HYDRIL CO - 10-Q Quarterly Report

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FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549

(Mark One)

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

For the quarterly period ended June 30, 2002
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OR

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

For the transition period from to
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Commission file number 000-31579
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HYDRIL COMPANY
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(Exact name of registrant as specified in its charter)

DELAWARE 95-2777268
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)

3300 North Sam Houston Parkway East Houston, Texas 77032-3411
- -------------------------------------------------- -----------
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code (281) 449-2000
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes [X] No [ ]

Indicate the number of shares outstanding of each of the issuer's
classes of common stock, as of the latest practicable date.
Shares outstanding at August 2, 2002:
Common stock, $.50 par value, 15,113,339 shares outstanding
Class B common stock, $.50 par value, 7,292,427 shares outstanding

HYDRIL COMPANY

INDEX

PART I--FINANCIAL INFORMATION

2

HYDRIL COMPANY
PART I, ITEM 1: CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share and Per Share Information)

See notes to unaudited consolidated financial statements

3

HYDRIL COMPANY
PART I, ITEM 1: CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share and Per Share Information)

See notes to unaudited consolidated financial statements

4

HYDRIL COMPANY
PART I, ITEM 1: UNAUDITED CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Share and Per Share Amounts)

See notes to unaudited consolidated financial statements

5

HYDRIL COMPANY
PART I, ITEM 1: UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)

See notes to unaudited consolidated financial statements

6

HYDRIL COMPANY

PART I, ITEM 1: NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1 -- BASIS OF PRESENTATION

Principles of Consolidation- The consolidated financial statements
include the accounts of Hydril Company and its wholly owned subsidiaries.
Intercompany accounts and transactions are eliminated in consolidation.

Use of Estimates- The preparation of financial statements in conformity
with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported
amount of assets and liabilities and disclosure of contingent assets and
liabilities as of the date of the financial statements and the reported amounts
of revenue and expenses during the reporting period. Actual results could differ
from those estimates.

Reclassifications- Certain prior year amounts within the consolidated
financial statements have been reclassified to conform to the current year's
presentation.

Interim Presentation- The accompanying consolidated interim financial
statements and disclosures have been prepared by the Company in accordance with
accounting principles generally accepted in the United States of America and in
the opinion of management reflect all adjustments (consisting solely of normal
recurring adjustments) necessary for a fair presentation in all material
respects of the financial position and results for the interim periods. These
financial statements should be read in conjunction with the audited financial
statements and notes thereto included in the Company's Annual Report on Form
10-K for the year ended December 31, 2001. The results of operations for the
three and six months ended June 30, 2002 are not necessarily indicative of
results to be expected for the full year.

NOTE 2 -- LONG-TERM CONTRACTS

The components of long-term contracts as of June 30, 2002 and December
31, 2001 consist of the following:

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NOTE 3 -- CONTINGENCIES

The Company is involved in legal proceedings arising in the ordinary
course of business. In the opinion of management, these matters are such that
their outcome will not have a material adverse effect on the financial position
or results of operations of the Company.

The Company has been identified as one of many potentially responsible
parties at a waste disposal site in California. The Company's agreed upon share
of total site cleanup costs is approximately $303,000. Subsequent to June 30,
2002, this amount was paid in full. This obligation had been adequately reserved
for in the financial statements and did not materially affect the Company's
results of operations or financial condition.

The Company has also been identified as a potentially responsible party
at a waste disposal site near Houston, Texas. Based on the number of other
potentially responsible parties, the total estimated site cleanup costs and its
estimated share of such costs, the Company does not expect this matter to
materially affect its results of operations or financial condition. This
obligation has been adequately reserved for in the financial statements.

NOTE 4 -- LONG-TERM DEBT

The Company's borrowings as of June 30, 2002 and December 31, 2001 were
as follows:

The $60,000,000 senior unsecured notes bear interest at a rate of 6.85%
per annum, which is payable quarterly. See Note 5 for a subsequent event
involving prepayment of $30,000,000 aggregate principal amount of the senior
notes. The senior notes mature June 30, 2003 and may not be prepaid prior to
this date unless the Company pays the noteholders a make-whole premium based on
prevailing market interest rates. The long-term note agreement for these notes
has one financial event of default covenant, a minimum tangible net worth test,
which the Company was in compliance with at June 30, 2002. Additional financial
tests under the long-term note agreement, if not passed, restrict the Company's
ability to incur additional indebtedness or make acquisitions, investments and
restricted payments, such as pay dividends and repurchase capital stock. At June
30, 2002, the Company satisfied these financial incurrence tests.

At June 30, 2002, the Company had available an unsecured U.S. revolving
line of credit of $25,000,000. See Note 5 for a subsequent event involving
reduction of commitment under the U.S. revolving line of credit. The credit line
will mature March 31, 2003. The Company may, at its election, borrow at either a
prime or LIBOR based interest rate. Interest rates under the line fluctuate
depending on the Company's leverage ratio and are LIBOR plus a spread ranging
from 125 to 200 basis points or prime. At June 30, 2002, there were no
outstanding borrowings under this credit facility. There are covenants under
this line which require the Company to maintain certain financial ratios. The
Company was in compliance with these covenants at June 30, 2002.

8

Additionally, at June 30, 2002, the Company had two foreign unsecured
lines of credit, one committed and one uncommitted, for a total of $14,000,000.
The committed line for $10,000,000 matures March 31, 2003. See Note 5 for a
subsequent event involving reduction of commitment under the committed foreign
line of credit. The Company may, at its election, borrow at either a prime or
LIBOR based interest rate. Interest rates under the credit line fluctuate
depending on the Company's leverage ratio and are prime plus a spread ranging
from zero to 25 basis points or LIBOR plus a spread ranging from 125 to 225
basis points. At June 30, 2002, there were no outstanding borrowings under this
facility.

The uncommitted line can be terminated at the bank's discretion and the
interest rate is a fixed rate based on current Eurodollar market rates at the
time of the draw. There were no borrowings under this line as of June 30, 2002.

NOTE 5 -- SUBSEQUENT EVENTS

Subsequent to June 30, 2002, the Company formally notified the
noteholder of its senior unsecured notes of its intent to voluntarily prepay
$30,000,000 aggregate principal amount of the notes. On August 6, 2002, this
payment was made, plus a make-whole premium of $1,215,000 relating to this
prepayment.

Additionally, effective July 31, 2002, the Company voluntarily
decreased the amount available on its U.S. unsecured line of credit from
$25,000,000 to $5,000,000, and the amount available on its committed foreign
facility from $10,000,000 to $5,000,000.

NOTE 6 -- STOCKHOLDERS' EQUITY

On May 21, 2002, the Company granted 164,000 options to officers and
key employees for the purchase of common stock. Of these, 160,077 were granted
at an exercise price of $25.49 per share and 3,923 at an exercise price of
$28.04 per share. These options have a term of ten years and vest and become
exercisable in cumulative annual installments of one-fifth each beginning on the
first anniversary of the date of grant.

