UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(MARK ONE)
| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2007
or
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from to .
Commission file number: 001-13439
Dril-Quip, Inc.
(Exact name of registrant as specified in its charter)
| Delaware | 74-2162088 | |
| (State or other jurisdiction of incorporation or organization) |
(IRS Employer Identification No.) | |
| 13550 Hempstead Highway Houston, Texas |
77040 | |
| (Address of principal executive offices) | (Zip code) | |
Registrant’s telephone number, including area code: (713) 939-7711
Securities registered pursuant to Section 12(b) of the Act:
| Title of Each Class |
Name of Each Exchange On Which Registered | |
| Common Stock, $.01 par value per share | New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act. YES x NO ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. YES ¨ NO x
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 by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definition of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (check one):
| Large accelerated filer x | Accelerated filer ¨ | Non-Accelerated filer ¨ | Smaller reporting company ¨ | |||
| (Do not check if a smaller reporting company) | ||||||
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
At June 30, 2007, the aggregate market value of the registrant’s Common Stock held by non-affiliates of the registrant was approximately $1,285,000,000 based on the closing price of such stock on such date of $44.95.
At February 25, 2008, the number of shares outstanding of registrant’s Common Stock was 40,798,213.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s Proxy Statement for its 2008 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A are incorporated by reference in Part III of this Form 10-K.
| PART I |
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| Item 1. |
2 | |||
| Item 1A. |
10 | |||
| Item 1B. |
16 | |||
| Item 2. |
17 | |||
| Item 3. |
17 | |||
| Item 4. |
18 | |||
| Item S-K 401(b). |
18 | |||
| PART II |
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| Item 5. |
19 | |||
| Item 6. |
20 | |||
| Item 7. |
Management’s Discussion and Analysis of Financial Condition and Results of Operations |
20 | ||
| Item 7A. |
29 | |||
| Item 8. |
29 | |||
| Item 9. |
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure |
51 | ||
| Item 9A. |
51 | |||
| Item 9B. |
52 | |||
| PART III |
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| Item 10. |
52 | |||
| Item 11. |
52 | |||
| Item 12. |
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
52 | ||
| Item 13. |
Certain Relationships and Related Transactions, and Director Independence |
52 | ||
| Item 14. |
52 | |||
| PART IV |
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| Item 15. |
52 | |||
| 55 | ||||
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K includes certain statements that may be deemed to be “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Statements contained in all parts of this document that are not historical facts are forward-looking statements that involve risks and uncertainties that are beyond the control of Dril-Quip, Inc. (the “Company” or “Dril-Quip”). You can identify the Company’s forward-looking statements by the words “anticipate,” “estimate,” “expect,” “may,” “project,” “believe” and similar expressions, or by the Company’s discussion of strategies or trends. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, no assurances can be given that these expectations will prove to be correct. These forward-looking statements include the following types of information and statements as they relate to the Company:
| • | future operating results and cash flow; |
| • | scheduled, budgeted and other future capital expenditures; |
| • | working capital requirements; |
| • | the availability of expected sources of liquidity; |
| • | the introduction into the market of the Company’s future products; |
| • | the market for the Company’s existing and future products; |
| • | the Company’s ability to develop new applications for its technologies; |
| • | the exploration, development and production activities of the Company’s customers; |
| • | compliance with present and future environmental regulations and costs associated with environmentally related penalties, capital expenditures, remedial actions and proceedings; |
| • | effects of pending legal and administrative proceedings; and |
| • | future operations, financial results, business plans and cash needs. |
These statements are based on assumptions and analyses in light of the Company’s experience and perception of historical trends, current conditions, expected future developments and other factors the Company believes were appropriate in the circumstances when the statements were made. Forward-looking statements by their nature involve substantial risks and uncertainties that could significantly impact expected results, and actual future results could differ materially from those described in such statements. While it is not possible to identify all factors, the Company continues to face many risks and uncertainties. Among the factors that could cause actual future results to differ materially are the risks and uncertainties discussed under “Item 1A. Risk Factors” in this report and the following:
| • | the volatility of oil and natural gas prices; |
| • | the cyclical nature of the oil and gas industry; |
| • | uncertainties associated with the United States and worldwide economies, including those due to political tensions in the Middle East and elsewhere; |
| • | current and potential governmental regulatory actions in the United States and regulatory actions and political unrest in other countries; |
| • | operating interruptions (including explosions, fires, weather-related incidents, mechanical failure, unscheduled downtime, labor difficulties, transportation interruptions, spills and releases and other environmental risks); |
| • | the Company’s reliance on product development; |
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| • | technological developments; |
| • | the Company’s dependence on key employees and skilled machinists, fabricators and technical personnel; |
| • | the Company’s reliance on sources of raw materials; |
| • | control by certain stockholders; |
| • | impact of environmental matters; |
| • | competitive products and pricing pressures; |
| • | fluctuations in foreign currency; |
| • | the Company’s reliance on significant customers; |
| • | creditworthiness of the Company’s customers; |
| • | access to capital markets; and |
| • | war and terrorist acts. |
Many of such factors are beyond the Company’s ability to control or predict. Any of the factors, or a combination of these factors, could materially affect the Company’s future results of operations and the ultimate accuracy of the forward-looking statements. Management cautions against putting undue reliance on forward-looking statements or projecting any future results based on such statements or present or prior earnings levels. Every forward-looking statement speaks only as of the date of the particular statement, and the Company undertakes no obligation to publicly update or revise any forward-looking statement.
PART I
| Item 1. | Business |
General
Dril-Quip, Inc., a Delaware corporation (the “Company” or “Dril-Quip”), designs, manufactures, sells and services highly engineered offshore drilling and production equipment that is well suited for use in deepwater, harsh environment and severe service applications. The Company’s principal products consist of subsea and surface wellheads, subsea and surface production trees, subsea control systems and manifolds, mudline hanger systems, specialty connectors and associated pipe, drilling and production riser systems, liner hangers, wellhead connectors and diverters. Dril-Quip’s products are used by major integrated, large independent and foreign national oil and gas companies in offshore areas throughout the world. Dril-Quip also provides installation and reconditioning services and rents running tools for use with the installation and retrieval of its products.
Dril-Quip has developed its broad line of subsea equipment, surface equipment and offshore rig equipment primarily through its internal product development efforts. The Company believes that it has achieved significant market share and brand name recognition with respect to its established products due to the technological capabilities, reliability, cost effectiveness and operational timesaving features of these products.
The Company’s operations are organized into three geographic segments: Western Hemisphere (including North and South America; headquartered in Houston, Texas), Eastern Hemisphere (including Europe and Africa; headquartered in Aberdeen, Scotland) and Asia-Pacific (including the Pacific Rim, Southeast Asia, Australia, India and the Middle East; headquartered in Singapore). Each of these segments sells similar products and services and the Company has major manufacturing facilities in all three headquarter locations as well as Macae,
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Brazil. The Company maintains additional facilities for fabrication and/or reconditioning in Norway, Denmark, and Australia. The Company’s manufacturing operations are vertically integrated, allowing it to perform substantially all of its forging, heat treating, machining, fabrication, inspection, assembly and testing at its own facilities. The Company’s major subsidiaries are Dril-Quip (Europe) Limited (DQE), located in Aberdeen with branches in Denmark, Norway and Holland; Dril-Quip Asia Pacific PTE Ltd. (DQAP), located in Singapore; and Dril-Quip do Brasil LTDA (DQB), located in Macae, Brazil. Dril-Quip (Nigeria) Ltd. is located in Port Harcourt, Nigeria and Dril-Quip Egypt for Petroleum Services S.A.E. is located in Alexandria, Egypt. Both are wholly owned subsidiaries of DQE. For additional discussion of our geographic segments, please see note 11 to our consolidated financial statements in “Item 8. Financial Statements and Supplementary Data.”
Dril-Quip markets its products through its offices and sales representatives located in the major international energy markets throughout the world. In 2007, the Company generated approximately 69% of its revenues from foreign sales compared to 65% and 66% in 2006 and 2005, respectively.
The Company was co-founded in 1981 by Larry E. Reimert, Gary D. Smith, J. Mike Walker and an investor who is no longer affiliated with the Company. Together, Messrs. Reimert, Smith and Walker have over 100 years of combined experience in the oilfield equipment industry, essentially all of which has been with the Company and its major competitors. In addition, most of the Company’s key department managers have been with the Company over 10 years, on average.
The Company makes available free of charge on its website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably practicable after it electronically files such reports with, or furnishes them to, the Securities and Exchange Commission (“SEC”). The Company’s website address is www.dril-quip.com. Except to the extent explicitly stated herein, documents and information on the Company’s website are not incorporated by reference herein. Any materials we file with the SEC may be read and copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information concerning the Public Reference Room may be obtained by calling 1-800-SEC-0330. In addition, the SEC maintains a website (www.sec.gov) that contains reports we file with the SEC.
Additionally, the Company makes available free of charge on its internet website:
| • | its Code of Business Conduct and Ethical Practices, |
| • | its Corporate Governance Guidelines, |
| • | its Nominating, Governance, and Compensation Committee Charter, and |
| • | its Audit Committee Charter. |
Any stockholder who so requests may obtain a printed copy of any of these documents from the Company. Changes in or waivers to our Code of Business Conduct and Ethical Practices involving directors and executive officers of the Company will be posted on our website within five business days and maintained for at least twelve months.
Industry Overview
Both the market for offshore drilling and production equipment and services and the Company’s business are substantially dependent on the financial condition of the oil and gas industry and, in particular, the willingness of oil and gas companies to make capital expenditures on exploration, drilling and production operations offshore. The level of capital expenditures has generally been dependent upon the prevailing view of future oil and gas prices, which are influenced by numerous factors affecting the supply and demand for oil and gas, including worldwide economic activity, interest rates and the cost of capital, environmental regulation, tax policies, and the ability of OPEC and other producing nations to set and maintain production levels and prices. Capital expenditures are also dependent on the cost of exploring for and producing oil and gas, the sale and expiration dates of offshore leases, the discovery rate of new oil and gas reserves in offshore areas and
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technological advances. Oil and gas prices and the level of offshore drilling and production activity have historically been characterized by significant volatility. See “Item 1A. Risk Factors—A material or extended decline in expenditures by the oil and gas industry could significantly reduce our revenue and income.”
High oil and gas prices from 2005 through 2007 have resulted in oil operators increasing capital spending for both exploration and development programs. As various geopolitical issues have limited the ability of oil and gas companies to invest in areas such as Russia and the Middle East, an increasing amount of this capital spending has been in the deepwater areas in which the Company operates. However, any significant future declines in oil and gas prices could have a material adverse effect on the Company’s results of operations. There can be no assurance that the current oil price levels will lead to increases in exploration and development activity or that demand for the Company’s products and services will reflect such increases, if any.
Products and Services
Products
Dril-Quip designs, manufactures, fabricates, inspects, assembles, tests and markets subsea equipment, surface equipment and offshore rig equipment. The Company derived approximately 84%, 84% and 85% of its revenues from the sale of its products in 2007, 2006 and 2005, respectively. The Company’s products are used to explore for oil and gas on offshore drilling rigs, such as floating rigs and jack-ups, and for drilling and production of oil and gas wells on offshore platforms, TLPs, Spars and moored vessels such as FPSOs. TLPs are floating production platforms that are connected to the ocean floor via vertical mooring tethers (called tension legs). A Spar is a floating cylindrical structure approximately six or seven times longer than its diameter that is anchored in place (like a Spar buoy). FPSOs are floating production, storage and offloading monohull moored vessels.
Subsea Equipment. Subsea equipment is used in the drilling and production of offshore oil and gas wells around the world. Included in the subsea equipment product line are subsea wellheads, mudline hanger systems, specialty connectors and associated pipe, subsea production trees, valves, TLP and Spar well systems, liner hangers, multiplex subsea control systems and multiwell subsea manifolds.
Subsea wellheads are pressure-containing forged and machined metal housings in which casing hangers are landed and sealed subsea to suspend casing (downhole pipe). As drilling depth increases, successively smaller diameter casing strings are installed, each suspended by an independent casing hanger. Subsea wellheads are utilized when drilling from floating drilling rigs, either semi-submersible or drillship types, and TLPs and Spars. The Company’s SS-15 Big Bore Subsea Wellhead System is designed to accommodate additional casing strings installed through a conventional marine riser and a subsea blowout preventer.
Mudline hanger systems are used in jack-up drilling operations to support the weight of the various casing strings at the ocean floor while drilling a well. They also provide a method to disconnect the casing strings in an orderly manner at the ocean floor after the well has been drilled, and subsequently reconnect to enable production of the well by either tying it back vertically to a subsequently installed platform or by installing a subsea tree.
Large diameter weld-on specialty connectors (threaded or stab type) are used in offshore wells drilled from floating drilling rigs, jack-ups, fixed platforms, TLPs and Spars. Specialty connectors join lengths of conductor or large diameter (16-inch or greater) casing. Specialty connectors provide a more rapid connection than other methods of connecting lengths of pipe. Connectors may be sold individually or as an assembly after being welded to sections of Company or customer supplied pipe. Dril-Quip’s weld-on specialty connectors are designed to prevent cross threading and provide a quick, convenient method of joining casing joints with structural integrity compatible with casing strength.
A subsea production tree is an assembly composed of valves, a wellhead connector, control equipment and various other components installed on a subsea wellhead or a mudline hanger system and used to control the flow
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of oil and gas from a producing well. Subsea trees may be either stand alone satellite type or template mounted cluster arrangements. Both types typically produce via flowlines to a central control point located on a platform, TLP, Spar or FPSO. The use of subsea production trees has become an increasingly important method for producing wells located in hard-to-reach deepwater areas or economically marginal fields located in shallower waters. The Company is an established manufacturer of more complicated dual-bore production trees, which are used in severe service applications. In addition, Dril-Quip manufactures a patented single bore (SingleBoreTM) subsea completion system which features a hydraulic mechanism instead of a wireline-installed mechanism that allows the operator to plug the tubing hanger annulus remotely from the surface via a hydraulic control line and subsequently unplug it when the well is put on production. This mechanism eliminates the need for an expensive multibore installation and workover riser, thereby saving both cost and installation time. Dril-Quip’s guidelineless subsea production tree is used in ultra-deepwater applications. This tree features remote multiple flowline and control connections, utilizing remotely operated intervention tools. The Company’s subsea production trees are generally custom designed and manufactured to customer specifications.
A liner hanger is used to hang-off and seal casing into a previously installed casing string in the well bore, and can provide a means of tying back the liner for production to surface. Dril-Quip has developed a state-of-the-art liner hanger system and is in the final phase of field-performance testing. This product represents Dril-Quip’s entry into the market for downhole tools and is expected to provide new market opportunities for the Company.
A subsea control system is used to remotely control the operations of subsea production equipment such as subsea trees and/or manifolds. In December 2005, Dril-Quip successfully delivered to an operator in the North Sea a multiplex subsea control system used to control both a subsea manifold and subsea trees. The subsea control system utilizes a “signal on power” communications system that controls a satellite subsea tree and manifold, and was designed with expansion capability to allow additional wells to be connected at a later date. Another subsea control system and subsea tree was supplied to the Dutch sector of the North Sea in the summer of 2005 and became operational in 2006. This was the first installation of Dril-Quip’s fiber optics-based communications system and continues the Company’s emergence into the high-tech subsea control systems market. The addition of this product expands Dril-Quip’s opportunities in subsea development projects.
A subsea manifold is a structure located on the ocean floor consisting of valves, chokes, flowline connections and a control module used to collect and control the flow of oil and gas from subsea wells for delivery to a terminal. Dril-Quip successfully installed its first subsea manifold system in December 2005. This new product further complements the Company’s product offerings for integrated system developments.
Surface Equipment. Surface equipment is principally used for flow control on offshore production platforms, TLPs and Spars. Included in the Company’s surface equipment product line are platform wellheads and platform production trees. Dril-Quip’s development of platform wellheads and platform production trees was facilitated by adaptation of its existing subsea wellhead and tree technology to surface wellheads and trees.
Platform wellheads are pressure-containing forged and machined metal housings in which casing hangers are landed and sealed at the platform deck to suspend casings. The Company emphasizes the use of metal-to-metal sealing wellhead systems with operational time-saving features which can be used in high pressure, high temperature and corrosive drilling and production applications.
After installation of a wellhead, a platform production tree, consisting of gate valves, a wellhead connector, controls, tree cap and associated equipment, is installed on the wellhead to control and regulate oil or gas production. Platform production trees are similar to subsea production trees but utilize less complex equipment and more manual, rather than hydraulically activated, valves and connectors. Platform wellheads and platform production trees and associated equipment are designed and manufactured in accordance with customer specifications.
Offshore Rig Equipment. Offshore rig equipment includes drilling and production riser systems, wellhead connectors and diverters. The drilling riser system consists of (i) lengths of riser pipe and associated riser
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connectors that secure one to another; (ii) the telescopic joint, which connects the entire drilling riser system to the diverter at the rig and provides a means to compensate for vertical motion of the rig relative to the ocean floor; and (iii) the wellhead connector, which provides a means for remote connection and disconnection of the drilling riser system to and from the blowout preventer stack. Production risers provide a vertical conduit from the subsea wellhead to a TLP, Spar or FPSO. The wellhead connector also provides remote connection/disconnection of the blowout preventer stack, production tree or production riser to/from the wellhead. Diverters are used to provide protection from shallow gas blowouts and to divert gases off of the rig during the drilling operation.
Wellhead connectors and drilling and production riser systems are also used on both TLPs and Spars, which are being installed more frequently in deepwater applications. The principal markets for offshore rig equipment are new rigs, rig upgrades, TLPs and Spars. Diverters, drilling and production risers and wellhead connectors are generally designed and manufactured to customer specifications.
Certain products of the Company are used in potentially hazardous drilling, completion and production applications that can cause personal injury, product liability and environmental claims. See “Item 1A. Risk Factors—Our business involves numerous operating hazards that may not be covered by insurance.” The occurrence of an event not fully covered by insurance could have a material adverse effect on the financial condition, results of operations and cash flows of the Company.
Services
Services provided by Dril-Quip include field installation services, reconditioning of its products which are customer-owned, and rental running tools for installation and retrieval of its products. These services are provided from the Company’s worldwide locations and represented approximately 16%, 16% and 15% of revenues in 2007, 2006 and 2005, respectively.
