and estimated earnings
    
    
    222
    
    
    
    (1,442
    )Accrued liabilities
    
    
    568
    
    
    
    (5,848
    )Income taxes payable
    
    
    (226
    )
    
    
    2,085Other long-term liabilities
    
    
    510
    
    
    
    692Net cash provided by operating activities
    
    
    24,083
    
    
    
    17,176NET CASH FROM INVESTING ACTIVITIES:Purchase of held-to-maturity investments
    
    
    (10,435
    )
    
    
    (13,146
    )Proceeds from held-to-maturity investments
    
    
    6,169
    
    
    
    12,230Capital expenditures
    
    
    (2,986
    )
    
    
    (3,915
    )Other, net
    
    
    
    
    
    
    (1,096
    )Net cash used in investing activities
    
    
    (7,252
    )
    
    
    (5,927
    )NET CASH FROM FINANCING ACTIVITIES:Repayment of debt
    
    
    
    
    
    
    (30,000
    )Net proceeds from issuance of common stock
    
    
    126
    
    
    
    102Net proceeds from exercise of stock options
    
    
    2,154
    
    
    
    1,222Net cash provided by (used in) financing activities
    
    
    2,280
    
    
    
    (28,676
    )NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
    
    
    19,111
    
    
    
    (17,427
    )CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD
    
    
    54,139
    
    
    
    61,590CASH AND CASH EQUIVALENTS AT END OF PERIOD
    
    $
    73,250
    
    
    $
    44,163SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:Interest paid
    
    $
    
    
    
    $
    1,039Income taxes paid:Domestic
    
    
    2,530
    
    
    
    Foreign
    
    
    3,565
    
    
    
    3,203
 See notes to unaudited consolidated financial statements 6




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Hydril Company 
 Part I, Item 1: Notes to Unaudited Consolidated Financial Statements Note 1  BASIS OF PRESENTATION Principles of Consolidation- The consolidated financial statements include
the accounts of Hydril Company and its wholly owned subsidiaries. Intercompany
accounts and transactions are eliminated in consolidation. Use of Estimates- 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
amount of assets and liabilities and disclosure of contingent assets and
liabilities as of the date of the financial statements and the reported amounts
of revenue and expenses during the reporting period. Actual results could
differ from those estimates. Reclassifications- Certain prior year amounts within the consolidated
financial statements have been reclassified to conform to the current years
presentation. Interim Presentation- The accompanying consolidated interim financial
statements and disclosures have been prepared by the Company in accordance with
accounting principles generally accepted in the United States of America and in
the opinion of management reflect all adjustments (consisting solely of normal
recurring adjustments) necessary for a fair presentation in all material
respects of the financial position and results for the interim periods. These
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 results of operations for the
three and six months ended June 30, 2004 are not necessarily indicative of
results to be expected for the full year. Note 2  Product Warranty Liability The changes in the aggregate product warranty liability is as follows for
the three and six months ended June 30: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,(in thousands)
    
    2004
    
    2003
    
    2004
    
    2003Beginning balance
    
    $
    2,178
    
    
    $
    2,912
    
    
    $
    2,192
    
    
    $
    3,274Claims paid
    
    
    (129
    )
    
    
    (424
    )
    
    
    (294
    )
    
    
    (836
    )Additional warranty charged to expense
    
    
    
    
    
    
    (284
    )
    
    
    151
    
    
    
    (234
    )Ending balance
    
    $
    2,049
    
    
    $
    2,204
    
    
    $
    2,049
    
    
    $
    2,204
 7




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Note 3  LONG-TERM CONTRACTS The components of long-term contracts as of June 30, 2004 and December 31,
2003 consist of the following: June 30, 2004
    
    December 31, 2003(in thousands)Costs and estimated earnings on
uncompleted contracts
    
    $
    18,394
    
    
    $
    34,682Less: billings to date
    
    
    (15,022
    )
    
    
    (30,803
    )Excess of costs and
estimated earnings over billings
    
    $
    3,372
    
    
    $
    3,879Included in the accompanying balance
sheets under the following captions:Contract costs and estimated earnings
in excess of billings
    
    $
    4,081
    
    
    $
    4,366Billings in excess of contract costs
and estimated earnings
    
    
    (709
    )
    
    
    (487
    )Total
    
    $
    3,372
    
    
    $
    3,879
 Note 4  CONTINGENCIES The Company is involved in legal proceedings arising in the ordinary
course of business. In the opinion of management these matters are such that
their outcome will not have a material adverse effect on the financial position
or results of operations of the Company. The Company has been identified as a potentially responsible party at a
waste disposal site near Houston, Texas. Based on the number of other
potentially responsible parties, the total estimated site cleanup costs and its
estimated share of such costs, the Company continues to believe this matter
will not materially affect its results of operation or financial condition. Note 5 LINES OF CREDIT At June 30, 2004, the Company had $20,000,000 in total committed unsecured
revolving lines of credit, which extend through June 30, 2005. Of this,
$15,000,000 relates to the Companys U.S. operations and $5,000,000 relates to
the Companys foreign operations. Under both the domestic and foreign lines,
the Company may, at its election, borrow at either a prime or LIBOR based
interest rate. Interest rates fluctuate depending on the Companys leverage
ratio and are prime minus a spread ranging from 60 to 115 basis points or LIBOR
plus a spread ranging from 85 to 140 basis points. At June 30, 2004, there
were no outstanding borrowings under either facility. Our U.S. revolving
credit agreement contains covenants with respect to debt levels, tangible net
worth and debt-to-capitalization ratios. 8




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The Company was in compliance with these covenants at June 30, 2004. The
foreign line does not contain any separate financial covenants but contains
cross-default provisions which would be triggered by a default under the U.S.
line of credit. The terms of the Companys credit facilities allow for the issuance of
letters of credit. The amount of outstanding letters of credit reduces the
amount available for borrowing under the credit facilities. The letters of
credit are generally short in duration and immaterial in amount. At June 30,
2004 there was approximately $532,000 outstanding in letters of credit. Note 6  EARNINGS PER SHARE The Company has presented basic and diluted income per share (EPS) on
the consolidated statement of operations. Basic EPS excludes dilution and is
computed by dividing income available to common stockholders by the weighted
average number of common shares outstanding for the period. Dilutive EPS is
based on the weighted average number of shares outstanding during each period
plus the assumed exercise of dilutive stock options and vesting of restricted
stock and restricted stock units, less the number of treasury shares from the
assumed exercise proceeds using the average market price for the Companys
common stock for each of the periods presented. When potentially dilutive
securities are anti-dilutive, they are not included in dilutive EPS. Basic
weighted average shares outstanding for the three months ended June 30, 2004
and 2003 were 22,913,096 and 22,685,637, respectively, while for the six months
ended June 30, 2004 and 2003 were 22,880,553 and 22,637,244, respectively.
Dilutive weighted average shares outstanding for the three months ended June
30, 2004 and 2003 were 23,258,520 and 23,019,217, respectively, while for the
six months ended June 30, 2004 and 2003 were 23,190,522 and 22,969,513,
respectively. The following table summarizes the computation of basic and diluted net
income per share: Weighted
    
    NetAverage
    
    Income(in thousands except per share data)
    
    Net Income
    
    Shares
    
    Per ShareThree months ended June 30, 2004Basic net income
    
    $
    9,023
    
    
    
    22,913
    
    
    $
    0.39Effect of dilutive stock options
    
    
    
    
    
    
    345
    
    
    
    Diluted net income
    
    $
    9,023
    
    
    
    23,258
    
    
    $
    0.39Three months ended June 30, 2003Basic net income
    
    $
    6,163
    
    
    
    22,686
    
    
    $
    0.27Effect of dilutive stock options
    
    
    
    
    
    
    333
    
    
    
    Diluted net income
    
    $
    6,163
    
    
    
    23,019
    
    
    $
    0.27Six months ended June 30, 2004
 9




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Weighted
    
    NetAverage
    
    Income(in thousands except per share data)
    
    Net Income
    
    Shares
    
    Per ShareBasic net income
    
    $
    16,897
    
    
    
    22,881
    
    
    $
    0.74Effect of dilutive stock options
    
    
    
    
    
    
    310
    
    
    
    Diluted net income
    
    $
    16,897
    
    
    
    23,191
    
    
    $
    0.73Six months ended June 30, 2003Basic net income
    
    $
    12,626
    
    
    
    22,637
    
    
    $
    0.56Effect of dilutive stock options
    
    
    
    
    
    
    333
    
    
    
    Diluted net income
    
    $
    12,626
    
    
    
