-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SYnvAguGfk3ZAK+977LMt94AbZ64aolQuKy7e6L9Vwb+W3kNvCqrqcQuuqH4B/2b 3slKxjWMRFGcDJ0AMXsqgQ== 0000899243-97-001845.txt : 19970927 0000899243-97-001845.hdr.sgml : 19970927 ACCESSION NUMBER: 0000899243-97-001845 CONFORMED SUBMISSION TYPE: S-1/A PUBLIC DOCUMENT COUNT: 6 FILED AS OF DATE: 19970919 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: DRIL-QUIP INC CENTRAL INDEX KEY: 0001042893 STANDARD INDUSTRIAL CLASSIFICATION: OIL & GAS FILED MACHINERY & EQUIPMENT [3533] IRS NUMBER: 742162088 STATE OF INCORPORATION: TX FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: S-1/A SEC ACT: SEC FILE NUMBER: 333-33447 FILM NUMBER: 97682954 BUSINESS ADDRESS: STREET 1: 13550 HEMPSTEAD HIGHWAY CITY: HOUSTON STATE: TX ZIP: 77040 BUSINESS PHONE: 7139397711 MAIL ADDRESS: STREET 1: 180 EAST FIFTH STREET CITY: HOUSTON STATE: TX ZIP: 77040 S-1/A 1 AMENDMENT #1 TO FORM S-1 AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON SEPTEMBER 19, 1997 REGISTRATION NO. 333-33447 - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 --------------- AMENDMENT NO. 1 TO FORM S-1 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 --------------- DRIL-QUIP, INC. (EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER) DELAWARE 3533 74-2162088 (STATE OR OTHER (PRIMARY STANDARD INDUSTRIAL (I.R.S. EMPLOYER JURISDICTION OF CLASSIFICATION CODE NUMBER) IDENTIFICATION NO.) INCORPORATION OR ORGANIZATION) 13550 HEMPSTEAD HIGHWAY HOUSTON, TEXAS 77040 (713) 939-7711 (ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF REGISTRANT'S PRINCIPAL EXECUTIVE OFFICES) --------------- LARRY E. REIMERT 13550 HEMPSTEAD HIGHWAY HOUSTON, TEXAS 77040 (713) 939-7711 (NAME, ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE, OF AGENT FOR SERVICE) --------------- COPIES TO: WALTER J. SMITH THOMAS P. MASON BAKER & BOTTS, L.L.P. ANDREWS & KURTH L.L.P. 3000 ONE SHELL PLAZA 4200 TEXAS COMMERCE TOWER 910 LOUISIANA HOUSTON, TEXAS 77002 HOUSTON, TEXAS 77002-4995 (713) 220-4200 (713) 229-1234 --------------- APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC: As soon as practicable after this Registration Statement becomes effective. --------------- If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box. [_] If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering. [_] If delivery of the Prospectus is expected to be made pursuant to Rule 434, please check the following box. [_] CALCULATION OF REGISTRATION FEE - ------------------------------------------------------------------------------- - -------------------------------------------------------------------------------
PROPOSED MAXIMUM TITLE OF EACH CLASS OF PROPOSED MAXIMUM AGGREGATE SECURITIES TO BE AMOUNT TO BE OFFERING PRICE OFFERING AMOUNT OF REGISTERED REGISTERED(1) PER SHARE(1) PRICE(2)(3) REGISTRATION FEE - ----------------------------------------------------------------------------------------- Common Stock, par value $0.01 per share (4).... -- -- $115,000,000 $34,849(5) - -----------------------------------------------------------------------------------------
- ------------------------------------------------------------------------------- (1) In accordance with Rule 457(o) under the Securities Act of 1933, as amended, the number of shares being registered and the proposed maximum offering price per share are not included in this table. (2) Estimated solely for the purpose of calculating the registration fee. (3) Includes shares of Common Stock issuable upon exercise of the Underwriters' over-allotment option. (4) Includes associated rights to purchase preferred stock. (5) A filing fee of $31,364 has previously been paid. An additional fee of $3,485 is being paid herewith. THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(A), MAY DETERMINE. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ +INFORMATION CONTAINED HEREIN IS SUBJECT TO COMPLETION AND AMENDMENT. A + +REGISTRATION STATEMENT RELATING TO THESE SECURITIES HAS BEEN FILED WITH THE + +SECURITIES AND EXCHANGE COMMISSION. THESE SECURITIES MAY NOT BE SOLD NOR MAY + +OFFERS TO BUY BE ACCEPTED PRIOR TO THE TIME THE REGISTRATION STATEMENT + +BECOMES EFFECTIVE. THIS PROSPECTUS SHALL NOT CONSTITUTE AN OFFER TO SELL OR + +THE SOLICITATION OF AN OFFER TO BUY NOR SHALL THERE BE ANY SALE OF THESE + +SECURITIES IN ANY STATE IN WHICH SUCH OFFER, SOLICITATION OR SALE WOULD BE + +UNLAWFUL PRIOR TO REGISTRATION OR QUALIFICATION UNDER THE SECURITIES LAWS OF + +ANY SUCH STATE. + ++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++++ PROSPECTUS (Subject to Completion) Issued September 19, 1997 5,000,000 Shares DRIL-QUIP, INC. COMMON STOCK OF THE 5,000,000 SHARES OF COMMON STOCK BEING OFFERED HEREBY, 2,500,000 SHARES ARE BEING SOLD BY THE COMPANY AND 2,500,000 SHARES ARE BEING SOLD BY THE SELLING STOCKHOLDERS. SEE "PRINCIPAL AND SELLING STOCKHOLDERS." THE COMPANY WILL NOT RECEIVE ANY OF THE PROCEEDS FROM THE SALE OF SHARES BY THE SELLING STOCKHOLDERS. PRIOR TO THE OFFERING MADE HEREBY (THE "OFFERING"), THERE HAS BEEN NO PUBLIC MARKET FOR THE COMMON STOCK OF THE COMPANY. IT IS CURRENTLY ESTIMATED THAT THE INITIAL PUBLIC OFFERING PRICE PER SHARE WILL BE BETWEEN $18.00 AND $20.00. SEE "UNDERWRITERS" FOR A DISCUSSION OF THE FACTORS CONSIDERED IN DETERMINING THE INITIAL PUBLIC OFFERING PRICE. ----------- APPLICATION HAS BEEN MADE TO LIST THE COMMON STOCK ON THE NEW YORK STOCK EXCHANGE, UNDER THE SYMBOL "DRQ." ----------- SEE "RISK FACTORS" COMMENCING ON PAGE 7 HEREOF FOR INFORMATION THAT SHOULD BE CONSIDERED BY PROSPECTIVE INVESTORS. ----------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. ----------- PRICE $ A SHARE
PRICE UNDERWRITING PROCEEDS PROCEEDS TO TO DISCOUNTS AND TO SELLING PUBLIC COMMISSIONS(1) COMPANY(2) STOCKHOLDERS ------ -------------- ---------- ------------ Per Share......................... $ $ $ $ Total(3).......................... $ $ $ $
