DRIL-QUIP INC, 10-K, 2000-03-23

DRIL-QUIP INC
10-K, 2000-03-23
OIL & GAS FIELD MACHINERY & EQUIPMENT

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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, 1999

Commission file number: 001-13439

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Dril-Quip, Inc.
(Exact name of registrant as specified in its charter)

Delaware 74-2162088
(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)

13550 Hempstead Highway 77040
Houston, Texas (Zip code)
(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:

<TABLE>
<CAPTION>
Name of Each Exchange
Title of Each Class On Which Registered
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<S> <C>
Common Stock, $.01 par value per share New York Stock Exchange
Rights to purchase Series A Junior Participating New York Stock Exchange
Preferred Stock
</TABLE>

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. [_]

At March 20, 2000, the aggregate market value of the registrant's Common
Stock held by non-affiliates of the registrant was approximately $241,587,000
based on the closing price of such stock on such date of $40.

At March 20, 2000, the number of shares outstanding of registrant's Common
Stock was 17,250,624.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant's Proxy Statement for its 2000 Annual Meeting of
Stockholders 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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<C> <S> <C>
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.. 10
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.................. 12
Item 7A. Quantitative and Qualitative Disclosures About Market
Risk................................................. 17
Item 8. Financial Statements and Supplementary Data.......... 18
Item 9. Changes In and Disagreements With Accountants on
Accounting and Financial Disclosure.................. 31

PART III.................................................................. 32
Item 10. Directors and Executive Officers of the Registrant... 32
Item 11. Executive Compensation............................... 32
Item 12. Security Ownership of Certain Beneficial Owners and
Management........................................... 32
Item 13. Certain Relationships and Related Party
Transactions......................................... 32

PART IV................................................................... 32
Item 14. Exhibits, Financial Statement Schedules, and Reports
on Form 8-K.......................................... 33
</TABLE>

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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 the 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
cyclical nature 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 primarily through its internal product
development efforts. The Company believes that it has achieved significant
market share and brand name recognition with respect to its established
products due to the technological

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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 SS-15(R) subsea wellheads are among the most widely used in the
industry. During the 1990s, the Company 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. In the last year,
Dril-Quip developed a number of new products, including the SS-15 Big Bore
Subsea wellhead system, the SS-15ES Deepwater Wellhead System, the Quik-Lok
High Preload Specialty Casing Connector and an ultra-deepwater subsea
production tree.

Dril-Quip markets its products through its offices and sales representatives
located in all of the major international energy markets throughout the world.
In 1999, the Company generated approximately 48% 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 90 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.

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.

The decline in worldwide offshore exploration and production activity which
began in 1998 continued during 1999. This reduction in offshore activity
occurred as oil and gas companies reduced their budgets in response to low oil
prices that began in 1998 and continued through the first half of 1999.
Consequently, demand for Dril-Quip products, particularly those products used
in drilling and producing economically marginal properties, declined. Although
oil prices rebounded in the last half of 1999, any future 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
oil price levels will lead to increased oil and gas exploration and production
activity or that demand for the Company's products and services will reflect
such improvement, if any.

Products and Services

Product Group

Dril-Quip designs, manufactures, fabricates, inspects, assembles, tests and
markets subsea equipment, surface equipment and offshore rig equipment. In
1999, the Company derived approximately 88.3% 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

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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.
Sales of the Company's equipment in connection with TLPs, Spars and FPSOs are
becoming increasingly important sources of 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. In 1999, the
Company introduced its SS-15 Big Bore Subsea Wellhead System, which was
designed to accommodate additional casing strings installed through a
conventional marine riser and a subsea blowout preventer. 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. In addition, Dril-Quip introduced a new guidelineless subsea production
tree in 1999 for use in ultra-deepwater applications. This tree features
remote multiple flowline and control connections, utilizing remotely operated
intervention tools. This product is scheduled for installation during the
first half of 2000. The Company's subsea production trees are generally custom
designed and manufactured to customer specifications.

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

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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 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
11.7% of revenues in 1999.

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.

Reconditioning. The Company provides reconditioning of its products at its
facilities in Houston, Texas; Aberdeen, Scotland; Stavanger, Norway; and
Singapore.

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Rental. The Company rents running and installation tools for use in
installing its products. These tools are used to install and retrieve Company
products which are purchased by customers. Running tools are available from
Dril-Quip's locations in Houston, Texas; Aberdeen, Scotland; Stavanger,
Norway; Esbjerg, Denmark; Beverwijk, Holland; Singapore; 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. In addition, the Company's
manufacturing facility in Singapore is ISO 9001 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.

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%. During 1998 and 1999, this
expansion continued 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 768,000 square feet at the end of 1999. 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 2000
consolidation of finish machine operations under one roof. A new riser tower
and test pit and a new riser fabrication and assembly building have also been
added at the Eldridge site. The original three-year capital expenditure
program is expected to be completed during 2000.

