國民油井華高 (NOV) 2003 Q2 法說會逐字稿

Good morning. My name is Adrienne (ph) and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Grant Prideco Reports Second-quarter Earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer period. (CALLER INSTRUCTIONS). Thank you. Mr. Mike McShane, you may begin your conference.

Thank you. Good morning, everybody, and thank you for joining us this morning to discuss our second-quarter earnings release. As always, Lou Raspino, our Senior VP and CFO, is with me, and Lou will discuss the numbers in a little bit of detail here in a few minutes.

Let's begin with -- as always, we will make a few forward-looking statements, and I will refer you to our SEC disclosures, which describe and discuss the risks and assumptions therein.

We released earnings a little while ago for the second quarter -- $3.8 million in earnings, three cents per share, essentially flat with the first quarter. As highlighted in the earnings release, there are many special items impacting the results this quarter. Lou will go through those in a little more detail. But we had the renegotiation of a liability to our former Parent, Wurtherford (ph), which was completed during the quarter, resulting in a favorable gain -- I guess all gains are favorable -- $6.5 million. We had an inventory reserve of approximately $6.5 million related to some of the discontinued business lines that we've discussed in prior quarters. Then we had about $1.7 million of transition related expenses associated with the ReedHycalog operations, and we will discuss those as well. If you were to exclude these items, then we came in at about 4.9 million in earnings, four cents per share -- again, essentially flat with the prior quarter; the prior quarter likewise had some special items as well, which are highlighted in the press release.

So, while earnings were essentially flat quarter-to-quarter, the way we got there was a little bit different. While volumes were up on the drill pipe side of the business, the quality of revenues was not quite as good. As a result, their margins declined. We likewise had a bit of a setback in revenues in the Marine Products division. These declines were offset by essentially stable operating results at the Tubular Division and improvements at ReedHycalog.

Before we go into a discussion of the revenues and earnings, let me just touch on a few operating highlights during the quarter. We are now six months into the ownership of ReedHycalog. As discussed at the time of the acquisition, the first six months was viewed to be the transition period. We've had some 30 to 40 countries where we've had to get out from underneath the legal umbrella of Schlumberger (ph) (inaudible) establish operating entities, relationships in those countries. We've had numerous office moves to complete, organizations to put in place. Those have all gone exceedingly well. While a major distraction to the management team of ReedHycalog, they have managed to maintain their competitive position in the marketplace. They've had a very successful product launch with their TReX PDC bits and as reflected in results, produced very strong revenues and margins, so we're quite pleased with that operation.

On the Marine Division, specifically to the XL product line, while clearly disappointed with the revenue results this quarter, we understand what happened to us. We had a number of orders where shipments were delayed; those shipments -- those orders have since been shipped or are in the process of being shipped during the quarter. The nature of that business is very project oriented and so things frequently do get pushed out from quarter-to-quarter. The current quarter results we don't think are reflective of the underlying momentum with that product line. They have been very successful in being awarded two major contracts during the quarter, one with BP and one with Pemex (ph). These are both large tenders which give them a very solid foundation of business that makes it easier for them to schedule manufacturing, so we're quite pleased with the progress. Likewise, they have proceeded with the development of their new weld-on connector, which should be ready for market launch during this quarter. We are progressing with the completion of two international facilities in Indonesia and Holland, which will better position them to support those markets. So again, while disappointed with the current quarter results, we again don't think it's reflective of the underlying momentum in that group.

On the manufacturing side, during the quarter, we started up the automated welding and upsetting operations at Navasoto (ph), which lead to operating efficiencies. With the subsidence of the SARS scare in China, we've been able to proceed with the installation of our new automated upsetting operations, which eventually will enable us to source our green tubes within country and reduce our manufacturing costs. We've also continued to make some headway on the R&D front with the intelli-pipe (ph) project. We now have all three of the major MWD (ph) companies either in possession of pipe or discussing taking possession of pipe to work on tool-compatibility issues. We have progressed, as I mentioned, with our weld-on connector for the XL product line. Reed is in the process of rolling of their new tough duty roller-cone (ph) bits and the initial results are quite encouraging. We continue to make progress with our GPEX (ph); that's our composite motor and mud business, and expect product testing in the field by late 2003.

I guess the other note would be that, finally, we've seen a bit of an improvement in our backlog on the drilling product side. Although not a big number, it's in the right direction. It's up and the pricing is up, so that's encouraging to us. Clearly, the Marine backlog is reflective of these recent tender awards. So, there some good news there.