- ----- (1) The Company and the Selling Stockholders have agreed to indemnify the Underwriters against certain liabilities, including under the Securities Act of 1933, as amended. See "Underwriters." (2) Before deducting expenses payable by the Company estimated at $700,000. (3) The Company and the Selling Stockholders have granted to the Underwriters an option, exercisable within 30 days of the date hereof, to purchase up to an aggregate of 750,000 additional Shares at the price to public less underwriting discounts and commissions for the purpose of covering over-allotments, if any. If the Underwriters exercise such option in full, the total price to public, underwriting discounts and commissions, proceeds to the Company and proceeds to Selling Stockholders will be $ , $ , $ and $ , respectively. See "Underwriters." ----------- The Shares are offered, subject to prior sale, when, as and if accepted by the Underwriters named herein and subject to approval of certain legal matters by Andrews & Kurth L.L.P., counsel for the Underwriters. It is expected that delivery of the Shares will be made on or about , 1997 at the office of Morgan Stanley & Co. Incorporated, New York, N.Y., against payment therefor in immediately available funds. ----------- MORGAN STANLEY DEAN WITTER DONALDSON, LUFKIN & JENRETTE Securities Corporation , 1997 [Map showing the locations of Dril-Quip's (i) manufacturing, engineering, sales and service operations, (ii) sales and service operations and (iii) sales representatives. Photographs of Dril-Quip's World Headquarters, Europe Headquarters, Asia-Pacific Headquarters and Eldridge Road Facility.] i [Illustrations of jack-up, platform, floating rig, tension leg platform and spar installations, accompanied by a list of Dril-Quip products used in each installation appear on pages ii-iv. The illustrations show where each product is utilized. Illustrations of platform wellheads, mudline hanger systems, platform production trees, diverters, specialty connectors, subsea wellheads, wellhead connectors, subsea production trees and drilling and production riser systems are also included.] NO PERSON IS AUTHORIZED IN CONNECTION WITH THE OFFERING MADE HEREBY TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN AS CONTAINED IN THIS PROSPECTUS, AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY, BY ANY SELLING STOCKHOLDER OR BY ANY UNDERWRITER. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITY OTHER THAN THE COMMON STOCK OFFERED HEREBY NOR DOES IT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY SECURITIES OFFERED HEREBY TO ANY PERSON IN ANY JURISDICTION IN WHICH IT IS UNLAWFUL TO MAKE SUCH AN OFFER OR SOLICITATION TO SUCH PERSONS. NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY OFFER OR SALE MADE HEREUNDER SHALL UNDER ANY CIRCUMSTANCES IMPLY THAT THE INFORMATION HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF. ---------------- UNTIL , 1997 (25 DAYS AFTER THE COMMENCEMENT OF THE OFFERING), ALL DEALERS EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING IN THIS DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS DELIVERY REQUIREMENT IS IN ADDITION TO THE OBLIGATION OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS. ---------------- TABLE OF CONTENTS
PAGE ---- Prospectus Summary........................................................ 3 Risk Factors.............................................................. 7 Use of Proceeds........................................................... 12 Dividend Policy........................................................... 12 Dilution.................................................................. 13 Capitalization............................................................ 14 Selected Financial Data................................................... 15 Management's Discussion and Analysis of Financial Condition and Results of Operations............................................................... 16 Business.................................................................. 23 Management................................................................ 39 Certain Transactions...................................................... 44 Principal and Selling Stockholders........................................ 45 Shares Eligible for Future Sale........................................... 46 Description of Capital Stock.............................................. 47 Underwriters.............................................................. 53 Legal Matters............................................................. 55 Experts................................................................... 55 Additional Information.................................................... 55 Index to Consolidated Financial Statements................................ F-1