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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.

In 1999, Chevron USA Production Company accounted for approximately 15% of
the Company's total revenues. However, the Company is not dependent on any one
customer or group of customers. 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 ten 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, India,
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 corrosive and water depths in excess of 5,000
feet. Since its founding, Dril-Quip has actively engaged in continuing

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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.

The Company has continually introduced new products and product enhancements
since its founding in 1981. In the 1990s, the Company introduced a series of
new products, including diverters, wellhead connectors, 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 as early as 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, 1999 was
1,061. Of these, 759 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 768,000 218 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 768,000
square feet of buildings located at the Eldridge site in Houston, Texas,
buildings consisting of approximately 240,000 square feet have been completed,
but were not in service as of December 31, 1999.

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........ 1,600 -- Sales/Service
Darwin, Australia....... 2,500 1.0 Service/Warehouse
Stavanger, Norway....... 15,700 8.5 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 involved in a number of legal actions arising in the ordinary
course of business. Although no assurance can be given with respect to the
ultimate outcome of such legal actions, in the opinion of management, the
ultimate liability with respect thereto will not have a material adverse
effect on the Company's financial position.

9
<PAGE>

Item 4. Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of security holders of the Company
during the quarter ended December 31, 1999.

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, 2000) and
positions of the Company's executive officers:

<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
Larry E. Reimert........ 52 Co-Chairman of the Board and Co-Chief Executive Officer
Gary D. Smith........... 57 Co-Chairman of the Board and Co-Chief Executive Officer
J. Mike Walker.......... 56 Co-Chairman of the Board and Co-Chief Executive Officer
Jerry M. Brooks......... 48 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, an 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

The Company's Common Stock has been publicly traded on the New York Stock
Exchange under the symbol DRQ since its initial public offering on October 22,
1997. The following table sets forth the quarterly high and low sales prices
for the indicated quarters of fiscal 1998 and 1999:

<TABLE>
<CAPTION>
Sales Price ($)
---------------------------
1998 1999
------------- -------------
Quarter Ended High Low High Low
------------- ------ ------ ------ ------
<S> <C> <C> <C> <C>
March 31....................................... 35 22 3/8 24 1/4 11 3/4
June 30........................................ 37 26 1/4 26 1/8 18
September 30................................... 26 1/2 11 3/4 30 1/2 17 5/8
December 31.................................... 22 1/2 13 1/8 30 7/8 21 1/8
</TABLE>

There were approximately 68 stockholders of record of the Company's Common
Stock as of March 20, 2000. 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.

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,
------------------------------------------------
1995 1996 1997 1998 1999
-------- -------- -------- -------- --------
(In Thousands, Except Per Share Amount)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Revenues..................... $108,390 $115,864 $146,823 $177,642 $156,368
Cost of sales................ 76,471 77,863 99,800 118,923 106,419
Selling, general and
administrative expenses..... 13,597 15,031 16,313 21,293 21,253
Engineering and product
development expenses........ 5,769 6,971 9,158 11,968 11,022
-------- -------- -------- -------- --------
95,837 99,865 125,271 152,184 138,694
Operating income............. 12,553 15,999 21,552 25,458 17,674
Interest expense (income).... 2,944 2,647 2,027 (1,197) (440)
-------- -------- -------- -------- --------
Income before income taxes... 9,609 13,352 19,525 26,655 18,114
Income tax provision......... 3,023 4,234 6,587 9,228 6,349
-------- -------- -------- -------- --------
Net income................... $ 6,586 $ 9,118 $ 12,938 $ 17,427 $ 11,765
======== ======== ======== ======== ========
Diluted earnings per share... $ .46 $ .63 $ .87 $ 1.01 $ .68
Weighted average shares
outstanding................. 14,370 14,370 14,895 17,275 17,277

Statement of Cash Flows Data:
Net cash provided by
operating activities........ $ 6,466 $ 5,185 $ 10,325 $ 9,118 $ 18,433
Net cash used in investing
activities.................. (5,659) (7,006) (10,240) (29,450) (19,748)
Net cash provided by (used
in) financing activities.... 560 1,261 31,386 (203) (165)

Other Data:
EBITDA(1).................... $ 17,201 $ 20,387 $ 26,541 $ 31,108 $ 24,352
Depreciation and
amortization................ 4,648 4,388 4,989 5,650 6,678
Capital expenditures......... 6,184 7,228 10,375 29,642 19,909
<CAPTION>
As of December 31,
------------------------------------------------
1995 1996 1997 1998 1999
-------- -------- -------- -------- --------
(In Thousands)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Working capital.............. $ 40,682 $ 49,524 $ 89,373 $ 83,595 $ 81,912
Total assets................. 93,186 114,777 152,921 177,246 179,463
Total debt................... 31,052 32,536 518 315 149
Total stockholders' equity... 39,501 50,882 124,161 141,912 152,624
</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.

