Back to GetFilings.com
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
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, 1997
COMMISSION FILE NUMBER: 001-13439
----------------
DRIL-QUIP, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
74-2162088
DELAWARE (IRS EMPLOYER
(STATE OR OTHER JURISDICTION OF IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
77040
13550 HEMPSTEAD HIGHWAY (ZIP CODE)
HOUSTON, TEXAS
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (713) 939-7711
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:
NAME OF EACH EXCHANGE
TITLE OF EACH CLASS ON WHICH REGISTERED
------------------- ---------------------
Common Stock, $.01 par value per share New York Stock Exchange
Rights to purchase Series A Junior Participating
Preferred Stock New York Stock Exchange
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 17, 1998, the aggregate market value of the registrant's Common
Stock held by non-affiliates of the registrant was approximately $149,113,663
based on the closing price of such stock on such date of $26 1/8.
At March 17, 1998, the number of shares outstanding of registrant's Common
Stock was 17,245,000.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant's 1998 Proxy Statement for the Annual Meeting of
Shareholders to be filed pursuant to Regulation 14A are incorporated by
reference in Part III of this Form 10-K.
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
TABLE OF CONTENTS
PART I................................................................ 1
Item 1. Business......................................... 1
Item 2. Properties....................................... 10
Item 3. Legal Proceedings................................ 10
Item 4. Submission of Matters to a Vote of Security
Holders.......................................... 10
Item S-K 401(b). Executive Officers of the Registrant............. 11
PART II............................................................... 12
Item 5. Market for Registrant's Common Stock and Related
Shareholder Matters.............................. 12
Item 6. Selected Financial Data.......................... 13
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............. 14
Item 7A. Quantitative and Qualitative Disclosures About
Market Risk...................................... 19
Item 8. Financial Statements and Supplementary Data...... 19
Item 9. Changes In and Disagreements With Accountants on
Accounting and Financial Disclosure.............. 32
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............................................................... 33
Item 14. Exhibits, Financial Statement Schedules, and
Reports on Form 8-K.............................. 33
i
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"). All
statements, other than statements of historical facts, included in this Annual
Report on Form 10-K that address activities, events or developments that the
Company expects, projects, believes or anticipates will or may occur in the
future, including such matters as business strategy, plans and objectives of
management of the Company for future operations and future industry
conditions, are forward-looking statements. These statements are based on
certain assumptions and analyses made by management of the Company 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 the risk factors discussed herein, general
economic and business conditions, prices of crude oil and natural gas, foreign
exchange and currency fluctuations, changes in laws or regulations and other
factors beyond the control of the Company. Prospective investors are cautioned
that any such statements are not guarantees of future performance and that
actual results or developments may differ materially from those projected in
the forward-looking statements.
PART I
ITEM 1. BUSINESS
GENERAL
Dril-Quip, Inc., a Delaware corporation ("Dril-Quip" or the "Company"), is
one of the world's leading manufacturers of highly engineered offshore
drilling and production equipment which is well suited for use in deepwater,
harsh environment and severe service applications. The Company designs and
manufactures subsea equipment, surface equipment and offshore rig equipment
for use by major integrated, large independent and foreign national oil and
gas companies in offshore areas throughout the world. The Company's principal
products consist of subsea and surface wellheads, subsea and surface
production trees, mudline hanger systems, specialty connectors and associated
pipe, drilling and production riser systems, wellhead connectors and
diverters. The Company also provides installation and reconditioning services
and rents running tools for use in connection with the installation and
retrieval of its products.
Dril-Quip has developed its broad line of subsea equipment, surface
equipment and offshore rig equipment exclusively through its internal product
development efforts. The Company believes that it has achieved significant
market share and brand name recognition with respect to its established
products due to the technological capabilities, reliability, cost
effectiveness and operational timesaving features of these products. In
particular, the Company's Quik-Thread(R) and Quik-Stab(R) specialty
connectors, MS-15(R) mudline hanger systems and SS-10(R) and SS-15(R) subsea
wellheads are among the most widely used in the industry. Since 1991, the
Company has introduced a number of new products, including diverters, wellhead
connectors, dual-bore and single-bore subsea production trees, subsea and
platform valves, platform wellheads, platform trees, drilling risers and Spar
and TLP production risers.
The Company has experienced increased demand for its products due to the
increased drilling and production activity in offshore areas throughout the
world during the last several years, particularly in deeper waters. The
increase in offshore drilling and production activity has been driven by a
number of factors, including (i) the prospect for relatively larger
hydrocarbon discoveries in deepwater areas and (ii) recent technological
advances in offshore drilling and production equipment (including those
introduced by Dril-Quip), seismic data collection and interpretation
techniques, and drilling techniques, which have enhanced the economics of
offshore drilling and production. In addition, several foreign national oil
companies have recently opened offshore areas for exploration and development
by other parties, including major integrated and large independent oil and gas
companies.
Dril-Quip markets its products through its offices and sales representatives
located in all of the major international energy markets throughout the world.
In 1997, the Company generated approximately 60% of its revenues from foreign
sales. The Company manufactures its products at its facilities located in
Houston, Texas;
1
Aberdeen, Scotland; and Singapore, and maintains additional facilities for
fabrication and/or reconditioning in Norway, Denmark and Australia. Dril-
Quip's manufacturing operations are vertically integrated, with the Company
performing substantially all of its forging, heat treating, machining,
fabrication, inspection, assembly and testing at its own facilities.
The Company was co-founded as a Texas corporation in 1981 by Larry E.
Reimert, Gary D. Smith, J. Mike Walker and Gary W. Loveless. Together, Messrs.
Reimert, Smith and Walker have over 75 years of combined experience in the
oilfield equipment industry, essentially all of which has been with the
Company and its major competitors. In addition, key department managers have
been with the Company over 10 years, on average. The Company was
reincorporated as a Delaware corporation on August 12, 1997.
On October 28, 1997, the Company sold 2,875,000 shares of common stock, par
value $.01 per share ("Common Stock") in an initial public offering (the
"Offering"). The net proceeds to the Company from the Offering were
approximately $63.4 million. The Company repaid approximately $30 million of
indebtedness with the proceeds from the Offering and is using the remaining
proceeds to expand its manufacturing capacity, improve and expand facilities
and manufacture additional running tools for rental.
INDUSTRY OVERVIEW
The market for offshore drilling and production equipment and services is
fundamentally driven by the exploration, development and production spending
of oil and gas companies, particularly with respect to offshore activities
worldwide. Industry exploration, development and production spending primarily
depends on the cash flow of oil and gas producers, which is a function of
current and anticipated future oil and gas production volumes and prices and
operating costs of oil and gas producers. Oil and gas prices are influenced
significantly by a variety of factors beyond the control of oil and gas
companies, including worldwide demand for oil and gas, production levels,
governmental policies regarding exploration and development of reserves and
political factors in production countries. Fundamental economics in the oil
and gas sector have improved in recent years. Much of the incremental supply
in recent years has come from areas outside the Organization of Petroleum
Exporting Countries ("OPEC"), particularly in offshore regions such as the
North Sea, the Gulf of Mexico and offshore Southeast Asia. These factors have
contributed to generally higher, and relatively more stable, oil and gas
prices during the last several years, although hydrocarbon prices have
declined in recent months. There can be no assurance that this recent down
trend in hydrocarbon prices will not continue.
Since 1995, offshore exploration, development and production activity has
increased considerably due to, among other factors, (i) favorable oil and gas
prices (with the exception of the recent decline in hydrocarbon prices), (ii)
significant improvement in the financial condition of many oil and gas
companies in recent years, (iii) increasing worldwide demand for hydrocarbons,
(iv) the potential for relatively large oil and gas discoveries in various
offshore areas, particularly previously unexplored deepwater areas, (v) the
opening of new offshore areas for foreign investment, including areas offshore
of Brazil, China and West Africa, and (vi) royalty relief granted by the U.S.
government for oil and gas produced from wells drilled in newly acquired
deepwater blocks in the Gulf of Mexico. In addition, technological advances in
exploration, development and production techniques, including seismic data
collection and interpretation (particularly with respect to 3-D seismic data),
drilling techniques (such as the use of deviated, horizontal and multilateral
wells), subsea completion and production equipment, and mobile production
units have contributed to increased offshore activity by oil and gas
companies. These factors have facilitated exploration for and development of
new reserves in deepwater and harsh environment offshore areas, allowed the
development of oil and gas fields that were considered commercially marginal
and extended development and production of reserves from existing fields.
The Company's business is substantially dependent upon the condition of the
oil and gas industry and, in particular, the willingness of oil and gas
companies to make capital expenditures on exploration, drilling and production
operations offshore. The level of capital expenditures is generally dependent
on the prevailing view of future oil and gas prices, which are influenced by
numerous factors affecting the supply and demand for oil and gas,
2
including worldwide economic activity, interest rates and the cost of capital,
environmental regulation, tax policies, coordination by OPEC, 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 been
characterized by significant volatility in recent years. Although the level of
offshore exploration, drilling and production activity has increased in recent
years, hydrocarbon prices have declined in recent months, and there can be no
assurance that such activity levels will be sustained and that there will not
be continued volatility in the level of drilling and production related
activities. A significant and prolonged decline in hydrocarbon prices would
likely have a material adverse effect on the Company's results of operations.