    22,970
    
    
    $
    0.55
 Note 7  STOCK-BASED COMPENSATION On June 1, 2004, the Company granted stock options to officers and key
employees for the purchase of 202,800 shares of the Companys common stock at
an exercise price of $28.79 per share. The exercise price is the mean between
the highest and lowest sales price per share of the Companys common stock as
reported by the Nasdaq Stock Market on the date of grant. These options have a
term of ten years and vest and become exercisable in cumulative annual
installments of one-fifth each beginning on the first anniversary of the date
of grant. In addition, on June 1, 2004 each of the Companys non-employee directors
received a grant of non-qualified stock options to purchase 3,000 shares of
common stock as provided under the Companys 2000 Incentive Plan, for a total
of options to purchase 24,000 shares. These options were granted at an
exercise price of $28.79 per share, have a term of ten years, are fully vested
upon the completion of one year of service, and are exercisable in cumulative
annual installments of one-third each beginning on the first anniversary of the
date of grant. The Company accounts for stock-based compensation using the intrinsic
value method prescribed by Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees. Accordingly, no compensation
expense has been recognized for the Companys stock option plans. In December
2002, the Financial Accounting Standards Board (FASB) issued Statement of
Financial Accounting Standard (SFAS) 148 Accounting for Stock-Based
Compensation-Transition and Disclosure. The statement requires pro forma
disclosures that reflect the difference in stock-based employee compensation
cost, if any, included in net income and the total cost measured by the fair
value based method per SFAS 123 Accounting for Stock-Based Compensation, if
any, that would have been recognized in the income statement if the fair value
based method had been applied to all awards. 10




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The following table illustrates the effect on net income and earnings per
share if the Company had applied the fair value recognition provisions of SFAS
123 for the three and six months ended June 30, 2004 and 2003: Three Months
    
    Six MonthsEnded June 30,
    
    Ended June 30,(in thousands except per share data)
    
    2004
    
    2003
    
    2003
    
    2003Net income, as reported
    
    $
    9,023
    
    
    $
    6,163
    
    
    $
    16,897
    
    
    $
    12,626Deduct: Total stock-based employee compensation
expense determined under the fair value based
method for all awards, net of tax
    
    
    (534
    )
    
    
    (466
    )
    
    
    (883
    )
    
    
    (899
    )Proforma net income
    
    $
    8,489
    
    
    $
    5,697
    
    
    $
    16,014
    
    
    $
    11,727Earnings per share:Basic-as reported
    
    $
    0.39
    
    
    $
    0.27
    
    
    $
    0.74
    
    
    $
    0.56Basic-proforma
    
    $
    0.37
    
    
    $
    0.25
    
    
    $
    0.70
    
    
    $
    0.52Diluted-as reported
    
    $
    0.39
    
    
    $
    0.27
    
    
    $
    0.73
    
    
    $
    0.55Diluted-proforma
    
    $
    0.36
    
    
    $
    0.25
    
    
    $
    0.69
    
    
    $
    0.51
 On June 1, 2004, the Company granted a total of 78,500 restricted stock
units to officers and key employees. A stock unit represents the right to
receive a share of common stock on the date the restrictions on the unit lapse.
The restrictions on restricted stock units lapse over a five year period with
sixty percent of the units vesting on the third anniversary of the date of
grant and twenty percent vesting on each of the fourth and fifth anniversary
dates of the grant. In the event a grantee terminates employment with the
Company, any restricted stock units remaining subject to restrictions are
forfeited. Restricted unit awards result in the recognition of deferred
compensation. Deferred compensation is a contra-equity account with an offset
to additional paid in capital and is amortized to operating expense over the
vesting period of the award. Additionally, on June 1, 2004 each of the Companys non-employee directors
received a grant of 2,500 deferred share units, for a total of 20,000 units.
Each deferred share unit represents one hypothetical share of common stock.
The deferred share units vest and become payable three years from the date of
grant if the director remains a member of the Companys Board of Directors at
such time, or earlier under specified circumstances. Upon vesting, the
deferred share units are settled in cash at the fair market value of common
stock on a one-for-one basis. Note 8  EMPLOYEE BENEFITS The Company has a defined benefit plan and post retirement health and life
benefits which are described in detail in Note 6 EMPLOYEE BENEFITS under Item
8 of our Annual Report on Form 10-K for the year-ended December 31, 2003 filed
with the Securities 11




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##### Table of Contents



and Exchange Commission. The table below shows the amount of estimated
net periodic benefit costs under each plan for the three and six months ended
June 30: Post RetirementHealth and LifeDefined Benefit Plan
    
    BenefitsThree Months
    
    Three MonthsEnded June 30,
    
    Ended June 30,(in thousands)
    
    2004
    
    2003
    
    2004
    
    2003Components of net periodic benefit cost
Service cost
    
    $
    
    
    
    $
    
    
    
    $
    14
    
    
    $
    14Interest cost
    
    
    453
    
    
    
    437
    
    
    
    82
    
    
    
    101Expected return on plan assets
    
    
    (441
    )
    
    
    (439
    )
    
    
    
    
    
    
    Amortization of prior service cost (benefit)
    
    
    4
    
    
    
    4
    
    
    
    (122
    )
    
    
    (122
    )Amortization of net loss
    
    
    
    
    
    
    32
    
    
    
    
    
    
    
    Amortization of transition obligation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net periodic cost
    
    $
    16
    
    
    $
    34
    
    
    $
    (26
    )
    
    $
    (7
    )
 Post RetirementHealth and LifeDefined Benefit Plan
    
    BenefitsSix Months
    
    Six MonthsEnded June 30,
    
    Ended June 30,(in thousands)
    
    2004
    
    2003
    
    2004
    
    2003Components of net periodic benefit cost
Service cost
    
    $
    
    
    
    $
    
    
    
    $
    27
    
    
    $
    28Interest cost
    
    
    905
    
    
    
    874
    
    
    
    163
    
    
    
    202Expected return on plan assets
    
    
    (882
    )
    
    
    (878
    )
    
    
    
    
    
    
    Amortization of prior service cost (benefit)
    
    
    8
    
    
    
    8
    
    
    
    (244
    )
    
    
    (244
    )Amortization of net loss
    
    
    
    
    
    
    65
    
    
    
    
    
    
    
    Amortization of transition obligation
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net periodic cost
    
    $
    31
    
    
    $
    69
    
    
    $
    (54
    )
    
    $
    (14
    )
 Note 9  SEGMENT AND RELATED INFORMATION In accordance with SFAS No. 131, Disclosures About Segments of an
Enterprise and Related Information, the Company has identified the following
reportable segments: Premium Connection and Pressure Control. The Companys premium connection segment manufactures premium connections
that are used in drilling environments where extreme pressure, temperature,
corrosion and mechanical stress are encountered, as well as in environmentally
sensitive drilling. These harsh drilling conditions are typical for deepwater,
deep-formation and horizontal or highly deviated wells. Hydril applies premium
threaded connections to tubulars owned by its customers and purchases pipe in
certain international markets for threading and resale. 12




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Hydril manufactures premium threaded connections and provides services at
facilities located in Houston, Texas; Westwego, Louisiana; Bakersfield,
California; Nisku, Alberta, and Dartmouth, Nova Scotia, Canada; Aberdeen,
Scotland; Veracruz, Mexico; Batam, Indonesia; and Warri, Nigeria. The Companys pressure control segment manufactures a broad range of
pressure control equipment used in oil and gas drilling and well completion
typically employed in harsh environments. The Companys pressure control
products are primarily safety devices that control and contain fluid and gas
pressure during drilling, completion and maintenance in oil and gas wells. The
Company also provides aftermarket replacement parts, repair and field services
for its installed base of pressure control equipment. Hydril manufactures
pressure control products at two plant locations in Houston, Texas. The accounting policies of the segments are the same as those described in
Note 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES under Item 8 of our Annual
Report on Form 10-K for the year-ended December 31, 2003 filed with the
Securities and Exchange Commission. The Company evaluates segment performance
based on operating income or loss. Financial data for the business segments for the three and six months
ended June 30, 2004 and 2003 is as follows: Three Months Ended
    
    Six Months EndedJune 30,
    
    June 30,(in thousands)
    
    2004
    
    2003
    
    2004
    
    2003RevenuePremium Connection
    
    $
    39,564
    
    
    $
    28,057
    
    
    $
    72,989
    
    
    $
    59,502Pressure Control
    
    
    23,341
    
    
    
    26,494
    
    
    
    47,413
    
    
    
    52,387Total
    
    $
    62,905
    
    
    $
    54,551
    
    
    $
    120,402
    
    
    $
    111,889Operating income (loss)Premium Connection
    
    $
    12,778
    
    
    $
    7,230
    
    
    $
    22,175
    
    
    $
    15,436Pressure Control
    
    
    4,491
    
    
    
    5,803
    
    
    
    9,277
    
    
    
    11,064Corporate Administration
    
    
    (3,901
    )
    
    
    (3,345
    )
    
    
    (7,627
    )
    
    
    (6,484
    )Total
    
    $
    13,368
    
    
    $
    9,688
    
    
    $
    23,825
    
    
    $
    20,016Depreciation expensePremium Connection
    
    $
    1,901
    
    
    $
    1,808
    
    
    $
    3,806
    
    
    $
    3,591Pressure Control
    
    
    723
    
    
    