---------------- The Company intends to furnish to its stockholders annual reports containing audited consolidated financial statements examined by an independent accounting firm and quarterly reports for the first three quarters of each fiscal year containing interim unaudited consolidated financial information. ---------------- CERTAIN PERSONS PARTICIPATING IN THE OFFERING MAY ENGAGE IN TRANSACTIONS THAT STABILIZE, MAINTAIN, OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK. SPECIFICALLY, THE UNDERWRITERS MAY OVERALLOT IN CONNECTION WITH THE OFFERING, AND MAY BID FOR, AND PURCHASE, SHARES OF THE COMMON STOCK IN THE OPEN MARKET. FOR A DESCRIPTION OF THESE ACTIVITIES, SEE "UNDERWRITERS." 2 PROSPECTUS SUMMARY The following summary should be read in conjunction with, and is qualified in its entirety by, the more detailed information and financial statements, including the notes thereto, appearing elsewhere in this Prospectus. Unless otherwise indicated, the information in this Prospectus (i) gives effect to the Company's 14.3686 for one stock split and its expected reorganization as a Delaware corporation prior to the consummation of the Offering, and (ii) assumes that the Underwriters' over-allotment option will not be exercised. Unless otherwise indicated by the context, references herein to the "Company" or "Dril-Quip" mean a Delaware corporation that is the issuer of the Common Stock offered hereby, its predecessor and its subsidiaries. THE COMPANY Dril-Quip is one of the world's leading manufacturers of highly engineered offshore drilling and production equipment which is well suited for use in deepwater, harsh environment and severe service applications. The Company designs and manufactures subsea equipment, surface equipment and offshore rig equipment for use by major integrated, large independent and foreign national oil and gas companies in offshore areas throughout the world. The Company's principal products consist of subsea and surface wellheads, subsea and surface production trees, mudline hanger systems, specialty connectors and associated pipe, drilling and production riser systems, wellhead connectors and diverters. The Company also provides installation and reconditioning services and rents running tools for use in connection with the installation and retrieval of its products. In 1996, the Company derived 82.1% of its revenues from the sale of its products and 17.9% of its revenues from services. Dril-Quip has developed its broad line of subsea equipment, surface equipment and offshore rig equipment exclusively through its internal product development efforts. The Company believes that it has achieved significant market share and brand name recognition with respect to its established products due to the technological capabilities, reliability, cost effectiveness and operational timesaving features of these products. In particular, the Company's Quik- Thread(R) and Quik-Stab(R) specialty connectors, MS-15(R) mudline hanger systems and SS-10(R) and SS-15(R) subsea wellheads are among the most widely used in the industry. The Company believes that, as of June 1, 1997, its subsea wellhead equipment was being used on approximately 70% of the wells being drilled in waters deeper than 3,000 feet worldwide. Since 1991, the Company has introduced a number of new products, including diverters, wellhead connectors, dual-bore and single-bore subsea production trees, subsea and platform valves, platform wellheads, platform trees, drilling risers and Spar and tension leg platform ("TLP") production risers. The Company has grown consistently since its inception in 1981 and has been profitable in every year since 1983. As a result of new product introductions, increased market share in established product lines and increased offshore drilling and production activity, the Company's revenues have increased from $65.2 million in 1992 to $115.9 million in 1996 (an annual growth rate of 15.4%), and its net income has increased from $1.7 million in 1992 to $9.1 million in 1996 (an annual growth rate of 52.1%). From 1995 to 1996, the Company's revenues and net income grew by 7% and 38%, respectively. For the six months ended June 30, 1997, the Company's revenues were $68.7 million and its net income was $5.1 million, representing a 24% increase in revenues and a 26% increase in net income from the comparable period in 1996. The Company has experienced increased demand for its products due to the increased drilling and production activity in offshore areas throughout the world during the last several years, particularly in deeper waters. The increase in offshore drilling and production activity has been driven by a number of factors, including (i) the prospect for relatively larger hydrocarbon discoveries in deepwater areas and (ii) recent technological advances in offshore drilling and production equipment (including those introduced by Dril- Quip), seismic data collection and interpretation techniques, and drilling techniques, which have enhanced the economics of offshore drilling and production. In addition, several foreign national oil companies have recently opened offshore areas for exploration and development by other parties, including major integrated and large 3 independent oil and gas companies. These factors have contributed to the increase in the Company's backlog from approximately $56 million at December 31, 1996 to approximately $101 million at June 30, 1997, an 80% increase. The Company intends to use the proceeds from the Offering to expand its manufacturing capacity in order to satisfy the increased demand for its products. Dril-Quip markets its products through its offices and sales representatives located in all of the major international energy markets throughout the world. In 1996, the Company generated approximately 68% of its revenues from foreign sales. The Company manufactures its products at its facilities located in Houston, Texas; Aberdeen, Scotland; and Singapore, and maintains additional facilities for fabrication and/or reconditioning in Norway, Denmark and Australia. Dril-Quip's manufacturing operations are vertically integrated, with the Company performing substantially all of its forging, heat treating, machining, fabrication, inspection, assembly and testing at its own facilities. Unlike essentially all of the Company's competitors, which depend on outside sources for forging and heat treatment services, Dril-Quip owns a forge and heat treatment facility that handles virtually all of the Company's requirements. This vertically integrated manufacturing capability provides Dril-Quip with