國民油井華高 (NOV) 2004 Q1 法說會逐字稿

At this time, I would like to welcome everyone to the Grant Prideco first-quarter earnings conference call. (OPERATOR INSTRUCTIONS). Mr. McShane, you may begin your conference.

Thank you, operator. Good morning, everyone, and thank you for joining us this morning to discuss our first-quarter results, which have just been released. As reported, we had a nice pickup in both revenues and earnings during the quarter, some marked improvements over the same time last year; and importantly some further progress made during the quarter in restructuring some of our operations; and lastly, a nice pickup in our backlog. And we will cover all those topics here momentarily.

Revenues for the quarter were up 21 percent. Operating income, excluding some of the charges related to restructuring was up in excess of 80 percent. Earnings per share as reported from 3 cents up to 9 cents. Last year's 3 cents concluded about a penny of some unusual charges or non-recurring charges, if you will. So 4 cents up to 9 cents on an operating basis. Operating income margins expanded from 9 percent to 12 percent in the current quarter. We continued to make progress in our debt reductions during the quarter. And as I mentioned, we finished the quarter with a 65 percent increase in our backlog. During the quarter, we completed our drill pipe manufacturing consolidation project that we discussed previously. The downsizing of our Canadian operations was completed without disruption to manufacturing operations. So the cost benefits from that effort should begin to accrue as we go forward. We also, towards the end of the quarter, consolidated our Marine and Tubular Technologies divisions. And shortly after the end of the quarter, we completed the divestiture of Texas Arai, which was the coupling business that we've had here. These steps will all drive margin improvements as we proceed further into the year and into the future.

I think if you look at the results of the efforts of what we have been doing here the last year and a half or two years, you're beginning to see the results of that. With a 21 percent improvement in revenues this quarter, our staffing levels are actually down 3 percent year-on-year. And despite the working capital requirements required to support that type of revenue growth, the capital employed in our business today is flat with where it was a year ago. So progress is being made on a number of fronts.

I will cover some revenue highlights, and then I will turn it over to Matt, who will walk you through some of the financials, and then we will come back and have a couple of closing comments on the outlook.

Drilling Products division, revenues were up 32 percent year-on-year. 1.9 million feet of drill pipe was produced and sold during the quarter; that was a 41 percent increase over the same period last year. During the quarter, we were aided by the shipment of a special string of drill pipe going out to the Gulf of Mexico for the Tahiti project. That helped from a pricing perspective. Pricing on the year-on-year basis was up about 7 percent, and sequentially was up about 3 percent. All of that being mixed revenue as opposed to price-book (ph) driven. As I mentioned, our backlog has improved dramatically on the Drill Pipe side of the business. Our backlog was up 74 percent on the year-on-year basis and 55 percent sequentially. So clearly, we are beginning to see the -- predominantly the U.S. land contractors come back into the market, as we have talked about here for some time. And that should begin to benefit us as we get into the second half of the year. Excluding the charges associated with the downsizing of the Canadian operations, operating margins at this segment improved to 17 percent versus 12 percent in the prior year.

Moving on to ReedHycalog, they continue to perform quite well. Revenues were up 49 percent year-over-year. If you look at the business on a sequential basis, it was down somewhat as expected. That was predominantly due to the very strong fourth quarter we had in the international arena. We talked about that last quarter that we had a lot of year-end purchasing that was not expected to repeat. If we look at the business geographically, and on a year-over-year basis, I think the comparisons are quite impressive. Rig activity in U.S. was up 21 percent year-over-year. ReedHycalog's revenues were up 91 percent. In Canada, rig activity was up 9 percent year-on-year. Our bit revenues were up 31 percent. And in the international market, rig activity was up 6 percent and our revenues improved by 32 percent.

On the fixed-cutter side of the business, we continue to benefit from the tremendous success of our rotary steerable directional drilling products, which are then further complemented by the incorporation of our TReX cutter technology. Today, over 80 percent of our fixed-cutter bits incorporate the TReX cutters.

On the roller-cone side of the business, we recently rolled out new product lines, marketed as TuffDuty and Titan. These introductions have gone quite well, and that is aiding us on the roller-cone side of the business as well. And you will recall last year towards the year-end, we put in place an advanced technology group to work closer with our customers throughout the world. Those efforts are beginning to bear fruit, particularly in the Middle East and the U.S.