Additionally, on May 21, 2002, each of the Company's non-employee
directors received a grant of nonqualified stock options to purchase 2,942
shares of common stock as provided under the Company's 2000 Incentive Plan.
These options were granted at an exercise price of $25.49 per share, have a term
of ten years, are fully vested upon the completion of one year of service, and
are exercisable in cumulative annual installments of one-third each beginning on
the first anniversary of the date of grant.

NOTE 7 -- OTHER INCOME AND EXPENSE

Other expense for the three months ended June 30, 2001 includes
$560,000 in expenses incurred in facilitating the offering of common stock by
certain existing stockholders of the Company during May 2001 pursuant to the
terms of a registration rights agreement. Hydril did not receive any proceeds
from this offering.

NOTE 8 -- EARNINGS PER SHARE

The Company has presented basic and diluted income per share ("EPS") on
the consolidated statement of operations. Basic EPS excludes dilution and is
computed by dividing income available to common stockholders by the weighted
average number of common shares outstanding for the period. Dilutive EPS is
based on the weighted average number of shares outstanding during each period
and the assumed exercise of dilutive stock options less the number of treasury
shares from the proceeds using the average market price for the Company's common
stock for each of the periods presented. When potentially dilutive securities
are anti-dilutive, they are not included in dilutive EPS. Basic weighted average
shares outstanding for the six months

9

ended June 30, 2002 and 2001 were 22,360,659 and 22,135,678, respectively, while
the three months ended June 30, 2002 and 2001 were 22,380,883 and 22,214,393,
respectively. Diluted weighted average shares outstanding for the six months
ended June 30, 2002 and 2001 were 22,801,721 and 22,608,623, respectively, and
for the three months ended June 30, 2002 and 2001 were 22,893,743 and
22,705,194, respectively.

NOTE 9 -- SEGMENT AND RELATED INFORMATION

In accordance with Statement of Financial Accounting Standards ("SFAS")
No. 131, "Disclosures About Segments of an Enterprise and Related Information",
the Company has identified the following reportable segments: Premium Connection
and Pressure Control.

The Company's premium connection segment manufactures premium
connections that are used in harsh drilling environments. Hydril applies premium
threaded connections to tubulars owned by its customers and purchases pipe in
certain international markets for threading and resale. Hydril manufactures
premium threaded connections and provides services at facilities located in
Houston, Texas; Westwego, Louisiana; Bakersfield, California; Nisku, Alberta,
Canada; Aberdeen, Scotland; Veracruz, Mexico; Batam, Indonesia; Port Harcourt
and Warri, Nigeria.

The Company's pressure control segment manufactures a broad range of
pressure control equipment used in oil and gas drilling and well completion
typically employed in harsh environments. The Company's pressure control
products are primarily safety devices that control and contain fluid and gas
pressure during drilling, completion and maintenance in oil and gas wells. The
Company also provides replacement parts, repair and field services for its
installed base of pressure control equipment. Hydril manufactures pressure
control products at two plant locations in Houston, Texas.

The accounting policies of the segments are the same as those described
in the summary of significant accounting policies. The Company evaluates
performance based on operating income or loss.

10

Financial data for the business segments for the three and six months
ended June 30, 2002 and 2001 is as follows: (in thousands)

NOTE 10 -- RECENT ACCOUNTING PRONOUNCEMENTS

In July 2001, the Financial Accounting Standards Board ("FASB") issued
two new pronouncements: SFAS No. 141, "Business Combinations", and SFAS No. 142,
"Goodwill and Other Intangible Assets." SFAS 141 prohibits the use of the
pooling-of-interest method for business combinations initiated after June 30,
2001 and also applies to all business combinations accounted for by the purchase
method that are completed after June 30, 2001. SFAS 142, effective for fiscal
years beginning after December 15, 2001, addresses financial accounting and
reporting for acquired goodwill and other intangible assets and supercedes APB
Opinion No. 17, Intangible Assets. It addresses how intangible assets that are
acquired individually or with a group of other assets (but not those acquired in
a business combination) should be accounted for in financial statements upon
their acquisition. This statement also addresses how goodwill and other
intangible assets should be accounted for after they have been initially
recognized in the financial statements. The Company adopted SFAS 141 and 142
effective January 1, 2002, which had no material impact on our results of
operations or financial condition.

In August and October 2001, the FASB issued SFAS No. 143, "Accounting
for Asset Retirement Obligations" and SFAS No. 144, "Accounting for Impairment
or Disposal of Long-Lived Assets". SFAS 143 requires entities to record the fair
value of a liability for an asset retirement obligation in the period in which
it is incurred and a corresponding increase in the carrying amount of the
related long-lived asset. Subsequently, the asset retirement costs should be
allocated to expense using a systematic and rational method. SFAS 143 is
effective for fiscal years beginning after June 15, 2002. The Company has
evaluated the provisions of SFAS 143 and expects no impact on its financial
statements from the adoption of this standard. SFAS 144 addresses

11

financial accounting and reporting for the impairment of long-lived assets and
for long-lived assets to be disposed of. It supersedes, with exceptions, SFAS
121, "Accounting for the Impairment of Long-Lived assets and Long-Lived Assets
to be Disposed of", and is effective for fiscal years beginning after December
15, 2001. The Company adopted SFAS 144 effective January 1, 2002, which had no
material impact on our results of operations or financial condition.

In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical
Corrections." The rescission of SFAS No. 4, "Reporting Gains and Losses from
Extinguishment of Debt," and SFAS No. 64, "Extinguishments of Debt Made to
Satisfy Sinking-Fund Requirements," which amended SFAS No. 4, will affect income
statement classification of gains and losses from extinguishment of debt. SFAS
No. 4 requires that gains and losses from extinguishment of debt be classified
as an extraordinary item, if material. Under SFAS No. 145, extinguishment of
debt is now considered a risk management strategy by the reporting enterprise
and the FASB does not believe it should be considered extraordinary under the
criteria in APB Opinion No. 30, "Reporting the Results of Operations-Reporting
the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual
and Infrequently Occurring Events and Transactions", unless the debt
extinguishment meets the unusual in nature and infrequency of occurrence
criteria in APB Opinion No. 30. SFAS No. 145 will be effective for fiscal years
beginning after May 15, 2002. The Company is currently evaluating the impact of
adopting SFAS 145, however, it does not expect the adoption to materially affect
its results of operations or financial condition.

In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities." This standard requires companies
to recognize costs associated with exit or disposal activities when they are
incurred rather than at the date of a commitment to exit or disposal plan.
Previous accounting guidance was provided by EITF Issue No. 94-3. "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring). SFAS No. 146
replaces Issue 94-3 and is to be applied prospectively to exit or disposal
activities initiated after December 31, 2002. This statement is effective for
fiscal years beginning after January 1, 2003. The Company is currently
evaluating the impact of adopting SFAS 146, however, it does not expect the
adoption to materially affect its results of operations or financial
condition.