Now, let's go through each of the divisions in a little more detail. As I mentioned, on revenues overall, $190 million -- essentially flat quarter-to-quarter. Increases at Drilling Products -- they were up about $4 million, or six percent. As we discussed on the last conference call, this revenue growth was fueled by some low-margin, small-diameter API-type drill pipe where clearly the revenue per foot and the margin per foot is not as attractive as our premium products. ReedHycalog increased revenues by $3.5 million, which was a pleasant surprise; we had anticipated their revenues to be essentially flat in the second quarter with a significant downturn in Canada. They were able to not only offset that but grow their revenues on the strength of some international performance. This offset the revenue decline in the Marine group due to some of these project delays (indiscernible) reduced revenues in the other segment, which was the exit of our industrial business, and the Tubular Technology revenues were off only slightly, down about $900,000. Year-over-year revenues increased from 168 million to 190 million, clearly on the addition of ReedHycalog, which was offset by declines in our other segments.

More specifically, (indiscernible) Drilling Products. As I mentioned, revenue was up on these low-margin businesses. Sales volumes increased 23 percent. We sold 1.7 million feet of drill pipe during the quarter, compared to 1.3 million feet the first quarter, so while volumes are up, price per foot was down. The continued weak demand in North America is what we are contending with here, clearly. The major drilling contractors are still on the sidelines. We are continuing to depend on some of the international business. As I mentioned, the backlog has increased somewhat during the quarter. We've begun to see some of the North American rental companies come back into the market and so that's helping out, both in terms of volumes as well as the average price per foot. Our backlog going into the next quarter is up about 12 percent, so that should help us in the third quarter.

On the drill bit side of the business, sequential quarter revenues up $3.5 million on a decline in worldwide rig count. International markets other than Canada were all strong. We had nice gains in Latin America, primarily driven by Mexico. The North Sea and Russia increased, although the North Sea market continues to be relatively weak, but we are making some market penetration in the Russia and former Soviet Union markets as we introduce some of our bits, which are better performing than what they've historically used. The Middle East market was up somewhat, as was Asia. This was offset by the decline in Canada, which was down significantly as you would expect with spring break up. North American revenues were up in line with rig activity.

We are very pleased with the introduction of our TReX PDC (ph) cutter business. These products are now comprising about two-thirds of our PDC (ph) bit sales. Obviously, during this stage of the introduction, they encroach on our existing products, both on the PDC (ph) side as well as the rollercone side. However, based on the performance, we are optimistic that these bits are going to lead to some share gains as we move forward.

Let's see here -- as I mentioned, on the Tubular Technology Division, revenues were essentially flat quarter-to-quarter. We had a slight increase in premium printing business, but this was offset by some of the field service and support work that they do. Obviously, Canada revenues were down a bit during the quarter. The TCA (ph) business was down somewhat as some of the large OD (ph) business shifted away from them. Our couplings business was up. Of course, they participate both on the premium market as well as the API casing market, and so their business is up in line with the overall activity in U.S. drilling. The Tubeloy (ph) accessory trading business was essentially stable quarter-to-quarter. This segment continues to struggle with a flat environment. Gulf of Mexico activity, which is so critical to them, was essentially flat quarter-to-quarter. We saw only a minor pickup in rigs drilling in deep formations, defined as 15,000 feet or deeper. It did, however, pick up a little bit towards end of the quarter -- too late to help us in Q2, but we now have about 150 rigs drilling in deep formations, which is up nicely -- about 20 percent above what was in Q1 and about 18 percent above the level of Q2. That should lead to improved premium tubular-related sales in Q3 and Q4. We don't see it in the backlog and we don't have the visibility on it yet, but just intuitively, it should happen.

The Marine Division I think I've covered. Again, plagued by some project delays -- expecting to be back on track in Q3 and Q4. We will go into our outlook here in a few minutes. I think that about covers it. I guess the final comment was on the industrial segment, which reflected a $3 million revenue decline as we wind down that segment. I'm going to turn it over to Lou. He's going to go through some of the margins and earnings numbers a little bit and then I will wrap up with a few comments about what we see out in Q3 and Q4.