Field Installation. Dril-Quip provides field installation services through the use of its technicians. These technicians assist in the onsite installation of Company products and are available on a 24-hour call out from the Company’s facilities located in Houston, Texas; Aberdeen, Scotland; Stavanger, Norway; Esbjerg, Denmark; Singapore; Perth, Australia; and Macae, Brazil.
Reconditioning. The Company provides reconditioning of its products at its facilities in Houston, Texas; Aberdeen, Scotland; Stavanger, Norway; Singapore; and Macae, Brazil.
Rental. The Company rents running and installation tools for use in installing its products. These tools are used to install and retrieve Company products which are purchased by customers. Running tools are available from Dril-Quip’s locations in Houston, Texas; Aberdeen, Scotland; Stavanger, Norway; Esbjerg, Denmark; Beverwijk, Holland; Singapore; Perth, Australia; Tianjin, China; and Macae, Brazil.
Manufacturing
Dril-Quip has major manufacturing facilities in Houston, Texas; Aberdeen, Scotland; and Singapore. Each location conducts a broad variety of processes, including machining, fabrication, inspection, assembly and testing. The Houston facility provides forged and heat treated products to all the major manufacturing facilities.
The Company’s Houston, Aberdeen and Singapore manufacturing plants are ISO 9001 and American Petroleum Institute certified. See “Properties—Major Manufacturing Facilities.” Dril-Quip maintains its high standards of product quality through the use of quality assurance specialists who work with product manufacturing personnel throughout the manufacturing process by inspecting and documenting equipment as it is
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processed through the Company’s manufacturing facilities. The Company has the capability to manufacture various products from each of its product lines at its major manufacturing facilities and believes that this localized manufacturing capability is essential in order to compete with the Company’s major competitors.
The Company’s manufacturing process is vertically integrated, producing in house, a majority of its forging requirements and essentially all of its heat treatment, machining, fabrication, inspection, assembly and testing. The Company’s primary raw material is cast steel ingots, from which it produces steel shaped forgings at its forging and heat treatment facility. The Company routinely purchases steel ingots from approximately four suppliers on a purchase order basis and does not have any long-term supply contracts. The Company’s Houston facility provides forgings and heat treatment for its Aberdeen and Singapore facilities. The Company’s major competitors depend on outside sources for all or a substantial portion of their forging and heat treatment requirements. The Company has made significant capital investments in developing its vertically integrated manufacturing capability. Prolonged periods of low demand in the market for offshore drilling and production equipment could have a greater effect on the Company than on certain of its competitors that have not made large capital investments in facilities.
Dril-Quip’s manufacturing facilities utilize state-of-the-art computer numerically controlled (“CNC”) machine tools and equipment, which contribute to the Company’s product quality and timely delivery. The Company has also developed a cost effective, in-house machine tool rebuild capability which produces “like new” machine upgrades with customized features to enhance the economic manufacture of its specialized products. The Company purchases quality used machine tools as they become available and stores them at its facilities to be rebuilt and upgraded as the need arises. Rebuilding used machine tools allows for greater customization suitable for manufacturing Dril-Quip proprietary product lines. This provides the added advantage of requiring only in-house expertise for repairs and maintenance of these machines. A significant portion of the Company’s manufacturing capacity growth has been through the rebuild/upgrade of quality used machine tools, including the replacement of outdated control systems with state-of-the-art CNC controls.
Customers
The Company’s principal customers are major integrated, large independent and foreign national oil and gas companies. Offshore drilling contractors and engineering and construction companies also represent a minor customer base. The Company’s customers are generally oil and gas companies that are well-known participants in offshore exploration and production.
The Company is not dependent on any one customer or group of customers. In 2006, the Company’s top 15 customers represented approximately 61% of total revenues, with no customer accounting for more than 10% of the Company’s total revenues. In 2007, the Company’s top 15 customers represented approximately 51% of total revenues, with no customer accounting for more than 10% of the Company’s total revenues. The number and variety of the Company’s products required in a given year by any one customer depends upon the amount of that customer’s capital expenditure budget devoted to offshore exploration and production and on the results of competitive bids for major projects. Consequently, a customer that accounts for a significant portion of revenues in one fiscal year may represent an immaterial portion of revenues in subsequent years. While the Company is not dependent on any one customer or group of customers, the loss of one or more of its significant customers could, at least on a short-term basis, have an adverse effect on the Company’s results of operations.
Backlog
Backlog consists of firm customer orders for which a purchase order has been received, satisfactory credit or financing arrangements exist and delivery is scheduled. The Company’s revenues for a specific period have not been directly related to its backlog as stated at a particular point in time. The Company’s backlog was approximately $429 million at December 31, 2007, an increase of $93 million or 28% over the backlog of
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$336 million at December 31, 2006. This increase in backlog is primarily due to improving worldwide market conditions resulting in increased demand for the Company’s products. The Company expects to fill approximately 70% of the December 31, 2007 backlog by December 31, 2008. The remaining backlog at December 31, 2007 consists of longer-term projects which are being designed and manufactured to customer specifications requiring longer lead times. The Company can give no assurance that backlog will remain at current levels. Sales of the Company’s products are affected by prices for oil and natural gas, which fluctuated significantly between 2005 and 2007. Significant future declines in oil and natural gas prices could reduce new customer orders, which would cause the Company’s backlog to decline. All of the Company’s projects currently included in its backlog are subject to change and/or termination at the option of the customer. In the case of a change or termination, the customer is required to pay the Company for work performed and other costs necessarily incurred as a result of the change or termination. In the past, terminations and cancellations have not been significant to the Company’s overall operating results.
Marketing and Sales
Dril-Quip markets its products and services throughout the world directly through its sales personnel in two domestic and fifteen international locations. In addition, in certain foreign markets where the Company does not maintain offices, it utilizes independent sales representatives to enhance its marketing and sales efforts. Some of the locations in which Dril-Quip has sales representatives are India, Canada, Mexico, the Philippines, Brazil, Indonesia, Malaysia, China, Japan, and the Middle East. Although they do not have authority to contractually bind the Company, these representatives market the Company’s products in their respective territories in return for sales commissions. The Company also advertises its products and services in trade and technical publications targeted to its customer base. The Company also participates in industry conferences and trade shows to enhance industry awareness of its products.
The Company’s customers generally order products on a purchase order basis. Orders are typically filled within three to six months after receipt of a purchase order, depending on the type of product and whether it is sold out of inventory or requires some customization. Contracts for certain of the Company’s larger, more complex products, such as subsea production trees, drilling risers and equipment for TLPs and Spars can take a year or more to complete.
The primary factors influencing a customer’s decision to purchase the Company’s products are the quality, reliability and reputation of the product, price and technologically superior features. Timely delivery of equipment is also very important to customer operations and the Company maintains an experienced sales coordination staff to help assure such delivery. For large drilling and production system orders, project management teams coordinate customer needs with engineering, manufacturing and service organizations, as well as with subcontractors and vendors.
A portion of the Company’s business consists of designing, manufacturing, selling and installing equipment for major projects pursuant to competitive bids, and the number of such projects in any year fluctuates. The Company’s profitability on such projects is critically dependent on making accurate and cost effective bids and performing efficiently in accordance with bid specifications. Various factors can adversely affect the Company’s performance on individual projects, with potential material adverse effects on project profitability.
Product Development and Engineering
The technological demands of the oil and gas industry continue to increase as offshore exploration and drilling expand into more hostile environments. Conditions encountered in these environments include well pressures of up to 15,000 psi (pounds per square inch), mixed flows of oil and gas under high pressure that may also be highly corrosive and water depths in excess of 8,000 feet. Since its founding, Dril-Quip has actively engaged in continuing product development to generate new products and improve existing products. When developing new products, the Company typically seeks to design the most technologically advanced version for a particular application to
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establish its reputation and qualification in that product. Thereafter, the Company leverages its expertise in the more technologically advanced product to produce less costly and complex versions of the product for less demanding applications. The Company also focuses its activities on reducing the overall cost to the customer, which includes not only the initial capital cost but also operating and installation costs associated with its products.
The Company has continually introduced new products and product enhancements since its founding in 1981. In the 1990s, the Company introduced a series of new products, including diverters, wellhead connectors, SingleBoreTM subsea trees, improved severe service dual bore subsea trees, subsea and platform valves, platform wellheads, platform trees, subsea tree workover riser systems, drilling risers and TLP and Spar production riser systems. In 2005, Dril-Quip introduced three new product lines: liner hangers, subsea control systems and subsea manifolds.
Dril-Quip’s product development work is conducted at its facilities in Houston, Texas and Aberdeen, Scotland. In addition to the work of its product development staff, the Company’s application engineering staff provides engineering services to customers in connection with the design and sales of its products. The Company’s ability to develop new products and maintain technological advantages is important to its future success. There can be no assurance that the Company will be able to develop new products, successfully differentiate itself from its competitors or adapt to evolving markets and technologies.
The Company believes that the success of its business depends more on the technical competence, creativity and marketing abilities of its employees than on any individual patent, trademark or copyright. Nevertheless, as part of its ongoing product development and manufacturing activities, Dril-Quip’s policy has been to seek patents when appropriate on inventions concerning new products and product improvements. All patent rights for products developed by employees are assigned to the Company and almost all of the Company’s products have components that are covered by patents.
Dril-Quip has numerous U.S. registered trademarks, including Dril-Quip®, Quik-Thread®, Quick-Stab®, Multi-Thread® , MS-15®, SS-15®, SS-10® and SU-90®. The Company has registered its trademarks in the countries where such registration is deemed material.
Although in the aggregate the Company’s patents and trademarks are of considerable importance to the manufacturing and marketing of many of its products, the Company does not consider any single patent or trademark or group of patents or trademarks to be material to its business as a whole, except the Dril-Quip® trademark. At December 31, 2007, the Company held 79 U.S. patents and 182 foreign patents. The Company also relies on trade secret protection for its confidential and proprietary information. The Company routinely enters into confidentiality agreements with its employees and suppliers. There can be no assurance, however, that others will not independently obtain similar information or otherwise gain access to the Company’s trade secrets.
Competition
Dril-Quip faces significant competition from other manufacturers and suppliers of exploration and production equipment. Several of its primary competitors are diversified multinational companies with substantially larger operating staffs and greater capital resources than those of the Company and which, in many instances, have been engaged in the manufacturing business for a much longer period of time than the Company. The Company competes principally with Vetco International and the petroleum production equipment segments of Cameron International Corporation, FMC Technologies, Inc. and Aker Kvaerner.
Because of their relative size and diversity of products, several of these companies have the ability to provide “turnkey” services for offshore drilling and production applications, which enables them to use their own products to the exclusion of Dril-Quip’s products. See “Item 1A. Risk Factors—We may be unable to successfully compete with other manufacturers of drilling and production equipment.” The Company also
9
competes to a lesser extent with a number of other companies in various products. The principal competitive factors in the petroleum drilling and production equipment markets are quality, reliability and reputation of the product, price, technology, service and timely delivery.
Employees
The total number of the Company’s employees as of December 31, 2007 was 1,890. Of these, 1,124 were located in the United States. Substantially all of the Company’s employees are not covered by collective bargaining agreements, and the Company considers its employee relations to be good.
The Company’s operations depend in part on its ability to attract quality employees. While the Company believes that its wage and salary rates are competitive and that its relationship with its labor force is good, a significant increase in the wages and salaries paid by competing employers could result in a reduction of the Company’s labor force, increases in the wage and salary rates paid by the Company or both. If either of these events were to occur, in the near-term, the profits realized by the Company from work in progress would be reduced and, in the long-term, the production capacity and profitability of the Company could be diminished and the growth potential of the Company could be impaired. See “Item 1A. Risk Factors—Loss of our key management or other personnel could adversely impact our business.”
Governmental Regulations
Many aspects of the Company’s operations are affected by political developments and are subject to both domestic and foreign governmental regulations, including those relating to oilfield operations, worker safety and the protection of the environment. In addition, the Company depends on the demand for its services from the oil and gas industry and, therefore, is affected by changing taxes, price controls and other laws and regulations relating to the oil and gas industry in general, including those specifically directed to offshore operations. The adoption of laws and regulations curtailing exploration and development drilling for oil and gas for economic or other policy reasons could adversely affect the Company’s operations by limiting demand for the Company’s products. See “Item 1A. Risk Factors—Our operations and our customers’ operations are subject to a variety of governmental laws and regulations that may increase our costs, limit the demand for our products and services or restrict our operations.”
In recent years, increased concern has been raised over the protection of the environment. Offshore drilling in certain areas has been opposed by environmental groups and, in certain areas, has been restricted. To the extent that new laws or other governmental actions prohibit or restrict offshore drilling or impose additional environmental protection requirements that result in increased costs to the oil and gas industry in general and the offshore drilling industry in particular, the business of the Company could be adversely affected. The Company cannot determine to what extent its future operations and earnings may be affected by new legislation, new regulations or changes in existing regulations. See “Item 1A. Risk Factors—Our business and our customers’ businesses are subject to environmental laws and regulations that may increase our costs, limit the demand for our products and services or restrict our operations.”
Based on the Company’s experience to date, the Company does not currently anticipate any material adverse effect on its business or consolidated financial position as a result of future compliance with existing environmental laws and regulations controlling the discharge of materials into the environment. However, future events, such as changes in existing laws and regulations or their interpretation, more vigorous enforcement policies of regulatory agencies, or stricter or different interpretations of existing laws and regulations, may require additional expenditures by the Company, which may be material.
| Item 1A. | Risk Factors |
In this Item 1A, the terms “we,” “our,” “us,” and “Dril-Quip” used herein refer to Dril-Quip, Inc. and its subsidiaries unless otherwise indicated or as the context so requires.
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Our principal stockholders have the ability to significantly influence our management and affairs and matters on which shareholders may vote.
Our principal stockholders, Larry E. Reimert, Gary D. Smith and J. Mike Walker and certain entities they control, beneficially own approximately 24% of our common stock and are able to exert significant control over us. The collective ownership of Messrs. Reimert, Smith and Walker may have the effect of delaying or preventing a change of control. In addition, our principal stockholders are generally not prohibited from selling their interest in us to a third party.
A material or extended decline in expenditures by the oil and gas industry could significantly reduce our revenue and income.
Our business depends upon the condition of the oil and gas industry and, in particular, the willingness of oil and gas companies to make capital expenditures on exploration, drilling and production operations offshore. The level of capital expenditures is generally dependent on the prevailing view of future oil and gas prices, which are influenced by numerous factors affecting the supply and demand for oil and gas, including:
| • | worldwide economic activity; |
| • | the level of exploration and production activity; |
| • | interest rates and the cost of capital; |
| • | environmental regulation; |
| • | federal, state and foreign policies regarding exploration and development of oil and gas; |
| • | the ability of the Organization of Petroleum Exporting Countries (OPEC) to set and maintain production levels and pricing; |
| • | the cost of exploring and producing oil and gas; |
| • | the cost of developing alternative energy sources; |
| • | the sale and expiration dates of offshore leases in the United States and overseas; |
| • | the discovery rate of new oil and gas reserves in offshore areas; |
| • | technological advances; and |
| • | weather conditions. |
Oil and gas prices and the level of offshore drilling and production activity have been characterized by significant volatility in recent years. Worldwide military, political and economic events have contributed to oil and natural gas price volatility and are likely to continue to do so in the future. Although hydrocarbon prices have improved in recent years and the level of offshore exploration, drilling and production activity has increased, we cannot assure you that such price and activity levels will be sustained and that there will not be continued volatility in the level of drilling and production related activities. Even during periods of high prices for oil and natural gas, companies exploring for oil and gas may cancel or curtail programs, or reduce their levels of capital expenditures for exploration and production for a variety of reasons. In addition, a significant and prolonged decline in hydrocarbon prices would likely have a material adverse effect on our results of operations.
Our international operations expose us to instability and changes in economic and political conditions and other risks inherent to international business, which could have a material adverse effect on our operations or financial condition.
We have substantial international operations, with approximately 69%, 65% and 66%, respectively, of our revenues derived from foreign sales in each of 2007, 2006 and 2005. We operate our business and market our products and services in all of the significant oil and gas producing areas in the world and are, therefore, subject
11
to the risks customarily attendant to international operations and investments in foreign countries. Risks associated with our international operations include:
| • | volatility in general economic, social and political conditions; |
| • | terrorist acts, war and civil disturbances; |
| • | expropriation or nationalization of assets; |
| • | renegotiation or nullification of existing contracts; |
| • | foreign taxation, including changes in law or interpretation of existing law; |
| • | assaults on property or personnel; |
| • | restrictive action by local governments; |
| • | foreign and domestic monetary policies; |
| • | limitations on repatriation of earnings; |
| • | travel limitations or operational problems caused by public health threats; and |
| • | changes in currency exchange rates. |
Any of these risks could have an adverse effect on our ability to manufacture products abroad or the demand for our products and services in some locations. To date, we have not experienced any significant problems in foreign countries arising from local government actions or political instability, but there is no assurance that such problems will not arise in the future. Interruption of our international operations could have a material adverse effect on our overall operations.
We are subject to taxation in many jurisdictions and there are inherent uncertainties in the final determination of our tax liabilities.
As a result of our international operations, we are subject to taxation in many jurisdictions. Therefore, the final determination of our tax liabilities involves the interpretation of the statutes and requirements of taxing authorities worldwide. Foreign income tax returns of foreign subsidiaries and related entities are routinely examined by foreign tax authorities. These tax examinations may result in assessments of additional taxes or penalties or both.
Our excess cash is invested in marketable securities which may subject us to potential losses.
We invest excess cash in various financial instruments and money market mutual funds rated at the highest quality by nationally recognized rating agencies. However, changes in the financial markets, including interest rates, as well as the performance of the issuers, can affect the market value of our short-term investments.
We may suffer losses as a result of foreign currency fluctuations and limitations on the ability to repatriate income or capital to the U.S.
We conduct a portion of our business in currencies other than the United States dollar, and our operations are subject to fluctuations in foreign currency exchange rates. We cannot assure you that we will be able to protect the Company against such fluctuations in the future. Historically, we have not conducted business in countries that limit repatriation of earnings. However, as we expand our international operations, we may begin operating in countries that have such limitations. Further, we cannot assure you that the countries in which we currently operate will not adopt policies limiting repatriation of earnings in the future.