12

PART I, ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

This quarterly report on Form 10-Q contains forward-looking statements.
These statements relate to future events or our future financial performance,
including our business strategy and product development plans, and involve known
and unknown risks and uncertainties. These risks and uncertainties and
assumptions, which are more fully described under "RISK FACTORS" elsewhere in
this report and in Hydril Company's Annual Report on Form 10-K for the
year-ended December 31, 2001 filed with the Securities and Exchange Commission,
include the impact of oil and natural gas prices and worldwide economic
conditions on drilling activity, and the demand for and pricing of Hydril's
products and Hydril's assumptions relating thereto. These factors may cause our
company's or our industry's actual results, levels of activity, performance or
achievements to be materially different from those expressed or implied by the
forward-looking statements. In some cases, you can identify forward-looking
statements by terminology such as "may," "will," "should," "could," "expects,"
"intends," "plans," "anticipates," "believes," "estimates," "predicts,"
"potential," "continue," or the negative of these terms or other comparable
terminology.

OVERVIEW

Hydril Company is engaged worldwide in engineering, manufacturing and
marketing premium connections and pressure control products used for oil and gas
drilling and production. Our premium connections are used in drilling
environments where extreme pressure, temperature, corrosion and mechanical
stress are encountered, as well as in environmentally sensitive drilling. These
harsh drilling conditions are typical for deepwater, deep-formation and
horizontal wells. Our pressure control products are primarily safety devices
that control and contain fluid and gas pressure during drilling, completion and
maintenance of oil and gas wells in the same environments. We also provide
aftermarket replacement parts, repair and field services for our installed base
of pressure control equipment. These products and services are required on a
recurring basis because of the impact of the extreme conditions in which
pressure control products are used.

Demand for our products and services is cyclical and substantially
dependent on the activity levels in the oil and gas industry and its willingness
to spend capital on the exploration and development of oil and gas reserves. The
level of these capital expenditures is highly sensitive to current and expected
oil and gas prices. Our premium connections are marketed primarily to oil and
gas operators. In North America, our premium connection business is driven
principally by the number of rigs drilling to target depths greater than 15,000
feet and by rigs drilling in water depths greater than 1,500 feet.
Internationally, the total rig count is a relevant indicator of the premium
connection market. Our pressure control products are primarily sold to drilling
contractors. The main factors that affect sales of pressure control capital
equipment products are the level of construction of new drilling rigs and the
rate at which existing rigs are refurbished. Demand for our pressure control
aftermarket replacement parts, repair and field services primarily depends upon
the level of worldwide offshore drilling activity as well as the total U.S. rig
count. The following tables illustrate the data for these sectors over the last
five quarters:

13

(1) Source: Average rig count calculated by Hydril using weekly
data published by Smith International

(2) Source: Average rig count calculated by Hydril using month-end
data provided by ODS-Petrodata Group

(3) Source: Average rig count calculated by Hydril using monthly
data published by Baker Hughes International. The
international rig count includes land and offshore data for
Europe, the Middle East, Africa, Latin America and Asia
Pacific, and excludes data for Canada and the United States.

(4) Source: Average rig count calculated by Hydril using weekly
data for the United States and Canada, and monthly data for
the international regions, as published by Baker Hughes
International. The worldwide offshore rig count includes data
for Europe, the Middle East, Africa, Latin America, Asia
Pacific, the United States and Canada.

(5) Source: Average rig count calculated by Hydril using weekly
data published by Baker Hughes

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2002 AND 2001

REVENUE

Total revenue increased $4.0 million, or 7%, to $64.1 million for the
three months ended June 30, 2002 compared to $60.1 million for the three months
ended June 30, 2001. Our premium connection revenue decreased $3.7 million, or
10%, to $34.3 million for the three months ended June 30, 2002 as compared to
$38.0 million for the prior year period. The decrease in premium connection
revenue was due primarily to lower active rig counts in North America which
reduced demand for our products. Pressure control revenue increased $7.7
million, or 35%, to $29.8 million for the three months ended June 30, 2002 as
compared to $22.1 million for the same period in 2001. Capital equipment revenue
more than doubled over the prior-year period due to progress made on a
substantially higher backlog of long-term project orders, which are recorded on
a percentage of completion basis, scheduled for delivery from the second half of
2002 to the second half of 2003. Aftermarket revenue decreased 8% due to lower
demand as a result of the decline in the worldwide offshore and U.S. rig counts.

14

GROSS PROFIT

Gross profit increased $3.4 million to $24.0 million for the three
months ended June 30, 2002 from $20.6 million for the three months ended June
30, 2001. The increase was primarily due to higher international sales volumes
of premium connections, increased efficiencies in our premium connection
plants and higher revenue in our pressure control segment.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

Selling, general, and administrative expenses for the second quarter of
2002 were $12.0 million compared to $10.1 million for the prior year period. The
increase was due to higher engineering expense to support the increased number
of pressure control capital equipment projects, increased research and
development expenditures and commercialization of our subsea mudlift drilling
technology. Additionally, higher sales and marketing expenses primarily for the
international markets, and increases in administrative expenses, including
public company costs, insurance, and management, supervisory and sales
incentives contributed to the increase as compared to the prior-year period. As
a percentage of sales, selling, general, and administrative expenses increased
from 17% for the second quarter of 2001, to 19% for the second quarter of 2002.

OPERATING INCOME

Operating income increased $1.6 million to $12.0 million for the three
months ended June 30, 2002, compared to $10.4 million for the same period in
2001. Operating income for our premium connection segment increased $2.0 million
from $8.2 million for the second quarter of 2001 to $10.2 million for the second
quarter of 2002. Operating income for our pressure control segment increased
$0.3 million to $4.9 million for the quarter ended June 30, 2002 as compared to
the same period in 2001. Corporate and administrative expenses were $3.1 million
for the second quarter of 2002 compared to $2.4 million for the same period in
2001.

OTHER INCOME AND EXPENSE

Other expense for the three months ended June 30, 2001 was $ 0.7
million which was primarily attributable to expenses incurred in facilitating
the offering of common stock by certain of our stockholders in May of 2001.

RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2002 AND 2001

REVENUE

Total revenue increased $6.5 million, or 6%, to $122.1 million for the
six months ended June 30, 2002 compared to $115.6 million for the six months
ended June 30, 2001. Our premium connection revenue decreased $4.8 million, or
7%, to $63.6 million for the six months ended June 30, 2002 as compared to $68.4
million for the prior year period. This decrease is primarily the result of
decreased demand in our North American markets due to lower rig count activity
reducing demand, which was slightly offset by improvements in our international
markets. Pressure control revenue increased $11.2 million, or 24%, to $58.5
million for the six months ended June 30, 2002 as compared to $47.3 million for
the same period in 2001. Capital equipment revenue increased 73% due to progress
made on a substantially higher backlog of long-term project orders, which are
recorded on a percentage of completion basis, scheduled for delivery from the
second half of 2002 to the second half of 2003. Aftermarket revenue decreased
10% over the first half of 2001 due to the decline in the worldwide offshore and
U.S. rig counts.

GROSS PROFIT

Gross profit increased $6.2 million to $44.7 million for the six months
ended June 30, 2002 from $38.5 million for the six months ended June 30, 2001.
The increase was primarily due to higher international

15

volumes of premium connections, increased efficiencies in our premium connection
plants and higher revenue in our pressure control segment.

