國民油井華高 (NOV) 2007 Q3 法說會逐字稿

Welcome to the Grant Prideco third 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. (OPERATOR INSTRUCTIONS) During the call, the Company will be making forward-looking statements. We refer you to the Company's SEC disclosures which describe and discuss the risks and assumptions therein.

With that I will turn the call over to Mr. McShane, President and CEO of Grant Prideco. Please go ahead, sir.

Thank you. Good morning, everyone. As always, thank you for taking the time this morning to discuss our quarterly results. We released our third quarter results last night after the market closed, and I will have a few brief comments on those and then as usual, I will turn it over to Matt who will walk you through a more detailed discussion on the financials and then we will save most of our time for questions and discussions afterwards. We reported last night revenues of $540 million, reflecting a 20% increase in revenues over the same quarter in the prior year. Without a doubt, the revenue highlights of the quarter were at our growing products division which had another strong performance. I will come back to that in a moment. And at ReedHycalog primarily on the strength of Andergauge growth and its international business. Offsetting these positive factors and revenues was of course a continued soft environment we have in the tubular related businesses here in the U.S. and I will have a few comments on that here in a moment as well.

Earnings per share was $0.96 compared to $0.95 per share in the prior year. Two significant factors that impact this comparison, last yea results of course included a $20 million gain, $0.10 per share on the TReX license and royalty fee that we recognized. And of course this year's earnings per share, $0.96 was unfavorably impacted by approximately $0.07 in charges relating to the ReedHycalog manufacturing consolidation which was the topic of a pre-release a few weeks ago. Let me make a few brief comments on each of these topics and I will turn it over to Matt. Growing products and service, revenues of $306 million, were up 43%, on the year-over-year basis, almost equally driven by pricing and volumes. Pricing was up about 25% year on year, as were volumes. The offset was a slight decline in our third party tool joint sales which have come down during the year as we have consumed all of our internal consumption for our own requirements.

Footage sold was up about 25% on a year-over-year basis. Price per foot was up nicely as I mentioned. And this was largely driven by an increasing mix to premium end products. Premium sales mix was about 38% in the current quarter, and that's a trend we see continuing into next year. Operating income margins were up nicely on a year-over-year basis. It was down marginally on a sequential basis as expected, primarily as a result of customer mix. As expected, our backlog for drill pipe fell somewhat during the quarter as our North American customer base continues to defer purchasing decisions given the uncertain outlook for 2008. Nonetheless, the backlog we have today is very strong. $930 million represents about three quarters of the current revenue run rates, and it is important to note that what is in that backlog is skewed heavily to high end products at very attractive prices. So while down somewhat on a sequential basis, the quality of the backlog continues to look quite good. I'm sure we will have a few questions and comments on that a little bit later. So I will move on.

ReedHycalog had another good quarter from a revenue and field margin perspective. Revenues of $149 million, increased 16% year-over-year, with the primary contributors being the growth in the international markets and the exceptional growth we're achieving with the Andergauge acquisition. The negative of course was the disruption cost experienced with the manufacturing consolidation. That issue will improve considerably in the current quarter. And while disappointed that we did not do a better job of envisioning some of these costs and disruptions, the project is still going -- it is still going well. We're a little bit behind schedule because of some weather delays, but the benefits that we anticipate from this consolidation are very solid, and will contribute nicely in 2008. Excluding these costs, operating income margins would have improved sequentially reflecting the underlying favorable trends in this business.

Tubular Technologies continues to perform well in a tough market environment. We've talked about this for several quarters. The inventory correction that has been going on at the distribution level, the very soft drilling environment we've got in the Gulf of Mexico, have both worked against the demand for these products and services. In spite of that, even though revenues were down 22% on a year-over-year basis, our operating income margins were very solid, mid 20% range, comparable to where we were last year at this time, and actually improved modestly on a sequential basis. We think the worst is over in those sectors. In fact in the last couple of weeks we've seen a nice pickup in backlog in our TCA business and so we think there should be some modest improvement in those businesses through the balance of the year. With that, I am going to turn it over to Matt and he will walk you through a little more detailed discussion on the financial results.

Okay. Thank you, Mike. As Mike said, consolidated revenues were another record at $539.9 million, up 20% year-over-year, and 3% sequentially. Mike covered the divisional revenue changes, so I will touch upon the operating income margins and the product mix figures. Drilling products and services, drill pipe sales represented 83% of total revenues up from 76% in the prior year due to substantial reduction of third-party tool joints. All other product lines showed year-over-year revenue increases. Sales of premium drill product represented 38% of total sales, up from 32% in the prior year, and 31% sequentially due to increased sales to rental tool companies. The average price per foot was up 25% year-over-year, and 5% sequentially, due to favorable size and product mix. Operating income margins improved to 39% from 37% in the prior year, due to both volume and price improvement, but as expected, declined slightly on a sequential basis due to a higher percentage of sales to alliance customers.

At ReedHycalog, drill bits represented 74% of total revenues, up from 80% in the prior year, but down from 77% in the prior quarter, as the chlorine and drilling tool product lines showed the biggest sequential revenue increases. On a pro forma basis, Andergauge revenues were up 32% year-over-year. 53% of ReedHycalog's revenues came from international operations. ReedHycalog's operating income margins declined to 24% as a result of costs associated with the consolidation of our ReedHycalog drill bit facilities. These costs included manufacturing inefficiencies due to the phasing out of production at four of our existing facilities, and the start-up of the new Conroe facility, an inventory valuation adjustment for PDC cutters transferred from our Provo facility and direct costs associated with moving equipment into the new facility. These costs totaled approximately $14 million, and an additional $5 million to 7 million in costs are expected in the fourth quarter when the move will be substantially completed. Excluding these costs, operating income margins would have been approximately 33%.