We recently issued a new price book at ReedHycalog; it went into effect on April 1; that was for all markets excluding Canada. It was about a 5 to 6 percent price book increase. The Canadian price book is expected to be increased a little bit later in the year as we come out of the spring break out. At ReedHycalog, operating income was up 93 percent year-over-year. Operating margins expanded from 19 percent in the same quarter last year to 24 percent this year.

At Tubular Technologies, of course, the results have been re-stated to incorporate the Marine division. The Marine division, as most of you know, has been a division where we have been divesting some of the noncore businesses. What was left was essentially the XL product line, which of course is the large diameter products for Marine applications or offshore applications. It seemed logical to take the step now to consolidate those divisions and eliminate some overhead. With Gulf of Mexico activity continuing to be down on a year-on-year basis, our premium threading businesses were impacted by this. Rig activity in the Gulf was down 10 percent-year-on year. But if you look at our business, the threading business was actually up 4.5 percent year-over-year. TCA, our specialized processing heat treating business for large diameter casing products, was up 7.8 percent year-on-year. And in XL products, our business was up 25 percent year-over-year on the strength of some of the large orders that we received about midway through the year last year. These increases were somewhat offset by the decline at tube alloy, principally due to the lack of sales of our vacuum-insulated tubing, a product -- that business tends to be sporadic, and that's what's driving the decrease there. So all in all, the revenue performance within that group, pretty good, given the markets that they serve.

The consolidation that I've mentioned should reduce our operating expenses as we go forward. Initially a couple of million dollars of overhead expense should be eliminated. And we are beginning to evaluate a number of other areas where we may have opportunities for cost reductions or operating synergies.

At the XL product line, just to come back to that, their backlog, likewise, improved dramatically year-over-year. It's up 104 percent, and 41 percent improvement, sequentially. So that product line continues to make some headway. I am going to turn it over to Matt and let him go through some of the margins and balance-sheet issues and I will come back with a couple of closing comments.

Thank you, Mike. Summarizing the consolidated financial statement, as Mike indicated, substantial improvement in earnings per share of 9 cents compared to 3 cents in prior year's first quarter. On the revenue side, revenues increased 39.3 million or 21 percent on only a 13 percent rig count increase. On a sequential basis, we saw revenues decline by only 3 percent, which compares relatively favorably with historical trends, which typically see a revenue decline in the first quarter.

The gross profit side, we saw margins increase from 31.2 percent to 36.8 percent, and gross margins improved in each of our operating segments. SG&A showed a 9.9 million increase from the prior year. A good chunk of that was at ReedHycalog, which is commensurate with their revenue increase. And those costs primarily represent distribution costs in the field. We also saw an increase in corporate due to implementation of a new ERP system, as well as some increased incentive costs. On a sequential basis, SG&A actually decreased.

Research and engineering, we saw a 1.6 million increase compared to the first quarter of the previous year. ReedHycalog showed increases as they are shifting -- they're transitioning from the transition that they saw in the previous year and now they're focusing more on new product developments. Also, we saw some R&D spending at one of our joint ventures, which has since been discontinued. Also included in the P&L this quarter were special charges totaling 2.7 million. 1.8 million of that represents exit costs related to our Drilling products rationalization program; and that represents lease buy-out costs as well as some severance costs. And we also saw some severance costs in our Tubular division of about 900,000 related to that reorganization.

Overall operating income, including the charges, was up 66 percent. And the March operating income margins improved to 11.8 percent from 8.6 percent in prior year's first quarter, or 13 percent if you exclude the charges. Excluding the charges, this represents a 38 percent incremental margin improvement on a year-over-year basis. Our interest expense was down slightly from both the prior year and sequentially. We have other income of $2 million, that includes $2.8 million from the sale of assets from discontinued operations, that's Drilling products, rationalization program and the rotator sale from last year. That was offset somewhat by some foreign exchange losses. We also expect, as we indicated I believe in the last couple of weeks, we expect about an $11 million loss in our second-quarter due to the sale of Texas Arai. The tax rate for the quarter was 37 percent, that's up from 35 percent in the previous year.