Thank you, Mike. For simplicity purposes, it's probably best to explain upfront the special items that Mike mentioned are included in Q2's results. First of all, as we announced last quarter, we recently closed our manufacturing facility in Bryan, Texas. That facility was manufacturing industrial drill pipe used for horizontal directional drilling for laying fiber-optic cables and gas pipelines, under-river crossings and the like. As we all know, after the Company exited that business several years ago, the fiber-optic industry took a severe downturn and has never recovered. Our Bryan (ph), facility was also manufacturing oil and gas tubing -- an unprofitable commodity product line that we exited at the same time we closed the facility. For the past several years, the facility was generating revenue of about 25 to $40 million and operating losses of about 5 to $6 million. We originally thought we would be able to scale-down the operations at this plant while continuing to process the remaining inventory and to finish product and order to recover our investment in inventory. However, after further review, we decided it was best to totally shut down the plant as quickly as possible to avoid the continued operating losses and management distraction. Therefore, in Q2, we wrote down the remaining inventories to their estimated realizable value in their current state. The write-down totaled 6.4 million pretax and 4.1 million after-tax. The pretax charge was distributed -- $6 million in the Other segment and 400,000 in the Tubular Technology segment. Now, these amounts were included in the determination of operating income. The remaining book value of these inventories after the write-down is about 3.8 million.

Next, as we discussed last quarter, transition costs related to the integration of ReedHycalog will continue throughout the year, however at a decreasing rate. The Q2 amount totaled 1.7 million pretax and 1.1 million after-tax. A half a million of the pretax amount is included in operating income for the quarter and the remaining 1.2 million is included in Other Expense, which is below the operating income line. Finally, during the quarter, we reported income of 6.6 million pretax, or 4.2 million after-tax, related to the renegotiation of a liability to our former parent. That liability has been on our balance sheet since we were spun out in 2000. The pretax amount of the gain was recorded in Other Income, again below the operating income line. Also included in the press release are details of certain special items in Q1 of this year and in last year's Q2. All of my following comments are going to exclude the impact of the items I just discussed.

Turning to consolidated operating income, we reported $17.9 million. That compares to 18.5 million sequentially and 19.5 million year-over-year. The operating income margin was nine percent in Q2, compared to ten percent sequentially and 12 percent year-over-year. Sequential increase in operating income at ReedHycalog was offset by decreases at our remaining segments. At the Drilling Products and Services segment, operating income of $8 million was down slightly from 8.9 million sequentially, and the margin of 12 percent compares to 14 percent sequentially. As Mike mentioned, sales volumes of drill pipe increased from 1.7 million feet from 1.3 million feet sequentially, and production also increased to 1.7 million feet from 1.5 million feet sequentially. Even though we were able to increase sales volume of drill pipe footage, the mix shift (indiscernible) as Mike mentioned, to lower-value and lower margin products. Sales of premium drill pipe decreased from about two-thirds of total drill pipe revenue in Q1 to about half in Q2, resulting in a decline in average price per foot of approximately six percent. However, adjusting for mix, pricing was essentially flat with Q1. Q2 was also impacted by a decline in sales of products other than drill pipe, such as tool joints and processing of (indiscernible) third parties, as well as by lower absorption due to the unfavorable shift in product mix. Backlog in this segment at the end of the quarter improved by 8.3 million from $73 million to $81 million. It's the second quarter in a row that backlog has increased. You may remember, we started the year with only 56 million in backlog, and the average price per foot in backlog is now up 12 percent from the beginning of the quarter.

Turning to ReedHycalog, as Mike mentioned, the integration continues to go well. I mentioned the transition expenses -- 1.1 million after taxes; this is down from 1.7 million in Q1. As we look forward, we expect these costs again to phase out with after-tax amounts of about 600,000 in Q3 and 300,000 in Q4. Now, excluding the effects of these transition costs, operating income increased 2.2 million, or 20 percent, over Q1, representing a 64 percent incremental margin. The operating income margin increased from 21 percent to 24 percent. The improvements in revenue and margin reflect a favorable sales mix shift toward the higher-margin new products that Mike mentioned, such as the TReX fixed cutter bits. It also reflects the beginning of benefits from the price increase we announced last quarter, as well as favorable manufacturing overhead absorption.

As Mike discussed, the Tubular Technology segment turned in flat revenues sequentially. Operating income was also flat at $2.8 million. Headcount in the Division continued to decrease with the reduction of another 107 employees in the quarter, or ten percent of the workforce. That decrease was primarily the result of our exiting the oil and gas tubing product lines. Year-over-year operating income was down 2.3 million, representing only a 24 percent detrimental margin. Coincident with the $4 million decline in revenues at the Marine Division, they reported an operating loss of $1 million for the quarter. The decrease was primarily attributable, as Mike mentioned, to the temporary decline in project-based sales at XL Systems due to the volatility of project timing and the delivery of products. The Division backlog was 19 million at the end of Q2, which is up from about 11.6 million at Q1. We expect the increase in backlog to drive improvements in XL's performance for the second half of '03.

