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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission file number: 001-13439
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Dril-Quip, Inc.
(Exact name of registrant as specified in its charter)
74-2162088
Delaware (IRS Employer
(State or other jurisdiction of Identification No.)
incorporation or organization)
77040
13550 Hempstead Highway (Zip code)
Houston, Texas
(Address of principal executive offices)
Registrant's telephone number, including area code: (713) 939-7711
Securities registered pursuant to Section 12(b) of the Act:
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Name of Each Exchange
Title of Each Class On Which Registered
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Common Stock, $.01 par value per share New York Stock Exchange
Rights to purchase Series A Junior Participating
Preferred Stock New York Stock Exchange
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Securities registered pursuant to Section 12(g) of the Act: None
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. [X]
At March 24, 1999, the aggregate market value of the registrant's Common
Stock held by non-affiliates of the registrant was approximately $113,106,638
based on the closing price of such stock on such date of $19 7/8.
At March 24, 1999, the number of shares outstanding of registrant's Common
Stock was 17,245,000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's Proxy Statement for its 1999 Annual Meeting of
Shareholders to be filed pursuant to Regulation 14A are incorporated by
reference in Part III of this Form 10-K.
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TABLE OF CONTENTS
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PART I.................................................................... 1
Item 1. Business............................................. 1
Item 2. Properties........................................... 9
Item 3. Legal Proceedings.................................... 9
Item 4. Submission of Matters to a Vote of Security Holders.. 9
Item S-K 401(b). Executive Officers of the Registrant................. 10
PART II................................................................... 11
Item 5. Market for Registrant's Common Stock and Related
Shareholder Matters.................................. 11
Item 6. Selected Financial Data.............................. 12
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.................. 13
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk................................................. 18
Item 8. Financial Statements and Supplementary Data.......... 18
Item 9. Changes In and Disagreements With Accountants on
Accounting and Financial Disclosure.................. 31
PART III.................................................................. 31
Item 10. Directors and Executive Officers of the Registrant... 31
Item 11. Executive Compensation............................... 31
Item 12. Security Ownership of Certain Beneficial Owners and
Management........................................... 31
Item 13. Certain Relationships and Related Party Transactions. 31
PART IV................................................................... 32
Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K.......................................... 32
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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 Dril-Quip's control. You can identify Dril-Quip's forward looking
statements by the words "anticipate," "estimate," "expect," "may," "project,"
"believe" and similar expressions. These forward-looking statements include
the following types of information and statements as they relate to Dril-Quip:
.scheduled, budgeted and other future capital expenditures;
.working capital requirements;
.the availability of expected sources of liquidity;
.the impact of the Year 2000 problem; and
.all statements regarding future operations, financial results, business
plans and cash needs.
These statements are based upon certain assumptions and analyses made by
management of Dril-Quip in light of its experience and its perception of
historical trends, current conditions, expected future developments and other
factors it believes are appropriate in the circumstances. Such statements are
subject to a number of assumptions, risks and uncertainties, including but not
limited to, those relating to the volatility of oil and natural gas prices and
cyclicality of the oil and gas industry, Dril-Quip's international operations,
operating risks, Dril-Quip's dependence on key employees, Dril-Quip's
dependence on skilled machinists and technical personnel, Dril-Quip's reliance
on product development and possible technological obsolescence, control by
certain stockholders, the potential impact of governmental regulation and
environmental matters, competition, reliance on significant customers, the
risk factors discussed herein and other factors detailed in the Registration
Statement on Form S-1 (Registration No. 333-33447) filed in connection with
Dril-Quip's initial public offering, and Dril-Quip's other filings with the
Securities and Exchange Commission. Prospective investors are cautioned that
any such statements are not guarantees of future performance, and that, should
one or more of these risks or uncertainties materialize, or should underlying
assumptions prove incorrect, actual outcomes may vary materially from those
indicated.
PART I
Item 1. Business
General
Dril-Quip, Inc., a Delaware corporation ("Dril-Quip" or the "Company"), is
one of the world's leading manufacturers of highly engineered offshore
drilling and production equipment which 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, mudline hanger systems, specialty connectors and associated
pipe, drilling and production riser systems, wellhead connectors and
diverters. The Company also provides installation and reconditioning services
and rents running tools for use in connection with the installation and
retrieval of its products.
Dril-Quip has developed its broad line of subsea equipment, surface
equipment and offshore rig equipment exclusively 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. In
particular, the Company's Quik-Thread(R) and Quik-Stab(R) specialty
connectors, MS-15(R) mudline hanger systems and SS-10(R) and
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SS-15(R) subsea wellheads are among the most widely used in the industry.
Since 1991, the Company has introduced a number of new products, including
diverters, wellhead connectors, dual-bore and single-bore subsea production
trees, subsea and platform valves, platform wellheads, platform trees,
drilling risers and Spar and TLP production risers.
Dril-Quip markets its products through its offices and sales representatives
located in all of the major international energy markets throughout the world.
In 1998, the Company generated approximately 62% of its revenues from foreign
sales. The Company manufactures its products at its facilities located in
Houston, Texas; Aberdeen, Scotland; and Singapore, and maintains additional
facilities for fabrication and/or reconditioning in Norway, Denmark and
Australia. Dril-Quip's manufacturing operations are vertically integrated,
with the Company performing substantially all of its forging, heat treating,
machining, fabrication, inspection, assembly and testing at its own
facilities.
The Company was co-founded as a Texas corporation in 1981 by Larry E.
Reimert, Gary D. Smith, J. Mike Walker and Gary W. Loveless. Together, Messrs.
Reimert, Smith and Walker have over 75 years of combined experience in the
oilfield equipment industry, essentially all of which has been with the
Company and its major competitors. In addition, key department managers have
been with the Company over 10 years, on average. The Company was
reincorporated as a Delaware corporation on August 12, 1997.
On October 28, 1997, the Company sold 2,875,000 shares of common stock, par
value $.01 per share ("Common Stock") in an initial public offering (the
"Offering"). The net proceeds to the Company from the Offering were
approximately $63.4 million. The Company repaid approximately $30 million of
indebtedness with the proceeds from the Offering and has used the remaining
proceeds to expand its manufacturing capacity, improve and expand facilities
and manufacture additional running tools for rental.
Industry Overview
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. The level of capital expenditures is generally 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 in the United States
and overseas, the discovery rate of new oil and gas reserves in offshore areas
and technological advances. Oil and gas prices and the level of offshore
drilling and production activity have historically been characterized by
significant volatility.
Crude oil prices declined substantially in 1998, and these depressed prices
may continue in 1999. During 1998, oil prices fell to 12-year lows as measured
in absolute dollars, and 25-year lows as measured in inflation-adjusted
dollars. As a result, worldwide offshore exploration and production activity
declined, with the number of offshore rigs under contract in January 1999 at
their lowest levels since the second quarter of 1995. Consequently, demand for
Dril-Quip products, particularly those products used in drilling and producing
economically marginal properties, has declined. As a result of continued
depressed oil prices, virtually all major oil and gas companies have announced
reduced exploratory capital spending budgets for 1999. Consequently, the
Company may see a reduction in orders in 1999, which could adversely affect
financial results.
Any further significant or prolonged decline in hydrocarbon prices would
likely have a material adverse effect on the Company's results of operations.
There can be no assurance that the current level of oil and gas exploration,
drilling and production activity will increase or that demand for the
Company's products and services will reflect such improvement, if any.
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Products and Services
Product Group
Dril-Quip designs, manufactures, fabricates, inspects, assembles, tests and
markets subsea equipment, surface equipment and offshore rig equipment. In
1998, the Company derived approximately 87.9% of its revenues from the sale of
its products. 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.
The Company believes that sales of its equipment in connection with TLPs,
Spars and FPSOs are potentially important sources of future revenues.
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 and TLP and
Spar well systems.