    685
    
    
    
    1,443
    
    
    
    1,362Corporate Administration
    
    
    475
    
    
    
    432
    
    
    
    956
    
    
    
    861Total
    
    $
    3,099
    
    
    $
    2,925
    
    
    $
    6,205
    
    
    $
    5,814Capital expendituresPremium Connection
    
    $
    1,169
    
    
    $
    1,171
    
    
    $
    1,955
    
    
    $
    1,795Pressure Control
    
    
    273
    
    
    
    707
    
    
    
    772
    
    
    
    1,592Corporate Administration
    
    
    142
    
    
    
    234
    
    
    
    259
    
    
    
    528Total
    
    $
    1,584
    
    
    $
    2,112
    
    
    $
    2,986
    
    
    $
    3,915
 13




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Part I, Item 2: Managements Discussion and Analysis of Financial Condition
and Results of Operations The following discussion of Hydrils historical results of operations and
financial condition should be read in conjunction with Hydrils unaudited
consolidated financial statements and notes thereto included elsewhere in this
report and the audited consolidated financial statements and notes thereto
included in Hydrils Annual Report on Form 10-K for the year ended December 31,
2003. OVERVIEW Hydril Company is engaged worldwide in engineering, manufacturing and
marketing premium connection and pressure control products used for oil and gas
drilling and production. Hydril applies premium threaded connections to
tubulars owned by its customers and purchases pipe in certain international
markets for threading and resale. Our premium connections are used in drilling
environments where extreme pressure, temperature, corrosion and mechanical
stress are encountered, as well as in environmentally sensitive drilling.
These harsh drilling conditions are typical for deep-formation, deepwater and
horizontal or highly deviated wells. Our pressure control products are
primarily safety devices that control and contain fluid and gas pressure during
drilling, completion and maintenance of oil and gas wells in these same
environments. We also provide aftermarket replacement parts, repair and field
services for our installed base of pressure control equipment. These products
and services are required on a recurring basis because of the impact on
original equipment from the extreme conditions in which pressure control
products are used. Demand for our products and services is cyclical and substantially
dependent on the activity levels in the oil and gas industry and our customers
willingness to spend capital on the exploration and development of oil and gas
reserves. The level of these capital expenditures is highly sensitive to
current and expected oil and gas prices, which have historically been
characterized by significant volatility. Generally, increasing commodity
prices result in increased oil and gas exploration and production, which
translates into greater demand for oilfield products and services. Conversely,
falling commodity prices generally result in reduced demand for oilfield
products and services. Historically, changes in budgets and activity levels by
oil and gas exploration and production companies have lagged significant
movements in commodity prices. Our premium connection products are marketed primarily to exploration and
production company operators. The premium connection market is driven by the
level of worldwide drilling activity, in particular by the number of rigs
drilling to a target depth greater than 15,000 feet and rigs drilling in water
depths greater than 1,500 feet. The majority of such wells have been drilled
in North America. These depths require substantially more premium connections
than shallower wells. Internationally, while the total international rig count
is a general indicator of the premium connection market, there are many
variables, including political and civil unrest, which may adversely impact the 14




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level of drilling activity in particular countries or regions. If we are
affected by conditions that exist in only specific markets, our premium
connections results may differ relative to movements in the international rig
count. We sell our pressure control products primarily to drilling contractors
for use in oil and gas drilling and to a lesser extent to exploration and
production companies for oil and gas production. The main factors that affect
sales of pressure control capital equipment products are the level of
construction of new drilling rigs and the rate at which existing rigs are
refurbished. Demand for our pressure control aftermarket replacement parts,
repair and field services primarily depends upon the level of worldwide
offshore drilling activity as well as the total U.S. rig count. The following
tables illustrate the data for these sectors over the last five quarters: Average
    
    AverageU.S. Rig Count
    
    Gulf of Mexico Rig CountOver 15,000 ft Target Depth (1)
    
    Over 1,500 ft Water Depth (2)Quarter
    
    Number
    
    NumberEnded
    
    of Rigs
    
    of Rigs06/30/03
    
    
    
    131
    
    
    
    2609/30/03
    
    
    
    153
    
    
    
    2312/31/03
    
    
    
    162
    
    
    
    2003/31/04
    
    
    
    170
    
    
    
    2006/30/04
    
    
    
    164
    
    
    
    20
 AverageWorldwide Offshore
    
    U.S. TotalRig Count (3)
    
    Rig Count (4)Quarter
    
    Number
    
    NumberEnded
    
    of Rigs
    
    of Rigs06/30/03
    
    
    
    343
    
    
    
    1,02809/30/03
    
    
    
    339
    
    
    
    1,08812/31/03
    
    
    
    346
    
    
    
    1,10903/31/04
    
    
    
    337
    
    
    
    1,11806/30/04
    
    
    
    349
    
    
    
    1,164
  (1)
    
    Source: Average rig count calculated by Hydril using weekly
data published by Smith International.(2)
    
    Source: Average rig count calculated by Hydril using
month-end data provided by ODS-Petrodata Group.(3)
    
    Source: Average rig count calculated by Hydril using weekly
data for the United States and Canada, and monthly data for the
international regions, as published by Baker Hughes International.
The worldwide offshore rig count includes data for Europe, the
Middle East, Africa, Latin America, Asia Pacific, the United States
and Canada, and therefore excludes the Former Soviet Union and
China. 15




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##### Table of Contents



(4)
    
    Source: Average rig count calculated by Hydril using weekly
data published by Baker Hughes Incorporated. RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2004 AND
2003 Revenue Total revenue increased $8.3 million, to $62.9 million for the three
months ended June 30, 2004 compared to $54.6 million for the three months ended
June 30, 2003. Our premium connection revenue increased $11.5 million, or 41%,
to $39.6 million for the three months ended June 30, 2004 compared to $28.1
million for the prior year period. This increase was primarily the result of
higher demand in certain international markets, primarily Latin America, and in
North America due to higher levels of drilling activity. Pressure control
revenue decreased $3.2 million, or 12%, to $23.3 million for the three months
ended June 30, 2004 compared to $26.5 million for the same period in 2003.
Pressure control capital equipment revenue decreased 27% primarily due to lower
revenue from projects that are complete or nearing completion, consistent with
the low level of new rig construction and refurbishment in the industry.
Aftermarket pressure control revenue, was $14.7 million for the three months
ended June 30, 2004 compared to $14.6 million for the prior year period. Gross Profit Gross profit increased $4.5 million to $26.1 million for the three months
ended June 30, 2004 compared to $21.6 million for the prior year period. Gross
profit in our premium connection segment increased over the prior year quarter
due to higher demand which led to higher plant utilization, and accordingly,
lower manufacturing costs per unit. Pressure control gross profit decreased
from the prior year period due to the decline in capital equipment revenue. Selling, General and Administrative Expenses Selling, general, and administrative expenses for the three months ended
June 30, 2004 were $12.7 million compared to $11.9 million for the prior year
quarter. Higher employee incentive accruals resulting from the improved
financial performance, and higher sales and marketing expenses in the second
quarter of 2004 were partially offset by lower engineering expenses when
compared to the prior year period. As a percentage of revenue, selling,
general, and administrative expenses were 20% for the second quarter of 2004
compared to 22% for the prior year quarter. Operating Income Operating income increased $3.7 million to $13.4 million for the three
months ended June 30, 2004 compared to $9.7 million for the same period in
2003. Operating income for our premium connection segment increased $5.6
million to $12.8 million for the second quarter of 2004 from $7.2 million for
the first quarter of 2003. Operating income for our 16




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pressure control segment decreased $1.3 million to $4.5 million for the
quarter ended June 30, 2004 compared to the same period in 2003. Corporate and
administrative expenses were $3.9 million for the three months ended June 30,
2004 compared to $3.3 million for the prior year period due to higher
administrative expenses and employee compensation incentives. Interest Expense There was no interest expense for the three months ended June 30, 2004
compared to $0.5 million for the prior year period. During the second quarter
of 2003, our remaining debt of $30.0 million was repaid. RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2004 AND 2003 Revenue Total
revenue increased $8.5 million, to $120.4 million for the six months
ended June 30, 2004 compared to $111.9 million for the six months ended June
30, 2003. Our premium connection revenue increased $13.5 million, or 23%, to
$73.0 million for the first half of 2004 compared to $59.5 million for the
prior year period. This increase was primarily the result of higher demand in
certain international markets, primarily Latin America, and in North America
due to higher levels of drilling activity. Pressure control revenue decreased
$5.0 million, or 9%, to $47.4 million for the first half of 2004 compared to
$52.4 million for the same period in 2003. Pressure control capital equipment
revenue decreased 31% primarily due to lower revenue from projects that are
complete or nearing completion, consistent with the low level of new rig
construction and refurbishment in the industry. This decrease was partially
offset by a 10% increase in aftermarket pressure control revenue, primarily
repair and service activity, principally due to an increase in worldwide
drilling activity. Gross Profit Gross profit increased $4.5 million to $48.4 million for the six months
ended June 30, 2004 compared to $43.9 million for the prior year period. Gross
profit in our premium connection segment increased over the first half of 2003
due to higher demand which led to higher plant utilization and accordingly
lower manufacturing costs per unit. Pressure control gross profit decreased
from the prior year period due to a decline in capital equipment sales which
was partially offset by an increase in higher-margin spare part sales. Selling, General and Administrative Expenses Selling, general, and administrative expenses for the six months ended
June 30, 2004 were $24.6 million compared to $23.9 million for the prior year
period. Higher employee incentive accruals resulting from improved
performance, and sales and marketing expenses in the first half of 2004 were
partially offset by lower engineering expenses when compared to the prior year
period. As a percentage of revenue, selling, general, and administrative
expenses were 20% for the first half of 2004 compared to 21% for the prior year
period. 17