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

Selling, general, and administrative expenses for the first six months
of 2002 were $23.2 million compared to $19.8 million for the prior year period.
The increase was due to higher engineering expense to support the increased
number of pressure control capital equipment projects, increased research and
development expenditures and commercialization of our subsea mudlift drilling
technology. Additionally, higher sales and marketing expenses primarily for the
international markets, and increases in administrative expenses, including
public company costs, higher administrative expenses in our international
operations, and higher insurance expenditures contributed to the increase as
compared to the prior-year period. As a percentage of sales, selling, general,
and administrative expenses increased from 17% for the first six months of 2001
to 19% for the half of 2002.

OPERATING INCOME

Operating income increased $2.8 million to $21.5 million for the six
months ended June 30, 2002, compared to $18.7 million for the same period in
2001. Operating income for our premium connection segment increased $3.6 million
to $17.4 million from $13.8 million for the first six months of 2001. Operating
income for our pressure control segment increased $0.8 million to $10.3 million
for the six months ended June 30, 2002 as compared to the same period in 2001.
Corporate and administrative expenses were $6.2 million for the six months ended
June 30, 2002 compared to $4.7 million for the prior year period.

OTHER INCOME AND EXPENSE

Other expense was $0.07 million for the six months ended June 30, 2002
compared to $0.8 million for the same period in 2001. Other expense for the six
months ended June 2001 consists primarily of expenses incurred in facilitating
the offering of common stock by certain of our stockholders in the second
quarter of 2001.

LIQUIDITY AND CAPITAL RESOURCES

Our primary liquidity needs are to fund capital expenditures, such as
expanding and upgrading manufacturing facilities and capacity, to fund new
product development and to provide for working capital. Our primary sources of
funds have been from our initial public offering completed in October 2000 from
which we received net proceeds of $39.6 million, cash flow from operations, and
proceeds from borrowings under our bank facilities.

OPERATING ACTIVITIES

For the six months ended June 30, 2002, cash provided by operating
activities was $8.4 million primarily due to earnings, contractual cash payments
received from customers for progress made on capital equipment long-term
projects and utilization of deferred income tax assets, and partially offset by
higher working capital requirements. Cash used in operating activities for the
first half of 2001 was $5.3 million due to higher international premium
connection working capital requirements to support a higher demand for our
products in these markets.

INVESTING ACTIVITIES

Net cash used in investing activities was $11.6 million for the six
months ended June 30, 2002 and $10.2 million for the six months ended June 30,
2001. The investment of cash in both of these periods is attributable to capital
spending. Capital spending for the first half of 2002 included $6.7 million in
our premium connection segment related to plant capacity expansion and $4.2
million in our pressure control segment to

16

replace and refurbish machine tools as well as to construct a new deepwater
assembly building for blowout preventer stack assembly at our Houston plant.
Capital spending during the first half of 2001 included $7.0 million in our
premium connection segment primarily related to capacity expansion in North
America, and $2.8 million in our pressure control segment to upgrade the
equipment in our Houston plant.

CREDIT FACILITIES

We have a domestic unsecured revolving line of credit for working
capital requirements that provides up to $5.0 million (reduced from $25.0
million effective July 31, 2002), in committed revolving credit borrowings
through March 31, 2003. See note 5 to our unaudited consolidated financial
statements included elsewhere in this report for more information regarding
subsequent events. We may borrow, at our election, at either a prime or LIBOR
based interest rate. Interest rates under the facility fluctuate depending on
our leverage ratio and are LIBOR plus a spread ranging from 125 to 200 basis
points or prime. At June 30, 2002, there were no outstanding borrowings under
this facility. Our revolving credit agreement contains covenants with respect to
debt levels, tangible net worth, debt-to-capitalization and interest coverage
ratios. At June 30, 2002, we were in compliance with these covenants.

Additionally, Hydril has a committed unsecured foreign line of credit
for $5.0 million (reduced from $10.0 million effective July 31, 2002), and an
uncommitted foreign line of credit for $4.0 million. See note 5 to our unaudited
consolidated financial statements included elsewhere in this report for more
information regarding subsequent events. Under the committed facility, we may,
at our election, borrow at either a prime or LIBOR based interest rate. Interest
rates under this credit line fluctuate depending on the Company's leverage ratio
and are prime plus a spread ranging from zero to 25 basis points or LIBOR plus a
spread ranging from 125 to 225 basis points. At June 30, 2002, there were no
outstanding borrowings under this facility.

The uncommitted line can be terminated at the bank's discretion and the
interest rate is a fixed rate based on current Eurodollar market rates at the
time of the draw. There were no borrowings under this line as of June 30, 2002.

OTHER

Subsequent to June 30, 2002, the Company formally notified the holder
of its senior unsecured notes of its intent to prepay $30,000,000 aggregate
principal amount of the notes. On August 6, 2002, this payment was made, plus a
make-whole premium of $1,215,000 relating to this prepayment. The source of
funds for this payment was cash from operations. The remaining $30,000,000
million aggregate principal amount of these notes will mature on June 30, 2003.
We anticipate having cash available at June 30, 2003 to pay the balance of this
obligation at maturity; however, depending on the facts and circumstances at the
time, we may choose to refinance all or a portion of the remaining notes.

BACKLOG

The pressure control capital equipment backlog was $44.0 million at
June 30, 2002, $55.8 million at December 31, 2001 and $58.6 million at June 30,
2001. We include in this backlog orders for pressure control capital equipment
and long-term projects. It is possible for orders to be cancelled. However, in
the event of cancellations, all costs incurred would be billable to the
customer. We recognize the revenue and gross profit from pressure control
long-term projects using the percentage-of-completion accounting method. The
remaining revenue from projects currently in backlog is expected to be recorded
during the remainder of 2002 and 2003. As revenue is recognized under the
percentage-of-completion method, the order value in backlog is reduced. Our
backlog of premium connection and pressure control aftermarket parts and service
are not a meaningful measure of business prospects due to the quick turnover of
such orders.

17

CRITICAL ACCOUNTING POLICIES

Our accounting policies are described in Note 1 "SUMMARY OF SIGNIFICANT
ACCOUNTING POLICIES" under Item 8 of our Annual Report on Form 10-K for the
year-ended December 31, 2001 filed with the Securities and Exchange Commission.
We prepare our consolidated financial statements in conformity with accounting
principles generally accepted in the United States, which require us to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenue and expenses during
the year. Actual results could differ from those estimates. We consider the
following policies to be most critical in understanding the judgments that are
involved in preparing our financial statements and the uncertainties that could
impact our results of operations, financial condition and cashflows.

REVENUE RECOGNITION

Revenue for all products and services is recognized at the time such
products are delivered or services are performed, except as described below.

Revenue from long-term contracts, which are generally contracts from
six to eighteen months and an estimated contract price in excess of $1,000,000
is recognized using the percentage-of-completion method measured by the
percentage of cost incurred to estimated final cost. Contract costs include all
direct material, labor and subcontract costs and those indirect costs related to
contract performance. If a long-term contract was anticipated to have an
estimated loss, such loss would be recognized in the period in which the loss
becomes apparent. It is possible but not contemplated that estimates of contract
costs could be revised in the near term.