Now I will turn to the balance sheet. At the quarter end, at the end of first quarter, we had a cash balance of $20.8 million, that's up $1.5 million from the previous year-end. We also showed about $8 million increases in both receivables and inventory due to activity. However, on a relative basis, our DSOs were down by four days and days of inventory was down one day. Our total debt declined $14 million from the previous fiscal year-end; and the free cash flow was used to eliminate the revolver balance. And we appear to be on track to re-pay about $60 million of debt during this fiscal year. At the end of the quarter, our debt to cap balance was 40.4 percent. And net debt to cap, net of the cash balance, was 38.5 percent.

I've got a few cash flow comments. Cash flow from operations was $16 million during the quarter. Taking into account capital spending of about $6 million, we generated free cash flow of about $10 million. Depreciation and amortization was 10.8 million. And as Mike indicated, our backlog has now increased to 176 million. That represents the highest backlog level since September of 2001. And with that, I will turn it over to Mike for some closing comments.

Well I think that as outlined in the press release, given the relative strength of the first quarter -- came in somewhat better than what we expected, U.S. drilling activity did not seasonally decline as it typically does -- led to better performance at ReedHycalog. And importantly, as we've mentioned, we have seen a significant improvement in our backlog. Much of that backlog is supporting our revenue forecast in the second half of the year. It provides us the opportunity, hopefully, to do a little bit better than this. But I think that given all those things and without making heroic assumptions on any further increases in drilling activity, which may very well happen, we have raised our earnings guidance to the range of 38 to 42 cents, which is a nice step up from what we had expected about 90 days ago. Hopefully, that will prove to be conservative as well, but we will take this one quarter at a time. With that, we are going to open it up to questions, operator.

(OPERATOR INSTRUCTIONS). Dan Pickering.

Mike, could you talk a little bit about, in the Drilling Products segment, volume indications from customers, 1.9 million feet this quarter, kind of what's the sense in tone from your customer base, what are you seeing there?

Well, the pickup in volumes is coming from the rental companies. And the pickup in the backlog activity is coming predominantly from the U.S. land contractors. We are trying to update our inventory numbers right now. Without a doubt, those numbers show that inventories are continuing to decline. We are finding a few of the numbers are getting a little tougher to get our hands around, in terms of the disclosure of the inventory numbers, which is interesting in and of itself. But I think what we are seeing is exactly what we have been talking about for some time, that was that we believe as we got into the second half of '04 that we would start to see a requirement for some of these contractors who have been out of the market for the last couple of years to start replenishing inventories; and that if we were right that we would start seeing it appear in our backlog in the first half of the year. So, I mean that's essentially what's playing out. I am not sure if you're looking for further granularity there or --?

No, that's helpful. Of the 176 backlog, I assume that's for the Company in total?

It is.

And what does that translate to in terms of -- for the Drilling Products business?

Hold on a few seconds. We've got that number.

One-hundred twenty-six million is from the Drilling Products segment.

Okay. And Matt, how would that 126 compare to a year ago and to last quarter?

Last quarter, it was 80 million. And in the March quarter of the previous year, it was 72 million. That includes China, as well.

Got you. So that's an apples-to-apples number,. year-over-year.

Yes it is.

And we've got building backlog, U.S. land customers indicating stronger interest. I mean, how does that impact the way you are approaching the pricing issues?

Well, we are approaching pricing from two fronts. One is, we have implemented a surcharge of -- it was 8 percent on drill pipe and approximately 15 percent on heavyweight and drill collar products to compensate us for the rapid rise in steel prices. And those surcharges will be adjusted up or down as steel prices move. Secondarily then, and the more importantly in some respects, as the backlog begins to improve, we will be looking for every opportunity to move up our base pricing. And that's, as you well know, is -- it's a battle and it's customer by customer. But it's been a couple of years since we've had an increase in our base pricing. So certainly, we will be working that aspect of pricing as well.

What roughly, just because guys like us like to think about specific numbers, base pricing -- give us a range there for dollars per foot, standard drill pipe? Where we are now?

Well, during the quarter, you know, we have gotten away from this because it's so heavily skewed by pricing or by mix. (multiple speakers). You just talk about standard drill pipe, it can be anywhere from 32, $33 a foot to $100 a foot.

Okay.