The Other segment used to include our industrial drill pipe operations, our construction casing and (indiscernible) operations and our technology joint ventures. As we announced last quarter, we exited the industrial drill pipe business by shutting down the Rhine facility. We exited the construction casing and water well business by selling that operation in Q1. Now, we also moved our technology joint ventures to our other operating divisions. The Intelligent (ph) Drill Pipe venture is now included in our Drilling Products segment and the Composite Pumps and Motors (ph) venture is now included in our ReedHycalog segment. The mothballed Bryan, (ph) Texas plant is now under the management of our Drilling Products segment, as that plant used to sometimes produce drill pipe and provide backup (indiscernible) facilities for our drill pipe operations. Going forward, this segment will only include the disposition of our remaining 2.6 million of industrial product inventories.

CapEx for the quarter totaled 9.3 million, down slightly from the 10.5 million in Q1. We expect CapEx for the year to total approximately $40 million. Debt remained constant with last quarter at about 465 million; this was down 30 million from the beginning of the year. At quarter-end, we had undrawn availability in our revolver of just over $90 million. We expect an effective book tax rate of 35 percent for the remainder of the year. With that, I'll turn it back over to Mike for a few concluding comments.

Well, as we look at the balance of the year, obviously, the market that we see is a little bit different from than what we had envisioned and certainly what one may have envisioned, given the strong commodity price environment we've got. We're getting lots of mixed signals from the E&P industry. I think drilling contractors are very cautious in terms of their drill pipe purchases in this environment, and so we've had to take a little more conservative view as to what we think may happen in the second half of the year. With that being said, however, on the strength of an improved backlog that we currently have and seeing the mix improve a little bit, we do think the Drilling Products division will see some improvements both in Q3 and Q4. We expect, obviously, ReedHycalog to benefit from the seasonal recovery in Canada, the continued strength of the U.S. market and I think some ongoing improvements in the international arena as well.

The Tubular Technology Division is a tough one to project. You know, the Gulf of Mexico, the deep drilling markets have been hard to figure out. Assuming that those businesses or that activity kicks in, then they will benefit, but we've taken a view that that business may be relatively stable for the balance of the year, so that may be some upside potential in our assumptions there. During this next quarter, we deal with the seasonal downturn in our (indiscernible) mill operations and our Italian tool joint operations. They both shutdown for essentially a month during July, so that impacts earnings in a negative way during the quarter. With all that said, we would expect the Q3 earnings to come in modestly above the quarter we are at -- i.e., should be somewhere in the six to eight cent range. Then we would expect Q4 to improve upon that level by roughly the same magnitude. So that leaves our year somewhere in the mid-twenties, possibly a little lower, possibly a little higher, depending on what happens principally at the drill pipe division and what the purchasing mentality is as the year proceeds.

With that, we're going to go ahead and open it up to questions. We would ask you to limit yourself to one question and one follow-up so that everybody has an opportunity. Operator, why don't you go ahead and start taking questions?

(OPERATOR GIVES CALLER INSTRUCTIONS). Kenneth Sill of CSFB.

Good morning, guys. I just wondered if you could quantify on the premium connections business (indiscernible) the deep rig count having made this kind of bump-up here at the end of the quarter -- what kind of sequential revenue growth and margins would you expect just on that being flat from here?

Well, with it being up -- I think if it stays where it is right now, we would say that sector of the market would be up almost 18 percent sequentially. You know, the (indiscernible) we're dealing with here is the distributor networks seem to be intent on continuing to drive down inventory levels. I mean, that's the psychology as much as it is anything, and we are hoping that psychology may be beginning to shift. The other thing we see them doing right now is even though some of their purchasing of premium tubulars is beginning to improve, they are putting that into inventory (indiscernible) i.e., they are not investing it in threading until they absolutely have to. So all things being equal, Ken, I mean, one would expect that we would see a ten-plus percent increase in that business sequentially, but we're just not seeing it yet. So, that's why we are hedging our bets here a little bit.

Okay. Then just in the regular Drilling Products business, what kind of visibility is there out there on the drill pipe inventories? How much of the kind of disappointing I guess results from our perspective is driven by the Gulf of Mexico being down, or just your customers managing inventories tighter than usual?