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.

12
<PAGE>

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.

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 1999, the Company derived 88.3% of its revenues
from the sale of its products and 11.7% 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 60%, 62% and 48% of its revenues
derived from foreign sales in 1997, 1998 and 1999, respectively. During the
same years, approximately 74% of all products sold were manufactured in the
United States.

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.

13
<PAGE>

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,
-------------------
1997 1998 1999
----- ----- -----
<S> <C> <C> <C>
Revenues:
Product Group.............................................. 86.1% 87.9% 88.3%
Service Group.............................................. 13.9 12.1 11.7
----- ----- -----
Total.................................................. 100.0 100.0 100.0
Cost of sales.............................................. 68.0 67.0 68.1
Selling, general and administrative expenses............... 11.1 12.0 13.6
Engineering and product development expenses............... 6.2 6.7 7.0
----- ----- -----
Operating income........................................... 14.7 14.3 11.3
Interest expense (income).................................. 1.4 (0.7) (0.3)
----- ----- -----
Income before income taxes................................. 13.3 15.0 11.6
Income tax provision....................................... 4.5 5.2 4.1
----- ----- -----
Net income................................................. 8.8% 9.8% 7.5%
===== ===== =====
</TABLE>

Year Ended December 31, 1999 Compared to Year Ended December 31, 1998

Revenues. Revenues decreased by $21.2 million, or approximately 12%, to
$156.4 million in 1999 from $177.6 million in 1998. The decrease was primarily
attributable to depressed oil prices that began in 1998 and continued through
the first half of 1999, which led to worldwide exploration and production
budget cuts by most major oil companies. These reductions have resulted in
pricing pressure and lower demand for Dril-Quip products. Revenue decreases of
$17.5 million and $8.6 million in the European area and the Asia-Pacific area,
respectively, were offset by increased sales in the United States area of $4.9
million. Domestic sales in the United States area increased by $15.6 million,
or 23.3%, while export sales in the United States area decreased by $10.7
million, or 32.6%.

Cost of Sales. Cost of sales decreased by $12.5 million, or 11%, to $106.4
million for the twelve months ended December 31, 1999 from $118.9 million for
the same period in 1998. However, as a percentage of revenues, cost of sales
increased from 67% in 1998 to 68% in 1999, primarily due to pricing pressure
resulting from lower demand for Dril-Quip products.

Selling, General and Administrative Expenses. For both the twelve months
ended December 31, 1999 and 1998, selling, general and administrative expenses
were $21.3 million Selling, general and administrative expenses increased as a
percentage of revenues from 12% in 1998 to approximately 13.6% in 1999.

Engineering and Product Development Expenses. During the year ended December
31, 1999, engineering and product development expenses decreased by $946
thousand, or 8%, to $11.0 million from $12.0 million during the same period in
1998. This decrease primarily reflects a decreased number of personnel. As a
percentage of revenues, engineering and product development expenses increased
slightly from 6.7% in 1998 to approximately 7.0% in 1999.

14
<PAGE>

Interest Expense/Income. Interest income for 1999 was $440 thousand,
compared to interest income of $1.2 million for the prior year. This change
was primarily due to lower cash balances resulting from reduced operating
income and the Company using the proceeds from its initial public offering to
fund capital expenditures.

Net Income. Net income decreased by $5.6 million, or 32%, from $17.4 million
in 1998 to $11.8 million in 1999 for the reasons set forth above.

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 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.

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. The Company's principal sources of funds are cash flows from
operations and bank indebtedness. However, as a result of the Company's
October 1997 initial public offering of common stock, all of the Company's
bank indebtedness was repaid in 1997. Since that time, the Company has used
the remaining proceeds from the initial public offering and cash flows from
operations as its principal sources of funds.

Net cash provided by operating activities was $10.3 million in 1997, $9.1
million in 1998 and $18.4 million in 1999. Improvements in cash flow from
operating activities in 1999 were principally the result of decreased working
capital requirements attributable to decreases in trade receivables and
inventories, offset by decreases in trade accounts payable, accrued expenses
and net income. The decrease in cash flow from operating activities in 1998
was the result

15
<PAGE>

of a substantial increase in accounts receivable, offset by improved operating
results. Accounts receivable at December 31, 1999 decreased 17% over December
31, 1998 levels compared to a 12% decrease in revenues for the year. The
disproportionate decrease in accounts receivable was due to timing of cash
receipts and billings related to long-term projects.

Capital expenditures by the Company were $10.4 million, $29.6 million and
$19.9 million in 1997, 1998 and 1999, respectively. Principal payments on
long-term debt were $36.3 million, $200 thousand and $165 thousand in 1997,
1998 and 1999, respectively.