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
generally supplies subsea wellheads to customers from inventory.
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. The Company generally supplies mudline hanger systems to customers from
inventory.
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. The Company generally supplies specialty
connectors individually or specialty connectors welded to pipe from inventory.
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 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 (SingleBore(TM)) 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. The Company's subsea production trees are generally custom designed and
manufactured to customer specifications.
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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
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 BOP 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 BOP 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 Company has recently delivered its first drilling and
production risers. 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. Litigation arising from a catastrophic
occurrence at a location where the Company's equipment and/or services are
used may in the future result in the Company being named as a defendant in
lawsuits asserting potentially large claims. The Company maintains insurance
coverage that it believes is customary in the industry. Such insurance does
not, however, provide coverage for all liabilities (including liability for
certain events involving pollution), and there is no assurance that its
insurance coverage will be adequate to cover claims that may arise or that the
Company will be able to maintain adequate insurance at rates it considers
reasonable. The occurrence of an event not fully covered by insurance could
have a material adverse effect on the financial condition and results of
operations of the Company.
Service Group
Dril-Quip's Service Group provides 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
12.1% of revenues in 1998.
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; and Perth, Australia.
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Reconditioning. The Company provides reconditioning of its products at its
facilities in Houston, Texas; Aberdeen, Scotland; Stavanger, Norway; and
Singapore.
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; Singapore; and Perth, Australia.
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 and Aberdeen 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 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, approximately 80% 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.
Since 1996, the Company has been operating at close to full capacity. In
1997, in conjunction with its initial public offering, the Company announced a
three-year, $50 million capital expansion program to increase its
manufacturing capacity by approximately 90% by the end of 1999. During 1998
this expansion continued substantially on schedule and on budget as the
Company increased its facilities at its Eldridge site in Houston, Texas from
approximately 280,000 square feet at the end of 1997 to approximately 664,000
square feet at the end of 1998. Facility expansions included additions to the
Company's rough-out machine shop, forge and heat treat building, blast and
paint facilities, and fabrication building. Additionally, a new machine shop
was erected which will allow for the 1999 consolidation of finish machine
operations under one roof. A new riser tower and test pit and a new riser
fabrication and assembly building were also added at the Eldridge site.
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Customers
The Company's 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 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
1998, the Company's top 15 customers represented approximately 74% of total
revenues, with the Royal Dutch Shell Group of Companies (aggregating sales to
all of its worldwide affiliates), accounting for approximately 13%, and
Chevron USA Production Company accounting for approximately 11%, of 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 in any
single year 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.
Marketing and Sales
Dril-Quip markets its products and services throughout the world directly
through its sales personnel in two domestic and seven 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 the United Arab Emirates, Saudi Arabia, China,
Canada, the Philippines, Brazil, Indonesia, Malaysia, Kuwait, Brunei, Oman,
Qatar and West Africa. 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
places print advertising from time to time in trade and technical publications
targeted to its customer base. It 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 two weeks to three 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 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
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corrosive and water depths in excess of 5,000 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 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 costs associated with its
products.
All of the Company's products have been developed from internally generated
designs, and the Company has continually introduced new products and product
enhancements since its founding in 1981. Product developments that began in
1991 have led to a series of new products, including diverters, wellhead
connectors, SingleBore(TM) 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.
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. The Company's existing patents
expire at various times beginning in 2001.
Dril-Quip has numerous U.S. registered trademarks, including Dril-Quip(R),
Quik-Thread(R), Quick-Stab(R), Multi-Thread(R), MS-15(R), SS-15(R), SS-10(R),
SU-90(R) and DX(R). 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(R) trademark. 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 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
time than the Company. The Company competes principally with ABB Vetco Gray
Inc. (a subsidiary of Asea Brown Boveri, more commonly referred to as ABB),
the petroleum production equipment segment of Cooper Cameron Corporation, the
Petroleum Equipment Group of FMC Corporation and Kvaerner National Ltd. (a
division of Kvaerner A.S.).
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. The Company also 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.
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Employees
The total number of the Company's employees as of December 31, 1998 was
1,169. Of these, 756 were located in the United States. 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 a skilled
labor force. While the Company believes that its wage rates are competitive
and that its relationship with its skilled labor force is good, a significant
increase in the wages paid by competing employers could result in a reduction
of the Company's skilled labor force, increases in the wage 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.
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 generally, 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.
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.
The Company's operations are affected by numerous foreign, federal, state
and local environmental laws and regulations. The technical requirements of
these laws and regulations are becoming increasingly expensive, complex and
stringent. These laws may provide for "strict liability" for damages to
natural resources or threats to public health and safety, rendering a party
liable for the 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. Certain environmental laws provide for joint and several
strict liability for remediation of spills and releases of hazardous
substances. In addition, companies 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. Such laws and regulations
may also expose the Company to liability for the conduct of or conditions
caused by others, or for acts of the Company that were in compliance with all
applicable laws at the time such acts were performed. Compliance with
environmental laws and regulations may require the Company to obtain permits
or other authorizations for certain activities and to comply with various
standards or procedural requirements. The Company believes that its facilities
are in substantial compliance with current regulatory standards.
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.
8
<PAGE>
Item 2. Properties
Major Manufacturing Facilities
<TABLE>
<CAPTION>
Building
Size Land
(Approximate (Approximate
Location Square Feet) Acreage) Owned or Leased
-------- ------------ ------------ ---------------
<S> <C> <C> <C>
Houston, Texas
--13550 Hempstead Highway.... 175,000 15 Owned
14,000 -- Leased (offices)
--6401 N. Eldridge Parkway... 664,000 218 Owned
Aberdeen, Scotland............. 137,000 14 Owned
15,000 -- Leased (offices)
Singapore...................... 24,000 2 Leased
</TABLE>
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. Of the 664,000
square feet of buildings located at the Eldridge site in Houston, Texas,
buildings consisting of approximately 215,000 square feet have been completed,
but were not in service as of December 31, 1998.
Sales, Service and Reconditioning Facilities
<TABLE>
<CAPTION>
Building
Size Land
(Approximate (Approximate
Leased Location Square Feet) Acreage) Activity
--------------- ------------ ------------ --------
<S> <C> <C> <C>
New Orleans, Louisiana.. 2,300 -- Sales/Service
Beverwijk, Holland...... 5,200 0.2 Sales/Warehouse
Perth, Australia........ 5,400 0.2 Sales/Service/Reconditioning/Warehouse
Stavanger, Norway....... 15,700 2.4 Sales/Service/Reconditioning/
Warehouse/Fabrication
Esbjerg, Denmark........ 19,400 1.2 Sales/Service/Reconditioning/Warehouse
</TABLE>
The Company also performs sales, service and reconditioning activities at
its facilities in Houston, Aberdeen and Singapore. As part of its capital
expansion, the Company plans to expand its facilities in Stavanger to meet
growing demands for its products and services.
Item 3. Legal Proceedings
The Company is not a party to, nor is any of its property the subject of,
any pending legal proceedings, which, in the opinion of management, are
expected to have a material adverse effect on the Company's consolidated
results of operations or financial position.
Item 4. Submission of Matters to a Vote of Security Holders
The Company's Annual Meeting of Stockholders was held on May 14, 1998, to
elect one Class I member of the Board of Directors and to approve the
appointment of Ernst & Yount LLP as independent public accountants of the
Company for 1998. The Class I director who was so elected was James M.
Alexander, by 16,338,508 affirmative votes. 717,607 votes were withheld. The
directors whose term of office continued after the Annual Meeting are J. Mike
Walker, Gary W. Loveless, Larry E. Reimert and Gary D. Smith. In the matter of
the approval of the appointment of the independent accountants, there were
16,518,283 affirmative votes 5,250 negative votes, 3,860 abstentations and
717,607 broker non-votes.