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Our business involves numerous operating hazards that may not be covered by insurance. The occurrence of an event not fully covered by insurance could have a material adverse effect on our financial conditions and results of operations.
Our products are used in potentially hazardous drilling, completion and production applications that can cause personal injury, product liability and environmental claims. A catastrophic occurrence at a location where our equipment and/or services are used may expose us to substantial liability for personal injury, wrongful death, product liability or commercial claims. To the extent available, we maintain insurance coverage that we believe is customary in the industry. Such insurance does not, however, provide coverage for all liabilities, and we cannot assure you that our insurance coverage will be adequate to cover claims that may arise or that we will be able to maintain adequate insurance at rates we consider reasonable. The occurrence of an event not fully covered by insurance could have a material adverse effect on our financial condition and results of operations.
We may lose money on fixed-price contracts.
A portion of our business consists of designing, manufacturing, selling and installing equipment for major projects pursuant to competitive bids, and is performed on a fixed-price basis. Under these contracts, we are typically responsible for all cost overruns, other than the amount of any cost overruns resulting from requested changes in order specifications. Our actual costs and any gross profit realized on these fixed-price contracts will often vary from the estimated amounts on which these contracts were originally based. This may occur for various reasons, including:
| • | errors in estimates or bidding; |
| • | changes in availability and cost of labor and materials; and |
| • | variations in productivity from our original estimates. |
These variations and the risks inherent in our projects may result in reduced profitability or losses on projects. Depending on the size of a project, variations from estimated contract performance could have a material adverse impact on our operating results.
Our business could be adversely affected if we do not develop new products and secure and retain patents related to our products.
Technology is an important component of our business and growth strategy, and our success as a company depends to a significant extent on the development and implementation of new product designs and improvements. Whether we can continue to develop systems and services and related technologies to meet evolving industry requirements and, if so, at prices acceptable to our customers will be significant factors in determining our ability to compete in the industry in which we operate. Many of our competitors are large multinational companies that may have significantly greater financial resources than we have, and they may be able to devote greater resources to research and development of new systems, services and technologies than we are able to do.
Our ability to compete effectively will also depend on our ability to continue to obtain patents on our proprietary technology and products. As of December 31, 2007 we held 79 U.S. patents and 182 foreign patents. Although we do not consider any single patent to be material to our business as a whole, the inability to protect our future innovations through patents could have a material adverse effect.
We may be required to recognize a charge against current earnings because of percentage-of-completion accounting.
Revenues and profits on long-term project contracts are recognized on a percentage-of-completion method based on the ratio of costs incurred to the total estimated costs. Accordingly, purchase order price and cost estimates are reviewed periodically as the work progresses, and adjustments proportionate to the percentage
13
complete are reflected in the period when such estimates are revised. To the extent that these adjustments result in a reduction or elimination of previously reported profits, we would have to recognize a charge against current earnings, which could be significant depending on the size of the project or the adjustment.
Loss of our key management or other personnel could adversely impact our business.
We depend on the services of our executive management team, Larry E. Reimert, Gary D. Smith and J. Mike Walker. The loss of any of these officers could have a material adverse effect on our operations and financial condition. In addition, competition for skilled machinists, fabricators and technical personnel among companies that rely heavily on engineering and technology is intense, and the loss of qualified employees or an inability to attract, retain and motivate additional highly skilled employees required for the operation and expansion of our business could hinder our ability to conduct research activities successfully and develop and produce marketable products and services. While we believe that our wage rates are competitive and that our relationship with our skilled labor force is good, a significant increase in the wages paid by competing employers could result in a reduction of our skilled labor force, increases in the wage rates paid by us or both. If either of these events were to occur, in the near-term, the profits realized by us from work in progress would be reduced and, in the long-term, our production capacity and profitability could be diminished and our growth potential could be impaired.
Our operations and our customers’ operations are subject to a variety of governmental laws and regulations that may increase our costs, limit the demand for our products and services or restrict our operations.
Our business and our customers’ businesses may be significantly affected by:
| • | federal, state and local and foreign laws and other regulations relating to the oilfield operations, worker safety and the protection of the environment; |
| • | changes in these laws and regulations; and |
| • | the level of enforcement of these laws and regulations. |
In addition, we depend on the demand for our products and services from the oil and gas industry. This demand is affected by changing taxes, price controls and other laws and regulations relating to the oil and gas industry in general, including those specifically directed to offshore operations. For example, the adoption of laws and regulations curtailing exploration and development drilling for oil and gas for economic or other policy reasons could adversely affect our operations by limiting demand for our products. We cannot determine the extent to which our future operations and earnings may be affected by new legislation, new regulations or changes in existing regulations.
Because of our foreign operations and sales, we are also subject to changes in foreign laws and regulations that may encourage or require hiring of local contractors or require foreign contractors to employ citizens of, or purchase supplies from, a particular jurisdiction. If we fail to comply with any applicable law or regulation, our business, results of operations or financial condition may be adversely affected.
Our businesses and our customers’ businesses are subject to environmental laws and regulations that may increase our costs, limit the demand for our products and services or restrict our operations.
Our operations and the operations of our customers are also subject to federal, state and local and foreign laws and regulations relating to the protection of the environment. These environmental laws and regulations affect the products and services we design, market and sell, as well as the facilities where we manufacture our products. In addition, environmental laws and regulations could limit our customers’ exploration and production activities. We are required to invest financial and managerial resources to comply with environmental laws and regulations and anticipate that we will continue to be required to do so in the future. These laws and regulations change frequently, which makes it impossible for us to predict their cost or impact on our future operations. The
14
modification of existing laws or regulations or the adoption of new laws or regulations imposing more stringent environmental restrictions could adversely affect our operations.
These laws may provide for “strict liability” for damages to natural resources or threats to public health and safety, rendering a party liable for environmental damage without regard to negligence or fault on the part of such party. Sanctions for noncompliance may include revocation of permits, corrective action orders, administrative or civil penalties, and criminal prosecution. Some environmental laws and regulations provide for joint and several strict liability for remediation of spills and releases of hazardous substances. In addition, we may be subject to claims alleging personal injury or property damage as a result of alleged exposure to hazardous substances, as well as damage to natural resources. These laws and regulations also may expose us to liability for the conduct of or conditions caused by others, or for our acts that were in compliance with all applicable laws and regulations at the time such acts were performed. Any of these laws and regulations could result in claims, fines or expenditures that could be material to our earnings, financial condition or cash flow.
We may be unable to successfully compete with other manufacturers of drilling and production equipment.
Several of our primary competitors are diversified multinational companies with substantially larger operating staffs and greater capital resources than ours and which have been engaged in the manufacturing business for a much longer time than us. If these competitors substantially increase the resources they devote to developing and marketing competitive products and services, we may not be able to compete effectively. Similarly, consolidation among our competitors could enhance their product and service offerings and financial resources, further intensifying competition.
The loss of a significant customer could have an adverse impact on our financial results.
Our principal customers are major integrated oil and gas companies, large independent oil and gas companies and foreign national oil and gas companies. Offshore drilling contractors and engineering and construction companies also represent a portion of our customer base. In 2006, our top 15 customers represented approximately 61% of total revenues, with no customer accounting for more than 10% of our total revenues. In 2007, our top 15 customers represented approximately 51% of total revenues, with no customer accounting for more than 10% of our total revenues. While we are not dependent on any one customer or group of customers, the loss of one or more of our significant customers could, at least on a short-term basis, have an adverse effect on our results of operations.
Our customers’ industries are undergoing continuing consolidation that may impact our results of operations.
The oil and gas industry is rapidly consolidating and, as a result, some of our largest customers have consolidated and are using their size and purchasing power to seek economies of scale and pricing concessions. This consolidation may result in reduced capital spending by some of our customers or the acquisition of one or more of our primary customers, which may lead to decreased demand for our products and services. We cannot assure you that we will be able to maintain our level of sales to a customer that has consolidated or replace that revenue with increased business activity with other customers. As a result, the acquisition of one or more of our primary customers may have a significant negative impact on our results of operations or our financial condition. We are unable to predict what effect consolidations in the industry may have on price, capital spending by our customers, our selling strategies, our competitive position, our ability to retain customers or our ability to negotiate favorable agreements with our customers.
Increases in the cost of raw materials and energy used in our manufacturing processes could negatively impact our profitability.
Any increases in commodity prices for items such as nickel, molybdenum and heavy metal scrap that are used to make the steel alloys required for our products would result in an increase in our raw material costs.
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Similarly, any increase in energy costs would increase our product costs. If we are not successful in raising our prices on products to compensate for any increased raw material or energy costs, our margins will be negatively impacted.
We depend on third party suppliers for timely deliveries of raw materials, and our results of operations could be adversely affected if we are unable to obtain adequate supplies in a timely manner.
Our manufacturing operations depend upon obtaining adequate supplies of raw materials from third parties. The ability of these third parties to deliver raw materials may be affected by events beyond our control. Any interruption in the supply of raw materials needed to manufacture our products could adversely affect our business, results of operations and reputation with our customers.
Our shares that are eligible for future sale may have an adverse effect on the price of our common stock.
Future sales of substantial amounts of our common stock, or a perception that such sales could occur, could adversely affect the market price of our common stock and could impair our ability to raise capital through the sale of our equity securities. This risk is compounded by the fact that a substantial portion of our common stock is owned by Messrs. Reimert, Smith and Walker and certain entities they control. Messrs. Reimert, Smith and Walker and certain entities they control have piggyback and demand registration rights that provide for the registration of the resale of shares at our expense which will allow those shares to be sold in the public market generally without restriction.
The market price of our common stock is volatile.
The trading price of our common stock and the price at which we may sell common stock in the future are subject to large fluctuations in response to any of the following:
| • | limited trading volume in our common stock; |
| • | quarterly variations in operating results; |
| • | general financial market conditions; |
| • | the prices of natural gas and oil; |
| • | announcements by us and our competitors; |
| • | our liquidity; |
| • | changes in government regulations; |
| • | our ability to raise additional funds; |
| • | our involvement in litigation; and |
| • | other events. |
We do not anticipate paying dividends on our common stock in the near future.
We have not paid any dividends in the past and do not intend to pay cash dividends on our common stock in the foreseeable future. Our Board of Directors reviews this policy on a regular basis in light of our earnings, financial condition and market opportunities. We currently intend to retain any earnings for the future operation and development of our business.
| Item 1B. | Unresolved Staff Comments |
None.
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| Item 2. | Properties |
Major Manufacturing Facilities
| Location |
Building Size (Approximate Square Feet) |
Land (Approximate Acreage) |
Owned or Leased | |||
| Houston, Texas |
||||||
| —Hempstead Highway |
175,000 | 15.0 | Owned | |||
| 21,000 | — | Leased (offices) | ||||
| —N. Eldridge Parkway |
910,500 | 218.0 | Owned | |||
| Aberdeen, Scotland |
158,000 | 14.6 | Owned | |||
| Singapore |
56,000 | — | Owned | |||
| — | 14.7 | Leased |
Dril-Quip’s manufacturing facilities in Houston and Aberdeen are capable of manufacturing each of its products, and the facility in Singapore is capable of manufacturing most of the Company’s established products. The Houston facility at Eldridge produces in-house a majority of the Company’s forging requirements and essentially all of the Company’s heat treatment.
Sales, Service and Reconditioning Facilities
| Location(1) |
Building Size (Approximate Square Feet) |
Land (Approximate Acreage) |
Activity | |||
| New Orleans, Louisiana |
2,300 | — | Sales/Service | |||
| Great Yarmouth, England |
1,300 | 0.4 | Sales/Service | |||
| Beverwijk, Holland |
5,200 | 0.4 | Sales/Warehouse | |||
| Perth, Australia |
1,400 | — | Sales/Service | |||
| Darwin, Australia |
4,100 | 1.0 | Service/Warehouse | |||
| Stavanger, Norway |
42,000 | 6.1 | Sales/Service/Reconditioning/Warehouse/Fabrication | |||
| Esbjerg, Denmark |
19,400 | 1.2 | Sales/Service/Reconditioning/Warehouse | |||
| Macae, Brazil |
83,600 | 10.0 | Sales/Service/Reconditioning/Warehouse/Fabrication | |||
| Port Harcourt, Nigeria |
8,300 | 0.5 | Sales/Service/Reconditioning/Warehouse/Fabrication | |||
| Tianjin, China |
12,000 | — | Service/Reconditioning/Warehouse | |||
| Paris, France |
500 | — | Sales | |||
| Cairo, Egypt |
6,400 | — | Sales/Service/Reconditioning/Warehouse |
| (1) | All facilities are leased except Stavanger, Norway and Macae, Brazil which are owned. |
The Company also performs sales, service and reconditioning activities at its facilities in Houston, Aberdeen and Singapore.
| Item 3. | Legal Proceedings |
On December 1, 2006, Cameron International Corporation (“Cameron”) filed a patent infringement suit against the Company in the United States District Court for the District of Delaware. The complaint asserts that the Company has infringed and continues to infringe on certain of Cameron’s patents related to horizontal spool tree technology. The Company denies any liability. To date, the Company has not sold any horizontal spool trees. Cameron seeks injunctive relief and unspecified damages, including attorneys’ fees. Although no assurance can be given with respect to the ultimate outcome of this matter, in the opinion of management the ultimate liability with respect thereto will not have a material adverse effect on the Company’s operations, financial position or cash flows.
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In August 2007, our Brazilian subsidiary was served with assessments collectively valued at approximately $12.8 million from the State of Rio de Janiero, Brazil, to collect a state tax on the importation of goods. We believe that our subsidiary is not liable for the taxes and plan to vigorously contest the assessments in the Brazilian administrative and judicial systems. At this time, the ultimate disposition of this matter cannot presently be determined and therefore, it is not possible to reasonably estimate the amount of loss or the range of possible losses that might result from an adverse judgment or settlement of these assessments. Accordingly, no liability has been accrued in conjunction with this matter. We do not expect the liability, if any, resulting from these assessments to have a material adverse effect on the Company’s operations, financial position or cash flows.
The Company also is involved in a number of legal actions arising in the ordinary course of business. Although no assurance can be given with respect to the ultimate outcome of such legal actions, in the opinion of management the ultimate liability with respect thereto will not have a material adverse effect on the Company’s operations, financial position or cash flows.
| Item 4. | Submission of Matters to a Vote of Security Holders |
No matters were submitted to a vote of security holders of the Company during the quarter ended December 31, 2007.
Item S-K 401(b). Executive Officers of the Registrant
Pursuant to Instruction 3 to Item 401(b) of Regulation S-K and General Instruction G(3) to Form 10-K, the following information is included in Part I of this Form 10-K:
The following table sets forth the names, ages (as of February 28, 2008) and positions of the Company’s executive officers:
| Name |
Age | Position | ||
| Larry E. Reimert |
60 | Co-Chairman of the Board and Co-Chief Executive Officer | ||
| Gary D. Smith |
65 | Co-Chairman of the Board and Co-Chief Executive Officer | ||
| J. Mike Walker |
64 | Co-Chairman of the Board and Co-Chief Executive Officer | ||
| Jerry M. Brooks |
56 | Chief Financial Officer |
Larry E. Reimert is Co-Chairman of the Board and Co-Chief Executive Officer with principal responsibility for engineering, product development and finance. He has been the Director—Engineering, Product Development and Finance, as well as a member of the Board of Directors, since the Company’s inception in 1981. Prior to that, he worked for Vetco Offshore, Inc. in various capacities, including Vice President of Technical Operations, Vice President of Engineering and Manager of Engineering. Mr. Reimert holds a BSME degree from the University of Houston and an MBA degree from Pepperdine University.
Gary D. Smith is Co-Chairman of the Board and Co-Chief Executive Officer with principal responsibility for sales, service, training and administration. He has been the Director—Sales, Service, Training and Administration, as well as a member of the Board of Directors, since the Company’s inception in 1981. Prior to that, he worked for Vetco Offshore, Inc. in various capacities, including General Manager and Vice President of Sales and Service.
J. Mike Walker is Co-Chairman of the Board and Co-Chief Executive Officer with principal responsibility for manufacturing, purchasing and facilities. He has been the Director—Manufacturing, Purchasing and Facilities, as well as a member of the Board of Directors, since the Company’s inception in 1981. Prior to that, he served as the Director of Engineering, Manager of Engineering and Manager of Research and Development with Vetco Offshore, Inc. Mr. Walker holds a BSME degree from Texas A&M University, an MSME degree from the University of Texas at Austin and a Ph.D. in mechanical engineering from Texas A&M University.
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Jerry M. Brooks has been Chief Financial Officer since March 1999. Prior to that, he served as Chief Accounting Officer since joining the Company in 1992. From 1980 to 1991, he held various positions with Chiles Offshore Corporation, most recently as Chief Financial Officer, Secretary and Treasurer. Mr. Brooks holds a BBA in Accounting and an MBA from the University of Texas at Austin.
PART II
| Item 5. | Market for Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities |
The Company’s Common Stock is publicly traded on the New York Stock Exchange under the symbol DRQ. The following table sets forth the quarterly high and low sales prices of the Common Stock as reported on the New York Stock Exchange for the indicated quarters of fiscal 2006 and 2007. Share prices have been adjusted for the two-for-one common stock split effective October 5, 2006.
| Sales Price ($) | ||||||||
| 2006 | 2007 | |||||||
| Quarter Ended |
High | Low | High | Low | ||||
| March 31 |
36.68 | 24.07 | 44.45 | 32.85 | ||||
| June 30 |
45.02 | 32.82 | 52.92 | 42.64 | ||||
| September 30 |
44.06 | 29.76 | 50.27 | 37.55 | ||||
| December 31 |
44.68 | 30.31 | 63.49 | 48.77 | ||||
There were approximately 43 stockholders of record of the Company’s Common Stock as of February 20, 2008. This number does not include the number of security holders for whom shares are held in a “nominee” or “street” name.
The Company has not paid any dividends in the past. The Company currently intends to retain any earnings for the future operation and development of its business and does not currently anticipate paying any dividends in the foreseeable future. The Board of Directors will review this policy on a regular basis in light of the Company’s earnings, financial condition and market opportunities.