On August 27, 1999, the Company entered into a credit agreement with Bank
One, Texas, N.A. which provides for an unsecured revolving line of credit of
up to $10 million. At the election of the Company, borrowing under this
facility bears interest at either a rate equal to LIBOR (London Interbank
Offered Rate) plus 2% or the Bank One base rate. In addition, the facility
calls for quarterly interest payments and terminates on August 27, 2001. To
date, there have been no drawdowns under this facility.

The Company believes that cash on hand plus cash generated from operations
(in conjunction with its existing revolving line of credit, if necessary) will
be sufficient to fund operations, working capital needs and anticipated
capital expenditure requirements. However, should the above-mentioned market
conditions result in unexpected cash requirements, the Company believes that
additional 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 $130 million at December
31, 1998 and was approximately $81 million at December 31, 1999. This decrease
in backlog was primarily attributable to reduced demand for Dril-Quip products
resulting from the decline in worldwide exploration and production activity.
The Company expects to fill approximately 70% of the December 31, 1999 backlog
by December 31, 2000. The remaining backlog at December 31, 1999 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 fluctuated
significantly during 1998 and 1999. Any future 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, 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
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.

16
<PAGE>

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 1997, the Company had an exchange gain, net of income taxes,
of approximately $1.0 million. In 1998 and 1999, the Company had net losses of
approximately $195 thousand and $150 thousand, respectively. The gain in 1997
was primarily related to the repayment of debt and the losses in 1998 and 1999
were the result of slight currency fluctuations on payables and trade
receivables. 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

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. The Company
experienced no critical failures during the date roll-over from 1999 to 2000,
nor do we anticipate any critical failures during 2000.

Prior to the date roll-over, the Company addressed the Year 2000 problem
internally and progress was regularly reported to management and the board of
directors. The Company completed assessment, remediation and testing phases of
its Year 2000 program in the areas of information systems and automated
production systems prior to the date roll-over. The Company had also contacted
substantially all of its third party suppliers and vendors about their Year
2000 readiness prior to the date roll-over.

Although the Company believes that internal Year 2000 issues pose no
material threat to its business, results of operations or financial condition,
we cannot predict the potential impact of any post roll-over failures
experienced by third parties critical to the Company's operations. Post roll-
over Year 2000 failures among critical third parties could possibly cause
significant business interruptions. At this time, we cannot quantify the
potential impact of such failures. For this reason, the Company remains on
alert for third party Year 2000 failures.

The total cost of the Company's Year 2000 program prior to the date roll-
over was less than $200,000 and was not material to the Company's operations,
liquidity or capital resources. The Company does not expect any material
additional costs. Costs have been handled within the current information
systems budget, and no special allocations have been made.

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.

17
<PAGE>

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, 1999........................................................ 20
Consolidated Balance Sheets as of December 31, 1998 and 1999.............. 21
Consolidated Statements of Cash Flows for the Three Years in the Period
Ended December 31, 1999.................................................. 22
Consolidated Statements of Changes in Stockholders' Equity for the Three
Years in the Period Ended December 31, 1999.............................. 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, 1999 and 1998, 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, 1999. 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 auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the financial
statements. 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, 1999 and 1998, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States.

Ernst & Young LLP

Houston, Texas
February 21, 2000

19
<PAGE>

DRIL-QUIP, INC.

CONSOLIDATED STATEMENTS OF INCOME

<TABLE>
<CAPTION>
Year ended December 31
---------------------------------
1997 1998 1999
---------- ---------- ----------
(In Thousands, Except Share
Amounts)

<S> <C> <C> <C>
Revenues..................................... $ 146,823 $ 177,642 $ 156,368

Cost and expenses:
Cost of sales.............................. 99,800 118,923 106,419
Selling, general, and administrative....... 16,313 21,293 21,253
Engineering and product development........ 9,158 11,968 11,022
---------- ---------- ----------
125,271 152,184 138,694
---------- ---------- ----------
Operating income............................. 21,552 25,458 17,674
Interest expense (income).................... 2,027 (1,197) (440)
---------- ---------- ----------
Income before income taxes................... 19,525 26,655 18,114
Income tax provision......................... 6,587 9,228 6,349
---------- ---------- ----------
Net income................................... $ 12,938 $ 17,427 $ 11,765
========== ========== ==========

Earnings per share:
Basic...................................... $ .87 $ 1.01 $ .68
========== ========== ==========
Fully diluted.............................. $ .87 $ 1.01 $ .68
========== ========== ==========

Weighted average shares
Basic...................................... 14,881,986 17,245,000 17,245,000
========== ========== ==========
Fully diluted.............................. 14,895,222 17,275,222 17,277,101
========== ========== ==========
</TABLE>

The accompanying notes are an integral part of these statements.

20
<PAGE>

DRIL-QUIP, INC.

CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
December 31
------------------
1998 1999
ASSETS -------- --------
(In Thousands)
<S> <C> <C>
Current assets:
Cash and cash equivalents................................ $ 11,869 $ 10,456
Trade receivables........................................ 44,527 36,832
Inventories.............................................. 55,536 53,561
Deferred taxes........................................... 3,883 4,894
Prepaids and other current assets........................ 1,387 960
-------- --------
Total current assets................................... 117,202 106,703
Property, plant, and equipment, net........................ 59,753 72,288
Other assets............................................... 291 472
-------- --------
Total assets........................................... $177,246 $179,463
======== ========

<CAPTION>
LIABILITIES AND STOCKHOLDERS' EQUITY
<S> <C> <C>
Current liabilities:
Accounts payable......................................... $ 16,712 $ 12,775
Current maturities of long-term debt..................... 165 88
Accrued income taxes..................................... 1,637 482
Customer prepayments..................................... 9,039 5,119
Accrued compensation..................................... 3,742 4,439
Other accrued liabilities................................ 2,312 1,888
-------- --------
Total current liabilities.............................. 33,607 24,791
Long-term debt............................................. 150 61
Deferred taxes............................................. 1,577 1,987
-------- --------
Total liabilities...................................... 35,334 26,839
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........................................ 80,017 91,782
Foreign currency translation adjustment.................. (1,568) (2,621)
-------- --------
Total stockholders' equity............................. 141,912 152,624
-------- --------
Total liabilities and stockholders' equity............. $177,246 $179,463
======== ========
</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
----------------------------
1997 1998 1999
-------- -------- --------
(In Thousands)
<S> <C> <C> <C>
Operating activities
Net income...................................... $ 12,938 $ 17,427 $ 11,765
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization................. 4,989 5,650 6,678
Gain on sale of equipment..................... (9) (6) 139
Deferred income taxes......................... (189) 299 (599)
Changes in operating assets and liabilities:
Trade receivables........................... (2,822) (16,994) 7,570
Inventories................................. (2,763) (2,743) 1,166
Prepaids and other assets................... 133 (641) 229
Trade accounts payable and accrued expenses. (1,952) 6,126 (8,515)
-------- -------- --------
Net cash provided by operating activities....... 10,325 9,118 18,433

Investing activities
Purchase of property, plant, and equipment...... (10,375) (29,642) (19,909)
Proceeds from sale of equipment................. 135 192 161
-------- -------- --------
Net cash used in investing activities........... (10,240) (29,450) (19,748)

Financing activities
Proceeds from revolving line of credit and long-
term borrowings................................ 4,373 -- --
Principal payments on long-term debt............ (36,307) (203) (165)
Proceeds from sale of stock..................... 63,320 -- --
-------- -------- --------
Net cash provided by (used in) financing
activities..................................... 31,386 (203) (165)
Effect of exchange rate changes on cash
activities..................................... (220) (208) 67
-------- -------- --------
Increase (decrease) in cash..................... 31,251 (20,743) (1,413)
Cash at beginning of period..................... 1,361 32,612 11,869
-------- -------- --------
Cash at end of period........................... $ 32,612 $ 11,869 $ 10,456
======== ======== ========
</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, 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
---------
Translation adjustment........ -- -- -- (1,053) (1,053)
Net income.................... -- -- 11,765 -- 11,765
---------
Comprehensive income.......... -- -- -- -- 10,712
----- -------- -------- -------- ---------
Balance at December 31, 1999.... $ 172 $ 63,291 $ 91,782 $ (2,621) $ 152,624
===== ======== ======== ======== =========
</TABLE>

The accompanying notes are an integral part of these statements.

23
<PAGE>

DRIL-QUIP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

December 31, 1999

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, 1998 and
1999, cash and cash equivalents include $10,075,000 and $9,265,000,
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.

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.

24
<PAGE>

DRIL-QUIP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued

December 31, 1999

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, 1999 and 1998, trade receivables
included $10,458,000 and $11,032,000, respectively, in unbilled revenue, and
inventories have been reduced by $21,856,000 and $22,571,000, 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 loss of $2,978,000 in 1997, a gain of $324,000 in 1998 and a loss of
$1,053,000 in 1999, net of allocated income taxes of $772,000 $316,000 and $0,
respectively.

Foreign currency exchange transactions are recorded using the exchange rate
at the date of the settlement. Exchange gains (losses) were approximately
$1,080,000 in 1997, ($195,000) in 1998 and ($150,000) in 1999, 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 StandardsNo. 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.

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.