9
<PAGE>
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 March 15, 1999) and
positions of the Company's executive officers:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Larry E. Reimert... 51 Co-Chairman of the Board and Co-Chief Executive Officer
Gary D. Smith...... 56 Co-Chairman of the Board and Co-Chief Executive Officer
J. Mike Walker..... 55 Co-Chairman of the Board and Co-Chief Executive Officer
Jerry M. Brooks.... 47 Chief Financial Officer
</TABLE>
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 a 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, a MSME degree from the University of
Texas at Austin and a Ph.D. in mechanical engineering from Texas A&M
University.
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.
10
<PAGE>
PART II
Item 5. Market for Registrant's Common Stock and Related Stockholder Matters
(a) The Company's Common Stock has been publicly traded on the New York
Stock Exchange under the symbol DRQ since the Offering on October 22, 1997.
The following table sets forth the quarterly high and low sales prices for the
indicated quarters of fiscal 1997 and 1998:
<TABLE>
<CAPTION>
Quarter Ended High Low
------------- -------- -------
<S> <C> <C>
December 31, 1997........................................ $40 7/16 $27 1/2
March 31, 1998........................................... 35 22 3/8
June 30, 1998............................................ 37 26 1/4
September 30, 1998....................................... 26 1/2 11 3/4
December 31, 1998........................................ 22 1/2 13 1/8
</TABLE>
There were approximately 85 stockholders of record of the Company's Common
Stock as of March 24, 1999. This number does not include the number of
security holders for whom shares are held in a "nominee" or "street" name.
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.
(b) Use of Proceeds.
In October 1997, Dril-Quip sold 2,875,000 shares of Common Stock in the
Offering. The net proceeds to the Company from the Offering were $63.4
million. As of December 31, 1998, the Company had used such net proceeds as
follows: (i) to repay $30 million of indebtedness outstanding under the
Company's credit facilities and term loans, which constitutes repayment of
such facilities in full and (ii) $33.4 million for the purchase of property,
plant and equipment. None of such payments was a direct or indirect payment to
directors or officers of the Company or their associates, to persons owning
10% or more of any class of equity securities of the Company or to affiliates
of the Company.
11
<PAGE>
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.
<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------------------------------
1994 1995 1996 1997 1998
------- -------- -------- -------- --------
(In Thousands, Except Per Share Amount)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenues...................... $80,548 $108,390 $115,864 $146,823 $177,642
Cost of sales................. 58,604 76,471 77,863 99,800 118,923
Selling, general and
administrative expenses...... 11,673 13,597 15,031 16,313 21,293
Engineering and product
development expenses......... 6,069 5,769 6,971 9,158 11,968
------- -------- -------- -------- --------
76,346 95,837 99,865 125,271 152,184
Operating income.............. 4,202 12,553 15,999 21,552 25,458
Interest expense (income)..... 2,273 2,944 2,647 2,027 (1,197)
------- -------- -------- -------- --------
Income before income taxes.... 1,929 9,609 13,352 19,525 26,655
Income tax provision.......... 635 3,023 4,234 6,587 9,228
------- -------- -------- -------- --------
Net income.................... $ 1,294 $ 6,586 $ 9,118 $ 12,938 $ 17,427
======= ======== ======== ======== ========
Diluted earnings per share.... $ .09 $ .46 $ .63 $ .87 $ 1.01
Weighted average shares
outstanding.................. 14,370 14,370 14,370 14,895 17,275
Statement of Cash Flows Data:
Net cash provided by operating
activities................... $ 2,422 $ 6,466 $ 5,185 $ 10,325 $ 9,118
Net cash used in investing
activities................... (4,524) (5,659) (7,006) (10,240) (29,450)
Net cash provided by financing
activities................... 2,668 560 1,261 31,386 (203)
Other Data:
EBITDA(1)..................... $ 8,069 $ 17,201 $ 20,387 $ 26,541 $ 32,305
Depreciation and amortization. 3,867 4,648 4,388 4,989 5,650
Capital expenditures.......... 4,614 6,184 7,228 10,375 29,642
<CAPTION>
As of December 31,
-----------------------------------------------
1994 1995 1996 1997 1998
------- -------- -------- -------- --------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Working capital............... $34,099 $ 40,682 $ 49,524 $ 89,373 $ 83,595
Total assets.................. 79,208 93,186 114,777 152,921 177,246
Total debt.................... 30,416 31,052 32,536 518 315
Total stockholders' equity.... 32,903 39,501 50,882 124,161 141,912
</TABLE>
- --------
(1) EBITDA, or "earnings from continuing operations before interest expense,
interest income, income taxes, depreciation and amortization," is not a
generally accepted accounting principle measure, but is a supplemental
financial measurement used by the Company in the evaluation of its
business. EBITDA should not be construed as an alternative to net income
or to cash flow from operations or any other measure of performance in
accordance with generally accepted accounting principles, and is presented
solely as a supplemental disclosure.
12
<PAGE>
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
and results of operations during the periods included in the 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 manufactures highly engineered offshore drilling and production
equipment which 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, mudline
hanger systems, specialty connectors and associated pipe, drilling and
production riser systems, 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.
Crude oil prices declined substantially in 1998, and these depressed prices
may continue in 1999. During 1998, oil prices fell to 12-year lows as measured
in absolute dollars, and 25-year lows as measured in inflation-adjusted
dollars. As a result, worldwide offshore exploration and production activity
also declined, with the number of offshore rigs under contract in January 1999
at their lowest levels since the second quarter of 1995. Consequently, demand
for Dril-Quip products, particularly those products used in drilling and
producing economically marginal properties, has declined. As a result of
continued depressed oil prices, virtually all major oil and gas companies have
announced reduced exploratory capital spending budgets for 1999. Consequently,
the Company may see a reduction in orders in 1999, which could adversely
affect financial results.
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 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.
Dril-Quip's revenues are generated by its two operating groups: the Product
Group and the Service Group. The Product Group manufactures offshore drilling
and production equipment, and the Service Group provides installation and
reconditioning services as well as rental running tools for installation and
retrieval of its products. In 1998, the Company derived 87.9% of its revenues
from the sale of its products and 12.1% of its revenues from services.
Revenues from the Service Group generally correlate to revenues from product
sales, because increased product sales generate increased revenues from
installation services and rental running tools. The Company has substantial
international operations, with approximately 70%, 68%, 60% and 62% of its
revenues derived from foreign sales in 1995, 1996, 1997 and 1998,
respectively. During the same years, approximately 70% of all products sold
were manufactured in the United States. 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.
13
<PAGE>
Historically, Drip-Quip recognized revenues upon the delivery of a completed
product. Beginning in 1997, the Company began receiving orders relating to
larger and more complex projects that have longer manufacturing time frames.
The Company accounts for such projects on a percentage of completion basis and
revenues 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
percentage of completion are reflected in the period when such estimates are
revised.
The principal elements of cost of sales are labor, raw materials and
manufacturing overhead. Variable costs, such as labor, raw materials, supplies
and energy, generally account for approximately two-thirds of the Company's
cost of sales. The Company has experienced increased labor costs over the past
few years due to the limited supply of skilled workers. Fixed costs, such as
the fixed portion of manufacturing overhead, constitute the remainder of the
Company's cost of sales. The Company continually seeks to improve its
efficiency and cost position. Cost of sales as a percentage of revenues is
also influenced by the product mix sold in any particular quarter and market
conditions. The Company's costs related to its foreign operations do not
significantly differ from its domestic costs.