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##### Table of Contents



Operating Income Operating income increased $3.8 million to $23.8 million for the six
months ended June 30, 2004 compared to $20.0 million for the same period in
2003. Operating income for our premium connection segment increased $6.7
million to $22.1 million for the first half of 2004 from $15.4 million for the
same period in 2003. Operating income for our pressure control segment
decreased $1.8 million to $9.3 million for the six months ended June 30, 2004
compared to the same period in 2003. Corporate and administrative expenses
were $7.6 million for the six months ended June 30, 2004 compared to $6.5
million for the prior year period due to higher administrative expenses and
employee compensation incentives. Interest Expense There was no interest expense for the six months ended June 30, 2004
compared to $1.1 million for the prior year period. During the second quarter
of 2003, our remaining debt of $30.0 million was repaid. Provision for Income Taxes The provision for income taxes for the six months ended June 30, 2004 was
$7.3 million compared to $6.8 million for the same period in 2003. The first
quarter of 2004 includes a research and experimentation tax credit of $0.9
million. The research and experimentation tax credit covers qualified spending
for the two-year period from 2002 to 2003. Prior to 2003, the Company was an
alternative minimum tax payer and accordingly could not benefit from this type
of tax credit. Expenses of $125,000 associated with the tax credit study are
included in general and administrative expenses. LIQUIDITY AND CAPITAL RESOURCES Our primary liquidity needs are to fund capital expenditures, fund new
product development and provide additional working capital. Capital
expenditures are expected to be $10.0 to $12.0 million for 2004, of which $3.0
million had been incurred as of June 30, 2004. Our primary source of funds is
cash flow from operations. In addition, we had cash, cash equivalents and
investments of $85.3 million as of June 30, 2004, and also have the capacity to
borrow up to $19.5 million under our committed revolving credit facilities. As
of June 30, 2004, we had $0.5 million in outstanding letters of credit and no
outstanding indebtedness. We believe that cash from operations and existing cash, cash equivalents
and investment balances will be sufficient to meet anticipated cash
requirements, including working capital needs, contractual obligations and
planned capital expenditures, for at least the next 12 months. In the
longer-term, if we were to need additional cash, we could borrow under our
credit facilities and anticipate that we could also raise additional funds
through issuing debt or equity securities. 18




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Operating Activities For the six months ended June 30, 2004, cash provided by operating
activities was $24.1 million primarily due to earnings, lower working capital
requirements and contractual cash payments received from customers on long-term
capital equipment projects. Cash provided by operating activities was $17.2
million for the six months ended June 30, 2003 primarily due to earnings and
contractual cash payments received from customers on long-term capital
equipment projects which was partially offset by higher working capital
requirements. Investing Activities Net cash used in investing activities was $7.3 million for the six months
ended June 30, 2004 compared to $5.9 million for the six months ended June 30,
2003. Capital spending for the six months ended June 30, 2004 of $3.0 million
included $0.8 million for our pressure control segment and $2.0 million for our
premium connection segment, in both cases primarily to support manufacturing
operations, and $0.2 million for general corporate purposes. Capital spending
for the six months ended June 30, 2003 of $3.9 million included $1.6 million
for our pressure control segment and $1.8 million for our premium connection
segment, in both cases primarily to support manufacturing operations, and $0.5
million for general corporate purposes. Credit Facilities We have two unsecured revolving lines of credit for working capital
requirements that provide up to $20.0 million in total committed revolving
credit borrowings through June 30, 2005. Of these, $15.0 million relates to
our U.S. operations and $5.0 million relates to our foreign operations. Under
these lines, we may borrow, at our election, at either a prime or LIBOR based
interest rate. Interest rates fluctuate depending on our leverage ratio and
are prime minus a spread ranging from 60 to 115 basis points or LIBOR plus a
spread ranging from 85 to 140 basis points. At June 30, 2004, there were no
outstanding borrowings under either facility. Our U.S. revolving credit
agreement contains covenants with respect to debt levels, tangible net worth
and debt-to-capitalization ratios. At June 30, 2004, we were in compliance
with these covenants. Our foreign line of credit does not contain any separate
financial covenants but contains cross-default provisions which would be
triggered by a default under our U.S. line of credit. The terms of the Companys credit facilities allow for the issuance of
letters of credit. The amount of outstanding letters of credit reduces the
amount available for borrowing under the credit facilities. The letters of
credit are generally short in duration and immaterial in amount. At June 30,
2004 there was approximately $0.5 million outstanding in letters of credit. Additional Contractual Cash Obligations We made disclosure of certain estimated obligations in the
Contractual Cash Obligations table included in Item 7 of our Annual
Report on Form 10-K for the year ended December 31, 2003. In addition
to those items, we estimate that we will 19




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make cash payments in the future for our long-term liabilities,
which currently consist of post-retirement health and life benefits,
pension plan benefits and deferred compensation. We estimate that those
cash payments will be approximately $0.7 million, $1.6 million, $1.4
million and $11.5 million for each of the 2004, 2005-2006 and 2007-2008
periods and thereafter, respectively. Backlog The pressure control capital equipment backlog was $14.0 million at June
30, 2004, $11.5 million at December 31, 2003 and $19.2 million at June 30,
2003. The decrease from June 30, 2003 was the result of work completed and
revenue recognized on several large long-term capital equipment project orders
and no new substantial project orders having been received. Substantially all
of the remaining revenue from projects currently in backlog is expected to be
recorded by the end of 2004. We recognize the revenue and gross profit from
pressure control long-term projects using the percentage-of-completion
accounting method. As revenue is recognized under the percentage-of-completion
method, the order value in backlog is reduced. It is possible for orders to be
cancelled; however, in the event of cancellations all costs incurred would be
billable to the customer. Our backlog of premium connection and pressure
control aftermarket parts and service is not a meaningful measure of business
prospects due to the quick turnover of such orders. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Our accounting policies are described in Note 1 in the Notes to
Consolidated Financial Statements in Item 8 of our Annual Report on Form 10-K
for the year ended December 31, 2003. We prepare our consolidated financial
statements in conformity with accounting principles generally accepted in the
United States, which require us to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosures of contingent
assets and liabilities at the date of the financial statements and the reported
amounts of revenue and expense during the year. Actual results could differ
from those estimates. We consider the following policies and related estimates
to be most critical in understanding the judgments that are involved in
preparing our financial statements and the uncertainties that could impact our
results of operations, financial condition and cash flows. Revenue Recognition Revenue for most of our products and services is recognized at the time
those products are delivered or services are performed. For the years ended
December 31, 2003, 2002 and 2001 approximately 87%, 84% and 92%, respectively
of our total revenues were recognized on this basis. A smaller portion of our revenue is generated from long-term contracts in
our pressure control segment. These long-term contracts are generally
contracts from six to eighteen months with an estimated contract price in
excess of $1.0 million. Revenue from long-term contracts was approximately
13%, 16% and 8% of total revenue for the years ended December 31, 2003, 2002
and 2001, respectively. Pressure control capital equipment 20