competitive advantages because the Company is able to (i) control the quality of its products from initial stages, (ii) control the costs of its production and (iii) assure timely delivery of high-volume and customized orders. The Company was co-founded in 1981 by the current Board of Directors, Larry E. Reimert, Gary D. Smith, J. Mike Walker and Gary W. Loveless (the "Founders"). Together, Messrs. Reimert, Smith and Walker have over 75 years of combined experience in the oilfield equipment industry, essentially all of which has been with the Company and its major competitors. In addition, key department managers have been with the Company over 10 years, on average. See "Management." After the Offering, the Founders will collectively beneficially own approximately 70% of the outstanding Common Stock (approximately 67% if the over-allotment option is exercised in full). STRATEGY The Company's goal is to expand its existing market position in the offshore oil and gas equipment and services sector while at the same time increasing its earnings and cash flow per share to enhance overall stockholder value. Key elements of the Company's strategy for achieving this goal are to: . CONTINUE TO DEVELOP NEW PRODUCTS. The Company plans to utilize its technological expertise to continue to develop and introduce new products and product enhancements in both its existing product lines and new product lines. For example, the Company has recently received purchase orders for drilling risers, production risers and deepwater subsea production trees. The Company believes that the strong brand name recognition and reputation of its existing products will assist it in successfully introducing new products to customers. . INCREASE MANUFACTURING CAPACITY. To maintain and improve market share in its major product lines, the Company plans to expand its manufacturing capacity by approximately 90% during the three year period 1997 through 1999, approximately two-thirds of which is expected to be completed by the end of 1998. The Company has been operating at close to full capacity in recent years, and believes that this expansion is essential in order to meet customer demand for its existing products and to continue its strategy of developing new products. . CONTINUE TO REDUCE COSTS AND INCREASE OPERATIONAL EFFICIENCIES. The Company controls its costs through such activities as performing its own forging and heat treatment, rebuilding quality used machine tools (rather than purchasing new machine tools) and optimizing manufacturing operations to increase the rate of production. Dril-Quip also plans to expand its forging capacity to begin marketing forgings to third parties in addition to supplying its own forging requirements. The Company expects that this will provide additional cost efficiencies as well as additional revenues, thereby contributing to profits. 4 . CONTINUE EXPANSION INTO SELECTED INTERNATIONAL MARKETS. The Company's products are currently utilized primarily in the Gulf of Mexico, the North Sea and in selected markets in Southeast Asia, Australia and South America. The Company has recently engaged international sales representatives in several additional markets, including Mexico, West Africa and the Middle East. The Company believes that there is significant potential for increased sales through focused marketing efforts in other active offshore areas in the world, such as China, Argentina and the Caspian Sea. . CAPITALIZE ON STRONG BALANCE SHEET. The Company plans to use a portion of the net proceeds from the Offering initially to repay its existing indebtedness. The Company believes that its strong balance sheet will provide it with the financial flexibility to carry out its strategy to design and develop new products, significantly increase manufacturing capacity and expand its international presence. THE OFFERING Common Stock offered by: The Company...................... 2,500,000 shares The Selling Stockholders......... 2,500,000 shares Total.......................... 5,000,000 shares Common Stock to be outstanding after the Offering................ 16,870,000 shares (1) Use of Proceeds.................... To increase manufacturing capacity, improve and expand facilities, and manufacture additional running tools for rental. See "Use of Proceeds." Proposed New York Stock Exchange Symbol............................ DRQ
- -------- (1) Excludes an aggregate of shares of Common Stock reserved for issuance upon exercise of stock options to be granted at the closing of the Offering under the Company's 1997 Incentive Plan (the "Incentive Plan"). See "Management--Incentive Plan," "Shares Eligible for Future Sale" and Notes to the Company's Consolidated Financial Statements. RISK FACTORS Prospective purchasers should consider all of the information contained in this Prospectus before making an investment in shares of Common Stock. In particular, prospective purchasers should consider the factors set forth herein under "Risk Factors." 5 SUMMARY FINANCIAL DATA