In tubular technology and service, three of the four product lines showed year-over-year revenue declines, with Tube-Alloy showing the only revenue increase. Sequentially both Tube-Alloy and XL showed revenue increases. Operating income margins were 25%, relatively flat on both a year-over-year and sequential basis. Operating losses at our corporate other segment declined sequentially due to lack of Intelliserve revenues during the quarter. Year-over-year, the operating loss drew by $2.6 million due to legal costs for patent litigation. Overall, consolidated operating income declined slightly on a year-over-year basis, as higher revenues were offset by the prior year $20 million license and royalty fee, and the ReedHycalog facility consolidation costs. Excluding these items, operating income margins would have been 32%, flat sequentially, and up from 31% in the prior year. Equity income from Voest-Alpine Tubular came in at the low end of our expectations at $24.3 million, due to continued softness the U.S. OCTG market and unfavorable exchange rates. We should see recovery in Q4 as we come out of the summer maintenance period and are currently expecting profits in the $28 million to $30 million range in the fourth quarter.

The tax rate for the quarter was 29.8%, flat with the prior year, but up slightly from the second quarter rate of 29.3%. We are forecasting the fourth quarter rate to be between 29 and 30%. In total this adds up to 96% for fully diluted share. Now for the balance sheet, at quarter end, we had cash and short-term investments of $240 million, up from $194 million as of the prior quarter end. Interest bearing debt was $207 million resulting, in a debt-to-cap ratio of 10.8%. Our day sales outstanding increased slightly to 65 days. For cash flows, our cash flow from operations were $105.5 million, capital spending was $27.5 million, leaving free cash flow of $78 million. Capital spending for the year is forecast to be approximately $130 million. EBITDA for the quarter was $193.4 million, and we repurchased 758,000 shares during the quarter, at a total cost of $40.4 million.

I will now give a brief outlook. We are currently forecasting Q4 earnings to be in the range of $1.09 to $1.11 per share, with revenue improvements at each of our three divisions and at Voest-Alpine Tubular. This figure reflects approximately $0.03 per share of continued manufacturing efficiencies and direct costs associated with the facility consolidation at ReedHycalog, which should be substantially completed by year end. With that, we will turn it over for questions.

Okay. Operator, if you can open it up to questions. As always, we will ask you folks to limit yourselves to one question and one follow-up the first round through and if we have time to take more at the end, we will.

Thank you. (OPERATOR INSTRUCTIONS) Once again, we ask that you limit yourself to one question and one follow-up. We will pause for just a moment to compile the Q&A roster. The first question comes from the line of [Colin Jerry] of Raymond James.

Good morning, guys.

Good morning, Colin.

I wanted to hone in a little bit more on the DPS segment. You mentioned kind of the downtick in non-drill pipe revenues as related to lower tool joint sales and maybe some customer mix. Obviously, that had an impact on margins, it looks like. Can you maybe give us little bit more color there as to what is happening and how we can look at that going forward?

Historically, we had had a pretty nice business selling tool joints to some of the other drill pipe companies that didn't have the capacity to meet their internal requirements. And as we've gotten busier and have run at near capacity, our ability to service them has gone away. So that production has been diverted to internal consumption as opposed to third-party sales. That's been going on through the year, and it is just when you look at what is happening to the revenues, when you add up the pieces, drill pipe revenues being up 50%, the offset is this decline in third-party tool joint sales. As regards the margins, as can happen in any given quarter, the size mix, the customer mix, the API versus premium mix can move our margins around a little bit. And in this particular quarter, while we had a pretty good mix from a premium perspective, we had a somewhat higher than average business mix with some of our very large, what we call alliance customers. Which as you might imagine get somewhat favorable price versus some of our other customer base. So that was more of a customer mix issue than anything else.

Okay. So going forward, the lower tool joint sales, that's not necessarily something that is indicative, we shouldn't put that 38.5% --

No, I think it is kind of in the base. It is just that we try to reconcile sales and volumes on a year-over-year basis, those non-drill pipe sales need to be considered as well.

But we are expecting drill pipe margins or drilling products margins to increase in the fourth quarter.

Okay. And then second question, I guess, you kind of glossed over Intelliserve kind of quick. Can you give us the overall update. What are we looking for as far as projects go? What is the status tracking like?

Sure. I knew it would come up in the Q&A, so I was just trying to save time. As expected, Intelliserve had a slow quarter from a revenue generation perspective, and a very busy quarter from a prospecting perspective, and so we went into this quarter realizing that we are kind of in a lull if you will between projects. That being said, our best estimates right now are that we will be on four projects as the current quarter develops, a couple of international projects, a couple here in the U.S.. Those should be developing about mid November onwards, so that by the end of the quarter, we would expect to be on four, four rigs plus or minus. We have at this point scheduled about an additional four projects that we believe will be starting up during Q1, so that in theory, by Q1, we might be on six or seven rigs, and we have a number of projects that are on various stages of negotiation that go beyond that. So it is basically the same report as I gave you 90 days ago, a slow third quarter, about four projects that start up in Q4, and more to come in Q1.

Okay. Great. Thanks, guys.

You bet.

Your next question comes from the line of Kurt Hallead of RBC.

Good morning.

Good morning, Curt.