I think, depending on what reference point we are using -- yes, as we went into this quarter 90 days ago when we had this call, we expected our earnings to be flat to up slightly. Now, we're not up slightly, obviously. Why is that? Well, we had anticipated that we would see a bit of a bump in the Tubular Technologies group with some deep drilling, some Gulf of Mexico activity that just has not transpired. I would say that, then coupled with, obviously, the disappointment of some project delays in the Marine group, would be the primary things that turned out differently this quarter from what we had anticipated 90 days ago. We talked at length I think on the last conference call that the Q2 backlog for drill pipe, while up a little bit quarter-to-quarter, was largely comprised of some international orders of small-diameter non-premium pipe. That's what we did. So, I think those would be -- if you talk about why weren't the earnings up a little bit this quarter? It would be primarily because of the Tubular group and the Marine group that we otherwise were expecting a little bit better performance from.

The drill pipe business I think this quarter did about what we thought. I think what we did talk about, though, was that as we got into Q3 and 4, we expected to start seeing drill pipe purchases pick up by the major drilling contractors. They are not ordering drill pipe yet and I think, as we've always talked, the order rate is driven as much by what their mentality is about the level of rig activity in the next several quarters as it is driven by what the absolute level of drilling activity is in the current quarter. If they think rigs are going to flatten out or even decline in certain cases, then they are going to be very tight-fisted about (indiscernible) a drill pipe. I would do the same. I think that's the environment we're in right now, so until their outlook improves, the confidence level improves, you know, their drill pipe requirements and purchasing is going to be on an absolutely as-needed type basis. So we've had to tone down a little bit our expectations of what kind of drill pipe sales we're going to have in the second half of the year.

Thank you.

Bill Herbert of Simmons & Company.

Thanks. Good morning. Mike, we talked about the delayed shipments for XL in the second quarter. Can you quantify what the magnitude of those shipments were?

About $3.5 million (indiscernible).

Then secondly, we discussed the contracts at BP and Pemex. Could you sort of amplify on those contracts and give us a sense as to how large they might be?

The BP is (indiscernible) the Atlantis project in the Gulf of Mexico. I expect those shipments to occur between now and year-end.

How large?

I don't think they want us discussing that. I will give you a total of the two here in a moment. The other major contract is with Pemex and obviously, for use in the Bay of Campeche drilling programs down there. That is a project which will span 2.5 to 3 years. The combination of those two projects can range at the low-end about $20 million of revenues, at the high-end could be close to 40.

Fantastic! The last item, we've done a fair amount of cost-cutting with respect to headcount reductions. We've consolidated a few manufacturing facilities, but you still, I think, are characterized by a fairly far-flung indisparate manufacturing network worldwide. So with the eye towards reducing costs on a structural basis, what are you doing on that front with respect to evaluating manufacturing consolidation opportunities?

It sounds like you've been at my recent staff meetings, Bill! (LAUGHTER).

I haven't, but nonetheless...

I mean, we've got two issues we've got to deal with here, I think, on the drill pipe side of the business. One is, what level of capacity do we need through these cycles? Clearly, there's more than enough drill pipe capacity in the industry to service what the world needs. We understand that. The second issue really is three issues -- the second issue is, where it is the most cost-efficient way or the most efficient places to make the drill pipe? The third is, there is some strategic positioning that comes into play here. All three of those issues are under intense review as we speak. We are looking at that. It's going to take us several months, quite frankly, to go to the process and make a determination as to how we optimize our drill pipe capacity that we've got out there today. It may ultimately result in us moving things around a little bit. Whether it results in consolidation or not, I will differ on. But we're looking at that very objectively, in terms of what our capacity requirements are, what our cost efficiencies are at one facility versus the other and what the strategic considerations are. I would hope that that's a project that culminates between now and year-end.

Finally, last to say, it's early days. You are still doing your analysis, but it is conceptually a pretty significant opportunity.

I certainly think it's not. Yes, I view it as an opportunity. You know, the drill pipe operations today -- it's interesting -- you know, if you look at their operating income margins, considering this is a sector that's operating at probably 40 or 45 percent utilization, it's not all that bad. But I think there's an opportunity to do quite a bit better, and it's going to come through streamlining some of the manufacturing operations and taking a hard look at how we really optimize the cost advantages of one facility versus the other. But it's going to take a little while to go through that process.

Thank you.

Francisco Garcia of J.P. Morgan.