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backlog, which includes future long-term contract revenue, was $11.5
million, $32.5 million and $55.8 million for the years ended December 31, 2003,
2002 and 2001, respectively. Revenue and profit from long-term contracts are recognized as work
progresses using the percentage-of-completion method in accordance with the
American Institute of Certified Public Accountants Statement of Position 81-1,
Accounting for Performance of Construction-Type and Certain Production-Type
Contracts. Under this method, estimated contract income and resulting revenue
is generally accrued based on costs incurred to date as a percentage of total
estimated costs. This requires us to estimate the contract costs, which
include all direct material, labor and subcontract costs and those indirect
costs related to contract performance. Recognized revenues and profit are
subject to revisions as the contract progresses to completion. Revisions in
estimates are charged to income or expense in the period in which the facts and
circumstances that give rise to the revision become known. If a long-term
contract were anticipated to have an estimated loss, such loss would be
recognized in the period in which the loss became apparent. For the years 2001 through 2003, our estimates of total costs and costs to
complete have approximated actual costs incurred to complete contracts.
However, there are many factors that impact future costs, including but not
limited to the cost of labor and materials and other factors as outlined in our
Risk Factors. Unexpected changes in these factors could affect the accuracy
of our estimates and materially impact our future reported earnings. Inventories Our inventories are stated at the lower of cost or market. Inventory
costs include material, labor and production overhead. Cost is determined by
the last in, first out (LIFO) method for substantially all pressure control
products (approximately 84% and 85% of total gross inventories at December 31,
2003 and 2002, respectively) and by the first-in, first-out (FIFO) method for
all other inventories. If the FIFO method had been used to value all
inventories, the cost of inventory would have been $13.4 million, $13.3 million
and $12.1 million higher at December 31, 2003, 2002 and 2001, respectively. The Company provides a reserve for the difference between the carrying
value of excess or obsolete inventory items and their estimated net realizable
value (market price). The reserve was $11.1 million, $7.7 million and $8.0
million at each of December 31, 2003, 2002 and 2001. Additions to the reserve
were $4.0 million, $3.9 million and $3.8 million for the years ended December
31, 2003, 2002 and 2001, respectively. Our industry is cyclical in nature,
which can cause some inventory items to be slow-moving and in excess between
industry cycles. As a result, our provision for excess and obsolete inventory
has tended to be higher for the 2001 through 2003 periods when our industry,
and especially the pressure control capital equipment market, was weaker than
in prior periods. In order to determine the appropriate reserve for excess and obsolete
inventory, we perform a detailed review of inventory at least annually and
review the reserve on a more generalized basis at least quarterly. Reserves
for inventory obsolescence are determined based on our historical usage of
inventory on-hand as well as our estimates regarding future 21




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market demand and other factors. We could be required to increase our
reserve as a result of unexpected downturns in market demand for specific
products, new technology that renders certain products obsolete or changes in
customer purchasing decisions due to a shift in market activity. Additions to
the reserve are recorded as an expense and included in cost of sales. We
believe that our reserves are adequate to cover anticipated losses under
current conditions; however, significant or unanticipated changes to our
estimates and forecasts, either adverse or positive, could impact the amount
and timing of any additional provisions for excess or obsolete inventory that
may be required. If an additional 1% of our gross inventories had been
determined to be excess or obsolete inventory during 2003, our pre-tax income
would have been reduced by approximately $0.6 million. Product Warranties The Company sells most of its products to customers with a product
warranty. This warranty provides that customers can return a defective product
during a specified warranty period, generally one year, following the purchase.
In such event, we would exchange the defective product for a replacement
product, repair the defective product at no cost to the customer or issue a
credit to the customer. The cost of product warranties is estimated and
recorded as an accrued liability at the time of delivery of a product, or in
some cases, when specific warranty claims are made. The estimates of exposure
for product warranties are based on known warranty claims as well as current
and historical warranty costs incurred. Additions to the reserve are recorded
as an expense and included in cost of goods sold. The reserve for product warranties was $2.2 million, $3.3 million and $3.2
million as of December 31, 2003, 2002 and 2001, respectively, and additions to
the warranty reserve were $0.3 million, $0.7 million and $3.0 million for the
respective years then ended. Actual warranty claims paid were $1.3 million,
$0.7 million and $3.7 million for the years ended December 31, 2003, 2002 and
2001, respectively. We believe that our reserve for product warranties is
sufficient based on our current estimates. However, because we manufacture
complicated products that are subjected to harsh drilling environments, our
experience with warranty claims may vary from period to period. Should actual
product failure rates or repair costs be higher than the Companys current
estimates, increases in the estimated warranty liability could be required. Pension Plan The Company has a frozen defined benefit pension plan covering
substantially all of its U.S. employees. Benefits are based on the employees
years of service and compensation. No additional benefits are being accrued
under this plan, which was frozen effective December 31, 2001. At December 31,
2003, the Company had an estimated unfunded pension obligation under the plan
of $0.9 million. Net periodic pension cost was $0.1 million, $0.2 million and
$1.7 million for each of the years ended December 31, 2003, 2002 and 2001. The
Company made contributions to the pension plan of $7.0 million and $1.7 million
in 2003 and 2002, respectively. Based on current expectations, the Company
does not plan to make any additional contribution during 2004. 22




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The Companys pension costs and obligations recorded in the financial
statements are determined on an actuarial basis. In order to estimate the
pension obligation, management must make assumptions regarding the discount
rate used to determine the present value of liabilities and the rate of return
on pension assets. We use third-party specialists to assist management in
evaluating our assumptions, which are reviewed annually. The assumed discount
rate used in determining the benefit obligation was 6.0%, 6.5% and 6.75% at
December 31, 2003, 2002 and 2001, respectively. Discount rates are based on
the yield of high quality corporate bonds. Significant changes in the discount
rate, such as those caused by changes to the yield curve, the mix of bonds
available in the market, the maturity of selected bonds, and the timing of
expected benefit payments may result in volatility. Plan assets consist
primarily of investments in equities and fixed income funds. The expected
long-term rate of return on pension plan assets at December 31, 2003, 2002 and
2001 was 6.0%, 8.0% and 9.0%, respectively. The expected long-term rate of
return is based on anticipated future returns in each of the plans asset
categories. Changes in any of the assumptions used, as well as differences
between actual results and estimates, could impact our projected benefit
obligation and benefit costs. The following table illustrates the sensitivity to a change in certain
assumptions used in the calculation of pension expense for the year ending
December 31, 2004 and the calculation of the projected benefit obligation (PBO)
at December 31, 2003 for the Companys pension plan: Impact on
    
    Impact on2004 Pre-tax
    
    December 31, 2003(in millions)
    
    Pension Expense
    
    PBOChange in Assumption:50 basis point decrease in discount rate
    
    $
    0.2
    
    
    $
    2.550 basis point increase in discount rate
    
    
    *
    
    
    
    (2.2
    )50 basis point decrease in expected return on
assets
    
    
    0.1
    
    
    
    50 basis point increase in expected return on
assets
    
    
    (0.1
    )
    
    
    
  *
    
    Amount was negligible. 23




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Post-Retirement Health and Life Benefits The Company provides certain medical, life insurance and/or dental
benefits for eligible employees, hired before December 31, 1989, who have or
will retire under one of the Companys pension plans. At December 31, 2003,
the Company had an estimated unfunded obligation for retiree life and health of
approximately $8.9 million. The Company recognized post-retirement benefit
income for the year ended December 31, 2003 of approximately $29,000 and had
post-retirement benefit expense of $67,000 and $30,000 for the years ended
December 31, 2002 and 2001, respectively. The Company made cash payments to
pay for post-retirement health and life benefits of $0.7 million and $0.8
million for the years ended December 31, 2003 and 2002, respectively. The Companys costs and obligations related to its post retirement health
and life benefits that are recorded in the financial statements are determined
on an actuarial basis. In order to estimate the obligation, management must
make many assumptions including the discount rate (discussed above
under Pension Plan), healthcare cost trends and certain employee-related
factors, such as turnover, retirement age and mortality. We use third-party
specialists to assist management in evaluating our assumptions, which are
reviewed annually. The assumed health care cost trend rates have a significant
effect on the amounts reported for the post retirement health and life plan. A
12% annual rate of increase in the per capita cost of both pre-age 65 and
post-age 65 covered health care benefits was assumed for 2003 in determining
the benefit obligation for the post-retirement health and life plan. This rate
is assumed to decrease gradually to 5% for 2011 and remain at that level
thereafter. The pre-age 65 rate was increased to 12% from the 10% rate used in
prior periods. Changes in any of the assumptions used, as well as differences
between actual results and estimates, could impact our projected obligation and
costs as well as other calculations. The following table illustrates the sensitivity to a change in certain
assumptions used in the calculation of components of post-retirement health and
life costs for the year ended December 31, 2004 and the calculation of benefit
obligation at December 31, 2003 for the Companys post-retirement health and
life benefits: Impact on 2004
    
    Impact on December 31,(in millions)
    
    Service and Interest
    
    2003 Benefit ObligationChange in Assumption:50 basis point decrease in discount rate
    
    
    *
    
    
    $
    0.250 basis point increase in discount rate
    
    
    *
    
    
    
    (0.2
    )100 basis point decrease in healthcare
cost trend rates
    
    
    *
    
    
    
    (0.1
    )100 basis point increase in healthcare
cost trend rates
    
    
    *
    
    
    
