UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
(MARK ONE)
| x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE |
SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2004
OR
| ¨ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) |
OF THE SECURITIES EXCHANGE ACT OF 1934
Commission file number 001-13439
DRIL-QUIP, INC.
(Exact name of registrant as specified in its charter)
| DELAWARE | 74-2162088 | |
| (State or other jurisdiction | (I.R.S. Employer Identification No.) | |
| of incorporation or organization) | ||
13550 HEMPSTEAD HIGHWAY
HOUSTON, TEXAS
77040
(Address of principal executive offices)
(Zip Code)
(713) 939-7711
(Registrant’s telephone number, including area code)
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. Yesx No¨
Indicate by check mark whether the registrant is an accelerated filer (as defined by Rule 12b-2 of the Exchange Act). Yesx No¨
As of May 7, 2004, the number of shares outstanding of the registrant’s common stock, par value $.01 per share, was 17,293,373.
PART I—FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
DRIL-QUIP, INC.
CONSOLIDATED CONDENSED BALANCE SHEETS
| December 31, 2003 | March 31, 2004 | |||||
| (Unaudited) | ||||||
| (In thousands) | ||||||
| ASSETS | ||||||
Current assets: | ||||||
Cash and cash equivalents | $ | 8,325 | $ | 5,993 | ||
Trade receivables | 48,627 | 50,076 | ||||
Inventories | 105,028 | 105,609 | ||||
Deferred taxes | 4,780 | 4,629 | ||||
Prepaids and other current assets | 4,627 | 3,207 | ||||
Total current assets | 171,387 | 169,514 | ||||
Property, plant and equipment, net | 106,535 | 107,721 | ||||
Other assets | 259 | 204 | ||||
Total assets | $ | 278,181 | $ | 277,439 | ||
| LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||
Current liabilities: | ||||||
Accounts payable | $ | 16,196 | $ | 16,301 | ||
Current maturities of long-term debt | 1,288 | 1,319 | ||||
Accrued income taxes | 2,899 | 1,592 | ||||
Customer prepayments | 3,649 | 6,268 | ||||
Accrued compensation | 5,782 | 7,102 | ||||
Other accrued liabilities | 5,649 | 6,429 | ||||
Total current liabilities | 35,463 | 39,011 | ||||
Long-term debt | 38,320 | 30,165 | ||||
Deferred taxes | 4,751 | 4,737 | ||||
Total liabilities | 78,534 | 73,913 | ||||
Stockholders’ equity: | ||||||
Preferred stock: | ||||||
10,000,000 shares authorized at $0.01 par value (none issued) | — | — | ||||
Common stock: | ||||||
50,000,000 shares authorized at $0.01 par value, 17,293,373 shares issued and outstanding | 173 | 173 | ||||
Additional paid-in capital | 64,737 | 64,737 | ||||
Retained earnings | 132,689 | 135,224 | ||||
Foreign currency translation adjustment | 2,048 | 3,392 | ||||
Total stockholders’ equity | 199,647 | 203,526 | ||||
Total liabilities and stockholders’ equity | $ | 278,181 | $ | 277,439 | ||
The accompanying notes are an integral part of these statements.
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DRIL-QUIP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
| Three months ended March 31, | ||||||
| 2003 | 2004 | |||||
| (In thousands except share data) | ||||||
Revenues | $ | 55,221 | $ | 53,378 | ||
Cost and expenses: | ||||||
Cost of sales | 40,130 | 37,505 | ||||
Selling, general and administrative | 7,329 | 7,396 | ||||
Engineering and product development | 4,287 | 4,272 | ||||
| 51,746 | 49,173 | |||||
Operating income | 3,475 | 4,205 | ||||
Interest expense | 450 | 310 | ||||
Income before income taxes | 3,025 | 3,895 | ||||
Income tax provision | 953 | 1,360 | ||||
Net income | $ | 2,072 | $ | 2,535 | ||
Earnings per share: | ||||||
Basic | $ | 0.12 | $ | 0.15 | ||
Fully diluted | $ | 0.12 | $ | 0.15 | ||
Weighted average shares: | ||||||
Basic | 17,293,373 | 17,293,373 | ||||
Fully diluted | 17,293,373 | 17,334,402 | ||||
The accompanying notes are an integral part of these statements.