I was wondering if you could talk little bit about the makeup of your Drilling Products backlog and how long you think you'll be working off these lower margin international orders.

Well, as we mentioned, the current quarter -- the third quarter backlog is benefiting from a mix shift back to some of the premium products. That's driven by, primarily, some of the rental companies here in the U.S.; that's typically the type of drill pipe they buy. So we are beginning to see a little bit of a shift back to those premium products already. You know, it's -- you know, I'm not sure I can elaborate a lot more. That's what's in the backlog today; it's a combination of some of the lower margin stuff aided by some of the higher margin premium products.

So sequentially, pricing could possibly improve?

Sequentially, based on what's in our backlog today, most of which is for delivery here in the next 90 days, our pricing per foot is up about 12 percent. That should help drill pipe margins in Q3.

Thanks. On ReedHycalog -- impressive sequential incremental margin. Are you able to quantify or break out how much of that is related to pricing versus increased market penetration?

No. I mean, we could, but I don't think I would. What I will say is that during the quarter, of course, they rolled out a new price book increase of approximately five percent for non TReX products. That price (inaudible) TReX is totally independent of that. That price book implementation has gone well. You know, they feel like they are beginning to see the benefits ready. As with any sector in the industry, when you roll out price books, it takes a period of time to introduce and implement that, but it's going well and (inaudible) further benefit from that in Q3 and Q4.

Thank you.

Michael LaMotte of J.P. Morgan.

Thanks. There's been a lot of conversation in this quarter's conference calls about Russia and activity in Russia Proper. Can you talk about what y'all are doing to penetrate that market -- where you stand today?

Principally, it's impacting and helping out our drill bit operations. I believe most of the Russian operators use Russian drill pipe. There's not a lot of our products to go into that market. It's something that we are interested in longer-term. That's going to take some time, though to change the purchasing mentality and sell the values of that. The numbers for ReedHycalog in and of themselves are not big in the grand scheme of things; it's just a piece of the overall market for them.

Some of the other equipment (indiscernible) have talked about looking at manufacturing operations in Russia, not buying companies but assets. Is it premature for Grant Prideco to look at that on the pipe side?

I would say we have bigger fish to fry here in the near term.

(LAUGHTER). Okay. Then if I can ask a follow-up on the bit side?

Yes.

The write-down -- was that really driven by -- I mean, you came into the year -- or came into the ownership of ReedHycalog quite a bit of inventory. Was the write-down there driven by technical obsolescence?

No. I think there's a misunderstanding here, Mike. None of the inventory reserve relates to ReedHycalog.

Okay. I thought there was four hundred and --.

No. That's in the Tubular Technologies for the discontinued two-step tubing business. No, I'm glad to clear up that misunderstanding.

Thank you.

Kevin Simpson of Miller (indiscernible).

Good morning, Mike. On the conference calls of a number of your customers, most are basically saying they don't have any significant drill pipe line needs for this year. Do you think that's business as usual for them, where they are certainly not going to signal to you, or do you think that it's more likely now that if we're going to see an inflection point, it's going to happen sometime in early ' 04? Let's assume, you know, in terms of activity from where we are today that rig count is up, say, five to eight percent sequentially going into next year.

Well, no, I think that's -- it's a little bit of both Kevin -- a little bit of business as usual and a little bit of reality. I think, again, a lot of it is predicated on the at least temporary flattening out of rig activity. That changes your whole disposition towards what you need to have laying on the ground out there. If you don't think you'll be putting another (indiscernible) if you don't think you are going to be putting in another couple hundred rigs to work anytime soon, then you're not going to be speculating on buying new drill pipe for those rigs. You could continue to cannibalize off of inventories that are on the ground. So yes, I do think the story has changed here somewhat in that what the drilling contractors had been indicating to us earlier in the year was that they envision needing to step up the replacement needs as we got into the third and fourth quarter. I think that's been pushed to the right. You know, one quarter, two quarter -- so much risk could depend on what that mentality is as we go into 2004 and ahead of that. What we have in the Q3 backlog is only a modest pickup of some specialty items by the rental companies (indiscernible) just absolutely run their inventories dry and they need these if they want to generate the rental income. We expect to continue to see some of those specialty type needs in Q3 and somewhat accelerate in Q4. But the real inflection point is probably now -- assuming a flat (indiscernible) increase in rig count in 2004 is probably, you know, Q4 -- second half of Q4 into early 2004 at this point.