There can be no assurance that the current level of oil and gas exploration,
drilling and production activity will be maintained or that demand for the
Company's products and services will reflect the level of such activity.
PRODUCTS AND SERVICES
Product Group
Dril-Quip designs, manufactures, fabricates, inspects, assembles, tests and
markets subsea equipment, surface equipment and offshore rig equipment. In
1997, the Company derived approximately 86% of its revenues from the sale of
its products. The Company's products are used to explore for oil and gas on
offshore drilling rigs, such as floating rigs and jack-ups, and for drilling
and production of oil and gas wells on offshore platforms, TLPs, Spars and
moored vessels such as FPSOs. TLPs are floating production platforms that are
connected to the ocean floor via vertical mooring tethers (called tension
legs). A Spar is a floating cylindrical structure approximately six or seven
times longer than its diameter that is anchored in place (like a Spar buoy).
FPSOs are floating production, storage and offloading monohull moored vessels.
Major oil companies are actively pursuing TLPs, Spars and FPSOs as cost-
effective means of producing oil and gas from water depths in excess of 1,000
feet. The Company believes that sales of its equipment in connection with
TLPs, Spars and FPSOs are potentially important sources of future revenues.
Subsea Equipment. Subsea equipment is used in the drilling and production of
offshore oil and gas wells around the world. Included in the subsea equipment
product line are subsea wellheads, mudline hanger systems, specialty
connectors and associated pipe, subsea production trees, valves and TLP and
Spar well systems.
Subsea wellheads are pressure-containing forged and machined metal housings
in which casing hangers are landed and sealed subsea to suspend casing
(downhole pipe). As drilling depth increases, successively smaller diameter
casing strings are installed, each suspended by an independent casing hanger.
Subsea wellheads are utilized when drilling from floating drilling rigs,
either semi-submersible or drillship types, and TLPs and Spars. Competitive
advantages of the Company's subsea wellheads include proprietary metal-to-
metal seal technology and simple installation procedures. 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. Dril-Quip's MS-15(R) mudline hanger systems are technologically advanced
products designed for simple operation while providing high load and high
pressure capacity. 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, and,
although more expensive, their use becomes economically attractive when time
savings are considered, particularly as the rig day rate charged by offshore
drilling contractors increases. 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.
3
A subsea production tree is an assembly composed of valves, a wellhead
connector, control equipment and various other components installed on a
subsea wellhead or a mudline hanger system and used to control the flow of oil
and gas from a producing well. Subsea trees may be either stand alone
satellite type or template mounted cluster arrangements. Both types typically
produce via flowlines to a central control point located on a platform, TLP,
Spar or FPSO. The use of subsea production trees has become an increasingly
important method for producing wells located in hard-to-reach deepwater areas
or economically marginal fields located in shallower waters. The Company is an
established manufacturer of more complicated dual-bore production trees, which
are used in severe service applications. In addition, Dril-Quip manufactures a
patented single bore (SingleBore(TM)) subsea completion system which features
a hydraulic mechanism instead of a wireline-installed mechanism that allows
the operator to plug the tubing hanger annulus remotely from the surface via a
hydraulic control line and subsequently unplug it when the well is put on
production. This mechanism eliminates the need for an expensive multibore
installation and workover riser, thereby saving both cost and installation
time. The Company's subsea production trees are generally custom designed and
manufactured to customer specifications.
Surface Equipment. Surface equipment is principally used for flow control on
offshore production platforms, TLPs and Spars. Included in the Company's
surface equipment product line are platform wellheads and platform production
trees. Dril-Quip's development of platform wellheads and platform production
trees was facilitated by adaptation of its existing subsea wellhead and tree
technology to surface wellheads and trees.
Platform wellheads are pressure-containing forged and machined metal
housings in which casing hangers are landed and sealed at the platform deck to
suspend casings. The Company emphasizes the use of metal-to-metal sealing
wellhead systems with operational time-saving features which can be used in
high pressure, high temperature and corrosive drilling and production
applications.
After installation of a wellhead, a platform production tree, consisting of
gate valves, a wellhead connector, controls, tree cap and associated
equipment, is installed on the wellhead to control and regulate oil or gas
production. Platform production trees are similar to subsea production trees
but utilize less complex equipment and more manual, rather than hydraulically
activated, valves and connectors. Platform wellheads and platform production
trees and associated equipment are designed and manufactured in accordance
with customer specifications.
Offshore Rig Equipment. Offshore rig equipment includes drilling and
production riser systems, wellhead connectors and diverters. The drilling
riser system consists of (i) lengths of riser pipe and associated riser
connectors that secure one to another; (ii) the telescopic joint, which
connects the entire drilling riser system to the diverter at the rig and
provides a means to compensate for vertical motion of the rig relative to the
ocean floor; and (iii) the wellhead connector, which provides a means for
remote connection and disconnection of the drilling riser system to and from
the BOP stack. Production risers provide a vertical conduit from the subsea
wellhead to a TLP, Spar or FPSO. The wellhead connector also provides remote
connection/disconnection of the BOP stack, production tree or production riser
to/from the wellhead. Diverters are used to provide protection from shallow
gas blowouts and to divert gases off of the rig during the drilling operation.
Wellhead connectors and drilling and production riser systems are also used
on both TLPs and Spars, which are being installed more frequently in deepwater
applications. The Company has recently introduced drilling and production
risers as new product lines. 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.
4
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
14% of revenues in 1997.
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.
Rental. The Company rents running and installation tools for use in
installing its products. These tools are used to install and retrieve Company
products which are purchased by customers. Running tools are available from
Dril-Quip's locations in Houston, Texas; Aberdeen, Scotland; Stavanger,
Norway; Esbjerg, Denmark; Singapore; and Perth, Australia.
MANUFACTURING
Dril-Quip has major manufacturing facilities in Houston, Texas; Aberdeen,
Scotland; and Singapore. Each location conducts a broad variety of processes,
including machining, fabrication, inspection, assembly and testing. The
Houston facility provides forged and heat treated products to all the major
manufacturing facilities.
The Company's Houston and Aberdeen manufacturing plants are ISO 9001 and
American Petroleum Institute certified. See "Properties--Major Manufacturing
Facilities." Dril-Quip maintains its high standards of product quality through
the use of quality assurance specialists who work with product manufacturing
personnel throughout the manufacturing process by inspecting and documenting
equipment as it is processed through the Company's manufacturing facilities.
The Company has the capability to manufacture various products from each of
its product lines at its major manufacturing facilities and believes that this
localized manufacturing capability is essential in order to compete with the
Company's major competitors.
The Company's manufacturing process is vertically integrated, performing, in
house, approximately 80% of its forging requirements and essentially all of
its heat treatment, machining, fabrication, inspection, assembly and testing.
This vertically integrated manufacturing capability provides competitive
advantages because Dril-Quip is able to (i) control the quality of its
products from initial stages, (ii) control the cost of its production and
(iii) assure timely delivery of high-volume and customized orders. 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. With the expansion of its forging capacity, the
Company plans to market forgings to third party customers. The Company has
made significant capital investments in developing its vertically integrated
manufacturing capability. A significant downturn in the market for subsea
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. Purchasing and
rebuilding used machine tools is a competitive advantage, allowing Dril-Quip
to add machine tools at lower overall costs than its competitors. Rebuilding
used machine tools also allows for greater
5
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.
As demand for offshore exploration and production equipment has increased
significantly, the Company has been operating at close to full capacity. The
Company plans to expand its manufacturing capacity by approximately 90% during
the three-year period 1997 through 1999, approximately two-thirds of which is
expected to be completed by the end of 1998. The Company believes that this
capital expansion program will allow it to prudently manage its growth in
response to customer demand for its products. The Company has already begun
adding machine tools at its existing facilities that it will move to the new
facilities when they are completed.
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, but steadily increasing,
customer base. The Company's customers are generally oil and gas companies
that are well-known participants in offshore exploration and production, which
depend on high quality, efficient, reliable products, such as those produced
by Dril-Quip, for their offshore activities, particularly in deepwater areas.
The Company is not dependent on any one customer or group of customers. In
1997, the Company's top 15 customers represented approximately 65% of total
revenues, with the Royal Dutch Shell Group of Companies (aggregating orders
placed by all of its worldwide affiliates), accounting for approximately 11%
of revenues. The number and variety of the Company's products required in a
given year by any one customer depends upon the amount of that customer's
capital expenditure budget devoted to offshore exploration and production in
any single year and on the results of competitive bids for major projects.
Consequently, a customer that accounts for a significant portion of revenues
in one fiscal year may represent an immaterial portion of revenues in
subsequent years. While the Company is not dependent on any one customer or
group of customers, the loss of one or more of its significant customers
could, at least on a short-term basis, have an adverse effect on the Company's
results of operations.
MARKETING AND SALES
Dril-Quip markets its products and services throughout the world directly
through its sales personnel in two domestic and six international locations.
In addition, in certain foreign markets where the Company does not maintain
offices, it utilizes independent sales representatives to enhance its
marketing and sales efforts. Some of the locations in which Dril-Quip has
sales representatives are the United Arab Emirates, Saudi Arabia, China,
Canada, the Philippines, Brazil, Indonesia, Malaysia, Kuwait, Brunei, Oman,
Qatar and West Africa. Although they do not have authority to contractually
bind the Company, these representatives market the Company's products in their
respective territories in return for sales commissions. The Company also
places print advertising from time to time in trade and technical publications
targeted to its customer base. It also participates in industry conferences
and trade shows to enhance industry awareness of its products.