3. Inventories

Inventories consist of the following:

<TABLE>
<CAPTION>
December 31
----------------
1998 1999
-------- -------
(In Thousands)
<S> <C> <C>
Raw materials and supplies............................... $ 13,114 $15,012
Work in progress......................................... 18,114 11,731
Finished goods and purchased supplies.................... 24,308 26,818
-------- -------
$ 55,536 $53,561
======== =======
</TABLE>

25
<PAGE>

DRIL-QUIP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued

December 31, 1999

4. Property, Plant, and Equipment

Property, plant, and equipment consist of:

<TABLE>
<CAPTION>
December 31
Estimated ----------------
Useful Lives 1998 1999
------------ ------- --------
(In Thousands)
<S> <C> <C> <C>
Land and improvements..................... 10-25 years $ 8,513 $ 11,358
Buildings................................. 15-40 years 27,063 31,590
Machinery and equipment................... 3-10 years 62,777 73,421
------- --------
98,353 116,369
Less accumulated depreciation............. 38,600 44,081
------- --------
$59,753 $ 72,288
======= ========
</TABLE>

5. Long-Term Debt

Long-term debt consists of the following:

<TABLE>
<CAPTION>
December 31
---------------
1998 1999
------- -------
(In Thousands)
<S> <C> <C>
Equipment financing agreements............................ $ 315 $ 149
Less current portion...................................... 165 88
------- ------
$ 150 $ 61
======= ======
</TABLE>

Interest paid on long-term debt for the years ended December 31, 1997, 1998
and 1999 was $2,563,000, $44,000, and $55,000 respectively. Scheduled
maturities of long-term debt are as follows: 2000--$88,000; 2001--$49,000;
2002--$12,000; 2003 and thereafter--$-0-.

On August 27, 1999, the Company entered into a credit agreement with Bank
One, Texas, N.A., which provides for an unsecured revolving line of credit of
up to $10.0 million. At the election of the Company, borrowings under this
facility bear interest at either a rate equal to LIBOR, plus 2% or the Bank
One base rate. In addition, the facility calls for quarterly interest payments
and terminates on August 27, 2001. At December 31, 1999, there were no amounts
outstanding under this facility.

6. Income Taxes

Income before income taxes consisted of the following:

<TABLE>
<CAPTION>
1997 1998 1999
-------- -------- --------
(In Thousands)
<S> <C> <C> <C>
Domestic..................................... $ 13,547 $ 26,404 $ 20,758
Foreign...................................... 5,978 251 (2,644)
-------- -------- --------
Total........................................ $ 19,525 $ 26,655 $ 18,114
======== ======== ========
</TABLE>

26
<PAGE>

DRIL-QUIP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued

December 31, 1999

The income tax provision consists of the following:

<TABLE>
<CAPTION>
1997 1998 1999
------- ------- -------
(In Thousands)
<S> <C> <C> <C>
Current:
Federal...................................... $ 4,640 $ 8,894 $ 6,620
Foreign...................................... 2,258 36 330
------- ------- -------
Total current.............................. 6,898 8,930 6,950
Deferred:
Federal...................................... 55 (16) 232
Foreign...................................... (366) 314 (833)
------- ------- -------
Total deferred............................. (311) 298 (601)
------- ------- -------
$ 6,587 $ 9,228 $ 6,349
======= ======= =======

The difference between the effective tax rate reflected in the provision for
income taxes and the U.S. federal statutory rate was as follows:

<CAPTION>
1997 1998 1999
------- ------- -------
<S> <C> <C> <C>
Federal income tax statutory rate.............. 35.0% 35.0% 35.0%
Benefit of foreign sales corporation........... (1.2) (1.7) (1.6)
Other.......................................... (.1) 1.3 1.6
------- ------- -------
Effective tax rate............................. 33.7% 34.6% 35.0%
======= ======= =======
</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
---------------
1998 1999
------- -------
(In Thousands)
<S> <C> <C>
Deferred tax liability:
Property, plant and equipment.......................... $ 1,577 $ 1,987
Deferred tax assets:
Deferred profit on intercompany sales.................. 2,815 2,807
Other--net............................................. 1,068 2,087
------- -------
Total deferred tax assets................................ 3,883 4,894
------- -------
Net deferred tax asset................................... $ 2,306 $ 2,907
======= =======
</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 $7,143,000, $8,813,000 and $8,116,000 in
income taxes in 1997, 1998 and 1999, respectively.

27
<PAGE>

DRIL-QUIP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued

December 31, 1999

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 $601,000, $652,000 and $744,000 in 1997, 1998 and
1999, respectively.

8. Commitments and Contingencies

The Company leases certain office, shop and warehouse facilities,
automobiles, and equipment. The Company expenses all lease payments when
incurred. Total lease expense incurred was $771,000, $1,167,000 and $1,266,000
in 1997, 1998 and 1999, respectively. Annual minimum lease commitments at
December 31, 1999 are as follows: 2000--$692,000; 2001--$386,000; and 2002--
$117,000 and thereafter--$4,000.

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.

The Company is involved in a number of legal actions arising in the ordinary
course of business. In the opinion of management, the amount of ultimate
liability with respect to these actions will not materially affect the
consolidated financial statements of the Company, although no assurance can be
given with respect to the ultimate outcome of this litigation.