SIX MONTHS YEAR ENDED DECEMBER 31, ENDED JUNE 30, --------------------------- ---------------- 1994 1995 1996 1996 1997 ------- -------- -------- ------- ------- (IN THOUSANDS, EXCEPT PER SHARE AND INDUSTRY DATA) (UNAUDITED) STATEMENT OF OPERATIONS DATA: Revenues........................ $80,548 $108,390 $115,864 $55,346 $68,669 Cost of sales................... 58,604 76,471 77,863 37,602 47,725 Selling, general and administrative expenses........ 11,673 13,597 15,031 7,253 7,839 Engineering and product development expenses........... 6,069 5,769 6,971 3,245 4,109 ------- -------- -------- ------- ------- 76,346 95,837 99,865 48,100 59,673 Operating income................ 4,202 12,553 15,999 7,246 8,996 Interest expense................ 2,273 2,944 2,647 1,301 1,400 ------- -------- -------- ------- ------- Income before income taxes...... 1,929 9,609 13,352 5,945 7,596 Income tax provision............ 635 3,023 4,234 1,885 2,483 ------- -------- -------- ------- ------- Net income...................... $ 1,294 $ 6,586 $ 9,118 $ 4,060 $ 5,113 ======= ======== ======== ======= ======= Earnings per share.............. $ .09 $ .46 $ .63 $ .28 $ .36 Weighted average shares outstanding.................... 14,370 14,370 14,370 14,370 14,370 STATEMENT OF CASH FLOWS DATA: Net cash provided by operating activities..................... $ 2,422 $ 6,466 $ 5,185 $ 1,374 $ 2,437 Net cash used in investing ac- tivities....................... (4,524) (5,659) (7,006) (2,756) (3,379) Net cash provided by (used in) financing activities........... 2,668 560 1,261 (351) 4 OTHER DATA: EBITDA (1)...................... $ 8,069 $ 17,201 $ 20,387 $ 9,646 $11,604 Depreciation and amortization... 3,867 4,648 4,388 2,400 2,608 Capital expenditures............ 4,614 6,184 7,228 2,832 3,603 OFFSHORE INDUSTRY DATA (2): Worldwide average contracted offshore rig count............. 535.8 540.5 572.0 561.5 592.3 Worldwide average contracted floating rig count (3)......... 143.0 139.4 152.8 150.7 159.0
AS OF JUNE 30, 1997 ----------------------- ACTUAL AS ADJUSTED(4) -------- -------------- (IN THOUSANDS) (UNAUDITED) BALANCE SHEET DATA: Working capital......................................... $ 52,877 $ 67,385 Total assets............................................ 113,823 124,809 Total debt.............................................. 32,489 -- Total stockholders' equity.............................. 54,911 98,386
- -------- (1) EBITDA, or "earnings from continuing operations before interest expense, interest income, income taxes, depreciation and amortization," is not a generally accepted accounting principle measure, but is a supplemental financial measurement used by the Company in the evaluation of its business. EBITDA should not be construed as an alternative to net income or to cash flow from operations or any other measure of performance in accordance with generally accepted accounting principles, and is presented solely as supplemental disclosure. EBITDA is a supplemental financial measure commonly used by investors in the oil services industry and is being presented because management believes that EBITDA provides supplemental information about the Company's ability to meet its future requirements for debt service, capital expenditures and working capital. Management monitors the trends in EBITDA closely, as well as the trends in revenues and net income, to aid it in managing the business, controlling costs and increasing revenues. Management believes that the recent increases in EBITDA are indicative of the increased level of profitable business activity experienced by the Company. Because EBITDA excludes some, but not all, items that affect net income and this measure may vary among companies, the EBITDA data presented above may not be comparable to similarly titled measures of other companies. (2) Data obtained from Offshore Data Services. (3) Includes semisubmersible and drillship-type rigs. (4) Adjusted to give effect to the Offering and the application of the estimated net proceeds to the Company therefrom of approximately $43 million (assuming an initial public offering price of $19.00 per share). See "Use of Proceeds" and "Capitalization." 6 RISK FACTORS In addition to the other information in this Prospectus, the following risk factors should be considered carefully in evaluating the Company and its business before purchasing the Common Stock offered hereby. All statements other than statements of historical facts included in this Prospectus, including, without limitation, statements regarding the Company's business strategy, plans and objectives of management of the Company for future operations and future industry conditions are forward-looking statements. Although the Company believes that the expectations reflected in such forward- looking statements are reasonable, it can give no assurance that such expectations will be met. Important factors that could cause actual results to differ materially from the Company's expectations are disclosed below and elsewhere in this Prospectus. VOLATILITY OF OIL AND NATURAL GAS PRICES AND CYCLICALITY OF THE OIL AND GAS INDUSTRY The Company's business is substantially dependent upon the condition of the oil and gas industry and, in particular, the willingness of oil and gas companies to make capital expenditures on exploration, drilling and production operations offshore. The level of capital expenditures is generally dependent on the prevailing view of future oil and gas prices, which are influenced by numerous factors affecting the supply and demand for oil and gas, including worldwide economic activity, interest rates and the cost of capital, environmental regulation, tax policies, coordination by the Organization of Petroleum Exporting Countries ("OPEC"), the cost of exploring for and producing oil and gas, the sale and expiration dates of offshore leases in the United States and overseas, the discovery rate of new oil and gas reserves in offshore areas and technological advances. Oil and gas prices and the level of offshore drilling and production activity have been characterized by significant volatility in recent years. Although hydrocarbon prices have improved in recent years and the level of offshore exploration, drilling and production activity has increased, there can be no assurance that such price and activity levels will be sustained and that there will not be continued volatility in the level of drilling and production related activities. A significant and prolonged decline in hydrocarbon