3
DRIL-QUIP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
| Three months ended March 31, | ||||||||
| 2003 | 2004 | |||||||
| (In thousands) | ||||||||
Operating activities | ||||||||
Net income | $ | 2,072 | $ | 2,535 | ||||
Adjustments to reconcile net income to net cash provided by operating activities: | ||||||||
Depreciation and amortization | 2,652 | 2,819 | ||||||
Loss on sale of equipment | 15 | — | ||||||
Deferred income taxes | (43 | ) | 148 | |||||
Changes in operating assets and liabilities: | ||||||||
Trade receivables | 8,916 | (967 | ) | |||||
Inventories | (2,053 | ) | 569 | |||||
Prepaids and other assets | (458 | ) | 1,499 | |||||
Trade accounts payable and accrued expenses | (5,489 | ) | 3,166 | |||||
Net cash provided by operating activities | 5,612 | 9,769 | ||||||
Investing activities | ||||||||
Purchase of property, plant and equipment | (2,266 | ) | (3,411 | ) | ||||
Transfer of rental assets to inventory | 5,518 | — | ||||||
Proceeds from sale of equipment | 16 | 25 | ||||||
Net cash provided by (used in) investing activities | 3,268 | (3,386 | ) | |||||
Financing activities | ||||||||
Principal payments on revolving line of credit and long-term debt | (6,498 | ) | (8,316 | ) | ||||
Net cash used in financing activities | (6,498 | ) | (8,316 | ) | ||||
Effect of exchange rate changes on cash activities | 245 | (399 | ) | |||||
Increase (decrease) in cash | 2,627 | (2,332 | ) | |||||
Cash at beginning of period | 3,276 | 8,325 | ||||||
Cash at end of period | $ | 5,903 | $ | 5,993 | ||||
The accompanying notes are an integral part of these statements.
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DRIL-QUIP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. ORGANIZATION AND PRINCIPLES OF CONSOLIDATION
Dril-Quip, Inc., a Delaware corporation (the “Company” or “Dril-Quip”), manufactures highly engineered offshore drilling and production equipment which is well suited for use in deepwater, harsh environment and severe service applications. The Company’s principal products consist of subsea and surface wellheads, subsea and surface production trees, mudline hanger systems, specialty connectors and associated pipe, drilling and production riser systems, wellhead connectors and diverters for use by major integrated, large independent and foreign national oil and gas companies in offshore areas throughout the world. Dril-Quip also provides installation and reconditioning services and rents running tools for use in connection with the installation and retrieval of its products. The Company’s activities are within a single industry segment. The Company has four subsidiaries that manufacture and market the Company’s products abroad. Dril-Quip (Europe) Limited (“DQE”) is located in Aberdeen, Scotland, with branches in Norway, Holland and Denmark. Dril-Quip Asia Pacific PTE Ltd. is located in Singapore. DQ Holdings PTY Ltd. is located in Perth, Australia and Dril-Quip do Brasil LTDA is located in Macae, Brazil. Dril-Quip (Nigeria) Ltd. is located in Port Harcourt, Nigeria and is a wholly-owned subsidiary of DQE.
The condensed consolidated financial statements included herein have been prepared by Dril-Quip and are unaudited, except for the balance sheet at December 31, 2003, which has been prepared from the audited financial statements at that date. In the opinion of management, the unaudited condensed consolidated interim financial statements include all adjustments, consisting solely of normal recurring adjustments, necessary for a fair presentation of the financial position as of March 31, 2004, and the results of operations and the cash flows for each of the three-month periods ended March 31, 2004 and 2003. Although management believes the unaudited interim related disclosures in these financial statements are adequate to make the information presented not misleading, certain information and footnote disclosures normally included in annual audited financial statements prepared in accordance with generally accepted accounting principles in the United States have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. The results of operations and the cash flows for the three-month period ended March 31, 2004 are not necessarily indicative of the results to be expected for the full year. The consolidated financial statements included herein should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.
2. SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany accounts and transactions have been eliminated.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Some of the Company’s more significant estimates are those affected by critical accounting policies for revenue recognition, inventories and contingent liabilities.