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, 1999

10. Geographic Areas

<TABLE>
<CAPTION>
1997 1998 1999
-------- -------- --------
(In Thousands)
<S> <C> <C> <C>
Revenues
United States:
Domestic........................................ $ 58,169 $ 67,021 $ 82,634
Export.......................................... 7,447 33,016 22,269
Intercompany.................................... 22,260 22,738 10,727
-------- -------- --------
Total United States........................... 87,876 122,775 115,630
Europe, Middle East, and Africa................... 61,742 60,352 42,989
Asia-Pacific...................................... 20,119 17,718 9,112
Eliminations...................................... (22,914) (23,203) (11,363)
-------- -------- --------
Total......................................... $146,823 $177,642 $156,368
======== ======== ========
Operating Income
United States..................................... $ 13,656 $ 24,266 $ 21,645
Europe, Middle East, and Africa................... 5,026 (653) (2,160)
Asia-Pacific...................................... 2,610 2,163 (545)
Eliminations...................................... 260 (318) (1,266)
-------- -------- --------
Total......................................... $ 21,552 $ 25,458 $ 17,674
======== ======== ========
Identifiable Assets
United States..................................... $ 93,259 $117,237 $127,233
Europe, Middle East, and Africa................... 51,904 55,768 49,048
Asia-Pacific...................................... 12,779 9,468 8,395
Eliminations...................................... (5,021) (5,227) (5,213)
-------- -------- --------
Total............................................. $152,921 $177,246 $179,463
======== ======== ========
</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 11% and 13% of consolidated sales in 1997 and
1998, respectively. In 1998 and 1999, Chevron USA Production Company accounted
for approximately 11% and 15% of consolidated sales, respectively.

11. Employee Stock Option Plan and Awards

On September 19, 1997 the Company adopted the Dril-Quip, Inc. 1997 Incentive
Plan (the "1997 Plan"). The Company reserved 1,700,000 shares of Common Stock
for use in connection with the 1997 Plan. Persons eligible for awards under
the 1997 Plan are employees holding positions of responsibility with the
Company or any of its subsidiaries. Options granted under the 1997 Plan have a
term of ten years and became exercisable in

29
<PAGE>

DRIL-QUIP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued

December 31, 1999
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. Option activity for the years ended December 31, 1997, 1998 and
1999 were as follows:

<TABLE>
<CAPTION>
Weighted
Average
Number of Exercise
Options Price
--------- --------

<S> <C> <C>
Outstanding at January 1, 1997............................... 0 $ 0.00
Granted--1997 Plan....................................... 411,250 24.00
------- ------
Outstanding at December 31, 1997............................. 411,250 24.00
Granted--1997 Plan....................................... 261,596 19.81
------- ------
Outstanding at December 31, 1998............................. 672,846 22.37
Granted--1997 Plan....................................... 250,280 23.44
------- ------
Outstanding at December 31, 1999............................. 923,126 $22.66
======= ======
<CAPTION>
Weighted
Average
Number of Exercise
Options Price
--------- --------
<S> <C> <C>
Exercisable, December 31,
1997....................................................... 0 $ 0.00
1998....................................................... 102,813 $24.00
1999....................................................... 271,024 $22.99
</TABLE>

Exercise price for options outstanding as of December 31, 1999, ranged from
$19.81 per share to $24.00 per share. The weighted-average remaining
contractual life at those options was 8.2 years.

The Company applied Accounting Principles Board Opinion No. 25 ("APB No.
25") and related interpretations in accounting for this plan. Accordingly, no
compensation cost has been recognized during the years ended December 31,
1997, 1998 and 1999. 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 .761; 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, $8.11 per share for the options granted in October, 1998 and
$15.49 per share for the options granted in October, 1999. The Company does
not presently anticipate issuing dividends in the future. Had compensation
cost for the Company's stock-based compensation plans been determined based on
the fair value at the grant dates for awards under the above plan consistent
with the method available under SFAS No. 123, the

30
<PAGE>

DRIL-QUIP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--Continued

December 31, 1999
Company's net income and earnings per share for the years ended December 31,
1997, 1998 and 1999 would have been reduced to the pro forma amounts listed
below.

<TABLE>
<CAPTION>
Year Ended December 31,
-----------------------
1997 1998 1999
------- ------- -------
<S> <C> <C> <C>
Net Income
As reported........................................... $12,938 $17,427 $11,765
======= ======= =======
Pro forma............................................. $12,809 $16,730 $11,071
======= ======= =======
Earnings per share
Basic................................................. $ .87 $ 1.01 $ .68
======= ======= =======
Diluted............................................... $ .87 $ 1.01 $ .68
======= ======= =======
Pro forma
Basic................................................. $ .86 $ .97 $ .64
======= ======= =======
Diluted............................................... $ .86 $ .97 $ .64
======= ======= =======
</TABLE>