You guys do a great job in studying the market and everything else, and given the slowdown we've had in the U.S. land drilling in general, some of the -- I think the 200 rigs, 300 rigs are kind of laid up at the moment, what is your best guess as to how much inventory is sitting around right now?

Obviously, there is more inventory sitting around than we'd like. I think principally related to those idle rigs. In other words if all of those rigs were working today, I don't think there is a sense of an excess of inventory out there. So what we've got is a situation where you have several hundred rigs out in the U.S. market that don't have a home and you've got all of the inventory that is associated with those, including drill pipe. The question that we will be contending with here over the next quarter or two is what the tendency is of our customers to dig into that inventory and live off of it while they get a better handle for what this U.S. marketplace is going to do. And so I think that that is going to be a factor. And I think it is going to vary a lot, Kurt, on a customer by customer basis. You know, I think that depending on the quality of their rig fleet, some have a higher utilization than others, and those ones are going to probably be bigger customers for us in '08 than some of the guys that have a higher underutilization.

What does all that mean? We will be seeing what comes through here in the next 90 days, in terms of drill pipe orders, and they're beginning to trickle in from our North American customers. They're not trickling in at quite the rate we would like to see but they nonetheless are coming in. Our best guess right now, Curt, is that the U.S. demand for drill pipe in 2008, as it impacts Grant Prideco, is probably going to be down somewhere in the neighborhood of 2 to 3 million feet as we go into 2008. The mitigating factors to that are going to be the increase in demand for offshore drill pipe, which is reflected in our backlog, and see if there are more orders to come. The increasing demand from the international side, which is very important to us.

But as we've been saying for the last several months, when we look at all of that, it kind of translates into a story where we expect our drill pipe volumes to be down in '08, in the range of 1.5 to potentially 2 million feet, albeit skewed to a higher quality, if you will, a higher premium mix of drill pipe which will help us quite a bit on the margin front. That can change as 2008 develops. If the gas markets start looking a little bit more robust in mid 2008, I think that that demand on the U.S. side could start to pick up again. It is going to pick up. It is just a matter of when it starts to pick up in the second half of '08 or if that is an '09 event. I have no doubt that there is a second leg up to this U.S. marketplace. We just got to get through a couple of quarters here.

And my follow-up question is, is on drill bits, in general. Halliburton was out early this week basically saying they are seeing some pricing pressures in the drill bit markets. I know they're not one of the top three players, but was wondering if you could give us some color commentary on what you see happening out there on drill bits.

Well, I think as we've talked about on prior calls, we have tried to maintain a pretty strict pricing discipline in the drill bit sector. That's gotten a little tough to do here in North America, without a doubt with things slowing down a bit. We believe our pricing is actually improved modestly here in the last quarter or so, in North America. Has it cost us a little bit of market share? Yes. Are we prepared to continue to lose a little bit of share to continue to hold or improve pricing? Within reason, yes. So I think each player probably has a different perspective on this. That's ours.

Okay. Thanks a lot.

You bet.

Your next question comes from the line of Dan Pickerring of Tudor Pickerring.

Good morning, guys.

Good morning, Dan.

Mike, I just want to pardon the pun, drill down a little bit here on the pipe side in North America. You just indicated you're thinking 2 to 3 million feet which puts '08 down a 1.5 million or 2 million feet or so. Remind us again how big in general the U.S. is as a percent of your business. And then how much does the price improvement that you've already got in backlog help offset the volume decline?

Fair points. Just to clarify, when we talk about the demand being down, in the numbers we talked about, I'm talking about North America, so clearly, Canada weighs in on that factor as well. So collectively, Canada, U.S., could be down in that range of 2 to 3 million feet. That represents -- Canada and the U.S. have represented about 60% of our drill pipe business, so it's the other 40% that we're looking for, continued growth in. We expect our demand in China to be up nicely, on a year-over-year basis. We expect our demand in the general international market to continue to improve. As you well know, some of these U.S. land rigs are finding homes in the international arena, and all the times they've moved there is a change-out of the drill pipe involved so we benefit from that. And then as I mentioned, the increase in demand for offshore rigs coming into the market in '08 are helping us as well.

So the mix and the base pricing that we've got in the backlog today are certainly going to help. If you look at the pricing we've got in the backlog today, it is up quite nicely. It is actually, the backlog we've got today is, you know, for 2008, is actually north of $70 a foot. And that compares to an average price per foot in 2007 of about $58 a foot. And now clearly, that average for 2008 is going to come down somewhat, as we do book some of the business for the U.S. land contractors. But that pricing is going to go a long ways, that pricing and mix is going to go a long ways to offsetting some of the volume declines. What all that adds up to, we're in the process of doing our bottoms up forecast right now. We also have some manufacturing cost efficiencies that are coming in next year that are going to help us. We have some non-drill pipe business that we think we can go after next year, to fill some of the idle capacity, and so I think we've got a few things we're working on to try to offset that, that volume decline.

Okay. So Mike, as it looks now, does that translate to slightly up revenues for next year, but not dramatically up revenues, it sounds like?

In the drill pipe business?

Well, just in the drilling products business.

The drilling products? That's the question. It is probably -- we will probably be doing good if the revenues are kind of flattish in that environment. They could actually be down a little bit. But you know, still see some margin expansion on that.

Right. Okay. And follow-up question would be in a sort of I guess 14.5, 15 million-foot environment, which is kind of what you're talking about at this point, do you change anything about your cost structure or the plant scheduling, things like that?