Cash and cash equivalents
Short term investments that have a maturity of three months or less from the date of purchase are classified as cash equivalents.
5
DRIL-QUIP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(UNAUDITED)
Inventories
Inventory costs are determined principally by the use of the first-in, first out (FIFO) method, and are stated at the lower of cost or market. Inventory is valued principally using standard costs that are calculated based upon direct costs incurred and overhead allocations. Periodically, obsolesence reviews are performed on slow moving inventories and reserves are established based upon current assessments about future demands and market conditions.
Property, Plant, and Equipment
Property, plant, and equipment are carried at cost, with depreciation provided on a straight-line basis over their estimated useful lives.
Income Taxes
The Company accounts for income taxes using the liability method. Deferred income taxes are provided on income and expenses which are reported in different periods for income tax and financial reporting purposes.
Revenue Recognition
The Company delivers most of its products and services on an as-needed basis by its customers and records revenues as the products are shipped and as services are rendered. Allowances for doubtful accounts are determined generally on a case by case basis. Certain revenues are derived from long-term contracts which generally require more than one year to fulfill. Revenues and profits on long-term contracts are recognized under the percentage-of-completion method based on a cost-incurred basis. Losses, if any, on contracts are recognized when they become known. Contracts for long-term projects contain provisions for customer progress payments. Payments in excess of revenues recognized are included as a customer prepayment liability.
Foreign Currency
The financial statements of foreign subsidiaries are translated into U.S. dollars at current exchange rates except for revenues and expenses, which are translated at average rates during each reporting period. Translation adjustments are reflected as a separate component of stockholders’ equity and have no current effect on earnings or cash flows.
Foreign currency exchange transactions are recorded using the exchange rate at the date of the settlement. These amounts are included in selling, general, and administrative costs in the consolidated statements of income.
Stock-Based Compensation
The Company has adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, “Accounting For Stock Based Compensation” (“SFAS No. 123”). Accordingly, no compensation cost has been recognized for stock options granted under the Company’s incentive plan.
Under SFAS No. 123, pro forma information is required to reflect the estimated effect on net income and earnings per share as if the Company had accounted for the stock options using the fair value method. The fair value was estimated at the date of grant using a Black-Scholes option pricing model.
6
DRIL-QUIP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(UNAUDITED)
Had compensation cost for the Company’s stock-based compensation plans been determined based on the fair value at the grant dates for awards consistent with the method available under SFAS No. 123, the Company’s net income and earnings per share for each of the three months ended March 31, 2003, and 2004 would have been reduced to the pro forma amounts listed below.
Three months Ended March 31, | ||||||
| 2003 | 2004 | |||||
| (In thousands) | ||||||
Net Income | ||||||
As reported | $ | 2,072 | $ | 2,535 | ||
Pro forma | $ | 1,491 | $ | 1,973 | ||
Earnings per share | ||||||
Basic | $ | 0.12 | $ | 0.15 | ||
Diluted | $ | 0.12 | $ | 0.15 | ||
Pro forma | ||||||
Basic | $ | 0.09 | $ | 0.11 | ||
Diluted | $ | 0.09 | $ | 0.11 | ||
There were no option grants during the first quarter of 2004.
Fair Value of Financial Instruments
The Company’s financial instruments consist primarily of cash and cash equivalents, receivables, payables, and debt instruments. The carrying values of these financial instruments approximate their respective fair values as they are either short-term in nature or carry interest rates which approximate market rates.
Concentration of Credit Risk
Financial instruments which subject the Company to concentrations of credit risk consist principally of trade receivables. The Company grants credit to its customers, which operate primarily in the oil and gas industry. The Company performs periodic credit evaluations of its customers’ financial condition and generally does not require collateral. The Company maintains reserves for potential losses and such losses have historically been within management’s expectations.
Comprehensive Income
The Company includes unrealized gains or losses on foreign currency translation adjustments in other comprehensive income. Generally, gains are attributed to a weakening U.S. dollar and losses are the result of a strengthening U.S. dollar.