Results of Operations
The following table sets forth, for the periods indicated, certain statement
of operations data expressed as a percentage of revenues:
<TABLE>
<CAPTION>
Year Ended
December 31,
-------------------
1996 1997 1998
----- ----- -----
<S> <C> <C> <C>
Revenues:
Product Group.............................................. 82.1% 86.1% 87.9%
Service Group.............................................. 17.9 13.9 12.1
----- ----- -----
Total.................................................. 100.0 100.0 100.0
Cost of sales.............................................. 67.2 68.0 66.9
Selling, general and administrative expenses............... 13.0 11.1 12.0
Engineering and product development expenses............... 6.0 6.2 6.7
----- ----- -----
Operating income........................................... 13.8 14.7 14.3
Interest expense (income).................................. 2.3 1.4 (0.7)
----- ----- -----
Income before income taxes................................. 11.5 13.3 15.0
Income tax provision....................................... 3.6 4.5 5.2
----- ----- -----
Net income................................................. 7.9% 8.8% 9.8%
===== ===== =====
</TABLE>
Year Ended December 31, 1998 Compared to Year Ended December 31, 1997
Revenues. Revenues increased by $30.8 million, or approximately 21%, to
$177.6 million in 1998 from $146.8 million in 1997. This increase relates to
increased sales in the United States area of $34.4 million, decreased revenues
of $1.2 million in the European area and decreased sales of $2.4 million in
the Asia-Pacific area. Domestic sales in the United States area increased by
$8.8 million, or 15%, while export sales in the United States area increased
by $25.6 million, or 343%. These increases were mainly due to increased
manufacturing capacity and increased sales of new products related to larger
and longer-term projects.
Cost of Sales. Cost of sales increased by $19.1 million, or 19%, to $118.9
million for the twelve months ended December 31, 1998 from $99.8 million for
the same period in 1997. As a percentage of revenues, cost of sales decreased
from 68% in 1997 to 67% in 1998. This decrease in cost of sales as a
percentage of revenues was primarily due to strong market demand for new
products related to larger and longer-term projects.
Selling, General and Administrative Expenses. For the twelve months ended
December 31, 1998, selling, general and administrative expenses increased by
$5 million, or 31%, to $21.3 million from $16.3 million in the 1997
14
<PAGE>
period. This increase was due to an increased number of personnel needed to
support higher sales volumes and increased labor costs. Selling, general and
administrative expenses increased as a percentage of revenues from 11% in 1997
to approximately 12% in 1998.
Engineering and Product Development Expenses. During the year ended December
31, 1998, engineering and product development expenses increased by $2.8
million, or 31%, to $12 million from $9.2 million during the same period in
1997. This increase primarily reflects an increased number of personnel, and
to a lesser extent, increased development testing related to new products. As
a percentage of revenues, engineering and product development expenses
increased from 6.2% in 1997 to approximately 6.7% in 1998.
Interest Expense/Income. Interest income for 1998 was $1.2 million, compared
to interest expense of $2.0 million for the prior year. This change was
primarily due to the repayment of substantially all of the Company's bank debt
during the fourth quarter of 1997 and interest income earned on cash generated
by the Offering.
Net Income. Net income increased by $4.5 million, or 35%, from $12.9 million
in 1997 to $17.4 million in 1998 for the reasons set forth above.
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Revenues. Revenues increased by $30.9 million, or approximately 27%, to
$146.8 million in 1997 from $115.9 million in 1996. This increase relates to
increased domestic sales in the United States area of $21.4 million, increased
revenues of $7.0 million in the European area and increased sales of $3.2
million in the Asia-Pacific area. These increases were mainly due to strong
market demand, along with increased manufacturing capacity, price increases
and an increase in project related sales of new products.
Cost of Sales. Cost of sales increased by $21.9 million, or 28%, to $99.8
million for the twelve months ended December 31, 1997 from $77.9 million for
the same period in 1996. As a percentage of revenues, cost of sales increased
from 67% in 1996 to 68% in 1997. This increase in cost of sales as a
percentage of revenues was primarily due to sales of new products, which tend
to initially have lower margins, and higher labor costs, which factors were
partially offset by improved pricing.
Selling, General and Administrative Expenses. For the twelve months ended
December 31, 1997, selling, general and administrative expenses increased by
$1.3 million, or 9%, to $16.3 million from $15.0 million in the 1996 period.
This increase was due to an increased number of personnel needed to support
higher sales volumes and increased labor costs. Selling, general and
administrative expenses decreased as a percentage of revenues from 13% in 1996
to approximately 11% in 1997.
Engineering and Product Development Expenses. During the year ended December
31, 1997, engineering and product development expenses increased by $2.2
million, or 31%, to $9.2 million from $7.0 million during the same period in
1996. This increase primarily reflects an increased number of personnel, and
to a lesser extent, increased development testing related to new products. As
a percentage of revenues, engineering and product development expenses
remained essentially unchanged at approximately 6% in both 1997 and 1996.
Interest Expense. Interest expense for 1997 was $2.0 million, a decrease of
approximately $600,000, or approximately 23%, from interest expense of $2.6
million for the prior year. This decrease was primarily due to the repayment
of a substantial portion of the Company's bank debt during the fourth quarter
of 1997 which resulted, on average, in lower outstanding debt balances in 1997
as compared to 1996.
Net Income. Net income increased by $3.8 million, or 42%, from $9.1 million
in 1996 to $12.9 million in 1997 for the reasons set forth above.
15
<PAGE>
Liquidity and Capital Resources
The primary liquidity needs of the Company are (i) to fund capital
expenditures to increase manufacturing capacity, improve and expand facilities
and manufacture additional rental running tools and (ii) to fund working
capital. Historically, the Company's principal sources of funds have been cash
flow from operations and bank indebtedness. However, as a result of the
Offering, all of the Company's bank indebtedness was repaid in 1997.
Net cash provided by operating activities was $5.2 million in 1996, $10.3
million in 1997 and $9.1 million in 1998. Improvements in cash flow from
operating activities in 1997 were principally the result of improved operating
results, offset by increased working capital requirements attributable to
increases in accounts receivable and inventory due to increased sales. The
decrease in cash flow from operating activities in 1998 was the result of a
substantial increase in accounts receivable, offset by improved operating
results. Accounts receivable at December 31, 1998 increased 63% over December
31, 1997 levels compared to a 21% increase in revenues for the year. The
disproportionate increase in accounts receivable was due to timing of cash
receipts and billings related to long-term projects.
Capital expenditures by the Company were $7.2 million, $10.4 million and
$29.6 million in 1996, 1997 and 1998, respectively. Principal payments on
long-term debt were $3.2 million, $36.3 million and $200,000 in 1996, 1997 and
1998, respectively.
In October 1997, the Offering provided the Company with proceeds of
approximately $63.4 million, net of expenses. The Company repaid approximately
$30 million of indebtedness with the proceeds from the Offering and has used
the remaining proceeds to expand its manufacturing capacity, improve and
expand facilities and manufacture additional running tools for rental. The
Company believes that cash on hand plus cash generated from operations will be
sufficient to fund operations, working capital needs and anticipated capital
expenditure requirements. Should unexpected cash requirements arise, however,
the Company believes that borrowing from commercial lending institutions would
be readily available and more than 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 backlog was approximately $125 million at December
31, 1997 and was approximately $130 million at December 31, 1998. This
increase in backlog was primarily attributable to certain larger and longer
term projects, including such products as drilling and production risers. The
Company expects to fill approximately 60% of the December 31, 1998 backlog by
December 31, 1999. The remaining backlog at December 31, 1998 consists of
longer-term projects that will be designed and manufactured to customer
specifications rather than sold out of inventory. 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 declined
significantly during 1998. Any further significant or prolonged decline 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.
Geographic Areas
The Company's operations are divided into three geographic areas based upon
the locations of its manufacturing facilities: the United States (Houston,
Texas); Europe, Middle East and Africa (Aberdeen, Scotland) and Asia-Pacific
(Singapore). The United States area includes sales to both North and South
America. The area of Europe, Middle East and Africa includes primarily sales
to the North Sea with lesser sales to the Middle East and Africa. The Asia-
Pacific area includes sales primarily to Australia, Thailand, Malaysia and
Indonesia.