I think that the way that it would play out, Dan, is we will take advantage of our lower cost manufacturing centers. Some of the expansion that we've gone through here in the last couple of years has been geared toward the international marketplace, China and Mexico, where we have a somewhat lower cost of manufacturing, and so that will help us on the margin front. And we will reduce overtime. There has been a lot of inefficiencies that we've had to incur to deliver the volumes of drill pipe we've had. We have had a lot of logistic expenses of moving things around. We've had to outsource some heat treating. There is a number of those inefficiencies, if you will, that will be the first areas we cut back on. As I mentioned, things like overtime and whatnot we'll pare back on. I think that the natural attrition will right-size our work force to where it needs to be. And as I say, I think this is a temporary issue. I think there is a very good chance that somewhere in the second half of '08, we're starting to gear back up for that next round of demand coming out of the U.S. and Canada. I think that the cost issues that we will have to address can be managed appropriately. I don't think there is any significant change on our operating structure. And I think we just take advantage of our low cost manufacturing locations.

Thank you.

You bet.

Your next question comes from the line of Mike Urban of Deutsche Bank.

Thanks, good morning.

Good morning, Mike.

I was wondering if -- this may be difficult to pin down, if you do see a little bit of an extended slowdown here in the U.S., given the increased consumption rates on the rigs that are running, how long would you have to wait to kind of work through -- if the customers were out cannibalizing the pipe off of the stacked rigs, about how long do you think it would take to work through that, do you think?

Mike it is a fair question to ask. It is a tough one to answer with any degree of accuracy, unfortunately. You do point to a couple of underlying trends that I think are notable, and that is with the contingent growth in horizontal drilling, both in the U.S. and in international, that certainly is a factor that probably increases the consumption of the drill pipe. As you know, that is very wearing on drill pipe, and drill accessories. It is certainly driving an increased demand for heavy weight products which is one of the areas we think we've underexploited and we can go after it a little more aggressively next year. You know, what that inventory correction, if you will, if we assume that the rig activity was kind of flattish here, for the next several quarters, I would think we're looking at two or three quarter-type environment where some of that drill pipe is consumed before we get back to some sort of normalized replacement rate, but Mike, I got to be honest with you, I could easily be off by a quarter or two.

Sure. That's helpful, though. And in terms of when, and I agree with you, it is a when and not if question when the U.S. guys come back. At what point, or how much lead time would you need to have that still be an '08 event for you?

Oh, our lead times right now on drill pipe are about -- we still have some holes in the second quarter of next year, so we can take an order today and deliver it in six to seven months. We can't do that with tremendous volumes but we can still begin to backfill some spots. So I think that if we got into the first or second quarter, and things start looking a little built more favorable, and our customers come back and say hey, can I increase my volumes in the fourth quarter, we probably could respond fairly effectively. And of course, they know that today, and that's why they have the luxury of deferring some of these purchasing decisions as well.

Okay. Great. Thank you.

Okay.

Your next question comes from the line of Robin Shoemaker of Bear Stearns.

Thanks, Mike. Wanted to ask, since you got a little bit of offset of international versus the projected decline in domestic drill pipe sales, principally what areas is that coming from? I think it is like 1 to 1.5 million feet, given that you expect the domestic to be down 2 to 3.

Okay. We're saying right now, this is still to be finalized a little bit between now and the end of the calendar year, at least our estimates be firmed up a bit as we get some of these orders. But we're saying that the North American demand is down in the range of 2 to 3 million feet, that we think we can offset that with some increased international business, some increased heavy weight business and what not that translates to potential the equivalent of 1 million, 1.5 million feet. I think the single biggest area where we believe there is an opportunity for increased demand would be China. Clearly, it is probably in one of the very fast expansion mode right now in terms of new rigs being added to that marketplace, and those new rigs all need drill pipe, and so we are certainly looking right now to where our drill pipe demand in China could be up as much as 0.5 million feet or more next year.

The Middle East has certainly been a good market for rig activity growth. And as rigs are either added from a new rig perspective, or from a transfer out of the U.S., that is creating an opportunity to outfit those rigs with new drill pipe, and so that has been helping us and we think that is going to continue to help us going into 2008. Those will probably be two of the areas I would highlight. And then I would say the other areas are just in general growth, whether it be in Latin America, we're expecting our processing, for instance, down in Mexico to be up quite a bit next year, based on what we're hearing from our customer down there for demand. We're expecting generally increased demand on the offshore side of the business, most of which of course is geared to the international market. So those will be the areas I guess I would highlight off the cuff.

If you can compare our backlog today to where it was as of the beginning of the year, pretty much every international region is up. The only other one I would highlight significantly would be the North Sea Russia region, we're up quite a bit in backlog in that area as well.

Okay. Just switching subjects, on Intelliserve, you mentioned four projects starting up six to seven, perhaps thereafter, what do you deem to be your capacity? Kind of how many wells or rigs could you be on simultaneously today and where is that capacity going?

Well, I guess I would say today, I would have to check with our guys, I think we have field service hands and the number of strings available to effectively manage six, seven, eight projects currently, probably in that neighborhood. We're gradually gearing up but we're trying to temper how quickly we add people and add capital, as we get more and more confident these projects are going to be there. So I think the question is really how quickly can we gear up. And I don't think that is going to be our limiting factor. I think we can gear up as quickly within reason as these projects materialize. Most of these projects tend to have a fairly long lead time in terms of when we get a commitment and when they are actually going to start up, and the number of the projects that we're looking at and believing are going to be starting up here, in the next four to five months are things we've been talking to the operators about for a year now. So I think we have enough lead time to respond.

Okay. Thank you.

You bet.

Your next question comes from the line of Bill Herbert of Simmons & Company.

Thanks, good morning.

