UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Form 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2005

Commission file number 001-15423

Grant Prideco, Inc.

(281) 878-8000
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No o

     Indicate by check mark whether the issuer is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ No o

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

GRANT PRIDECO, INC.
Consolidated Statements of Operations
(Unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

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GRANT PRIDECO, INC.
Consolidated Balance Sheets
(Unaudited)
(In thousands, except per share data)

The accompanying notes are an integral part of these consolidated financial statements.

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GRANT PRIDECO, INC.
Consolidated Statements of Cash Flows
(Unaudited)

The accompanying notes are an integral part of these consolidated financial statements.

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GRANT PRIDECO, INC.
Notes to Consolidated Financial Statements
(Unaudited)

1. General

Basis of Presentation

     The accompanying consolidated financial statements of Grant Prideco, Inc. (the “Company” or “Grant Prideco”) have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all disclosures required by generally accepted accounting principles for complete financial statements. All significant transactions between Grant Prideco and its consolidated subsidiaries have been eliminated. The interim financial statements have not been audited. However, in the opinion of management, all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the financial statements have been included. Results of operations for interim periods are not necessarily indicative of the results of operations that may be expected for the entire year. The balance sheet at December 31, 2004 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. These interim financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004.

     The Annual Report on Form 10-K for the year ended December 31, 2004 includes disclosures related to significant accounting policies including revenue recognition, deferred revenues and charges, inventory valuation, fair value estimations for assets acquired and liabilities assumed in a business combination, impairment of long-lived assets, impairment of goodwill and intangible assets, valuation allowance for deferred tax assets, estimates related to contingent liabilities and future claims and pension liabilities.

     As a result of the Company’s testing of internal controls as of December 31, 2004 in connection with Sarbanes-Oxley Section 404 requirements, the Company reported a material weakness in its revenue recognition practices. The material weakness relates to inadequate documentation supporting the Company’s revenue recognition procedures at its Drilling Products and Services and Tubular Technology and Services segments. As a result of the material weakness, the Company tested revenue transactions and determined that while title and risk of loss had transferred to the customer, in certain instances the supporting documentation did not meet all of the requirements to recognize revenue prior to the products being in the physical possession of the customer. Therefore, the revenue and profits from these transactions are required to be deferred until the period in which the customer takes physical possession. The first three quarters of 2004 were restated to properly reflect these deferred revenue transactions. The impact of this restatement on the first quarter of 2004 was revenues were decreased by $28.1 million, operating income was decreased by $5.2 million, net income from continuing operations was decreased by $3.4 million and basic and diluted net income per share were decreased by $0.03. All sales transactions that did not meet all of the requirements to recognize revenue prior to the products being in the physical possession of the customer have been recorded as deferred revenues and the related inventory costs are recorded as deferred charges in the accompanying Consolidated Balance Sheets.

     Certain reclassifications of prior year balances have been made to conform such amounts to corresponding 2005 classifications. These reclassifications have no impact on net income. During the second quarter of 2004, the Company completed the sale of its Texas Arai division. Accordingly, first quarter of 2004 results of operations of Texas Arai have been reclassified as discontinued operations. See Note 13 for further details.

Use of Estimates

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of certain assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements, and the related reported amounts of revenues and expenses during the reporting period. The significant estimates made by management in the accompanying consolidated financial statements include reserves for inventory obsolescence, restructuring, self-insurance, valuation of goodwill and long-lived assets, allowance for doubtful accounts, determination of income taxes, contingent liabilities and purchase accounting allocations. Actual results could differ from those estimates.

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2. Stock-Based Compensation

Pro Forma Stock Option Compensation Expense

     The Company has elected to account for its stock-based compensation using the intrinsic value method of accounting in accordance with Accounting Principles Board Opinion (APB) No. 25, “Accounting for Stock Issued to Employees”, as allowed under Statement of Financial Accounting Standards (SFAS) No. 123, “Accounting for Stock-Based Compensation” and as amended by SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure”. Under this method, no compensation expense is recognized when the number of shares granted is known and the exercise price of the stock option at the time of grant is equal to or greater than the market price of the Company’s common stock. Reported net income does include compensation expense associated with restricted stock awards and accelerated vesting of certain stock awards.

     Had compensation expense for stock options been determined based on the fair value at the grant dates for awards under the Company’s incentive compensation plans, the Company’s net income and net income per share would have been reduced to the pro forma amounts indicated as follows:

     The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility.

Restricted Stock

     During the three-month period ended March 31, 2005, the Company awarded 195,000 shares of restricted stock to officers and other key employees under the Company’s 2000 Employee Stock Option and Restricted Stock Plan. The restricted shares vest on the ninth anniversary of the date of grant, however there is an accelerated vesting schedule based on the achievement of certain predetermined performance metrics. Beginning with the third anniversary date of the grant through the eighth anniversary date, the performance metrics are evaluated annually and early vesting will occur for meeting the performance goals. Restricted shares are subject to certain restrictions on ownership and transferability when granted. These terms are equivalent to the 2004 restricted stock award except there is no tax gross up bonus component.