Revenues for each of these areas are dependent upon the ultimate sale of
products and services to the Company's customers. For information on revenues
by geographic area, see note 10 "Notes to Consolidated Financial Statements
16
<PAGE>
and Supplementary Data" on page 29. Revenues of the United States area are
also influenced by its sale of products to the European and Asia-Pacific
subsidiaries. Accordingly, the operating incomes of each area are closely tied
to third-party sales, and the operating income of the United States area 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 the Norwegian kroner. 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 and by
contractual purchase price adjustments based on an exchange rate formula
related to U.S. dollars. 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 1996 and 1997, the Company had exchange gains, net of income
taxes, of approximately $163,000 and $1 million, respectively. In 1998, the
Company had a loss of approximately $296,000. The gain in 1997 was primarily
related to debt which was repaid in 1997. 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. The
functional currency of these foreign operations is the local currency and,
accordingly, financial statement assets and liabilities are translated at
current exchange rates. Resulting translation adjustments are reflected as a
separate component of stockholders' equity and have no current effect on
earnings or cash flow.
Year 2000 Readiness Disclosure
Historically, certain computerized systems have used two digits rather than
four digits to define the applicable year, which could result in recognizing
the date using "00" as the year 1900 rather than the year 2000. This could
result in major failures or miscalculations and is generally referred to as
the Year 2000 problem.
The Company has undertaken a Year 2000 readiness program that encompasses a
comprehensive review of three distinct areas that are susceptible to the Year
2000 problem:
.information systems;
.automated production systems; and
.third parties.
Information systems include communications and traditional software and
hardware in the Company network and desktop environments. Automated production
systems include all automation and embedded chips used in production and
manufacturing. Third parties include any party that supplies goods or services
to the Company. The Company does not anticipate any material year 2000
exposure arising out of the sale of its products to third party customers
because the Company's products are mechanical and structural in nature and do
not include integrated circuitry.
The Year 2000 problem is being addressed within the Company and progress is
regularly reported to management and the Board of Directors. In implementing
the Year 2000 program, the Company has prioritized its readiness efforts into
two categories: "mission critical" and "non-mission critical." Systems and
third parties which are considered mission critical are those of which a Year
2000 failure could cause any of the following to occur:
.the inability of the Company to meet its product delivery obligations;
.a reduction or cessation of the Company's manufacturing capacity or
capabilities;
.the inability of the Company to meet its financial obligations; or
.any other major interruption to Company operations.
17
<PAGE>
Mission critical systems and third parties are addressed on a priority basis
over non-mission critical systems and third parties.
The Company's Year 2000 program is made up of three phases: assessment,
remediation and testing. As of March 1, 1999 the Company had completed
assessment and remediation of all mission critical information systems and
automated production systems. Testing of mission critical systems is already
underway and will be completed by July 1, 1999. As of March 1, 1999, the
Company had completed assessment and remediation of approximately 50% of all
non-mission critical information systems and automated production systems.
Assessment and remediation of all non-mission critical systems will be
completed by July 1, 1999 and testing will be completed by August 1, 1999.
As of March 1, 1999, the Company had contacted substantially all of its
mission critical third party suppliers and vendors about their Year 2000
readiness. The Company has received responses from a majority of those third
parties contacted. By July 1, 1999, the Company plans to have contacted all of
its mission critical third parties and substantially all of its non-mission
critical third parties.
Although the Company is taking affirmative steps to determine the readiness
of third parties, there can be no assurance that the systems and processes of
such third parties will remain functional. Year 2000 failures among mission
critical third parties could possibly cause shutdowns or other significant
business interruptions that could result in a material effect on the
operations, liquidity or capital resources of the Company. At this time, the
Company cannot quantify the potential impact of these failures. The Company is
currently developing contingency plans to address issues within its control.
The program minimizes, but does not eliminate, the issues of third parties.
The total cost of the Company's Year 2000 program is not expected to be
material to the Company's operations, liquidity or capital resources. Costs
are being handled within the current information systems budget, and no
special allocations have been made. The total estimated cost for the Company's
Year 2000 program is expected to be less than $200,000. This includes costs
for the replacement, repair or upgrade of existing non-ready systems.
This disclosure is provided pursuant to Securities Exchange Act Release No.
34-40277. As such, it is protected as a forward-looking statement under the
Private Securities Litigation Reform Act of 1995. See "Forward-Looking
Statements" on page 1. This disclosure is also subject to protection under the
Year 2000 Information and Readiness Disclosure Act of 1998, Public Law 105-
271, as a "Year 2000 Statement" and "Year 2000 Readiness Disclosure" as
defined therein.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Not applicable.
Item 8. Financial Statements and Supplementary Data
<TABLE>
<CAPTION>
Page
----
<S> <C>
Report of Independent Auditors............................................ 19
Consolidated Statements of Income for the Three Years in the Period Ended
December 31, 1998........................................................ 20
Consolidated Balance Sheets as of December 31, 1997 and 1998.............. 21
Consolidated Statements of Cash Flows for the Three Years in the Period
Ended December 31, 1998.................................................. 22
Consolidated Statements of Changes in Stockholders' Equity for the Three
Years in the Period Ended December 31, 1998.............................. 23
Notes to Consolidated Financial Statements................................ 24
</TABLE>
18
<PAGE>
REPORT OF INDEPENDENT AUDITORS
Board of Directors and Stockholders
Dril-Quip, Inc.
We have audited the accompanying consolidated balance sheets of Dril-Quip,
Inc., as of December 31, 1998 and 1997, and the related consolidated
statements of income, changes in stockholders' equity, and cash flows for each
of the three years in the period ended December 31, 1998. 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 generally accepted auditing
standards. 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. An audit
also includes 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 financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Dril-Quip,
Inc., at December 31, 1998 and 1997, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting
principles.
Ernst & Young LLP
Houston, Texas
February 15, 1999
19
<PAGE>
DRIL-QUIP, INC.
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
Year ended December 31
--------------------------------
1996 1997 1998
---------- ---------- ----------
(In Thousands, Except Share
Amounts)
<S> <C> <C> <C>
Revenues...................................... $ 115,864 $ 146,823 $ 177,642
Cost and expenses:
Cost of sales............................... 77,863 99,800 118,923
Selling, general, and administrative........ 15,031 16,313 21,293
Engineering and product development......... 6,971 9,158 11,968
---------- ---------- ----------
99,865 125,271 152,184
---------- ---------- ----------
Operating income.............................. 15,999 21,552 25,458
Interest expense (income)..................... 2,647 2,027 (1,197)
---------- ---------- ----------
Income before income taxes.................... 13,352 19,525 26,655
Income tax provision.......................... 4,234 6,587 9,228
---------- ---------- ----------
Net income.................................... $ 9,118 $ 12,938 $ 17,427
========== ========== ==========
Earnings per share:
Basic....................................... $ .63 $ .87 $ 1.01
========== ========== ==========
Fully diluted............................... $ .63 $ .87 $ 1.01
========== ========== ==========
Weighted average shares
Basic....................................... 14,370,000 14,881,986 17,245,000
========== ========== ==========
Fully diluted............................... 14,370,000 14,895,222 17,275,222
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these statements.