    0.1
  *
    
    Amount was negligible. 24




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RISK FACTORS You should consider carefully the following risk factors and all other
information contained in this quarterly report on Form 10-Q and our Annual
Report on Form 10-K for the year-ended December 31, 2003. Any of the following
risks could impair our business, financial condition and operating results. Risks Relating to Our Business A material or extended decline in expenditures by the oil and gas
industry, due to a decline in oil and gas prices or other economic factors,
would reduce our revenue. Demand for our products and services is substantially dependent on the
level of capital expenditures by the oil and gas industry for the exploration
for and development of crude oil and natural gas reserves. In particular,
demand for our premium connections and our aftermarket pressure control
products and services is driven by the level of worldwide drilling activity,
especially drilling in harsh environments. A substantial or extended decline
in drilling activity will adversely affect the demand for our products and
services. Demand for our pressure control capital equipment is directly
affected by the number of drilling rigs being built or refurbished. At this
time, drilling rig utilization for many categories of rigs is below capacity.
Therefore, in general, drilling contractors are not planning significant
refurbishment of drilling rigs or new rig construction. As a result of these
conditions, we do not expect to receive any significant new capital equipment
orders for at least the next several months. An extended decline in capital
equipment orders could adversely affect revenue and operating income for our
pressure control segment and could result in additional charges if we are
required to take cost reduction measures in light of business conditions. Worldwide drilling activity is generally highly sensitive to oil and gas
prices and can be dependent on the industrys view of future oil and gas
prices, which have been 25




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historically characterized by significant volatility. Oil and gas prices
are affected by numerous factors, including:  
    
    the level of worldwide oil and gas exploration and production activity;
    
    worldwide demand for energy, which is affected by worldwide economic
conditions;
    
    the policies of the Organization of Petroleum Exporting Countries, or OPEC;
    
    significant decreases or increases in the production of oil or gas from
countries due to war or civil unrest, such as in Iraq, Nigeria and
Venezuela;
    
    the cost of producing oil and gas;
    
    interest rates and the cost of capital;
    
    technological advances affecting hydrocarbon consumption, particularly oil and gas;
    
    environmental regulation;
    
    level of oil and gas inventories in storage;
    
    tax policies;
    
    policies of national governments; and
    
    war, civil disturbances and political instability. We expect prices for oil and natural gas to continue to be volatile and
affect the demand and pricing of our products and services. A material decline
in oil or gas prices could materially adversely affect our business. In
addition, recessions and other adverse economic conditions can also cause
declines in spending levels by the oil and gas industry, and thereby decrease
our revenue and materially adversely affect our business. We rely on a few distributors for sales of our premium connections in the
United States and Canada; a loss of one or more of our distributors or a change
in the method of distribution could adversely affect our ability to sell our
products. There are a limited number of distributors who buy steel tubulars,
contract with us to thread the tubulars and sell completed tubulars with our
premium connections. In 2003, our eight distributors accounted for 59% of our
premium connection sales in the United States and Canada. In the United States, tubular distributors have combined on a rapid basis
in recent years resulting in fewer distribution alternatives for our products.
In 1999, four distributors, one of which distributed our premium connections,
combined to become one of the largest distributors of tubulars in the United
States, and the combined company no longer distributes our products. Because
of the limited number of distributors, we have few alternatives if we lose a
distributor. Identifying and utilizing additional or replacement distributors
may not be accomplished quickly and could involve significant additional costs.
Even if we find replacement distributors, the terms of new distribution
agreements may not 26




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be favorable to us. In addition, distributors may not be as well
capitalized as our end-users and may present a higher credit risk. We cannot assure you that the current distribution system for premium
connections will continue. For example, products may in the future be sold
directly by tubular manufacturers to end-users or through other distribution
channels such as the internet. If methods of distribution change, many of our
competitors may be better positioned to take advantage of those changes than we
are. The intense competition in our industry could result in reduced
profitability and loss of market share for us. Contracts for our products and services are generally awarded on a
competitive basis, and competition is intense. The most important factors
considered by our customers in awarding contracts include:  
    
    availability and capabilities of the equipment;
    
    ability to meet the customers delivery schedule;
    
    price and indexes affecting price;
    
    reputation;
    
    experience;
    
    safety record, and
    
    technology. Many of our major competitors are diversified multinational companies that
are larger and have substantially greater financial resources, larger operating
staffs and greater budgets for marketing and research and development than we
do. They may be better able to compete in making equipment available faster
and more efficiently, meeting delivery schedules or reducing prices. In
addition, two or more of our major competitors could consolidate producing an
even larger company. Also our competitors may acquire product lines that would
allow them to offer a more complete package of drilling equipment and services
rather than providing only individual components. As a result of any of the
foregoing reasons, we could lose customers and market share to those
competitors. These companies may also be better able than we are to
successfully endure downturns in the oil and gas industry. We do not do business in as many countries as some of our larger
multinational competitors and in some cases even where we do business, we do
not have as significant a presence. Our lack of geographic diversity and
penetration may have a material adverse affect on our results of operations and
competitive position. Spending on exploration and production is typically
spread unevenly between various regions with changes in geographic spending
patterns arising as discoveries are made, the price of oil and gas changes,
political changes take place or other factors occur that make drilling more or
less attractive in a given geographic area. As a result, even when
international rig counts and 27




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drilling activity increase overall, if the increased activity is not in
countries in which we have a strong presence, we may not experience any
increase in business and may lose market share. Our international operations may experience severe interruptions due to
political, economic and other risks. In 2003, approximately 67% of our total revenue was derived from services
or equipment ultimately provided or delivered to end-users outside the United
States, and approximately 28% of our revenue was derived from products which
were produced and used outside of the United States. We are, therefore,
significantly exposed to the risks customarily attendant to international
operations and investments in foreign countries. These risks include:  
    
    political instability, civil disturbances, war and terrorism;
    
    nationalization, expropriation, and nullification of contracts;
    
    changes in regulations and labor practices;
    
    changes in currency exchange rates and potential devaluations;
    
    changes in currency restrictions which could limit the repatriations of
profits or capital;
    
    restrictive actions by local governments;
    
    seizure of plant and equipment; and
    
    changes in foreign tax laws. An interruption of our international operations could reduce our earnings
or adversely affect the value of our foreign assets. The occurrence of any of
these risks could also have an adverse effect on demand for our products and
services or our ability to provide them. We have manufacturing facilities in
Warri, Nigeria and in Batam, Indonesia and a portion of our revenue is from
sales to customers in these countries and surrounding areas. In addition, a
portion of our revenue is from sales to customers in Venezuela. These
countries in recent history have experienced civil disturbances and violence,
which have disrupted oil and gas exploration and production operations located
there as well as day-to-day operations and oversight of our business from time
to time. These disruptions have affected our operations and resulted in lower
demand for our premium connection products and services and, accordingly have
had an adverse affect on our results of operations in recent periods and may
continue to do so. The level and pricing of tubular goods imported into the United States and
Canada could adversely affect demand for our products and our results of
operations. The level of imports of tubular goods, which has varied significantly over
time, affects the domestic tubular goods market. High levels of imports reduce
the volume sold by domestic producers and tend to reduce their selling prices,
both of which could have an 28




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adverse impact on our business. We believe that United States import
levels are affected by, among other things:  
    
    United States and worldwide demand for tubular goods;
    
    the trade practices of and government subsidies to foreign producers;
and
    
    the presence or absence of antidumping and countervailing duty orders. In many cases, foreign producers of tubular goods have been found to have
sold their products, which may include premium connections, for export to the
United States at prices that are lower than the cost of production or their
prices in their home market or a major third-country market, a practice
commonly referred to as dumping. If not constrained by antidumping duty
orders and countervailing duty orders, which impose duties on imported tubulars
to offset dumping and subsidies provided by foreign governments, this practice
allows foreign producers to capture sales and market share from domestic
producers. Duty orders normally reduce the level of imported goods and result
in higher prices in the United States market. Duty orders may be modified or
revoked as a result of administrative reviews conducted at the request of a
foreign producer or other party. In addition, antidumping and countervailing duty orders may be revoked as
a result of periodic sunset reviews. Under the sunset review procedure, an
order must be revoked after five years unless the United States Department of
Commerce and the International Trade Commission determine that dumping is
likely to continue or recur and that material injury to the domestic injury is
likely to continue or recur. Antidumping duty orders continue to cover imports
of tubulars from Argentina, Italy, Japan, Korea and Mexico, and a
countervailing duty order continues to cover imports from Italy. On July 17,
2001, the Department of Commerce ordered the continuation of the countervailing
and antidumping duty orders on tubular goods other than drill pipe on
Argentina, Italy, Korea and Mexico, and the continuation of the antidumping
duty order on tubular goods, inclusive of drill pipe, from Japan. If the
orders covering imports from these countries are revoked in full or in part or
the duty rates lowered, we could be exposed to increased competition from
imports that could reduce our sales and market share or force us to lower
prices. Tubulars produced by domestic steel mills and threaded by us may not
be able to economically compete with tubulars manufactured and threaded at
steel mills outside the U.S. The Department of Commerce intends to initiate
the next five-year review of these orders no later that June 2006. The sunset
review for tubular products from Argentina, Italy, Japan, Korea and Mexico will
take place in 2006, with a decision expected by April 2007. 29