Good morning, Bill.

I'm not sure if you all covered this or not, but what was the footage in the quarter, please? Matt, do you have that number handy?

Yes, footage sold was 4.2 million feet, that is excluding the processing we do for TAMSA out of Mexico.

4.2 million feet. So we averaged about $60 a foot?

That's correct.

And so would you expect that you would ship out a similar amount going into Q4?

Yes, we're operating at pretty much full capacity, so that represents full capacity on production. Our production was 4.5 million feet during the quarter, which is right at our full capacity.

So if we've got --

The sales sometimes can slip from one quarter to the next, but certainly, we're at full speed today.

Understood. If we're averaging $70 a foot in backlog, Mike, that means we have 13 and change in terms of volumes in backlog?

On a total footage in backlog?

Yes.

It is about 12 million feet in backlog. So then really, we go into -- sorry, go ahead. That $70 figure is for 2008. So it is a little bit less on an average basis.

Got it. Now, Mike, with regard to -- you mentioned that the orders from the North American land drillers were beginning to trickle in and you had seen some orders from those whose rigs were enjoying a higher rate of employment. I would assume that is probably Helmrich and Payne. Which other significant land drillers have submitted orders in '08 thus far?

Bill, we don't want to get into a customer by customer discussion. Suffice it to say that several of our biggest customers have yet to order any meaningful quantities for 2008.

Okay. And so you mentioned expectations. And I guess this is not necessarily a question you want to answer on the call, but I'm going to ask it anyway. But you mentioned that North American volumes would be down a couple million feet year-over-year. That was your prognosis. Given that, expectations for pricing would likely be lower as well?

I don't think we will see a big shift in price. I mean clearly, the ability to push price increases much beyond where they are here in the near term is going to be limited. I will grant you that. I believe that the, if we look at the bulk of our alliance customers, we either have modest price increase built into the agreements, and with some of the -- a lot of the price increases we're expecting next year is driven by the premium end of the market, which is still very much in demand. I think that we will have to be realistic, and realize that this environment, some of the commodity end of the business next year, some of the spot business, that inevitably will come along, will probably be a little bit more aggressive, some of our smaller competitors will be a little hungrier and they will go after that business a little more aggressively than we'll be willing to. So there may be a little bit of that. But you know, I don't think we're going to chase that business, and we recognize some of the smaller guys will have to get some orders to stay busy, and we will be content to kind of pick off the business that we can get at good solid prices, and we were successful doing that a couple, few years ago when things were a heck of a lot worse than they are today so I have no reason to think we can't do that again.

Switching gears here, with respect to TTS, we have witnessed a sort of heroic round of consolidation with respect to the OCTG business over the past, call it year and change. Characterize for me the imperative for further consolidation in this market given the fact that the overall demand profile has been somewhat suppressed since those transactions took place. Is the appetite still there to do deals of any consequence?

Yes, I think what I would say, Bill, is that when I look at the -- from a mill perspective, I think there is still arguably room for some further consolidation. You've got new foreign mills coming into the market which will be a factor, they certainly are going to be looking to import more and more of their products into the U.S. and I think that trend is undeniable and it is there and it is going to probably continue to force some of the mills to look at consolidating opportunities. The other trend that we have been watching closely is of course the vertical integration if you will of some of the other related services into the provision of the pipe itself. And you know, it is hard to say. I think there is still some things that could happen that make some sense, but whether those happen or not, I guess we just have to wait and see.

All right. And last one, Matt, you gave guidance for V.A. for Q4. Any thoughts with respect to what is a sensible starting rate assumption for '08?

We will provide that next year. Or next quarter's call.

I appreciate that. Thanks, guys.

Your next question comes from the line of Geoff Keiburtz of Citigroup.

Good morning.

Good morning, Geoff.

A couple of clean-up questions. You mentioned a couple of times the outlook for offshore to be a positive factor in the drill pipe business. Of the rigs that are scheduled to come into the -- out of the shipyard in '08, how many of those have ordered drill pipe?

I will give you our best estimate, okay? In 2008, there are approximately 57 new builds to be delivered to the marketplace. We believe pipe has been ordered for about 32 of those. Of those 32, we think we got orders on 20. 2009, there is another 45 new builds scheduled to be delivered, and only three to five of those have placed orders. So there is still a lot to come for 2009. There is still a fair amount to come for 2008. That's our best estimate. Now, bear in mind, some of this goes through the rental tool market and so it is not always as easy, but that is our best estimate, Geoff.

Some upside there.

I think so, yes.

You talked earlier about China and I think specifically about dialogue with China, can you update us on those discussions?

They are ongoing. Actually we have one of our guys over there this week that is digging into the whole market environment over there a little bit better to try to help us better quantify just what the demand may translate to. From a macro perspective though, the new rig construction continues in that marketplace. We think there is an undeniable push there to expand drilling activity within the China borders. And our estimates are, there is probably somewhere around 150 to 200 land rigs that were added to that marketplace this year. And we are trying to get a handle but I suspect it is going to look similar going into 2008, and with that, you're going to need drill pipe for those rigs. And the other thing that is happening gradually is a push towards a little bit more difficult drilling going on over there, there has been some projects announced later that are all going be in sour service type environments and that clearly spells an opportunity for us to distinguish ourselves from some of our Chinese competitors in terms of ability to provide sour service drill pipe rig. So there is both a mix shift taking place, as well as a volume story to be told over there.

Okay. When you talk about 0.5 million feet of incremental demand in China, how are you factoring in the Sinopac opportunity?