Okay. I guess the follow-up would be more for Lou, or for you, Mike. You know, for modeling purposes now, is industrial zero assuming you've got your inventory valuation correct?

That would be right, Kevin. Assuming the inventory valuation is correct, there is nothing else to go through that segment.

Thank you.

Robin Shoemaker of Bear Stearns.

Good morning. I wanted to ask you, you are kind of on your macro picture -- based on your projection of worldwide rig count, the amount of drill pipe production per year -- and I think you had been using a figure of about 2,000 on the worldwide rig count, which seems certainly achievable if not a little conservative, and about nine million feet of drill pipe production worldwide. Do you think that's about right? Would sales of drill pipe this year equal that production number? I noticed that you said in your current quarter, your production was equal to your sales.

Generally, we're not building any drill pipe that isn't for a specific order, okay? I mean, we haven't done that for quite some time. I have to think about those numbers here for a moment, but I think that, generally speaking, out production numbers probably reflect -- in this environment probably reflect close to 70 percent, if not more of the total drill pipe being built in the world today, okay? The industry, the drilling contractors -- we talk to them -- generally speaking, use a number -- I'm going to switch numbers on you here a bit -- but they usually use an average of about 150 joints per year per rig in terms of consumption. A joint is about 31.5 feet, okay?

What's interesting is, if you look at -- just at North America right now, you know, we've got -- or in the U.S., we've got -- I beg your pardon. If we had, in the U.S., about 1100 rigs using 150 joints per year, that says they are using about 41,000 joints per quarter. You run some numbers and you can start getting -- you know, we produced, outside of China, about 33,000 joints. If you look at the global rig count, excluding China, you would estimate there is about 47,000 joints consumed. So the industry is still depleting inventories at a rate of somewhere around 14,000 joints per quarter. Our production to date is 3.2 million feet. We expect the second half of the year to be up from that number somewhat. Maybe we end up at seven million feet. So if you divide that by .7, you're probably back up to somewhere around your 9, 9.5 million feet of total drill pipe being produced this year. (indiscernible) numbers, but you can do some modeling as to what's being liquidated in inventories out there and see clearly that as an industry, we are still in a fairly significant inventory liquidation mode as opposed to building inventories or even maintaining inventories.

Okay, so the pricing of your generic drill pipe in this kind of environment is really just sort of flattish?

Yes. Adjusted for a mix issues, it's essentially flat.

Thank you.

Tom Scott (ph) of Pritchards (ph) Capital.

Good morning, fellas. I know you said that total revenues were pretty flattish sequentially from first to second quarter, but were you're seeing a solid acceleration such that the month of June was perhaps the best month you've had in six months and maybe the best month you've had in a year?

Well, let think about that. Clearly, June in total was -- actually, all three months were pretty flat, Tom. (indiscernible due to multiple speakers). I'm sorry, I'm just (indiscernible) were essentially flat during the quarter. No, I don't think we saw, on the drill pipe side of the business, any kind of acceleration during the quarter. In total, revenues picked up in June and that would be driven as much as anything by Canada starting to come back and helping out ReedHycalog. Other than that, no, I don't think there was any significant trend you could point to within the quarter. ReedHycalog (indiscernible) follow the rig activity. The Tubular business was pretty consistent through the quarter, as was the Drilling Products business.

Thank you.

Michael Urban (ph) of Deutsche Bank.

Good morning. I wanted to follow-up on the inventories that you see out there. I know it's kind of a tough number to pin down exactly, but I think in the past you've been able to kind of put together some anecdotal evidence. Given the liquidations that you've seen, how many joints would you guess are out there today, in end-user inventories?

Yeah, I'm going to qualify this, Mike, because each time we do this (LAUGHTER) this inventory survey, we get answers that are inconsistent with prior surveys, and it's a moving target. When we ask some of these folks what they've got, and sometimes they find out they've got drill pipe they didn't know they had. The estimate that we've got, the total drill pipe inventories (sic), is in excess of 800,000 joints in North America. The lion's share of that is used, okay? And what you don't know of that used drill pipe, you don't know what condition it is, if it's the size that they need for the current drilling programs or not. The visibility on that aspect is just -- you know, it's just very poor.

New joints are estimated to be somewhere in the 160 to 170,000 joint range. So you can see, when we talk about in excess of 800,000 joints in inventory in North America, that 70 percent of that is used and no one really has a good handle globally on what condition it is -- it really kind of renders this inventory survey -- I won't say meaningless by any stretch, but it certainly makes it problematic to conclude anything from it.