prices would likely have a material adverse effect on the Company's results of operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Overview." INTERNATIONAL OPERATIONS The Company has substantial international operations, with approximately two-thirds of its revenues derived from foreign sales in each of 1994, 1995 and 1996. The Company operates its business and markets its products and services in all of the significant oil and gas producing areas in the world and is, therefore, subject to the risks customarily attendant to international operations and investments in foreign countries. These risks include nationalization, expropriation, war and civil disturbance, restrictive action by local governments, limitation on repatriation of earnings, change in foreign tax laws and change in currency exchange rates, any of which could have an adverse effect on either the Company's ability to manufacture its products in its facilities abroad or the demand in certain regions for the Company's products or both. To date, the Company has not experienced any significant problems in foreign countries arising from local government actions or political instability, but there is no assurance that such problems will not arise in the future. Interruption of the Company's international operations could have a material adverse effect on its overall operations. The Company conducts a portion of its business in currencies other than the United States dollar, and the Company's operations are subject to fluctuations in foreign currency exchange rates. The Company has generally endeavored to protect itself against substantial foreign currency fluctuations by limiting the amount of sales denominated in currencies other than United States dollars and by contractual purchase price adjustments based on an exchange rate formula related to U.S. dollars. 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. 7 See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Currency Risk." OPERATING RISKS Potential Liabilities. Certain products of the Company are used in potentially hazardous drilling, completion and production applications that can cause personal injury, product liability and environmental claims. Litigation arising from a catastrophic occurrence at a location where the Company's equipment and/or services are used may in the future result in the Company being named as a defendant in lawsuits asserting potentially large claims. To the extent available, the Company maintains insurance coverage that it believes is customary in the industry. Such insurance does not, however, provide coverage for all liabilities (including liability for certain events involving pollution), and there is no assurance that its insurance coverage will be adequate to cover claims that may arise or that the Company will be able to maintain adequate insurance at rates it considers reasonable. The occurrence of an event not fully covered by insurance could have a material adverse effect on the financial condition and results of operations of the Company. Competitive Project Bids. A portion of the Company's business consists of designing, manufacturing, selling and installing equipment for major projects pursuant to competitive bids, and the number of such projects in any year fluctuates. The Company's profitability on such projects is critically dependent on making accurate and cost effective bids and performing efficiently in accordance with bid specifications. Various factors can adversely affect the Company's performance on individual projects, with potential adverse effects on project profitability. Percentage-of-Completion Accounting. Some of the Company's revenues are earned on a percentage-of-completion basis generally based on the ratio of costs incurred to the total estimated costs. Accordingly, purchase order 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. To the extent that these adjustments result in a reduction or elimination of previously reported profits, the Company would have to recognize a charge against current earnings, which could be significant depending on the size of the project or the adjustment. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Overview." DEPENDENCE ON KEY EMPLOYEES The Company depends to a large extent on the services of the Company's executive management team, Mr. Larry E. Reimert, Mr. Gary D. Smith and Mr. J. Mike Walker, the loss of any of whom could have a material adverse effect on the Company's operations. Prior to the completion of the Offering, the Company will enter into employment agreements with each of Messrs. Reimert, Smith and Walker. See "Management--Employment Agreements." DEPENDENCE ON SKILLED MACHINISTS AND TECHNICAL PERSONNEL The Company believes that its success is dependent upon its ability to continue to employ and retain skilled machinists and technical personnel. The Company's ability to expand its operations depends in part on its ability to increase its skilled labor force. The demand for such workers is high and the supply is limited. While the Company believes that its wage rates are competitive and that its relationship with its skilled labor force is good, a significant increase in the wages paid by competing employers could result in a reduction of the Company's skilled labor force, increases in the wage rates paid by the Company or both. If either of these events were to occur, in the near-term, the profits realized by the Company from work in progress would be reduced and, in the long-term, the production capacity and profitability of the Company could be diminished and the growth potential of the Company could be impaired. RELIANCE ON PRODUCT DEVELOPMENT AND POSSIBLE TECHNOLOGICAL OBSOLESCENCE The Company's ability to develop new products and maintain technological advantages is important to its future success. There can be no assurance that the Company will be able to develop new products, successfully differentiate itself from its competitors or adapt to evolving markets and technologies. 