12. Quarterly Results of Operations: (unaudited)

<TABLE>
<CAPTION>
Quarter Ended
---------------------------------------
March 31 June 30 Sept. 30 Dec. 31
--------- --------- --------- ---------
(In Thousands, Except Share Amounts)
<S> <C> <C> <C> <C>
1999
Revenues................................ $ 39,584 $ 39,895 $ 38,813 $ 38,076
Operating income........................ 4,726 4,354 4,418 4,176
Net income.............................. 3,142 2,897 2,945 2,781
Earnings per share:
Basic (1)............................. 0.18 0.17 0.17 0.16
Diluted (1)........................... 0.18 0.17 0.17 0.16

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 (1)............................. 0.24 0.26 0.26 0.25
Diluted (1)........................... 0.24 0.26 0.26 0.25
</TABLE>
- --------
(1) The sum of the quarterly per share amounts may not equal the annual amount
reported, as per share amounts are computed independently for each quarter
and for the full year.

Item 9. Changes In and Disagreements With Accountants on Accounting and
Financial Disclosure

None.

31
<PAGE>

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 "2000 Proxy Statement")
for its annual meeting of stockholders to be held on May 9, 2000, 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 2000 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 2000
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 2000 Proxy Statement,
which section is incorporated herein by reference.

32
<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
------- -----------
*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)).

<C> <S>
*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 the Company and certain
stockholders (Incorporated herein by reference to Exhibit 4.2 to the
Company's Registration Statement on Form S-1 (Registration No. 333-
33447)).

*4.3 --Rights Agreement between the Company 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 --Credit Agreement between the Company and Bank One, Texas, N.A. dated
August 27, 1999 (Incorporated herein by reference to Exhibit 10.1 to
the Company's Report on Form 10-Q for the Quarter ended September 30,
1999).

+*10.2 --Form of Employment Agreement between the Company and each of Messrs.
Reimert, Smith and Walker (Incorporated herein by reference to
Exhibit 10.12 to the Company's Registration Statement On Form S-1
(Registration No. 333-33447)).

+*10.3 --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 (Incorporated herein by reference to
Exhibit 21.1 of the Company's Annual Report on Form 10-K for the year
ended December 31, 1998).

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.

33
<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 22, 2000.

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 22, 2000
- ----------------------------------- Board and Director
J. Mike Walker (Co-Principal
Executive Officer)

/s/ Larry E. Reimert Co-Chairman of the March 22, 2000
- ----------------------------------- Board and Director
Larry E. Reimert (Co-Principal
Executive Officer)

/s/ Gary D. Smith Co-Chairman of the March 22, 2000
- ----------------------------------- Board and Director
Gary D. Smith (Co-Principal
Executive Officer)

/s/ Jerry M. Brooks Chief Financial March 22, 2000
- ----------------------------------- Officer (Principal
Jerry M. Brooks Financial and
Accounting Officer)

/s/ Gary W. Loveless Director March 22, 2000
- -----------------------------------
Gary W. Loveless

/s/ James M. Alexander Director March 22, 2000
- -----------------------------------
James M. Alexander

<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 21, 2000, 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, 1999.

/s/ Ernst & Young LLP

Houston, Texas
March 23, 2000

<PAGE>

<ARTICLE> 5
<MULTIPLIER> 1,000

<S> <C> <C>
<PERIOD-TYPE> 12-MOS 12-MOS
<FISCAL-YEAR-END> DEC-31-1998 DEC-31-1999
<PERIOD-START> JAN-01-1998 JAN-01-1999
<PERIOD-END> DEC-31-1998 DEC-31-1999
<CASH> 11,869 10,456
<SECURITIES> 0 0
<RECEIVABLES> 44,527 36,832
<ALLOWANCES> 0 0
<INVENTORY> 55,536 53,561
<CURRENT-ASSETS> 117,202 106,703
<PP&E> 98,353 116,369
<DEPRECIATION> (38,600) (44,081)
<TOTAL-ASSETS> 177,246 179,463
<CURRENT-LIABILITIES> 33,607 24,791
<BONDS> 0 0
0 0
0 0
<COMMON> 172 172
<OTHER-SE> 141,740 152,452
<TOTAL-LIABILITY-AND-EQUITY> 177,246 179,463
<SALES> 177,642 156,368
<TOTAL-REVENUES> 177,642 156,368
<CGS> 118,923 106,419
<TOTAL-COSTS> 152,184 138,694
<OTHER-EXPENSES> 0 0
<LOSS-PROVISION> 0 0
<INTEREST-EXPENSE> (1,197) (440)
<INCOME-PRETAX> 26,655 18,114
<INCOME-TAX> 9,228 6,349
<INCOME-CONTINUING> 17,427 11,765
<DISCONTINUED> 0 0
<EXTRAORDINARY> 0 0
<CHANGES> 0 0
<NET-INCOME> 17,427 11,765
<EPS-BASIC> 1.01 0.68
<EPS-DILUTED> 1.01 0.68

</TABLE>