You know, we track the new inventory a little closer, because I think that's indicative of -- you know, we know that's good drill pipe they can use.

At what level would you think inventories become a little tighter and you might see some people or customers ordering? Is that 125, 130,000 joints, or is it higher than that?

It's probably somewhere in that range. Obviously, again, if you look assume just a little rig count of somewhere in the 1000 to 1100 rig count range, it's probably somewhere in that range, (indiscernible) would still have another quarter, quarter and half of liquidation before you would expect them to have to start replacing some of this. (indiscernible due to multiple speakers) not too different than what we thought earlier in the year. We just thought it would start happening a little quicker because the contractors would be -- (technical difficulty) -- several quarters that the rigs would be continuing to increase and so they would see that their consumption was continuing to increase as well. I think that's changed, at least near-term it has.

Great. That's helpful. That's all for me. Thanks.

Mike Haughn (ph) of Merrill Lynch.

Thank you, my question has been answered.

Geoffrey Kieburtz of Smith Barney.

Good morning. One more question on the drill pipe trends here -- this increase in the orders for kind of higher end (indiscernible due to multiple speakers) from the rental companies -- you know, is that typical? I mean, can you relate that to past periods? I mean, is there anything we might (indiscernible) about when contractors might be picking up, if the rental companies are beginning to order?

Unfortunately, I don't think we can. It would probably be stretching too much.

Okay. In terms of the rental companies as a percentage of the total demand in a -- let's call it a normal environment -- can you kind of characterize how much they might be?

(inaudible). Again, I would have to go back and look. Their purchasing patterns are so dramatically different, you know, it could be, you know, 20 to 30 percent of the market. It would be a higher percent of the premium market, because that tends to be what they stock in inventory. They don't buy much of the API drill pipe. You know, the contractors tend to own that themselves. Let me go back and look over several years and see if we can smooth it somehow to give you a number, but it's probably in that order of magnitude.

Do you have any sense that now that you can see that they have at least modestly started to increase their orders, that there's some follow-through behind that?

Geoffrey, it's mixed messages. We're getting a few orders in. Quite frankly, we had expected some fairly meaningful orders from some of the larger rental companies that have absolutely put everything on hold right now and have said they are not buying a string of drill pipe unless they have a specific project that's going to use it; they are not speculating at all. So even within that subsector of the market, we're getting conflicting signals as to what their near-term needs are.

Separately, you had mentioned international markets being a benefit to both ReedHycalog and to the Drilling Products. You know, any specific areas that we might want to keep our eyes on?

Well, I think the international business for ReedHycalog -- they're doing well in Latin America; that's driven a lot by Mexico. They have a very strong position in the market and as that market continues to grow, we would expect them to do well. You know, they think there's some opportunity to do a little bit better in a few of other countries -- Brazil and a few other areas down there -- than what they've done historically.

You know, the highlights -- they continue to make some progress in Russia. Africa, the Middle East is doing very well. They have got a number of areas where they're doing quite well -- Saudi Arabia, Algeria, Oman. It's really kind of scattered throughout and as you know, the international market is not exploding in any one particular area; it's just kind of a gradual improvement of a rig here, a rig there, and they are benefiting from that.

The same markets would pertain to the drill pipe?

Yes. On the drill pipe side, you look at that generally but then you tend to -- a lot of the international business tends to be some large tenders that come and go, and so that's a little bit different dynamic there.

Okay. Just a last question on Marine -- you mentioned 3.5 million of delayed shipments. I'm presuming that the 3.5 million would flow back into the third quarter on top of sort of, if you will, the normal expected run-rate?

Yes. I mean, they should be coming in in the second half of the year with revenues averaging somewhere in the $20 million a quarter range. Now, as always, they can have a particular shipment that can be 2 or $3 million that an operator can elect to defer for 30 days and a project gets delayed, so it's always subject to a little bit of movement. But on average, we would expect their business to be running closer to $20 million a quarter for the balance of the year as opposed to kind of midteens (indiscernible).

That would be inclusive of the 3.5 million catch-up.

Yes, and we're fairly comfortable at that type of level.

Thank you.

At this time, there are no further questions. Do you have any further remarks?

No. we appreciate your attention this morning and look forward to talking to you again here in 90 days. Thanks.

Thank you for participating on today's Grant Prideco (indiscernible) second-quarter earnings conference call. You may now disconnect. (CONFERENCE CALL CONCLUDED)