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We may lose premium connection business to international and domestic
competitors who produce their own pipe, as well as other new entrants. In the United States and Canada and sometimes internationally, our premium
connections are added to steel tubulars purchased by a distributor from
third-party steel suppliers. After our premium connections are added, the
distributor sells the completed premium tubular to a customer at a price that
includes, but does not differentiate between, the costs of the steel pipe and
the connection. Pricing of premium connections can be affected by steel
prices, as the steel pipe is the largest component of the overall price. We
have no control over the price of the steel pipe that is supplied for our
connections. During 2003, we derived approximately 67% of our revenue from services or
equipment ultimately provided or delivered to end-users for use outside of the
United States. Many of our larger competitors, especially internationally, are
integrated steel producers, who produce, rather than purchase, steel. For
example, several foreign steel mills have formed a corporation that is licensed
to produce and sell a competing premium connections product line outside of the
United States and Canada. Foreign integrated steel producers have more pricing
flexibility for premium connections since they control the production of both
the steel tubulars to which the connections are applied, as well as the premium
connections. This inherent pricing and supply control puts us at a competitive
disadvantage, and we could lose business to integrated steel producers even if
we may have a better product. The recent acquisition or future acquisitions of
U.S. tubular steel manufacturing capacity by foreign integrated steel producers
could result in a loss of market share for Hydril. Other domestic and foreign
steel producers who do not currently manufacture tubulars with premium
connections may in the future enter the premium connections business and
compete with us. The occurrence or threat of terrorist attacks could have an adverse affect
on our results and growth prospects, as well as on our ability to access
capital and obtain adequate insurance. The occurrence or threat of future terrorist attacks could adversely
affect the economies of the United States and other developed countries. A
lower level of economic activity could result in a decline in energy
consumption, which could cause a decrease in spending by oil and gas companies
for exploration and development. In addition, these risks could trigger
increased volatility in prices for crude oil and natural gas which could also
adversely affect spending by oil and gas companies. A decrease in spending for
any reason could adversely affect the markets for our products and thereby
adversely affect our revenue and margins and limit our future growth prospects.
Moreover, these risks could cause increased instability in the financial and
insurance markets and adversely affect our ability to access capital and to
obtain insurance coverage that we consider adequate or are otherwise required
by our contracts with third parties. The consolidation or loss of potential end-users of our products could
adversely affect demand for our products and services and reduce our revenue. 30




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Exploration and production company operators and drilling contractors have
undergone substantial consolidation in the last few years. Additional
consolidation is probable. In addition, many oil and gas properties will be
transferred over time to different potential customers. Consolidation results in fewer end-users for our products. In addition,
merger activity among both major and independent oil and gas companies also
affects exploration, development and production activity, as these consolidated
companies attempt to increase efficiency and reduce costs. Generally, only the
more promising exploration and development projects from each merged entity are
likely to be pursued, which may result in overall lower post-merger exploration
and development budgets. Moreover, some end-users are not as risk-averse and,
as such, do not use as many premium products in drilling deep formation wells. In 2003, our largest premium connection customer accounted for 21% of
segment sales, and our ten largest premium connection customers accounted for
64% of total segment sales. In 2003, our largest pressure control customer
accounted for 27% of segment sales and our ten largest pressure control
customers accounted for 65% of segment sales. The loss of one or more of our end-users, a reduction in exploration and
development budgets as a result of industry consolidation or other reasons or a
transfer of deep formation drilling prospects to end-users that do not rely as
heavily on premium products could adversely affect demand for our products and
services and reduce our revenue. Overcapacity in the pressure control industry and high fixed costs could
exacerbate the level of price competition for our products, adversely affecting
our business and revenue. There currently is and historically has been overcapacity in the pressure
control equipment industry. When oil and gas prices fall, cash flows of our
customers are reduced, leading to lower levels of expenditures and reduced
demand for pressure control equipment. In addition, adverse economic
conditions can reduce demand for oil and gas, which in turn could decrease
demand for our pressure control products. Under these conditions, the
overcapacity causes increased price competition in the sale of pressure control
products and aftermarket services as competitors seek to capture the reduced
business to cover their high fixed costs and avoid the idling of manufacturing
facilities. Because we have multiple facilities that produce different types
of pressure control products, it is even more difficult for us to reduce our
fixed costs since to do so we might have to shut down more than one plant.
During and after periods of increasing oil and gas prices when sales of
pressure control products may be increasing, the overcapacity in the industry
will tend to keep prices for the sale of pressure control products lower than
if overcapacity were not a factor. As a result, when oil and gas prices are
low, or are increasing from low levels because of increased demand, our
business and revenue may be adversely affected because of either reduced sales
volume or sales at lower prices or both. 31




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If we do not develop new technologies and products that are commercially
successful, our revenue may decline or we may be required to write-off any
capitalized investment. The markets for premium connections and pressure control products and
services are characterized by continual technological developments. As a
result, substantial improvements in the scope and quality of product function
and performance can occur over a short period of time. If we are not able to
develop commercially competitive products in a timely manner in response to
changes in technology, our business and revenue may be adversely affected. Our
future ability to develop new products depends on our ability to:  
    
    design and commercially produce products that meet the needs of our
customers;
    
    successfully market new products; and
    
    obtain and maintain patent protection. We may encounter resource constraints or technical or other difficulties
that could delay introduction of new products and services in the future. Our
competitors may introduce new products before we do and achieve a competitive
advantage. Additionally, the time and expense invested in product development
may not result in commercial applications and provide revenue. For example, while we have incurred significant amounts in the development
of new technologies, such as advanced composite tubing and subsea mudlift
drilling, demand for these products may be limited for various reasons. In the
case of subsea mudlift drilling, due in part to the cost to implement the
technology, we do not anticipate any customer orders for the product in the
near future. In addition, there are other groups of companies in our
industry that are also developing competing technologies for deepwater
drilling, and they may be ahead of us in completing development of their
technology or develop more cost effective competing products. If we are unable to successfully commercialize subsea mudlift drilling or
our advanced composite tubing or successfully implement other technological or
R&D type activities, our growth prospects may be reduced and the level of our
future revenue may be materially and adversely affected. In addition, we would
be required to write-off any capitalized investment in a product that is not a
commercial success and does not have an alternative use. 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. Limitations on our ability to protect our intellectual property rights
could cause a loss in revenue and any competitive advantage we hold. Some of our products and the processes we use to produce them have been
granted United States and international patent protection, or have patent
applications pending. Nevertheless, patents may not be granted from our
applications and, if patents are issued, the claims allowed may not be
sufficient to protect our technology. If our patents are not enforceable, our
business may be adversely affected. In addition, if any of our products 32




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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. The latter 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. After our patents expire, our competitors will not be
legally constrained from developing products substantially similar to ours. The loss of any member of our senior management and other key employees
may adversely affect our results of operations. Our success depends heavily on the continued services of our senior
management and other key employees. Our senior management consists of a small
number of individuals relative to other comparable or larger companies. These
individuals are Christopher T. Seaver, our President and Chief Executive
Officer, Charles E. Jones, our Executive Vice President and Chief Operating
Officer, Neil G. Russell, our Senior Vice President-Premium Connections and
Senior Vice President-Business Development, Chuck Chauviere-Vice
President-Pressure Control, and Chris D. North, Secretary and
Chief Financial Officer. These individuals, as well as other key
employees, possess sales and marketing, engineering, manufacturing, financial
and administrative skills that are critical to the operation of our business.
We generally do not have employment or non-competition agreements with members
of our senior management or other key employees. If we lose or suffer an
extended interruption in the services of one or more of our senior officers or
other key employees, our results of operations may be adversely affected.
Moreover, we may not be able to attract and retain qualified personnel to
succeed members of our senior management and other key employees. Our quarterly sales and earnings may vary significantly, which could cause
our stock price to fluctuate. Fluctuations in quarterly revenue and earnings could adversely affect the
trading price of our common stock. Our quarterly revenue and earnings may vary
significantly from quarter to quarter depending upon:  
    
    the level of drilling activity worldwide;
    
    the variability of customer orders, which are particularly unpredictable in international markets;
    
    the mix of our products sold and the margins on those products;
    
    new products offered and sold by us or our competitors and;
    
    weather conditions that can affect our customers operations. Revenue derived from current pressure control long-term projects is
expected to be realized over the next two quarters. As a result, our revenue
and earnings could fluctuate significantly from quarter to quarter if there is
any delay in completing these projects or if 33




