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EX-32.2 - EXHIBIT 32.2 - DRIL-QUIP INCa20161231exhibit322.htm
EX-32.1 - EXHIBIT 32.1 - DRIL-QUIP INCa20161231exhibit321.htm
EX-31.2 - EXHIBIT 31.2 - DRIL-QUIP INCa20161231exhibit312.htm
EX-31.1 - EXHIBIT 31.1 - DRIL-QUIP INCa20161231exhibit311.htm
EX-23.1 - EXHIBIT 23.1 - DRIL-QUIP INCa20161231exhibit231.htm
EX-21.1 - EXHIBIT 21.1 - DRIL-QUIP INCa20161231exhibit211.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_______________________________________________________
FORM 10-K
_______________________________________________________
(MARK ONE)
ý
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2016
or
¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from            to           .
Commission file number 001-13439
_______________________________________________________
DRIL-QUIP, INC.
(Exact name of registrant as specified in its charter)
_______________________________________________________
Delaware
74-2162088
(State or other jurisdiction of
incorporation or organization)
(IRS Employer
Identification No.)
 
 
6401 N. Eldridge Parkway
Houston, Texas
77041
(Address of principal executive offices)
(Zip code)
Registrant’s telephone number, including area code: (713) 939-7711
_______________________________________________________
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Name of Each Exchange On Which Registered
Common Stock, $.01 par value per share
New York Stock Exchange
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 if the registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act.    Yes  ý    No  ¨
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  ý
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  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of regulations S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    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.  ý
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
ý
Accelerated filer
¨
Non-Accelerated filer
¨  (Do not check if a smaller reporting company)
Smaller reporting company
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  ý
At June 30, 2016, the aggregate market value of the registrant’s Common Stock held by non-affiliates of the registrant was approximately $2,183,800,000 based on the closing price of such stock on such date of $58.43.
At February 27, 2017, the number of shares outstanding of registrant’s Common Stock was 37,806,683.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s Proxy Statement for its 2017 Annual Meeting of Stockholders to be filed pursuant to Regulation 14A are incorporated by reference in Part III of this Form 10-K.





TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

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FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K includes certain statements that may be deemed to be “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Statements contained in all parts of this document that are not historical facts are forward-looking statements that involve risks and uncertainties that are beyond the control of Dril-Quip, Inc. (the “Company” or “Dril-Quip”). You can identify the Company’s forward-looking statements by the words “anticipate,” “estimate,” “expect,” “may,” “project,” “believe” and similar expressions, or by the Company’s discussion of strategies or trends. Although the Company believes that the expectations reflected in such forward-looking statements are reasonable, no assurance can be given that these expectations will prove to be correct. These forward-looking statements include the following types of information and statements as they relate to the Company:
future operating results and cash flow;
scheduled, budgeted and other future capital expenditures;
working capital requirements;
the need for and the availability of expected sources of liquidity;
the introduction into the market of the Company’s future products;
the market for the Company’s existing and future products;
the Company’s ability to develop new applications for its technologies;
the exploration, development and production activities of the Company’s customers;
compliance with present and future environmental regulations and costs associated with environmentally related penalties, capital expenditures, remedial actions and proceedings;
effects of pending legal proceedings;
changes in customers’ future product and service requirements that may not be cost effective or within the Company’s capabilities; and
future operations, financial results, business plans and cash needs.
These statements are based on assumptions and analyses in light of the Company’s experience and perception of historical trends, current conditions, expected future developments and other factors the Company believes were appropriate in the circumstances when the statements were made. Forward-looking statements by their nature involve substantial risks and uncertainties that could significantly impact expected results, and actual future results could differ materially from those described in such statements. While it is not possible to identify all factors, the Company continues to face many risks and uncertainties. Among the factors that could cause actual future results to differ materially are the risks and uncertainties discussed under “Item 1A. Risk Factors” in this report and the following:
the volatility of oil and natural gas prices;
the cyclical nature of the oil and gas industry;
uncertainties associated with the United States and worldwide economies;
uncertainties regarding political tensions in the Middle East, South America, Africa and elsewhere;
current and potential governmental regulatory actions in the United States and regulatory actions and political unrest in other countries;
uncertainties regarding future oil and gas exploration and production activities, including new regulations, customs requirements and product testing requirements;
operating interruptions (including explosions, fires, weather-related incidents, mechanical failure, unscheduled downtime, labor difficulties, transportation interruptions, spills and releases and other environmental risks);
project terminations, suspensions or scope adjustments to contracts reflected in the Company’s backlog;
the Company’s reliance on product development;
technological developments;
the Company’s reliance on third-party technologies;

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acquisition and merger activities involving the Company or its competitors;
the Company’s dependence on key employees and skilled machinists, fabricators and technical personnel;
the Company’s reliance on sources of raw materials;
impact of environmental matters, including future environmental regulations;
competitive products and pricing pressures;
fluctuations in foreign currency, including those attributable to Brexit;
the ability of the Organization of Petroleum Exporting Countries (OPEC) to set and maintain production levels and pricing;
the Company’s reliance on significant customers;
creditworthiness of the Company’s customers;
fixed-price contracts;
changes in general economic, market or business conditions;
access to capital markets;
negative outcome of litigation, threatened litigation or government proceedings;
terrorist threats or acts, war and civil disturbances; and
changes to, and differing interpretations of, tax laws with respect to our operations and subsidiaries.
Many of such factors are beyond the Company’s ability to control or predict. Any of the factors, or a combination of these factors, could materially affect the Company’s future results of operations and the ultimate accuracy of the forward-looking statements. Management cautions against putting undue reliance on forward-looking statements or projecting any future results based on such statements or present or prior earnings levels. Every forward-looking statement speaks only as of the date of the particular statement, and the Company undertakes no obligation to publicly update or revise any forward-looking statement.

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PART I
Item 1.        Business
General
Dril-Quip, Inc., a Delaware corporation (the “Company” or “Dril-Quip”), designs, manufactures, sells and services highly engineered drilling and production equipment that is well suited primarily 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, diverters and safety valves. Dril-Quip’s products are used by major integrated, large independent and foreign national oil and gas companies and drilling contractors primarily 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.
Dril-Quip has developed its broad line of subsea equipment, surface equipment and offshore rig equipment primarily through its internal product research and development efforts. The Company believes that it has achieved significant market share and brand name recognition with respect to its established products due to the technological capabilities, reliability, cost effectiveness and operational timesaving features of these products.
The Company’s operations are organized into three geographic segments—Western Hemisphere (including North and South America; headquartered in Houston, Texas), Eastern Hemisphere (including Europe and Africa; headquartered in Aberdeen, Scotland) and Asia-Pacific (including the Pacific Rim, Southeast Asia, Australia, India and the Middle East; headquartered in Singapore). Each of these segments sells similar products and services, and the Company has major manufacturing facilities in all three of its headquarter locations as well as in Macae, Brazil. The Company maintains additional facilities for fabrication and/or reconditioning and rework in Australia, Norway, Denmark, Nigeria, Indonesia, China, Egypt, Ghana and Qatar. The Company’s manufacturing operations are vertically integrated, allowing it to perform substantially all of its forging, heat treating, machining, fabrication, inspection, assembly and testing at its own facilities. The Company’s major subsidiaries are Dril-Quip (Europe) Limited, located in Aberdeen with branches in Denmark, Norway and Holland; Dril-Quip Asia Pacific PTE Ltd., located in Singapore; Dril-Quip do Brasil LTDA, located in Macae, Brazil; and DQ Holdings Pty. Ltd., located in Perth, Australia. Other subsidiaries include Dril-Quip (Ghana) Ltd. located in Takoradi, Ghana; PT DQ Oilfield Services Indonesia located in Jakarta, Indonesia; Dril-Quip (Nigeria) Ltd. located in Port Harcourt, Nigeria; Dril-Quip Egypt for Petroleum Services S.A.E. located in Alexandria, Egypt; Dril-Quip Oilfield Services (Tianjin) Co. Ltd. located in Tianjin, China; and Dril-Quip Qatar LLC, located in Doha, Qatar.
On November 10, 2016, the Company acquired TIW Corporation (TIW), a Texas corporation, located in Houston, Texas, and all of its subsidiaries. TIW manufactures consumable downhole products for the onshore and offshore global oil and gas market. TIW's subsidiaries include TIW Canada Ltd. located in Alberta, Canada; TIW de Mexico S.A. de C.V., located in Villahermosa, Mexico; TIW de Venezuela S.A., located in Anaco, Venezuela and with a registered branch located in Shushufindi, Ecuador; TIW (UK) Limited, located in Aberdeen, Scotland; TIW Hungary LLC, located in Szolnok, Hungary; and TIW International, Inc., which has a registered branch located in Singapore.
Dril-Quip markets its products through its offices and sales representatives located in the major international energy markets throughout the world. In 2016, the Company generated approximately 66% of its revenues from foreign sales compared to 63% in both 2015 and 2014.
The Company makes available, free of charge on its website, its Annual Report on Form 10-K and quarterly reports on Form 10-Q (in both HTML and XBRL formats), current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practical after it electronically files such reports with, or furnishes them to, the Securities and Exchange Commission (SEC). The Company’s website address is www.dril-quip.com. Documents and information on the Company’s website, or on any other website, are not incorporated by reference into this Form 10-K. Any materials the Company files with the SEC may be read and copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Information concerning the Public Reference Room may be obtained by calling 1-800-SEC-0330. In addition, the SEC maintains a website (www.sec.gov) that contains reports the Company has filed with the SEC.

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The Company also makes available free of charge on its website (www.dril-quip.com/govern.html) its:
Corporate Governance Guidelines,
Code of Business Conduct and Ethical Practices,
Audit Committee Charter,
Nominating and Governance Committee Charter, and
Compensation Committee Charter.
Any stockholder, who so requests, may obtain a printed copy of any of these documents from the Company. Changes in or waivers to the Company's Code of Business Conduct and Ethical Practices involving directors and executive officers of the Company will be posted on its website.
Overview and Industry Outlook
Both the market for 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. The level of capital expenditures has generally been dependent upon the prevailing view of future oil and gas prices, which are influenced by numerous factors affecting the supply and demand for oil and gas, including worldwide economic activity, interest rates and the cost of capital, environmental regulation, tax policies and the ability and/or desire of OPEC and other producing nations to set and maintain production levels and prices. The Brent crude oil price reached a high of $115.19 per barrel in June 2014 and then began to drop sharply during the fourth quarter of 2014, ending the year at $55.27 per barrel. Crude oil prices continued to drop in 2015, reaching a low of $35.26 per barrel in December 2015. During the first quarter of 2016, the price per barrel reached a low of $26.01, before rebounding slightly to end the year at $54.96 per barrel. On November 30, 2016, OPEC met and decided to cut production by approximately 1.2 million barrels per day. The reduced production, if realized, is expected to keep oil prices over $50 per barrel during 2017. Capital expenditures are also dependent on the cost of exploring for and producing oil and gas, the availability, expiration date and price of leases, the discovery rate of new oil and gas reserves, technological advances and alternative opportunities to invest in onshore exploration and production operations. Oil and gas prices and the level of drilling and production activity have historically been characterized by significant volatility. Future declines in oil and gas prices may further adversely affect the willingness of some oil and gas companies to make capital expenditures on exploration, drilling and production operations, which could have an adverse impact on the Company’s results of operations, financial position and cash flows.
Brent crude oil prices per barrel for the current and previous two years are summarized below:
 
Brent Crude Oil Prices
Year
Low
 
High
 
Average
 
Dec. 31,
2014
$
55.27

 
$
115.19

 
$
98.97

 
$
55.27

2015
35.26

 
66.33

 
52.32

 
36.61

2016
26.01

 
54.96

 
43.67

 
54.96

The decrease in Brent crude oil prices over the past three years continues to have a significant effect on major integrated, large independent and foreign national oil and gas companies’ capital expenditure budgets. 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. See “Item 1A. Risk Factors—A material or extended decline in expenditures by the oil and gas industry could significantly reduce our revenue and income.”
Recent Developments
On October 14, 2016, the Company entered into an agreement with Pearce Industries, Inc. to acquire all the outstanding common stock, par value $100.00 per share, of TIW Corporation for a cash purchase price of $142.7 million, which is subject to customary adjustments for cash and working capital. The acquisition closed on November 10, 2016. The acquisition of TIW

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is expected to strengthen the Company's liner hanger sales and increase market share. Additionally, the acquisition of TIW gives Dril-Quip a presence in the onshore oil and gas market.
Products and Services
Dril-Quip’s revenues are generated from two sources: products and services. Product revenues are derived primarily 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. In 2016, the Company derived 80% of its revenues from the sale of its products and 20% of its revenues from services compared to 81% and 19% in 2015 and 83% and 17% in 2014, respectively.
Products
Dril-Quip designs, manufactures, fabricates, inspects, assembles, tests and markets subsea equipment, surface equipment and offshore rig equipment. The Company’s products are used primarily to explore for oil and gas from offshore drilling rigs, such as floating rigs and jack-up rigs, and for drilling and production of oil and gas wells on offshore platforms, tension leg 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. A Spar is a floating cylindrical structure approximately six or seven times longer than its diameter and is anchored in place. FPSOs are floating production, storage and offloading monohull moored vessels. The TIW products are used in the drilling and production for oil and gas both onshore and offshore.
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, production riser systems, subsea production trees, liner hangers, safety valves, subsea control systems and subsea manifolds.
Subsea wellheads are pressure-containing vessels that are sometimes referred to as a “wellhead housing” and are made from forged and machined steel. A casing hanger, also made of steel, lands inside the wellhead housing and suspends casing (pipe) downhole. 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, or TLPs and Spars. The Company’s flagship subsea wellhead, called the SS-15® Subsea Wellhead System, is rated for 15,000 psi internal pressure and is offered to the industry in a variety of configurations. The Company’s newest wellhead product, the SS-20TM BigBoreTM II-H Subsea Wellhead System, is designed to contain higher pressures (20,000 pounds per square inch (psi)) and accommodate additional casing strings installed through a marine drilling riser and a subsea blowout preventer.
Mudline hanger systems are used in jack-up drilling operations to support the weight of the various casing strings at the ocean floor while drilling a well. They also provide a method to disconnect the casing strings in an orderly manner at the ocean floor after the well has been drilled, and subsequently reconnect to enable production of the well by either tying it back vertically to a subsequently installed platform or by installing a shallow water subsea tree.
Large diameter weld-on specialty connectors (threaded or stab type) are used primarily in offshore wells drilled from floating drilling rigs, jack-up rigs, fixed platforms, TLPs and Spars. Specialty connectors join lengths of conductor or large diameter (16-inch or greater) casing. Specialty connectors provide a more rapid connection than other methods of connecting lengths of pipe. Connectors may be sold individually or as an assembly after being welded to sections of Company or customer supplied pipe. Dril-Quip’s weld-on specialty connectors are designed to prevent cross threading and provide a quick, convenient method of joining casing joints with structural integrity compatible with casing strength.
Production riser systems are generally designed and manufactured to customer specifications. Production risers provide a vertical conduit from the subsea wellhead up to a TLP, Spar or FPSO floating at the surface.
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 used as stand alone satellite wells or multiple well template mounted and cluster arrangements. These types typically produce via a subsea gathering system of manifolds and 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 complicated dual-bore production trees. In addition, Dril-Quip manufactures a patented single bore (SingleBoreTM) subsea completion system which features a hydraulic valve mechanism instead of a

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wireline-installed mechanism that allows the operator to plug the tubing hanger annulus remotely from the surface via a hydraulic control line and subsequently unplug it when the well is put on production. This mechanism eliminates the need for an expensive multibore installation and workover riser, thereby saving both cost and installation time. Dril-Quip’s subsea production trees are used in ultra-deepwater applications. These trees feature remote flowline and control connections, utilizing remotely operated intervention tools. The Company’s subsea production trees are generally custom designed and manufactured to customer specifications.
A liner hanger is used to hang-off and seal casing into a previously installed casing string in the well bore, and can provide a means of tying back the liner for production to surface. Dril-Quip has developed a state-of-the-art liner hanger system and has installed its liner hangers in a number of difficult well applications, resulting in improved industry recognition and market opportunities. In addition to liner hanger systems that are well suited for onshore use, TIW offers expandable liner hanger systems that are typically utilized in challenging environments such as deepwater or High Pressure, High Temperature (HPHT) applications.
A safety valve is used to provide a quick, sure shutoff in the drill string at the drill floor and prevent flow up the drill pipe. The TIW Kelly Valve is located in the drill string below the kelly, the uppermost component of the drill string, and is designed to be closed under pressure to remove the kelly.
A subsea control system provides control of subsea trees, manifolds, ocean floor process equipment and pipeline protection equipment. Dril-Quip has developed a variety of subsea control systems, including fiber optic based multiplex control systems that provide real time access to tree functions and tree equipment status. The control system can be packaged for shallow water or deepwater applications. Dril-Quip also manufactures control systems used in the installation, retrieval and workover of production equipment.
A subsea manifold is a structure located on the ocean floor consisting of valves, flowline connections and a control module used to collect and control the flow of oil and gas from subsea wells for delivery to a floating production unit or terminal.
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, platform production trees and riser tensioners. 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 surface 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 actuated, valves and connectors. Platform wellheads and platform production trees and associated equipment are designed and manufactured in accordance with customer specifications.
Riser tensioners are used on a floating drilling/production vessel to provide a continuous and reliable upward force on a riser string that is independent of the movement of the floating vessel.
Offshore Rig Equipment. Offshore rig equipment includes drilling 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 top of the riser 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 blowout preventer stack to or 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 are used on production riser systems and drilling riser systems. They are also used on both TLPs and Spars, which are installed in deepwater applications. The principal markets for offshore rig equipment are new rigs, rig upgrades, TLPs and Spars. Drilling risers, wellhead connectors and diverters are generally designed and manufactured to customer specifications.

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Certain products of the Company are used in potentially hazardous drilling, completion and production applications that can cause personal injury, product liability and environmental claims. See “Item 1A. Risk Factors—Our business involves numerous operating hazards that may not be covered by insurance. The occurrence of an event not fully covered by insurance could have a material adverse effect on our results of operations, financial position and cash flows.”
Services
The Company provides services to customers, including technical advisory assistance and rental tools during installation and retrieval of the Company’s products. The Company also provides rework and reconditioning services on its customer-owned products. These services are provided from the Company’s worldwide locations and represented approximately 20% of revenues in 2016 compared to 19% in 2015 and 17% in 2014.
Technical Advisory Assistance. Dril-Quip does not install products for its customers, but it does provide technical advisory assistance to the customer, if requested, in the installation of its products. The customer is not obligated to utilize these services and may use its own personnel or a third party to perform these services. Technical advisory assistance services performed by the Company are negotiated and sold separately from the Company’s products. These services are not a prerequisite to the sale of the Company’s products as its products are fully functional on a stand alone basis. The Company’s technicians provide assistance in the onsite installation of the Company’s products and are available on a 24-hour call out from the Company’s facilities located in Houston, Texas; Midland, Texas; Oklahoma City, Oklahoma; Youngsville, Louisiana; New Orleans, Louisiana; Villahermosa, Mexico; Nisku, Alberta, Canada; Anaco, Venezuela; Shushufindi, Ecuador; Macae, Brazil; Aberdeen, Scotland; Szolnok, Hungary; Stavanger, Norway; Esbjerg, Denmark; Port Harcourt, Nigeria; Alexandria, Egypt; Takoradi, Ghana; Tianjin, China; Doha, Qatar; Singapore; and Perth, Australia.
Rental. The Company rents running and installation tools for use in installing its products. These tools are required to install and retrieve the Company’s products that are purchased by customers. Rental or purchase of running tools is not a condition of the sale of the Company’s products and is contracted for separately from product sales and other services offered by the Company. Running tools are available from Dril-Quip’s locations in Houston, Texas; Midland, Texas; Oklahoma City, Oklahoma; Youngsville, Louisiana; Villahermosa, Mexico; Nisku, Alberta, Canada; Anaco, Venezuela; Shushufindi, Ecuador; Macae, Brazil; Aberdeen, Scotland; Szolnok, Hungary; Stavanger, Norway; Esbjerg, Denmark; Beverwijk, Holland; Singapore; and Perth, Australia.
Reconditioning. The Company provides reconditioning of its customer-owned products at its facilities in Houston, Texas; Macae, Brazil; Aberdeen, Scotland; Stavanger, Norway; Esbjerg, Denmark; Port Harcourt, Nigeria; Alexandria, Egypt; Takoradi, Ghana; Balikpapan, Indonesia; Tianjin, China; Doha, Qatar; Singapore; and Perth, Australia. The Company does not typically service, repair or recondition its competitors’ products.
Manufacturing
Dril-Quip has major manufacturing facilities in Houston, Texas; Aberdeen, Scotland; Singapore; and Macae, Brazil. See “Item 2. Properties—Manufacturing Facilities.” Only the Houston facility at Eldridge Parkway provides forged and heat treated products to its major manufacturing facilities. Dril-Quip maintains its high standards of product quality through the implementation of Advanced Product Quality Planning (APQP) methodologies, as well as through the use of quality control specialists.
The Company’s Houston, Aberdeen, Singapore and Macae manufacturing plants are ISO 14001, OHSAS 18001 and ISO 9001 certified. The Houston, Aberdeen, Singapore and Macae plants are also licensed to applicable American Petroleum Institute (API) product specifications and are API Q1, 9th edition compliant. The Metallurgical Laboratory at the Houston operations is ISO 17025 certified for Crack Tip Opening Displacement, Hardness, Tensile and Charpy V-Notch testing. Dril-Quip works to maintain its high standards of product quality through the use of precision measuring equipment such as Gage Masters, Faro Arms, Coordinate Measuring Machine and the application of APQP. APQP entails concurrent engineering principles to identify and address potential quality concerns early in the product development process. 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 processes are vertically integrated, providing capability for the majority of its forging and heat treating and essentially all of its machining, fabrication, inspection, assembly and testing to be performed in-house. The Company’s primary raw material is cast steel ingots, from which it produces steel shaped forgings at its forging and heat treatment facility in Houston, Texas. The Company routinely purchases steel ingots from multiple 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 Houston, Aberdeen, Singapore and Macae facilities. The Company’s major competitors depend on outside sources for all

9


or a substantial portion of their forging and heat treatment requirements. The Company has made significant capital investments in developing its vertically integrated manufacturing capability. Prolonged periods of low demand in the market for drilling and production equipment could have a greater effect on the Company than on certain of its competitors that have not made such large capital investments in their 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 manufacturing of its specialized products. The Company purchases quality used machine tools as they become available and stores them at its facilities to be rebuilt and upgraded as the need arises. Rebuilding used machine tools allows for greater customization suitable for manufacturing Dril-Quip proprietary product lines. This strategy provides the added advantage of in-house expertise for repairs and maintenance of these machines. A significant portion of the Company’s manufacturing capacity growth has been through the rebuild/upgrade of quality used machine tools, including the replacement of outdated control systems with state-of-the-art CNC controls.
Customers
The Company’s principal customers are major integrated, large independent and foreign national oil and gas companies. Drilling contractors and engineering and construction companies also represent a portion of the Company’s customer base. The Company’s customers are generally oil and gas companies that are well-known participants in exploration and production.
The Company is not dependent on any one customer or group of customers. In 2016, the Company’s top 15 customers represented approximately 75% of total revenues, and Chevron and its affiliated companies accounted for approximately 16% of total revenues. In 2015 and 2014, the Company’s top 15 customers represented approximately 61% of total revenues, and Chevron and its affiliated companies accounted for approximately 12% and 10% of total revenues, respectively. No other customer accounted for more than 10% of total revenues in 2016, 2015 or 2014. 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 exploration and production and on the results of competitive bids for major projects. Consequently, a customer that accounts for a significant portion of revenues in one fiscal year may represent an immaterial portion of revenues in subsequent years. While the Company is not dependent on any one customer or group of customers, the loss of one or more of its significant customers could, at least on a short-term basis, have an adverse effect on the Company’s results of operations.
Backlog
Backlog consists of firm customer orders of Dril-Quip products for which a purchase order or signed contract has been received, satisfactory credit or financing arrangements exist and delivery is scheduled. Historically, the Company’s revenues for a specific period have not been directly related to its backlog as stated at a particular point in time. The Company’s product backlog was approximately $318 million at December 31, 2016 and $685 million at December 31, 2015. The backlog at the end of 2016 represents a decrease of approximately $367 million, or 54%, from the end of 2015. The Company’s backlog balance during 2016 was negatively impacted by translation adjustments of approximately $1.3 million, due primarily to the weakening of the British pound sterling against the U.S. dollar, and by approximately $113 million in cancellations, of which $52 million was attributable to the cancellation of one contract during the first quarter of 2016 for wellhead equipment for a development project. In addition, the continued depressed hydrocarbon prices and resulting business environment has resulted in a significant decrease in new customer orders.
The Company expects to fill approximately 70% to 80% of the December 31, 2016 product backlog by December 31, 2017. The remaining backlog at December 31, 2016 consists of longer-term projects which are being designed and manufactured to customer specifications requiring longer lead times. In August 2012, the Company’s Brazilian subsidiary, Dril-Quip do Brasil LTDA, was awarded a four-year contract by 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 $407 million based on the December 31, 2016 exchange rate of 3.26 Brazilian real to 1.00 U.S. dollar) if all the 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 $129 million have been recognized on this contract through December 31, 2016. As of December 31, 2016, the Company’s backlog included $29 million of purchase orders under this Petrobras contract. The Company has not recognized revenue of approximately $11 million as of December 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. Following an interim amendment to extend the term of the contract pending the resolution of discussions, the Company entered into an amendment on October 17, 2016 to extend the duration of the contract until July 2020. As part of the amendment to the contract, Petrobras agreed to issue purchase orders totaling a minimum of approximately $30 million (based on current

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exchange rates) before 2019. The Company cannot provide assurance that Petrobras will order all of the equipment under the contract. See “Item 1A. Risk Factors—Our backlog is subject to unexpected adjustments and cancellations and is, therefore, an uncertain indicator of our future revenues and earnings.”
Marketing and Sales
Dril-Quip markets its products and services throughout the world directly through its sales personnel in multiple domestic and international locations. In addition, in certain foreign markets the Company utilizes independent sales agents or representatives to enhance its marketing and sales efforts.
Some of the locations in which Dril-Quip has sales agents or representatives are Trinidad, Indonesia, Malaysia, Saudi Arabia and United Arab Emirates. 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 advertises its products and services in trade and technical publications targeted to its customer base. The Company also participates in industry conferences and trade shows to enhance industry awareness of its products.
The Company’s customers generally order products on a purchase order basis. Orders, other than those considered to be long-term projects, are typically filled within twelve months after receipt, 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, technology, service and timely delivery. For large drilling and production system orders, project management teams coordinate customer needs with the Company’s engineering, manufacturing and service organizations, as well as with subcontractors and vendors.
A portion of the Company’s business consists of designing, manufacturing and selling equipment, as well as offering technical advisory assistance during installation of the equipment, for major projects pursuant to competitive bids. The number of such projects in any year may fluctuate. 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, including availability of raw materials, changes in customer requirements and governmental regulations, can adversely affect the Company’s performance on individual projects, with potential material adverse effects on project profitability.
Product Development and Engineering
The technological demands of the oil and gas industry continue to increase as exploration and drilling expand into more hostile environments. Conditions encountered in these environments include water depths in excess of 10,000 feet, well pressures exceeding 15,000 psi, well flowing temperatures beyond 350oF (Fahrenheit) and mixed flows of oil, gas and water that may also be highly corrosive and impact material properties.
Since its founding in 1981, Dril-Quip has actively engaged in continuing development efforts 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, installation and maintenance costs associated with its products.
In the 1980s, the Company introduced its first product, specialty connectors, as well as mudline suspension systems, template systems and subsea wellheads. In the 1990s, the Company introduced a series of new products, including diverters, wellhead connectors, SingleBoreTM subsea trees, improved severe service dual bore subsea trees, subsea and platform valves, platform wellheads, platform trees, subsea tree workover riser systems, drilling riser systems and TLP and Spar production riser systems. Since 2000, Dril-Quip has introduced multiple new products, including liner hangers, subsea control systems, subsea manifolds and riser tensioners.
Historically, Dril-Quip’s product development work is primarily conducted at its facilities in Houston, Texas; however, such activities have gradually increased in other regions, such as Aberdeen, Singapore and Brazil. In addition to the work of its product development staff, the Company’s application engineering staff provides technical services to customers in connection with the design and sales of its products. The Company’s ability to develop new products and maintain technological

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advantages is important to its future success. See “Item 1A. Risk Factors—Our business could be adversely affected if we do not develop new products and secure and retain patents related to our products.”
The Company believes that the success of its business depends more on the technical competence, creativity and marketing abilities of its employees than on any individual patent, trademark or copyright. Nevertheless, as part of its ongoing product development and manufacturing activities, Dril-Quip’s policy has been to seek patents when appropriate on inventions concerning new products and product improvements. All patent rights for products developed by employees are assigned to the Company and almost all of the Company’s products have components that are covered by patents.
In 2016, major production milestones were met for several key global projects. In the North Sea, seven subsea completion trees for a subsea field development project were successfully installed. Subsea trees previously delivered for a field development project off the coast of Trinidad were subsequently installed. Also, off the cost of Trinidad, multiple deepwater subsea wellhead systems were installed with the support of a service facility in Trinidad; this is Dril-Quip's first aftermarket support presence in the region. With the completion of engineering, manufacturing, assembly and testing of dry tree equipment, Dril-Quip was able to support the tieback of multiple wells for projects in the Gulf of Mexico and off the coast of Malaysia. Engineering, manufacturing, assembly and test work continued on additional dry tree projects in the Company's backlog. The requirements of the equipment in these projects represent significant technological challenges, the development of which is serving to enhance the Company's overall engineering capabilities.
In an ongoing test program, the Company continued the utilization of its recently constructed high-load horizontal test machine and fatigue test machine for rigorous validation testing of its existing specialty connector product line. Active engineering programs have been initiated in-house to continue development in specialty connector product enhancements as well as new product development. Engineering development efforts are on-going in subsea production systems and capital equipment product lines.
In early 2016, the Company announced that it is establishing a research and development facility in Singapore that focuses on materials and products suitable for HPHT applications. The new facility, which is expected to open in late 2017, will serve as an additional hub for research and development activities for the Company.
Dril-Quip has numerous U.S. registered trademarks, including Dril-Quip®, Quik-Thread®, Quik-Stab®, Multi-Thread®, MS-15®, SS-15®, SS-10® and SU-90®. The Company has registered its trademarks in the countries where such registration is deemed material.
Although in the aggregate, the Company’s patents and trademarks are of considerable importance to the manufacturing and marketing of many of its products, the Company does not consider any single patent or trademark or group of patents or trademarks to be material to its business as a whole, except the Dril-Quip® trademark. The Company also relies on trade secret protection for its confidential and proprietary information. The Company routinely enters into confidentiality agreements with its employees and suppliers. There can be no assurance, however, that others will not independently obtain similar information or otherwise gain access to the Company’s trade secrets.
Competition
Dril-Quip faces significant competition from other manufacturers and suppliers of exploration and production equipment. Several of its primary competitors are diversified multinational companies with substantially larger operating staffs and greater capital resources than those of the Company and which, in many instances, have been engaged in the manufacturing business for a much longer period of time than the Company. The Company competes principally with GE Oil and Gas (formerly Vetco Gray) and the petroleum production equipment segments of Schlumberger, Ltd., TechnipFMC plc and Aker Solutions.
Because of their relative size and diversity of products, several of the Company’s competitors have the ability to provide “turnkey” services for drilling and production applications, which enables them to use their own products to the exclusion of Dril-Quip’s products. See “Item 1A. Risk Factors—We may be unable to successfully compete with other manufacturers of drilling and production equipment.” The Company also competes to a lesser extent with a number of other companies in various products. The principal competitive factors in the petroleum drilling and production equipment markets are quality, reliability and reputation of the product, price, technology, service and timely delivery.

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Employees
As of December 31, 2015, the total number of the Company's employees was 2,319, of which 1,246 were located in the United States. The total number of the Company’s employees as of December 31, 2016 was 2,355, which includes the addition of 406 employees of TIW during the fourth quarter of 2016. Of these 2,355, 1,193 were located in the United States. As a result of additional worldwide reductions in force, the total number of employees as of February 24, 2017 was reduced to 2,179, an 7.5% reduction from December 31, 2016. In addition, reductions in pay have been instituted globally during the first quarter of 2017. Substantially all of the Company’s employees are not covered by collective bargaining agreements, and the Company considers its employee relations to be good.
The Company’s operations depend in part on its ability to attract quality employees. While the Company believes that its wage and salary rates are competitive and that its relationship with its labor force is good, a significant increase in the wages and salaries paid by competing employers could result in a reduction of the Company’s labor force, increases in the wage and salary rates paid by the Company or both. If either of these events were to occur, in the near-term, the profits realized by the Company from work in progress would be reduced and, in the long-term, the production capacity and profitability of the Company could be diminished and the growth potential of the Company could be impaired. See “Item 1A. Risk Factors—Loss of our key management or other personnel could adversely impact our business.”
Governmental Regulations
Many aspects of the Company’s operations are affected by political developments and are subject to both domestic and foreign governmental regulations, including those relating to oilfield operations, the discharge of materials into the environment from our manufacturing or other facilities, health and worker safety aspects of our operations, or otherwise relating to human health and environmental protection. In addition, the Company depends on the demand for its services from the oil and gas industry and, therefore, is affected by changing taxes, price controls and other laws and regulations relating to the oil and gas industry in general, including those specifically directed to onshore and offshore operations. The adoption of laws and regulations curtailing exploration and development drilling for oil and gas for economic or other policy reasons could adversely affect the Company’s operations by limiting demand for the Company’s products. See “Item 1A. Risk Factors—Our operations and our customers’ operations are subject to a variety of governmental laws and regulations that may increase our costs, limit the demand for our products and services or restrict our operations.”
In recent years, increased concern has been raised over the protection of the environment. Legislation to regulate emissions of greenhouse gases has been introduced, but not enacted, in the U.S. Congress, and there has been a wide-ranging policy debate, both nationally and internationally, regarding the impact of these gases and possible means for their regulation. In addition, efforts have been made and continue to be made in the international community toward the adoption of international treaties or protocols that would address global climate change issues, such as the annual United Nations Climate Change Conferences. In November 2015, the United Nations Climate Change Conference (COP21) was held in Paris with the objective to achieve a legally binding and universal agreement on climate, with the aim of keeping global warming below 2o C (Celsius), from all nations, regardless of size. The Paris Agreement, signed by the U.S. on April 22, 2016, requires countries to review and “represent a progression” in their nationally determined contributions, which set greenhouse gas emission reduction goals, every five years. In November 2014, the United States and China agreed to new targets for carbon emissions reductions. Also, the U.S. Environmental Protection Agency (EPA) has undertaken efforts to collect information regarding greenhouse gas emissions and their effects. Following a finding by the EPA that certain greenhouse gases represent a danger to human health, the EPA has expanded its regulations relating to those emissions and has adopted rules imposing permitting and reporting obligations. The results of the permitting and reporting requirements could lead to further regulation of these greenhouse gases by the EPA. Moreover, specific design and operational standards apply to U.S. outer continental shelf vessels, rigs, platforms, vehicles, structures and equipment.
The U.S. Bureau of Safety and Environmental Enforcement (BSEE) regulates the design and operation of well control and other equipment at offshore production sites, among other requirements. BSEE has adopted stricter requirements for subsea drilling production equipment. In April 2016, BSEE published a final blowout preventer systems and well control rule, which focuses on blowout preventer requirements and includes reforms in well design, well control, casing, cementing, real-time monitoring and subsea containment, among other things. In addition, drilling in certain areas has been opposed by environmental groups and, in certain areas, has been restricted. For example, in December 2016, the Obama administration banned offshore drilling in portions of the Arctic and Atlantic oceans. To the extent that new laws or other governmental actions prohibit or restrict drilling or impose additional environmental protection requirements that result in increased costs to the oil and gas industry in general and the drilling industry in particular, the business of the Company could be adversely affected. The Company cannot determine to what extent its future operations and earnings may be affected by new legislation, new regulations or changes in existing regulations. See “Item 1A. Risk Factors—Our business and our customers’ businesses are

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subject to environmental laws and regulations that may increase our costs, limit the demand for our products and services or restrict our operations.”
Our operations are also governed by laws and regulations related to workplace safety and worker health, such as the Occupational Safety and Health Act and regulations promulgated thereunder.
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, health and safety laws. However, future events, such as changes in existing laws and regulations or their interpretation, more vigorous enforcement policies of or by regulatory agencies, or stricter or different interpretations of existing laws and regulations, may require additional expenditures by the Company, which may be material.
Executive Officers of the Registrant
Pursuant to Instruction 3 to Item 401(b) of Regulation S-K and General Instruction G(3) to Form 10-K, the following information is included in Part I of this Form 10-K:
The following table sets forth the names, ages (as of February 20, 2017) and positions of the Company’s executive officers:
Name
Age
Position
Blake T. DeBerry
57
President, Chief Executive Officer and Director
James A. Gariepy
59
Senior Vice President and Chief Operating Officer
Jerry M. Brooks
65
Vice President—Finance and Chief Financial Officer
James C. Webster
47
Vice President, General Counsel and Secretary
Blake T. DeBerry has been President and Chief Executive Officer and a member of the Board of Directors of the Company since October 2011. Mr. DeBerry was Senior Vice President—Sales and Engineering from July 2011 until October 2011, and was Vice President—Dril-Quip Asia-Pacific (which covers the Pacific Rim, Asia, Australia, India and the Middle East) from March 2007 to July 2011. He has been an employee of the Company since 1988 and has held a number of management and engineering positions in the Company’s domestic and international offices. Mr. DeBerry holds a Bachelor of Science degree in mechanical engineering from Texas Tech University.
James A. Gariepy is Senior Vice President and Chief Operating Officer, a position he has held since October 2011. Mr. Gariepy was Senior Vice President—Manufacturing, Project Management and Service from July 2011 until October 2011, and was Vice President—Dril-Quip Europe (which covers Europe, Africa and Northern Eurasia) from March 2007 to July 2011. He has held domestic and international management positions since joining the Company in 2004. Mr. Gariepy holds a Bachelor of Science degree in mechanical engineering from the Lawrence Technological University and an MBA from the University of St. Thomas.
Jerry M. Brooks is Vice President—Finance and Chief Financial Officer. He has been Vice President since 2007 and Chief Financial Officer since 1999. From 2009 until May 2011, he also served as Secretary of the Company. From 1992 until March 1999, Mr. Brooks served as Chief Accounting Officer. 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 in Finance from the University of Texas at Austin.
James C. Webster is Vice President, General Counsel and Secretary. He joined the Company in February 2011 as Vice President and General Counsel and was elected to the additional position of Secretary in May 2011. From September 2005 until September 2010, he was Vice President, General Counsel and Secretary of M-I SWACO, at the time, a joint venture between Smith International, Inc. and Schlumberger Ltd., and then was an area general counsel for Schlumberger from September 2010 to February 2011 following Schlumberger’s acquisition of Smith International. From 1999 to September 2005, he was an associate with, and later a partner in, the law firm of Gardere Wynne Sewell LLP in Houston. Mr. Webster holds an economics degree from the University of Arizona and a joint Law/MBA from Loyola University.


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Item 1A.        Risk Factors
In this Item 1A., the terms “we,” “our,” “us” and “Dril-Quip” used herein refer to Dril-Quip, Inc. and its subsidiaries unless otherwise indicated or as the context so requires.
A material or extended decline in expenditures by the oil and gas industry could significantly reduce our revenue and income.
Our business depends upon the condition of the oil and gas industry and, in particular, the willingness of oil and gas companies to make capital expenditures on exploration, drilling and production operations. The level of capital expenditures is generally dependent on the prevailing view of future oil and gas prices, which are influenced by numerous factors affecting the supply and demand for oil and gas, including:
worldwide economic activity;
the level of exploration and production activity;
interest rates and the cost of capital;
environmental regulation;
federal, state and foreign policies regarding exploration and development of oil and gas;
the ability and/or desire of OPEC and other major producers to set and maintain production levels and pricing;
governmental regulations regarding future oil and gas exploration and production;
the cost of exploring and producing oil and gas;
the cost of developing alternative energy sources;
the availability, expiration date and price of onshore and offshore leases;
the discovery rate of new oil and gas reserves in onshore and offshore areas;
the success of drilling for oil and gas in unconventional resource plays such as shale formations;
alternative opportunities to invest in onshore exploration and production opportunities;
technological advances; and
weather conditions.
Oil and gas prices and the level of drilling and production activity have been characterized by significant volatility in recent years. Worldwide military, political and economic events have contributed to crude oil and natural gas price volatility and are likely to continue to do so in the future.
We expect 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 our products and services, or reduce their levels of capital expenditures for exploration and production for a variety of reasons. These risks are greater during periods of low or declining commodity prices. Continued significant or prolonged declines in hydrocarbon prices have had, and may continue to have, a material adverse effect on our results of operations.
We may not be able to satisfy technical requirements, testing requirements or other specifications under contracts and contract tenders.
Our products are used primarily in deepwater, harsh environment and severe service applications. Our contracts with customers and customer requests for bids typically set forth detailed specifications or technical requirements for our products and services, which may also include extensive testing requirements. We anticipate that such testing requirements will become more common in our contracts. In addition, recent scrutiny of the drilling industry has resulted in more stringent technical specifications for our products and more comprehensive testing requirements for our products to ensure compliance with such specifications. We cannot assure you that our products will be able to satisfy the specifications or that we will be able to perform the full-scale testing necessary to prove that the product specifications are satisfied in future contract bids or under existing contracts, or that the costs of modifications to our products to satisfy the specifications and testing will not adversely affect our results of operations. If our products are unable to satisfy such requirements, or we are unable to perform any

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required full-scale testing, our customers may cancel their contracts and/or seek new suppliers, and our business, results of operations, cash flows or financial position may be adversely affected.
We rely on technology provided by third parties and our business may be materially adversely affected if we are unable to renew our licensing arrangements with them.
We have existing contracts and may enter into new contracts with customers that require us to use technology or to purchase components from third parties, including some of our competitors. In the ordinary course of our business, we have entered into licensing agreements with some of these third parties for the use of such technology, including a license from a competitor of a technology important to our subsea wellheads. We may not be able to renew our existing licenses or to purchase these components on terms acceptable to us, or at all. If we are unable to use a technology or purchase a component, we may not be able to meet existing contractual commitments without increased costs or modifications or at all. In addition, we may need to stop selling products incorporating that technology or component or to redesign our products, either of which could result in a material adverse effect on our business and operations.
We may be unable to successfully compete with other manufacturers of drilling and production equipment.
Several of our primary competitors are diversified multinational companies with substantially larger operating staffs and greater capital resources than ours and which have been engaged in the manufacturing business for a much longer time than us. If these competitors substantially increase the resources they devote to developing and marketing competitive products and services, we may not be able to compete effectively. Similarly, consolidation among our competitors could enhance their product and service offerings and financial resources, further intensifying competition.
The loss of a significant customer could have an adverse impact on our financial results.
Our principal customers are major integrated oil and gas companies, large independent and foreign national oil and gas companies throughout the world. Drilling contractors and engineering and construction companies also represent a portion of our customer base. In 2016, our top 15 customers represented approximately 75% of total revenues, and Chevron and its affiliated companies accounted for approximately 16% of total revenues. In 2015 and 2014, our top 15 customers represented approximately 61% of total revenues, and Chevron and its affiliated companies accounted for approximately 12% and 10% of total revenues, respectively. No other customer accounted for more than 10% of total revenues in 2016, 2015 or 2014. While we are not dependent on any one customer or group of customers, the loss of one or more of our significant customers could have an adverse effect on our results of operations, financial position and cash flows.
Our customers’ industries are undergoing continuing consolidation that may impact our results of operations.
The oil and gas industry is rapidly consolidating and, as a result, some of our largest customers have consolidated and are using their size and purchasing power to seek economies of scale and pricing concessions. This consolidation may result in reduced capital spending by some of our customers or the acquisition of one or more of our primary customers, which may lead to decreased demand for our products and services. We cannot assure you that we will be able to maintain our level of sales to a customer that has consolidated or replace that revenue with increased business activity with other customers. As a result, the acquisition of one or more of our primary customers may have a significant negative impact on our results of operations, financial position or cash flows. We are unable to predict what effect consolidations in the industry may have on price, capital spending by our customers, our selling strategies, our competitive position, our ability to retain customers or our ability to negotiate favorable agreements with our customers.
Increases in the cost of raw materials and energy used in our manufacturing processes could negatively impact our profitability.
Any increases in commodity prices for items such as nickel, molybdenum and heavy metal scrap that are used to make the steel alloys required for our products would result in an increase in our raw material costs. Similarly, any increase in energy costs would increase our product costs. If we are not successful in raising our prices on products to compensate for any increased raw material or energy costs, our margins will be negatively impacted.
We depend on third-party suppliers for timely deliveries of raw materials, and our results of operations could be adversely affected if we are unable to obtain adequate supplies in a timely manner.
Our manufacturing operations depend upon obtaining adequate supplies of raw materials from third parties. The ability of these third parties to deliver raw materials may be affected by events beyond our control. Any interruption in the supply of raw

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materials needed to manufacture our products could adversely affect our business, results of operations and reputation with our customers.
Conditions in the global financial system may have impacts on our business and financial position that we currently cannot predict.
Uncertainty in the credit markets may negatively impact the ability of our customers to finance purchases of our products and services and could result in a decrease in, or cancellation of, orders included in our backlog or adversely affect the collectability of our receivables. If the availability of credit to our customers is reduced, they may reduce their drilling and production expenditures, thereby decreasing demand for our products and services, which could have a negative impact on our financial position. Additionally, unsettled conditions could have an impact on our suppliers, causing them to be unable to meet their obligations to us. Although we do not currently anticipate a need to access the credit markets in the short term, a prolonged constriction on future lending by banks or investors could result in higher interest rates on future debt obligations or could restrict our ability to obtain sufficient financing to meet our long-term operational and capital needs.
We are exposed to the credit risks of our customers, and a general increase in the nonpayment and nonperformance by customers could have an adverse impact on our cash flows, results of operations and financial condition.
Our business is subject to risks of loss resulting from nonpayment or nonperformance by our customers. Certain of our customers finance their activities through cash flow from operations, the incurrence of debt or the issuance of equity. In an economic downturn, commodity prices typically decline, and the credit markets and availability of credit can be expected to be constrained. Additionally, certain of our customers’ equity values could decline. The combination of lower cash flow due to commodity prices, a reduction in borrowing bases under reserve-based credit facilities and the lack of available debt or equity financing may result in a significant reduction in our customers’ liquidity and ability to pay or otherwise perform on their obligations to us. Furthermore, some of our customers may be highly leveraged and subject to their own operating and regulatory risks, which increases the risk that they may default on their obligations to us. Any increase in the nonpayment and nonperformance by our customers could have an adverse impact on our operating results and could adversely affect our liquidity.
Our backlog is subject to unexpected adjustments and cancellations and is, therefore, an uncertain indicator of our future revenues and earnings.
The revenues projected in our backlog may not be realized or, if realized, may not result in profits. All of the projects currently included in our 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 generally required to pay us for work performed and other costs necessarily incurred as a result of the change or termination.
We can give no assurance that our backlog will remain at current levels. Sales of our products are affected by prices for oil and natural gas, which have fluctuated significantly and may continue to do so in the future. Contracts denominated in foreign currency are also affected by changes in exchange rates, which may have a negative impact on our backlog. When drilling and production levels are depressed, a customer may no longer need the equipment or services currently under contract or may be able to obtain comparable equipment or services at lower prices. As a result, customers may exercise their termination rights or attempt to renegotiate contract terms. Continued declines in oil and natural gas prices could also reduce new customer orders, possibly causing a decline in our future backlog. If we experience significant project terminations, suspensions or scope adjustments to contracts reflected in our backlog, our financial condition, results of operations and cash flows may be adversely impacted.
Our international operations expose us to instability and changes in economic and political conditions and other risks inherent to international business, which could have a material adverse effect on our results of operations, financial position or cash flows.
We have substantial international operations, with approximately 66% of our revenues from foreign sales in 2016 compared to 63% in both 2015 and 2014. We operate our business and market our products and services in many of the significant oil and gas producing areas in the world and are, therefore, subject to the risks customarily attendant to international operations and investments in foreign countries. Risks associated with our international operations include:
volatility in general economic, social and political conditions;
terrorist threats or acts, war and civil disturbances;

17


expropriation or nationalization of assets;
renegotiation or nullification of existing contracts;
foreign taxation, including changes in laws or differing interpretations of existing laws;
assaults on property or personnel;
restrictive action by local governments;
foreign and domestic monetary policies;
limitations on repatriation of earnings;
travel limitations or operational problems caused by public health threats; and
changes in currency exchange rates.
Any of these risks could have an adverse effect on our ability to manufacture products abroad or the demand for our products and services in some locations. To date, we have not experienced any significant problems in foreign countries arising from local government actions or political instability, but there is no assurance that such problems will not arise in the future. Interruption of our international operations could have a material adverse effect on our overall operations.
Our international operations expose us to compliance risks.
Doing business on a worldwide basis exposes us and our subsidiaries to risks inherent in complying with the laws and regulations of a number of different nations, including various anti-bribery laws. We do business and have operations in a number of developing countries that have relatively underdeveloped legal and regulatory systems compared to more developed countries. Several of these countries are generally perceived as presenting a higher than normal risk of corruption, or as having a culture in which requests for improper payments are not discouraged. Maintaining and administering an effective anti-bribery compliance program under the U.S. Foreign Corrupt Practices Act, the United Kingdom’s Bribery Act of 2010 and similar statutes of other nations in these environments presents greater challenges than is the case in more developed countries.
In addition, our import and export activities are governed by unique customs laws and regulations in each of the countries where we operate. The laws and regulations concerning import and export activity, recordkeeping and reporting, import and export control and economic sanctions are complex and subject to frequent change.
The precautions we take to prevent and detect misconduct, fraud or non-compliance with applicable laws and regulations may not be able to prevent such occurrences, and we could face unknown risks or losses. Our failure to comply with applicable laws or regulations or acts of misconduct could subject us to fines, penalties or other sanctions, including debarment from government contracts, seizure of shipments and loss of import and export privileges, which could have a material adverse effect on our business and our results of operations, financial position and cash flows.
We are subject to taxation in many jurisdictions and there are inherent uncertainties in the final determination of our tax liabilities.
As a result of our international operations, we are subject to taxation in many jurisdictions. Accordingly, our effective income tax rate and other tax obligations in the future could be adversely affected by a number of factors including changes in the mix of earnings in countries with differing statutory tax rates, changes in the valuation of deferred tax assets and liabilities, disagreements with taxing authorities with respect to the interpretation of tax laws and regulations and changes in tax laws. In particular, foreign income tax returns of foreign subsidiaries and related entities are routinely examined by foreign tax authorities, and these tax examinations may result in assessments of additional taxes, interest or penalties. Refer to “Item 3. Legal Proceedings” regarding tax assessments in Brazil. We regularly assess all of these matters to determine the adequacy of our tax provision, which is subject to discretion. If our assessments are incorrect, it could have an adverse effect on our business and financial condition.
Moreover, the United States Congress, the Organization for Economic Co-operation and Development and other government agencies in the other jurisdictions where we and our subsidiaries do business have had an extended focus on issues related to the taxation of multinational corporations. One example is in the area of "base erosion and profit shifting," where payments are made between affiliates from a jurisdiction with high tax rates to a jurisdiction with lower tax rates. As a result, the tax laws in the United States and other countries in which we and our subsidiaries do business could change on a prospective or retroactive basis, and such changes could adversely affect us.

18


Our excess cash is invested in various financial instruments which may subject us to potential losses.
We invest excess cash in various financial instruments including interest bearing accounts, money market mutual funds and funds which invest in U.S. Treasury obligations and repurchase agreements backed by U.S. Treasury obligations. However, changes in the financial markets, including interest rates, as well as the performance of the issuers, can affect the market value of our short-term investments.
We may suffer losses as a result of foreign currency fluctuations and limitations on the ability to repatriate income or capital to the United States.
We conduct a portion of our business in currencies other than the U. S. dollar, and our operations are subject to fluctuations in foreign currency exchange rates. We cannot assure you that we will be able to protect the Company against such fluctuations in the future. Historically, we have not conducted business in countries that limit repatriation of earnings. However, as we expand our international operations, we may begin operating in countries that have such limitations. Further, we cannot assure you that the countries in which we currently operate will not adopt policies limiting repatriation of earnings in the future.
Our foreign subsidiaries also hold significant amounts of cash that may be subject to both U.S. income taxes (subject to adjustment for foreign tax credits) and withholding taxes of the applicable foreign country if we dividend that cash to us, as we are located in the United States.
Our business involves numerous operating hazards that may not be covered by insurance. The occurrence of an event not fully covered by insurance could have a material adverse effect on our results of operations, financial position and cash flows.
Our products are used in potentially hazardous drilling, completion and production applications that can cause personal injury, product liability and environmental claims. In addition, certain areas where our products are used, including in and near the U.S. Gulf of Mexico, are close to high population areas and subject to hurricanes and other extreme weather conditions on a relatively frequent basis. A catastrophic occurrence at a location where our equipment and/or services are used may expose us to substantial liability for personal injury, wrongful death, product liability, environmental damage or commercial claims. Our general liability insurance program includes an aggregate coverage limit of $200 million for claims with respect to property damage, injury or death and pollution. However, our insurance policies may not cover fines, penalties or costs and expenses related to government-mandated cleanup of pollution. In addition, our insurance does not provide coverage for all liabilities, and we cannot assure you that our insurance coverage will be adequate to cover claims that may arise or that we will be able to maintain adequate insurance at rates we consider reasonable. The occurrence of an event not fully covered by insurance could have a material adverse effect on our results of operations, financial position and cash flows.
We attempt to further limit our liability through contractual indemnification provisions with our customers. We generally seek to enter into contracts for the provision of our products and services that provide for (1) the responsibility of each party to the contract for personal injuries to, or the death of, its employees and damages to its property, (2) cross-indemnification with other contractors providing products and/or services to the other party to the contract with respect to personal injury, death and property damage and (3) the operator being responsible for claims brought by third parties for personal injury, death, property loss or damage relating to pollution or other well control events. We may not be able to successfully obtain favorable contractual provisions, and a failure to do so may increase our risks and costs, which could materially impact our results of operations. In addition, we cannot assure you that any party that is contractually obligated to indemnify us will be financially able to do so.
We may lose money on fixed-price contracts.
A portion of our business consists of the designing, manufacturing and selling of our equipment for major projects pursuant to competitive bids, and is performed on a fixed-price basis. Under these contracts, we are typically responsible for all cost overruns, other than the amount of any cost overruns resulting from requested changes in order specifications. Our actual costs and any gross profit realized on these fixed-price contracts may vary from the estimated amounts on which these contracts were originally based. This may occur for various reasons, including:
errors in estimates or bidding;
changes in availability and cost of labor and materials;
variations in productivity from our original estimates; and
material changes in foreign currency exchange rates.

19


These variations and the risks inherent in our projects may result in reduced profitability or losses on projects. Depending on the size of a project, variations from estimated contract performance could have a material adverse impact on our operating results.
Our business could be adversely affected if we do not develop new products and secure and retain patents related to our products.
Technology is an important component of our business and growth strategy, and our success as a company depends to a significant extent on the development and implementation of new product designs and improvements. Whether we can continue to develop systems and services and related technologies to meet evolving industry requirements and, if so, at prices acceptable to our customers will be significant factors in determining our ability to compete in the industry in which we operate. Many of our competitors are large multinational companies that may have significantly greater financial resources than we have, and they may be able to devote greater resources to research and development of new systems, services and technologies than we are able to do.
Our ability to compete effectively will also depend on our ability to continue to obtain patents on our proprietary technology and products. Although we do not consider any single patent to be material to our business as a whole, the inability to protect our future innovations through patents could have a material adverse effect.
We may be required to recognize a charge against current earnings because of percentage-of-completion accounting.
Revenues and profits on long-term project contracts are recognized on a percentage-of-completion basis. We calculate the percent complete and apply the percentage to determine revenues earned and the appropriate portion of total estimated costs. Accordingly, purchase order price and cost estimates are reviewed periodically as the work progresses, and adjustments proportionate to the percentage complete are reflected in the period when such estimates are revised. To the extent that these adjustments result in a reduction or elimination of previously reported profits, we would have to recognize a charge against current earnings, which could be significant depending on the size of the project or the adjustment.
Loss of our key management or other personnel could adversely impact our business.
We depend on the services of Blake DeBerry, President and Chief Executive Officer, and James Gariepy, Senior Vice President and Chief Operating Officer. Together, Mr. DeBerry and Mr. Gariepy have over 40 years with the Company and approximately 70 years of relevant industry experience. The loss of either of these officers could have a material adverse effect on our results of operations, financial position and cash flows.
In addition, competition for skilled machinists, fabricators and technical personnel among companies that rely heavily on engineering and technology is intense, and the loss of qualified employees or an inability to attract, retain and motivate additional highly skilled employees required for the operation and expansion of our business could hinder our ability to conduct research activities successfully and develop and produce marketable products and services. A significant increase in the wages paid by competing employers could result in a reduction of our skilled labor force, increase in the wage rates paid by us or both. If either of these events were to occur, in the near-term, the profits realized by us from work in progress would be reduced and, in the long-term, our production capacity and profitability could be diminished and our growth potential could be impaired.
Acquisitions, dispositions and investments may not result in anticipated benefits and may present risks not originally contemplated, which could have a material adverse effect on our financial condition, results of operations and cash flows.
From time to time, we evaluate purchases and sales of assets, businesses or other investments. These transactions may not result in the anticipated realization of savings, creation of efficiencies, offering of new products or services, generation of cash or income or reduction of risk. In addition, acquisitions may be financed by borrowings, requiring us to incur debt, or by the issuance of our common stock. These transactions involve numerous risks, and we cannot ensure that:
any acquisition would be successfully integrated into our operations and internal controls;
the due diligence conducted prior to an acquisition would uncover situations that could result in financial or legal exposure;
the use of cash for acquisitions would not adversely affect our cash available for capital expenditures and other uses;

20


any disposition, investment, acquisition or integration would not divert management resources from the operation of our business; or
any disposition, investment, acquisition or integration would not have a material adverse effect on our financial condition, results of operations or cash flows.
Our operations and our customers’ operations are subject to a variety of governmental laws and regulations that may increase our costs, limit the demand for our products and services or restrict our operations.
Our business and our customers’ businesses may be significantly affected by:
federal, state, local and foreign laws and other regulations relating to the oilfield operations, worker safety and the protection of the environment;
changes in these laws and regulations;
levels of enforcement of these laws and regulations; and
interpretation of existing laws and regulations.
In addition, we depend on the demand for our products and services from the oil and gas industry. This demand is affected by changing taxes, price controls and other laws and regulations relating to the oil and gas industry in general, including those specifically directed to offshore operations. For example, the adoption of laws and regulations curtailing exploration and development drilling for oil and gas for economic or other policy reasons could adversely affect our operations by limiting demand for our products. We cannot determine the extent to which our future operations and earnings may be affected by new legislation, new regulations or changes in existing regulations and enforcement thereof.
Various new regulations intended to improve particularly offshore safety systems and environmental protection have been issued since 2010 that have increased the complexity of the drilling permit process and may limit the opportunity for some operators to continue deepwater drilling in the U.S. Gulf of Mexico, which could adversely affect the Company’s financial operations. Third-party challenges to industry operations in the U.S. Gulf of Mexico may also serve to further delay or restrict activities. If the new regulations, policies, operating procedures and possibility of increased legal liability are viewed by our current or future customers as a significant impairment to expected profitability on projects, they could discontinue or curtail their operations, thereby adversely affecting our financial operations by decreasing demand for our products.
Because of our foreign operations and sales, we are also subject to changes in foreign laws and regulations that may encourage or require hiring of local contractors or require foreign contractors to employ citizens of, or purchase supplies from, a particular jurisdiction. If we fail to comply with any applicable law or regulation, our business, results of operations, financial position and cash flows may be adversely affected.
Our businesses and our customers’ businesses are subject to environmental laws and regulations that may increase our costs, limit the demand for our products and services or restrict our operations.
Our operations and the operations of our customers are also subject to federal, state, local and foreign laws and regulations relating to the protection of human health and the environment. These environmental laws and regulations affect the products and services we design, market and sell, as well as the facilities where we manufacture our products. For example, our operations are subject to numerous and complex laws and regulations that, among other things, may regulate the management and disposal of hazardous and non-hazardous wastes; require acquisition of environmental permits related to our operations; restrict the types, quantities and concentrations of various materials that can be released into the environment; limit or prohibit operation activities in certain ecologically sensitive and other protected areas; regulate specific health and safety criteria addressing worker protection; require compliance with operational and equipment standards; impose testing, reporting and record-keeping requirements; and require remedial measures to mitigate pollution from former and ongoing operations. We are required to invest financial and managerial resources to comply with such environmental, health and safety laws and regulations and anticipate that we will continue to be required to do so in the future. In addition, environmental laws and regulations could limit our customers’ exploration and production activities. These laws and regulations change frequently, which makes it impossible for us to predict their cost or impact on our future operations. For example, legislation to regulate emissions of greenhouse gases has been introduced, but not enacted, in the U.S. Congress, and there has been a wide-ranging policy debate, both nationally and internationally, regarding the impact of these gases and possible means for their regulation. In addition, efforts have been made and continue to be made in the international community toward the adoption of international treaties or protocols that would address global climate change issues, such as the annual United Nations Climate Change Conferences, including the United Nations Climate Change Conference in Paris (COP 21) in November 2015, which

21


resulted in the creation of the Paris Agreement. The Paris Agreement, signed by the U.S. on April 22, 2016, requires countries to review and “represent a progression” in their nationally determined contributions, which set greenhouse gas emission reduction goals, every five years. Also, the EPA has undertaken efforts to collect information regarding greenhouse gas emissions and their effects. Following a finding by the EPA that certain greenhouse gases represent a danger to human health, the EPA has expanded its regulations relating to those emissions and has adopted rules imposing permitting and reporting obligations. The results of the permitting and reporting requirements could lead to further regulation of these greenhouse gases by the EPA. Subsequent to the Paris Agreement, there has been no significant legislative progress in cap and trade proposals or greenhouse gas emission reductions. The adoption of legislation or regulatory programs to reduce greenhouse gas emissions could also increase the cost of consuming, and thereby reduce demand for, the hydrocarbons that our customers produce. Consequently, such legislation or regulatory programs could have an adverse effect on our financial condition and results of operations. It is too early to determine whether, or in what form, further regulatory action regarding greenhouse gas emissions will be adopted or what specific impact a new regulatory action might have on us or our customers. Generally, the anticipated regulatory actions do not appear to affect us in any material respect that is different, or to any materially greater or lesser extent, than other companies that are our competitors. However, our business and prospects could be adversely affected to the extent laws are enacted or modified or other governmental action is taken that prohibits or restricts our customers’ exploration and production activities or imposes environmental protection requirements that result in increased costs to us or our customers.
Environmental laws may provide for “strict liability” for damages to natural resources or threats to public health and safety, rendering a party liable for environmental damage without regard to negligence or fault on the part of such party. Sanctions for noncompliance may include revocation of permits, corrective action orders, administrative or civil penalties and criminal prosecution. Some environmental laws and regulations provide for joint and several strict liability for remediation of spills and releases of hazardous substances. In addition, we may be subject to claims alleging personal injury or property damage as a result of alleged exposure to hazardous substances, as well as damage to natural resources. These laws and regulations also may expose us to liability for the conduct of or conditions caused by others, or for our acts that were in compliance with all applicable laws and regulations at the time such acts were performed. Any of these laws and regulations could result in claims, fines or expenditures that could be material to results of operations, financial position and cash flows.
Our business could be adversely affected by a failure or breach of our information technology systems.
Our business operations depend on our information technology (IT) systems. Despite our security and back-up measures, our IT systems are vulnerable to computer viruses, natural disasters and other disruptions or failures. The failure of our IT systems to perform as anticipated for any reason or any significant breach of security could disrupt our business and result in numerous adverse consequences, including reduced effectiveness and efficiency of our operations and those of our customers, inappropriate disclosure of confidential information, increased overhead costs, loss of intellectual property and damage to our reputation, which could have a material adverse effect on our business and results of operations. In addition, we may be required to incur significant costs to prevent or respond to damage caused by these disruptions or security breaches in the future.
The market price of our common stock may be volatile.
The trading price of our common stock and the price at which we may sell common stock in the future are subject to large fluctuations in response to any of the following:
limited trading volume in our common stock;
quarterly variations in operating results;
general financial market conditions;
the prices of natural gas and oil;
announcements by us and our competitors;
our liquidity;
changes in government regulations;
our ability to raise additional funds;
our involvement in litigation; and
other events.

22


We do not anticipate paying dividends on our common stock in the near future.
We have not paid any dividends in the past and do not intend to pay cash dividends on our common stock in the foreseeable future. Our Board of Directors review this policy on a regular basis in light of our earnings, financial position and market opportunities. We currently intend to retain any earnings for the future operation and development of our business as well as potential stock repurchases or acquisition opportunities.
Provisions in our corporate documents and Delaware law could delay or prevent a change in control of the Company, even if that change would be beneficial to our stockholders.
The existence of some provisions in our corporate documents and Delaware law could delay or prevent a change in control of our company, even if that change would be beneficial to our stockholders. Our certificate of incorporation and bylaws contain provisions that may make acquiring control of our company difficult, including:
provisions relating to the classification, nomination and removal of our directors;
provisions regulating the ability of our stockholders to bring matters for action at annual meetings of our stockholders;
provisions requiring the approval of the holders of at least 80% of our voting stock for a broad range of business combination transactions with related persons; and
the authorization given to our Board of Directors to issue and set the terms of preferred stock.
Our stockholder rights plan could also make it more difficult for a third party to acquire, or could discourage a third party from acquiring, our company or a large block of our common stock. In addition, the Delaware General Corporation Law imposes restrictions on mergers and other business combinations between us and any holder of 15% or more of our outstanding common stock.
Item 1B.    Unresolved Staff Comments
None.

23



Item 2.        Properties
Manufacturing Facilities
Location
 
Building Size
(Approximate
Square Feet)
 
Land
(Approximate
Acreage)
 
Owned or Leased
Houston, Texas
 
 
 
 
 
 
—Hempstead Highway
 
175,000
 
12.9
 
Owned
—N. Eldridge Parkway
 
1,731,000
 
218.0
 
Owned
—S. Main Street
 
127,000
 
2.9
 
Owned
—Taylor Road
 
17,500
 
0.4
 
Owned
Youngsville, Louisiana
 
36,100
 
0.8
 
Owned
Alberta, Canada
 
20,000
 
0.5
 
Owned
Aberdeen, Scotland
 
 
 
 
 
 
—Dyce
 
222,800
 
24.1
 
Owned
—Birchmoss
 
26,200
 
0.7
 
Leased
Singapore
 
293,200
 
14.4
 
Leased
Macae, Brazil
 
169,600
 
10.6
 
Owned
The Company’s forging and heat treatment requirements are performed at the Houston Eldridge Parkway facility.

24


Sales, Service and Reconditioning Facilities
Location*
 
Building Size
(Approximate
Square Feet)
 
Land
(Approximate
Acreage)
 
Activity
Odessa, Texas*
 
6,000
 
0.1
 
Warehouse
Midland, Texas
 
10,000
 
0.2
 
Sales/Service/Warehouse
New Orleans, Louisiana
 
1,600
 
 
Sales/Service
Oklahoma City, Oklahoma*
 
6,000
 
0.1
 
Sales/Warehouse
Calgary, Alberta, Canada
 
1,350
 
 
Sales
Nisku, Alberta, Canada
 
12,500
 
0.3
 
Sales/Service/Warehouse
Villahermosa, Mexico*
 
12,400
 
0.3
 
Sales/Service/Warehouse
Anaco, Venezuela*
 
3,000
 
0.1
 
Sales/Service/Warehouse
Quito, Ecuador
 
2,600
 
0.1
 
Sales
Shushufindi, Ecuador
 
135,800
 
3.1
 
Sales/Service/Warehouse
Szolnok, Hungary
 
4,300
 
0.1
 
Sales/Service/Warehouse
Beverwijk, Holland
 
32,000
 
0.7
 
Sales/Warehouse
Stavanger, Norway*
 
42,000
 
6.1
 
Sales/Service/Reconditioning/Warehouse/Fabrication
Esbjerg, Denmark
 
19,100
 
2.6
 
Sales/Service/Reconditioning/Warehouse
Takoradi, Ghana
 
2,500
 
0.8
 
Service/Reconditioning/Warehouse
Port Harcourt, Nigeria
 
6,600
 
0.1
 
Service/Reconditioning/Warehouse
Cairo, Egypt
 
2,200
 
 
Sales
Alexandria, Egypt
 
5,200
 
0.6
 
Service/Reconditioning/Warehouse
Balikpapan, Indonesia
 
2,000
 
 
Reconditioning
Doha, Qatar
 
8,900
 
 
Service/Reconditioning/Warehouse
Tianjin, China
 
12,200
 
 
Service/Reconditioning/Warehouse
Shekou, China
 
600
 
 
Sales
Perth and Welshpool, Australia
 
28,000
 
2.9
 
Sales/Service/Reconditioning/Warehouse
*These facilities are owned; all other facilities are leased.
The Company also performs sales, service and reconditioning activities at its facilities in Houston, Youngsville, Alberta, Aberdeen, Singapore and Macae.

25



Item 3.        Legal Proceedings
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, 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 filed an appeal with a 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 filed a similar appeal in the judicial system with regard to the January 2011 assessment and was required to deposit with the court approximately $5.7 million in December 2016. 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.
For a further description of the Company’s legal proceedings, see “Commitments and Contingencies,” Note 12 of Notes to Consolidated Financial Statements. The Company also is involved in a number of legal actions arising in the ordinary course of business. Although no assurance can be given with respect to the ultimate outcome of such legal actions, in the opinion of management, the ultimate liability with respect thereto will not have a material adverse effect on the Company’s results of operations, financial position or cash flows.
Item 4.        Mine Safety Disclosure
Not applicable.

26


PART II
Item 5.
Market for Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Company’s common stock is publicly traded on the New York Stock Exchange under the symbol DRQ. The following table sets forth the quarterly high and low sales prices of the common stock as reported on the New York Stock Exchange for the indicated quarters of fiscal years 2016 and 2015.
 
 
Sales Price ($)
 
 
2016
 
2015
Quarter Ended
 
High
 
Low
 
High
 
Low
March 31
 
$
61.80

 
$
48.88

 
$
81.13

 
$
65.28

June 30
 
66.73

 
56.24

 
81.78

 
67.56

September 30
 
59.89

 
50.13

 
75.48

 
53.37

December 31
 
$
69.40

 
$
46.90

 
$
68.69

 
$
56.87

There were approximately 126 stockholders of record of the Company’s common stock as of December 31, 2016. This number includes the Company’s employees and directors that hold shares, but does not include the number of security holders for whom shares are held in a “nominee” or “street” name.
The Company has not paid any dividends in the past and does not currently anticipate paying any dividends in the foreseeable future. The Company intends to reinvest any retained earnings for the future operation and development of its business, or to use for potential stock repurchases or acquisition opportunities. The Board of Directors will review this policy on a regular basis in light of the Company’s earnings, financial position and market opportunities.
Information concerning securities authorized for issuance under equity compensation plans is included in Note 15 of Notes to Consolidated Financial Statements.
Repurchase of Equity Securities
On February 26, 2015, the Company announced that its Board of Directors authorized a stock repurchase plan under which the Company was authorized to repurchase up to $100 million of its common stock. During 2015, the Company repurchased and cancelled 1,184,700 shares at an average price of $63.98 for a total cost of $75.8 million. In the first six months of 2016, the Company repurchased and cancelled 400,500 shares at an average cost of $60.51 per share for a total cost of $24.2 million. As of June 30, 2016, the Company had repurchased and cancelled the maximum amount allowed under the February 26, 2015 authorization. The following table summarizes the repurchase and cancellation of common stock during 2016.
Period
 
Total Number
of Shares
Purchased
 
Average
Price Paid
Per Share
 
Total Number of
Shares Purchased as
Part of a Publicly
Announced Plan or
Program
 
Maximum Dollar
Value (in millions) of
Shares that
May Yet Be Purchased
Under the Program
April 2016
 

 
$

 

 
$
24.2

May 2016
 
345,600

 
60.56

 
345,600

 
3.3

June 2016
 
54,900

 
30.21

 
54,900

 

Total
 
400,500

 
$
60.51

 
400,500

 
$


On July 26, 2016, the Board of Directors authorized a new stock repurchase plan under which the Company can repurchase up to $100 million of its common stock. The repurchase plan has no set expiration date and any repurchased shares are expected to be cancelled. No repurchases have been made pursuant to this plan as of December 31, 2016.

27


Item 6.        Selected Financial Data
The information set forth below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and Notes thereto included elsewhere in this report on Form 10-K.
 
Year Ended December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
(In thousands, except per share amounts)
Statement of Operations Data:
 
 
 
 
 
 
 
 
 
Revenues:
 
 
 
 
 
 
 
 
 
Products
$
433,012

 
$
685,364

 
$
773,205

 
$
731,617

 
$
610,218

Services
105,719

 
158,946

 
157,752

 
140,755

 
122,813

Total revenues
538,731

 
844,310

 
930,957

 
872,372

 
733,031

Cost and expenses:
 
 
 
 
 
 
 
 
 
Cost of sales:
 
 
 
 
 
 
 
 
 
Products
268,405

 
382,925

 
428,125

 
436,359

 
384,513

Services
59,999

 
76,361

 
85,402

 
77,547

 
67,153

Total cost of sales
328,404

 
459,286

 
513,527

 
513,906

 
451,666

Selling, general and administrative
53,143

 
88,044

 
92,762

 
94,806

 
82,218

Engineering and product development
44,325

 
48,145

 
45,920

 
40,115

 
37,455

Operating income
112,859

 
248,835

 
278,748

 
223,545

 
161,692

Interest income
3,037

 
948

 
667

 
587

 
462

Interest expense
(28
)
 
(12
)
 
(35
)
 
(35
)
 
(32
)
Income before income taxes
115,868

 
249,771

 
279,380

 
224,097

 
162,122

Income tax provision
22,647

 
57,763

 
70,668

 
54,270

 
42,913

Net income
$
93,221

 
$
192,008

 
$
208,712

 
$
169,827

 
$
119,209

Earnings per common share:
 
 
 
 
 
 
 
 
 
Basic
$
2.48

 
$
5.00

 
$
5.22

 
$
4.18

 
$
2.96

Diluted
$
2.47

 
$
4.98

 
$
5.19

 
$
4.16

 
$
2.94

Weighted average common shares outstanding:
 
 
 
 
 
 
 
 
 
Basic
37,537

 
38,364

 
39,964

 
40,648

 
40,332

Diluted
37,667

 
38,531

 
40,190

 
40,865

 
40,523

Statement of Cash Flows Data:
 
 
 
 
 
 
 
 
 
Net cash provided by (used in) operating activities
$
246,522

 
$
190,155

 
$
149,313

 
$
162,229

 
$
(8,159
)
Net cash used in investing activities
(157,849
)
 
(26,655
)
 
(41,571
)
 
(41,873
)
 
(48,999
)
Net cash provided by (used in) financing activities
(21,893
)
 
(73,565
)
 
(186,827
)
 
3,367

 
12,257

Other Data:
 
 
 
 
 
 
 
 
 
Depreciation and amortization
$
31,857

 
$
30,477

 
$
31,155

 
$
29,340

 
$
26,224

Capital expenditures
25,763

 
27,079

 
42,549

 
42,633

 
50,773

 
December 31,
 
2016
 
2015
 
2014
 
2013
 
2012
 
(In thousands)
Balance Sheet Data:
 
 
 
 
 
 
 
 
 
Working capital
$
955,231

 
$
1,023,483

 
$
928,498

 
$
931,563

 
$
769,299

Total assets
1,461,404

 
1,428,250

 
1,449,251

 
1,396,805

 
1,249,708

Total stockholders’ equity
1,356,424

 
1,324,458

 
1,245,192

 
1,242,018

 
1,066,432



28


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 aspects of the Company’s financial position, results of operations, comprehensive income and cash flows 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 designs, manufactures, sells and services highly engineered drilling and production equipment that is primarily 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 primarily 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 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. Oil and gas prices and the level of drilling and production activity have historically been characterized by significant volatility. See “Item 1A. Risk Factors—A material or extended decline in expenditures by the oil and gas industry could significantly reduce our revenue and income.”
During 2016, Brent crude oil prices averaged $43.67 per barrel compared to $52.32 per barrel in 2015 and $98.97 per barrel in 2014. According to the January 2017 release of the Short-Term Energy Outlook published by the EIA, Brent crude oil prices are projected to average $53.50 per barrel in 2017 and $56.18 in 2018. The International Energy Agency projected the global oil demand to slow by 0.2 million barrels per day in 2017 based on its January 2017 Oil Market Report.
According to the EIA, between January 3, 2017 and February 10, 2017, the price of Brent crude oil ranged from $53.18 per barrel to $55.94 per barrel, closing at $55.20 per barrel on February 10, 2017.
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 years ended December 31, 2016, 2015 and 2014. 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.
 
2016
 
2015
 
2014
 
Floating Rigs
 
Jack-up Rigs
 
Floating Rigs
 
Jack-up Rigs
 
Floating Rigs
 
Jack-up Rigs
Western Hemisphere
83

 
43

 
115

 
66

 
125

 
96

Eastern Hemisphere
62

 
65

 
85

 
84

 
100

 
96

Asia-Pacific
29

 
221

 
39

 
248

 
54

 
260

Total
174

 
329

 
239

 
398

 
279

 
452


Source: IHS—Petrodata RigBase—December 31, 2016, 2015 and 2014
According to IHS-Petrodata RigBase, as of December 31, 2016, there were 461 rigs contracted for the Company’s geographic regions (151 floating rigs and 310 jack-up rigs), which represents a 20.4% decrease from the rig count of 579 rigs (217 floating rigs and 362 jack-up rigs) as of December 31, 2015. The December 31, 2015 rig count represented a 19.2% decrease from the rig count on December 31, 2014 of 717 rigs (274 floating rigs and 443 jack-up rigs).

29


The Company believes that the number of rigs (semi-submersibles, drillships and jack-up rigs) under construction impacts its backlog and resulting revenues 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, at the end of 2016, 2015 and 2014, there were 152, 198 and 228 rigs, respectively, under construction. The expected delivery dates for the rigs under construction on December 31, 2016 are as follows:
 
Floating
Rigs
 
Jack-Ups
 
Total
2017
31

 
80

 
111

2018
9

 
14

 
23

2019
5

 
4

 
9

2020
3

 
6

 
9

 
48

 
104

 
152

However, given the sustained low level of oil and gas prices and oversupply of offshore drilling rigs, the Company believes it is possible that delivery of some rigs under construction could be postponed or cancelled, decreasing 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 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 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.

30


The June 23, 2016 referendum by British voters to exit the European Union (Brexit) adversely impacted global markets, including currencies, and resulted in a decline in the value of the British pound sterling, as compared to the U.S. dollar and other currencies. Volatility in exchange rates could be expected to continue in the short term as the United Kingdom (U.K.) negotiates its exit from the European Union. A weaker British pound sterling compared to the U.S. dollar during a reporting period would cause local currency results of the Company's U.K. operations to be translated into fewer U.S. dollars. Continued adverse consequences such as deterioration in economic conditions and volatility in currency exchange rates could have a negative impact on the Company's financial position and results of operations. See “Item 1A. Risk Factors—Our international operations expose us to instability and changes in economic and political conditions and other risks inherent to international business, which could have a material adverse effect on our results of operations, financial position or cash flows.”
Revenues. Dril-Quip’s revenues are generated from two sources: products and services. Product revenues are derived from the sale of 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. In 2016, the Company derived 80% of its revenues from the sale of its products and 20% of its revenues from services compared to 81% and 19% in 2015 and 83% and 17% in 2014, respectively. 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 66% of its revenues derived from foreign sales in 2016 and 63% in both 2015 and 2014. Substantially all of the Company’s domestic revenue relates to operations in the U. S. Gulf of Mexico. Domestic revenue approximated 34% of the Company’s total revenues for 2016 and 37% in both 2015 and 2014.
Product contracts are typically 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 worldwide economic conditions in the 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. During 2016, there were 10 projects that were accounted for using the percentage-of-completion method, which represented approximately 14% of the Company’s total revenues and 17% of the Company’s product revenues. During 2015, there were 14 projects that were accounted for using the percentage-of-completion method, which represented 16% of the Company’s total revenues and 19% of the Company’s product revenues. During 2014, there were 17 projects that were accounted for using the percentage-of-completion method, which represented 11% of the Company’s total revenues and 13% of the Company’s product revenues. These percentages 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 percentage 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. See “Item 1A. Risk Factors—We may be required to recognize a charge against current earnings because of percentage-of-completion accounting.”
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. The Company’s U.K. subsidiary, whose functional currency is the British pound sterling, conducts a portion of its operations in U.S. dollars. As a result, this subsidiary holds significant monetary assets denominated in U.S. dollars. These monetary assets

31


are subject to changes in exchange rates between the U.S. dollar and the British pound sterling, which has resulted in pre-tax non-cash foreign currency gains during the year ended December 31, 2016 totaling $31.8 million.
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 overall 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.

32



Results of Operations
The following table sets forth, for the periods indicated, certain consolidated statements of income data expressed as a percentage of revenues:
 
Year Ended December 31,
 
2016
 
2015
 
2014
Revenues:
 
 
 
 
 
Products
80.4
%
 
81.2
%
 
83.1
%
Services
19.6

 
18.8

 
16.9

Total revenues
100.0

 
100.0

 
100.0

Cost of sales:
 
 
 
 
 
Products
49.8

 
45.4

 
46.0

Services
11.1

 
9.0

 
9.2

Total cost of sales
61.0

 
54.4

 
55.2

Selling, general and administrative
9.9

 
10.5

 
10.0

Engineering and product development
8.2

 
5.7

 
4.9

Operating income
20.9

 
29.4

 
29.9

Interest income
0.6

 
0.1

 
0.1

Income before income taxes
21.5

 
29.5

 
30.0

Income tax provision
4.2

 
6.8

 
7.6

Net income
17.3
%
 
22.7
%
 
22.4
%
The following table sets forth, for the periods indicated, a breakdown of our products and service revenues:
 
2016
 
2015
 
2014
 
(In millions)
Revenues:
 
 
 
 
 
Products
 
 
 
 
 
Subsea equipment
$
382.2

 
$
606.9

 
$
684.4

Surface equipment
16.7

 
25.6

 
35.2

Offshore rig equipment
34.1

 
52.9

 
53.6

Total products
433.0

 
685.4

 
773.2

Services
105.7

 
158.9

 
157.8

Total revenues
$
538.7

 
$
844.3

 
$
931.0


33


Year Ended December 31, 2016 Compared to Year Ended December 31, 2015
Revenues. Revenues decreased by $305.6 million, or approximately 36.2%, to $538.7 million in 2016 from $844.3 million in 2015. The overall decrease in revenues was impacted by a 21.0% decrease in the average contracted offshore rig count (including floating and jack-up rigs) in 2016 as compared to 2015. Product revenues decreased by approximately $252.4 million for the year ended December 31, 2016 compared to the same period in 2015 as a result of decreased revenues of $224.7 million in subsea equipment, $8.9 million in surface equipment and $18.8 million in offshore rig equipment. Product revenues decreased in the Western Hemisphere by $78.1 million, in Asia-Pacific by $46.3 million and in the Eastern Hemisphere by $128.0 million. The decreased revenues are largely due to the decline in oil and gas prices resulting in decreases in the demand for exploration and production equipment, especially subsea equipment. 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 $53.2 million resulting from decreased service revenues in the Western Hemisphere of $25.0 million, in the Eastern Hemisphere of $18.1 million and $10.1 million in Asia-Pacific. The decrease in service revenues is 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 $130.9 million, or 28.5%, to $328.4 million for 2016 from $459.3 million for the same period in 2015. As a percentage of revenues, cost of sales was approximately 61.0% in 2016 and 54.4% in 2015. Cost of sales as a percentage of revenue increased in 2016 primarily as a result of unabsorbed manufacturing overhead costs.
Selling, General and Administrative Expenses. For 2016, selling, general and administrative expenses decreased by approximately $34.9 million, or 39.7%, to $53.1 million from $88.0 million in 2015. The decrease in selling, general and administrative expenses was primarily due to decreases in personnel and related expenses of $4.1 million, a 5.9% decrease from 2015, acquisition and restructuring costs of $4.3 million compared to zero in 2015 and foreign currency gains of $31.8 million in 2016 as compared to gains of $5.0 million in 2015. The increase in the foreign exchange gain was caused by a 16.9% decline in the value of the British pound sterling against the U.S. dollar from December 31, 2015 to December 31, 2016. During 2015, the value of the British pound sterling declined only 5.1% against the U.S. dollar. Selling, general and administrative expenses as a percentage of revenues were 9.9% in 2016 and 10.5% in 2015.
Engineering and Product Development Expenses. For 2016, engineering and product development expenses decreased by approximately $3.8 million, or 7.9%, to $44.3 million from $48.1 million in 2015 primarily due to a reduction in payroll related expenses. Engineering and product development expenses as a percentage of revenues increased to 8.2% in 2016 from 5.7% in 2015 largely due to the decrease in revenues.
Income Tax Provision. Income tax expense for 2016 was $22.6 million on income before taxes of $115.9 million, resulting in an effective income tax rate of approximately 19.5%. Income tax expense in 2015 was $57.8 million on income before taxes of $249.8 million, resulting in an effective tax rate of approximately 23.1%. The decrease 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, research and development credits, foreign intellectual property tax benefits and deductions related to domestic manufacturing activities.
Net Income. Net income was approximately $93.2 million in 2016 and $192.0 million in 2015 for the reasons set forth above.
Year Ended December 31, 2015 Compared to Year Ended December 31, 2014
Revenues. Revenues decreased by $86.7 million, or approximately 9.3%, to $844.3 million in 2015 from $931.0 million in 2014. The overall decrease in revenues was impacted by a 12.9% decrease in the average contracted offshore rig count (including floating and jack-up rigs) in 2015 as compared to 2014. Product revenues decreased by approximately $87.8 million for the year ended December 31, 2015 compared to the same period in 2014 as a result of decreased revenues of $77.5 million in subsea equipment, $9.6 million in surface equipment and $0.7 million in offshore rig equipment. Product revenues decreased in the Western Hemisphere by $98.1 million and in Asia-Pacific by $19.4 million, partially offset by a $29.7 million increase in the Eastern Hemisphere. 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 increased by approximately $1.1 million resulting from increased service revenues in the Western Hemisphere of $13.8 million, partially offset by decreases of $6.8 million in the Eastern Hemisphere and $5.9 million in Asia-Pacific. The majority of the increases in service revenues related to increased rental of the Company’s running and installation tools, partially offset by a decrease in technical advisory assistance.

34


Cost of Sales. Cost of sales decreased by $54.2 million, or 10.6%, to $459.3 million for 2015 from $513.5 million for the same period in 2014. As a percentage of revenues, cost of sales was approximately 54.4% in 2015 and 55.2% in 2014. Cost of sales as a percentage of revenue decreased in 2015 primarily due to changes in the product mix and a reduction in unabsorbed manufacturing overhead expense.
Selling, General and Administrative Expenses. For 2015, selling, general and administrative expenses decreased by approximately $4.8 million, or 5.2%, to $88.0 million from $92.8 million in 2014. The decrease in selling, general and administrative expenses was primarily due to decreases in personnel and related expenses of $5.2 million coupled with foreign currency gains of $5.0 million in 2015 as compared to gains of $4.5 million in 2014. The decrease was offset by an increase in stock-based compensation of $1.2 million to $13.1 million in 2015 from $11.9 million in 2014. Selling, general and administrative expenses as a percentage of revenues were 10.5% in 2015 and 10.0% in 2014.
Engineering and Product Development Expenses. For 2015, engineering and product development expenses increased by approximately $2.2 million, or 4.8%, to $48.1 million from $45.9 million in 2014. Personnel and related expenses increased by $2.0 million. Engineering and product development expenses as a percentage of revenues increased to 5.7% in 2015 from 4.9% in 2014.
Income Tax Provision. Income tax expense for 2015 was $57.8 million on income before taxes of $249.8 million, resulting in an effective income tax rate of approximately 23.1%. Income tax expense in 2014 was $70.7 million on income before taxes of $279.4 million, resulting in an effective income tax rate of approximately 25.3%. The decrease 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, research and development credits, foreign intellectual property tax benefits and deductions related to domestic manufacturing activities.
Net Income. Net income was approximately $192.0 million in 2015 and $208.7 million in 2014 for the reasons set forth above.
Liquidity and Capital Resources
Cash flows provided by (used in) operations by type of activity were as follows:
 
Year Ended December 31,
 
2016
 
2015
 
2014
 
(In thousands)
Operating activities
$
246,522

 
$
190,155

 
$
149,313

Investing activities
(157,849
)
 
(26,655
)
 
(41,571
)
Financing activities
(21,893
)
 
(73,565
)
 
(186,827
)
 
66,780

 
89,935

 
(79,085
)
Effect of exchange rate changes on cash activities
(24,619
)
 
(7,304
)
 
(6,566
)
Increase (decrease) in cash and cash equivalents
$
42,161

 
$
82,631

 
$
(85,651
)
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 year, as these are non-cash changes. As a result, changes reflected in certain accounts on the Consolidated Statements of Cash Flows may not reflect the changes in corresponding accounts on the 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 increased $56.4 million in 2016 compared to 2015, primarily due to an increase in operating assets and liabilities of $154.8 million offset by lower net income of $98.8 million. Net cash provided by operating activities increased $40.8 million in 2015 compared to 2014, primarily due to increases in operating assets and liabilities of $57.1 million, offset by lower net income of $16.7 million.

35


Net income decreased by $98.8 million to $93.2 million in 2016 from $192.0 million in 2015. Net income decreased by $16.7 million to $192.0 million in 2015 from $208.7 million in 2014. The reasons for the changes in net income are set forth in the “Results of Operations” section above.
The change in operating assets and liabilities of $112.7 million during 2016 primarily reflected a decrease in trade receivables of $106.5 million largely related to increased collection efforts and a decline in revenues. Prepaids and other assets decreased by $9.8 million due to decreases in vendor prepayments. Inventory decreased $7.9 million due to decreases in inventory for long-term projects. Accounts payable and accrued expenses increased by $11.4 million due to a $9.1 million increase in customer prepayments.
The change in operating assets and liabilities of $42.1 million during 2015 primarily reflected a decrease in trade receivables of $36.7 million and a decrease in inventory of $28.5 million. Trade receivables decreased primarily due to increased collection efforts and an overall downward shift of market activities. Inventory decreased due to lower balances in finished goods and an increase in the allowance for excess and slow-moving inventory. Prepaids and other assets increased by $17.9 million mostly from advances to suppliers related to long-term projects. Accounts payable and accrued expenses were lower by approximately $89.4 million which included a decrease of $52.8 million in customer prepayments.
Net cash used in investing activities increased due to the acquisition of TIW. See Note 4 of the Notes to the Consolidated Financial Statements for details of the purchase price allocation. Capital expenditures by the Company were $25.8 million, $27.1 million and $42.5 million in 2016, 2015 and 2014, respectively. Capital expenditures in 2016, 2015 and 2014 included expanding worldwide manufacturing facilities as well as increased expenditures on machinery and equipment and running tools. The capital expenditures for 2016 were primarily $10.8 million for facilities, $6.0 million for machinery and equipment, $7.9 million for running tools and other expenditures of $1.1 million. Capital expenditures in 2015 were primarily $1.0 million for facilities, $12.7 million for machinery and equipment, $11.8 million for running tools and other expenditures of $1.6 million. Capital expenditures in 2014 were comprised of $3.0 million for facilities, $27.0 million for machinery and equipment, $8.3 million for running tools and other expenditures of $4.2 million.
The exercise of stock options generated cash to the Company of $2.2 million in both 2016 and 2015 and $2.8 million in 2014. Under two separate share repurchase plans approved by its Board of Directors, the Company repurchased and cancelled 2,023,172 shares for a total cost of $190 million during 2014. 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 1,184,700 shares under this plan in 2015 for a total of $75.8 million. During 2016, the Company repurchased 400,500 shares under this plan for a total of $24.2 million. All repurchased shares were subsequently cancelled.
On July 26, 2016, the Board of Directors authorized a new stock repurchase plan under which the Company can repurchase up to $100 million of its common stock. The repurchase plan has no set expiration date and any repurchased shares are expected to be cancelled. No repurchases have been made pursuant to this plan as of December 31, 2016.
The following table presents long-term contractual obligations of the Company and the related payments in total and by year as of December 31, 2016:
 
 
Payments Due by Year
Contractual Obligations
 
2017
 
2018
 
2019
 
2020
 
2021
 
After 2021
 
Total
 
 
(In millions)
Operating lease obligations
 
$
3.5

 
$
2.4

 
$
1.8

 
$
1.6

 
$
0.8

 
$
6.7

 
$
16.8


In addition to the above, the Company has issued purchase orders in the ordinary course of business for the purchase of goods and services. These purchase orders are enforceable and legally binding. However, none of the Company’s purchase obligations call for deliveries of goods or services for time periods in excess of one year.
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, a continued depression, or a significant future decline, 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

36


conditions result in unexpected cash requirements, the Company believes that borrowing from commercial lending institutions would be available and adequate to meet such requirements.
Backlog
Backlog consists of firm customer orders of Dril-Quip products for which a purchase order or signed contract has been received, satisfactory credit or financing arrangements exist and delivery is scheduled. Historically, the Company’s revenues for a specific period have not been directly related to its backlog as stated at a particular point in time. The Company’s product backlog was approximately $318 million at December 31, 2016 and $685 million at December 31, 2015. The backlog at the end of 2016 represents a decrease of approximately $367 million, or 54%, from the end of 2015. In June 2016, the Company was awarded a contract valued at approximately $40 million to supply subsea drilling and production equipment and related services to Kangean Energy Indonesia, Ltd. for the development of its Terang/Sirasun/Batur gas fields project located offshore Indonesia. Of the $40 million contract, $29 million is related to equipment, which is included in the Company's backlog at December 31, 2016, and $11 million is related to services, which is not included in backlog. The Company’s backlog balance during 2016 was negatively impacted by $1.3 million in translation adjustments, due primarily to the weakening of the British pound sterling against the U.S. dollar, and by approximately $113 million in cancellations, of which $52 million was attributable to the cancellation of one contract during the first quarter of 2016 for wellhead equipment for a development project.
The Company expects to fill approximately 70% to 80% of the December 31, 2016 product backlog by December 31, 2017. The remaining backlog at December 31, 2016 consists of longer-term projects which are being designed and manufactured to customer specifications requiring longer lead times. In August 2012, the Company’s Brazilian subsidiary, Dril-Quip do Brasil LTDA, was awarded a four-year contract by 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 $407 million based on the December 31, 2016 exchange rate of 3.26 Brazilian real to 1.00 U.S. dollar) if all the equipment under the contract is ordered. Amounts are included in the Company’s backlog as purchase orders under the contract are received. Revenues of approximately $129 million have been recognized on this contract through December 31, 2016. As of December 31, 2016, the Company’s backlog included $29 million of purchase orders under this Petrobras contract. The Company has not yet recognized revenue of approximately $11 million as of December 31, 2016 for certain items of equipment that were completed but not 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. Following an interim amendment to extend the term of the contract pending the resolution of discussions, the Company entered into an amendment on October 17, 2016 to extend the duration of the contract until July 2020. As part of the amendment to the contract, Petrobras agreed to issue purchase orders totaling a minimum of approximately $30 million (based on current exchange rates) before 2019. The Company cannot provide assurance that Petrobras will order all of the equipment under the contract. See “Item 1A. Risk Factors—Our backlog is subject to unexpected adjustments and cancellations and is, therefore, an uncertain indicator of our future revenues and earnings.”
Geographic Segments
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 in Macae, Brazil. Revenues for each of these segments are dependent upon the ultimate sale of products and services to the Company’s customers. For information on revenues by geographic segment, see Note 13 of Notes to Consolidated Financial Statements. Revenues of the Western Hemisphere are also influenced by its sale of products to the Eastern Hemisphere and Asia-Pacific segments. Accordingly, the operating incomes of each area are closely tied to third-party sales, and the operating income of the Western Hemisphere is also dependent upon its level of intercompany sales.
Currency Risk
The Company has operations in various countries around the world and conducts business in a number of different currencies other than the U. S. dollar, principally the British pound sterling and the Brazilian real. Our significant foreign subsidiaries may also have monetary assets and liabilities not denominated in their functional currency. These monetary assets and liabilities are exposed to changes in currency exchange rates which may result in non-cash gains and losses primarily due to fluctuations between the U.S. dollar and each subsidiary’s functional currency.
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

37


the balance of the contracts. The Company had, net of income taxes, transaction gains of $25.6 million, $3.9 million and $3.4 million in 2016, 2015 and 2014, respectively. 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 Scotland, Singapore, Brazil and, to a lesser extent, Norway. The functional currency of these foreign operations is the local currency except for Singapore, where the U.S. dollar is used. Financial statement assets and liabilities in the functional currency are translated at the end of the period exchange rates. Resulting translation adjustments are reflected as a separate component of stockholders’ equity and have no current effect on earnings or cash flow.
Critical Accounting Policies
The Company’s discussion and analysis of its financial condition and results of operations are based on the Company’s consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America. The preparation of the consolidated financial statements requires the Company to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. There can be no assurance that actual results will not differ from those estimates. The Company believes the following accounting policies affect its more significant judgments and estimates used in preparation of its consolidated financial statements.
Revenue Recognition
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 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 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 December 31, 2016 and 2015, receivables included $56.8 million and $70.8 million of unbilled receivables, respectively. For the year ended December 31, 2016, there were 10 projects representing approximately 14% of the Company’s total revenues and approximately 17% of its product revenues, and 14 projects during 2015 representing approximately 16% of the Company’s total revenues and approximately 19% of its product revenues, which were accounted for using percentage-of-completion accounting.

38


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 earns 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 provides 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.
Inventories. Inventory costs are determined principally by the use of the first-in, first-out (FIFO) costing method and are stated at the lower of cost or market. Company manufactured inventory is valued principally using standard costs, which are calculated based upon direct costs incurred and overhead allocations and approximate actual costs. Inventory purchased from third-party vendors is principally valued at the weighted average cost. Periodically, obsolescence reviews are performed on slow-moving inventories and reserves are established based on current assessments about future demands and market conditions. The inventory values have been reduced by a reserve for excess and slow-moving inventories of $45.6 million and $39.2 million as of December 31, 2016 and 2015, respectively. If market conditions are less favorable than those projected by management, additional inventory reserves may be required.
Contingent Liabilities. The Company establishes reserves for estimated loss contingencies when the Company believes a loss is probable and the amount of the loss can be reasonably estimated. Revisions to contingent liabilities are reflected in net income in the period in which different or additional facts or information become known or circumstances change that affect the Company’s previous assumptions with respect to the likelihood or amount of loss. Reserves for contingent liabilities are based upon the Company’s assumptions and estimates regarding the probable outcome of the matter. Should the outcome differ from the Company’s assumptions and estimates, revisions to the estimated reserves for contingent liabilities would be required.
Off-Balance Sheet Arrangements
The Company has no derivative instruments and no off-balance sheet hedging or financing arrangements, contracts or operations.
New Accounting Standards
The information set forth under Note 3 of Notes to the Consolidated Financial Statements under the caption "New Accounting Standards" is incorporated herein by reference.

39



Item 7A.    Quantitative and Qualitative Disclosures About Market Risk
The Company is currently exposed to certain market risks related to interest rate changes on its short-term investments and fluctuations in foreign currency exchange rates. The Company does not engage in any material hedging transactions, forward contracts or currency trading which could mitigate the market risks inherent in such transactions. There have been no material changes in market risks for the Company from December 31, 2015.
Foreign Currency Exchange Rate Risk
Through its subsidiaries, the Company conducts a portion of its business in currencies other than the United States dollar, principally the British pound sterling and the Brazilian real. There is no assurance that the Company will be able to protect
itself against currency fluctuations in the future. In periods where the dollar is strong as compared to other currencies, it is possible that foreign sales may reflect a decline in profits due to translation. It does not appear the Company’s sales have experienced significant profit declines. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Currency Risk” in Item 7 of this report.
The Company uses a sensitivity analysis model to measure the potential impact on revenue and net income of a 10% adverse movement of foreign currency exchange rates for the British pound sterling and the Brazilian real against the U.S. dollar over the previous year. Based upon this model, a 10% decrease would have resulted in a decrease in revenues of approximately $17.6 million and a decrease in net income of approximately $3.6 million for 2016. There can be no assurance that the exchange rate decrease projected above will materialize as fluctuations in exchange rates are beyond the Company’s control.

40


Item 8.        Financial Statements and Supplementary Data

41


Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) or 15d-15(f) promulgated under the Securities Exchange Act of 1934 as a process designed by, or under the supervision of, the Company’s principal executive and principal financial officers and effected by the Company’s board of directors, management and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
 
pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the company;
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with accounting principles generally accepted in the United States of America, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the company’s assets that could have a material effect on the financial statements.
Management has designed its internal control over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Under the supervision and with the participation of our management, including our principal executive officers and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control—Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under the framework in Internal Control—Integrated Framework (2013), our management has concluded that our internal control over financial reporting was effective as of December 31, 2016.
PricewaterhouseCoopers LLP, the independent registered public accounting firm, who audited the consolidated financial statements included in this Annual Report on Form 10-K, has also audited the effectiveness of our internal control over financial reporting, as stated in their report which appears herein.

42


Report of Independent Registered Public Accounting Firm

To the Board of Directors and Stockholders of
Dril-Quip, Inc.

In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, comprehensive income, stockholders’ equity and cash flows present fairly, in all material respects, the financial position of Dril-Quip, Inc. and its subsidiaries at December 31, 2016 and December 31, 2015, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2016 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the accompanying index 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company's management is responsible for these financial statements and financial statement schedule, for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express opinions on these financial statements, on the financial statement schedule, and on the Company's internal control over financial reporting based on our integrated audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PricewaterhouseCoopers LLP
Houston, Texas
February 27, 2017


43


DRIL-QUIP, INC.
CONSOLIDATED STATEMENTS OF INCOME
 
Year Ended December 31,
 
2016
 
2015
 
2014
 
(In thousands, except per share data)
Revenues:
 
 
 
 
 
Products
$
433,012

 
$
685,364

 
$
773,205

Services
105,719

 
158,946

 
157,752

Total revenues
538,731

 
844,310

 
930,957

Cost and expenses:
 
 
 
 
 
Cost of sales:
 
 
 
 
 
Products
268,405

 
382,925

 
428,125

Services
59,999

 
76,361

 
85,402

Total cost of sales
328,404

 
459,286


513,527

Selling, general and administrative
53,143

 
88,044

 
92,762

Engineering and product development
44,325

 
48,145

 
45,920

Total costs and expenses
425,872

 
595,475

 
652,209

Operating income
112,859

 
248,835

 
278,748

Interest income
3,037

 
948

 
667

Interest expense
(28
)
 
(12
)
 
(35
)
Income before income taxes
115,868

 
249,771

 
279,380

Income tax provision
22,647

 
57,763

 
70,668

Net income
$
93,221

 
$
192,008

 
$
208,712

Earnings per common share:
 
 
 
 
 
Basic
$
2.48

 
$
5.00

 
$
5.22

Diluted
$
2.47

 
$
4.98

 
$
5.19

Weighted average common shares outstanding:
 
 
 
 
 
Basic
37,537

 
38,364

 
39,964

Diluted
37,667

 
38,531

 
40,190


The accompanying notes are an integral part of these consolidated financial statements.

44


DRIL-QUIP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
Year Ended December 31,
 
2016
 
2015
 
2014
 
(In thousands)
Net income
$
93,221

 
$
192,008

 
$
208,712

Other comprehensive loss, net of tax:
 
 
 
 
 
Foreign currency translation adjustments
(49,141
)
 
(51,060
)
 
(30,034
)
Total comprehensive income
$
44,080

 
$
140,948

 
$
178,678


The accompanying notes are an integral part of these consolidated financial statements.

45


DRIL-QUIP, INC.
CONSOLIDATED BALANCE SHEETS
 
December 31,
2016
 
2015
 
(In thousands)
ASSETS
 
Current assets:
 
 
 
Cash and cash equivalents
$
423,497

 
$
381,336

Trade receivables, net
213,513

 
319,780

Inventories, net
355,413

 
344,458

Deferred income taxes
24,497

 
24,613

Prepaids and other current assets
39,791

 
54,111

Total current assets
1,056,711

 
1,124,298

Property, plant and equipment, net
323,149

 
294,251

Deferred income taxes
1,699

 

Goodwill
34,371

 

Intangible assets
29,594

 

Other assets
15,880

 
9,701

Total assets
$
1,461,404

 
$
1,428,250

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
36,108

 
$
30,934

Accrued income taxes
24,543

 
14,052

Customer prepayments
11,884

 
18,388

Accrued compensation
10,829

 
17,957

Other accrued liabilities
18,116

 
19,484

Total current liabilities
101,480

 
100,815

Deferred income taxes
3,500

 
2,977

Total liabilities
104,980

 
103,792

Commitments and contingencies (Note 12)

 

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 at December 31, 2016 and 2015, 37,797,317 and 37,951,223 issued and outstanding at December 31, 2016 and 2015
375

 
378

Additional paid-in capital
5,468

 

Retained earnings
1,500,988

 
1,425,344

Accumulated other comprehensive losses
(150,407
)
 
(101,264
)
Total stockholders’ equity
1,356,424

 
1,324,458

Total liabilities and stockholders’ equity
$
1,461,404

 
$
1,428,250


The accompanying notes are an integral part of these consolidated financial statements.

46


DRIL-QUIP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
Year Ended December 31,
 
2016
 
2015
 
2014
 
(In thousands)
Operating activities
 
 
 
 
 
Net income
$
93,221

 
$
192,008

 
$
208,712

Adjustments to reconcile net income to net cash provided by (used in) operating activities:
 
 
 
 
 
Depreciation and amortization
31,857

 
30,477

 
31,155

Stock-based compensation expense
12,217

 
13,125

 
11,856

Loss (gain) on sale of equipment
(103
)
 
69

 
(146
)
Deferred income taxes
(3,400
)
 
(3,465
)
 
(3,145
)
Changes in operating assets and liabilities:
 
 
 
 
 
Trade receivables, net
106,544

 
36,729

 
(102,696
)
Inventories, net
7,873

 
28,539

 
(36,814
)
Prepaids and other assets
9,816

 
(17,883
)
 
(13,239
)
Excess tax benefits of stock options and awards
(135
)
 
(70
)
 
(558
)
Accounts payable and accrued expenses
(11,368
)
 
(89,374
)
 
54,188

Net cash provided by operating activities
246,522

 
190,155

 
149,313

Investing activities
 
 
 
 
 
Purchase of property, plant and equipment
(25,763
)
 
(27,079
)
 
(42,549
)
Proceeds from sale of equipment
357

 
424

 
978

Acquisition of business, net of cash acquired
(132,443
)
 

 

Net cash used in investing activities
(157,849
)
 
(26,655
)
 
(41,571
)
Financing activities
 
 
 
 
 
Repurchase of common stock
(24,234
)
 
(75,805
)
 
(190,234
)
Proceeds from exercise of stock options
2,206

 
2,170

 
2,849

Excess tax benefits of stock options and awards
135

 
70

 
558

Net cash used in financing activities
(21,893
)
 
(73,565
)
 
(186,827
)
Effect of exchange rate changes on cash activities
(24,619
)
 
(7,304
)
 
(6,566
)
Increase (decrease) in cash and cash equivalents
42,161

 
82,631

 
(85,651
)
Cash and cash equivalents at beginning of year
381,336

 
298,705

 
384,356

Cash and cash equivalents at end of year
$
423,497

 
$
381,336

 
$
298,705


The accompanying notes are an integral part of these consolidated financial statements.

47


DRIL-QUIP, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
 
Common
Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Total
 
(In thousands)
Balance at December 31, 2013
$
407

 
$
191,965

 
$
1,069,816

 
$
(20,170
)
 
$
1,242,018

Foreign currency translation adjustment

 

 

 
(30,034
)
 
(30,034
)
Net income

 

 
208,712

 

 
208,712

Comprehensive income

 

 

 

 
178,678

Options exercised and awards vested (48,523 shares)
1

 
2,848

 

 

 
2,849

Stock-based compensation

 
11,856

 

 

 
11,856

Excess tax benefits—stock options and awards

 
25

 

 

 
25

Repurchase of common stock (2,023,172 shares)
(20
)
 
(190,214
)
 

 

 
(190,234
)
Balance at December 31, 2014
388

 
16,480

 
1,278,528

 
(50,204
)
 
1,245,192

Foreign currency translation adjustment

 

 

 
(51,060
)
 
(51,060
)
Net income

 

 
192,008

 

 
192,008

Comprehensive income

 

 

 

 
140,948

Options exercised and awards vested (168,268 shares)

 
2,170

 

 

 
2,170

Stock-based compensation

 
13,125

 

 

 
13,125

Excess tax benefits—stock options and awards

 
(1,172
)
 

 

 
(1,172
)
Repurchase of common stock (1,184,700 shares)
(10
)
 
(30,603
)
 
(45,192
)
 

 
(75,805
)
Balance at December 31, 2015
378

 

 
1,425,344

 
(101,264
)
 
1,324,458

Foreign currency translation adjustment

 

 

 
(49,141
)
 
(49,141
)
Net income

 

 
93,221

 

 
93,221

Comprehensive income

 

 

 

 
44,080

Options exercised and awards vested (163,547 shares)
1