INVENTORIES

Inventories are stated at the lower of cost or market. Inventory costs
include material, labor and production overhead. Cost is determined by the last
in, first out method for substantially all pressure control products
(approximately 81% and 80% of total gross inventories at December 31, 2001 and
2000, respectively) and by the first-in, first-out method for all other
inventories.

The Company periodically reviews its inventory for excess or obsolete
items and provides a reserve for the difference in the carrying value of excess
or obsolete items and their estimated net realizable value.

CONTINGENCIES

Contingencies are accounted for in accordance with the FASB's SFAS No.
5, "Accounting for Contingencies". SFAS No. 5 requires that we record an
estimated loss from a loss contingency when information available prior to the
issuance of our financial statements indicates that it is probable that an asset
has been impaired or a liability has been incurred at the date of the financial
statements and the amount of the loss can be reasonably estimated. Accounting
for contingencies such as environmental, legal, and income tax matters requires
us to use our judgment. While we believe that our accruals for these matters are
adequate, if the actual loss from a contingency is significantly different than
the estimated loss, our results of operations may be over or understated.

RISK FACTORS

You should consider carefully the following risk factors and all other
information contained in this quarterly report on Form 10-Q and our Annual
Report on Form 10-K for the year-ended December 31, 2001. Any of the following
risks could impair our business, financial condition and operating results.

18

RISKS RELATING TO OUR BUSINESS

A MATERIAL OR EXTENDED DECLINE IN OIL OR GAS PRICES COULD RESULT IN
LOWER EXPENDITURES BY THE OIL AND GAS INDUSTRY, THEREBY REDUCING OUR REVENUE.

Demand for our products and services is cyclical and substantially
dependent on the level of capital expenditures by the oil and gas industry for
the exploration for and development of crude oil and natural gas reserves. In
particular, demand for our premium connections and our aftermarket pressure
control products and services is driven by the level of worldwide drilling
activity, especially drilling in harsh environments. Demand for our pressure
control products is directly affected by the number of drilling rigs being built
or refurbished. A substantial or extended decline in worldwide drilling activity
or in construction or refurbishment of rigs will adversely affect the demand for
our products or services.

Worldwide drilling activity as well as the construction and
refurbishment of rigs, is highly sensitive to oil and gas prices and is
generally dependent on the industry's view of future oil and gas prices, which
have been historically characterized by significant volatility. Oil and gas
prices are affected by numerous factors, including:

o the level of worldwide oil and gas exploration and production
activity;

o worldwide demand for energy, which is affected by worldwide
economic conditions;

o the policies of the Organization of Petroleum Exporting Countries,
or OPEC;

o the cost of producing oil and gas;

o interest rates and the cost of capital;

o technological advances affecting energy consumption;

o environmental regulation;

o tax policies; and

o policies of national governments.

We expect prices for oil and natural gas to continue to be volatile and
affect the demand and pricing of our products and services. A material decline
in oil or gas prices could materially adversely affect our business.

WE RELY ON A FEW DISTRIBUTORS FOR SALES OF OUR PREMIUM CONNECTIONS IN
THE UNITED STATES AND CANADA; A LOSS OF ONE OR MORE OF OUR DISTRIBUTORS OR A
CHANGE IN THE METHOD OF DISTRIBUTION COULD ADVERSELY AFFECT OUR ABILITY TO SELL
OUR PRODUCTS.

There are a limited number of distributors who buy steel tubulars,
contract with us to thread the tubulars and sell completed tubulars with our
premium connections. In 2001, our eight largest distributors accounted for 71%
of our premium connection sales in the United States and Canada.

In the United States, tubular distributors have combined on a rapid
basis in recent years resulting in fewer distribution alternatives for our
products. In 1999, four distributors, one of which distributed our premium
connections, combined to become one of the largest distributors of tubulars in
the United States, and the combined company no longer distributes our products.
Because of the limited number of distributors, we have few alternatives if we
lose a distributor. Identifying and utilizing additional or replacement
distributors may not be accomplished quickly and could involve significant
additional costs. Even if we find replacement distributors, the terms of new
distribution agreements may not be favorable to us. In addition, distributors
may not be as well capitalized as our end-users and may present a higher credit
risk.

We cannot assure you that the current distribution system for premium
connections will continue. For example, products may in the future be sold
directly by tubular manufacturers to end-users or through other

19

distribution channels such as the internet. If methods of distribution change,
many of our competitors may be better positioned to take advantage of those
changes than we are.

THE CONSOLIDATION OR LOSS OF END-USERS OF OUR PRODUCTS COULD ADVERSELY
AFFECT DEMAND FOR OUR PRODUCTS AND SERVICES AND REDUCE OUR REVENUE.

Oil and gas operators and drilling contractors have undergone
substantial consolidation in the last few years. Additional consolidation is
probable.

Consolidation results in fewer end-users for our products. In addition,
merger activity among both major and independent oil and gas companies also
affects exploration, development and production activity, as these consolidated
companies attempt to increase efficiency and reduce costs. Generally, only the
more promising exploration and development projects from each merged entity are
likely to be pursued, which may result in overall lower post-merger exploration
and development budgets.

In 2001, our two largest premium connection customers worldwide (both
being distributors), each accounted for 13% of segment sales, and our ten
largest premium connection customers accounted for 63% of total segment sales.
In 2001, our two largest pressure control customers accounted for 13% and 12% of
segment sales and our ten largest pressure control customers accounted for 56%
of segment sales.

The loss of one or more of our end-users or a reduction in exploration
and development budgets as a result of industry consolidation or other reasons
could adversely affect demand for our products and services and reduce our
revenue.

THE INTENSE COMPETITION IN OUR INDUSTRY COULD RESULT IN REDUCED
PROFITABILITY AND LOSS OF MARKET SHARE FOR US.

Contracts for our products and services are generally awarded on a
competitive basis, and competition is intense. The most important factors
considered by our customers in awarding contracts include:

o availability and capabilities of the equipment;

o ability to meet the customer's delivery schedule;

o price;

o reputation;

o experience; and

o safety record.

Many of our major competitors are diversified multinational companies
that are larger and have substantially greater financial resources, larger
operating staffs and greater budgets for marketing and research and development
than we do. They may be better able to compete in making equipment available
faster and more efficiently, meeting delivery schedules or reducing prices. In
addition, two or more of our major competitors could consolidate producing an
even larger company. Also our competitors may acquire product lines that would
allow them to offer a more complete package of drilling equipment and services
rather than providing only individual components. As a result of any of the
foregoing reasons, we could lose customers and market share to those
competitors. These companies may also be better able than us to successfully
endure downturns in the oil and gas industry.

WE MAY LOSE BUSINESS TO COMPETITORS WHO PRODUCE THEIR OWN PIPE.

In the United States and Canada and sometimes internationally, our
premium connections are added to steel tubulars purchased by a distributor from
third- party steel suppliers. After our premium connections are added, the
distributor sells the completed premium tubular to a customer at a price that
includes, but does not

20

differentiate between, the costs of the steel pipe and the connection. Pricing
of premium connections can be affected by steel prices, as the steel pipe is the
largest component of the overall price. We have no control over the price of the
steel pipe that is supplied for our connections.