The following table provides comprehensive income for the periods indicated:
Three months March 31, | |||||||
| 2003 | 2004 | ||||||
| (In thousands) | |||||||
Net income | $ | 2,072 | $ | 2,535 | |||
Foreign currency translation adjustment | (925 | ) | 1,344 | ||||
Comprehensive income | $ | 1,147 | $ | 3,879 | |||
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DRIL-QUIP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(UNAUDITED)
Earnings Per Share
Basic earnings per share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the year. Diluted earnings per share is computed considering the dilutive effect of stock options.
The net income used in the basic and diluted earnings per share calculations is the same due to no dilutive effects of stock options or other contingently issuable shares. The following table reconciles the number of common shares outstanding at March 31 of each year to the weighted average of common shares outstanding and the weighted average number of common and dilutive potential common shares outstanding for the purpose of calculating basic and diluted earnings per common share:
Three months ended March 31, | ||||
| 2003 | 2004 | |||
| (In thousands) | ||||
Number of common shares outstanding at end of period | 17,293 | 17,293 | ||
Effect of using weighted average common shares outstanding | — | — | ||
Weighted average basic common shares outstanding | 17,293 | 17,293 | ||
Dilutive effect of common stock options | — | 41 | ||
Weighted average diluted common shares outstanding | 17,293 | 17,334 | ||
New Accounting Standards
In January 2003, the FASB issued Interpretation No. 46R,Consolidation of Variable Interest Entities. The Interpretation requires the consolidation of entities in which an enterprise absorbs a majority of the entity’s losses, received a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual, or other financial interests in the entity. Prior to the issuance of this Interpretation, entities were generally consolidated by an enterprise when it had a controlling interest through ownership of a majority voting interest. This Interpretation applies immediately to entities created after January 31, 2003, and with respect to variable interests held prior to that date, the Company has applied this Interpretation during the current reporting period. The Company has no investments or contractual arrangements that may constitute a variable interest. The adoption of the Interpretation did not have a material impact on the Company’s results of operation or financial position.
3. INVENTORIES
Inventories consist of the following:
December 31, 2003 | (Unaudited) March 31, 2004 | |||||
| (In Thousands) | ||||||
Raw materials and supplies | $ | 17,020 | $ | 13,955 | ||
Work in progress | 18,169 | 24,196 | ||||
Finished goods | 69,839 | 67,458 | ||||
| $ | 105,028 | $ | 105,609 | |||
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DRIL-QUIP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
(UNAUDITED)
4. GEOGRAPHIC AREAS
Three months ended March 31, | ||||||||
| 2003 | 2004 | |||||||
| (In thousands) | ||||||||
Revenues | ||||||||
United States: | ||||||||
Domestic | $ | 20,917 | $ | 24,457 | ||||
Export | 13,916 | 1,652 | ||||||
Intercompany | 6,917 | 6,181 | ||||||
Total United States | 41,750 | 32,290 | ||||||
Europe and Africa | 14,491 | 22,528 | ||||||
Asia-Pacific | 5,897 | 4,741 | ||||||
Eliminations | (6,917 | ) | (6,181 | ) | ||||
Total | $ | 55,221 | $ | 53,378 | ||||
Operating Income (Loss) | ||||||||
United States | $ | 3,513 | $ | 650 | ||||
Europe and Africa | (1,476 | ) | 2,226 | |||||
Asia-Pacific | 1,756 | 973 | ||||||
Eliminations | (318 | ) | 356 | |||||
Total | $ | 3,475 | $ | 4,205 | ||||
Identifiable Assets | ||||||||
United States | $ | 179,311 | $ | 167,808 | ||||
Europe and Africa | 77,541 | 91,389 | ||||||
Asia-Pacific | 17,810 | 21,982 | ||||||
Eliminations | (4,130 | ) | (3,740 | ) | ||||
Total | $ | 270,532 | $ | 277,439 | ||||
Revenues from the Company’s Product Group totaled approximately $46.5 million and $42.9 million for each of the three month periods ended March 31, 2003 and 2004, respectively. Additionally, revenues from the Company’s Service Group totaled approximately $8.7 million and $10.5 million for the three months ended March 31, 2003 and 2004, respectively.
Export sales from the United States to unaffiliated customers consist of worldwide sales outside the territorial waters of the United States. Europe and Africa sales are primarily to the North Sea, with lesser sales to Africa, while Asia-Pacific’s sales are primarily to Australia, Thailand, Malaysia, Indonesia and the Middle East.