It is all -- it in that as well as the other customers, it is not all predicated on one customer, by any stretch.

Okay. And I guess you talk about, you had talked about DPS as sort of a picture of volume declines, margin improvement in '08, with a somewhat uncertain outcome at the EBIT level. Could you characterize your thoughts on Tubular Technologies and ReedHycalog in those terms?

I think that from a ReedHycalog perspective, bearing in mind that 50% of their revenue stream is outside North America, if not more, we certainly are expecting that to continue to grow in line with rig activity, as well as we think there is still some markets that we have room for expansion into, so I would expect us to perform at or above the rate of international growth in '08 for that part of their business. I think Canada, whereas we don't see Canada getting a lot better, in '08, right now, '07 has already been a pretty tough year, so the comparison should get a little bit easier. And then the U.S., of course, is going to move more or less in line with the level of rig activity, so you know, right now, our rigs can kind of flatten out where they are, they can go down another 3 or 4%, I am sure there are a variety of opinions on that, and we will be forming those as guys announce their budgets and what not.

On that top of that, we believe that ReedHycalog will continue to benefit from the expansion of its coring services into the international market, and more importantly, the expansion -- ongoing expansion of the Andergauge product line which has done quite well I think on a year-to-date basis, they're up almost 30%, versus what they were running at last year and we still have a lot of untapped opportunities to expand their business, and so it is a matter of how quickly we can grow their fleet size. So I think, ReedHycalog should have a pretty reasonable growth year next year, in spite of a lackluster North American environment.

Tubular technology and services, again I think we've been through a pretty tough environment already. It is dependent as much as at what is going on at the distribution level in terms of right-sizing inventories as much as the absolute level of drilling activity. Our estimates are that OCTG inventories have continued to come down, and are now, depending on what reports you look at, are getting into a fairly reasonable range. And with that, I think we are going to see a stabilization of that business and arguably a little bit of a recovery at TCA and that with Bradford. And I think they will be okay in '08 versus '07. And the XL products line within that division, we're continuing to expect a pretty good growth out of the international market. So I think net net, it can have a year in '08 that is up modestly from '07.

Okay. I will leave it there. I will let somebody ask a question. Thanks.

Okay.

Your next question comes from the line of Brad Handler of Wachovia Capital.

Thanks. Good morning, guys.

Good morning.

A couple of things I guess coming back to where Geoff was going, on the bit side, perhaps you spoke about the revenues, I appreciate that, can you quantify for us at all the hoped for benefit of the consolidation effort that you've just finished up in terms of some annual run rate of savings?

Yes, our estimates were that that was going to produce direct cost savings of about $8 million a year. A lot of intangible benefits that come along with it. Those are harder to quantify, but then the direct overhead type of costs associated with running four facilities versus one was approximately $8 million a year.

Okay. And that's -- in a sense, that's effective Q1 of '08?

Yes, we should be -- I think we will start seeing the full benefit of that pretty much right out of the gate in 2008.

Okay. Fair enough. Thanks. And then following on, I'm just -- maybe it is instructive which is why I ask it this way, in your preannouncement, I think you looked for revenues of about $550 million, you came in at $540, and maybe I will offer the guess that it maybe was related to Tubular Technologies and maybe Gulf of Mexico softness but can you speak to that mess and what that might tell us about your visibility or what happened in September?

Well, there is always variables in this business. And I think that the difference between that and what we actually booked, I think we have an order or two within Tubular Technologies that got pushed out a little bit. And then we had some drill pipe orders that we thought were going to ship this quarter, but they are subcontractors and didn't get the pipe coated in time, so we couldn't recognize the revenues. So things as simple as that that could cause you to have those type of small variances in revenues, in any given quarter. And they're tough to predict.

Fair enough. All right. Well, if it didn't go that way I guess I have to ask more explicitly, was there some issue in September related to hurricane precaution, anything to do with the recount falloff in the back half of September?

No, not to any meaningful degree impacting us, no.

Okay. And how much in your thoughts right now are you assuming -- that the recap rebounds let's say to the 70 rigs operating level, or something higher, for next year, what is your guidance outlook on that? How much do we think?

I think we're getting some indications there is going to be a little bit of a bounce back in the gulf drilling, I think there is -- the operators increasingly have gotten to a point where they just lay down the rigs during hurricane season. The risk, their insurance costs have gotten so excessive, and they're taking on more risk themselves, they're taking higher deductibles and what not, and so to mitigate that, they're also looking at curtailing some of their drilling activities during the hurricane season to offset the higher risks they're taking, and I can think of a few cases where we know operators are picking up rigs as the hurricane season comes to an end. So I think we are going to see a little bit of pick-up in gulf activity here for the balance of the year.

So again, so Tube-Alloy stronger fourth quarter than third?

Tube-Alloy should be a little bit better. We should see TCA, we're getting indications, backlog is picking back up again. And Atlas Bradford has been reasonably steady but on the margin I think they could be marginally better in the fourth fourth quarter versus the third quarter as well. And then XL products based on some international shipments should be up nicely in the fourth quarter as well.

That's very helpful. Thanks, guys.

Okay.

Your next question comes from Alan Laws of Merrill Lynch.

Good morning.

Good morning, Alan.

See what I got left here. On the litigation cost that you mentioned in your comments, could you update us on the progress of your ongoing TReX cutter lawsuit and the bits business? Are you close to any settlement agreements here? Or like the one you signed with Smith last year?