The Company's customers generally order products on a purchase order basis.
Orders are typically filled within two weeks to three months after receipt of
a purchase order, depending on the type of product and whether it is sold out
of inventory or requires some customization. Contracts for certain of the
Company's larger, more complex products, such as subsea production trees,
drilling risers and equipment for TLPs and Spars can take a year or more to
complete.
The primary factors influencing a customer's decision to purchase the
Company's products are the quality, reliability and reputation of the product,
price and technologically superior features. Timely delivery of equipment is
also very important to customer operations and the Company maintains an
experienced sales coordination staff to help assure such delivery. For large
drilling and production system orders, project management teams coordinate
customer needs with engineering, manufacturing and service organizations, as
well as with subcontractors and vendors.
6
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.
The Company historically has experienced some seasonality, with revenues and
operating income slightly lower during the first and third quarters compared
to the second and fourth quarters. The Company's revenues are affected by its
customers' capital expenditure budgeting process, which generally results in
lower revenues in the first quarter and higher revenues in the fourth quarter.
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 product
development to generate new products and improve existing products. When
developing new products, the Company typically seeks to design the most
technologically advanced version for a particular application to establish its
reputation and qualification in that product. Thereafter, the Company
leverages its expertise in the more technologically advanced product to
produce less costly and complex versions of the product for less demanding
applications. The Company also focuses its activities on reducing the overall
cost to the customer, which includes not only the initial capital cost but
also operating costs associated with its products.
All of the Company's products have been developed from internally generated
designs, and the Company has continually introduced new products and product
enhancements since its founding in 1981. Product developments that began in
1991 have led to a series of new products, including diverters, wellhead
connectors, SingleBore(TM) subsea trees, improved severe service dual bore
subsea trees, subsea and platform valves, platform wellheads, platform trees,
subsea tree workover riser systems, drilling risers and TLP and Spar
production riser systems.
Dril-Quip's product development work is conducted at its facilities in
Houston, Texas and Aberdeen, Scotland. In addition to the work of its product
development staff, the Company's application engineering staff provides
engineering services to customers in connection with the design and sales of
its products. The Company's ability to develop new products and maintain
technological advantages is important to its future success. There can be no
assurance that the Company will be able to develop new products, successfully
differentiate itself from its competitors or adapt to evolving markets and
technologies.
The Company believes that the success of its business depends more on the
technical competence, creativity and marketing abilities of its employees than
on any individual patent, trademark or copyright. Nevertheless, as part of its
ongoing product development and manufacturing activities, Dril-Quip's policy
has been to seek patents when appropriate on inventions concerning new
products and product improvements. As of December 31, 1997, the Company held
38 United States patents and 84 foreign patents. All patent rights for
products developed by employees are assigned to the Company. Virtually all of
the Company's products have components that are covered by patents. The
Company's existing patents expire at various times beginning in 2001.
Dril-Quip has 13 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.
7
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.
EMPLOYEES
The total number of the Company's employees as of December 31, 1997 was 983.
Of these, 625 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 ability to expand its operations depends in part on its
ability to increase its skilled labor force. The demand for such workers is
high and the supply is limited. 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.
Recently, 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
8
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.
9
ITEM 2. PROPERTIES
MAJOR MANUFACTURING FACILITIES
BUILDING
SIZE LAND
(APPROXIMATE (APPROXIMATE
LOCATION SQUARE FEET) ACREAGE) OWNED OR LEASED
-------- ------------ ------------ ----------------
Houston, Texas
--13550 Hempstead Highway.... 175,000 15 Owned
12,000 -- Leased (offices)
--6401 N. Eldridge Parkway... 280,000 218 Owned
Aberdeen, Scotland............. 110,000 12 Owned
9,400 -- Leased (offices)
Singapore...................... 13,000 1.8 Leased
Dril-Quip's manufacturing facilities in Houston and Aberdeen are capable of
manufacturing each of its products, and the facility in Singapore is capable
of manufacturing most of the Company's established products. The Company plans
to focus its domestic capacity expansion at the Eldridge site in Houston,
Texas.
SALES, SERVICE AND RECONDITIONING FACILITIES
BUILDING
SIZE LAND
(APPROXIMATE (APPROXIMATE
LEASED LOCATION SQUARE FEET) ACREAGE) ACTIVITY
--------------- ------------ ------------ --------------------------------------
New Orleans, Louisiana...... 2,300 -- Sales/Service
Beverwijk, Holland.......... 5,200 0.2 Sales/Warehouse
Perth, Australia............ 13,300 1.4 Sales/Service/Reconditioning/Warehouse
Stavanger, Norway........... 15,700 2.4 Sales/Service/Reconditioning/
Warehouse/Fabrication
Esbjerg, Denmark............ 7,800 0.5 Sales/Service/Reconditioning/Warehouse
The Company also performs sales, service and reconditioning activities at
its facilities in Houston, Aberdeen and Singapore. As part of its capital
expansion, the Company plans to expand its facilities in Stavanger to meet
growing demands for its products and services.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to, nor is any of its property the subject of,
any pending legal proceedings, which, in the opinion of management, are
expected to have a material adverse effect on the Company's consolidated
results of operations or financial position.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
On October 17, 1997, prior to the closing of the Offering, the stockholders
of the Company, acting by unanimous written consent, (i) approved and adopted
the Rights Agreement between the Company and ChaseMellon Shareholder Services,
L.L.C. and (ii) approved the division of the directors of the Company into
three classes.
10
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, 1998) and
positions of the Company's executive officers:
NAME AGE POSITION
---- --- -------------------------------------
Co-Chairman of the Board and Co-Chief
Larry E. Reimert............ 50 Executive Officer
Co-Chairman of the Board and Co-Chief
Gary D. Smith............... 55 Executive Officer
Co-Chairman of the Board and Co-Chief
J. Mike Walker.............. 54 Executive Officer
Jerry M. Brooks............. 46 Chief Accounting Officer
Larry E. Reimert is Co-Chairman of the Board and Co-Chief Executive Officer
with principal responsibility for engineering, product development and
finance. He has been the Director--Engineering, Product Development and
Finance, as well as a member of the Board of Directors, since the Company's
inception in 1981. Prior to that, he worked for Vetco Offshore, Inc. in
various capacities, including Vice President of Technical Operations, Vice
President of Engineering and Manager of Engineering. Mr. Reimert holds a BSME
degree from the University of Houston and a MBA degree from Pepperdine
University.
Gary D. Smith is Co-Chairman of the Board and Co-Chief Executive Officer
with principal responsibility for sales, service, training and administration.
He has been the Director--Sales, Service, Training and Administration, as well
as a member of the Board of Directors, since the Company's inception in 1981.
Prior to that, he worked for Vetco Offshore, Inc. in various capacities,
including General Manager and Vice President of Sales and Service.
J. Mike Walker is Co-Chairman of the Board and Co-Chief Executive Officer
with principal responsibility for manufacturing, purchasing and facilities. He
has been the Director--Manufacturing, Purchasing and Facilities, as well as a
member of the Board of Directors, since the Company's inception in 1981. Prior
to that, he served as the Director of Engineering, Manager of Engineering and
Manager of Research and Development with Vetco Offshore, Inc. Mr. Walker holds
a BSME degree from Texas A&M University, a MSME degree from the University of
Texas at Austin and a Ph.D. in mechanical engineering from Texas A&M
University.
Jerry M. Brooks has been Chief Accounting Officer since he joined 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. He is a certified public accountant.
11
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED SHAREHOLDER MATTERS
(a) The Company's Common Stock has been publicly traded on the New York
Stock Exchange under the symbol DRQ since the Offering on October 22, 1997.
The following table sets forth the quarterly high and low sales prices for the
indicated quarter of fiscal 1997:
QUARTER ENDED HIGH LOW
------------- ------- ------
December 31, 1997.......................................... 40 7/16 27 1/2
There were approximately 43 shareholders of record of the Company's Common
Stock as of March 17, 1998. This number does not include the number of
security holders for whom shares are held in a "nominee" or "street" name.
The Company paid dividends of $.007 per share of Common Stock in 1996. 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. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations--Liquidity and Capital
Resources" and Notes to the Company's Consolidated Financial Statements.
(b) Use of Proceeds.
In October 1997, Dril-Quip sold 2,875,000 shares of Common Stock in the
Offering. The net proceeds to the Company from the Offering were $63.4
million. As of December 31, 1997, the Company had used such net proceeds as
follows: (i) to repay $30 million of indebtedness outstanding under the
Company's credit facilities and term loans, which constitutes repayment of
such facilities in full, (ii) $5.2 million for the purchase of property, plant
and equipment and (iii) $28.2 million in temporary investments. None of such
payments was a direct or indirect payment to directors or officers of the
Company or their associates, to persons owning 10% or more of any class of
equity securities of the Company or to affiliates of the Company.
12
ITEM 6. SELECTED FINANCIAL DATA
The selected financial data as of December 31, 1996 and 1997 and for each of
the years ended December 31, 1995, 1996 and 1997 are derived from the audited
consolidated financial statements of the Company included elsewhere in this
Report. The selected financial data presented below as of December 31, 1993,
1994 and 1995 and for the years ended December 31, 1993 and 1994 are derived
from audited consolidated financial statements of the Company not included in
this Report. The information set forth below should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results
of Operations" and the Consolidated Financial Statements and Notes thereto
included elsewhere in this Report.