Eliminations of operating profits are related to intercompany inventory transfers that are deferred until shipment is made to third party customers.
9
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following is management’s discussion and analysis of certain significant factors that have affected certain aspects of the Company’s financial position and results of operations during the periods included in the accompanying unaudited condensed consolidated financial statements. This discussion should be read in conjunction with the unaudited condensed consolidated financial statements included elsewhere herein, and with the discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the annual consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.
Overview
Dril-Quip manufactures highly engineered offshore drilling and production equipment which is well suited for use in deepwater, harsh environment and severe service applications. The Company designs and manufactures subsea equipment, surface equipment and offshore rig equipment for use by major integrated, large independent and foreign national oil and gas companies in offshore areas throughout the world. The Company’s principal products consist of subsea and surface wellheads, subsea and surface production trees, mudline hanger systems, specialty connectors and associated pipe, drilling and production riser systems, wellhead connectors and diverters. Dril-Quip also provides installation and reconditioning services and rents running tools for use in connection with the installation and retrieval of its products.
Both the market for offshore drilling and production equipment and services and the Company’s business are substantially dependent on the condition of the oil and gas industry and, in particular, the willingness of oil and gas companies to make capital expenditures on exploration, drilling and production operations offshore. Oil and gas prices and the level of offshore drilling and production activity have historically been characterized by significant volatility.
Revenues.Dril-Quip’s revenues are generated by its two operating groups: the Product Group and the Service Group. The Product Group manufactures offshore drilling and production equipment, and the Service Group provides installation and reconditioning services as well as rental running tools for installation and retrieval of its products. For the three months ended March 31, 2004, the Company derived 80% of its revenues from the sale of its products and 20% of its revenues from services. Revenues from the Service Group generally correlate to revenues from product sales because increased product sales generate increased revenues from installation services and rental running tools. Substantially all of Dril-Quip’s sales are made on a purchase order basis. Purchase orders are subject to change and/or termination at the option of the customer. In case of a change or termination, the customer is required to pay the Company for work performed and other costs necessarily incurred as a result of the change or termination.
The Company accounts for larger and more complex projects that have relatively longer manufacturing time frames on a percentage of completion basis. For the first three months of 2004, three projects representing approximately 11% of the Company’s revenues were accounted for using percentage of completion accounting. This percentage may fluctuate in the future. Revenues accounted for in this manner are generally recognized on the ratio of costs incurred to the total estimated costs. Accordingly, price and cost estimates are reviewed periodically as the work progresses, and adjustments proportionate to the percentage of completion are reflected in the period when such estimates are revised. Losses, if any, are recognized when they become known. Amounts billed to or received from customers in excess of revenues recognized are classified as a current liability.
Foreign sales represent a significant portion of the Company’s business. In the three months ended March 31, 2004, the Company generated approximately 54% of its revenues from foreign sales. In this period, approximately 61% (on the basis of revenues generated) of all products sold were manufactured in the United States.
10
Cost of Sales.The principal elements of cost of sales are labor, raw materials and manufacturing overhead. Variable costs, such as labor, raw materials, supplies and energy, generally account for approximately two-thirds of the Company’s cost of sales. Fixed costs, such as the fixed portion of manufacturing overhead, constitute the remainder of the Company’s cost of sales. Cost of sales as a percentage of revenues is also influenced by the product mix sold in any particular quarter and market conditions. The Company’s costs related to its foreign operations do not significantly differ from its domestic costs.
Selling, General and Administrative Expenses.Selling, general and administrative expenses include the costs associated with sales and marketing, general corporate overhead, compensation expense, legal expenses and other related administrative functions.
Engineering and Product Development Expenses.Engineering and product development expenses consist of new product development and testing, as well as application engineering related to customized products.
Income Tax Provision.Dril-Quip’s effective tax rate has historically been lower than the statutory rate due to benefits from its foreign sales corporation or foreign income tax rate differentials.