You know, Alan, we can't really discuss that. I would have to say our best estimates right now is we're headed for trial. We have been very successful in some hearings that have taken place here recently. One most significantly was the Markman hearing up in east Texas here recently and it was a very favorable ruling for us. But in terms of settlement discussions, that could occur at any point in time between now and trial, or afterwards, but at this point in time, I would have to say the base case is we're going to trial.

Okay. Thanks. A little follow-up to that then can you talk about maybe the competitive dynamics of the bit startups and the loss of share by the bigger players? Are these startups also infringing on this patent as well?

They are. There is a number of parties that are named in a couple of lawsuits now. And clearly we believe that part of the rise, if you will, of what we will refer to loosely as second tier drill bit companies has been predicated on their utilization of some of our PDC technology. And it has enabled them to take a very, very successful cutter and place it into a bit body that is otherwise very average, and have a pretty good performing bit. And historically, some of these guys have not been as price disciplined in the marketplace, and so it has caused an environment where customers are winning. They're getting a pretty darn good performance for less than I think what they should have to pay. I can't blame them for taking advantage of that, but yes, the infringement of our patents has certainly changed the competitive dynamic that is out there in the marketplace. And until we get this thing resolved, we are probably going to have to live with that.

Okay. But when you look at it from a settlement point of view, would you settle with them as well? Are your thoughts here a little more Draconian?

I can't go into that on a call like this. I think we have to assess what opportunities are there, as and when they occur.

Can I get another stab at this? Would it be fair to say that a resolution of this lawsuit could be positive on the share side for pretty much all of the established players? Mostly you, of course.

I think a resolution of this would be a very positive development for ReedHycalog and Grant Prideco. And I will leave it at that.

Okay. All right. My last question, and I'm taking up too much time here, the balance sheet remains pretty pristine and you bought back more stock on 3Q. Can you update us on your thoughts of cash return or use of cash here going forward?

As much as we've said in the past, as the cash balance grows, our focus on what to do with that and to do something responsible with it increases and I think we will have more to say on that here in the near future.

All right. You've had some other people make some rather larger moves. Are you thinking bigger or just sort of --

Well, I think the longer we go without finding a significant acquisition opportunity, which is of course would be our first choice to redeploy this cash, but the longer we go without finding something of a meaningful nature, I think that we feel increasing pressure to either step up the share repurchases or turn that -- send that cash back to shareholders in some other form. So as I say, I think that it is something that is getting increasing attention, not decreasing attention. It could change tomorrow, if somebody picks up the phone and there is a great acquisition opportunity, that could answer all of those issues, but in any event, anything that we would do, we are still going to leave ourselves flexibility to respond to reasonable acquisition opportunities. But it is something that is getting lots of attention.

Thanks for the answers. I will turn it back.

Your next question comes from the line of David Anderson of UBS.

Thank you. A question, you had mentioned last quarter that offshore represented about 50% of your drill pipe backlog. I assume it sounds like from your comments that has gone up a little bit?

I think Matt can give that you number.

Yes, our backlog currently, let's see, it has increased, it is about 55% currently.

And I'm just kind of looking at -- you had mentioned on your premium side about 38% was premium, that's the first time, if I'm not mistaken, first time that has actually turned up in several quarters and I assume it is related to. That I'm just kind of wondering about your projections as you go forward, you had mentioned that you are expecting that trend to continue, but if a big chunk of your -- I assume probably about a quarter of your backlog, probably in China and most of that is going to be API grade. Can you just walk me through how you would expect, with the mix change, and how the premium versus API grade, how you expect that to play out over the next several quarters?

I think to -- I'm sure Matt can go through this in a little more detail maybe with you on a side call, but I think in simplistic terms, if you assume next year when all of the dust settles that our volumes are down because of it diminished requirements from our U.S. and Canadian customers, which is largely API-related drill pipe, combined with an increased demand for offshore-oriented products, that in itself would drive that premium mix up on a year-over-year basis. Now, to get overly precise at this stage, before we booked orders for a number of our rental tool and U.S.-oriented customers, is probably a little bit premature, but the trend, I think we're pretty comfortable in saying the trend is going to be, that this can be a heavier mix for the full year '08, versus '07 to the premium side of the business.

Dave, one thing that impacts that is sales to rental tool companies. They typically buy a large percentage of premium drill pipe and we just coincidentally had a large amount of sales to the rental tool companies in the quarter. So that can bounce around from quarter to quarter, but as Mike said, overall the trend is certainly increasing.

Very helpful. And then on the bit side, you had mentioned about 50% of your revenue is coming from international markets. Roughly where was that this year at this time?

I may be off, it is general, I may be off a percent or two on the exact number, but I think Matt can give it to you.

I'm just trying to get a rough sense.

The international revenues as a percentage of total was a little less than 50%.

Okay. I'm just trying to get a little sense of the pricing and maybe Mike you can just give me a few words on what you see the difference between bit pricing say international markets versus the U.S. markets. How close is the pricing levels international versus say North America and -- in terms of market dynamics?

Pricing can vary so much, and the international, you're talking about, you know -- I don't know, 40, 45 different marketplaces, all of which operate fairly independently. So you almost have to look at it country by country and it can vary a fair amount and then of course you have all of the product mix, and it is a roller cutter market or a fixed cutter market. In general terms, what I would say, and I would have to verify it with our guys, but the operating income, or the fill margins that we realize in general, internationally and domestically, are fairly comparable product mix adjusted. Even within the U.S. within international there are variances to that. The pricing trends have been generally a little bit stronger for us on the international front, as you might imagine, as compared to the domestic front. Two reasons for that, number one, the second tier drill bit players tend to be less prominent and less of a factor in the international marketplace, and clearly, the international marketplace has had a little more momentum associated with it than has the North American marketplace here lately. So both of those things have led to reasonably steady pricing improvements across the international front, whereas in the U.S. it has clearly got an little tougher.