8 The Company's ability to compete effectively will also depend on its ability to continue to obtain patents on its proprietary technology and products. As of June 30, 1997 the Company held 36 U.S. patents and 77 foreign patents. Although the Company does not consider any single patent to be material to its business as a whole, the inability to protect its future innovations through patents could have a material adverse effect on the Company. CONTROL BY CERTAIN STOCKHOLDERS Upon completion of the Offering, the Founders collectively will beneficially own approximately 70% (67% if the Underwriters' over-allotment option is exercised in full) of the outstanding shares of Common Stock. As a result, they will be able to influence significantly and possibly control the outcome of certain matters requiring a stockholder vote, including the election of directors. Such ownership of Common Stock may have the effect of delaying or preventing a change of control of the Company and may adversely affect the voting and other rights of other stockholders. In addition, Messrs. Reimert, Smith and Walker have entered into a Stockholders Agreement pursuant to which each party has agreed to vote the shares of Common Stock held by such party to elect to the Company's Board of Directors one designee of each of the other parties. See "Principal and Selling Stockholders" and "Certain Transactions-- Stockholders Agreement." GOVERNMENTAL REGULATION AND ENVIRONMENTAL MATTERS Many aspects of the Company's operations are affected by political developments and are subject to both domestic and foreign governmental regulations, including those relating to oilfield operations, worker safety and the protection of the environment. In addition, the Company depends on the demand for its services from the oil and gas industry and, therefore, is affected by changing taxes, price controls and other laws and regulations relating to the oil and gas industry generally, including those specifically directed to offshore operations. The adoption of laws and regulations curtailing exploration and development drilling for oil and gas for economic or other policy reasons could adversely affect the Company's operations by limiting demand for the Company's products. The Company cannot determine the extent to which its future operations and earnings may be affected by new legislation, new regulations or changes in existing regulations. The Company's operations are affected by numerous foreign, federal, state and local environmental laws and regulations. The technical requirements of these laws and regulations are becoming increasingly expensive, complex and stringent. These laws may provide for "strict liability" for damages to natural resources or threats to public health and safety, rendering a party liable for environmental damage without regard to negligence or fault on the part of such party. Sanctions for noncompliance may include revocation of permits, corrective action orders, administrative or civil penalties, and criminal prosecution. Certain environmental laws provide for joint and several strict liability for remediation of spills and releases of hazardous substances. In addition, companies may be subject to claims alleging personal injury or property damage as a result of alleged exposure to hazardous substances, as well as damage to natural resources. Such laws and regulations may also expose the Company to liability for the conduct of or conditions caused by others, or for acts of the Company that were in compliance with all applicable laws at the time such acts were performed. See "Business-- Governmental Regulations." COMPETITION The Company faces significant competition from other manufacturers of drilling 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 some instances, have been engaged in the manufacturing business for a much longer time than the Company. See "Business--Competition." RELIANCE ON SIGNIFICANT CUSTOMERS The Company's business is dependent on securing and maintaining customers by promptly delivering reliable, high-performance products. For the year ended December 31, 1996, one of the Company's customers, the Royal Dutch Shell Group of Companies (aggregating orders placed by all of its worldwide affiliates), 9 accounted for approximately 19% of revenues. The products that the Company may sell to any particular customer depend on the size of that customer's capital expenditure budget devoted to offshore drilling plans in a particular year and on the results of competitive bids for major projects. Consequently, a customer that accounts for a significant portion of revenues in one fiscal year may represent an immaterial portion of revenues in subsequent years. See "--Operating Risks--Competitive Project Bids." 