Results of Operations
The following table sets forth, for the periods indicated, certain statement of operations data expressed as a percentage of revenues:
Three months March 31, | ||||||
| 2003 | 2004 | |||||
Revenues: | ||||||
Product Group | 84.2 | % | 80.3 | % | ||
Service Group | 15.8 | % | 19.7 | % | ||
Total | 100.0 | % | 100.0 | % | ||
Cost of sales | 72.7 | % | 70.3 | % | ||
Selling, general and administrative expenses | 13.3 | % | 13.8 | % | ||
Engineering and product development expenses | 7.7 | % | 8.0 | % | ||
Operating income | 6.3 | % | 7.9 | % | ||
Interest expense | 0.8 | % | 0.6 | % | ||
Income before income taxes | 5.5 | % | 7.3 | % | ||
Income tax provision | 1.7 | % | 2.5 | % | ||
Net income | 3.8 | % | 4.8 | % | ||
Three Months Ended March 31, 2004 Compared to Three Months Ended March 31, 2003
Revenues. Revenues decreased by $1.8 million, or approximately 3.3%, to $53.4 million in the three months ended March 31, 2004 from $55.2 million in the three months ended March 31, 2003. The net decrease resulted from decreased export sales from the United States of $12.3 million and decreased sales of $1.1 million in the Asia Pacific region, offset by increased domestic sales from the United States of $3.6 and increased sales of $8.0 million in the European area. Decreased export sales from the United States were due to reduced sales activity in South America, primarily Brazil. Decreased sales in the Asia Pacific region resulted from reduced sales activity in Australia. The increase in domestic sales in the United States occurred in the Gulf of Mexico while the increased sales in the European area came principally from North and West Africa.
Cost of Sales.Cost of sales decreased $2.6 million, or approximately 6.5%, to $37.5 million for the three months ended March 31, 2004 from $40.1 million for the same period in 2003. As a percentage of revenues, cost
11
of sales were approximately 70% and 73% for the three-month periods ending March 31, 2004 and 2003, respectively. This reduction in cost of sales as a percentage of revenues was primarily attributed to improved sales margins resulting from manufacturing efficencies and changes in product mix.
Selling, General and Administrative Expenses.In the three months ended March 31, 2004, selling, general and administrative expenses increased by approximately $100,000, or 1%, to $7.4 million from $7.3 million in the 2003 period. The increase in selling, general and administrative expenses was primarily due to increased costs of labor, insurance and employee benefits. Selling, general and administrative expenses as a percentage of revenues were 13.3% in 2003 to 13.8% in 2004.
Engineering and Product Development Expenses.In the three months ended March 31, 2004 and 2003, engineering and product development expenses remained constant at approximately $4.3 million. Engineering and product development expenses as a percentage of revenues were 8.0% in 2004 and 7.7% in 2003.
Interest Expense.Interest expense for the three months ended March 31, 2004 was $310,000 as compared to interest expense of $450,000 for the three-month period ended March 31, 2003. This change resulted primarily from reduced borrowings during the period ended March 31, 2004 under the Company’s unsecured revolving line of credit as compared to borrowings during the period ended March 31, 2003.
Net Income.Net income was approximately $2.5 million for the three months ended March 31, 2004 and $2.1 million for the same period in 2003, for the reasons set forth above.
Liquidity and Capital Resources
The primary liquidity needs of the Company are (i) to fund capital expenditures to increase manufacturing capacity, improve and expand facilities and manufacture additional rental running tools and (ii) to fund working capital. The Company’s principal sources of funds are cash flows from operations and bank indebtedness.
Net cash provided by operating activities was approximately $9.8 million and $5.6 million for the three months ended March 31, 2004 and 2003, respectively. The improvement in cash flow from operating activities was principally due to increased net income and decreased working capital requirements attributable to inventories, prepaids and other assets, trade payables and accrued expenses, offset by increased working capital requirements attributable to trade accounts receivable.
Capital expenditures by the Company were $3.4 million and $2.3 million for the three months ended March 31, 2004 and 2003, respectively. Principal payments on long-term debt were approximately $8.3 million and $6.5 million for the three months ended March 31, 2004 and 2003, respectively.
The Company has a credit facility with Guaranty Bank, FSB providing an unsecured revolving line of credit of up to $65 million. At the option of the Company, borrowing under this facility bears interest at either a rate equal to LIBOR (London Interbank Offered Rate) plus 1.75% or the Guaranty Bank base rate. The facility calls for quarterly interest payments and terminates on May 18, 2006. As of March 31, 2004, the Company had drawn down $23.0 million under this facility for operating activities and capital expenditures.