Information concerning securities authorized for issuance under equity compensation plans is included in Note 12 of the Notes to Consolidated Financial Statements.
Repurchases of Equity Securities
During the year ended December 31, 2007, none of the Company’s equity securities registered pursuant to Section 12 of the Exchange Act were purchased by or on behalf of the Company or any of the Company’s “affiliated purchasers,” as defined in Rule 10b-18(a)(3) under the Exchange Act.
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| Item 6. | Selected Financial Data |
The information set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and Notes thereto included elsewhere in this Report.
| Year ended December 31, | ||||||||||||||||||||
| 2003 | 2004 | 2005 | 2006 | 2007 | ||||||||||||||||
| (In thousands, except per share amounts) | ||||||||||||||||||||
| Statement of Operations Data: |
||||||||||||||||||||
| Revenues |
$ | 219,498 | $ | 221,586 | $ | 340,829 | $ | 442,742 | $ | 495,557 | ||||||||||
| Cost of sales |
157,988 | 153,433 | 229,849 | 256,688 | 285,281 | |||||||||||||||
| Selling, general and administrative expenses |
29,039 | 32,749 | 40,916 | 44,085 | 49,313 | |||||||||||||||
| Engineering and product development expenses |
16,525 | 17,090 | 20,867 | 19,559 | 22,578 | |||||||||||||||
| Special items |
1,400 | — | — | — | — | |||||||||||||||
| 204,952 | 203,272 | 291,632 | 320,332 | 357,172 | ||||||||||||||||
| Operating income |
14,546 | 18,314 | 49,197 | 122,410 | 138,385 | |||||||||||||||
| Interest income |
91 | 167 | 258 | 3,632 | 8,275 | |||||||||||||||
| Interest expense |
(1,650 | ) | (1,267 | ) | (2,045 | ) | (669 | ) | (370 | ) | ||||||||||
| Income before income taxes |
12,987 | 17,214 | 47,410 | 125,373 | 146,290 | |||||||||||||||
| Income tax provision |
4,036 | 4,741 | 14,843 | 38,482 | 38,349 | |||||||||||||||
| Net income |
$ | 8,951 | $ | 12,473 | $ | 32,567 | $ | 86,891 | $ | 107,941 | ||||||||||
| Earnings per common share: |
||||||||||||||||||||
| Basic |
$ | 0.26 | $ | 0.36 | $ | 0.92 | $ | 2.21 | $ | 2.67 | ||||||||||
| Diluted |
$ | 0.26 | $ | 0.36 | $ | 0.90 | $ | 2.15 | $ | 2.63 | ||||||||||
| Weighted average common shares outstanding: |
||||||||||||||||||||
| Basic |
34,586 | 34,590 | 35,276 | 39,340 | 40,447 | |||||||||||||||
| Diluted |
34,586 | 34,740 | 36,206 | 40,342 | 41,007 | |||||||||||||||
| Statement of Cash Flows Data: |
||||||||||||||||||||
| Net cash provided by (used in) operating activities |
$ | 26,965 | $ | 25,338 | $ | (16,889 | ) | $ | 93,482 | $ | 82,663 | |||||||||
| Net cash used in investing activities |
(2,470 | ) | (16,845 | ) | (19,206 | ) | (23,290 | ) | (24,854 | ) | ||||||||||
| Net cash provided by (used in) financing activities |
(16,396 | ) | (10,840 | ) | 62,961 | 36,851 | 10,160 | |||||||||||||
| Other Data: |
||||||||||||||||||||
| Depreciation and amortization |
$ | 10,558 | $ | 11,779 | $ | 13,426 | $ | 15,087 | $ | 15,653 | ||||||||||
| Capital expenditures |
8,328 | 17,061 | 20,557 | 24,133 | 25,208 | |||||||||||||||
| December 31, | ||||||||||||||||||||
| 2003 | 2004 | 2005 | 2006 | 2007 | ||||||||||||||||
| (In thousands) | ||||||||||||||||||||
| Balance Sheet Data: |
||||||||||||||||||||
| Working capital |
$ | 135,924 | $ | 137,716 | $ | 220,892 | $ | 347,250 | $ | 454,192 | ||||||||||
| Total assets |
278,181 | 303,565 | 428,262 | 594,935 | 699,822 | |||||||||||||||
| Total debt |
39,608 | 29,072 | 3,847 | 3,720 | 2,911 | |||||||||||||||
| Total stockholders’ equity |
199,647 | 216,363 | 329,462 | 467,497 | 592,495 | |||||||||||||||
As discussed in Note 2 to the consolidated financial statements, the Company adopted Statement of Financial Accounting Standards No. 123(R), “Share-Based Payment,” effective January 1, 2006. Additionally, all share and per share data has been adjusted for all periods presented for the two-for-one stock split effective October 5, 2006.
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
The following is management’s discussion and analysis of certain significant factors that have affected certain aspects of the Company’s financial position, results of operations and cash flows during the periods included in the
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accompanying consolidated financial statements. This discussion should be read in conjunction with the Company’s Consolidated Financial Statements and Notes thereto presented elsewhere in this Report.
Overview
Dril-Quip designs, manufactures, sells and services highly engineered offshore drilling and production equipment that is well suited for use in deepwater, harsh environment and severe service applications. The Company designs and manufactures subsea equipment, surface equipment and offshore rig equipment for use by major integrated, large independent and foreign national oil and gas companies in offshore areas throughout the world. The Company’s principal products consist of subsea and surface wellheads, subsea and surface production trees, subsea control systems and manifolds, mudline hanger systems, specialty connectors and associated pipe, drilling and production riser systems, liner hangers, wellhead connectors and diverters. Dril-Quip also provides installation and reconditioning services and rents running tools for use in connection with the installation and retrieval of its products.
Both the market for offshore drilling and production equipment and services and the Company’s business are substantially dependent on the condition of the oil and gas industry and, in particular, the willingness of oil and gas companies to make capital expenditures on exploration, drilling and production operations offshore. Oil and gas prices and the level of offshore drilling and production activity have historically been characterized by significant volatility. See “Item 1A. Risk Factors—A material or extended decline in expenditures by the oil and gas industry could significantly reduce our revenue and income.”
High oil and gas prices from 2005 through 2007 have resulted in oil operators increasing capital spending for both exploration and development programs. As various geopolitical issues have limited the ability of oil and gas companies to invest in areas such as Russia and the Middle East, an increasing amount of this capital spending has been in the deepwater areas in which the Company operates. However, any significant future declines in oil and gas prices could have a material adverse effect on the Company’s results of operations. There can be no assurance that the current oil price levels will lead to increases in exploration and development activity or that demand for the Company’s products and services will reflect such increases, if any.
The Company operates its business and markets its products and services in all of the significant oil and gas producing areas in the world and is, therefore, subject to the risks customarily attendant to international operations and investments in foreign countries. These risks include nationalization, expropriation, war, acts of terrorism and civil disturbance, restrictive action by local governments, limitation on repatriation of earnings, change in foreign tax laws and change in currency exchange rates, any of which could have an adverse effect on either the Company’s ability to manufacture its products in its facilities abroad or the demand in certain regions for the Company’s products or both. To date, the Company has not experienced any significant problems in foreign countries arising from local government actions or political instability, but there is no assurance that such problems will not arise in the future. Interruption of the Company’s international operations could have a material adverse effect on its overall operations. See “Item 1A. Risk Factors—Our international operations expose us to instability and changes in economic and political conditions and other risks inherent to international business, which could have a material adverse effect on our operations or financial condition.”
Dril-Quip’s revenues are generated from two sources: products and services. Product revenues are derived from the sale of offshore drilling and production equipment. Service revenues are earned when the Company provides installation and reconditioning services as well as rental of running tools for installation and retrieval of its products. In 2007, the Company derived 84% of its revenues from the sale of its products and 16% of its revenues from services. Service revenues generally correlate to revenues from product sales because increased product sales normally generate increased revenues from installation services and rental of running tools. The Company has substantial international operations, with approximately 66%, 65% and 69% of its revenues derived from foreign sales in 2005, 2006 and 2007, respectively. On the basis of revenues generated, approximately 65%, 66% and 62% of all products sold were manufactured in the United States during 2005, 2006 and 2007, respectively.
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Generally, the Company attempts to raise its prices as its costs increase. However, the actual pricing of the Company’s products and services is impacted by a number of factors, including competitive pricing pressure, the level of utilized capacity in the oil service sector, maintenance of market share, the introduction of new products and general market conditions.
The Company accounts for larger and more complex projects that have relatively longer manufacturing time frames on a percentage-of-completion basis. During 2007, 16 projects representing approximately 19% of the Company’s revenue were accounted for using percentage-of-completion accounting. This percentage may fluctuate in the future. Revenues accounted for in this manner are generally recognized on the ratio of costs incurred to the total estimated costs. Accordingly, price and cost estimates are reviewed periodically as the work progresses, and adjustments proportionate to the percent complete are reflected in the period when such estimates are revised. Losses, if any, are recognized when they become known. Amounts received from customers in excess of revenues recognized are classified as a current liability. See “Item 1A. Risk Factors—We may be required to recognize a charge against earnings because of percentage-of-completion accounting.”
Results of Operations
The following table sets forth, for the periods indicated, certain consolidated statements of income data expressed as a percentage of revenues:
| Year Ended December 31, | |||||||||
| 2005 | 2006 | 2007 | |||||||
| Revenues: |
|||||||||
| Product Group |
85.5 | % | 84.1 | % | 84.3 | % | |||
| Service Group |
14.5 | 15.9 | 15.7 | ||||||
| Total |
100.0 | 100.0 | 100.0 | ||||||
| Cost of sales |
67.4 | 57.9 | 57.6 | ||||||
| Selling, general and administrative expenses |
12.1 | 10.0 | 9.9 | ||||||
| Engineering and product development expenses |
6.1 | 4.4 | 4.6 | ||||||
| Operating income |
14.4 | 27.7 | 27.9 | ||||||
| Interest income |
0.1 | 0.8 | 1.7 | ||||||
| Interest expense |
(0.6 | ) | (0.2 | ) | (0.1 | ) | |||
| Income before income taxes |
13.9 | 28.3 | 29.5 | ||||||
| Income tax provision |
4.3 | 8.7 | 7.7 | ||||||
| Net income |
9.6 | % | 19.6 | % | 21.8 | % | |||
Year ended December 31, 2007 Compared to Year Ended December 31, 2006
Revenues. Revenues increased by $52.9 million, or approximately 11.9%, to $495.6 million in 2007 from $442.7 million in 2006. The increase resulted primarily from increased product revenues in the Western Hemisphere, Eastern Hemisphere and Asia-Pacific of $12.7 million, $12.3 million and $20.5 million, respectively. Service revenues increased by approximately $7.4 million from increased service revenues in the Western Hemisphere of $5.0 million and Eastern Hemisphere of $3.7 million and slightly offset by a decrease in Asia-Pacific of $1.3 million. In general, the increase in revenues resulted from increased demand for the Company’s products realized on a worldwide basis as oil and gas companies have increased their levels of capital expenditures on exploration, drilling and production operations offshore. The increase in service revenues is essentially a result of the increase in product sales. As product revenues increase, the demand for installation services is greater and the rental of running tools also increases.
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Cost of Sales. Cost of sales increased by $28.6 million, or approximately 11.1%, to $285.3 million for 2007 from $256.7 million for the same period in 2006. As a percentage of revenues, cost of sales were approximately 57.6% in 2007 and 57.9% in 2006. The reduction in cost of sales as a percentage of revenues resulted primarily from changes in product mix.
Selling, General and Administrative Expenses. For 2007, selling, general and administrative expenses increased by approximately $5.2 million, or 11.8%, to $49.3 million from $44.1 million in 2006. The increase in selling, general and administrative expenses was primarily due to increased labor and overhead expenses resulting from increased staffing levels in the areas of sales, administration and finance and increases in legal and professional fees. The Company experienced approximately $3.0 million in pre-tax foreign currency transaction gains during 2007 versus approximately $2.2 million in pre-tax foreign currency transaction gains during 2006. Selling, general and administrative expenses as a percentage of revenues was 10.0% in 2006 and 9.9% in 2007.
Engineering and Product Development Expenses. For 2007, engineering and product development expenses increased by $3.0 million, or approximately 15.3%, to approximately $22.6 million from $19.6 million in 2006. This increase was due primarily to an increase in personnel and associated operating expenses. Engineering and product development expenses as a percentage of revenues increased from 4.4% in 2006 to 4.6% in 2007.
Interest Income. Interest income for 2007 was $8.3 million as compared to $3.6 million in 2006. The increase was due to interest earned on short-term investments resulting from excess cash flows generated.
Interest expense. Interest expense for 2007 was $370,000 compared to $669,000 in 2006. This decrease was due to the partial pay down of long-term debt and a reduction in commitment fee expenses related to the Company’s unsecured revolving line of credit.
Income tax provision. Income tax expense for 2007 was $38.3 million on income before taxes of $146.3 million, resulting in an effective income tax rate of approximately 26.2%. Income tax expense in 2006 was $38.5 million on income before taxes of $125.4 million, resulting in an effective tax rate of approximately 30.7%. This decrease in the effective tax rate reflects a reduction in foreign tax rates resulting from a foreign development tax incentive and increased tax benefits for manufacturing companies located in the United States of America.
Net Income. Net income was approximately $107.9 million in 2007 and $86.9 million in 2006, for the reasons set forth above.
Year ended December 31, 2006 Compared to Year Ended December 31, 2005
Revenues. Revenues increased by $101.9 million, or approximately 29.9%, to $442.7 million in 2006 from $340.8 million in 2005. The increase resulted primarily from increased product revenues in the Western Hemisphere, Eastern Hemisphere and Asia-Pacific of $45.5 million, $22.5 million and $13.2 million, respectively. Service revenues increased by approximately $20.7 million with increased service revenues in the Western Hemisphere of $5.2 million, Eastern Hemisphere of $11.2 million and Asia-Pacific of $4.3 million. In general, the increase in revenues resulted from increased demand for the Company’s products realized on a worldwide basis as oil and gas companies have increased their levels of capital expenditures on exploration, drilling and production operations offshore. The increase in service revenues is essentially a result of the increase in product sales. As product revenues increase, the demand for installation services is greater and the rental of running tools also increases.
Cost of Sales. Cost of sales increased by $26.9 million, or approximately 11.7%, to $256.7 million for 2006 from $229.8 million for the same period in 2005. As a percentage of revenues, cost of sales were approximately 57.9% in 2006 and 67.4% in 2005. The reduction in cost of sales as a percentage of revenues resulted primarily from manufacturing efficiencies realized from the increased utilization of the Company’s manufacturing facilities, pricing and changes in product mix. This reduction occurred despite significant increases in the prices of raw materials.
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Selling, General and Administrative Expenses. For 2006, selling, general and administrative expenses increased by approximately $3.2 million, or 7.7%, to $44.1 million from $40.9 million in 2005. The increase in selling, general and administrative expenses was primarily due to increased labor and overhead expenses resulting from increased staffing levels in the areas of sales, administration and finance and the Company’s implementation of SFAS No. 123(R). The Company experienced approximately $2.2 million in foreign currency transaction gains during 2006 versus approximately $767,000 in foreign currency transaction losses during 2005. Selling, general and administrative expenses as a percentage of revenues declined from 12.1% in 2005 to 10.0% in 2006.
Engineering and Product Development Expenses. For 2006, engineering and product development expenses decreased by $1.3 million, or approximately 6.3%, to $19.6 million from $20.9 million in 2005. This decrease was primarily due to a reduction in engineering requirements. Engineering and product development expenses as a percentage of revenues declined from 6.1% in 2005 to 4.4% in 2006.
Interest Income. Interest income for 2006 was $3.6 million compared to $258,000 in 2005. The increase was due to interest earned on short-term investments resulting from excess cash flows generated throughout the year as well as from the partial use of proceeds from the Company’s December 2005 offering of common stock.
Interest expense. Interest expense for 2006 was $669,000 compared to $2.0 million in 2005. The decrease was primarily due to the partial use of proceeds from the Company’s December 2005 offering of common stock to pay down long-term debt.
Income tax provision. Income tax expense for 2006 was $38.5 million on income before taxes of $125.4 million, resulting in an effective tax rate of approximately 31%. Income tax expense in 2005 was $14.8 million on income before taxes of $47.4 million, also resulting in an effective tax rate of approximately 31%.
Net Income. Net income was approximately $86.9 million in 2006 and $32.6 million in 2005, for the reasons set forth above.
Liquidity and Capital Resources
The primary liquidity needs of the Company are (i) to fund capital expenditures to improve and expand facilities and manufacture additional running tools and (ii) to fund working capital. Historically, the Company’s principal sources of funds have been cash flows from operations and bank indebtedness. In December 2005, the Company sold 1.5 million shares of common stock which resulted in proceeds to the Company, before expenses, of $74,880,000.
Net cash used in operating activities was $16.9 million in 2005. Net cash provided by operating activities was $93.5 million in 2006 and $82.7 million in 2007. During 2006 and 2007, net cash provided by operating activities resulted primarily from increases in net income and depreciation and amortization offset by changes in operating assets and liabilities.
Capital expenditures by the Company were $20.6 million, $24.1 million and $25.2 million in 2005, 2006 and 2007, respectively. Capital expenditures in 2006 and 2007 included expanding manufacturing facilities in the Western Hemisphere and increased expenditures on machinery and equipment and running tools due to expanded operations. Capital expenditure increases during 2005 were primarily due to expenditures related to the expansion of the Company’s Houston forging facility as well as costs associated with running tools and equipment needed in the development and marketing of the Company’s new liner hanger and subsea controls product lines. Principal payments on long-term debt were approximately $24.9 million, $800,000 and $900,000 in 2005, 2006 and 2007, respectively. The reduction in long-term debt during 2005 on the Company’s revolving line of credit was due primarily to net cash provided by the sale of 1.5 million shares of common stock in the fourth quarter of 2005.
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The following table presents long-term contractual obligations of the Company and the related payments, excluding the effects of interest, due in total and by year as of December 31, 2007:
| Payments due by year | |||||||||||||||||||||
| Contractual Obligations |
2008 | 2009 | 2010 | 2011 | 2012 | After 2012 |
Total | ||||||||||||||
| (In thousands) | |||||||||||||||||||||
| Long-term debt maturities |
$ | 857 | $ | 856 | $ | 858 | $ | 309 | $ | 31 | $ | — | $ | 2,911 | |||||||
| Operating lease obligations (1) |
1,242 | 558 | 329 | 18,804 | 2,878 | 2,165 | 25,976 | ||||||||||||||
| Estimated interest payments (2) |
162 | 109 | 55 | 11 | 8 | — | 345 | ||||||||||||||
| Total |
$ | 2,261 | $ | 1,523 | $ | 1,242 | $ | 19,124 | $ | 2,917 | $ | 2,165 | $ | 29,232 | |||||||
| (1) | Includes certain minimum lease obligations for investments in machinery, leasehold improvements and buildings. |
| (2) | Interest rates for leases were calculated using the interest portion of the lease payment. Interest payments for variable rate debt were calculated using the interest rate and exchange rate in effect at December 31, 2007. |
At December 31, 2007 the Company had a credit facility with Guaranty Bank, FSB providing an unsecured revolving line of credit of up to $10 million. At the option of the Company, borrowing under this facility bears interest at either a rate equal to LIBOR (London Interbank Offered Rate) plus 1.75% or the Guaranty Bank base rate. The facility calls for quarterly interest payments and terminates on June 1, 2009. The facility also contains certain covenants including maintaining minimum tangible net worth levels, not exceeding specified funded debt amounts and required interest coverage ratios. As of December 31, 2006 and 2007, the Company had no borrowings under this facility and was in compliance with all loan covenants.
Dril-Quip (Europe) Limited has a credit agreement with the Bank of Scotland dated March 21, 2001 in the original amount of U.K. Pounds Sterling 4.0 million (approximately U.S. $8 million). Borrowing under this facility bears interest at the Bank of Scotland base rate, which was 5.5% at December 31, 2007, plus 1%, and is repayable in 120 equal monthly installments, plus interest. Substantially all of this facility was used to finance capital expenditures in Norway. The outstanding balance of this facility at December 31, 2006 and 2007 was approximately U.S. $3.4 million and U.S. $2.7 million, respectively. The facility is secured by land and buildings in Aberdeen, Scotland and contains no restrictive financial covenants.
In addition to the above, the Company has issued purchase orders in the ordinary course of business for the purchase of goods and services. These purchase orders are enforceable and legally binding. However, none of the Company’s purchase obligations call for deliveries of goods or services for time periods in excess of one year.
In October 2005, the Company filed with the SEC a universal shelf registration statement that, subject to the agreement on terms at the time of use and appropriate supplementation, allowed the Company to issue, in one or more offerings, up to $100 million of common stock, preferred stock, debt securities, warrants or a combination thereof. In December 2005, the Company issued $78 million in common stock (1.5 million shares, resulting in proceeds to the Company, before expenses, of $74.9 million.) At December 31, 2007, the Company had $22 million available under this shelf registration, subject to customary market terms and conditions.
The Company believes that cash generated from operations plus cash on hand and its current line of credit will be sufficient to fund operations, working capital needs and anticipated capital expenditure requirements in 2008. However, any significant future declines in hydrocarbon prices could have a material adverse effect on the Company’s liquidity. Should market conditions result in unexpected cash requirements, the Company believes that additional borrowing from commercial lending institutions would be available and adequate to meet such requirements.
Backlog
Backlog consists of firm customer orders for which a purchase order has been received, satisfactory credit or financing arrangements exist and delivery is scheduled. The Company’s revenues for a specific period have
25
not been directly related to its backlog as stated at a particular point in time. The Company’s backlog was approximately $429 million at December 31, 2007, an increase of $93 million or 28% over the backlog of $336 million at December 31, 2006. This increase in backlog is primarily due to improving worldwide market conditions resulting in increased demand for the Company’s products. The Company expects to fill approximately 70% of the December 31, 2007 backlog by December 31, 2008. The remaining backlog at December 31, 2007 consists of longer-term projects which are being designed and manufactured to customer specifications requiring longer lead times. The Company can give no assurance that backlog will remain at current levels. Sales of the Company’s products are affected by prices for oil and natural gas, which fluctuated significantly between 2005 and 2007. Significant future declines in oil and natural gas prices could reduce new customer orders, which would cause the Company’s backlog to decline. All of the Company’s projects currently included in its backlog are subject to change and/or termination at the option of the customer. In the case of a change or termination, the customer is required to pay the Company for work performed and other costs necessarily incurred as a result of the change or termination. In the past, terminations and cancellations have been immaterial to the Company’s overall operating results.
Geographic Segments
The Company’s operations are organized into three geographic segments—Western Hemisphere (including North and South America and Mexico; headquartered in Houston, Texas), Eastern Hemisphere (including Europe and Africa; headquartered in Aberdeen, Scotland) and Asia-Pacific (including the Pacific Rim, Southeast Asia, Australia, India and the Middle East; headquartered in Singapore). Each of these segments sells similar products and services and the Company has major manufacturing facilities in all three of its headquarter locations, as well as Macae, Brazil.
Revenues for each of these segments are dependent upon the ultimate sale of products and services to the Company’s customers. For information on revenues by geographic segment, see Note 11 to the consolidated financial statements. Revenues of the Western Hemisphere are also influenced by its sale of products to the Eastern Hemisphere and Asia-Pacific segments. Accordingly, the operating incomes of each area are closely tied to third-party sales, and the operating income of the Western Hemisphere is also dependent upon its level of intercompany sales.
Currency Risk
Through its subsidiaries, the Company conducts a portion of business in currencies other than the United States dollar, principally the British pound sterling and, to a lesser extent the Brazilian real. The Company generally attempts to minimize its currency exchange risk by seeking international contracts payable in local currency in amounts equal to the Company’s estimated operating costs payable in local currency and in U.S. dollars for the balance of the contract. Because of this strategy, the Company has not experienced significant transaction gains or losses associated with changes in currency exchange rates and does not anticipate such exposure to be material in the future. In 2005, 2006 and 2007, the Company had, net of income taxes, a loss of approximately $527,000, a gain of $1,531,000 and a gain of approximately $2,184,000, respectively. The U.K. intercompany balances were converted to an intercompany loan at the end of September 2006. The gains in 2006 and 2007 were primarily due to large intercompany receivable balances due to the Company from its U.K. subsidiary, payments on the intercompany loans recorded at the historical rate, as well as the strengthening of the British pound sterling compared to the U.S. dollar. There is no assurance that the Company will be able to protect itself against such fluctuations in the future. Historically, the Company has not conducted business in countries that limit repatriation of earnings. However, as the Company expands its international operations, it may begin operating in countries that have such limitations. Further, there can be no assurance that the countries in which the Company currently operates will not adopt policies limiting repatriation of earnings in the future. The Company also has significant investments in countries other than the United States, principally its manufacturing operations in Aberdeen, Scotland and, to a lesser extent, Singapore, Brazil and Norway. The functional currency of these foreign operations is the local
26
currency except for Singapore, where the U.S. dollar is used. Financial statement assets and liabilities are translated at the end of the period exchange rates. Resulting translation adjustments are reflected as a separate component of stockholders’ equity and have no current effect on earnings or cash flow.
Critical Accounting Policies
The Company’s discussion and analysis of its financial condition and results of operations are based on the Company’s consolidated financial statements, which have been prepared in accordance with generally accepted accounting principles in the United States of America. The preparation of the consolidated financial statements requires the Company 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 consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. There can be no assurance that actual results will not differ from those estimates. The Company believes the following accounting policies affect its more significant judgments and estimates used in preparation of its consolidated financial statements.
Revenue Recognition. For the majority of the Company’s sales, revenue is recorded at the time the manufacturing process is complete and the products have been shipped to the consumer. For these sales, ownership is transferred to the customer at the time of shipment. Service revenues are recorded at the time the service is rendered. The Company uses the percentage-of-completion method on long-term project contracts. Long-term project contracts have the following characteristics:
| • | The contracts call for products which are designed to customer specifications; |
| • | The structural design is unique and requires significant engineering and manufacturing efforts generally requiring more than one year in duration; |
| • | The contracts contain specific terms as to milestones, progress billings and delivery dates; |
| • | Product requirements cannot be filled directly from the Company’s standard inventory. |
For each project, the Company prepares a detailed analysis of estimated costs, profit margin, completion date and risk factors that include availability of material, production efficiencies and other factors that may impact the project. On a quarterly basis, management reviews the progress of each contract, which may result in revisions of previous estimates, including revenue recognition. Historically, the Company’s estimates of total costs and costs to complete have approximated actual costs incurred to complete the project. However, there are many factors that may impact future estimates as discussed under “Item 1A. Risk Factors”.
Under the percentage-of-completion method revenue is recognized based on the percentage of costs incurred to date compared to total cost to complete. Losses, if any, are recorded in full in the period they become evident.
Under the percentage-of-completion method, billings do not always correlate directly to the revenue recognized. Based upon the terms of the specific contract, billings may be in excess of the revenue recognized, in which case the amounts are included in customer prepayments as a liability on the Consolidated Balance Sheets. Likewise, revenue recognized may exceed customer billings in which case the amounts are reported in trade receivables. Unbilled revenues are expected to be billed and collected within the following year. At December 31, 2007 and 2006, trade receivables included $18,129,000 and $12,925,000 of unbilled receivables, respectively. During 2007, 16 projects representing approximately 19% of the Company’s revenue were accounted for using percentage-of-completion accounting.
Inventories. Inventory costs are determined principally by the use of the first-in, first-out (FIFO) costing method, and are stated at the lower of cost or market. Inventory is valued principally using standard costs which are calculated based upon direct costs incurred and overhead allocations. Periodically, obsolescence reviews are performed on slow-moving inventories and reserves are established based on current assessments about future demands and market conditions. The inventory values have been reduced by a reserve for excess and obsolete inventories. Inventory reserves of $16.9 million and $19.2 million were recorded as of December 31, 2006 and
27
2007, respectively. If market conditions are less favorable than those projected by management, additional inventory reserves may be required.
Contingent liabilities. We establish reserves for estimated loss contingencies when we believe a loss is probable and the amount of the loss can be reasonably estimated. Revisions to contingent liabilities are reflected in income in the period in which different facts or information become known or circumstances change that affect our previous assumptions with respect to the likelihood or amount of loss. Reserves for contingent liabilities are based upon our assumptions and estimates regarding the probable outcome of the matter. Should the outcome differ from our assumptions and estimates, revisions to the estimated reserves for contingent liabilities would be required.
Off-Balance Sheet Arrangements
The Company has no derivative instruments and no off-balance sheet hedging or financing arrangements or contracts or operations that rely upon credit or similar ratings.
New Accounting Standards
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (SFAS 141(R)). SFAS 141(R) replaces Statement No. 141, “Business Combinations”. The statement retains the purchase method of accounting used in business combinations but replaces SFAS 141 by establishing principles and requirements for the recognition and measurement of assets, liabilities and goodwill including the requirement that most transaction costs and restructuring costs be expensed. In addition, the statement requires disclosures to enable users to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. We will adopt SFAS 141(R) on January 1, 2009 for acquisitions on or after this date.
In December 2007, the FASB issued FASB 160 “Noncontrolling Interest in Consolidated Financial Statements—an amendment to ARB No. 51” (“SFAS No. 160”) which establishes accounting and reporting standards for noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The provision of SFAS No. 160 are effective for fiscal years beginning after December 15, 2008. The Company does not believe the provisions pf this statement will materially effect the results of operations.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115” (SFAS 159). SFAS 159 permits entities to choose to measure eligible financial assets and liabilities at fair value. Unrealized gains and loses on items for which the fair value option has been elected are reported in earnings. SFAS is effective for years beginning after November 15, 2007. We adopted SFAS 159 on January 1, 2008 and did not elect to apply the fair value method to any eligible assets or liabilities at that time.
The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109” (“FIN 48”), on January 1, 2007. FIN 48 was issued in June 2006 and prescribes that the Company recognize in its financial statements the impact of a tax position that is more likely than not to be sustained upon examination based upon the technical merits of the position, including resolution of any appeals. The interpretation provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
Based on our evaluation, we have concluded that there are no significant uncertain tax positions requiring recognition in our financial statements. Our evaluation was performed for the tax years which remain subject to examination by major tax jurisdictions as of December 31, 2007, which are the years ended December 31, 2001, through 2007.
28
We may from time to time be assessed interest or penalties by major tax jurisdictions, although any such assessments historically have been minimal and immaterial to our financial results.
In September 2006, the Financial Accounting Standards Board issued FASB Statement No. 157, “Fair Value Measurements” (or SFAS 157), which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures under fair value measurements. SFAS 157 applies to other accounting pronouncements that require or permit fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. However, on February 12, 2008, the FASB issued FSP FAS 157-2 which would delay the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). This FSP partially defers the effective date of Statement 157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of this FSP. Effective for 2008, we will adopt SFAS 157 except as it applies to those nonfinancial assets and nonfinancial liabilities as noted in FSP FAS 157-2. We are currently evaluating the potential impact on our financial statements, if any, upon adoption of this standard.
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
The Company is currently exposed to certain market risks related to interest rate changes and fluctuations in foreign exchange rates. The Company does not engage in any material hedging transactions, forward contracts or currency trading which could mitigate the market risks inherent in such transactions.
Foreign Exchange Rate Risk
Through its subsidiaries, the Company conducts a portion of its business in currencies other than the United States dollar, principally the British pound sterling and to a lesser extent, the Brazilian real. The Company has not experienced significant transaction gains or losses associated with changes in currency exchange rates and does not anticipate such exposure to be material in the future. However, there is no assurance that the Company will be able to protect itself against currency fluctuations in the future. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Currency Risk” in Item 7 of this report.
The Company uses a sensitivity analysis model to measure the impact on revenue and net income of a 10% adverse movement of foreign currency exchange rates against the U.S. dollar over the previous year. Based upon this model, a 10% decrease would result in a decrease in revenues of approximately $22.1 million and a decrease in net income of approximately $7.1 million over this period. There can be no assurance that the exchange rate decrease projected above will materialize as fluctuations in exchange rates are beyond the Company’s control.
Interest Rate Risk
As described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources,” the Company has two credit facilities or loans that require the Company to pay interest at a floating rate. These floating-rate obligations expose the Company to the risk of increased interest expense in the event of increases in the short-term interest rates. Based upon the December 31, 2007 balance of approximately $2.7 million related to these floating rate obligations, each 1.0% rise in interest rates would result in additional annual interest expense to the Company of approximately $27,000, or $6,750 per quarter.
| Item 8. | Financial Statements and Supplementary Data |
29
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, the company’s principal executive and principal financial officers and effected by the company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America and includes those policies and procedures that:
| • | pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company; |
| • | provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and |
| • | provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements. |
Management has designed its internal control over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements in accordance with accounting principles generally accepted in the United States of America. Management’s assessment included review and testing of both the design effectiveness and operating effectiveness of controls over all relevant assertions related to all significant accounts and disclosures in the financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of our management, including our principal executive officers and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control—Integrated Framework, our management has concluded that our internal control over financial reporting was effective as of December 31, 2007.
BDO Seidman, LLP, the independent registered public accounting firm, which audited the financial statements included in the annual report, has also issued an attestation on our internal control over financial reporting, and their report is set forth on page 31.
30
Report of Independent Registered Public Accounting Firm
Board of Directors and Shareholders
Dril-Quip, Inc.
Houston, Texas
We have audited Dril-Quip, Inc.’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Dril-Quip, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying “Item 9A. Management’s Annual Report on Internal Control Over Financial Reporting”. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Dril-Quip, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2007, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Dril-Quip, Inc. as of December 31, 2007 and 2006, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007 and our report dated February 28, 2008 expressed an unqualified opinion thereon.
/s/ BDO Seidman, LLP
Houston, Texas
February 28, 2008
31
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Dril-Quip, Inc.
Houston, Texas
We have audited the accompanying consolidated balance sheets of Dril-Quip, Inc. as of December 31, 2007 and 2006 and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2007. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Dril-Quip, Inc. at December 31, 2007 and 2006, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2007, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 2 to the consolidated financials statements, the Company adopted Statement of Financial Accounting Standards No. 123 (R), “Share-Based Payment” effective January 1, 2006.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Dril-Quip, Inc.’s internal control over financial reporting as of December 31, 2007, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 28, 2008, expressed an unqualified opinion thereon.
/s/ BDO Seidman, LLP
Houston, Texas
February 28, 2008
32
CONSOLIDATED STATEMENTS OF INCOME
| Year Ended December 31, | ||||||||||||
| 2005 | 2006 | 2007 | ||||||||||
| (In thousands, except per share data) | ||||||||||||
| Revenues |
$ | 340,829 | $ | 442,742 | $ | 495,557 | ||||||
| Cost and expenses: |
||||||||||||
| Cost of sales |
229,849 | 256,688 | 285,281 | |||||||||
| Selling, general and administrative |
40,916 | 44,085 | 49,313 | |||||||||
| Engineering and product development |
20,867 | 19,559 | 22,578 | |||||||||
| 291,632 | 320,332 | 357,172 | ||||||||||
| Operating income |
49,197 | 122,410 | 138,385 | |||||||||
| Interest income |
258 | 3,632 | 8,275 | |||||||||
| Interest expense |
(2,045 | ) | (669 | ) | (370 | ) | ||||||
| Income before income taxes |
47,410 | 125,373 | 146,290 | |||||||||
| Income tax provision |
14,843 | 38,482 | 38,349 | |||||||||
| Net income |
$ | 32,567 | $ | 86,891 | $ | 107,941 | ||||||
| Earnings per common share: |
||||||||||||
| Basic |
$ | 0.92 | $ | 2.21 | $ | 2.67 | ||||||
| Diluted |
$ | 0.90 | $ | 2.15 | $ | 2.63 | ||||||
| Weighted average common shares outstanding: |
||||||||||||
| Basic |
35,276 | 39,340 | 40,447 | |||||||||
| Diluted |
36,206 | 40,342 | 41,007 | |||||||||
The accompanying notes are an integral part of these statements.
33
CONSOLIDATED BALANCE SHEETS
| December 31, | ||||||
| 2006 | 2007 | |||||
| (In thousands) | ||||||
| ASSETS | ||||||
| Current assets: |
||||||
| Cash and cash equivalents |
$ | 135,429 | $ | 201,732 | ||
| Trade receivables, net |
144,820 | 142,064 | ||||
| Inventories, net |
162,503 | 183,031 | ||||
| Deferred income taxes |
15,424 | 16,303 | ||||
| Prepaids and other current assets |
6,879 | 9,468 | ||||
| Total current assets |
465,055 | 552,598 | ||||
| Property, plant and equipment, net |
129,340 | 141,646 | ||||
| Other assets |
540 | 5,578 | ||||
| Total assets |
$ | 594,935 | $ | 699,822 | ||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||
| Current liabilities: |
||||||
| Accounts payable |
$ | 38,572 | $ | 27,078 | ||
| Current maturities of long-term debt |
844 | 857 | ||||
| Accrued income taxes |
15,760 | 7,057 | ||||
| Customer prepayments |
39,387 | 38,324 | ||||
| Accrued compensation |
9,916 | 10,451 | ||||
| Other accrued liabilities |
13,326 | 14,639 | ||||
| Total current liabilities |
117,805 | 98,406 | ||||
| Long-term debt |
2,876 | 2,054 | ||||
| Deferred income taxes |
6,757 | 6,867 | ||||
| Total liabilities |
127,438 | 107,327 | ||||
| Commitments and contingencies (Notes 8 and 9) |
||||||
| Stockholders’ equity: |
||||||
| Preferred stock: 10,000,000 shares authorized at $0.01 par value (none issued) |
— | — | ||||
| Common stock: |
||||||
| 50,000,000 shares authorized at $0.01 par value, 40,357,656 and 40,793,713 issued and outstanding at December 31, 2006 and 2007, respectively |
404 | 408 | ||||
| Additional paid-in capital |
192,086 | 205,835 | ||||
| Retained earnings |
264,620 | 372,561 | ||||
| Foreign currency translation adjustment |
10,387 | 13,691 | ||||
| Total stockholders’ equity |
467,497 | 592,495 | ||||
| Total liabilities and stockholders’ equity |
$ | 594,935 | $ | 699,822 | ||
The accompanying notes are an integral part of these statements.
34
CONSOLIDATED STATEMENTS OF CASH FLOWS
| Year Ended December 31, | ||||||||||||
| 2005 | 2006 | 2007 | ||||||||||
| (In thousands) | ||||||||||||
| Operating activities |
||||||||||||
| Net income |
$ | 32,567 | $ | 86,891 | $ | 107,941 | ||||||
| Adjustments to reconcile net income to net cash provided by (used in) operating activities: |
||||||||||||
| Depreciation and amortization |
13,426 | 15,087 | 15,653 | |||||||||
| Stock-based compensation expense |
— | 1,803 | 2,286 | |||||||||
| Gain on sale of equipment |
(74 | ) | (377 | ) | (253 | ) | ||||||
| Deferred income taxes |
(3,542 | ) | (4,614 | ) | (666 | ) | ||||||
| Changes in operating assets and liabilities: |
||||||||||||
| Trade receivables, net |
(48,466 | ) | (29,028 | ) | 4,990 | |||||||
| Inventories, net |
(48,789 | ) | 1,338 | (18,172 | ) | |||||||
| Prepaids and other assets |
(2,029 | ) | (1,087 | ) | (7,428 | ) | ||||||
| Excess tax benefits of stock option exercises |
— | (17,993 | ) | (6,271 | ) | |||||||
| Trade accounts payable and accrued expenses |
40,018 | 41,462 | (15,417 | ) | ||||||||
| Net cash provided by (used in) operating activities |
(16,889 | ) | 93,482 | 82,663 | ||||||||
| Investing activities |
||||||||||||
| Purchase of property, plant, and equipment |
(20,557 | ) | (24,133 | ) | (25,208 | ) | ||||||
| Proceeds from sale of equipment |
1,351 | 843 | 354 | |||||||||
| Net cash used in investing activities |
(19,206 | ) | (23,290 | ) | (24,854 | ) | ||||||
| Financing activities |
||||||||||||
| Proceeds from revolving line of credit and long-term borrowings |
160 | 206 | — | |||||||||
| Principal payments on long-term debt |
(24,901 | ) | (797 | ) | (875 | ) | ||||||
| Proceeds from offering, net |
74,230 | — | — | |||||||||
| Proceeds from exercise of stock options |
10,693 | 19,449 | 4,764 | |||||||||
| Excess tax benefits—stock options |
2,779 | 17,993 | 6,271 | |||||||||
| Net cash provided by financing activities |
62,961 | 36,851 | 10,160 | |||||||||
| Effect of exchange rate changes on cash activities |
737 | (4,376 | ) | (1,666 | ) | |||||||
| Increase in cash and cash equivalents |
27,603 | 102,667 | 66,303 | |||||||||
| Cash and cash equivalents at beginning of year |
5,159 | 32,762 | 135,429 | |||||||||
| Cash and cash equivalents at end of year |
$ | 32,762 | $ | 135,429 | $ | 201,732 | ||||||
The accompanying notes are an integral part of these statements.
35
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
| Common Stock |
Additional Paid-In Capital |
Retained Earnings |
Foreign Currency Translation Adjustment |
Total | |||||||||||||
| (In thousands) | |||||||||||||||||
| Balance at December 31, 2004 |
$ | 345 | $ | 64,717 | $ | 145,162 | $ | 6,139 | $ | 216,363 | |||||||
| Translation adjustment |
— | — | — | (7,170 | ) | (7,170 | ) | ||||||||||
| Net income |
— | — | 32,567 | — | 32,567 | ||||||||||||
| Comprehensive income |
— | — | — | — | 25,397 | ||||||||||||
| Offering; 3,000,000 common shares, net of offering expenses of $650,000 |
30 | 74,200 | — | — | 74,230 | ||||||||||||
| Options exercised |
10 | 10,683 | — | — | 10,693 | ||||||||||||
| Excess tax benefits—options |
— | 2,779 | — | — | 2,779 | ||||||||||||
| Balance at December 31, 2005 |
385 | 152,379 | 177,729 | (1,031 | ) | 329,462 | |||||||||||
| Translation adjustment |
— | — | — | 11,418 | 11,418 | ||||||||||||
| Net income |
— | — | 86,891 | — | 86,891 | ||||||||||||
| Comprehensive income |
— | — | — | — | 98,309 | ||||||||||||
| Options exercised |
19 | 19,430 | — | — | 19,449 | ||||||||||||
| Stock-based compensation |
— | 1,803 | — | — | 1,803 | ||||||||||||
| Excess tax benefits—options |
— | 18,474 | — | — | 18,474 | ||||||||||||
| Balance at December 31, 2006 |
404 | 192,086 | 264,620 | 10,387 | 467,497 | ||||||||||||
| Translation adjustment |
— | — | — | 3,304 | 3,304 | ||||||||||||
| Net income |
— | — | 107,941 | — | 107,941 | ||||||||||||
| Comprehensive income |
— | — | — | — | 111,245 | ||||||||||||
| Options exercised |
4 | 4,760 | — | — | 4,764 | ||||||||||||
| Stock-based compensation |
— | 2,286 | — | — | 2,286 | ||||||||||||
| Excess tax benefits—options |
— | 6,703 | — | — | 6,703 | ||||||||||||
| Balance at December 31, 2007 |
$ | 408 | $ | 205,835 | $ | 372,561 | $ | 13,691 | $ | 592,495 | |||||||
The accompanying notes are an integral part of these statements.
36
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization
Dril-Quip, Inc., a Delaware corporation (the “Company” or “Dril-Quip”), designs, manufactures, sells and services highly engineered offshore drilling and production equipment that is well suited for use in deepwater, harsh environment and severe service applications. The Company’s principal products consist of subsea and surface wellheads, subsea and surface production trees, subsea control systems and manifolds, mudline hanger systems, specialty connectors and associated pipe, drilling and production riser systems, liner hangers, wellhead connectors and diverters. Dril-Quip’s products are used by major integrated, large independent and foreign national oil and gas companies in offshore areas throughout the world. Dril-Quip also provides installation and reconditioning services and rents running tools for use in connection with the installation and retrieval of its products.
The Company’s operations are organized into three geographic segments—Western Hemisphere (including North and South America; headquartered in Houston, Texas), Eastern Hemisphere (including Europe and Africa; headquartered in Aberdeen, Scotland) and Asia-Pacific (including the Pacific Rim, Southeast Asia, Australia, India and the Middle East; headquartered in Singapore). Each of these segments sells similar products and services and the Company has major manufacturing facilities in all three of its headquarter locations. The Company’s major subsidiaries are Dril-Quip (Europe) Limited (DQE), located in Aberdeen with branches in Denmark, Norway and Holland; Dril-Quip Asia Pacific PTE Ltd. (DQAP), located in Singapore; and Dril-Quip do Brasil LTDA (DQB), located in Macae, Brazil. Dril-Quip (Nigeria) Ltd. is located in Port Harcourt, Nigeria, and Dril-Quip Egypt for Petroleum Services S.A.E. is located in Alexandria, Egypt. Both are wholly owned subsidiaries of DQE.
2. Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. All material intercompany accounts and transactions have been eliminated.
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 reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Some of the Company’s more significant estimates are those affected by critical accounting policies for revenue recognition, inventories and contingent liabilities.
Cash and cash equivalents
Short-term investments that have a maturity of three months or less from the date of purchase are classified as cash equivalents. The Company invests excess cash in mutual funds rated as the highest quality by nationally recognized rating agencies. The funds primarily invest in short-term money market instruments that blend top-tier, high quality U.S. dollar denominated obligations, which include commercial paper, certificates of deposit, master and promissory notes, municipal securities and repurchase agreements. The Company’s investment objectives include the provision of a high level of current income consistent with the preservation of capital and the maintenance of liquidity.
37
Trade Receivables
The Company maintains an allowance for doubtful accounts on trade receivables equal to amounts estimated to be uncollectible. This estimate is based upon historical collection experience combined with a specific review of each customer’s outstanding trade receivable balance. Management believes that the allowance for doubtful accounts is adequate, however, actual write-offs may exceed the recorded allowance. The following is a summary of activity relating to the allowance for doubtful accounts for the years ended December 31, 2005, 2006 and 2007:
| In thousands | ||||
| Balance at December 31, 2004 |
$ | 2,735 | ||
| Charges to costs and expenses |
890 | |||
| Recoveries |
(1,752 | ) | ||
| Balance at December 31, 2005 |
1,873 | |||
| Charges to costs and expenses |
1,306 | |||
| Recoveries |
(507 | ) | ||
| Balance at December 31, 2006 |
2,672 | |||
| Charges to costs and expenses |
978 | |||
| Recoveries |
(1,338 | ) | ||
| Balance at December 31, 2007 |
$ | 2,312 | ||
Inventories
Inventory costs are determined principally by the use of the first-in, first-out (FIFO) costing method, and are stated at the lower of cost or market. Inventory is valued principally using standard costs, which are calculated based upon direct costs incurred and overhead allocations. Periodically, obsolescence reviews are performed on slow-moving inventories and reserves are established based on current assessments about future demands and market conditions. The inventory values have been reduced by a reserve for excess and obsolete inventories. Inventory reserves of $16.9 million and $19.2 million were recorded as of December 31, 2006 and 2007, respectively. If market conditions are less favorable than those projected by management, additional inventory reserves may be required.
Property, Plant, and Equipment
Property, plant and equipment are carried at cost, with depreciation provided on a straight-line basis over their estimated useful lives.
Impairment of Long-Lived Assets
Long-lived assets including property, plant and equipment, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the carrying amount of an asset exceeds the estimated undiscounted future cash flows expected to be generated by the asset, an impairment charge is recognized. No impairment of long-lived assets existed at December 31, 2006 or 2007.
Income Taxes
The Company accounts for income taxes using the asset and liability method. Current income taxes are provided on income reported for financial statement purposes, adjusted for transactions that do not enter into the computation of income taxes payable in the same year. Deferred tax assets and liabilities are measured using enacted tax rates for the expected future tax consequences of temporary differences between the carrying amounts and the tax basis of assets and liabilities.
38
Revenue Recognition
For the majority of the Company’s sales, revenue is recorded at the time the manufacturing process is complete and the products have been shipped to the consumer. For these sales, ownership is transferred to the customer at the time of shipment. Service revenues are recorded at the time the service is rendered. The Company uses the percentage-of-completion method on long-term project contracts. Long-term project contracts have the following characteristics:
| • | The contracts call for products which are designed to customer specifications; |
| • | The structural design is unique and requires significant engineering and manufacturing efforts generally requiring more than one year in duration; |
| • | The contracts contain specific terms as to milestones, progress billings and delivery dates; |
| • | Product requirement cannot be filled directly from the Company’s standard inventory. |
For each project, the Company prepares a detailed analysis of estimated costs, profit margin, completion date and risk factors which include availability of material, production efficiencies and other factors that may impact the project. On a quarterly basis, management reviews the progress of each contract, which may result in revisions of previous estimates, including revenue recognition. Historically, the Company’s estimates of total costs and costs to complete have approximated actual costs incurred to complete the project. However, there are many factors that may impact future estimates as discussed under “Item 1A. Risk Factors”.
Under the percentage-of-completion method revenue is recognized based on the percentage of costs incurred to date compared to total cost to complete. Losses, if any, are recorded in full in the period they become evident.
Under the percentage-of-completion method, billings do not always correlate directly to the revenue recognized. Based upon the terms of the specific contract, billings may be in excess of the revenue recognized, in which case the amounts are included in customer prepayments as a liability on the Consolidated Balance Sheets. Likewise, revenue recognized may exceed customer billings in which case the amounts are reported in trade receivables. Unbilled revenues are expected to be billed and collected within the following year. At December 31, 2007 and 2006, trade receivables included $18,129,000 and $12,925,000 of unbilled receivables, respectively. During 2007, 16 projects representing approximately 19% of the Company’s revenue were accounted for using percentage-of-completion accounting.
Foreign Currency
The financial statements of foreign subsidiaries are translated into U.S. dollars at period end exchange rates except for revenues and expenses, which are translated at average monthly rates. Translation adjustments are reflected as a separate component of stockholders’ equity and have no current effect on earnings or cash flows. These adjustments amounted to a loss of $7,170,000, a gain of $11,418,000 and a gain of $3,304,000 in 2005, 2006 and 2007, respectively.
Foreign currency exchange transactions are recorded using the exchange rate at the date of the settlement. Exchange gains (losses) were approximately ($527,000) in 2005, $1,531,000 in 2006, and $2,184,000 in 2007, net of income taxes. These amounts are included in selling, general and administrative costs in the consolidated statements of income.
Stock-Based Compensation
Effective January 1, 2006, the Company adopted SFAS No. 123 (Revised 2004), “Share-Based Payment” (“SFAS 123(R)”) using the modified prospective transition method and accordingly, no prior periods have been restated. The Company is recognizing compensation expense for the unvested portion of awards outstanding at January 1, 2006 ratably over the remaining vesting period based on the fair value at the date of the grant. The fair value of the options was estimated using the Black-Scholes option pricing model.
39
Prior to adopting SFAS 123(R), the Company accounted for stock-based employee compensation arrangements in accordance with the provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”) and complied with the disclosure provisions of SFAS No. 123, “Accounting for Stock-Based Compensation.” Under APB No. 25, compensation expense was based on the difference, if any, on the date of the grant, between the fair value of the Company’s common stock and the exercise price of the option. No stock-based employee compensation cost was recognized in the Company’s consolidated financial statements for the years ended December 31, 2005, as all options previously granted had an exercise price equal to the market value of the underlying common stock on the date of the grant.
Had compensation cost for the Company’s stock-based compensation plans been determined based on the fair value at the grant dates for awards consistent with the method available under SFAS No. 123, the Company’s net income and earnings per share for the years ended December 31, 2005 would have been reduced to the pro forma amounts listed below:
| Year ended December 31, 2005 |
||||
| (In thousands) | ||||
| Net Income |
||||
| As reported |
$ | 32,567 | ||
| Less: Compensation expense per SFAS No. 123, net of tax |
(1,523 | ) | ||
| Pro forma net income |
$ | 31,044 | ||
| Earnings per share |
||||
| As reported |
||||
| Basic |
$ | 0.92 | ||
| Diluted |
$ | 0.90 | ||
| Pro forma |
||||
| Basic |
$ | 0.88 | ||
| Diluted |
$ | 0.86 | ||
As a result of adopting SFAS 123(R), stock-based compensation expense recognized as selling, general and administrative expense in the accompanying consolidated statement of income during the years ended December 31, 2006 and 2007 totaled $1.8 million and $2.3 million, respectively. No stock-based compensation was capitalized during those years.
While the options granted to employees vest over four years, the Company recognizes compensation expense on a straight line basis over the vesting period of the options. At December 31, 2007, there was $10.3 million of total unrecognized compensation expense related to nonvested stock option awards. This expense is expected to be recognized over a weighted average of 2.2 years.
Fair Value of Financial Instruments
The Company’s financial instruments consist primarily of cash and cash equivalents, receivables, payables, and debt instruments. The carrying values of these financial instruments approximate their respective fair values as they are either short-term in nature or carry interest rates that approximate market rates.
Concentration of Credit Risk
Financial instruments which subject the Company to concentrations of credit risk include primarily trade receivables. The Company grants credit to its customers, which operate primarily in the oil and gas industry. The Company performs periodic credit evaluations of its customers’ financial condition and generally does not
40
require collateral. The Company maintains reserves for potential losses, and such losses have historically been within management’s expectations.
In addition, the Company invests excess cash in mutual funds. These money market funds, rated as the highest quality by nationally recognized rating agencies, are not insured or guaranteed by any governmental agency. Changes in the financial markets, including changes in interest rates, as well as changes in the performance of the issuers could affect the market value of our short-term investments.
Comprehensive Income
SFAS No. 130 “Reporting Comprehensive Income.” establishes the rules for the reporting and display of comprehensive income and its components. SFAS No. 130 requires the Company to include unrealized gains or losses on foreign currency translation adjustments in comprehensive income. Generally, gains are attributed to a weakening U.S. dollar and losses are the result of a strengthening U.S. dollar.
Interest Capitalization
The Company capitalizes interest on significant construction projects for which interest costs are being incurred. These projects principally consist of construction or expansion of the Company’s facilities. No interest was capitalized in 2005, 2006 or 2007.
Earnings Per Share
Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the year. Diluted earnings per share is computed considering the dilutive effect of stock options using the treasury stock method.
New Accounting Standards
In December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business Combinations” (SFAS 141(R)). SFAS 141(R) replaces Statement No. 141, “Business Combinations”. The statement retains the purchase method of accounting used in business combinations but replaces SFAS 141 by establishing principles and requirements for the recognition and measurement of assets, liabilities and goodwill including the requirement that most transaction costs and restructuring costs be expensed. In addition, the statement requires disclosures to enable users to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. We will adopt SFAS 141(R) on January 1, 2009 for acquisitions on or after this date.
In December 2007, the FASB issued FASB 160, “Noncontrolling Interest in Consolidated Financial Statements—an amendment to ARB No. 51” (“SFAS No. 160”), which establishes accounting and reporting standards for noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. The provision of SFAS No. 160 are effective for fiscal years beginning after December 15, 2008. The Company does not believe the provisions of this statement will materially effect the results of operations.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities—Including an amendment of FASB Statement No. 115” (SFAS 159). SFAS 159 permits entities to choose to measure eligible financial assets and liabilities at fair value. Unrealized gains and loses on items for which the fair value option has been elected are reported in earnings. SFAS is effective for years beginning after November 15, 2007. We adopted SFAS 159 on January 1, 2008 and did not elect to apply the fair value method to any eligible assets or liabilities at that time.
41
The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109” (“FIN 48”), on January 1, 2007. FIN 48 was issued in June 2006 and prescribes that the Company recognize in its financial statements the impact of a tax position that is more likely than not to be sustained upon examination based upon the technical merits of the position, including resolution of any appeals. The interpretation provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition.
Based on our evaluation, we have concluded that there are no significant uncertain tax positions requiring recognition in our financial statements. Our evaluation was performed for the tax years which remain subject to examination by major tax jurisdictions as of December 31, 2007, which are the years ended December 31, 2001 through 2007.
The Company has occasionally been assessed interest or penalties by major tax jurisdictions and these assessments historically have been minimal and immaterial to our financial results. In accordance with our accounting policy, both before and after adoption of FIN 48, interest expense assessed by tax jurisdictions is included with interest expense and assessed penalties are included in selling, general and administrative expenses.
In September 2006, the Financial Accounting Standards Board issued FASB Statement No. 157, “Fair Value Measurements” (or SFAS 157), which defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures under fair value measurements. SFAS 157 applies to other accounting pronouncements that require or permit fair value measurements. SFAS 157 is effective for fiscal years beginning after November 15, 2007. However, on February 12, 2008, the FASB issued FSP FAS 157-2 which would delay the effective date of SFAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). This FSP partially defers the effective date of Statement 157 to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years for items within the scope of this FSP. Effective for 2008, we will adopt SFAS 157 except as it applies to those nonfinancial assets and nonfinancial liabilities as noted in FSP FAS 157-2. We are currently evaluating the potential impact on our financial statements, if any, upon adoption of this standard.
3. Inventories
Inventories consist of the following:
| December 31, | ||||||||
| 2006 | 2007 | |||||||
| (In thousands) | ||||||||
| Raw materials and supplies |
$ | 40,861 | $ | 42,138 | ||||
| Work in progress |
35,624 | 47,327 | ||||||
| Finished goods |
102,891 | 112,793 | ||||||
| 179,376 | 202,258 | |||||||
| Less: allowance for obsolete and excess inventory |
(16,873 | ) | (19,227 | ) | ||||
| $ | 162,503 | $ | 183,031 | |||||
Summary of allowance for obsolete and excess inventory:
| In thousands | ||||
| Balance at December 31, 2004 |
$ | 9,860 | ||
| Charges to costs and expenses |
6,272 | |||
| Write-offs of obsolete inventory |
(481 | ) | ||
| Balance at December 31, 2005 |
15,651 | |||
| Charges to costs and expenses |
2,226 | |||
| Write-offs of obsolete inventory |
(1,004 | ) | ||
| Balance at December 31, 2006 |
16,873 | |||
| Charges to costs and expenses |
2,648 | |||
| Write-offs of obsolete inventory |
(294 | ) | ||
| Balance at December 31, 2007 |
$ | 19,227 | ||
42
4. Property, Plant and Equipment
Property, plant and equipment consists of:
| Estimated Useful Lives |
December 31, | |||||||||
| 2006 | 2007 | |||||||||
| (In thousands) | ||||||||||
| Land and improvements |
10-25 years | $ | 21,543 | $ | 21,891 | |||||
| Buildings |
15-40 years | 61,319 | 72,239 | |||||||
| Machinery and equipment |
3-10 years | 162,167 | 178,798 | |||||||
| 245,029 | 272,928 | |||||||||
| Less accumulated depreciation |
(115,689 | ) | (131,282 | ) | ||||||
| $ | 129,340 | $ | 141,646 | |||||||
5. Long-Term Debt
Long-term debt consists of the following:
| December 31, | ||||||||
| 2006 | 2007 | |||||||
| (In thousands) | ||||||||
| Bank Financing |
$ | 3,397 | $ | 2,653 | ||||
| Equipment financing agreements |
323 | 258 | ||||||
| 3,720 | 2,911 | |||||||
| Less current portion |
(844 | ) | (857 | ) | ||||
| $ | 2,876 | $ | 2,054 | |||||
The Company has a credit facility with Guaranty Bank, FSB providing an unsecured revolving line of credit of up to $10 million. At the option of the Company, borrowing under this facility bears interest at either a rate equal to LIBOR (London Interbank Offered Rate) plus 1.75% or the Guaranty Bank base rate. The facility calls for quarterly interest payments and terminates June 1, 2009. The facility also contains certain covenants including maintaining minimum tangible net worth levels, not exceeding specified funded debt amounts and required interest coverage ratios. As of December 31, 2006 and 2007, the Company had no borrowings under this facility and was in compliance with all loan covenants.
Dril-Quip (Europe) Limited has a credit agreement with the Bank of Scotland dated March 21, 2001 in the original amount of U.K. Pounds Sterling 4.0 million (approximately U.S. $8 million). Borrowing under this facility bears interest at the Bank of Scotland base rate, which was 5.5% at December 31, 2007, plus 1%, and is repayable in 120 equal monthly installments, plus interest. Substantially all of this facility was used to finance capital expenditures in Norway. The outstanding balance of this facility at December 31, 2006 and 2007 was approximately U.S. $3.4 million and U.S. $2.7, respectively. The facility is secured by land and buildings in Aberdeen, Scotland and contains no restrictive financial covenants.
Interest paid on long-term debt for the years ended December 31, 2005, 2006 and 2007 was $966,000, $749,000 and $253,000 respectively. Scheduled maturities of long-term debt are as follows: 2008—$857,000; 2009—$856,000; 2010—$858,000; 2011—$309,000; 2012—$31,000; and thereafter—$0.
43
6. Income Taxes
Income before income taxes consisted of the following:
| Year ended December 31, | |||||||||
| 2005 | 2006 | 2007 | |||||||
| (In thousands) | |||||||||
| Domestic |
$ | 30,302 | $ | 61,434 | $ | 79,397 | |||
| Foreign |
17,108 | 63,939 | 66,893 | ||||||
| Total |
$ | 47,410 | $ | 125,373 | $ | 146,290 | |||
The income tax provision (benefit) consists of the following:
| Year ended December 31, | ||||||||||||
| 2005 | 2006 | 2007 | ||||||||||
| (In thousands) | ||||||||||||
| Current: |
||||||||||||
| Federal |
$ | 13,019 | $ | 24,975 | $ | 25,371 | ||||||
| Foreign |
5,333 | 18,204 | 13,747 | |||||||||
| Total current |
18,352 | 43,179 | 39,118 | |||||||||
| Deferred: |
||||||||||||
| Federal |
(3,216 | ) | (4,675 | ) | 222 | |||||||
| Foreign |
(293 | ) | (22 | ) | (991 | ) | ||||||
| Total deferred |
(3,509 | ) | (4,697 | ) | (769 | ) | ||||||
| $ | 14,843 | $ | 38,482 | $ | 38,349 | |||||||
The difference between the effective income tax rate reflected in the provision for income taxes and the U.S. federal statutory rate was as follows:
| Year ended December 31, | |||||||||
| 2005 | 2006 | 2007 | |||||||
| Federal income tax statutory rate |
35.0 | % | 35.0 | % | 35.0 | % | |||
| Foreign income tax rate differential |
(2.0 | ) | (3.3 | ) | (4.0 | ) | |||
| Foreign development tax incentive |
— | — | (3.3 | ) | |||||
| Foreign sales benefit |
(0.8 | ) | (0.2 | ) | — | ||||
| Manufacturing benefit |
(0.9 | ) | (0.2 | ) | (0.9 | ) | |||
| Other |
— | (0.6 | ) | (0.6 | ) | ||||
| Effective income tax rate |
31.3 | % | 30.7 | % | 26.2 | % | |||
44
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Based upon existing market conditions and the Company’s earnings prospects, it is anticipated that all deferred tax benefits will be realized in future years. Significant components of the Company’s deferred tax assets and liabilities are as follows:
| December 31, | ||||||||
| 2006 | 2007 | |||||||
| (In thousands) | ||||||||
| Deferred tax assets: |
||||||||
| Deferred profit on intercompany sales |
$ | 6,733 | $ | 5,023 | ||||
| Inventory |
2,946 | 2,676 | ||||||
| Inventory reserve |
2,521 | 4,039 | ||||||
| Allowance for doubtful accounts |
568 | 418 | ||||||
| Reserve for accrued liabilities |
1,026 | 684 | ||||||
| Other |
1,630 | 3,463 | ||||||
| Total deferred tax assets |
15,424 | 16,303 | ||||||
| Deferred tax liability: |
||||||||
| Property, plant and equipment |
(6,757 | ) | (6,867 | ) | ||||
| Net deferred tax asset |
$ | 8,667 | $ | 9,436 | ||||
Undistributed earnings of the Company’s foreign subsidiaries are considered to be indefinitely reinvested and, accordingly, no provision for U.S. federal income taxes has been provided thereon. Upon distribution of those earnings in the form of dividends or otherwise, the Company may be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the various foreign countries. Determination of the amount of unrecognized deferred U.S. income tax liability is not practicable.
The Company’s income tax returns are subject to review and examination by the Internal Revenue Service (“IRS”) and in October 2007, the (“IRS”) scheduled an examination of the 2005 Tax Return. We believe the return is materially correct as filed and we do not expect that the examination will have a material impact on the Company’s results of operations, financial position or cash flows.
The American Jobs Creation Act of 2004 provides for a tax deduction for qualified production activities. Under the guidance of FASB Staff Position No 109-1, Application of FASB Statement No. 109, “Accounting for Income Taxes,” to the Tax Deduction on Qualified Production Activities Provided by American Jobs Creation Act of 2004, the deduction will be treated as a “special deduction” as described in SFAS No. 109 and not as a reduction in the tax rate. As such, the special deduction has no effect on deferred tax assets and liabilities existing on the date of enactment. The Company’s production activities qualify for the tax deduction and the Company’s 2007 tax provision includes an estimated deduction of approximately $1.3 million .
The Company paid $11,438,000, $15,167,000 and $41,840,000 in income taxes in 2005, 2006 and 2007, respectively.
45
7. Other Accrued Liabilities
Other accrued liabilities consist of the following:
| December 31, | ||||||
| 2006 | 2007 | |||||
| (In thousands) | ||||||
| Payroll taxes |
$ | 2,128 | $ | 2,415 | ||
| Property, sales and other taxes |
3,502 | 2,617 | ||||
| Commissions payable |
1,978 | 2,580 | ||||
| Accrued project costs |
2,693 | 1,184 | ||||
| Accrued vendor costs |
1,510 | 2,319 | ||||
| Other |
1,515 | 3,524 | ||||
| Total |
$ | 13,326 | $ | 14,639 | ||
8. Employee Benefit Plans
The Company has a defined-contribution 401(k) plan covering domestic employees and a defined-contribution pension plan covering certain foreign employees. The Company generally makes contributions to the plans equal to each participant’s eligible contributions for the plan year up to a specified percentage of the participant’s annual compensation. The Company’s contribution expense was $1,147,000, $1,520,000 and $2,656,000 in 2005, 2006 and 2007, respectively.
9. Commitments and Contingencies
The Company leases certain office, shop and warehouse facilities, automobiles, and equipment. The Company expenses all lease payments when incurred. Total lease expense incurred was $2,340,000, $3,023,000 and $2,676,000 in 2005, 2006 and 2007, respectively. Future annual minimum lease commitments, including required leasehold improvements, at December 31, 2007 are as follows: 2008—$1,242,000; 2009—$558,000; 2010—$329,000; 2011—$18,804,000; 2012—$2,878,000; and thereafter—$2,165,000.
In August 2007, our Brazilian subsidiary was served with assessments collectively valued at approximately $12.8 million from the State of Rio de Janiero, Brazil, to collect a state tax on the importation of goods. We believe that our subsidiary is not liable for the taxes and plan to vigorously contest the assessments in the Brazilian administrative and judicial systems. At this time, the ultimate disposition of this matter cannot presently be determined and therefore, it is not possible to reasonably estimate the amount of loss or the range of possible losses that might result from an adverse judgment or settlement of these assessments. Accordingly, no liability has been accrued in conjunction with this matter. We do not expect the liability, if any, resulting from these assessments to have a material adverse effect on the Company’s operations, financial position or cash flows.
In November 2007, the Company entered into a lease agreement in Singapore for approximately 11 acres of vacant land. The lease term is 30 years and the Company elected to make a lump sum payment for the entire lease. In addition, under the terms of the lease, the Company is obligated to make certain minimum investments in machinery, leasehold improvements and buildings within the next five years.
The Company operates its business and markets its products and services in most of the significant oil and gas producing areas in the world and is, therefore, subject to the risk customarily attendant to international operations and dependency on the condition of the oil and gas industry. Additionally, products of the Company are used in potentially hazardous drilling, completion, and production applications that can cause personal injury, product liability, and environmental claims. Although exposure to such risk has not resulted in any significant problems in the past, there can be no assurance that future developments will not adversely impact the Company.
46
The Company is also involved in a number of legal actions arising in the ordinary course of business. Although no assurance can be given with respect to the ultimate outcome of such legal action, in the opinion of management, the ultimate liability with respect thereto will not have a material adverse affect on the Company’s operations, financial position or cash flows.
10. Stockholders’ Equity
The Rights Agreement between the Company and ChaseMellon Shareholder Services, L.L.C. dated as of October 17, 1997 (the “Rights Plan”) included one Right to purchase one one-hundredth of a share of Series A Junior Participating Preferred Stock for each share of common stock. On October 17, 2007, the Rights Agreement and the rights issued thereunder expired by their terms. No shares of the Series A Preferred Stock were issued or outstanding.
11. Geographic Segments
| Year ended December 31, | ||||||||||||
| 2005 | 2006 | 2007 | ||||||||||
| (In thousands) | ||||||||||||
| Revenues |
||||||||||||
| Western Hemisphere |
||||||||||||
| Products |
$ | 140,171 | $ | 185,692 | $ | 198,346 | ||||||
| Services |
28,148 | 33,309 | 38,301 | |||||||||
| Intercompany |
51,657 | 72,677 | 69,125 | |||||||||
| Total |
$ | 219,976 | $ | 291,678 | $ | 305,772 | ||||||
| Eastern Hemisphere |
||||||||||||
| Products |
$ | 113,466 | $ | 135,948 | $ | 148,223 | ||||||
| Services |
17,789 | 29,042 | 32,699 | |||||||||
| Intercompany |
2,285 | 2,955 | 6,364 | |||||||||
| Total |
$ | 133,540 | $ | 167,945 | $ | 187,286 | ||||||
| Asia-Pacific |
||||||||||||
| Products |
$ | 37,662 | $ | 50,900 | $ | 71,401 | ||||||
| Services |
3,593 | 7,851 | 6,587 | |||||||||
| Intercompany |
2,812 | 6,748 | 6,524 | |||||||||
| Total |
$ | 44,067 | $ | 65,499 | $ | 84,512 | ||||||
| Summary |
||||||||||||
| Products |
$ | 291,299 | $ | 372,540 | $ | 417,970 | ||||||
| Services |
49,530 | 70,202 | 77,587 | |||||||||
| Intercompany |
56,754 | 82,380 | 82,013 | |||||||||
| Eliminations |
(56,754 | ) | (82,380 | ) | (82,013 | ) | ||||||
| Total |
$ | 340,829 | $ | 442,742 | $ | 495,557 | ||||||
47
| December 31, | ||||||||||||
| 2005 | 2006 | 2007 | ||||||||||
| (In thousands) | ||||||||||||
| Income (loss) before income taxes |
||||||||||||
| Western Hemisphere |
$ | 38,985 | $ | 82,490 | $ | 81,598 | ||||||
| Eastern Hemisphere |
(613 | ) | 27,774 | 31,538 | ||||||||
| Asia-Pacific |
12,566 | 24,742 | 28,093 | |||||||||
| Eliminations |
(3,528 | ) | (9,633 | ) | 5,061 | |||||||
| Total |
$ | 47,410 | $ | 125,373 | $ | 146,290 | ||||||
| Total Long-Lived Assets |
||||||||||||
| Western Hemisphere |
$ | 102,270 | $ | 110,452 | $ | 125,914 | ||||||
| Eastern Hemisphere |
27,085 | 30,782 | 29,169 | |||||||||
| Asia-Pacific |
7,728 | 10,557 | 15,496 | |||||||||
| Eliminations |
(20,037 | ) | (21,911 | ) | (23,355 | ) | ||||||
| Total |
$ | 117,046 | $ | 129,880 | $ | 147,224 | ||||||
| Total Assets |
||||||||||||
| Western Hemisphere |
$ | 264,414 | $ | 368,709 | $ | 463,528 | ||||||
| Eastern Hemisphere |
137,191 | 181,146 | 167,128 | |||||||||
| Asia-Pacific |
33,012 | 57,760 | 78,494 | |||||||||
| Eliminations |
(6,355 | ) | (12,680 | ) | (9,328 | ) | ||||||
| Total |
$ | 428,262 | $ | 594,935 | $ | 699,822 | ||||||
The Company’s operations are organized into three geographic segments—Western Hemisphere (including North and South America; headquartered in Houston, Texas), Eastern Hemisphere (including Europe and Africa; headquartered in Aberdeen, Scotland) and Asia-Pacific (including the Pacific Rim, Southeast Asia, Australia, India and the Middle East; headquartered in Singapore). Each of these segments sells similar products and services and the Company has major manufacturing facilities in all three of its headquarter locations.
Eliminations of operating profits are related to intercompany inventory transfers that are deferred until shipment is made to third party customers.
In 2007, 2006 and 2005, no single customer accounted for more than 10% of the Company’s revenues.
12. Employee Stock Option Plan and Awards
On September 19, 1997, the Company adopted the Dril-Quip, Inc. 1997 Incentive Plan (as amended, the “1997 Plan”) and the Company reserved 3,400,000 shares of Common Stock for use in connection with the 1997 Plan. During 2001, the Company reserved an additional 1,400,000 shares for use in connection with the 1997 Plan. Some options remain outstanding under the 1997 Plan, however no additional grants will be awarded under this plan. On May 13, 2004, the Company’s stockholders approved the 2004 Incentive Plan of Dril-Quip, Inc. (the “2004 Plan”), which reserved up to 2,696,294 shares of Common Stock to be used in connection with the 2004 Plan. Persons eligible for awards under the 1997 Plan and 2004 Plan are employees holding positions of responsibility with the Company or any of its subsidiaries. Options granted under the 1997 Plan and the 2004 Plan have a term of ten years and become exercisable in cumulative annual increments of one-fourth of the total number of shares of Common Stock subject thereto, beginning on the first anniversary of the date of the grant.
The fair value of stock options granted is estimated on the grant date using the Black-Scholes option pricing model. The expected life was based on the Company’s historical trends and volatility was based on the Company’s common stock historical volatility. The risk-free interest rate is based on U.S. Treasury yield curve at the grant date. The Company does not pay dividends and therefore there is no dividend yield. There were no options granted in 2005.
48
On October 27, 2006 and October 26, 2007 the Company granted options to purchase 264,435 and 256,284 shares, respectively, of common stock pursuant to the 2004 Plan to certain officers and employees. The following table presents the assumptions used in the option pricing model.
| 2006 | 2007 | |||||||
| Expected life (years) |
6.4 | 6.0 | ||||||
| Volatility |
47.8 | % | 45.8 | % | ||||
| Risk-free interest rate |
4.9 | % | 4.04 | % | ||||
| Dividend yield |
0.0 | % | 0.0 | % | ||||
| Fair value of each option |
$ | 20.92 | $ | 26.76 | ||||
Option activity for the years ended December 31, 2005, 2006 and 2007 was as follows:
| Number of Options |
Weighted Average Price |
Aggregate intrinsic value (in millions) | |||||||
| Outstanding at December 31, 2004 |
3,948,460 | $ | 10.51 | ||||||
| Exercised |
(942,200 | ) | 11.39 | $ | 8.0 | ||||
| Forfeited |
(19,374 | ) | 8.67 | ||||||
| Outstanding at December 31, 2005 |
2,986,886 | 10.24 | |||||||
| Granted |
264,435 | 38.97 | |||||||
| Exercised |
(1,813,710 | ) | 11.14 | 52.8 | |||||
| Forfeited |
(10,126 | ) | 8.21 | ||||||
| Outstanding at December 31, 2006 |
1,427,485 | 14.45 | 35.3 | ||||||
| Granted |
256,284 | 54.13 | |||||||
| Exercised |
(436,057 | ) | 9.36 | 19.9 | |||||
| Forfeited |
(11,500 | ) | 32.12 | ||||||
| Outstanding at December 31, 2007 |
1,236,212 | $ | 24.31 | $ | 38.8 | ||||
| Exercisable at December 31, |
|||||||||
| 2005 |
2,506,322 | $ | 10.63 | $ | 32.5 | ||||
| 2006 |
966,215 | $ | 9.16 | $ | 29.0 | ||||
| 2007 |
788,352 | $ | 11.05 | $ | 35.2 | ||||
The following table summarizes information about stock options outstanding and exercisable at December 31, 2007:
| Stock Options Outstanding | |||||||
| Range of Exercise Prices |
Number Outstanding |
Weighted Average Exercise Price |
Weighted Average Contractual Life | ||||
| $7.48 to $12.00 |
718,867 | $ | 8.65 | 5.03 years | |||
| $16.06 |
9,500 | $ | 16.06 | 2.82 years | |||
| $38.97 |
251,561 | $ | 38.97 | 8.82 years | |||
| $54.13 |
256,284 | $ | 54.13 | 9.82 years | |||
| 1,236,212 | $ | 24.31 | 6.78 years | ||||
| Stock Options Exercisable | |||||||
| Range of Exercise Prices |
Number Outstanding |
Weighted Average Exercise Price |
Weighted Average Contractual Life | ||||
| $7.48 to $12.00 |
718,867 | $ | 8.65 | 5.03 years | |||
| $16.06 |
9,500 | $ | 16.06 | 2.82 years | |||
| $38.97 |
59,985 | $ | 38.97 | 8.82 years | |||
| 788,352 | $ | 11.05 | 5.30 years | ||||
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The following table summarizes information for equity compensation plans in effect as of December 31, 2007:
| Number of securities to be issued upon exercise of outstanding options |
Weighted-average exercise price of outstanding options |
Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a)) | |||||
| Plan category |
(a) | (b) | (c) | ||||
| Equity compensation plans approved by stockholders |
1,236,212 | $ | 24.31 | 2,175,575 | |||
| Equity compensation plans not approved by stockholders |
0 | not applicable | 0 | ||||
| Total |
1,236,212 | $ | 24.31 | 2,175,575 | |||
13. Earnings Per Share
The following is a reconciliation of the basic and diluted earnings per share computation as required by Statement of Financial Accounting Standards No. 128, “Earnings per Share”:
| Year Ended December 31, | |||||||||
| 2005 | 2006 | 2007 | |||||||
| (In thousands, except per share amounts) | |||||||||
| Net income |
$ | 32,567 | $ | 86,891 | $ | 107,941 | |||
| Weighted average common shares outstanding |
35,276 | 39,340 | 40,447 | ||||||
| Effect of dilutive securities-options |
930 | 1,002 | 560 | ||||||
| Total shares and dilutive securities |
36,206 | 40,342 | 41,007 | ||||||
| Basic earnings per common share |
$ | 0.92 | $ | 2.21 | $ | 2.67 | |||
| Diluted earnings per common share |
$ | 0.90 | $ | 2.15 | $ | 2.63 | |||
| Weighted average number of options with an exercise price greater than average market price for the period |
0 | 264 | 306 | ||||||
14. Common Stock
In September 2006, the board of directors of the Company approved a two-for-one common stock split in the form of a stock dividend. As a result, the split was paid in the form of a stock dividend on October 5, 2006 to stockholders of record as of the close of business on September 21, 2006. The Company issued 19.9 million shares of common stock as a result of the stock split. In addition, the number of shares of common stock issuable upon the exercise of outstanding stock options and the number of shares of common stock reserved for issuance under the Company’s employee benefit plans were proportionately increased in accordance with the terms of those respective agreements and plans. The transaction reduced additional paid-in capital by $0.2 million and increased common stock by $0.2 million. All share and per share data (except par value) for all periods presented have been restated to reflect the stock split.
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15. Quarterly Results of Operations (Unaudited):
| Quarter Ended | ||||||||||||
| March 31 | June 30 | Sept. 30 | Dec. 31 | |||||||||
| (In thousands, except per share data) | ||||||||||||
| (Unaudited) | ||||||||||||
| 2006 |
||||||||||||
| Revenues |
$ | 98,198 | $ | 108,476 | $ | 117,767 | $ | 118,301 | ||||
| Cost of sales |
57,163 | 63,892 | 67,596 | 68,037 | ||||||||
| Operating income |
24,963 | 30,553 | 33,092 | 33,802 | ||||||||
| Net income |
17,319 | 21,273 | 23,412 | 24,887 | ||||||||
| Earnings per share: |
||||||||||||
| Basic(1) |
$ | 0.45 | $ | 0.54 | $ | 0.59 | $ | 0.62 | ||||
| Diluted (1) |
0.44 | 0.53 | 0.58 | 0.61 | ||||||||
| Quarter Ended | ||||||||||||
| March 31 | June 30 | Sept. 30 | Dec. 31 | |||||||||
| (In thousands, except per share data) | ||||||||||||
| (Unaudited) | ||||||||||||
| 2007 |
||||||||||||
| Revenues |
$ | 117,682 | $ | 114,701 | $ | 130,423 | $ | 132,751 | ||||
| Cost of sales |
67,750 | 64,492 | 75,895 | 77,144 | ||||||||
| Operating income |
32,708 | 32,863 | 36,747 | 36,067 | ||||||||
| Net income |
24,051 | 24,109 | 27,624 | 32,157 | ||||||||
| Earnings per share: |
||||||||||||
| Basic(1) |
$ | 0.60 | $ | 0.60 | $ | 0.68 | $ | 0.79 | ||||
| Diluted(1) |
0.59 | 0.59 | 0.67 | 0.78 | ||||||||
| (1) | The sum of the quarterly per share amounts may not equal the annual amount reported, as per share amounts are computed independently for each quarter and for the full year. |
| Item 9. | Changes in and Disagreements With Accountants on Accounting and Financial Disclosure |
None.
| Item 9A. | Controls and Procedures |
In accordance with Exchange Act Rules 13a-15 and 15d-15, the Company carried out an evaluation, under the supervision and with the participation of management, including the Company’s Co-Chief Executive Officers and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Company’s Co-Chief Executive Officers and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of December 31, 2007 to provide reasonable assurance that information required to be disclosed in the Company’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and such information is accumulated and communicated to management, including the Company’s Co-Chief Executive Officers and Chief Financial Officer, as appropriate to allow timely decisions regarding disclosure.
“Management’s Annual Report on Internal Control over Financial Reporting” appears on page 30 of this annual report on Form 10-K.
There has been no change in the Company’s internal controls over financial reporting that occurred during the three months ended December 31, 2007 that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.
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| Item 9B. | Other Information |
None.
PART III
| Item 10. | Directors, Executive Officers and Corporate Governance |
The information required by this item is set forth under the captions “Election of Directors,” “Corporate Governance Matters” and “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s definitive Proxy Statement (the “2008 Proxy Statement”) for its annual meeting of stockholders to be held on May 15, 2008, which sections are incorporated herein by reference.
Pursuant to Item 401(b) of Regulation S-K, the information required by this item with respect to executive officers of the Company is set forth in Part I of this report.
| Item 11. | Executive Compensation |
The information required by this item is set forth in the sections entitled “Director Compensation,” “Executive Compensation” and “Corporate Governance Matters” in the 2008 Proxy Statement, which sections are incorporated herein by reference.
| Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
The information required by this item is set forth in the sections entitled “Security Ownership of Certain Beneficial Owners and Management” and “Executive Compensation—Equity Compensation Plan Information” in the 2008 Proxy Statement, which sections are incorporated herein by reference.
| Item 13. | Certain Relationships and Related Transactions, and Director Independence |
The information required by this item is set forth in the section entitled “Corporate Governance Matters” in the 2008 Proxy Statement, which section is incorporated herein by reference.
| Item 14. | Principal Accountant Fees and Services |
The information required by this item is set forth in the sections entitled “Approval of Appointment of Independent Public Accounting Firm—Fees” and “—Audit Committee Pre-Approval Policy for Audit and Non-Audit Services” in the 2008 Proxy Statement, which sections are incorporated herein by reference.
PART IV
| Item 15. | Exhibits and Financial Statement Schedules |
(a)(1) Financial Statements
All financial statements of the registrant are set forth under Item 8 of this Annual Report on Form 10-K.
(a)(2) Financial Statement Schedules
All schedules and other statements are omitted because of the absence of conditions under which they are required or because the required information is presented in the financial statements or notes thereto.
(a)(3) Exhibits
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Dril-Quip will furnish any exhibit to a stockholder upon payment by the stockholder of the Company’s reasonable expenses to furnish the exhibit.
| Exhibit No. |
Description | |||
| *3.1 | — | Restated Certificate of Incorporation of the Company (Incorporated herein by reference to Exhibit 3.2 to the Company’s Registration Statement on Form S-1 (Registration No. 333-33447)). | ||
| *3.2 | — | Bylaws of the Company (Incorporated herein by reference to Exhibit 3.3 to the Company’s Registration Statement on Form S-1 (Registration No. 333-33447)). | ||
| *3.3 | — | Amended and restated Bylaws of the Company (Incorporated herein by reference to Exhibit 3.1 to the Company’s report on Form 8-K dated December 21, 2007.) | ||
| *4.1 | — | Form of certificate representing Common Stock (Incorporated herein by reference to Exhibit 4.1 the Company’s Registration Statement on Form S-1 (Registration No. 333-33447)). | ||
| *4.2 | — | Registration Rights Agreement among the Company and certain stockholders (Incorporated herein by reference to Exhibit 4.2 to the Company’s Registration Statement on Form S-1 (Registration No. 333-33447)). | ||
| *10.1.1 | — | Credit Agreement between the Company and Guaranty, FSB dated May 18, 2001 (Incorporated by reference to Exhibit 10.2 to the Company’s Report on Form 10-Q for the quarter ended June 30, 2001 (SEC File No. 001-13439)). | ||
| *10.1.2 | — | First Amendment to Credit Agreement between Dril-Quip, Inc. and Guaranty Bank, FSB effective November 19, 2001 (Incorporated herein by reference to Exhibit 4.5 to the Company’s Report on Form 10-Q for the Quarter ended June 30, 2005). | ||
| *10.1.3 | — | Second Amendment to Credit Agreement between Dril-Quip, Inc. and Guaranty Bank, FSB effective May 16, 2003 (Incorporated herein by reference to Exhibit 4.6 to the Company’s Report on Form 10-Q for the Quarter ended June 30, 2005). | ||
| *10.1.4 | — | Third Amendment to Credit Agreement between Dril-Quip, Inc. and Guaranty Bank, FSB effective June 1, 2005 (Incorporated herein by reference to Exhibit 4.7 to the Company’s Report on Form 10-Q for the Quarter ended June 30, 2005). | ||
| *10.1.5 | — | Fourth Amendment to the Credit Agreement between Dril-Quip, Inc. and Guaranty Bank, FSB effective January 26, 2007. (Incorporated herein by reference to Exhibit 10.1.5 to the Company’s Report on Form 10-K for the year ended December 31, 2006). | ||
| *10.2 | — | Credit Agreement between Dril-Quip (Europe) Limited and Bank of Scotland dated November 18, 1999 (Incorporated by reference to Exhibit 10.2 to the Company’s Report on Form 10-Q for the Quarter ended March 30, 2000 (SEC File No. 001-13439)). | ||
| *10.3 | — | Form of Employment Agreement between the Company and each of Messrs. Reimert, Smith and Walker (Incorporated herein by reference to Exhibit 10.12 to the Company’s Registration Statement on Form S-1 (Registration No. 333-33447)). | ||
| *10.4 | — | 2004 Incentive Plan of Dril-Quip, Inc. (Incorporated herein by reference to Annex II to the Company’s Proxy Statement, filed on March 22, 2004, for the annual meeting of Stockholders held on May 13, 2004 (SEC file No. 001-13439)). | ||
| **+10.5 | — | Summary of Executive Officer and Non-employee Director Compensation. | ||
| **21.1 | — | Subsidiaries of the Registrant. | ||
| **23.1 | — | Consent of BDO Seidman, LLP. | ||
| **31.1 | — | Rule 13a-14(a)/15d-14(a) Certification of Larry E. Reimert. | ||
53
| Exhibit No. |
Description | |||
| **31.2 | — | Rule 13a-14(a)/15d-14(a) Certification of Gary D. Smith. | ||
| **31.3 | — | Rule 13a-14(a)/15d-14(a) Certification of J. Mike Walker. | ||
| **31.4 | — | Rule 13a-14(a)/15d-14(a) Certification of Jerry M. Brooks. | ||
| **32.1 | — | Section 1350 Certification of Larry E. Reimert. | ||
| **32.2 | — | Section 1350 Certification of Gary D. Smith. | ||
| **32.3 | — | Section 1350 Certification of J. Mike Walker. | ||
| **32.4 | — | Section 1350 Certification of Jerry M. Brooks. | ||
| * | Incorporated herein by reference as indicated. |
| + | Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Form 10-K. |
| ** | Filed with this Report |
54
Pursuant to the requirements of Section 13 or 15(d) 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 on February 28, 2008.
| DRIL-QUIP, INC. | ||
| By: | /S/ LARRY E. REIMERT | |
| Larry E. Reimert | ||
| Co-Chairman of the Board of Directors | ||
Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
| Name |
Capacity |
Date | ||
| /S/ J. MIKE WALKER J. MIKE WALKER |
Co-Chairman of the Board and Director (Co-Principal Executive Officer) |
February 28, 2008 | ||
| /S/ LARRY E. REIMERT LARRY E. REIMERT |
Co-Chairman of the Board and Director (Co-Principal Executive Officer) |
February 28, 2008 | ||
| /S/ GARY D. SMITH GARY D. SMITH |
Co-Chairman of the Board and Director (Co-Principal Executive Officer) |
February 28, 2008 | ||
| /S/ JERRY M. BROOKS JERRY M. BROOKS |
Chief Financial Officer (Principal Financial and Accounting Officer) |
February 28, 2008 | ||
| /S/ JOHN V. LOVOI JOHN V. LOVOI |
Director | February 28, 2008 | ||
| /S/ L.H. DICK ROBERTSON L.H. DICK ROBERTSON |
Director | February 28, 2008 | ||
| /S/ A.P. SHUKIS A.P. SHUKIS |
Director | February 28, 2008 | ||
| /S/ GARY L. STONE GARY L. STONE |
Director | February 28, 2008 | ||
55