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3. Comprehensive Income

     Comprehensive income includes changes in stockholders’ equity during the periods that do not result from transactions with stockholders. The Company’s total comprehensive income was as follows:

4. Inventories

     Inventories by category are as follows:

5. Property, Plant and Equipment

     Net property, plant and equipment consisted of the following:

6. Other Charges

     In the first quarter of 2004, the Company incurred $2.7 million of pre-tax charges, $1.7 million net of tax. These charges include $1.8 million due to lease termination, severance and other exit costs related to the Drilling Products and Services rationalization program and $0.9 million of severance costs related to the Tubular Technology and Services organizational restructuring. The remaining liability balance at March 31, 2005 included in “Other Accrued Liabilities” in the Consolidated Balance Sheets was $1.1 million related to the lease termination costs, which is expected to be fully utilized by June 2005.

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7. Net Income Per Share

     Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflect the potential dilution from the exercise or conversion of securities into common stock. Common stock equivalent shares are excluded from the computation if their effect was antidilutive. The computation of diluted earnings per share for the three-month period ended March 31, 2005 did not exclude common stock equivalent shares because the average market price of the common stock for the applicable period was greater than exercise prices. For the three-month period ended March 31, 2004, the dilutive earnings per share computation excluded options to purchase 3.9 million shares of common stock because their exercise prices were greater than the average market price of the common stock for the applicable period.

8. Senior Credit Facility

     As of March 31, 2005 the Company did not have any outstanding borrowings under its $190 million Senior Credit Facility and $9.3 million of revolver availability had been reserved to support outstanding letters of credit. Net borrowing availability was $175.0 million at March 31, 2005.

9. Goodwill and Other Intangible Assets

     The carrying amount of goodwill by reporting unit is as follows:

     Intangible assets of $42.9 million and $43.8 million, net of accumulated amortization of $11.4 million and $10.3 million, as of March 31, 2005 and December 31, 2004, respectively, are recorded at cost and are amortized on a straight-line basis. The Company’s intangible assets primarily consist of patents, technology licenses, customer relationships, trademarks and covenants not to compete that are amortized over the definitive terms of the related agreement or the Company’s estimate of their useful lives if there are no definitive terms. The following table shows the Company’s intangible assets by asset category:

     Amortization expense related to intangible assets for the three-month periods ended March 31, 2005 and 2004 was $1.1 million and $1.1 million, respectively, and was recorded in “General and Administrative” and “Research and Engineering” expenses in the Consolidated Statements of Operations. Amortization expense related to existing intangible assets for the remainder of 2005 is estimated to be $3.4 million and for each of the years 2006 through 2010 is estimated to be approximately $3.9 million, $3.6 million, $3.2 million, $3.0 million and $2.9 million, respectively.

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10. Restricted Cash

     At March 31, 2005, the Company had $0.8 million of restricted cash. The restricted cash relates to the Company’s 60% interest in Tianjin Grant Prideco and is subject to dividend and distribution restrictions; however, such cash is available to fund the local operations in China.

11. Segment Information

Business Segments

     The Company operates through three primary business segments: Drilling Products and Services, Drill Bits and Tubular Technology and Services. The Company’s Drilling Products and Services segment manufactures and sells a full range of proprietary and API drill pipe, drill collars, heavyweight drill pipe and accessories. The Drill Bits segment designs, manufactures and distributes fixed-cutter and roller-cone drill bits. The Company’s Tubular Technology and Services segment designs, manufactures and sells a line of premium connections and associated premium tubular products and accessories for oil country tubular goods and offshore applications. The Company also has an Other segment that included the Company’s industrial drill pipe operations and its construction casing and water well operations. The Company exited these product lines during 2003 and as of December 31, 2004, this segment had liquidated the remaining industrial product inventories. Currently, this segment’s only remaining activity are costs associated with the Company’s POS-GRIP technology for subsea applications. Included in Corporate are general corporate expenses.

12. Dispositions

     On March 4, 2004, the Company sold its Plexus Ocean Systems (POS) rental wellhead business for $1.3 million in net cash. The POS operations were included in the Company’s Other segment. The Company recognized a pre-tax loss of $0.1 million on the sale, which was recorded in the Consolidated Statements of Operations in “Other Income, Net”. For the three-month period ended March 31, 2004, revenues related to POS included in the Other segment’s results was $0.2 million and operating results were break-even.

13. Discontinued Operations

     On April 23, 2004, the Company sold the assets and business of its Texas Arai division. Accordingly, the three-month period ended March 31, 2004 now reflects the operations of Texas Arai as discontinued operations. Summarized financial information for the discontinued operations of Texas Arai included in the Consolidated Statements of Operations is as follows:

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     Intercompany sales and profit related to Texas Arai, which were eliminated from the summarized information above, were not material for the periods presented.

14. Pension Plans

U.S. Pension Plan

     The following table shows the components of Net Periodic Benefit Cost for the Company’s Reed Hourly Pension Plan:

     The Company made contributions of $0.2 million during the first quarter of 2005 to meet the minimum funding requirements for the 2004 plan year. Estimated contributions for the 2005 plan year are expected to be $1.2 million.

Non-U.S. Pension Plan

     The following table shows the components of Net Periodic Benefit Cost for the Company’s UK Hycalog Retirement Death Benefit Scheme: