Item 1. Financial Statements
DRIL-QUIP, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
2016
|
|
December 31,
2015
|
|
|
(In thousands)
|
|
ASSETS
|
|
|
|
|
Current assets:
|
|
|
|
|
Cash and cash equivalents
|
$
|
423,366
|
|
|
$
|
381,336
|
|
|
Trade receivables, net
|
328,060
|
|
|
319,780
|
|
|
Inventories, net
|
343,073
|
|
|
344,458
|
|
|
Deferred income taxes
|
24,934
|
|
|
24,613
|
|
|
Prepaids and other current assets
|
45,183
|
|
|
54,111
|
|
|
Total current assets
|
1,164,616
|
|
|
1,124,298
|
|
|
Property, plant and equipment, net
|
294,941
|
|
|
294,251
|
|
|
Other assets
|
10,901
|
|
|
9,701
|
|
|
Total assets
|
$
|
1,470,458
|
|
|
$
|
1,428,250
|
|
|
LIABILITIES AND STOCKHOLDERS’ EQUITY
|
|
|
|
|
Current liabilities:
|
|
|
|
|
Accounts payable
|
$
|
33,509
|
|
|
$
|
30,934
|
|
|
Accrued income taxes
|
28,143
|
|
|
14,052
|
|
|
Customer prepayments
|
12,540
|
|
|
18,388
|
|
|
Accrued compensation
|
11,391
|
|
|
17,957
|
|
|
Other accrued liabilities
|
19,316
|
|
|
19,484
|
|
|
Total current liabilities
|
104,899
|
|
|
100,815
|
|
|
Deferred income taxes
|
2,264
|
|
|
2,977
|
|
|
Total liabilities
|
107,163
|
|
|
103,792
|
|
|
Commitments and contingencies (Note 7)
|
|
|
|
|
Stockholders’ equity:
|
|
|
|
|
Preferred stock, 10,000,000 shares authorized at $0.01 par value (none issued)
|
—
|
|
|
—
|
|
|
Common stock:
|
|
|
|
|
100,000,000 shares authorized at $0.01 par value, 37,957,052 and 37,951,223 shares issued and outstanding at March 31, 2016 and December 31, 2015
|
378
|
|
|
378
|
|
|
Additional paid-in capital
|
3,334
|
|
|
—
|
|
|
Retained earnings
|
1,462,113
|
|
|
1,425,344
|
|
|
Accumulated other comprehensive losses
|
(102,530
|
)
|
|
(101,264
|
)
|
|
Total stockholders’ equity
|
1,363,295
|
|
|
1,324,458
|
|
|
Total liabilities and stockholders’ equity
|
$
|
1,470,458
|
|
|
$
|
1,428,250
|
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
DRIL-QUIP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
|
|
|
|
|
|
|
|
|
|
|
|
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Three months ended
March 31,
|
|
|
2016
|
|
2015
|
|
|
(In thousands, except per share data)
|
|
Revenues:
|
|
|
|
|
Products
|
$
|
135,194
|
|
|
$
|
187,524
|
|
|
Services
|
31,367
|
|
|
38,478
|
|
|
Total revenues
|
166,561
|
|
|
226,002
|
|
|
Cost and expenses:
|
|
|
|
|
Cost of sales:
|
|
|
|
|
Products
|
76,922
|
|
|
106,007
|
|
|
Services
|
16,174
|
|
|
19,131
|
|
|
Total cost of sales
|
93,096
|
|
|
125,138
|
|
|
Selling, general and administrative
|
13,221
|
|
|
16,958
|
|
|
Engineering and product development
|
10,901
|
|
|
12,213
|
|
|
Total costs and expenses
|
117,218
|
|
|
154,309
|
|
|
Operating income
|
49,343
|
|
|
71,693
|
|
|
Interest income
|
482
|
|
|
49
|
|
|
Interest expense
|
(4
|
)
|
|
(3
|
)
|
|
Income before income taxes
|
49,821
|
|
|
71,739
|
|
|
Income tax provision
|
13,052
|
|
|
18,075
|
|
|
Net income
|
$
|
36,769
|
|
|
$
|
53,664
|
|
|
Earnings per common share:
|
|
|
|
|
Basic
|
$
|
0.97
|
|
|
$
|
1.38
|
|
|
Diluted
|
$
|
0.97
|
|
|
$
|
1.38
|
|
|
Weighted average common shares outstanding:
|
|
|
|
|
Basic
|
37,752
|
|
|
38,773
|
|
|
Diluted
|
37,847
|
|
|
38,940
|
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
DRIL-QUIP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(UNAUDITED)
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended
March 31,
|
|
|
2016
|
|
2015
|
|
|
(In thousands)
|
|
Net income
|
$
|
36,769
|
|
|
$
|
53,664
|
|
|
Other comprehensive loss, net of tax:
|
|
|
|
|
Foreign currency translation adjustments
|
(1,266
|
)
|
|
(32,534
|
)
|
|
Total comprehensive income
|
$
|
35,503
|
|
|
$
|
21,130
|
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
DRIL-QUIP, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended
March 31,
|
|
|
2016
|
|
2015
|
|
|
(In thousands)
|
|
Operating activities
|
|
|
|
|
Net income
|
$
|
36,769
|
|
|
$
|
53,664
|
|
|
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
|
|
|
|
|
Depreciation and amortization
|
7,775
|
|
|
7,455
|
|
|
Stock-based compensation expense
|
3,192
|
|
|
3,363
|
|
|
Loss (gain) on sale of equipment
|
(13
|
)
|
|
(63
|
)
|
|
Deferred income taxes
|
(962
|
)
|
|
(2,755
|
)
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
Trade receivables, net
|
(8,942
|
)
|
|
62,837
|
|
|
Inventories, net
|
1,899
|
|
|
(7,010
|
)
|
|
Prepaids and other assets
|
8,050
|
|
|
(1,259
|
)
|
|
Excess tax benefits of stock options and awards
|
(11
|
)
|
|
(24
|
)
|
|
Accounts payable and accrued expenses
|
4,766
|
|
|
(29,139
|
)
|
|
Net cash provided by operating activities
|
52,523
|
|
|
87,069
|
|
|
Investing activities
|
|
|
|
|
Purchase of property, plant and equipment
|
(7,732
|
)
|
|
(6,156
|
)
|
|
Proceeds from sale of equipment
|
76
|
|
|
121
|
|
|
Net cash used in investing activities
|
(7,656
|
)
|
|
(6,035
|
)
|
|
Financing activities
|
|
|
|
|
Repurchase of common stock
|
—
|
|
|
—
|
|
|
Proceeds from exercise of stock options
|
155
|
|
|
282
|
|
|
Excess tax benefits of stock options and awards
|
11
|
|
|
24
|
|
|
Net cash used in financing activities
|
166
|
|
|
306
|
|
|
Effect of exchange rate changes on cash activities
|
(3,003
|
)
|
|
(5,914
|
)
|
|
Increase (decrease) in cash and cash equivalents
|
42,030
|
|
|
75,426
|
|
|
Cash and cash equivalents at beginning of period
|
381,336
|
|
|
298,705
|
|
|
Cash and cash equivalents at end of period
|
$
|
423,366
|
|
|
$
|
374,131
|
|
The accompanying notes are an integral part of these condensed consolidated financial statements.
DRIL-QUIP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. Organization and Principles of Consolidation
Dril-Quip, Inc., a Delaware corporation (the “Company” or “Dril-Quip”), designs, manufactures, sells and services highly engineered offshore drilling and production equipment that is well suited for use in deepwater, harsh environment and severe service applications. The Company’s principal products consist of subsea and surface wellheads, subsea and surface production trees, subsea control systems and manifolds, mudline hanger systems, specialty connectors and associated pipe, drilling and production riser systems, liner hangers, wellhead connectors and diverters. Dril-Quip’s products are used by major integrated, large independent and foreign national oil and gas companies in offshore areas throughout the world. Dril-Quip also provides technical advisory assistance on an as-requested basis during installation of its products, as well as rework and reconditioning services for customer-owned Dril-Quip products. In addition, Dril-Quip’s customers may rent or purchase running tools from the Company for use in the installation and retrieval of the Company’s products.
The Company’s operations are organized into
three
geographic segments—Western Hemisphere (including North and South America; headquartered in Houston, Texas), Eastern Hemisphere (including Europe and Africa; headquartered in Aberdeen, Scotland) and Asia-Pacific (including the Pacific Rim, Southeast Asia, Australia, India and the Middle East; headquartered in Singapore). Each of these segments sells similar products and services and the Company has major manufacturing facilities in all
three
of its headquarter locations as well as Macae, Brazil.
The condensed consolidated financial statements included herein are unaudited. The balance sheet at
December 31, 2015
has been derived from the audited consolidated financial statements at that date. In the opinion of management, the unaudited condensed consolidated interim financial statements include all normal recurring adjustments necessary for a fair presentation of the financial position as of
March 31, 2016
and the results of operations, comprehensive income and the cash flows for the
three
-month periods ended
March 31, 2016
and
2015
. Certain information and footnote disclosures normally included in annual audited consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. Management believes the unaudited interim related disclosures in these condensed consolidated financial statements are adequate. The results of operations, comprehensive income and cash flows for the
three
-month period ended
March 31, 2016
are not necessarily indicative of the results to be expected for the full year. The condensed consolidated financial statements included herein should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended
December 31, 2015
.
2. Significant Accounting Policies
Principles of Consolidation
The condensed 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 accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Some of the Company’s more significant estimates are those affected by critical accounting policies for revenue recognition, inventories and contingent liabilities.
Revenue Recognition
Product revenues
The Company recognizes product revenues from
two
methods:
|
|
|
|
•
|
product revenues recognized under the percentage-of-completion method; and
|
|
|
|
|
•
|
product revenues from the sale of products that do not qualify for the percentage-of-completion method.
|
Revenues recognized under the percentage-of-completion method
The Company uses the percentage-of-completion method on long-term project contracts that have the following characteristics:
|
|
|
|
•
|
the contracts call for products which are designed to customer specifications;
|
|
|
|
|
•
|
the structural designs are unique and require significant engineering and manufacturing efforts generally requiring more than one year in duration;
|
|
|
|
|
•
|
the contracts contain specific terms as to milestones, progress billings and delivery dates; and
|
|
|
|
|
•
|
product requirements cannot be filled directly from the Company’s standard inventory.
|
For each project, the Company prepares a detailed analysis of estimated costs, profit margin, completion date and risk factors which include availability of material, production efficiencies and other factors that may impact the project. On a quarterly basis, management reviews the progress of each project, which may result in revisions of previous estimates, including revenue recognition. The Company calculates the percent complete and applies the percentage to determine the revenues earned and the appropriate portion of total estimated costs. Losses, if any, are recorded in full in the period they become known. Historically, the Company’s estimates of total costs and costs to complete have approximated actual costs incurred to complete the project.
Under the percentage-of-completion method, billings may not correlate directly to the revenue recognized. Based upon the terms of the specific contract, billings may be in excess of the revenue recognized, in which case the amounts are included in customer prepayments as a liability on the Condensed Consolidated Balance Sheets. Likewise, revenue recognized may exceed customer billings in which case the amounts are reported in trade receivables. Unbilled revenues are expected to be billed and collected within one year. At
March 31, 2016
and
December 31, 2015
, receivables included $
61.5 million
and $
70.8 million
of unbilled receivables, respectively. For the quarter ended
March 31, 2016
, there were
9
projects representing approximately
15%
of the Company’s total revenues and approximately
18%
of its product revenues that were accounted for using percentage-of-completion accounting, compared to
11
projects during the
first
quarter of
2015
, which represented approximately
15%
of the Company’s total revenues and approximately
18%
of its product revenues.
Revenues not recognized under the percentage-of-completion method
Revenues from the sale of inventory products, not accounted for under the percentage-of-completion method, are recorded at the time the manufacturing processes are complete and ownership is transferred to the customer.
Service revenues
The Company recognizes service revenues from
three
sources:
|
|
|
|
•
|
technical advisory assistance;
|
|
|
|
|
•
|
rental of running tools; and
|
|
|
|
|
•
|
rework and reconditioning of customer-owned Dril-Quip products.
|
The Company does not install products for its customers, but it does provide technical advisory assistance. At the time of delivery of the product, the customer is not obligated to buy or rent the Company’s running tools and the Company is not obligated to perform any subsequent services relating to installation. Technical advisory assistance service revenue is recorded at the time the service is rendered. Service revenues associated with the rental of running and installation tools are recorded as earned. Rework and reconditioning service revenues are recorded when the refurbishment process is complete.
The Company normally negotiates contracts for products, including those accounted for under the percentage-of-completion method, and services separately. For all product sales, it is the customer’s decision as to the timing of the product installation as well as whether Dril-Quip running tools will be purchased or rented. Furthermore, the customer is under no obligation to utilize the Company’s technical advisory assistance services. The customer may use a third party or their own personnel.
Fair Value of Financial Instruments
The Company’s financial instruments consist primarily of cash and cash equivalents, receivables and payables. The carrying values of these financial instruments approximate their respective fair values as they are short-term in nature.
Earnings Per Share
Basic earnings per common share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per common share is computed considering the dilutive effect of stock options and awards using the treasury stock method.
In each relevant period, the net income used in the basic and dilutive earnings per share calculations is the same. The following table reconciles the weighted average basic number of common shares outstanding and the weighted average diluted number of common shares outstanding for the purpose of calculating basic and diluted earnings per share:
|
|
|
|
|
|
|
|
|
|
|
Three months ended
March 31,
|
|
|
2016
|
|
2015
|
|
|
(In thousands)
|
|
Weighted average common shares outstanding—basic
|
37,752
|
|
|
38,773
|
|
|
Dilutive effect of common stock options and awards
|
95
|
|
|
167
|
|
|
Weighted average common shares outstanding—diluted
|
37,847
|
|
|
38,940
|
|
3. New Accounting Standards
In February 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2016-02 “Leases (Topic 842).” The new standard requires lessees to recognize lease assets (right of use) and lease obligations (lease liability) for leases previously classified as operating leases under generally accepted accounting principles on the balance sheet for leases with terms in excess of 12 months. The standard is effective for annual periods beginning after December 15, 2018, including interim periods within those fiscal years. The Company is evaluating the impact of the new standard on its consolidated financial statements.
In November 2015, the FASB issued ASU 2015-17 “Income Taxes (Topic 740).” In an effort to reduce complexity, the requirement to separate deferred income tax liabilities and assets into current and noncurrent amounts will no longer be necessary. In the future, all deferred income taxes will be considered noncurrent and will continue to be offset into a single amount within each country. The standard is effective for fiscal years beginning after December 15, 2016 and interim periods within those fiscal years. The Company’s financial statements will be revised to reflect this amendment beginning in the first quarter of 2017.
In July 2015, the FASB issued ASU 2015-11 “Simplifying the Measurement of Inventory (Topic 330).” This standard states that inventory within the scope of this update should be measured at the lower of cost and net realizable value. Net realizable value is defined as the estimated selling price in the normal course of business, less reasonably predictable costs of completion, disposal, and transportation. The standard is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The Company is evaluating the impact of the new standard on its consolidated financial statements.
In May 2014, the FASB issued ASU 2014-09 “Revenue from Contracts with Customers (Topic 606).” The amendment applies a new five-step revenue recognition model to be used in recognizing revenues associated with customer contracts. The amendment requires disclosure sufficient to enable readers of financial statements to understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers, including qualitative and quantitative disclosures, significant judgments and changes in judgments and assets recognized from the costs to obtain or fulfill the contract. The standard’s effective date was originally for fiscal years beginning after December 15, 2016, including interim periods within that reporting period. On April 1, 2015, the FASB voted to defer the effective date by one year to December 15, 2017 and interim periods within annual reporting periods beginning after December 15, 2017. The Company is evaluating the impact of the new standard on its consolidated financial statements.
4. Stock-Based Compensation and Stock Awards
During the
three
months ended
March 31, 2016
and
2015
, the Company recognized approximately $
3.2 million
and $
3.4 million
, respectively, of stock-based compensation expense, which is included in the selling, general and administrative expense line on the Condensed Consolidated Statements of Income.
No
stock-based compensation expense was capitalized during the
three
months ended
March 31, 2016
or
2015
.
5. Inventories, net
Inventories consist of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
2016
|
|
December 31,
2015
|
|
|
(In thousands)
|
|
Raw materials
|
$
|
97,107
|
|
|
$
|
101,311
|
|
|
Work in progress
|
94,474
|
|
|
104,102
|
|
|
Finished goods
|
191,002
|
|
|
178,292
|
|
|
|
382,583
|
|
|
383,705
|
|
|
Less: allowance for obsolete and excess inventory
|
(39,510
|
)
|
|
(39,247
|
)
|
|
Net inventory
|
$
|
343,073
|
|
|
$
|
344,458
|
|
6. Geographic Areas
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended
March 31,
|
|
|
2016
|
|
2015
|
|
|
(In thousands)
|
|
Revenues:
|
|
|
|
|
Western Hemisphere
|
|
|
|
|
Products
|
$
|
78,600
|
|
|
$
|
91,815
|
|
|
Services
|
16,993
|
|
|
22,309
|
|
|
Intercompany
|
10,711
|
|
|
9,985
|
|
|
Total
|
$
|
106,304
|
|
|
$
|
124,109
|
|
|
Eastern Hemisphere
|
|
|
|
|
Products
|
$
|
33,161
|
|
|
$
|
79,421
|
|
|
Services
|
13,004
|
|
|
11,642
|
|
|
Intercompany
|
185
|
|
|
221
|
|
|
Total
|
$
|
46,350
|
|
|
$
|
91,284
|
|
|
Asia-Pacific
|
|
|
|
|
Products
|
$
|
23,433
|
|
|
$
|
16,288
|
|
|
Services
|
1,370
|
|
|
4,527
|
|
|
Intercompany
|
280
|
|
|
1,181
|
|
|
Total
|
$
|
25,083
|
|
|
$
|
21,996
|
|
|
Summary
|
|
|
|
|
Products
|
$
|
135,194
|
|
|
$
|
187,524
|
|
|
Services
|
31,367
|
|
|
38,478
|
|
|
Intercompany
|
11,176
|
|
|
11,387
|
|
|
Eliminations
|
(11,176
|
)
|
|
(11,387
|
)
|
|
Total
|
$
|
166,561
|
|
|
$
|
226,002
|
|
|
Income before income taxes:
|
|
|
|
|
Western Hemisphere
|
$
|
24,956
|
|
|
$
|
32,948
|
|
|
Eastern Hemisphere
|
16,684
|
|
|
31,708
|
|
|
Asia-Pacific
|
6,113
|
|
|
3,425
|
|
|
Eliminations
|
2,068
|
|
|
3,658
|
|
|
Total
|
$
|
49,821
|
|
|
$
|
71,739
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
March 31,
2016
|
|
December 31,
2015
|
|
|
(In thousands)
|
|
Total Long-Lived Assets:
|
|
|
|
|
Western Hemisphere
|
$
|
212,069
|
|
|
$
|
208,408
|
|
|
Eastern Hemisphere
|
42,332
|
|
|
43,449
|
|
|
Asia-Pacific
|
54,367
|
|
|
55,021
|
|
|
Eliminations
|
(2,926
|
)
|
|
(2,926
|
)
|
|
Total
|
$
|
305,842
|
|
|
$
|
303,952
|
|
|
Total Assets:
|
|
|
|
|
Western Hemisphere
|
$
|
710,691
|
|
|
$
|
677,460
|
|
|
Eastern Hemisphere
|
398,324
|
|
|
391,672
|
|
|
Asia-Pacific
|
380,114
|
|
|
372,823
|
|
|
Eliminations
|
(18,671
|
)
|
|
(13,705
|
)
|
|
Total
|
$
|
1,470,458
|
|
|
$
|
1,428,250
|
|
7
. Commitments and Contingencies
Brazilian Tax Issue
From 2002 to 2007, the Company’s Brazilian subsidiary imported goods through the State of Espirito Santo in Brazil and subsequently transferred them to its facility in the State of Rio de Janeiro. During that period, the Company’s Brazilian subsidiary paid taxes to the State of Espirito Santo on its imports. Upon the final sale of these goods, the Company’s Brazilian subsidiary collected taxes from customers and remitted them to the State of Rio de Janeiro net of the taxes paid on importation of those goods to the State of Espirito Santo in accordance with the Company’s understanding of Brazilian tax laws.
In August 2007, the State of Rio de Janeiro served the Company’s Brazilian subsidiary with assessments to collect a state tax on the importation of goods through the State of Espirito Santo from 2002 to 2007 claiming that these taxes were due and payable to it under applicable law. The Company settled these assessments with payments to the State of Rio de Janeiro of $
12.2 million
in March 2010 and $
3.9 million
in December 2010. Approximately $
7.8 million
of these settlement payments were attributable to penalties, interest and amounts that had expired under the statute of limitations so that amount was recorded as an expense. The remainder of the settlement payments generated credits (recorded as a long-term prepaid tax) to be used to offset future state taxes on sales to customers in the State of Rio de Janeiro, which were subject to certification by the tax authorities. During the second quarter of 2015, the tax authorities certified approximately $
8.3 million
of those credits paid in 2010 and granted an additional $
2.3 million
in inflation-related credits. The additional amount of credits granted by the tax authorities increased long-term prepaid taxes and decreased selling, general and administrative expenses by $
2.3 million
.
In December 2010 and January 2011, the Company’s Brazilian subsidiary was served with
two
additional assessments totaling approximately $
13.0 million
from the State of Rio de Janeiro to cancel the credits associated with the tax payments to the State of Espirito Santo (“Santo Credits”) on the importation of goods from July 2005 to October 2007. The Santo Credits are not related to the credits described above. The Company has objected to these assessments on the grounds that they would represent double taxation on the importation of the same goods and that the Company is entitled to the credits under applicable Brazilian law. With regard to the December 2010 assessment, the Company’s Brazilian subsidiary has filed an appeal with the relevant State of Rio de Janeiro judicial court to annul the tax assessment following a ruling against the Company by the tax administration’s highest council. In connection with that appeal, the Company was required to deposit with the court approximately $
3.1 million
in December 2014 as the full amount of the assessment with penalties and interest. The Company intends to file a similar appeal in the judicial system with regard to the January 2011 assessment as a result of a ruling against the Company by the tax administration’s highest council once that ruling is finalized. The Company believes that these credits are valid and that success in the judicial court process is probable. Based upon this analysis, the Company has not accrued any liability in conjunction with this matter.
Since 2007, the Company’s Brazilian subsidiary has paid taxes on the importation of goods directly to the State of Rio de Janeiro and the Company does not expect any similar issues to exist for periods subsequent to 2007.
General
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 risks 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 ongoing and future developments will not adversely impact the Company.
The Company is also involved in a number of legal actions arising in the ordinary course of business. Although no assurance can be given with respect to the ultimate outcome of such legal action, in the opinion of management, the ultimate liability with respect thereto will not have a material adverse effect on the Company’s results of operations, financial position or cash flows.
Item 2. 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 aspects of the Company’s financial position, results of operations, comprehensive income and cash flows during the periods included in the accompanying unaudited condensed consolidated financial statements. This discussion should be read in conjunction with the Company's unaudited condensed consolidated financial statements and notes therein presented elsewhere herein as well as the discussion under “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements included in the Company’s Annual Report on Form 10-K for the year ended
December 31, 2015
.
Overview
Dril-Quip designs, manufactures, sells and services highly engineered offshore drilling and production equipment that is well suited for use in deepwater, harsh environment and severe service applications. The Company designs and manufactures subsea equipment, surface equipment and offshore rig equipment for use by major integrated, large independent and foreign national oil and gas companies and drilling contractors in offshore areas throughout the world. The Company’s principal products consist of subsea and surface wellheads, subsea and surface production trees, subsea control systems and manifolds, mudline hanger systems, specialty connectors and associated pipe, drilling and production riser systems, liner hangers, wellhead connectors and diverters. Dril-Quip also provides technical advisory assistance on an as-requested basis during installation of its products, as well as rework and reconditioning services for customer-owned Dril-Quip products. In addition, Dril-Quip customers may rent or purchase running tools from the Company for use in the installation and retrieval of the Company’s products.
Oil and Gas Prices
Both the market for offshore drilling and production equipment and services and the Company’s business are substantially dependent on the condition of the oil and gas industry and, in particular, the willingness of oil and gas companies to make capital expenditures on exploration, drilling and production operations offshore. Oil and gas prices and the level of offshore drilling activity have historically been characterized by significant volatility.
According to the Energy Information Administration (EIA) of the U.S. Department of Energy, Brent Crude oil prices per barrel are listed below for the periods covered by this report:
|
|
|
|
|
|
|
|
|
|
|
|
|
Brent Crude Oil Prices
|
|
Three Months Ended
|
Low
|
|
High
|
|
Average
|
|
Closing
|
|
March 31, 2016
|
$26.01
|
|
$40.54
|
|
$33.84
|
|
$36.75
|
|
March 31, 2015
|
45.13
|
|
61.89
|
|
53.98
|
|
53.69
|
According to the April 2016 release of the Short-Term Energy Outlook published by the EIA, Brent Crude oil prices are expected to average approximately
$34.73
per barrel in 2016 and
$40.58
per barrel in 2017. In its March 2016 Oil Market Report, the International Energy Agency projected the 2016 global oil demand will grow to
95.8
million barrels per day, a
1.2
million barrels per day increase over
2015
.
Rig Count
Detailed below is the average contracted offshore rig count (rigs currently drilling as well as rigs committed, but not yet drilling) for the Company’s geographic regions for the
three
months ended
March 31, 2016
and
2015
. The rig count data includes floating rigs (semi-submersibles and drillships) and jack-up rigs. The Company has included only these types of rigs as they are the primary assets used to deploy the Company’s products.
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended March 31,
|
|
|
2016
|
|
2015
|
|
|
Floating Rigs
|
|
Jack-up Rigs
|
|
Floating Rigs
|
|
Jack-up Rigs
|
|
Western Hemisphere
|
97
|
|
|
48
|
|
|
123
|
|
|
75
|
|
|
Eastern Hemisphere
|
71
|
|
|
73
|
|
|
94
|
|
|
92
|
|
|
Asia-Pacific
|
30
|
|
|
226
|
|
|
48
|
|
|
256
|
|
|
TOTAL
|
198
|
|
|
347
|
|
|
265
|
|
|
423
|
|
Source: IHS—Petrodata RigBase – March 31, 2016 and 2015
According to IHS-Petrodata RigBase, as of
March 31, 2016
, there were
540
rigs under contract for the Company’s geographic regions (
193
floating rigs and
347
jack-up rigs), which represents a
20.6%
decrease from the rig count of
680
rigs (
261
floating rigs and
419
jack-up rigs) as of
March 31, 2015
.
The Company believes that the number of rigs (semi-submersibles, drillships and jack-up rigs) under construction impacts its revenues and backlog because in certain cases, its customers order some of the Company’s products during the construction of such rigs. As a result, an increase in rig construction activity tends to favorably impact the Company’s backlog while a decrease in rig construction activity tends to negatively impact the Company’s backlog. According to IHS-Petrodata RigBase, as of
March 31, 2016
and
2015
, there were
191
and
214
rigs, respectively, under construction, which represents an approximate
10.7%
decline in rigs under construction. The expected delivery dates for the rigs under construction at
March 31, 2016
are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Floating
|
|
Jack-Up
|
|
|
|
|
Rigs
|
|
Rigs
|
|
Total
|
|
2016
|
22
|
|
|
76
|
|
|
98
|
|
|
2017
|
22
|
|
|
32
|
|
|
54
|
|
|
2018
|
11
|
|
|
7
|
|
|
18
|
|
|
2019
|
12
|
|
|
2
|
|
|
14
|
|
|
After 2019 or unspecified delivery date
|
2
|
|
|
5
|
|
|
7
|
|
|
|
69
|
|
|
122
|
|
|
191
|
|
However, given the sustained low level in oil and gas prices and oversupply of offshore drilling rigs, the Company believes it possible that delivery of some rigs under construction could be postponed or cancelled, limiting the opportunity for supply of the Company’s products.
Regulation
The demand for the Company’s products and services is also affected by laws and regulations relating to the oil and gas industry in general, including those specifically directed to offshore operations. The adoption of new laws and regulations, or changes to existing laws or regulations that curtail 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 its products.
Business Environment
Oil and gas prices and the level of offshore drilling and production activity have been characterized by significant volatility in recent years. Worldwide military, political, economic and other events have contributed to oil and natural gas price volatility and are likely to continue to do so in the future. Lower crude oil and natural gas prices have resulted in a trend of customers seeking to renegotiate contract terms with the Company, including reductions in the prices of its products and services, extensions of delivery terms and, in some instances, contract cancellations or revisions. In some cases, a customer may already hold an inventory of the Company's equipment, which may delay the placement of new orders. In addition, some of the Company’s customers could experience liquidity or solvency issues or could otherwise be unable or unwilling to perform under a contract, which could ultimately lead a customer to enter bankruptcy or otherwise encourage a customer to seek to repudiate, cancel or renegotiate a contract. An extended period of reduced crude oil and natural gas prices may accelerate these trends. If the Company experiences significant contract terminations, suspensions or scope adjustments to its contracts, then its financial condition, results of operations and cash flows may be adversely impacted.
The Company expects continued volatility in both crude oil and natural gas prices, as well as in the level of drilling and production related activities. Even during periods of high prices for oil and natural gas, companies exploring for oil and gas may cancel or curtail programs, seek to renegotiate contract terms, including the price of products and services, or reduce their levels of capital expenditures for exploration and production for a variety of reasons. A continued significant and prolonged decline in hydrocarbon prices would likely have a material adverse effect on the Company’s results of operations.
The Company believes that its backlog should help mitigate the impact of negative market conditions; however, a continued decline in commodity prices or an extended downturn in the global economy or future restrictions on or declines in offshore oil and gas exploration and production could have a negative impact on the Company and its backlog. The Company’s backlog at
March 31, 2016
was approximately
$522 million
, compared to approximately
$1.1 billion
at
March 31, 2015
and approximately
$685 million
at
December 31, 2015
. The Company’s backlog balance during the first
three
months of
2016
has been negatively impacted by purchase order cancellations and revisions totaling approximately
$63 million
, and, due primarily
to the strengthening of the Brazilian real versus the U.S. dollar, positively impacted by approximately
$3 million
in translation adjustments. Of the approximately $63 million in cancellations and revisions during the three months ended March 31, 2016, approximately $52 million was attributable to the cancellation of one contract for wellhead equipment for a development project.
In August 2012, the Company’s Brazilian subsidiary, Dril-Quip do Brasil LTDA, was awarded a four-year contract by Petroleo Brasileiro S.A. (“Petrobras”), Brazil’s national oil company. The contract was valued at
$650 million
, net of Brazilian taxes, at exchange rates in effect at that time (approximately
$372 million
based on the
March 31, 2016
exchange rate of
3.56
Brazilian real to 1.00 U.S. dollar) if all equipment under the contract was ordered. Amounts are included in the Company’s backlog as purchase orders under the contract are received. Revenues of approximately
$113 million
have been recognized on this contract through
March 31, 2016
. As of
March 31, 2016
, the Company’s backlog included
$46 million
of purchase orders under this Petrobras contract. The Company has not yet recognized revenue of approximately
$12 million
as of
March 31, 2016
for certain items of equipment that were completed but not yet accepted for delivery by Petrobras. If Petrobras does not ultimately accept these items for delivery or if they refuse to accept these or similar items completed in the future, the Company’s results of operations may be adversely affected. The Company is in ongoing discussions with Petrobras regarding this contract and does not expect that Petrobras will order all of the equipment under the contract during its current four-year term.
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 risks customarily attendant to international operations and investments in foreign countries. These risks include nationalization, expropriation, war, acts of terrorism and civil disturbance, restrictive action by local governments, limitation on repatriation of earnings, change in foreign tax laws and change in currency exchange rates, any of which could have an adverse effect on either the Company’s ability to manufacture its products in its facilities abroad or the demand in certain regions for the Company’s products or both. To date, the Company has not experienced any significant problems in foreign countries arising from local government actions or political instability, but there is no assurance that such problems will not arise in the future. Interruption of the Company’s international operations could have a material adverse effect on its overall operations.
Revenues
. Dril-Quip’s revenues are generated from two sources: products and services. Product revenues are derived from the sale of offshore drilling and production equipment. Service revenues are earned when the Company provides technical advisory assistance and rental tools during installation and retrieval of the Company’s products. Additionally, the Company earns service revenues when rework and reconditioning services are provided. For the
three
months ended
March 31, 2016
and
2015
, the Company derived
81%
and
83%
, respectively, of its revenues from the sale of its products and
19%
and
17%
, respectively, of its revenues from services. Service revenues generally correlate to revenues from product sales because increased product sales typically generate increased demand for technical advisory assistance services during installation and rental of running tools. The Company has substantial international operations, with approximately
57%
and
62%
of its revenues derived from foreign sales for the
three
months ended
March 31, 2016
and
2015
, respectively. Substantially all of the Company’s domestic revenue relates to operations in the U.S. Gulf of Mexico. Domestic revenue approximated
43%
and
38%
of the Company’s total revenues for the
three
months ended
March 31, 2016
and
2015
, respectively.
Product contracts are negotiated and sold separately from service contracts. In addition, service contracts are not typically included in the product contracts or related sales orders and are not offered to the customer as a condition of the sale of the Company’s products. The demand for products and services is generally based on world-wide economic conditions in the offshore oil and gas industry, and is not based on a specific relationship between the two types of contracts. Substantially all of the Company’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.
Generally, the Company attempts to raise its prices as its costs increase. However, the actual pricing of the Company’s products and services is impacted by a number of factors, including global oil prices, competitive pricing pressure, the level of utilized capacity in the oil service sector, maintenance of market share, the introduction of new products and general market conditions.
The Company accounts for larger and more complex projects that have relatively longer manufacturing time frames on a percentage-of-completion basis. For the quarter ended
March 31, 2016
, there were
9
projects representing approximately
15%
of the Company’s total revenues and approximately
18%
of its product revenues that were accounted for using percentage-of-completion accounting, compared to
11
projects during the first quarter of
2015
, which represented approximately
15%
of the Company’s total revenues and approximately
18%
of its product revenues. This percentage may fluctuate in the future. Revenues accounted for in this manner are generally recognized based upon a calculation of the percentage complete, which is used to determine the revenue earned and the appropriate portion of total estimated cost of sales. Accordingly, price and cost estimates are reviewed periodically as the work progresses, and adjustments proportionate to the percent complete are reflected
in the period when such estimates are revised. Losses, if any, are recorded in full in the period they become known. Amounts received from customers in excess of revenues recognized are classified as a current liability.
Cost of Sales
. The principal elements of cost of sales are labor, raw materials and manufacturing overhead. Cost of sales as a percentage of revenues is influenced by the product mix sold in any particular period, costs from projects accounted for under the percentage-of-completion method, over/under manufacturing overhead absorption 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, business development expenses, compensation expense, stock-based compensation expense, legal expenses, foreign currency transaction gains and losses 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
. The Company’s effective income tax rate has historically been lower than the statutory rate primarily due to foreign income tax rate differentials, research and development credits and deductions related to domestic manufacturing activities.
Results of Operations
The following table sets forth, for the periods indicated, certain statement of operations data expressed as a percentage of revenues:
|
|
|
|
|
|
|
|
|
|
|
Three months ended
March 31,
|
|
|
2016
|
|
2015
|
|
Revenues:
|
|
|
|
|
Products
|
81.2
|
%
|
|
83.0
|
%
|
|
Services
|
18.8
|
|
|
17.0
|
|
|
Total revenues:
|
100.0
|
|
|
100.0
|
|
|
Cost of sales:
|
|
|
|
|
Products
|
46.2
|
|
|
46.9
|
|
|
Services
|
9.7
|
|
|
8.5
|
|
|
Total cost of sales:
|
55.9
|
|
|
55.4
|
|
|
Selling, general and administrative expenses
|
8.0
|
|
|
7.5
|
|
|
Engineering and product development expenses
|
6.5
|
|
|
5.4
|
|
|
Operating income
|
29.6
|
|
|
31.7
|
|
|
Interest income
|
0.3
|
|
|
—
|
|
|
Income before income taxes
|
29.9
|
|
|
31.7
|
|
|
Income tax provision
|
7.8
|
|
|
8.0
|
|
|
Net income
|
22.1
|
%
|
|
23.7
|
%
|
The following table sets forth, for the periods indicated, a breakdown of our products and service revenues:
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended
March 31,
|
|
|
2016
|
|
2015
|
|
|
(In millions)
|
|
Revenues:
|
|
|
|
|
Products
|
|
|
|
|
Subsea equipment
|
$
|
121.1
|
|
|
$
|
168.0
|
|
|
Surface equipment
|
4.1
|
|
|
5.5
|
|
|
Offshore rig equipment
|
10.0
|
|
|
14.0
|
|
|
Total products
|
135.2
|
|
|
187.5
|
|
|
Services
|
31.4
|
|
|
38.5
|
|
|
Total revenues
|
$
|
166.6
|
|
|
$
|
226.0
|
|
Three Months Ended March 31, 2016
Compared to
Three Months Ended March 31, 2015
Revenues.
Revenues decreased by
$59.4 million
, or approximately
26.3%
, to
$166.6 million
in the
three
months ended
March 31, 2016
from
$226.0 million
in the
three
months ended
March 31, 2015
. Product revenues decreased by approximately
$52.3 million
for the
three
months ended
March 31, 2016
compared to the same period in
2015
as a result of decreased revenues of
$46.9 million
in subsea equipment,
$1.4 million
in surface equipment and
$4.0 million
in offshore rig equipment. Product revenues decreased in the Eastern Hemisphere and the Western Hemisphere by
$46.3 million
and
$13.2 million
,
respectively, largely due to the decline in oil and gas prices resulting in decreases in the demand for exploration and production equipment, especially subsea equipment. These decreases were offset by an increase in Asia-Pacific product revenues of
$7.2 million
. In any given time period, the revenues recognized between the various product lines and geographic areas will vary depending upon the timing of shipments to customers, completion status of the projects accounted for under the percentage-of-completion accounting method, market conditions and customer demand. Service revenues decreased by approximately
$7.1 million
resulting from decreased service revenues in the Western Hemisphere of
$5.3 million
and
$3.2 million
in Asia-Pacific, partially offset by an increase of
$1.4 million
in the Eastern Hemisphere. The majority of the decreases in service revenues related to decreased rental of the Company’s running and installation tools, largely due to the decline in oil and gas prices leading to decreased exploration and production activities.
Cost of Sales.
Cost of sales decreased by
$32.0 million
, or approximately
25.6%
, to
$93.1 million
for the
three
months ended
March 31, 2016
from
$125.1 million
for the same period in
2015
as a result of lower revenues. As a percentage of revenues, cost of sales increased slightly to
55.9%
from
55.4%
in the
three
months ended
March 31, 2016
as compared to the same period in
2015
, primarily as result of pricing concessions.
Selling, General and Administrative Expenses.
For the
three
months ended
March 31, 2016
, selling, general and administrative expenses decreased by approximately
$3.8 million
, or
22.1%
, to
$13.2 million
from
$17.0 million
for the same period in 2015, primarily due to a reduction in personnel and related costs associated with lower headcount. In addition, the Company experienced a pre-tax foreign currency transaction gain of
$7.3 million
in the
first
quarter of
2016
compared to a gain of
$6.5 million
in the
first
quarter of
2015
. Stock award expense totaled
$3.2 million
for the
first
quarter of
2016
as compared to
$3.4 million
in
2015
. Selling, general and administrative expenses as a percentage of revenues increased to
8.0%
in the
first
quarter of
2016
from
7.5%
in the
first
quarter of
2015
.
Engineering and Product Development Expenses.
For the
three
months ended
March 31, 2016
, engineering and product development expenses totaled
$10.9 million
compared to
$12.2 million
for the same period in
2015
, a decrease of
$1.3 million
, or
10.7%
. The majority of the decrease was due to a reduction in personnel and related costs associated with lower headcount. Engineering and product development expenses as a percentage of revenues increased to
6.5%
in the
first
quarter of
2016
from
5.4%
in the
first
quarter of
2015
.
Income tax provision
. Income tax expense for the
three
months ended
March 31, 2016
was
$13.1 million
on income before taxes of
$49.8 million
, resulting in an effective income tax rate of approximately
26.2%
. Income tax expense for the
three
months ended
March 31, 2015
was
$18.1 million
on income before taxes of
$71.7 million
, resulting in an effective income tax rate of approximately
25.2%
. The increase in the effective income tax rate percentage primarily reflects the changes in taxable income among the Company’s three geographic areas, which have different income tax rates.
Net Income.
Net income was approximately
$36.8 million
for the
three
months ended
March 31, 2016
and
$53.7 million
for the same period in
2015
for the reasons set forth above.
Liquidity and Capital Resources
Cash flows provided by (used in) type of activity were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31,
|
|
|
2016
|
|
2015
|
|
|
(In thousands)
|
|
Operating activities
|
$
|
52,523
|
|
|
$
|
87,069
|
|
|
Investing activities
|
(7,656
|
)
|
|
(6,035
|
)
|
|
Financing activities
|
166
|
|
|
306
|
|
|
|
45,033
|
|
|
81,340
|
|
|
Effect of exchange rate changes on cash activities
|
(3,003
|
)
|
|
(5,914
|
)
|
|
Increase (decrease) in cash and cash equivalents
|
$
|
42,030
|
|
|
$
|
75,426
|
|
Statements of cash flows for entities with international operations that are local currency functional exclude the effects of the changes in foreign currency exchange rates that occur during any given period, as these are non-cash changes. As a result, changes reflected in certain accounts on the Condensed Consolidated Statements of Cash Flows may not reflect the changes in corresponding accounts on the Condensed Consolidated Balance Sheets.
The primary liquidity needs of the Company are (i) to fund capital expenditures to improve and expand facilities and manufacture additional running tools and (ii) to fund working capital. The Company’s principal source of funds is cash flows from operations.
Net cash provided by operating activities decreased
$34.5 million
for the
first
quarter of
2016
compared to the same period in
2015
, primarily due to decreases in operating assets and liabilities of
$19.6 million
and lower net income of
$16.9 million
.
The change in operating assets and liabilities for the
three
months ended March 31,
2016
resulted in a
$5.8 million
increase in cash. Trade receivables increased
$8.9 million
primarily due to delays in customer collections from a tightening oil and gas market. Inventory slightly decreased by
$1.9 million
. Prepaids and other assets decreased by
$8.1 million
due to decreases in vendor prepayments. Accounts payable and accrued expenses decreased by approximately
$4.8 million
due to a reduction in customer prepayments of
$5.8 million
.
The change in operating assets and liabilities for the
three
months ended March 31,
2015
primarily reflected a decrease in trade receivables of $62.8 million and an increase in inventory of $7.0 million. Trade receivables primarily decreased due to strong collection efforts. Inventory increased due to higher balances in raw materials and work in progress (excluding foreign currency translation) to accommodate the backlog requirements related to long-term projects. Accounts payable and accrued expenses decreased by approximately $29.1 million due to a decrease in customer prepayments of $28.2 million.
Capital expenditures by the Company were
$7.7 million
and
$6.2 million
in the
three
months ended March 31,
2016
and
2015
, respectively. The capital expenditures for the
first
quarter of
2016
were
$6.2 million
for machinery and equipment and other expenditures of
$1.5 million
. The capital expenditures for the
first
quarter of
2015
were
$5.6 million
for machinery and equipment and other expenditures of $600,000.
The exercise of stock options generated cash to the Company of
$155,000
in the
first
quarter of
2016
as compared to
$282,000
in the same period of
2015
.
On February 26, 2015, the Company announced that its Board of Directors had authorized a stock repurchase plan under which the Company was authorized to repurchase up to $100 million of its common stock. The Company repurchased and cancelled 1,184,700 shares under this plan in 2015 for a total cost of $75.8 million. There were no repurchases during the
first
quarter of
2016
. The repurchase program has no expiration date and any repurchased shares are expected to be cancelled.
As of
March 31, 2016
, the Company has no commercial lending arrangement or lines of credit. The Company believes that cash generated from operations plus cash on hand will be sufficient to fund operations, working capital needs and
anticipated capital expenditure requirements for the next twelve months. However, continued significant declines in hydrocarbon prices, catastrophic events or significant changes in regulations affecting the Company or its customers could have a material adverse effect on the Company’s liquidity. Should market conditions result in unexpected cash requirements, the Company believes that borrowing from commercial lending institutions would be available and adequate to meet such requirements.
Off-Balance Sheet Arrangements
The Company has no derivative instruments and no off-balance sheet hedging or financing arrangements, contracts or operations.
Other Matters
From time to time, the Company enters into discussions or negotiations to acquire other businesses or enter into joint ventures. The timing, size or success of any such efforts and the associated potential capital commitments are unpredictable and dependent on market conditions and opportunities existing at the time. The Company may seek to fund all or part of any such efforts with proceeds from debt or equity issuances. Debt or equity financing may not, however, be available at that time due to a variety of events, including, among others, the Company’s credit ratings, industry conditions, general economic conditions and market conditions.
Critical Accounting Policies
Refer to our Annual Report on Form 10-K for the year ended
December 31, 2015
for a discussion of our critical accounting policies. During the
three
months ended
March 31, 2016
, there were no material changes in our judgments and assumptions associated with the development of our critical accounting policies.