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new project orders are not received. In addition, our fixed costs cause
our margins to decrease when demand is low and manufacturing capacity is
underutilized. We could be subject to substantial liability claims, which would adversely
affect our results and financial condition. Most of our products are used in hazardous drilling and production
applications where an accident or a failure of a product can have catastrophic
consequences. For example, if one of our blowout preventers fails, the oil and
gases from the well may ignite or the equipment and tubulars in the well may be
suddenly propelled out of the well, potentially resulting in injury or death of
personnel, destruction of drilling equipment, environmental damage and
suspension of operations. Damages arising from an occurrence at a location
where our products are used have in the past and may in the future result in
the assertion of potentially large claims against us. While we maintain insurance coverage against these risks, this insurance
may not protect us against liability for some kinds of events, including
specified events involving pollution, or against losses resulting from business
interruption. Our insurance may not be adequate in risk coverage or policy
limits to cover all losses or liabilities that we may incur. Moreover, we may
not be able in the future to maintain insurance at levels of risk coverage or
policy limits that we deem adequate. Any significant claims made under our
policies will likely cause our premiums to increase. Any future damages caused
by our products or services that are not covered by insurance, are in excess of
policy limits or are subject to substantial deductibles, could reduce our
earnings and our cash available for operations. If we are unable to attract and retain skilled labor, the results of our
manufacturing and services activities will be adversely affected. Our ability to operate profitably and expand our operations depends in
part on our ability to attract and retain skilled manufacturing workers,
equipment operators, engineers and other technical personnel. Because of the
cyclical nature of our industry, many qualified workers choose to work in other
industries where they believe lay-offs as a result of cyclical downturns are
less likely. As a result, our growth may be limited by the scarcity of skilled
labor. Even if we are able to attract and retain employees, the intense
competition for them, especially when our industry is in the top of its cycle,
may increase our compensation costs. Additionally, a significant increase in
the wages paid by competing employers could result in a reduction in our
skilled labor force, increases in the rates of wages we must pay or both. If
our compensation costs increase or we cannot attract and retain skilled labor,
the immediate effect on us would be a reduction in our profits and the extended
effect would be diminishment of our production capacity and profitability and
impairment of any growth potential. Changes in regulation or environmental compliance costs and liabilities
could have a material adverse effect on our results and financial condition. Our business is affected by changes in public policy, federal, state and
local laws and regulations relating to the energy industry. The adoption of
laws and regulations curtailing 34




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exploration and development drilling for oil and gas for economic,
environmental and other policy reasons may adversely affect our operations by
limiting available drilling and other opportunities in the oil and gas
exploration and production industry. Our operations and properties are subject
to increasingly stringent laws and regulations relating to environmental
protection, including laws and regulations governing air emissions, water
discharges, waste management and workplace safety. Many of our operations
require permits that may be revoked or modified, that we are required to renew
from time to time. Failure to comply with such laws, regulations or permits
can result in substantial fines and criminal sanctions, or require us to
purchase costly pollution control equipment or implement operational changes or
improvements. We incur, and expect to continue to incur, substantial capital
and operating costs to comply with environmental laws and regulations. We could become subject to claims related to the release of hazardous
substances which could adversely affect our results and financial condition. We use and generate hazardous substances and wastes in our manufacturing
operations. In addition, many of our current and former properties are or have
been used for industrial purposes for many years. Accordingly, we could become
subject to potentially material liabilities relating to the investigation and
cleanup of contaminated properties, including property owned or leased by us
now or in the past or third party sites to which we sent waste for disposal.
We also could become subject to claims alleging personal injury or property
damage as the result of exposures to, or releases of, hazardous substances. In
addition, stricter enforcement of existing laws and regulations, the enactment
of new laws and regulations, the discovery of previously unknown contamination
or the imposition of new or increased requirements could require us to incur
costs or become the basis of new or increased liabilities that could reduce our
earnings and our cash available for operations. See Note 4 CONTINGENCIES in
Item 1 of this report for more information regarding environmental
contingencies. Liability to customers under warranties may materially and adversely
affect our earnings. We provide warranties as to the proper operation and conformance to
specifications of the equipment we manufacture. Our pressure control equipment
and premium connections are often deployed in critical environments including
subsea applications. Failure of this equipment or our premium connections to
operate properly or to meet specifications may increase our costs by requiring
additional engineering resources and services, replacement of parts and
equipment or monetary reimbursement to a customer. We have in the past
received warranty claims and we expect to continue to receive them in the
future. To the extent that we incur substantial warranty claims in any period,
our reputation, our ability to obtain future business and our earnings could be
materially and adversely affected. We may lose money on fixed price contracts, and such contracts could cause
our quarterly revenue and earnings to fluctuate significantly. 35




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Almost all of our pressure control projects, including all of our larger
engineered subsea control systems projects, are performed on a fixed-price
basis. This means that we are responsible for all cost overruns, other than
any resulting from change orders. Our costs and any gross profit realized on
our fixed-price contracts could vary from the estimated amounts on which these
contracts were originally based. This may occur for various reasons,
including:  
    
    changes in cost, estimates or expected production time;
    
    engineering design changes;
    
    changes requested by customers; and
    
    changes in the availability and cost of labor and material. The variations and the risks inherent in engineered subsea control systems
projects may result in reduced profitability or losses on our projects.
Depending on the size of a project, variations from estimated contract
performance can have a significant impact on our operating results for any
particular fiscal quarter or year. Our significant losses in 1997 through 1999
on fixed-price contracts to provide pressure control equipment and subsea
control systems for pressure control equipment are an example of the problems
we can experience with fixed-price contracts. Excess cash is invested in marketable securities which may subject us to
potential losses. We invest excess cash in various securities and money market mutual funds
rated as the highest quality by a nationally recognized rating agency.
However, changes in the financial markets, including interest rates, as well as
the performance of the issuing companies can affect the market value of our
short-term investments. 
 Part I, Item 3: Quantitative and Qualitative Disclosures About Market Risk There have been no significant changes since December 31, 2003 in the
Companys exposure to market risk. 
 Part I, Item 4: Controls and Procedures Hydrils Chief Executive Officer and Chief Financial Officer have
evaluated the Companys disclosure controls and procedures as of June 30, 2004,
and they have concluded that these controls and procedures are effective.
There were no changes in the Companys internal control over financial
reporting that occurred during the Companys last fiscal quarter that have
materially affected, or are reasonably likely to materially affect, the
Companys internal control over financial reporting. 36




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Part II, Item 4: Submission of Matters to a vote of Security Holders Our annual meeting of shareholders was held on May 18, 2004. There were
80,471,488 votes represented at the meeting in person or by proxy, out of
83,419,621 votes entitled to be cast, constituting a quorum. The following are
the results of the vote: BrokerNon-For
    
    Against
    
    Withheld
    
    Abstain
    
    VotesProposals:Election of DirectorsKenneth McCormick
    
    
    79,815,100
    
    
    
    
    
    
    
    656,388
    
    
    
    
    
    
    
    Christopher T. Seaver
    
    
    76,297,729
    
    
    
    
    
    
    
    4,173,759
    
    
    
    
    
    
    
    Lew O. Ward
    
    
    72,510,142
    
    
    
    
    
    
    
    7,961,346
    
    
    
    
    
    
    
    Approval of Appointment
of Deloitte & Touche LLP
as Independent PublicAccountants
    
    
    79,938,317
    
    
    
    355,621
    
    
    
    
    
    
    
    177,550
    
    
    
    
 
 Part II, Item 6: Exhibits and Reports on Form 8-K Exhibits:10.1
    
    
    
    Form of 2004 Directors Deferred Share Unit Agreement.31.1
    
    
    
    Certification by Christopher T. Seaver, Chief Executive
Officer, pursuant to Rule 13a-14(a) of the Securities Exchange Act
of 1934.31.2
    
    
    
    Certification by Chris D. North, Chief Financial
Officer, pursuant to Rule 13a-14(a) of the Securities Exchange Act
of 1934.32.1
    
    
    
    Certification by Christopher T. Seaver, Chief Executive
Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(Subsection (a) and (b) of Section 1350, Chapter 63 of Title 18,
United States Code).32.2
    
    
    
    Certification by Chris D. North, Chief Financial
Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(Subsection (a) and (b) of Section 1350, Chapter 63 of Title 18,
United States Code).
 37




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Reports on Form 8-K: On April 29, 2004, we submitted a report on Form 8-K furnishing pursuant
to Item 12 the news release issued by Hydril Company dated April 28, 2004.
Pursuant to Item 7, we attached the news release as an exhibit to the report. SIGNATURE Pursuant to the requirements 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. HYDRIL COMPANYDate: August 6, 2004
    By:
    /s/  Chris D. NorthChris D. NorthChief Financial Officer (Authorized officer and principal
accounting and financial officer) 38




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EXHIBIT INDEX 10.1
    
    
    
    Form of 2004 Directors Deferred Share Unit Agreement.31.1
    
    
    
    Certification by Christopher T. Seaver, Chief Executive
Officer, pursuant to Rule 13a-14(a) of the Securities Exchange Act
of 1934.31.2
    
    
    
    Certification by Chris D. North, Chief Financial
Officer, pursuant to Rule 13a-14(a) of the Securities Exchange Act
of 1934.32.1
    
    
    
    Certification by Christopher T. Seaver, Chief Executive
Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(Subsection (a) and (b) of Section 1350, Chapter 63 of Title 18,
United States Code).32.2
    
    
    
    Certification by Chris D. North, Chief Financial
Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
(Subsection (a) and (b) of Section 1350, Chapter 63 of Title 18,
United States Code).
 39