20
<PAGE>
DRIL-QUIP, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31
------------------
ASSETS 1997 1998
(In Thousands)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................ $ 32,612 $ 11,869
Trade receivables........................................ 27,336 44,527
Inventories.............................................. 52,436 55,536
Deferred taxes........................................... 3,694 3,883
Prepaids and other current assets........................ 657 1,387
-------- --------
Total current assets................................... 116,735 117,202
Property, plant, and equipment, net........................ 35,814 59,753
Other assets............................................... 372 291
-------- --------
Total assets........................................... $152,921 $177,246
======== ========
<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
Current liabilities:
Accounts payable......................................... $ 15,354 $ 16,712
Current maturities of long-term debt..................... 210 165
Accrued income taxes..................................... 1,176 1,637
Customer prepayments..................................... 4,324 9,039
Accrued compensation..................................... 3,098 3,742
Other accrued liabilities................................ 3,200 2,312
-------- --------
Total current liabilities.............................. 27,362 33,607
Long-term debt............................................. 308 150
Deferred taxes............................................. 1,090 1,577
-------- --------
Total liabilities...................................... 28,760 35,334
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,
17,245,000 issued and outstanding...................... 172 172
Additional paid-in capital............................... 63,291 63,291
Retained earnings........................................ 62,590 80,017
Foreign currency translation adjustment.................. (1,892) (1,568)
-------- --------
Total stockholders' equity............................. 124,161 141,912
-------- --------
Total liabilities and stockholders' equity............. $152,921 $177,246
======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
21
<PAGE>
DRIL-QUIP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
Year ended December 31
----------------------------
1996 1997 1998
-------- -------- --------
(In Thousands)
<S> <C> <C> <C>
Operating activities
Net income...................................... $ 9,118 $ 12,938 $ 17,427
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization................. 4,388 4,989 5,650
Gain on sale of equipment..................... (82) (9) (6)
Deferred income taxes......................... (505) (189) 299
Changes in operating assets and liabilities:
Trade receivables........................... (4,553) (2,822) (16,994)
Inventories................................. (10,815) (2,763) (2,743)
Prepaids and other assets................... (144) 133 (641)
Trade accounts payable and accrued expenses. 7,778 (1,952) 6,126
-------- -------- --------
Net cash provided by operating activities....... 5,185 10,325 9,118
Investing activities
Purchase of property, plant, and equipment...... (7,228) (10,375) (29,642)
Proceeds from sale of equipment................. 222 135 192
-------- -------- --------
Net cash used in investing activities........... (7,006) (10,240) (29,450)
Financing activities
Proceeds from revolving line of credit and long-
term borrowings................................ 4,564 4,373 0
Principal payments on long-term debt............ (3,203) (36,307) (203)
Dividends paid.................................. (100) -- --
Proceeds from sale of stock..................... -- 63,320 0
-------- -------- --------
Net cash provided by (used in) financing
activities..................................... 1,261 31,386 (203)
Effect of exchange rate changes on cash
activities..................................... (658) (220) (208)
-------- -------- --------
Increase (decrease) in cash..................... (1,218) 31,251 (20,743)
Cash at beginning of period..................... 2,579 1,361 32,612
-------- -------- --------
Cash at end of period........................... $ 1,361 $ 32,612 $ 11,869
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these statements.
22
<PAGE>
DRIL-QUIP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
Unrealized
Common Paid-In Retained Translation
Stock Capital Earnings Adjustment Total
------ ------- -------- ----------- --------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Balance at December 31, 1995...... $144 $ -- $40,634 $(1,277) $ 39,501
--------
Translation adjustment.......... -- -- -- 2,363 2,363
Net income...................... -- -- 9,118 -- 9,118
--------
Comprehensive income............ -- -- -- -- 11,481
Dividends ($.007 per share)..... -- -- (100) -- (100)
---- ------- ------- ------- --------
Balance at December 31, 1996...... 144 -- 49,652 1,086 50,882
--------
Translation adjustment.......... -- -- -- (2,978) (2,978)
Net income...................... -- -- 12,938 -- 12,938
--------
Comprehensive income............ -- -- -- -- 9,960
Common stock offering........... 28 63,291 -- -- 63,319
---- ------- ------- ------- --------
Balance at December 31, 1997...... 172 63,291 62,590 (1,892) 124,161
--------
Translation adjustment.......... -- -- -- 324 324
Net income...................... -- -- 17,427 -- 17,427
--------
Comprehensive income............ -- -- -- -- 17,751
---- ------- ------- ------- --------
Balance at December 31, 1998...... $172 $63,291 $80,017 $(1,568) $141,912
==== ======= ======= ======= ========
</TABLE>
The accompanying notes are an integral part of these statements.
23
<PAGE>
DRIL-QUIP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998
1. Organization
Dril-Quip, Inc. (the "Company"), manufactures offshore drilling and
production equipment, which 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,
mudline hanger systems, specialty connectors and associated pipe, drilling and
production riser systems, wellhead connector and diverters for use 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 has three subsidiaries
that manufacture and market the Company's products abroad. Dril-Quip (Europe)
Limited is located in Aberdeen, Scotland, with branches in Norway, Holland,
and Denmark. Dril-Quip Asia Pacific PTE Ltd. is located in Singapore. DQ
Holdings PTY Ltd. is located in Perth, Australia.
2. Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All material intercompany accounts and transactions have
been eliminated.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles 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.
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. At December 31, 1997 and
1998, cash and cash equivalents include $30,235,000 and $10,075,000,
respectively, invested in United States Treasury money market funds.
Inventories
The Company's inventories are reported at the lower of cost (first-in,
first-out method) or market.
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.
Income Taxes
The Company accounts for income taxes using the liability method. Deferred
income taxes are provided on income and expenses which are reported in
different periods for income tax and financial reporting purposes.
24
<PAGE>
DRIL-QUIP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1998
Revenue Recognition
The Company delivers most of its products on an as-needed basis by its
customers and records revenues as the products are shipped. Certain revenues
are derived from long-term contracts which generally require more than one
year to fulfill. Revenues and profits on long-term contracts are recognized
under the percentage-of-completion method based on a cost-incurred basis.
Losses, if any, on contracts are recognized when they become known. Contracts
for long-term projects contain provisions for customer progress payments.
Payments in excess of revenues recognized are included as a customer
prepayment liability. At December 31, 1998 and 1997, trade receivables
included $11,032,000 and $1,900,000, respectively, in unbilled revenue, and
inventories have been reduced by $22,571,000 and $3,700,000, respectively, for
activities relating to long-term contracts.
Foreign Currency
The financial statements of foreign subsidiaries are translated into U.S.
dollars at current exchange rates except for revenues and expenses, which are
translated at average rates during each reporting period. 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 gain of $2,363,000 in 1996, a loss of $2,978,000 in 1997 and, a gain of
$324,000 in 1998, net of allocated income taxes of $458,000, $772,000 and
$316,000, respectively.
Foreign currency exchange transactions are recorded using the exchange rate
at the date of the settlement. Exchange gains (losses) were approximately
$163,000 in 1996, $1,080,000 in 1997 and ($296,000) in 1998, net of income
taxes. These amounts are included in the consolidated statements of income.
Stock-Based Compensation
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123. "Accounting For Stock Based
Compensation" ("SFAS No. 123"). Accordingly, no compensation cost has been
recognized for stock options granted under the Company's incentive plan.
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.
Concentration of Credit Risk
Financial instruments which subject the Company to concentrations of credit
risk consist principally of 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 customer's financial condition and
generally does not require collateral. The Company maintains reserves for
potential losses and such losses have historically been within management's
expectations.
Comprehensive Income
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, Reporting Comprehensive Income (SFAS No. 130).
The adoption of SFAS No. 130 had no impact on the Company's net income or
stockholders' equity. SFAS No. 130 requires the reporting of comprehensive
income, which includes net income plus unrealized foreign currency translation
gains and losses. Comprehensive income has been reported in the Consolidated
Statements of Changes in Stockholders' Equity.