And depending on the mix of premium products and all the adders that get on here, it's a little bit hard to make a comment on what that is. I mean, you can take our numbers, and during the quarter, I think our average price per foot was in the $37 range.

Okay.

What that means to next quarter or prior quarters is more you can't look at it without looking at the mix of products that made that up.

Okay. So suffice it to say, pricing (ph) opportunities may be emerging. Last question, the surcharge is 8 to 15 percent depending on the product, relative to steel prices. Talk to us a little bit -- I was under the impression that your steel prices were relatively hedged given your agreement with VA?

Yes, two issues there. Number one, the bar-stock that we have to buy to manufacture the tool joints and to manufacture heavyweight and drill collar products, that is not hedged. We have to buy those in the open market just like everybody else does. And clearly, the product cost there has risen rapidly. So that goes into the cost of our drill pipe. Secondly, you are right in that we have had an agreement in place on the green tubes and the supplier of the billets, likewise, has had an agreement in place. However, as with most steel manufacturers, they are lobbying hard for increases and financial duress, and continuing to honor those contracts. And even to a point where there is a risk of suppliers declaring Force Majeure. So you have to balance getting into, potentially, a litigation situation with these folks versus having a secure supply of billets. And so we are working with them and we are trying to negotiate a reasonable compromise on billet pricing and that's an ongoing process. But just the bar-stock alone going into our tool joint in the heavyweight drives a requirement of a surcharge in and of itself.

Okay. So if we get the 8 percent -- the surcharge really is a surcharge. If we get the 8 percent, your margins would be steady?

That's right.

Bill Herbert.

Mike, can you talk about the mix of drill pipe with respect to the sequential build in backlog, and what that portends for average pricing going forward as that product gets sold?

Yes. The backlog that is in there right now -- the price -- it is as expected -- it's going to start moving towards the API products, number one.

Right. So pricing should probably go a little bit lower in terms of realized pricing?

Realized pricing could come down on a per-foot basis somewhat. Now that backlog we're talking about is spread out over the balance of the year. So it's not as if that entire $126 million is what's going to be comprised or what's going to comprise our second quarter, okay. But actually, if we look at what's in the backlog today, the price per foot is actually pretty steady with what we just did this past quarter. Do you follow me?

Yes, I am just writing as you speak here. Okay, great. Secondly, with respect to the cost savings announced last quarter, 11 to $12 million, I believe, for the drill stem products.

Correct.

What kind of progress are we making on that front?

It is fully implemented.

Good.

And so from Q2 forward, we should see the full benefit of that. We had estimated we would realize about I think $10 million of that within the current year, and we are certainly on track to do that.

That's good news. Lastly, the supply agreement with Voest-Alpina, how many years do you have left on that?

There is about three.

Through July '07.

July '07.

Yes. So not quite three (multiple speakers).

Okay great, thanks guys.

Mike Urban, Deutsche Bank.

Obviously great pickup in the backlog there. I was just wondering if you are getting any sense, if, now they finally -- you are finally seeing the (ph) land (ph) drill is coming into the market. Have they come in in kind of large volumes in anticipation of price increases or maybe stockpiling because if raw material goes up and -- I'm just trying to get a sense of what your sense might be for going forward?

No, I don't think we see any indications that the -- building backlog would suggest that type of purchasing. In fact, you know a lot of the largest guys still are -- have not placed orders. They are getting quotes and they're talking about it but have not even placed orders yet. So no, I do not think we see anything in the backlog that suggests there's any kind of panic buying going on. In fact, we think right now, with steel prices starting to roll over a bit, you might see just the opposite where some of these guys, particularly, on collars and heavyweights may, if they can, defer it for another month or two in the hopes that some of these surcharges may come back down.

And I think you said that the -- you still think that the industry inventories are coming down a bit?

Yes.

Best guess? Okay.

Yes, without a doubt.

And in terms of the guidance, increasing the guidance, I am just trying to get a sense for how much of that is kind of driven by the better visibility in the backlog, or if you are also seeing maybe better than expected you know cost savings and efficiencies coming out of the restructuring that you have done? And if you could just kind of break it out, (multiple speakers) factors.