During 2001, we derived approximately 61% of our revenue from services
or equipment ultimately provided or delivered to end-users for use outside of
the United States. Many of our larger competitors, especially internationally,
are integrated steel producers, who produce, rather than purchase, steel.
Several foreign steel mills have formed a marketing group that is licensed to
produce and sell a competing premium connections product line outside of the
United States and Canada. Integrated steel producers have more pricing
flexibility for tubular connections given that they control the production of
both the tubular connections and the steel tubulars to which the connections are
applied. This inherent pricing and supply control puts us at a competitive
disadvantage, and we can lose business to integrated steel producers even if we
have a better product. Other steel producers who do not currently manufacture
tubulars with premium connections may in the future enter the premium
connections business and compete with us, including in the United States, where
historically there have been few integrated producers.

THE LEVEL AND PRICING OF TUBULAR GOODS IMPORTED INTO THE UNITED STATES
AND CANADA COULD ADVERSELY AFFECT DEMAND FOR OUR PRODUCTS AND OUR RESULTS OF
OPERATIONS.

The level of imports of tubular goods, which has varied significantly
over time, affects the domestic tubular goods market. High levels of imports
reduce the volume sold by domestic producers and tend to reduce their selling
prices, both of which could have an adverse impact on our business. We believe
that United States import levels are affected by, among other things:

o United States and overall world demand for tubular goods;

o the trade practices of and government subsidies to foreign
producers; and

o the presence or absence of antidumping and countervailing duty
orders.

In many cases, foreign producers of tubular goods have been found to
have sold their products, which may include premium connections, for export to
the United States at prices that are lower than the cost of production or their
prices in their home market or a major third-country market, a practice commonly
referred to as "dumping." If not constrained by antidumping duty orders and
counterveiling duty orders, which impose duties on imported tubulars to offset
dumping and subsidies provided by foreign governments, this practice allows
foreign producers to capture sales and market share from domestic producers.
Duty orders normally reduce the level of imported goods and result in higher
prices in the United States market. Duty orders may be modified or revoked as a
result of administrative reviews conducted at the request of a foreign producer
or other party.

In addition, antidumping and countervailing duty orders may be revoked
as a result of periodic "sunset reviews". Under the sunset review procedure, an
order must be revoked after five years unless the United States Department of
Commerce and the International Trade Commission determine that dumping is likely
to continue or recur and that material injury to the domestic injury is likely
to continue or recur. Antidumping duty orders continue to cover imports of
tubulars from Argentina, Italy, Japan, Korea and Mexico, and a countervailing
duty order continues to cover imports from Italy. On July 17, 2001, the
Department of Commerce ordered the continuation of the countervailing and
antidumping duty orders on tubular goods other than drill pipe on Argentina,
Italy, Korea and Mexico, and the continuation of the antidumping duty order on
tubular goods, inclusive of drill pipe, from Japan. If the orders covering
imports from these countries are revoked in full or in part or the duty rates
lowered, we could be exposed to increased competition from imports that could
reduce our sales and market share or force us to lower prices. Tubulars

21

produced by domestic steel mills and threaded by us may not be able to
economically compete with tubulars manufactured and threaded at steel mills
outside the U.S. The Department of Commerce intends to initiate the next
five-year review of these orders no later that June 2006.

OVERCAPACITY IN THE PRESSURE CONTROL INDUSTRY AND HIGH FIXED COSTS
COULD EXACERBATE THE LEVEL OF PRICE COMPETITION FOR OUR PRODUCTS, ADVERSELY
AFFECTING OUR BUSINESS AND REVENUE.

Historically, there has been overcapacity in the pressure control
equipment industry. When oil and gas prices fall, cash flows of our customers
are reduced, leading to lower levels of expenditures and reduced demand for
pressure control equipment. Under these conditions, the overcapacity causes
increased price competition in the sale of pressure control products and
aftermarket services as competitors seek to capture the reduced business to
cover their high fixed costs and avoid the idling of manufacturing facilities.
Because we have multiple facilities that produce different types of pressure
control products, it is even more difficult for us to reduce our fixed costs
since to do so we might have to shut down more than one plant. During and after
periods of increasing oil and gas prices when sales of pressure control products
may be increasing, the overcapacity in the industry will tend to keep prices for
the sale of pressure control products lower than if overcapacity were not a
factor. As a result, when oil and gas prices are low, or are increasing from low
levels because of increased demand, our business and revenue may be adversely
affected because of either reduced sales volume or sales at lower prices or
both.

IF WE DO NOT DEVELOP, PRODUCE AND COMMERCIALIZE NEW COMPETITIVE
TECHNOLOGIES AND PRODUCTS, OUR REVENUE MAY DECLINE.

The markets for premium connections and pressure control products and
services are characterized by continual technological developments. As a result,
substantial improvements in the scope and quality of product function and
performance can occur over a short period of time. If we are not able to develop
commercially competitive products in a timely manner in response to changes in
technology, our business and revenue may be adversely affected. Our future
ability to develop new products depends on our ability to:

o design and commercially produce products that meet the needs of our
customers;

o successfully market new products; and

o obtain and maintain patent protection.

We may encounter resource constraints or technical or other
difficulties that could delay introduction of new products and services in the
future. Our competitors may introduce new products before we do and achieve a
competitive advantage.

Additionally, the time and expense invested in product development may
not result in commercial applications and provide revenue. We could be required
to write off our entire investment in a new product that does not reach
commercial viability. Moreover, we may experience operating losses after new
products are introduced and commercialized because of high start-up costs,
unexpected manufacturing costs or problems, or lack of demand.

IF WE ARE NOT SUCCESSFUL IN DEVELOPING AND COMMERCIALIZING SUBSEA
MUDLIFT DRILLING TECHNOLOGY OR COMMERCIALIZING OUR ADVANCED COMPOSITE TUBING,
OUR GROWTH PROSPECTS MAY BE REDUCED.

We have been working with a number of operators and drilling
contractors to develop a subsea mudlift drilling technology that, if successful,
would enable oil and gas operators to economically drill for and produce oil and
gas in ultra-deepwater in excess of 5,000 feet. In October 2001, the subsea
drilling project successfully completed its final phase by drilling a test well
in the Gulf of Mexico. The joint industry project team has completed its work
and Hydril is now in the process of refining the design of the equipment and
pursuing

22

commercialization of this technology. However, there are other groups of
companies in our industry that are also developing competing technologies for
deepwater drilling, and they may be ahead of us in completing development of
their technology. If one or more of these groups develops a commercially viable
technology before we do, they may gain a significant competitive advantage over
us.

In addition, the cost to implement the technology may be high and there
may be little demand for the completed technology. We are devoting significant
resources to the development of subsea mudlift drilling technology.

At the end of 1999, we introduced a line of advanced composite tubing
that is lightweight, flexible and resists corrosion and fatigue. We are
marketing the tubing for use in transporting oil and gas both out of the well
and from the well to storage facilities. During 2000, we began the initial
commercial production and shipments of advanced composite tubing. During
2001, we reorganized the management directly responsible for the advanced
composite tubing and began the process of making certain refinements to the
products and developing marketing strategies which continued in 2002. Companies
with greater financial and marketing resources than us have already developed
and are selling proprietary tubing similar to our advanced composite tubing.