Dril-Quip (Europe) Limited has a credit agreement with the Bank of Scotland dated March 21, 2001 in the original amount of U.K. Pounds Sterling 3.7 million (approximately U.S. $6.8 million). Borrowing under this facility bears interest at the Bank of Scotland base rate, which was 4% at March 31, 2004, plus 1%, and is repayable in 120 equal monthly installments, plus interest. Substantially all of this facility was used to finance capital expenditures in Norway. The outstanding balance of this facility at March 31, 2004 was approximately U.S. $5.2 million.
Dril-Quip Asia Pacific PTE Ltd. has a secured term loan with the Overseas Union Bank dated August 29, 2001 in the original amount of Singapore Dollars $6.0 million (approximately U.S. $3.6 million). Borrowing
12
under this facility bears variable interest at the swap rate, approximately 0.67%, plus 1.5% and is repayable in 40 equal quarterly installments, plus interest. This facility was used to finance capital expenditures in Singapore. The outstanding balance of this loan at March 31, 2004 was approximately U.S. $2.9 million.
The Company believes that cash generated from operations plus cash on hand and its existing line of credit will be sufficient to fund operations, working capital needs and anticipated capital expenditure requirements in 2004. However, any significant future declines in hydrocarbon prices below historical levels could have a material adverse effect on the Company’s liquidity. Should market conditions result in unexpected cash requirements, the Company believes that additional borrowing from commercial lending institutions would be readily available and more than adequate to meet such requirements.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is currently exposed to certain market risks related to interest rate changes and fluctuations in foreign exchange rates. The Company does not believe that these risks are material. The Company does not engage in any material hedging transactions, forward contracts or currency trading which could be subject to market risks inherent to such transactions.
Foreign 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 Norwegian kroner. The Company generally attempts to minimize the associated currency exchange risks by seeking international contracts payable in local currency and in U.S. dollars for the balance of the contract. Because of this strategy, the Company has not experienced significant transaction gains or losses associated with changes in currency exchange rates and does not anticipate such exposure to be material in the future. There is no assurance that the Company will be able to protect itself against currency fluctuations in the future.
Interest Rate Risk
As described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations —Liquidity and Capital Resources,” the Company has entered into three credit facilities or loans that require the Company to pay interest at a floating rate. These floating-rate obligations expose the Company to the risk of increased interest expense in the event of increases in the short-term interest rates. The Company believes that significant interest rate changes will not have a material near-term impact on our future earnings or cash flows based on current borrowing levels.
Item 4. CONTROLS AND PROCEDURES
In accordance with Exchange Act Rules 13a-15 and 15d-15, the Company carried out an evaluation, under the supervision and with the participation of management, including the Company’s Co-Chief Executive Officers and Chief Financial Officer, of the effectiveness of the Company’s disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Company’s Co-Chief Executive Officers and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2004 to provide reasonable assurance that information required to be disclosed in the Company’s reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
There has been no change in the Company’s internal controls over financial reporting that occurred during the three months ended March 31, 2004 that has materially affected, or is reasonably likely to materially affect, the Company’s internal controls over financial reporting.
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PART II—OTHER INFORMATION
Item 1.Legal Proceedings.
The Company is involved in a number of legal actions arising in the ordinary course of business. Although no assurance can be given with respect to the ultimate outcome of such legal actions, in the opinion of management, the ultimate liability with respect thereto will not have a material adverse effect on the Company’s financial position.
Item 2.Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities.
None.
Item 3.Defaults Upon Senior Securities.
None.
Item 4.Submission of Matters to a Vote of Security Holders.
No matters were submitted to a vote of security holders of the Company during the quarter ended March 31, 2004.
Item 5.Other Information.