Yes. I would say Mike, principally, it's due to the fact that the U.S. rig activity is somewhat higher than what we had all envisioned, or at least forecasted at this point in time. It held up better through the first quarter and so we are going into the second half of the year from a somewhat higher level. That should directly benefit ReedHycalog. The visibility in the backlog is a big confidence booster. For the last couple of years, as we sat down each quarter and looked at what we thought we could do in drill pipe revenues, we may have had one month of backlog that we could count on and the rest of the guys have been out beating the bushes for. As we go into the second quarter, our second-quarter expectations on revenues are more or less in the backlog today. So that gives us a much higher degree of confidence that not only is our prior revenue forecast achievable but the opportunity to do a little bit better than that is there, as well. So it's a combination of those factors. I'd say our original plans and earnings plans incorporated the cost reductions at the -- within the Drilling Products group. To the extent that we can begin to get some cost efficiencies as a result of the Tubular and Marine division consolidation implemented, I'd say that's going to be somewhat additive from this point forward.

Okay, great. That's helpful. Last question is a housekeeping one. The D&A came down a little bit as I guess I would expect. I am assuming that will come down a little further with selling some more businesses. Do you have some guidance on that for the rest of the year?

Do you have something on that, Matt?

I don't have the forecast for next quarter.

You can use the current quarter --

(Multiple speakers) -- you are right, it will come down some because the restructuring was done midway through the quarter plus the sale of Texas Arai. I can get that number for you, though.

Okay, I will give you a call. Thanks.

Bo McKenzie, Sterne, Agee.

Hi, guys. Congratulations from somebody else on a good quarter.

Thanks.

Mike, if you look at bit sales and you look at the rig count, and you listen to some of the rig guys and some of the E&P guys, you might get the impression that drilling efficiency has moved up maybe a little more than people might have expected -- that the average footage per rig is coming in a lot higher. And if you compare your numbers and Baker's and anybody else's numbers, I mean, the bit sales are ahead of what rig count might have indicated. Some of it might be priced some of (indiscernible) products. But are you seeing a trend that's noticeable and that average consumption of bits per active rig has moved up? And if that is true, can you make that leap of faith that maybe this is going to happen to drill pipe as well?

Well I think, number one I'd say those are probably two different issues. If you look at the long-term trend on bit business, the bit consumption per footage drilled has trended down because of better-performing bits.

Right.

However, revenues generated have held up or grown as the bit companies have been paid for that better performance. There's such tremendous leverage in how a bit performs in terms of rig savings and whatnot that the industry is generally speaking, paid for that performance.

I guess my question is not per foot is drilled but per active rig. The footage drilled per active rig appears to be going up. So if you look back and you looked at a relevant measure and said you know we are at X rig count, we'd have normally sold blank in bits, we are at a 10 or 15 percent higher level or so -- is it fair to say that we can expect to see that? That if we looked at the inventories on the ground, the potential for the income on those sales and we look at historical kind of measures in terms of the footage of drill pipe consumed per active rig that if the efficiency really has been moving up, maybe we are higher this cycle?

I think there's a couple of things going on. If you look at the deep drilling on a year-over-year basis, rigs drilling below 10,000 feet have gone up by 27 percent year-on-year.

Above 10,000.

Deeper than 10,000 feet. And rigs drilling deeper than 15,000 feet have improved by over 30 percent. So clearly, a rig is not a rig. If they are drilling deeper, they were going to use more pipe, more bits, more drilling fluids and everything else can be -- is going to go up. And as you know, not necessarily on a linear relationship because as you get deeper, you get into more complex drilling environments and the products are at the upper end of the value chain, if you will. So I certainly think that would be a factor. We have seen a distinct trend towards more and more of fixed cutter bits being utilized in North America and globally, for that matter. And those generally generate higher revenues as well. So I think there's a number of factors going on here. I have not yet gone back and dissected our competitors' revenues; they are not quite as visible as ours are. We know there is a lot of reasons for our bit business being where it is. We know that part of that is that last year coming out of the gates from Schlumberger that in some markets we got off to a little bit of a slow start. And so we have re-gained some ground that we probably lost initially in the first quarter or two of ownership, albeit that those quarters were not bad. So there's so many factors here, I'm not sure I can conclude anything for you there.