If we are unable to successfully develop and commercialize subsea
mudlift drilling, commercialize our advanced composite tubing, or successfully
implement other technological or R&D type activities, our growth prospects may
be reduced and the level of our future revenue may be materially and adversely
affected. In addition, if we are unsuccessful we could be required to write-off
any capitalized investment in a new product that does not reach commercial
viability.

LIMITATIONS ON OUR ABILITY TO PROTECT OUR INTELLECTUAL PROPERTY RIGHTS
COULD CAUSE A LOSS IN REVENUE AND ANY COMPETITIVE ADVANTAGE WE HOLD.

Some of our products and the processes we use to produce them have been
granted United States and international patent protection, or have patent
applications pending. Nevertheless, patents may not be granted from our
applications and, if patents are issued, the claims allowed may not be
sufficient to protect our technology. If our patents are not enforceable, our
business may be adversely affected. In addition, if any of our products infringe
patents held by others, our financial results may be adversely affected. Our
competitors may be able to independently develop technology that is similar to
ours without infringing on our patents. The latter is especially true
internationally where the protection of intellectual property rights may not be
as effective. In addition, obtaining and maintaining intellectual property
protection internationally may be significantly more expensive than doing so
domestically. We may have to spend substantial time and money defending our
patents. After our patents expire, our competitors will not be legally
constrained from developing products substantially similar to ours.

23

THE LOSS OF ANY MEMBER OF OUR SENIOR MANAGEMENT AND OTHER KEY EMPLOYEES
MAY ADVERSELY AFFECT OUR RESULTS OF OPERATIONS.

Our success depends heavily on the continued services of our senior
management and other key employees. Our senior management consists of a small
number of individuals relative to other comparable or larger companies. These
individuals are Christopher T. Seaver, our President and Chief Executive
Officer, Neil G. Russell, our Vice President of our Premium Connection segment,
Charles E. Jones, our Vice President of our Pressure Control segment, and
Michael C. Kearney, Chief Financial Officer and Vice President-Administration.
These individuals, as well as other key employees, possess sales and marketing,
engineering, manufacturing, financial and administrative skills that are
critical to the operation of our business. We do not have employment or
non-competition agreements with any members of our senior management or other
key employees. If we lose or suffer an extended interruption in the services of
one or more of our senior officers or other key employees, our results of
operations may be adversely affected. Moreover, we may not be able to attract
and retain qualified personnel to succeed members of our senior management and
other key employees.

IF WE ARE UNABLE TO ATTRACT AND RETAIN SKILLED LABOR, THE RESULTS OF
OUR MANUFACTURING AND SERVICES ACTIVITIES WILL BE ADVERSELY AFFECTED.

Our ability to operate profitably and expand our operations depends in
part on our ability to attract and retain skilled manufacturing workers,
equipment operators, engineers and other technical personnel. Demand for these
workers is currently high and the supply is limited, particularly in the case of
skilled and experienced engineers and machinists. Because of the cyclical nature
of our industry, many qualified workers choose to work in other industries where
they believe lay-offs as a result of cyclical downturns are less likely. As a
result, our growth may be limited by the scarcity of skilled labor. Even if we
are able to attract and retain employees, the intense competition for them,
especially when our industry is in the top of its cycle, may increase our
compensation costs. Additionally, a significant increase in the wages paid by
competing employers could result in a reduction in our skilled labor force,
increases in the rates of wages we must pay or both. If our compensation costs
increase or we cannot attract and retain skilled labor, the immediate effect on
us would be a reduction in our profits and the extended effect would be
diminishment of our production capacity and profitability and impairment of any
growth potential.

OUR INTERNATIONAL OPERATIONS MAY EXPERIENCE SEVERE INTERRUPTIONS DUE TO
POLITICAL, ECONOMIC AND OTHER RISKS.

In 2001, approximately 61% of our total revenue was derived from
services or equipment ultimately provided or delivered to end-users outside the
United States, and approximately 32% of our revenue was derived from products
which were produced outside of the United States. We are, therefore,
significantly exposed to the risks customarily attendant to international
operations and investments in foreign countries. These risks include:

o political instability, civil disturbances and war;

o nationalization, expropriation, and nullification of contracts;

o changes in regulations and labor practices;

o changes in currency exchange rates and potential devaluations;

o changes in currency restrictions which could limit the
repatriations of profits or capital;

o restrictive actions by local governments

o seizure of plant and equipment; and

24

o changes in foreign tax laws.

We have manufacturing facilities in Warri and Port Harcourt, Nigeria
and in Batam, Indonesia. Both of these countries in recent history have
experienced civil disturbances and violence. An interruption of our
international operations could reduce our earnings or adversely affect the value
of our foreign assets. The occurrence of any of these risks could also have an
adverse effect on demand for our products and services or our ability to provide
them.

WE MAY LOSE MONEY ON FIXED PRICE CONTRACTS, AND SUCH CONTRACTS COULD
CAUSE OUR QUARTERLY REVENUE AND EARNINGS TO FLUCTUATE SIGNIFICANTLY.

Almost all of our pressure control projects, including all of our
larger engineered subsea control systems projects, are performed on a
fixed-price basis. This means that we are responsible for all cost overruns,
other than any resulting from change orders. Our costs and any gross profit
realized on our fixed-price contracts will often vary from the estimated amounts
on which these contracts were originally based. This may occur for various
reasons, including:

o errors in cost, design or production time estimates;

o engineering design changes;

o changes requested by customers; and

o changes in the availability and cost of labor and material.

The variations and the risks inherent in engineered subsea control
systems projects may result in reduced profitability or losses on our projects.
Depending on the size of a project, variations from estimated contract
performance can have a significant impact on our operating results for any
particular fiscal quarter or year. Our significant losses in 1997 through 1999
on fixed-price contracts to provide pressure control equipment and subsea
control systems for pressure control equipment are an example of the problems we
can experience with fixed-price contracts.

OUR QUARTERLY SALES AND EARNINGS MAY VARY SIGNIFICANTLY, WHICH COULD
CAUSE OUR STOCK PRICE TO FLUCTUATE.

Fluctuations in quarterly sales and earnings could adversely affect the
trading price of our common stock. Our quarterly sales may vary significantly
from quarter to quarter depending upon:

o the level of drilling activity worldwide;

o the variability of customer orders, especially for premium
connections, which are particularly unpredictable in international
markets;

o the mix of our products sold and the margins on those products; and

o new products offered and sold by us or our competitors.

Revenue derived from current or future pressure control long-term
projects is expected to be realized over periods of two to six quarters. As a
result, our revenue and earnings could fluctuate significantly from quarter to
quarter if there is any delay in completing these projects or if revenue is
recognized sooner than expected. In addition, our fixed costs cause our margins
to decrease when demand is low and manufacturing capacity is underutilized.

WE COULD BE SUBJECT TO SUBSTANTIAL LIABILITY CLAIMS, WHICH WOULD
ADVERSELY AFFECT OUR RESULTS AND FINANCIAL CONDITION.