Great. And that's exactly what I was looking for and I will break the rules and ask you a third question. (inaudible) Can you just give us the status of the contract there?

The contract has been finalized. And as we expected, there will be some cost increases associated with our green tubes going into next year. That has been contemplated in the pricing that we've quoted for orders so far and will continue to be a factor as we price out contracts for next year. Part of that is due to pure raw material cost increases that are occurring. Part of it is due to a little bit of a margin expansion that is built into that contract. Of course, half of that margin expansion comes back to us through the joint venture.

Great. Thank you very much. You bet.

Your next question comes from the line of Ken Sill of Credit Suisse.

Good morning, guys.

Good morning, Ken.

A couple of questions here. On this restructuring in the bits, you guys have kind of thrown that into continuing operations, but looking at that, that is really not an ongoing expense. How come you guys haven't treated that as a restructuring charge instead of throwing it into operating results?

I will let Matt handle. That sounds like an accounting question.

Yes, there are specific rules of what you can specifically call restructuring charges, and being able to break out separately. Quite frankly we treat this as part of our operations. It is a nonrecurring cost certainly because we expect them to go away by the end of the year, but it is part of our ongoing manufacturing and we try to manage that costs to be as low as possible.

Essentially if you look at your guidance that includes the $0.03 charge in Q4 for restructuring so you guidance isn't actually down, it is up a little bit for Q4. Would that be fair versus your prior guidance?

The prior guidance, I think we tweaked a little bit. It is down slightly from our previous guidance.

Again, I think the guidance was updated, I think Matt is right, it is within $0.01 of what we had estimated previously, and it never ceases to amaze me that -- here this is five years since I started and have we had the first conference call, and if we missed or beat by $0.01 back then when we were talking about making $0.02 or $0.03, those pennies mattered as much as they do when we're making over a buck a share. But that's the world we live in. I think that on the margin, if there is a message in the earnings guidance for Q4, versus what we previously said, I would say really the only change is drill pipe business, no real change there. Tubular Technologies, no real change there. I would say marginally we're a little more pessimistic about Canada going into the fourth quarter than what we may have been 90 days ago. There is just no good news coming out of that marketplace right now. And so I think if there is any area where we are probably a little more pessimistic than where we were 90 days ago, that would probably be it. Otherwise, things really have not changed much.

It looked like the charges were going up a little bit versus the prior guidance but everything else is still kind of where it was. And then a couple other questions. You got the license fee settlement from Smith. They said on their call that they think, what they're spending on that will actually go down with their expensing, once that first agreement expires and they start paying I guess an ongoing royalty. Do you guys -- do you have any view, I'm assuming when that starts coming into your revenue, it will come in pretty much as pure profit. Is it going to be material or just --

Smith is in a much better position to comment on that. Because they know how much they need to use, and they know what they've got on the drawing board that arguably could replace it, and reduce their dependency on that so they're in a much better position to comment on that than we are. We hope they have to keep using it and have to pay for it.

And when would that start showing up in your revenues?

I believe that we start accruing for it at the end of Q1.

Yes. It starts in March of next year.

So it would be the second quarter next year before you actually see it show up in the numbers.

And then one final question, just a housekeeping, how much footage do you guys produce in the quarter versus --

4.5 million feet produced.

4.5 produced. Okay. Thank you.

Okay. I think we have time for one more question if it is out there and then anybody that needs to, obviously, as always, feel free to contact any of us afterwards. We have another question, operator?

Your next question comes from the line of Roger Read of Natixis.

I guess better late than never. Thanks, guys.

Glad we could fit you in.

This may be get to a little more specifics than you want to get in 2008, but kind of going back to Dan's question and your comments about being able to pull out some of the manufacturing costs, outsourcing, et cetera, if you were to lose say 2 million feet next year and not make it up from international sales, or anything like that, is the amount of cost savings potential from reducing outsourcing, reducing overtime, enough to offset the majority of the detrimental margin you would typically experience against a fairly high fixed cost base?

Roger, we're good but we're not that good. I think if you look at -- if nothing were to change, but a couple of million, two to three million feet downturn in demand and you take our average price per foot on that, which would be at the more commodity end of the business, assume that we've got somewhere around the 35 to 40% variable margin in that business, it is a meaningful number, and while we have some manufacturing efficiencies that will help offset that, no, would those in themselves offset it? No, it won't. We have to have additional business international. We have to have this offshore business. We have to have some of these nonconventional markets, have some success in those to offset all of that. And those are the things that we are, number one, trying to work on quantifying what the opportunity is and, number two, putting the plans in place to pursue and we will be firming up what our expectations here over the next couple of months as we firm up our plans for 2008.

Okay. And then I guess the unrelated follow-up, on Intelliserve, I guess previously, we would have thought, maybe a robust U.S. market might have compromised your ability to create enough intelligent drilling pipe, I guess in an environment like this, it becomes easier to make that expectation, to deliver the pipe to your facility in Utah --

I think it is fair to assume that in 2008, we can supply them as much drill pipe as they need for the projects that they need to go after. That would not be a limitation.

Sounds good. Thanks.

You bet. Thank you.

Thanks, everyone. Appreciate your time and attention. As always, feel free to follow-up with any of us on any further questions you may have. Bye-bye.

This concludes today's Grant Prideco third quarter earnings conference call. Thank you for your participation. You may now disconnect.