25
<PAGE>
DRIL-QUIP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1998
3. Inventories
Inventories consist of the following:
<TABLE>
<CAPTION>
December 31
---------------
1997 1998
------- -------
(In Thousands)
<S> <C> <C>
Raw materials and supplies............................... $13,178 $13,114
Work in progress......................................... 14,766 18,114
Finished goods and purchased supplies.................... 24,492 24,308
------- -------
$52,436 $55,536
======= =======
</TABLE>
4. Property, Plant, and Equipment
Property, plant, and equipment consist of:
<TABLE>
<CAPTION>
Estimated December 31
Useful ---------------
Lives 1997 1998
----------- ------- -------
(In Thousands)
<S> <C> <C> <C>
Land and improvements........................ 10-25 years $ 6,826 $ 8,513
Buildings.................................... 15-40 years 15,987 27,063
Machinery and equipment...................... 3-10 years 46,236 62,777
------- -------
69,049 98,353
Less accumulated depreciation................ 33,235 38,600
------- -------
$35,814 $59,753
======= =======
</TABLE>
5. Long-Term Debt
Long-term debt consists of the following:
<TABLE>
<CAPTION>
December 31
---------------
1997 1998
------- -------
(In Thousands)
<S> <C> <C>
Equipment financing agreements........................... $ 518 $ 315
Less current portion..................................... 210 165
------- -------
$ 308 $ 150
======= =======
</TABLE>
Interest paid on long-term debt for the years ended December 31, 1996, 1997,
and 1998 was $2,695,000, $2,562,681, and $44,000 respectively. Scheduled
maturities of long-term debt are as follows: 1999--$165,000; 2000--$89,000;
2001--$49,000; 2002--$12,000; 2003 and thereafter--$-0-.
6. Income Taxes
Income before income taxes consisted of the following:
<TABLE>
<CAPTION>
1996 1997 1998
------- ------- -------
(In Thousands)
<S> <C> <C> <C>
Domestic.......................................... $ 9,068 $13,547 $26,404
Foreign........................................... 4,284 5,978 251
------- ------- -------
Total........................................... $13,352 $19,525 $26,655
======= ======= =======
</TABLE>
26
<PAGE>
DRIL-QUIP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1998
The income tax provision consists of the following:
<TABLE>
<CAPTION>
1996 1997 1998
------ ------ ------
(In Thousands)
<S> <C> <C> <C>
Current:
Federal......................................... $3,408 $4,640 $8,894
Foreign......................................... 1,331 2,258 36
------ ------ ------
Total current................................. 4,739 6,898 8,930
Deferred:
Federal......................................... (505) 55 (16)
Foreign......................................... -- (366) 314
------ ------ ------
Total deferred................................ (505) (311) 298
------ ------ ------
$4,234 $6,587 $9,228
====== ====== ======
</TABLE>
The difference between the effective tax rate reflected in the provision for
income taxes and the U.S. federal statutory rate was as follows:
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
Federal income tax statutory rate....................... 34.0% 35.0% 35.0%
Benefit of foreign sales corporation.................... (1.8) (1.2) (1.7)
Other................................................... (.5) (.1) 1.3
---- ---- ----
Effective tax rate...................................... 31.7% 33.7% 34.6%
==== ==== ====
</TABLE>
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. Significant components
of the Company's deferred tax liabilities and assets are as follows:
<TABLE>
<CAPTION>
December 31
-------------
1997 1998
------ ------
(In
Thousands)
<S> <C> <C>
Deferred tax liability:
Property, plant and equipment............................ $1,090 $1,577
Deferred tax assets:
Deferred profit on intercompany sales.................... 2,704 2,815
Other--net............................................... 990 1,068
------ ------
Total deferred tax assets.................................. 3,694 3,883
------ ------
Net deferred tax asset..................................... $2,604 $2,306
====== ======
</TABLE>
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 would 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 paid approximately $4,314,000, $7,143,000 and $8,813,000 in
income taxes in 1996, 1997 and 1998, respectively.
27
<PAGE>
DRIL-QUIP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1998
7. 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 $548,000, $601,000 and $652,000 in 1996, 1997 and
1998, respectively.
8. Commitments and Contingencies
The Company leases certain office, shop, and warehouse facilities;
automobiles; and equipment, and expenses all lease payments when incurred.
Total lease expense incurred was $853,000, $771,000 and $1,167,000 in 1996,
1997 and 1998, respectively. Annual minimum lease commitments at December 31,
1998 are as follows: 1999--$662,000; 2000--$299,000; 2001--$131,000; and 2002
and thereafter--$-0-.
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.
9. Stockholders' Equity
In October 1997, the Company completed its initial public offering of
5,750,000 shares of its common stock (the "Offering") at a public offering
price of $24.00 per share. Of the 5,750,000 shares, 2,875,000 shares were sold
by the Company and 2,875,000 shares were sold by certain selling stockholders
of the Company. The Offering provided the Company with proceeds of
approximately $63 million, net of expenses.
Under a Stockholder Rights Plan adopted by the Board of Directors in 1997,
each share of common stock includes one Right to purchase from the Company a
unit consisting of one one-hundredth of a share (a "Fractional Share") of
Series A Junior Participating Preferred Stock at a specified purchase price
per Fractional Share, subject to adjustment in certain events. The Rights will
cause substantial dilution to any person or group that attempts to acquire the
Company without the approval of the Company's Board of Directors.
28
<PAGE>
DRIL-QUIP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1998
10. Geographic Areas
<TABLE>
<CAPTION>
1996 1997 1998
-------- -------- --------
(In Thousands)
<S> <C> <C> <C>
Revenues
United States:
Domestic........................................ $ 36,759 $ 58,169 $ 67,021
Export.......................................... 7,561 7,447 33,016
Intercompany.................................... 28,188 22,260 22,738
-------- -------- --------
Total United States........................... 72,508 87,876 122,775
Europe, Middle East, and Africa................... 54,728 61,742 60,352
Asia-Pacific...................................... 16,944 20,119 17,718
Eliminations...................................... (28,316) (22,914) (23,203)
-------- -------- --------
Total......................................... $115,864 $146,823 $177,642
======== ======== ========
Operating Income
United States..................................... $ 13,693 $ 13,656 $ 24,266
Europe, Middle East, and Africa................... 3,309 5,026 (653)
Asia-Pacific...................................... 1,825 2,610 2,163
Eliminations...................................... (2,828) 260 (318)
-------- -------- --------
Total......................................... $ 15,999 $ 21,552 $ 25,458
======== ======== ========
Identifiable Assets
United States..................................... $ 50,664 $ 93,259 $117,237
Europe, Middle East, and Africa................... 59,564 51,904 55,768
Asia-Pacific...................................... 9,700 12,779 9,468
Eliminations...................................... (5,151) (5,021) (5,227)
-------- -------- --------
Total......................................... $114,777 $152,921 $177,246
======== ======== ========
</TABLE>
Export sales from the United States to unaffiliated customers consist of
worldwide sales outside the territorial waters of the United States. Europe
sales are primarily to the North Sea, with lesser sales to Africa and the
Middle East, while Asia-Pacific's sales are primarily to Australia, Thailand,
Malaysia, and Indonesia.
Eliminations of operating profits are related to intercompany inventory
transfers that are deferred until shipment is made to third party customers.
One of the Company's customers, the Royal Dutch Shell Group of Companies,
accounted for approximately 19%, 11% and 13% of consolidated sales in 1996,
1997 and 1998, respectively. In 1998 Chevron USA Production Company accounted
for approximately 11% of consolidated sales.
29
<PAGE>
DRIL-QUIP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
December 31, 1998
11. Employee Stock Option Plan and Awards
On September 19, 1997, the Company adopted the Dril-Quip, Inc. 1997
Incentive Plan. The Company reserved 1,700,000 shares of Common Stock for use
in connection with the Incentive Plan. Persons eligible for awards under the
Incentive Plan are employees holding positions of responsibility with the
Company or any of its subsidiaries. On the date of the Offering, options under
the Incentive Plan were granted to certain employees of the Company to
purchase a total of 411,250 shares of Common Stock at an exercise price per
share of $24.00 which was equal to the Offering price per share. In October
1998, 261,596 additional options were granted to certain employees at an
exercise price of $19.8125 per share, the mean between the highest and lowest
sale price per share of Common Stock on The New York Stock Exchange on the
date of the grant. All options 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. To date, no options have been exercised or cancelled. At
December 31, 1998, 102,813 options are exercisable at a price of $24.00 per
share.