25

Most of our products are used in hazardous drilling and production
applications where an accident or a failure of a product can cause personal
injury, loss of life, damage to property, equipment or the environment, or
suspension of operations. Damages arising from an occurrence at a location where
our products are used have in the past and may in the future result in the
assertion of potentially large claims against us.

While we maintain insurance coverage against these risks, this
insurance may not protect us against liability for some kinds of events,
including specified events involving pollution, or against losses resulting from
business interruption. Our insurance may not be adequate in risk coverage or
policy limits to cover all losses or liabilities that we may incur. Moreover, we
may not be able in the future to maintain insurance at levels of risk coverage
or policy limits that we deem adequate. Any claims made under our policies will
likely cause our premiums to increase. Any future damages caused by our products
or services that are not covered by insurance, are in excess of policy limits or
are subject to substantial deductibles, could reduce our earnings and our cash
available for operations.

CHANGES IN REGULATION OR ENVIRONMENTAL COMPLIANCE COSTS AND LIABILITIES
COULD HAVE A MATERIAL ADVERSE EFFECT ON OUR FINANCIAL CONDITION.

Our business is affected by changes in public policy, federal, state
and local laws and regulations relating to the energy industry. The adoption of
laws and regulations curtailing exploration and development drilling for oil and
gas for economic, environmental and other policy reasons may adversely affect
our operations by limiting available drilling and other opportunities in the oil
and gas exploration and production industry. Our operations and properties are
subject to increasingly stringent laws and regulations relating to environmental
protection, including laws and regulations governing air emissions, water
discharges, waste management and workplace safety. Many of our operations
require permits that may be revoked or modified, that we are required to renew
from time to time. Failure to comply with such laws, regulations or permits can
result in substantial fines and criminal sanctions, or require us to purchase
costly pollution control equipment or implement operational changes or
improvements. We incur, and expect to continue to incur, substantial capital and
operating costs to comply with environmental laws and regulations.

We use and generate hazardous substances and wastes in our
manufacturing operations. In addition, many of our current and former properties
are or have been used for industrial purposes for many years. Accordingly, we
could become subject to potentially material liabilities relating to the
investigation and cleanup of contaminated properties, including property owned
or leased by us now or in the past or third party sites to which we sent waste
for disposal. We also could become subject to claims alleging personal injury or
property damage as the result of exposures to, or releases of, hazardous
substances. In addition, stricter enforcement of existing laws and regulations,
the enactment of new laws and regulations, the discovery of previously unknown
contamination or the imposition of new or increased requirements could require
us to incur costs or become the basis of new or increased liabilities that could
reduce our earnings and our cash available for operations. See Note 3 to our
unaudited consolidated financial statements included elsewhere in this report
for more information regarding environmental contingencies.

LIABILITY TO CUSTOMERS UNDER WARRANTIES MAY MATERIALLY AND ADVERSELY
AFFECT OUR EARNINGS.

We provide warranties as to the proper operation and conformance to
specifications of the equipment we manufacture. Our equipment and premium
connections are complex and often deployed several miles below the earth's
surface in critical environments as well as subsea. Failure of this equipment or
our premium connections to operate properly or to meet specifications may
increase our costs by requiring additional engineering resources and services,
replacement of parts and equipment or monetary reimbursement to a customer. We
have in the past received warranty claims and we expect to continue to receive
them in the

26

future. To the extent that we incur substantial warranty claims in any period,
our reputation, our ability to obtain future business and our earnings could be
materially and adversely affected.

OUR DEBT INSTRUMENTS CONTAIN COVENANTS THAT LIMIT OUR OPERATING AND
FINANCIAL FLEXIBILITY.

Under the terms of our revolving credit facility, we must maintain
minimum levels of tangible net worth, not exceed levels of debt specified in the
agreement, to comply with a fixed coverage test and to not exceed a maximum
leverage ratio. The long-term note agreement for the senior notes has one
financial event of default covenant, which is a minimum tangible net worth test.
Additional financial tests under the long-term note agreement, if not passed,
restrict the Company's ability to incur additional indebtedness or make
acquisitions, investments and restricted payments, such as pay dividends and
repurchase capital stock.

Our ability to meet the financial ratios and tests under our revolving
credit facility and our note agreement can be affected by events beyond our
control, and we may not be able to satisfy those ratios and tests. A breach
under the note agreement or our revolving credit facility could permit the
lenders to accelerate the debt so that it is immediately due and payable. No
further borrowings would be available under the revolving credit facility.

EXCESS CASH IS INVESTED IN MARKETABLE SECURITIES WHICH MAY SUBJECT US
TO POTENTIAL LOSSES.

We invest excess cash in various securities and money market mutual
funds rated as the highest quality by a nationally recognized rating agency.
However, changes in the financial markets, including interest rates, as well as
the performance of the issuing companies can affect the market value of our
short-term investments.

PART I, ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

There have been no significant changes since December 31, 2001 in the
Company's exposure to market risk.

PART II, ITEM 2: CHANGES IN SECURITIES AND USE OF PROCEEDS

In October 2000, we completed an initial public offering of 8,600,000
shares of common stock, which were sold at $17.00 per share. Of the 8,600,000
shares, 2,672,668 shares were sold by Hydril and 5,927,332 shares were sold by
existing stockholders. The net proceeds to Hydril from the offering, after
deducting expenses, were $39.6 million. None of Hydril's proceeds from the
offering have been or will be paid to directors, officers, affiliates of Hydril,
or persons owning 10% or more of any class of Hydril's common stock.

Since completing the offering, we have used $21.0 million of the
proceeds to expand manufacturing capacity at our premium connection facilities,
$10.2 million to upgrade machinery and equipment in our Houston pressure control
plants and $3.6 million for the expansion of our advanced composite tubing
production, and the development and commercialization of our subsea mudlift
drilling technology. The balance of the proceeds to Hydril ($4.8 million at June
30, 2002) is invested in various high-grade securities and money market accounts
and will be used to complete approved capital expenditures that are currently in
progress to expand our manufacturing capacity to produce premium connections,
upgrade machine tools that we use in the manufacturing of our pressure control
products and commercialize our subsea mudlift drilling technology.

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PART II, ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Our annual meeting of shareholders was held on May 21, 2002. There were
77,591,002 votes represented at the meeting in person or by proxy, out of
93,925,624 votes entitled to be cast, constituting a quorum. The following are
the results of the vote:

PROPOSALS:

PART II, ITEM 6: EXHIBITS AND REPORTS ON FORM 8-K

Exhibits:

10.1 Fourth Amendment to Second Amended and Restated Loan Agreement dated as
of July 31, 2002 among Hydril Company and Bank One, NA.

Reports on Form 8-K:

On April 9, 2002, we filed a Form 8-K which disclosed the approval and
terms of a Rights Agreement entered into by Hydril Company.

On April 22, 2002, we filed a Form 8-K which disclosed financial
information to be presented by officers of Hydril Company to analysts,
investment banking firms and prospective investors beginning on April 22, 2002.

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

HYDRIL COMPANY

Date: August 14, 2002 By: /s/ Michael C. Kearney
-------------------------------------------
Michael C. Kearney
Chief Financial Officer and Vice President-
Administration (Authorized officer and principal
accounting and financial officer)

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