All right. And in your increased guidance and listening to what you're talking about a few moments ago, it sounded to me like when you said we're not trying to be any heroes here or whatever the quote was, in terms of our forecast, what specifically are you assuming in your re-count assumptions?

We are assuming that essentially a flat drilling environment for the balance of the year, which clearly you can debate.

Okay.

And I think the indications we are getting from the drilling contractors would suggest that that is probably going to tend to be a conservative expectation.

Okay. And one final question, if you look at the accounting for inventory, you know, there's -- China is trying to slow down some of its economy; steel prices have been coming under some pressure. Do you guys account for your inventory LIFO, FIFO, specific identification, what?

FIFO.

What?

It's done on a FIFO basis.

That's an F, not an L, right?

Yes. But those turn relatively quick. We don't store a lot in inventory.

Again, don't confuse us with the -- some of the OCTG players out there that have large inventory positions. We buy inventory you know, essentially to order to a specific order that's manufacturing, and it's turned within, hopefully within 90 to 120 days.

And I lied, it wasn't my last question. I know this is a small piece, do you think you can give us an update on where the status is on the IntelliPipe?

Yes, we have I think the free SPUG meeting is next week. And within a week or so after that, we should have IntelliPipe in-the-ground drilling. That's here in the U.S. We also have another opportunity up in Canada. We are working on the issues of customs clearance and whatnot to get the product in the country and getting the product actually manufactured. So within 30 to 45 days, we should have one well-being drilled, utilizing IntelliPipe. It's going to be, I believe the Baker Hughes co-pilot tool. It's going to be run in conjunction with it. And then the project we have up in Canada is going to employ ReedHycalog's DRT tool, which is a bit intelligence tool, if you will.

What is the kind of depth that you are targeting for capacity right now and ultimately where you would like to be able to go with that?

I beg your pardon?

The kind of footage that you're targeting on your first test here, your first wells -- with the IntelliPipe technology?

I believe the first well -- again, these are testing the actual application of the tool, with IntelliPipe in a live drilling impairment. The depth is not such a critical factor. But I believe that we are going to have somewhere in the neighborhood of eight, 9,000 feet ultimately in the hole.

Great, all right, guys. Thanks.

John Tysseland, Raymond James.

Mike, can you talk about -- I know switching to I guess Tubular Technology or premium connection business, and obviously you sold Texas Arai. What are your further plans? Are there any other assets within the Tubular Technology Services segment that you are looking to still pare out of?

Well, look, and I think we have been fairly open about this for the last year or so, and that was that these businesses -- we have talked about what their margin potential is. We have talked about some that have very good margin potential when the market is healthier than it has been. And we've talked about a couple of businesses that have been challenged from a margin generation potential even in good markets. Texas Arai was one of those that fit into that category. And so it clearly was a business as we looked at what we could do with it in terms of growing and improving margins, it was somewhat limited. And it always seemed to us it was probably a better strategic fit with one of the mills. And that's who owns it today. So I ensure Maverick will do quite well with it, and they will be able to get some synergies out of this business that we couldn't capture on our own. And so I think that anytime you have businesses in your portfolio that are limited in terms of what their growth opportunities are your ability to improve margins, you have to consider whether or not they're worth more to somebody else. And that's an ongoing process. And that's as specific as I will be.

Okay. Fair enough. Let me ask you this on the premium connection business -- has that business started to turn? Have you started to see less inventory liquidations, more kind of consumption-driven sales? Any kind of an uptick on the horizon there?

Marginally, marginally. As I said, if you look at the dynamics -- of course keep in mind that for us the premium threading business is principally a Gulf of Mexico business because of our licensing restrictions, okay? And if you look at Gulf of Mexico rig activity during this first quarter, it was down 10 percent year-over-year. And yet, our premium threading business was up 4.5 percent. So I certainly think that speaks to at least being out of the inventory liquidation mode that we seem to have been in last year at this time, and at least beginning to see replenishment of inventories. And again, most of the distributors carry inventories clean end. They don't thread it until it goes out to the rig. So I think -- I would not say that we are seeing orders that are due to inventory builds. We are just seeing orders that are going out to the rig because there is not any threader product on hand that is otherwise being liquidated.

Geoff Kieburtz, Smith Barney.

On the pricing subject, given your backlog, do you see there is a potential for you to be implementing any drill pipe price increases by the end of this year?

Well, we certainly are testing that order-by-order. We have had some success already this year with -- as we've renewed some purchasing agreements to get some base price increases. Clearly as the API business comes back, that is of course where we have the most competition. And our competitors seem to be preoccupied with filling their shops right now as opposed to trying to get a price increase. So it's going to have to run its course I think before we have quite the leverage we would like to have. But ultimately, what we are not going to do is fill up our backlog with a lot of aggressively-priced drill pipe orders. We are just not going to do it.

Sure, sure. In terms of the backlog, you mentioned it did include the China backlog. Was that a meaningful part of your sequential increase?

No, it's -- the increase is coming from the U.S. markets, principally.

Okay. And you also mentioned in terms of your guidance that it is based on a -- I think you said -- a flat rig count at first-quarter levels throughout the year. Is that correct?

That's correct.

Several other service companies have offered an opinion that rig count's going to be at or above 1200 rigs (multiple speakers) the end of the year.

Yes, right.

Can you give us some flavor of how you might anticipate that impacting pricing and volumes?

Well I think that from a volume perspective, one would expect, all things being equal, that on the bit side of the business, we ought to certainly be tracking any kind of volume increases. You know, that may give us a little more leverage later in the year to do something on the pricing front, although we've just barely implemented the price increase on the bit side of the business. So I'd say that business ought to move in hand with the rig activity. From a drill pipe perspective, it could be of course -- you know, drill pipe sales don't move in lock step with rig activity as clearly we have seen the last two years. But we are at a point where if inventories are already starting to get thin, as we believe they are, as you start to look at re-activating rigs from this point forward, you are going to have instances where you have got to buy drill pipe just to re-activate that rig. And so you could see a situation where our drill pipe revenue growth outstrips rig activity growth. In fact it should probably from here on out.

Okay. And you have no indications that the orders being made reflected in your backlog today are in fact for rigs to be re-activated; you see them as really being --?

I'm not sure we -- our customers give us that level of specificity. There is probably a little bit of that there. But I think mostly what we are seeing is them getting to a point where they are just having to address their normal replacement needs.

Right.

There's about what, 10 plus rigs under construction in the Far East right now. Those rigs are going to need drill pipe. So you start seeing some of those factors coming into the market as well.

Right, just back on the bits. You mentioned you are expecting to see volumes track the rig count increase. But as your earlier comments indicated, you have actually dramatically exceeded rig count increases in terms of your bit sales. Is there any reason that you don't think it will continue to run ahead of rig count?

Well as I said, I think there's a number of factors that are driving that tremendous performance by the bit business. And we've had tremendous success with a number of these new products that have come into the market. I am sure these guys will continue to bring new things in that will help us do well. But I also have to expect our competition is going to narrow the technology gap here sooner or later. So we have to be cognizant of that? Without a doubt, as I mentioned earlier, as we came out of Q1 last year, that was the first quarter out of the gate. We were in transition in a number of the international markets. I think that was probably somewhat disruptive to our revenue generation. And although at the time, we were hitting our expectations, I think retrospectively, we realize we probably did not get quite our share of the market in those first quarter -- first couple of quarters. So I think a little bit of this is catch up to what our historical position has been. So as I said, there's a number of factors here. And you know with rig activity up 20 percent in the U.S. and revenues up 90 percent, I'd hate to extrapolate that from this point forward, it's getting pretty dangerous.

I know.

There was a lot of momentum during last year, and certainly I think you will see the growth rates in the second half of the year come down from what you'll see in the first half.

Related to that, you mentioned historic marketshares. Obviously, ReedHycalog has had a zigzag history over just the past few years. Do you feel like ReedHycalog has re-gained its traditional market shares, if we kind of go back to a prior pre-Schlumberger period?

I think we are gaining on it, Geoff. But no, I think we are probably still a little short in certain product lines. And again, our goal here is not market share growth for the sake of market share. It's profitable high-margin growth that we are after. And market share will take care of itself.

Sure enough. And last question, just in a consolidated -- consolidated Grant Prideco, what is your kind of revenue exposure to Canada?

In the last quarter, obviously, it would have been quite high. Geoff, I may have to have Matt get back to you on that. We have to do a little homework on the drill pipe side of the business to really look at what drill pipe went into Canada versus what may have been made in Canada and shipped elsewhere and what was made in the U.S. and went into Canada.

Yes, all of our Canadian deliveries now would be out of (multiple speakers) Navasota facility. So it's getting harder and harder to track the ultimate location.

Do you want to venture kind of a guesstimate order of magnitude sort of thing?

Yes, I'd give you a guesstimate that we were probably in the 12 percent range. That is a pretty good guesstimate.

That's a pretty precise guesstimate.

12.3 to be (multiple speakers).

Great, thanks very much.

Tom Escott, Pritchard Capital.

Two quick questions. One, you indicated earlier I think that some of your major domestic drilling contractor customers were not in any big hurry, maybe were the words, or you did not see any sense of urgency about having to order a lot of pipe. And yet we here just for example, Neighbors says they are going to re-activate 40 more rigs this year. You know, your backlog is already out to July or beyond. If you're those major customers you want to re-activate a lot of rigs, does this set up the possibility for say a telescoping effect of orders, contractors having to order a lot more pipe just for replacement of existing rigs plus having to re-activate more later? Plus the fact that they're facing price increases. I mean there seems to be a disconnect that I'm not sure I'm understanding.

Well, in terms of the order quantities, you are right. When you get to a point where, as we've seen, for a number of these guys, they have been out of the market completely now for a couple of years. And so now just at current rig activity levels, they are starting to see that their replacement needs are staring them in the face and they are going to have to ramp up purchasing just to keep the rigs they have got running. So that's kind of step one. Step two, as you say, as they re-activate more rigs or if you have any kind of new rig builds, then you have a step function in terms of drill pipe demand for those. We are not seeing that yet. I would say that they are still at the stage where a number of these large contractors are still assessing what the replacement needs are going to be an they are still shopping right now as opposed to placing purchase orders. Obviously, that's not the case entirely because we have seen our backlog build. As regards buying in front of pricing increases, again, I don't see any indication that that is happening. I think they're -- at the end of the day, if they need the drill pipe, they need the drill pipe. And I think they are certainly cognizant of our desire to get some price improvement because it's been several years since we have had any. They are cognizant of what steel prices have done. That is a bit of a coin flip as to whether or not steel prices have peaked and whether or not all things being equal, they are better to wait 90 days and see if some of these surcharges come down. The gamble you take though is that if steel prices, you know, back up and you are still confronted with that, those surcharges are something higher. So I don't know how that is influencing their decision-making right now.

Okay, thanks. And then my second question was for Matt. Matt, as I look at the -- let's say the non-operating charges in the period, is it fair to say that the non-operating charges about balanced the non-operating 2.8 million sale of assets, so that those items are about a wash? (multiple speakers) And so the 9 cents a share really is a true, clean operating earnings number? Is that reasonable?

I think that's a reasonable assumption, yes.

Bill Sanchez, Howard Weil.

One quick question for you, just to follow up on the bit side. As we look at EBIT margins going forward, still very healthy levels in the first quarter, down a bit sequentially from the fourth. I am just curious with the mix shift now away from Canada, here and the pricing impact taking place, do we see margins trend back up a bit in the Drill Bits segment closer to fourth-quarter levels? Or was -- did that just significantly impact it because of the international orders that you'd shipped at year-end?

I think clearly it benefited from the strong international performance; and international margins tend to be a little bit better because it's more skewed towards the fixed-cutter side of the business. That being said, I would expect that you will see our margins from this point forward generally speaking continue to improve both on volume, the pricing and the mix should all I think aid the margins from this point forward.

Okay, great. Thanks, Mike.

Operator, if we have no further questions then, we will go ahead and wrap up.

I am sorry, sir. We do have one question from Ken Sill, Credit Suisse First Boston.

Thanks for having the patience to take the question.

You sure we have one?

Yes, sir, I am sorry. Hold on one second. Mr. Sill?

Yes, hello? Yes, hello?

I am sorry, sir. At this time, there is no response from his line.

That's fine. We will thank all of you for joining us this morning. As always, if you have any follow-up questions, feel free to give Matt or Jay a call. Thanks, and we will see you soon.

He didn't want to take any more questions.