YEAR ENDED DECEMBER 31,
----------------------------------------------
1993 1994 1995 1996 1997
------- ------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
STATEMENT OF OPERATIONS DATA:
Revenues....................... $82,553 $80,548 $108,390 $115,864 $146,823
Cost of sales.................. 61,704 58,604 76,471 77,863 99,800
Selling, general and adminis-
trative expenses.............. 10,907 11,673 13,597 15,031 16,313
Engineering and product devel-
opment expenses............... 5,152 6,069 5,769 6,971 9,158
------- ------- -------- -------- --------
77,763 76,346 95,837 99,865 125,271
Operating income............... 4,790 4,202 12,553 15,999 21,552
Interest expense............... 1,494 2,273 2,944 2,647 2,027
------- ------- -------- -------- --------
Income before income taxes..... 3,296 1,929 9,609 13,352 19,525
Income tax provision........... 886 635 3,023 4,234 6,587
------- ------- -------- -------- --------
Net income..................... $ 2,410 $ 1,294 $ 6,586 $ 9,118 $ 12,938
======= ======= ======== ======== ========
Diluted earnings per share..... $ .17 $ .09 $ .46 $ .63 $ .87
Weighted average shares out-
standing...................... 14,370 14,370 14,370 14,370 14,895
STATEMENT OF CASH FLOWS DATA:
Net cash provided by operating
activities.................... $ 3,182 $ 2,422 $ 6,466 $ 5,185 $ 10,325
Net cash used in investing ac-
tivities...................... (6,413) (4,524) (5,659) (7,006) (10,240)
Net cash provided by financing
activities.................... 1,448 2,668 560 1,261 31,386
OTHER DATA:
EBITDA(1)...................... $ 8,549 $ 8,069 $ 17,201 $ 20,387 $ 26,541
Depreciation and amortization.. 3,759 3,867 4,648 4,388 4,989
Capital expenditures........... 6,592 4,614 6,184 7,228 10,375
AS OF DECEMBER 31,
----------------------------------------------
1993 1994 1995 1996 1997
------- ------- -------- -------- --------
(IN THOUSANDS)
BALANCE SHEET DATA:
Working capital................ $30,913 $34,099 $ 40,682 $ 49,524 $ 89,373
Total assets................... 70,346 79,208 93,186 114,777 152,921
Total debt..................... 28,100 30,416 31,052 32,536 518
Total stockholders' equity..... 30,267 32,903 39,501 50,882 124,161
- --------
(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.
13
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following is management's discussion and analysis of certain significant
factors that have affected certain aspects of the Company's financial position
and results of operations during the periods included in the accompanying
consolidated financial statements. This discussion should be read in
conjunction with the Company's Consolidated Financial Statements and Notes
thereto presented elsewhere in this Report.
OVERVIEW
Dril-Quip manufactures highly engineered offshore drilling and production
equipment which is well suited for use in deepwater, harsh environment and
severe service applications. The Company designs and manufactures subsea
equipment, surface equipment and offshore rig equipment for use by major
integrated, large independent and foreign national oil and gas companies in
offshore areas throughout the world. The Company's principal products consist
of subsea and surface wellheads, subsea and surface production trees, mudline
hanger systems, specialty connectors and associated pipe, drilling and
production riser systems, wellhead connectors and diverters. Dril-Quip also
provides installation and reconditioning services and rents running tools for
use in connection with the installation and retrieval of its products.
The market for offshore drilling and production equipment and services is
fundamentally driven by the exploration, development and production spending
of oil and gas companies, particularly with respect to offshore activities
worldwide. The Company has experienced increased demand for its products due
to the increased drilling and production activity in offshore areas throughout
the world during the last several years, particularly in deeper waters.
Revenues. 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 1997, the Company derived 86%
of its revenues from the sale of its products and 14% 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. Revenues have increased
over the last three years principally as a result of increased sales volumes
of the Company's established products and services, the introduction of new
products and product enhancements and price increases for the Company's
products and services. These price increases have occurred due to an increase
in demand and capacity constraints experienced by the Company and its
competitors. Substantially all of Dril-Quip's sales are made on a purchase
order basis. Purchase orders are subject to change and/or termination at the
option of the customer. In 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.
Historically, Drip-Quip recognized revenues upon the delivery of a completed
product. During 1997, the Company was involved with larger and more complex
projects that have longer manufacturing times. The Company accounted for such
projects on a percentage of completion basis. Because the Company has only
recently become involved with such projects, the use of percentage of
completion accounting does not affect the comparability of financial
information to earlier periods. Revenues accounted for in this manner are
generally recognized on the ratio of costs incurred to the total estimated
costs. Accordingly, price and cost estimates are reviewed periodically as the
work progresses, and adjustments proportionate to the percentage of completion
are reflected in the period when such estimates are revised. Amounts received
from customers in excess of revenues recognized are classified as a current
liability. The Company historically has experienced some seasonality, with
revenues and operating income slightly lower during the first and third
quarters compared to the second and fourth quarters. The Company's revenues
are affected by its customers' capital expenditure budgeting process, which
generally results in lower revenues in the first quarter and higher revenues
in the fourth quarter. The increase in revenues recognized using percentage of
completion accounting may result in less fluctuation in revenues recognized
from quarter to quarter.
The Company has substantial international operations, with approximately
70%, 68% and 60% of its revenues derived from foreign sales in 1995, 1996 and
1997, respectively. During the same years, approximately 60% of all products
sold were manufactured in the United States. The Company operates its business
and markets its products
14
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.
Cost of Sales. 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.
Selling, General and Administrative Expenses. Selling, general and
administrative expenses include the costs associated with sales and marketing,
general corporate overhead, compensation expense, legal expenses and other
related administrative functions.
Engineering and Product Development Expenses. Engineering and product
development expenses consist of new product development and testing, as well
as application engineering related to customized products.
Income Tax Provision. Dril-Quip's effective tax rate has historically been
lower than the statutory rate due to benefits from its foreign sales
corporation. The Company's effective tax rate increased in 1997 because of
increases in income.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, certain statement
of operations data expressed as a percentage of revenues:
YEAR ENDED DECEMBER 31,
--------------------------
1994 1995 1996 1997
----- ----- ----- -----
Revenues:
Product Group....................................... 83.0% 83.7% 82.1% 86.1%
Service Group....................................... 17.0 16.3 17.9 13.9
----- ----- ----- -----
Total........................................... 100.0 100.0 100.0 100.0
Cost of sales....................................... 72.8 70.6 67.2 68.0
Selling, general and administrative expenses........ 14.5 12.5 13.0 11.1
Engineering and product development expenses........ 7.5 5.3 6.0 6.2
----- ----- ----- -----
Operating income.................................... 5.2 11.6 13.8 14.7
Interest expense.................................... 2.8 2.7 2.3 1.4
----- ----- ----- -----
Income before income taxes.......................... 2.4 8.9 11.5 13.3
Income tax provision................................ 0.8 2.8 3.6 4.5
----- ----- ----- -----
Net income.......................................... 1.6% 6.1% 7.9% 8.8%
===== ===== ===== =====
15
Year Ended December 31, 1997 Compared to Year Ended December 31, 1996
Revenues. Revenues increased by $30.9 million, or approximately 27%, to
$146.8 million in 1997 from $115.9 million in 1996. This increase relates to
increased domestic sales in the United States area of $21.4 million, increased
revenues of $7.0 million in the European area and increased sales of $3.2
million in the Asia-Pacific area. These increases were mainly due to strong
market demand, along with increased manufacturing capacity, price increases
and an increase in project related sales of new products.
Cost of Sales. Cost of sales increased by $21.9 million, or 28%, to $99.8
million for the twelve months ended December 31, 1997 from $77.9 million for
the same period in 1996. As a percentage of revenues, cost of sales increased
from 67% in 1996 to 68% in 1997. This increase in cost of sales as a
percentage of revenues was primarily due to sales of new products, which tend
to initially have lower margins, and higher labor costs, which factors were
partially offset by improved pricing.
Selling, General and Administrative Expenses. For the twelve months ended
December 31, 1997, selling, general and administrative expenses increased by
$1.3 million, or 9%, to $16.3 million from $15.0 million in the 1996 period.
This increase was due to an increased number of personnel needed to support
higher sales volumes and increased labor costs. Selling, general and
administrative expenses decreased as a percentage of revenues from 13% in 1996
to approximately 11% in 1997.
Engineering and Product Development Expenses. During the year ended December
31, 1997, engineering and product development expenses increased by $2.2
million, or 31%, to $9.2 million from $7.0 million during the same period in
1996. This increase primarily reflects an increased number of personnel, and
to a lesser extent, increased development testing related to new products. As
a percentage of revenues, engineering and product development expenses
remained essentially unchanged at approximately 6% in both 1997 and 1996.
Interest Expense. Interest expense for 1997 was $2.0 million, a decrease of
approximately $600,000, or approximately 23%, from interest expense of $2.6
million for the prior year. This decrease was primarily due to the repayment
of a substantial portion of the Company's bank debt during the fourth quarter
of 1997 which resulted, on average, in lower outstanding debt balances in 1997
as compared to 1996.
Net Income. Net income increased by $3.8 million, or 42%, from $9.1 million
in 1996 to $12.9 million in 1997 for the reasons set forth above.
Year Ended December 31, 1996 Compared to Year Ended December 31, 1995
Revenues. Revenues increased by $7.5 million, or approximately 7%, to $115.9
million in 1996 from $108.4 million in 1995. This increase relates to
increased revenues of $1.8 million in the European area, increased domestic
sales in the United States area of $4.8 million and increased export sales
from the United States area of $1.6 million, partially offset by decreased
sales of $1.2 million in the Asia-Pacific area. The overall increase in
revenues was primarily due to a small volume increase plus a slight increase
in prices in the last half of the year. There was continued strong market
demand for the Company's products and services, but revenues were limited by
manufacturing capacity constraints. Domestic sales accounted for $4.8 million,
or 64% of the increase.
Cost of Sales. Cost of sales increased $1.4 million, or 2%, to $77.9 million
for the year ended December 31, 1996 from $76.5 million for the year ended
December 31, 1995. Cost of sales increased due to higher sales volumes, offset
in part by decreases in costs. As a percentage of revenues, cost of sales
decreased from 71% in 1995 to 67% in 1996. This decrease was primarily due to
the effect of increased forging operations which resulted in lower per unit
costs than in the comparable prior period when more of the Company's forgings
were outsourced. In addition, price increases in the last half of the year
contributed to the decrease in cost of sales as a percentage of revenues.
Selling, General and Administrative Expenses. For the year ended December
31, 1996, selling, general and administrative expenses increased by $1.4
million, or 10%, to $15.0 million from $13.6 million in 1995, but remained at
approximately 13% of revenues in each year. This increase was primarily due to
the increased number of personnel on a worldwide basis required to meet sales
demand.
16
Engineering and Product Development Expenses. For the year ended December
31, 1996, engineering and product development expenses increased by $1.2
million, or 21%, to $7.0 million from $5.8 million in the same period in 1995.
The increase was due primarily to the addition of personnel needed to expand
new product development.
Interest Expense. Interest expense for the year ended December 31, 1996 was
$2.6 million, a decrease of $300,000, or 10%, from interest expense of $2.9
million for the prior year. The decrease was due to lower bank interest rates.
Net Income. Net income increased by $2.5 million, or 38%, from $6.6 million
for the year ended December 31, 1995 to $9.1 million in 1996 for the reasons
set forth above.
LIQUIDITY AND CAPITAL RESOURCES
The primary liquidity needs of the Company are to (i) fund capital
expenditures to increase manufacturing capacity, improve and expand facilities
and manufacture additional rental running tools; and (ii) fund working
capital. Historically, the Company's principal sources of funds have been cash
flow from operations and bank indebtedness.
Net cash provided by operating activities was $6.5 million in 1995, $5.2
million in 1996 and $10.3 million in 1997. Improvements in cash flow from
operating activities during 1995 and 1997 were principally the result of
improved operating results, offset by increased working capital requirements
attributable to increases in accounts receivable and inventory due to
increased sales. The decrease in cash flow from operating activities in 1996
was the result of a substantial increase in accounts receivable, offset by
improved operating results. Accounts receivable at December 31, 1996 increased
27% over December 31, 1995 levels compared to a 7% increase in revenues for
the year. The disproportionate increase in accounts receivable was due to
timing of cash receipts. In 1997, accounts receivable as a percentage of sales
returned to levels more consistent with past periods, with accounts receivable
at December 31, 1997 increasing 7% over December 31, 1996 levels compared to a
27% increase in revenues for the year.
Capital expenditures by the Company were $6.2 million, $7.2 million and
$10.4 million in 1995, 1996 and 1997, respectively. Principal payments on
long-term debt were $2.8 million, $3.2 million and $36.3 million in 1995, 1996
and 1997, respectively. During 1997, the Company's credit facilities with Bank
One, Texas, National Association ("Bank One") were provided through a Credit
Agreement dated March 30, 1994, as amended (the "Bank One Credit Facilities").
At October 30, 1997, the Company had repaid the indebtedness outstanding under
the Bank One Credit Facilities in full, and these facilities were terminated.
In addition, during 1997 the Company had three outstanding term loans with the
Bank of Scotland. Subsequent to the completion of the Offering, the Company
repaid the indebtedness outstanding under these term loans in full.
In October 1997, the Offering provided the Company with proceeds of
approximately $63.4 million, net of expenses. The Company intends to use a
portion of the proceeds from the Offering for a three-year capital expansion
program totalling approximately $50 million to increase manufacturing
capacity, improve and expand facilities and manufacture additional running
tools for rental. The Company plans to expand its manufacturing capacity by
approximately 90% during the three-year period 1997 through 1999,
approximately two-thirds of which is expected to be completed by the end of
1998. Dril-Quip spent approximately $10 million in 1997 for these purposes,
and expects that total capital expenditures for these purposes will be
approximately $23 million in 1998 and $17 million in 1999. Pending application
of the proceeds for these purposes, the Company used approximately $30 million
to repay its bank indebtedness in full during late October and November 1997.
The balance of the proceeds will be used for working capital and excess cash
will be invested in short-term investment grade securities.
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 at December 31, 1996 was approximately $56
million and at December 31, 1997 was approximately $125 million. This increase
in backlog was
17
primarily attributable to certain larger and longer term projects, such as
drilling and production risers. The Company expects to fill approximately 60%
of the December 31, 1997 backlog by December 31, 1998. The remaining backlog
at December 31, 1997 consists of longer-term projects that will be designed
and manufactured to customer specifications rather than sold out of inventory.
The Company does not expect that backlog will increase by a comparable
percentage in 1998, and 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 have declined significantly in recent months. A
continued and prolonged decline in oil and natural gas prices could reduce
significantly new customer orders, which would cause the Company's backlog to
decline. All of the Company's projects currently included in backlog are
subject to change and/or termination at the option of the customer. In the
case of a change or termination, the customer is required to pay the Company
for work performed and other costs necessarily incurred as a result of the
change or termination.
GEOGRAPHIC AREAS
The Company's operations are divided into three geographic areas based upon
the locations of its manufacturing facilities: the United States (Houston,
Texas); Europe, Middle East and Africa (Aberdeen, Scotland) and Asia-Pacific
(Singapore). The United States area includes sales to both North and South
America. The area of Europe, Middle East and Africa includes primarily sales
to the North Sea with lesser sales to the Middle East and Africa. The Asia-
Pacific area includes sales primarily to Australia, Thailand, Malaysia and
Indonesia.
Revenues for each of these areas are dependent upon the ultimate sale of
products and services to the Company's customers. Revenues of the United
States area are also influenced by its sale of products to the European and
Asia-Pacific subsidiaries. Accordingly, the operating incomes of each area are
closely tied to third-party sales, and the operating income of the United
States area is also dependent upon its level of intercompany sales.
CURRENCY RISK
Through its subsidiaries, the Company conducts a portion of business in
currencies other than the United States dollar, principally the British pound
sterling and the Norwegian kroner. The Company generally attempts to minimize
its currency exchange risk by seeking international contracts payable in local
currency in amounts equal to the Company's estimated operating costs payable
in local currency and in U.S. dollars for the balance of the contract and by
contractual purchase price adjustments based on an exchange rate formula
related to U.S. dollars. Because of this strategy, the Company has not
experienced significant transaction gains or losses associated with changes in
currency exchange rates and does not anticipate such exposure to be material
in the future. In 1995, 1996 and 1997, the Company had exchange gains of $0,
approximately $163,000 and approximately $1 million, respectively. The gain in
1997 was primarily related to debt which was repaid in 1997. There is no
assurance that the Company will be able to protect itself against such
fluctuations in the future. Historically, the Company has not conducted
business in countries that limit repatriation of earnings. However, as the
Company expands its international operations, it may begin operating in
countries that have such limitations. Further, there can be no assurance that
the countries in which the Company currently operates will not adopt policies
limiting repatriation of earnings in the future. The Company also has
significant investments in countries other than the United States, principally
its manufacturing operations in Aberdeen, Scotland and, to a lesser extent,
Singapore. The functional currency of these foreign operations is the local
currency and, accordingly, financial statement assets and liabilities are
translated at current exchange rates. Resulting translation adjustments are
reflected as a separate component of stockholders' equity and have no current
effect on earnings or cash flow.
YEAR 2000
The Company has assessed and continues to assess the impact of the Year 2000
issue on its operations, including the development and implementation of
project plans and cost estimates required to make its information systems
infrastructure Year 2000 compliant. Based on existing information, the Company
believes that anticipated spending necessary to become Year 2000 compliant
will not have a material effect on the financial position, cash flows or
results of operations of the Company, nor will the Year 2000 issues cause any
material adverse effect on the future business operations of the Company.
18
RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In February 1997, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 128 ("SFAS No. 128"), which
establishes standards for computing and presenting earnings per share ("EPS").
The Company adopted this standard in 1997 and EPS computations under SFAS No.
128 are reflected herein. There were no effects on previously reported
amounts.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"), which establishes
new rules for the reporting and display of comprehensive income. Adoption of
SFAS No. 130 will have no impact on the Company's net income or financial
position. SFAS No. 130 would require Dril-Quip's foreign currency translation
adjustments, which are currently reported in stockholders' equity, to be added
to net income to determine total comprehensive income and for such amounts to
be disclosed.
In June 1997, the FASB also issued SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information" ("SFAS No. 131"), which establishes
standards for reporting information about operating segments in both annual
and interim financial statements. SFAS No. 131 also establishes standards for
disclosures about products and services, geographic areas and major customers.
SFAS No. 131 is effective for fiscal years beginning after December 15, 1997.
The Company will adopt SFAS No. 131 retroactively in 1998 and the standards
and disclosure required thereby are not expected to significantly affect the
current disclosure.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
PAGE
----
Report of Independent Auditors............................................ 20
Consolidated Statements of Income for the Three Years in the Period Ended
December 31, 1997........................................................ 21
Consolidated Balance Sheets as of December 31, 1996 and 1997.............. 22
Consolidated Statements of Cash Flows for the Three Years in the Period
Ended December 31, 1997.................................................. 23
Consolidated Statements of Changes in Stockholders' Equity for the Three
Years in the Period Ended December 31, 1997.............................. 24
Notes to Consolidated Financial Statements................................ 25
19
REPORT OF INDEPENDENT AUDITORS
Board of Directors
Dril-Quip, Inc.
We have audited the accompanying consolidated balance sheets of Dril-Quip,
Inc., as of December 31, 1997 and 1996, 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, 1997. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Dril-Quip,
Inc., at December 31, 1997 and 1996, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting
principles.
Ernst & Young LLP
Houston, Texas
March 6, 1998
20
DRIL-QUIP, INC.
CONSOLIDATED STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31
--------------------------------
1995 1996 1997
---------- ---------- ----------
(IN THOUSANDS, EXCEPT SHARE
AMOUNTS)
Revenues....................................... $ 108,390 $ 115,864 $ 146,823
Cost and expenses:
Cost of sales................................ 76,471 77,863 99,800
Selling, general, and administrative......... 13,597 15,031 16,313
Engineering and product development.......... 5,769 6,971 9,158
---------- ---------- ----------
95,837 99,865 125,271
---------- ---------- ----------
Operating income............................... 12,553 15,999 21,552
Interest expense............................... 2,944 2,647 2,027
---------- ---------- ----------
Income before income taxes..................... 9,609 13,352 19,525
Income tax provision........................... 3,023 4,234 6,587
---------- ---------- ----------
Net income..................................... $ 6,586 $ 9,118 $ 12,938
========== ========== ==========
Earnings per share:
Basic........................................ $ .46 $ .63 $ .87
========== ========== ==========
Fully diluted................................ $ .46 $ .63 $ .87
========== ========== ==========
Weighted average shares
Basic........................................ 14,370,000 14,370,000 14,881,986
========== ========== ==========
Fully diluted................................ 14,370,000 14,370,000 14,895,222
========== ========== ==========
The accompanying notes are an integral part of these statements.
21
DRIL-QUIP, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31
-----------------
ASSETS 1996 1997
------ -------- --------
(IN THOUSANDS)
Current assets:
Cash and cash equivalents................................. $ 1,361 $ 32,612
Trade receivables......................................... 25,514 27,336
Inventories............................................... 51,571 52,436
Deferred taxes............................................ 3,739 3,694
Prepaids and other current assets......................... 789 657
-------- --------
Total current assets.................................... 82,974 116,735
Property, plant, and equipment, net......................... 31,384 35,814
Other assets................................................ 419 372
-------- --------
Total assets............................................ $114,777 $152,921
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current liabilities:
Accounts payable.......................................... $ 14,965 $ 15,354
Current maturities of long-term debt...................... 3,537 210
Accrued income taxes...................................... 2,712 1,176
Customer prepayments...................................... 7,215 4,324
Accrued compensation...................................... 2,737 3,098
Other accrued liabilities................................. 2,284 3,200
-------- --------
Total current liabilities............................... 33,450 27,362
Long-term debt.............................................. 28,999 308
Deferred taxes.............................................. 1,446 1,090
-------- --------
Total liabilities....................................... 63,895 28,760
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,
14,370,000 and 17,245,000, respectively, issued and
outstanding............................................. 144 172
Additional paid-in capital................................ -- 63,291
Retained earnings......................................... 49,652 62,590
Foreign currency translation adjustment................... 1,086 (1,892)
-------- --------
Total stockholders' equity.............................. 50,882 124,161
-------- --------
Total liabilities and stockholders' equity.............. $114,777 $152,921
======== ========
The accompanying notes are an integral part of these statements.
22
DRIL-QUIP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31
--------------------------
1995 1996 1997
------- ------- --------
(IN THOUSANDS)
OPERATING ACTIVITIES
Net income........................................ $ 6,586 $ 9,118 $ 12,938
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization................... 4,648 4,388 4,989
Gain on sale of equipment....................... (111) (82) (9)
Deferred income taxes........................... (426) (505) (189)
Changes in operating assets and liabilities:
Trade receivables............................. (4,025) (4,553) (2,822)
Inventories................................... (6,663) (10,815) (2,763)
Prepaids and other assets..................... 556 (144) 133
Trade accounts payable and accrued expenses... 5,901 7,778 (1,952)
------- ------- --------
Net cash provided by operating activities......... 6,466 5,185 10,325
INVESTING ACTIVITIES
Purchase of property, plant, and equipment........ (6,184) (7,228) (10,375)
Proceeds from sale of equipment................... 525 222 135
------- ------- --------
Net cash used in investing activities............. (5,659) (7,006) (10,240)
FINANCING ACTIVITIES
Proceeds from revolving line of credit and long-
term borrowings.................................. 3,436 4,564 4,373
Principal payments on long-term debt.............. (2,823) (3,203) (36,307)
Dividends paid.................................... (53) (100) --
Proceeds from sale of stock....................... -- -- 63,320
------- ------- --------
Net cash provided by financing activities......... 560 1,261 31,386
Effect of exchange rate changes on cash activi-
ties............................................. (232) (658) (220)
------- ------- --------
Increase (decrease) in cash....................... 1,135 (1,218) 31,251
Cash at beginning of period....................... 1,444 2,579 1,361
------- ------- --------
Cash at end of period............................. $ 2,579 $ 1,361 $ 32,612
======= ======= ========
The accompanying notes are an integral part of these statements.
23
DRIL-QUIP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
UNREALIZED
COMMON PAID-IN RETAINED TRANSLATION
STOCK CAPITAL EARNINGS ADJUSTMENT TOTAL
------ ------- -------- ----------- --------
(IN THOUSANDS)
Balance at December 31, 1994...... 144 $ -- $34,101 $(1,342) $ 32,903
Net income...................... -- -- 6,586 -- 6,586
Translation adjustment.......... -- -- -- 65 65
Dividends ($.004 per share)..... -- -- (53) -- (53)
--- ------- ------- ------- --------
Balance at December 31, 1995...... 144 -- 40,634 (1,277) 39,501
Net income...................... -- -- 9,118 -- 9,118
Translation adjustment.......... -- -- -- 2,363 2,363
Dividends ($.007 per share)..... -- -- (100) -- (100)
--- ------- ------- ------- --------
Balance at December 31, 1996...... 144 -- 49,652 1,086 50,882
Common stock offering........... 28 63,291 -- -- 63,319
Net income...................... -- -- 12,938 -- 12,938
Translation adjustment.......... -- -- -- (2,978) (2,978)
--- ------- ------- ------- --------
Balance at December 31, 1997...... 172 $63,291 $62,590 $(1,892) $124,161
=== ======= ======= ======= ========
The accompanying notes are an integral part of these statements.
24
DRIL-QUIP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1997
1. ORGANIZATION
Dril-Quip, Inc. (the "Company"), manufactures offshore drilling and
production equipment, which is well suited for use in deepwater, harsh
environment and severe service applications. The Company's principal products
consist of subsea and surface wellheads, subsea and surface production trees,
mudline hanger systems, specialty connectors and associated pipe, drilling and
production riser systems, wellhead connector and diverters for use by major
integrated, large independent and foreign national oil and gas companies in
offshore areas throughout the world. Dril-Quip also provides installation and
reconditioning services and rents running tools for use in connection with the
installation and retrieval of its products. The Company has three subsidiaries
that manufacture and market the Company's products abroad. Dril-Quip (Europe)
Limited is located in Aberdeen, Scotland, with branches in Norway, Holland,
and Denmark. Dril-Quip Asia Pacific PTE Ltd. is located in Singapore. DQ
Holdings PTY Ltd. is located in Perth, Australia.
2. SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company
and its subsidiaries. All material intercompany accounts and transactions have
been eliminated.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the
financial statements and reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Cash and cash equivalents
Short term investments that have a maturity of three months or less from the
date of purchase are classified as cash equivalents. At December 31, 1997,
cash and cash equivalents include $30,235,000 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.
25
DRIL-QUIP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
Revenue Recognition
The Company delivers most of its products on an as-needed basis by its
customers and records revenues as the products are shipped. Certain revenues
are derived from long-term contracts which generally require more than one
year to fulfill. Revenues and profits on long-term contracts are recognized
under the percentage-of-completion method based on a cost-incurred basis.
Losses, if any, on contracts are recognized when they become known. Contracts
for long-term projects contain provisions for customer progress payments.
Payments in excess of revenues recognized are included as a customer
prepayment liability. At December 31, 1997, trade receivables included
$1,900,000 in unbilled revenue and inventories have been reduced by $3,700,000
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 shareholders' equity and
have no current effect on earnings or cash flows. These adjustments amounted
to a gain of $65,000 in 1995, a gain of $2,363,000 in 1996 and, a loss of
$2,978,000 in 1997, net of allocated income taxes of $37,000, $458,000, and
$772,000, respectively.
Foreign currency exchange transactions are recorded using the exchange rate
at the date of the settlement. Exchange gains were approximately $-0- in 1995,
$163,000 in 1996, and $1,080,000 in 1997, net of income taxes. These amounts
are included in the consolidated statements of income.
Earnings Per Share
All earnings per share amounts have been presented in accordance with
Statement of Financial Accounting Standards No. 128, "Earnings Per Share"
("SFAS No. 128"), which replaced primary and fully diluted earnings per share
with basic and diluted earnings per share. SFAS No. 128 had no impact on the
prior-period amounts.
Stock-Based Compensation
The Company has adopted the disclosure-only provisions of Statement of
Financial Accounting Standards No. 123. "Accounting For Stock Based
Compensation" ("SFAS No. 123"). Accordingly, no compensation cost has been
recognized for stock options granted under the Company's incentive plan.
Fair Value of Financial Instruments
The Company's financial instruments consist primarily of cash and cash
equivalents, receivables, payables, and debt instruments. The carrying values
of these financial instruments approximate their respective fair values.
Concentration of Credit Risk
Financial instruments which subject the Company to concentrations of credit
risk consist principally of trade receivables. The Company grants credit to
its customers which operate primarily in the oil and gas industry. The Company
performs periodic credit evaluations of its customer's financial condition and
generally does not require collateral. The Company maintains reserves for
potential losses and such losses have historically been within management's
expectations.
26
DRIL-QUIP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
3. INVENTORIES
Inventories consist of the following:
DECEMBER 31
---------------
1996 1997
------- -------
(IN THOUSANDS)
Raw materials and supplies............................... $15,164 $13,178
Work in progress......................................... 13,356 14,766
Finished goods and purchased supplies.................... 23,051 24,492
------- -------
$51,571 $52,436
======= =======
4. PROPERTY, PLANT, AND EQUIPMENT
Property, plant, and equipment consist of:
ESTIMATED DECEMBER 31
USEFUL ---------------
LIVES 1996 1997
----------- ------- -------
(IN THOUSANDS)
Land and improvements........................ 10-25 years $ 6,910 $ 6,826
Buildings.................................... 15-40 years 14,759 15,987
Machinery and equipment...................... 3-10 years 39,051 46,236
------- -------
60,720 69,049
Less accumulated depreciation................ 29,336 33,235
------- -------
$31,384 $35,814
======= =======
5. LONG-TERM DEBT
Long-term debt consists of the following:
DECEMBER 31
------------
1996 1997
------- ----
(IN
THOUSANDS)
Revolving lines of credit................................... $16,600 $ --
Notes payable to bank....................................... 15,502 --
Other....................................................... 434 518
------- ----
32,536 518
Less current portion........................................ 3,537 210
------- ----
$28,999 $308
======= ====
Balances outstanding on the revolving lines of credit and notes payable to
banks were paid in full during 1997 with part of the proceeds from the
Company's initial public offering. The revolving line of credit facility was
terminated upon repayment. The remaining debt consists of equipment financing
agreements.
Interest paid on long-term debt for the years ended December 31, 1995, 1996,
and 1997 was $2,883,000, $2,695,000, and $2,562,681, respectively. At December
31, 1996, the average interest rate of short-term borrowings was 8.65%.
Scheduled maturities of long-term debt are as follows: 1998--$210,000;
1999--$158,000; 2000--$89,000; 2001--$49,000; 2002--$12,000; and thereafter--
$0.
27
DRIL-QUIP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
6. INCOME TAXES
Income before income taxes consisted of the following:
1995 1996 1997
------ ------- -------
(IN THOUSANDS)
Domestic........................................... $5,634 $ 9,068 $13,547
Foreign............................................ 3,975 4,284 5,978
------ ------- -------
Total............................................ $9,609 $13,352 $19,525
====== ======= =======
The income tax provision consists of the following:
1995 1996 1997
------ ------ ------
(IN THOUSANDS)
Current:
Federal......................................... $2,671 $3,408 $4,640
Foreign......................................... 778 1,331 2,258
------ ------ ------
Total current................................. 3,449 4,739 6,898
Deferred:
Federal......................................... (825) (505) 55
Foreign......................................... 399 -- (366)
------ ------ ------
Total deferred................................ (426) (505) (311)
------ ------ ------
$3,023 $4,234 $6,587
====== ====== ======
The difference between the effective tax rate reflected in the provision for
income taxes and the U.S. federal statutory rate was as follows:
1995 1996 1997
---- ---- ----
Federal income tax statutory rate....................... 34.0% 34.0% 35.0%
Benefit of foreign sales corporation.................... (1.4) (1.8) (1.2)
Other................................................... (1.1) (.5) (.1)
---- ---- ----
Effective tax rate...................................... 31.5% 31.7% 33.7%
==== ==== ====
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:
DECEMBER 31
-------------
1996 1997
------ ------
(IN
THOUSANDS)
Deferred tax liability:
Fixed assets............................................. $1,446 $1,090
Deferred tax assets:
Deferred profit on intercompany sales.................... 2,499 2,704
Other--net............................................... 1,240 990
------ ------
Total deferred tax assets.................................. 3,739 3,694
------ ------
Net deferred tax asset..................................... $2,293 $2,604
====== ======
28
DRIL-QUIP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
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 $1,909,000, $4,314,000, and $7,143,000 in
income taxes in 1995, 1996, and 1997, respectively.
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 $501,000, $548,000, and $600,672 in 1995, 1996, and
1997, respectively.
8. COMMITMENTS AND CONTINGENCIES
The Company leases certain office, shop, and warehouse facilities;
automobiles; and equipment, and expenses all lease payments when incurred.
Total lease expense incurred was $923,000, $853,000, and $770,543 in 1995,
1996, and 1997, respectively. Annual minimum lease commitments at December 31,
1997 are as follows: 1998--$511,899; 1999--$335,862; 2000--$143,304; and
2001--$3,719.
The Company operates its business and markets its products and services in
most of the significant oil and gas producing areas in the world and is,
therefore, subject to the risk customarily attendant to international
operations and dependency on the condition of the oil and gas industry.
Additionally, products of the Company are used in potentially hazardous
drilling, completion, and production applications that can cause personal
injury, product liability, and environmental claims. Although exposure to such
risk has not resulted in any significant problems in the past, there can be no
assurance that future developments will not adversely impact the Company.
9. STOCKHOLDERS' EQUITY
In August 1996, the Company revised its capital structure and retired all
outstanding common stock and issued new common stock. Additionally, in 1997,
the Company effected a recapitalizaton wherein each outstanding share of its
non-voting common stock was converted into 0.95 shares of its voting common
stock. Thereafter, each outstanding share of its voting common stock was
converted into 15.12472 shares of voting common stock, resulting in 14,370,000
outstanding shares. Dril-Quip, Inc., a Texas corporation, was then merged (the
"Merger") into Dril-Quip, Inc., a Delaware corporation, resulting in the
Company's reincorporation from Texas to Delaware. These changes in the capital
structure have been retroactively reflected in the financial statements.
Earnings per share and dividends per share in prior years have been restated
to reflect the change in the capital structure.
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.
29
DRIL-QUIP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
10. GEOGRAPHIC AREAS
1995 1996 1997
-------- -------- --------
(IN THOUSANDS)
Revenues
United States:
Domestic........................................ $ 31,945 $ 36,759 $ 58,169
Export.......................................... 5,938 7,561 7,447
Intercompany.................................... 30,243 28,188 22,260
-------- -------- --------
Total United States........................... 68,126 72,508 87,876
Europe, Middle East, and Africa................... 52,978 54,728 61,742
Asia-Pacific...................................... 18,150 16,944 20,119
Eliminations...................................... (30,864) (28,316) (22,914)
-------- -------- --------
Total......................................... $108,390 $115,864 $146,823
======== ======== ========
Operating Income
United States..................................... $ 10,944 $ 13,693 $ 13,656
Europe, Middle East, and Africa................... 2,948 3,309 5,026
Asia-Pacific...................................... 2,113 1,825 2,610
Eliminations...................................... (3,452) (2,828) 260
-------- -------- --------
Total......................................... $ 12,553 $ 15,999 $ 21,552
======== ======== ========
Identifiable Assets
United States..................................... $ 44,627 $ 50,664 $ 93,259
Europe, Middle East, and Africa................... 39,823 59,564 51,904
Asia-Pacific...................................... 12,730 9,700 12,779
Eliminations...................................... (3,994) (5,151) (5,021)
-------- -------- --------
Total......................................... $ 93,186 $114,777 $152,921
======== ======== ========
Export sales from the United States to unaffiliated customers consist of
sales to South America, Latin America, and Canada. 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%, 19% and 11% of consolidated sales in 1995,
1996, and 1997, respectively.