Under SFAS No. 123, pro forma information is required to reflect the
estimated effect on net income and earnings per share as if the Company had
accounted for the stock options and other awards granted using the fair value
method described in that Statement. The fair value was estimated at the date
of each grant using a Black-Scholes option pricing model with the following
assumptions: a risk free rate of 6%, a volatility factor of the expected
market price of the Company's common stock of .350; and an expected life of
the options of 5 years. These assumptions resulted in a grant date fair value
for the options of $9.83 per share for the options granted in October, 1997
and $8.11 per share for the options granted in October, 1998. For purposes of
the pro forma disclosures, the estimated fair value is amortized to expense
over the awards' vesting period. The amortization of this expense would have
approximately a 4% and a 1% effect on net income and earnings per share in
1998 and 1997, respectively.
12. Quarterly Results of Operations: (unaudited)
<TABLE>
<CAPTION>
Quarter Ended
-------------------------------
March Sept.
31 June 30 30 Dec. 31
------- ------- ------- -------
(In Thousands, Except Share
Amounts)
<S> <C> <C> <C> <C>
1998
Revenues........................................ $40,816 $44,888 $47,125 $44,813
Operating income................................ 5,926 6,508 6,629 6,395
Net income...................................... 4,129 4,474 4,543 4,281
Earnings per share:
Basic......................................... 0.24 0.26 0.26 0.25
Diluted....................................... 0.24 0.26 0.26 0.25
1997
Revenues........................................ $34,216 $34,454 $38,003 $40,150
Operating income................................ 3,988 5,008 5,960 6,596
Net income...................................... 2,256 2,857 3,520 4,306
Earnings per share:
Basic(1)...................................... 0.16 0.20 0.24 0.26
Diluted(1).................................... 0.16 0.20 0.24 0.26
</TABLE>
- --------
(1) The sum of the quarterly per share amounts does not equal the annual
amount reported, as per share amounts are computed independently for each
quarter and for the full year.
30
<PAGE>
Item 9. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
The information required by this item is set forth under the captions
"Election of Directors" and "--Compliance with Section 16(a) of the Exchange
Act" in the Company's definitive Proxy Statement (the "1999 Proxy Statement")
for its annual meeting of stockholders to be held on May 13, 1999, 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
"Election of Directors--Director Compensation" and "--Executive Compensation"
in the 1999 Proxy Statement, which sections are incorporated herein by
reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management
The information required by this item is set forth in the section entitled
"Security Ownership of Certain Beneficial Owners and Management" in the 1999
Proxy Statement, which section is incorporated herein by reference.
Item 13. Certain Relationships and Related Party Transactions
The information required by this item is set forth in the section entitled
"Election of Directors--Certain Transactions" in the 1999 Proxy Statement,
which section is incorporated herein by reference.
31
<PAGE>
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K
(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 for which provision is made in the
applicable regulations of the Commission have been omitted because they are
not required under the relevant instructions or are inapplicable.
(a)(3) Exhibits
<TABLE>
<CAPTION>
Exhibit
No. Description
------- -----------
<C> <S>
*2.1 --Agreement and Plan of Merger by and Between Dril-Quip, Inc., a Texas
corporation, and Dril-Quip, Inc., a Delaware corporation
(Incorporated herein by reference to Exhibit 2.1 to the Company's
Registration Statement on Form S-1 (Registration No. 333-33447)).
*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 --Certificate of Designations for Series A Junior Participating
Preferred Stock (Incorporated herein by reference to Exhibit 3.3 to
the Company's Report on Form 10-Q for the Quarter ended September 30,
1997).
*4.1 --Form of certificate representing Common Stock (Incorporated herein
by reference to Exhibit 4.1 to the Company's Registration Statement
on Form S-1 (Registration No. 333-33447)).
*4.2 --Registration Rights Agreement among Dril-Quip, Inc. 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)).
*4.3 --Rights Agreement between Dril-Quip, Inc. and ChaseMellon Shareholder
Services, L.L.C., as rights agent (Incorporated herein by reference
to Exhibit 4.3 to the Company's Registration Statement on Form S-1
(Registration No. 333-33447)).
+*10.1 --Form of Employment Agreement between Dril-Quip, Inc. 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)).
+*10.2 --Dril-Quip, Inc. 1997 Incentive Plan (Incorporated herein by
reference to Exhibit 10.13 to the Company's Registration Statement on
Form S-1 (Registration No. 333-33447)).
21.1 --Subsidiaries of the Registrant.
23.1 --Consent of Ernst & Young LLP.
27.1 --Financial Data Schedule.
</TABLE>
- --------
* Incorporated herein by reference as indicated.
+ Management contract or compensatory plan or arrangement required to be
filed as an exhibit pursuant to the requirements of Item 14(c) of Form 10-
K.
(b) Reports on Form 8-K
None.
32
<PAGE>
SIGNATURES
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 March 29, 1999.
DRIL-QUIP, INC.
/s/ Larry E. Reimert
By: _________________________________
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.
<TABLE>
<S> <C>
</TABLE>
Name Capacity Date
/s/ J. Mike Walker Co-Chairman of the March 29, 1999
- ----------------------------------- Board and Director
J. Mike Walker (Co-Principal
Executive Officer)
/s/ Larry E. Reimert Co-Chairman of the March 29, 1999
- ----------------------------------- Board and Director
Larry E. Reimert (Co-Principal
Executive Officer)
/s/ Gary D. Smith Co-Chairman of the March 29, 1999
- ----------------------------------- Board and Director
Gary D. Smith (Co-Principal
Executive Officer)
/s/ Jerry M. Brooks Chief Financial March 29, 1999
- ----------------------------------- Officer (Principal
Jerry M. Brooks Financial and
Accounting Officer)
/s/ Gary W. Loveless Director March 29, 1999
- -----------------------------------
Gary W. Loveless
/s/ James M. Alexander Director March 29, 1999
- -----------------------------------
James M. Alexander
<PAGE>
EXHIBIT 21.1
SUBSIDIARIES OF THE COMPANY
Dril-Quip (Europe) Limited, a private limited company.
Dril-Quip Asia Pacific PTE Ltd., a private limited company.
DQ Holdings PTY Ltd., a private limited company.
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT AUDITORS
We consent to the incorporation by reference in the Registration Statement
(Form S-8 No. 333-47453) pertaining to the 1997 Incentive Plan of Dril-Quip,
Inc. of our report dated February 15, 1999, with respect to the consolidated
financial statements of Dril-Quip, Inc. included in the Annual Report (Form
10-K) for the year ended December 31, 1998.
ERNST & YOUNG LLP
Houston, Texas
March 27, 1999
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 11,869
<SECURITIES> 0
<RECEIVABLES> 44,527
<ALLOWANCES> 0
<INVENTORY> 55,536
<CURRENT-ASSETS> 117,202
<PP&E> 98,353
<DEPRECIATION> (38,600)
<TOTAL-ASSETS> 177,246
<CURRENT-LIABILITIES> 33,607
<BONDS> 0
0
0
<COMMON> 172
<OTHER-SE> 141,740
<TOTAL-LIABILITY-AND-EQUITY> 177,246
<SALES> 177,642
<TOTAL-REVENUES> 177,642
<CGS> 118,923
<TOTAL-COSTS> 152,184
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (1,197)
<INCOME-PRETAX> 26,655
<INCOME-TAX> 9,228
<INCOME-CONTINUING> 17,427
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 17,427
<EPS-PRIMARY> 1.01
<EPS-DILUTED> 1.01
</TABLE>