FORWARD LOOKING STATEMENTS
This Quarterly Report on Form 10-Q includes certain statements that may be deemed to be “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Statements contained in all parts of this document that are not historical facts are forward looking statements that involve risks and uncertainties that are beyond Dril-Quip’s control. You can identify the Company’s forward looking statements by the words “anticipate,” “estimate,” “expect,” “may,” “project,” “believe” and similar expressions. These forward-looking statements include the following types of information and statements as they relate to the Company:
| • | scheduled, budgeted and other future capital expenditures; |
| • | working capital requirements; |
| • | the availability of expected sources of liquidity; |
| • | statements regarding the market for Company products; |
| • | statements regarding the exploration and production activities of Company customers; and |
| • | all statements regarding future operations, financial results, business plans and cash needs. |
These statements are based upon certain assumptions and analyses made by management of the Company in light of its experience and its perception of historical trends, current conditions, expected future developments and other factors it believes are appropriate in the circumstances. Such statements are subject to a number of assumptions, risks and uncertainties, including, but not limited to, those relating to the volatility of oil and natural gas prices and the cyclicality of the oil and gas industry, the Company’s international operations, operating risks, the Company’s dependence on key employees, the Company’s dependence on skilled machinists and technical personnel, the Company’s reliance on product development and possible technological obsolescence, control by certain stockholders, the potential impact of governmental regulation and environmental matters, competition, reliance on significant customers, political developments and instability, acts of terrorism or war and other factors detailed in the Company’s other filings with the Securities and Exchange Commission. Prospective
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investors are cautioned that any such statements are not guarantees of future performance, and that, should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual outcomes may vary materially from those indicated.
Item 6.Exhibits and Reports on Form 8-K.
(a) Exhibits
The following exhibits are filed herewith:
Exhibit No. | Description | |||
| *3.1 | — | Restated Certificate of Incorporation of the Company (Incorporated herein by reference to Exhibit 3.2 to the Company’s Registration Statement on Form S-1 (Registration No. 333-33447)). | ||
| *3.2 | — | Bylaws of the Company (Incorporated herein by reference to Exhibit 3.3 to the Company’s Registration Statement on Form S-1 (Registration No. 333-33447)). | ||
| *4.1 | — | Certificate of Designations for Series A Junior Participating Preferred Stock (Incorporated herein by reference to Exhibit 3.3 to the Company’s Report on Form 10-Q for the Quarter ended September 30, 1997.)) | ||
| *4.2 | — | Form of certificate representing Common Stock (Incorporated herein by reference to Exhibit 4.1 the Company’s Registration Statement on Form S-1 (registration No. 333-33447)). | ||
| *4.3 | — | Registration Rights Agreement among the Company and certain stockholders (Incorporated herein by reference to Exhibit 4.2 to the Company’s Registration Statement on Form S-1 (Registration No. 333-33447)). | ||
| *4.4 | — | Rights Agreement between the Company and ChaseMellon Shareholders Services, L.L.C., as rights agent (Incorporated herein by reference to Exhibit 4.3 to the Company’s registration Statement on Form S-1 (Registration No. 333-33447)). | ||
| 31.1 | — | Rule 13a-14(a)/15d-14(a) Certification of Larry E. Reimert. | ||
| 31.2 | — | Rule 13a-14(a)/15d-14(a) Certification of Gary D. Smith. | ||
| 31.3 | — | Rule 13a-14(a)/15d-14(a) Certification of J. Mike Walker. | ||
| 31.4 | — | Rule 13a-14(a)/15d-14(a) Certification of Jerry M. Brooks. | ||
| 32.1 | — | Section 1350 Certification of Larry E. Reimert. | ||
| 32.2 | — | Section 1350 Certification of Gary D. Smith. | ||
| 32.3 | — | Section 1350 Certification of J. Mike Walker. | ||
| 32.4 | — | Section 1350 Certification of Jerry M. Brooks. | ||
| * | Incorporated herein by reference as indicated. |
(b) Reports on Form 8-K
On February 27, 2004 the Company filed a Current Report on Form 8-K dated February 27, 2004 furnishing information regarding fourth quarter 2003 and full year 2003 earnings.
On April 30, 2004, the Company filed a Current Report on Form 8-K dated April 30, 2004 furnishing information regarding first quarter 2004 earnings.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| DRIL-QUIP, INC. | ||
| By: | /s/ JERRY M. BROOKS | |
Jerry M. Brooks, Chief Financial Officer (Principal Accounting Officer and Duly Authorized Signatory) | ||
Date: May 7, 2004
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