30
DRIL-QUIP, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
DECEMBER 31, 1997
11. EMPLOYEE STOCK OPTION PLAN AND AWARDS
On September 19, 1997, the Company adopted the Dril-Quip, Inc. 1997
Incentive Plan. The Company reserved 1,700,000 shares of Common Stock for use
in connection with the Incentive Plan. Persons eligible for awards under the
Incentive Plan are employees holding positions of responsibility with the
Company or any of its subsidiaries. On the date of the Offering, options under
the Incentive Plan were granted to certain employees of the Company to
purchase a total of 411,250 shares of Common Stock at an exercise price per
share equal to the Offering price per share. All options have a term of ten
years and become exercisable in cumulative annual increments of one-fourth of
the total number of shares of Common Stock subject thereto, beginning on the
first anniversary of the date of the grant.
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 the grant using a Black-Scholes option pricing model with the following
assumptions: a risk free rate of 6%, a volatility factor of the expected
market price of the Company's common stock of .350; and an expected life of
the options of 5 years. These assumptions resulted in a grant date fair value
for the options of $9.83 per share. For purposes of the pro forma disclosures,
the estimated fair value is amortized to expense over the awards' vesting
period. The amortization of this expense would have less than a 1% effect on
net income and earnings per share.
12. QUARTERLY RESULTS OF OPERATIONS: (UNAUDITED)
QUARTER ENDED
------------------------------------
MARCH 31 JUNE 30 SEPT. 30 DEC. 31
-------- ------- -------- -------
(IN THOUSANDS, EXCEPT SHARE AMOUNTS)
1997
Revenues.......... $34,216 $34,454 $38,003 $40,150
Operating income.. 3,988 5,008 5,960 6,596
Net income........ 2,256 2,857 3,520 4,306
Earnings per
share:
Basic(1)........ 0.16 0.20 0.24 0.26
Diluted(1)...... 0.16 0.20 0.24 0.26
1996
Revenues.......... $25,155 $30,191 $27,855 $32,663
Operating income.. 3,173 4,073 3,570 5,183
Net income........ 1,733 2,327 1,993 3,065
Earnings per
share:
Basic........... 0.12 0.16 0.14 0.21
Diluted......... 0.12 0.16 0.14 0.21
- --------
(1) The sum of the quarterly per share amounts does not equal the annual
amount reported, as per share amounts are computed independently for each
quarter and for the full year.
31
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item is set forth under the captions
"Election of Directors" and "--Compliance with Section 16(a) of the Exchange
Act" in the Company's definitive Proxy Statement (the "1998 Proxy Statement")
for its annual meeting of shareholders to be held on May 14, 1998, 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 section entitled
"Election of Directors--Executive Compensation" in the 1998 Proxy Statement,
which section is 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 1998
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 1998 Proxy Statement,
which section is incorporated herein by reference.
32
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
EXHIBIT
NO. DESCRIPTION
------- ----------------------------------------------------------------------
*2.1 --Agreement and Plan of Merger by and Between Dril-Quip, Inc., a Texas
corporation, and Dril-Quip, Inc., a Delaware corporation
(Incorporated herein by reference to Exhibit 2.1 to the Company's
Registration Statement on Form S-1 (Registration No. 333-33447)).
*3.1 --Restated Certificate of Incorporation of the Company (Incorporated
herein by reference to Exhibit 3.2 to the Company's Registration
Statement on Form S-1 (Registration No. 333-33447)).
*3.2 --Bylaws of the Company (Incorporated herein by reference to Exhibit
3.3 to the Company's Registration Statement on Form S-1 (Registration
No. 333-33447)).
*3.3 --Certificate of Designations for Series A Junior Participating
Preferred Stock (Incorporated herein by reference to Exhibit 3.3 to
the Company's Report on Form 10-Q for the Quarter ended
September 30, 1997).
*4.1 --Form of certificate representing Common Stock (Incorporated herein
by reference to Exhibit 4.1 to the Company's Registration Statement
on Form S-1 (Registration No. 333-33447)).
*4.2 --Registration Rights Agreement among Dril-Quip, Inc. and certain
stockholders (Incorporated herein by reference to Exhibit 4.2 to the
Company's Registration Statement on Form S-1 (Registration No.
333-33447)).
*4.3 --Rights Agreement between Dril-Quip, Inc. and ChaseMellon Shareholder
Services, L.L.C., as rights agent (Incorporated herein by reference
to Exhibit 4.3 to the Company's Registration Statement on Form S-1
(Registration No. 333-33447)).
*10.1 --Credit Agreement between Bank One Texas, National Association and
Dril-Quip, Inc., dated March 30, 1994 (Incorporated herein by
reference to Exhibit 10.1 to the Company's Registration Statement on
Form S-1 (Registration No. 333-33447)).
*10.2 --First Amendment to Credit Agreement between Dril-Quip, Inc. and Bank
One Texas, National Association, dated December 20, 1994
(Incorporated herein by reference to Exhibit 10.2 to the Company's
Registration Statement on Form S-1 (Registration No. 333-33447)).
*10.3 --Second Amendment to Credit Agreement between Dril-Quip, Inc. and
Bank One Texas, National Association, dated December 13, 1995
(Incorporated herein by reference to Exhibit 10.3 to the Company's
Registration Statement on Form S-1 (Registration No. 333-33447)).
*10.4 --Third Amendment to Credit Agreement between Dril-Quip, Inc. and Bank
One Texas, National Association, dated February 14, 1997
(Incorporated herein by reference to Exhibit 10.4 to the Company's
Registration Statement on Form S-1 (Registration No. 333-33447)).
*10.5 --Credit Agreement between Bank One Texas, National Association, and
Dril-Quip (Europe) Ltd., dated March 30, 1994 (Incorporated herein by
reference to Exhibit 10.5 to the Company's Registration Statement on
Form S-1 (Registration No. 333-33447)).
33
EXHIBIT
NO. DESCRIPTION
------- ----------------------------------------------------------------------
*10.6 --First Amendment to Credit Agreement between Dril-Quip (Europe) Ltd.
and Bank One Texas, National Association, dated December 20, 1994
(Incorporated herein by reference to Exhibit 10.6 to the Company's
Registration Statement on Form S-1 (Registration No. 333-33447)).
*10.7 --Second Amendment to Credit Agreement between Dril-Quip (Europe) Ltd.
and Bank One Texas, National Association, dated December 13, 1995
(Incorporated herein by reference to Exhibit 10.7 to the Company's
Registration Statement on Form S-1 (Registration No. 333-33447)).
*10.8 --Third Amendment to Credit Agreement between Dril-Quip (Europe) Ltd.
and Bank One Texas, National Association, dated February 14, 1997
(Incorporated herein by reference to Exhibit 10.8 to the Company's
Registration Statement on Form S-1 (Registration No. 333-33447)).
*10.9 --Loan Agreement between Dril-Quip (Europe) Ltd. and the Bank of
Scotland, dated June 7, 1996 (Incorporated herein by reference to
Exhibit 10.9 to the Company's Registration Statement on Form S-1
(Registration No. 333-33447)).
*10.10 --Loan Agreement between Dril-Quip (Europe) Ltd. and the Bank of
Scotland, dated September 19, 1994 (Incorporated herein by reference
to Exhibit 10.10 to the Company's Registration Statement on Form S-1
(Registration No. 333-33447)).
*10.11 --Loan Agreement between Dril-Quip (Europe) Ltd. and the Bank of
Scotland, dated December 12, 1991 (Incorporated herein by reference
to Exhibit 10.11 to the Company's Registration Statement on Form S-1
(Registration No. 333-33447)).
+*10.12 --Form of Employment Agreement between Dril-Quip, Inc. and each of
Messrs. Reimert, Smith and Walker (Incorporated herein by reference
to Exhibit 10.12 to the Company's Registration Statement on Form S-1
(Registration No. 333-33447)).
+*10.13 --Dril-Quip, Inc. 1997 Incentive Plan (Incorporated herein by
reference to Exhibit 10.13 to the Company's Registration Statement on
Form S-1 (Registration No. 333-33447)).
21.1 --Subsidiaries of the Registrant.
23.1 --Consent of Ernst & Young LLP.
27.1 --Financial Data Schedule.
- --------
* 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.
34
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 20, 1998.
DRIL-QUIP, INC.
/s/ Larry E. Reimert
By:__________________________________
Larry E. Reimert
Co-Chairman of the Board of
Directors
and Principal Financial Officer
Pursuant to the requirements of the Securities and Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
NAME CAPACITY DATE
/s/ J. Mike Walker Co-Chairman of the March 20, 1998
- ----------------------------------- Board and Director
J. Mike Walker (Co-Principal
Executive Officer)
/s/ Larry E. Reimert Co-Chairman of the March 20, 1998
- ----------------------------------- Board and Director
Larry E. Reimert (Co-Principal
Executive Officer
and Principal
Financial Officer)
/s/ Gary D. Smith Co-Chairman of the March 20, 1998
- ----------------------------------- Board and Director
Gary D. Smith (Co-Principal
Executive Officer)
/s/ Jerry M. Brooks Chief Accounting March 20, 1998
- ----------------------------------- Officer (Principal
Jerry M. Brooks Accounting Officer)
/s/ Gary W. Loveless Director March 20, 1998
- -----------------------------------
Gary W. Loveless
/s/ James M. Alexander Director March 20, 1998
- -----------------------------------
James M. Alexander