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. See "Business-- Customers." SHARES ELIGIBLE FOR FUTURE SALE Upon the completion of the Offering, the Company will have a total of 16,870,000 shares of Common Stock outstanding. Of these shares, the 5,000,000 shares of Common Stock offered hereby (5,750,000 shares if the Underwriters' over-allotment option is exercised in full) will be freely tradeable without restrictions or registration under the Securities Act of 1933, as amended (the "Securities Act"), by persons other than "affiliates" of the Company, as defined under the Securities Act. The remaining 11,870,000 shares of Common Stock outstanding will be restricted securities as that term is defined by Rule 144 as promulgated under the Securities Act. In addition, shares of Common Stock may be issued pursuant to options that will be issued under the Company's incentive plan at an exercise price equal to the initial public offering price in the Offering. See "Management--Executive Compensation." Under Rule 144 (and subject to the conditions thereof, including volume limitations), all of the 11,870,000 restricted shares will become eligible for sale 90 days after the Offering. The directors and officers of the Company have agreed that they will not, directly or indirectly, sell any shares of Common Stock for a period of 180 days from the date of this Prospectus without the prior written consent of Morgan Stanley & Co. Incorporated. The Company will enter into a Registration Rights Agreement upon the consummation of the Offering whereby it will agree to register under the Securities Act shares of Common Stock held by Messrs. Reimert, Smith, Walker and Loveless and certain of their related family limited partnerships to facilitate the sales thereof. See "Certain Transactions--Registration Rights Agreement." Future sales of substantial amounts of Common Stock in the public market following the Offering could adversely affect the market price of the Common Stock. For further information concerning Common Stock available for resale after the Offering, see "Shares Eligible for Future Sale" and "Underwriters." NO INTENTION TO PAY DIVIDENDS The Company currently intends to retain any earnings for the future operation and development of its business and does not currently anticipate paying any dividends in the foreseeable future. The Company's existing credit facilities restrict the payment of dividends. See "Dividend Policy," "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources" and Notes to the Company's Consolidated Financial Statements. CERTAIN ANTI-TAKEOVER PROVISIONS The Company's Certificate of Incorporation and Bylaws, among other things, provide for a classified Board of Directors with staggered terms, restrict the ability of stockholders to take action by written consent, impose certain supermajority voting requirements and authorize the Board of Directors to set the terms of Preferred Stock. In addition, the Company's Certificate of Incorporation and the Delaware General Corporation Law contain provisions that impose restrictions on business combinations with interested parties. The Company has also adopted a stockholder rights plan. The stockholder rights plan, the provisions of the Company's Certificate of Incorporation and Bylaws and the Delaware General Corporation Law may have the effect of delaying or preventing a change of control of the Company. See "Description of Capital Stock." 10 ABSENCE OF PRIOR PUBLIC MARKET Prior to the Offering, there has been no public market for the Common Stock. The initial public offering price will be determined by negotiation between the Company and the Underwriters and may not be indicative of the price at which the Common Stock will trade following the completion of the Offering. See "Underwriters" for a discussion of the factors to be considered in determining the initial public offering price. The completion of the Offering provides no assurance that an active trading market for the Common Stock will develop or, if developed, that it will be sustained. The market price of the Common Stock could also be subject to significant fluctuation and may be influenced by many factors, including variations in results of operations, variations in natural gas and oil prices, investor perceptions of the Company and the oil and natural gas industry, and general economic and other conditions. DILUTION Purchasers of Common Stock in the Offering will experience immediate and substantial dilution in the net tangible book value of their stock of $13.18 per share (assuming an initial public offering price of $19.00 per share). See "Dilution." 11 USE OF PROCEEDS The net proceeds to the Company from the Offering, assuming an initial public offering price of $19.00 per share, and after deducting underwriting discounts, commissions and estimated expenses, are estimated to be approximately $43 million ($50 million if the Underwriters' over-allotment option is exercised in full). The Company intends to use the net proceeds for capital expenditures to increase manufacturing capacity, improve and expand facilities and manufacture additional running tools for rental. Dril-Quip expects that these expenditures will be incurred over a three-year period and that total capital expenditures for these purposes will be approximately $11 million in 1997 and approximately $23 million in 1998. In particular, the Company expects to spend approximately $16 million to complete the planned expansion at its Eldridge site in Houston, Texas, which is expected to be completed in 1999. The Company plans to spend approximately $4.5 million in 1997 to add machine tools at its existing facilities, most of which will be moved to the new facilities upon their completion. Pending application of the proceeds for these purposes, the Company intends to use approximately $32 million to repay its bank indebtedness in full and the balance will be used for working capital. Excess cash will be invested in short term investment grade securities. The Company's credit facilities with Bank One, Texas, National Association ("Bank One") are provided through a Credit Agreement dated March 30, 1994, as amended, and currently consist of (i) a $25 million revolving credit facility bearing interest at a rate of 1/4% over Bank One's base rate from day to day (this facility terminates on June 1, 1999), (ii) a $3 million advancing credit facility for the purchase of land and equipment and improvements to facilities bearing interest at a rate of 1/2% over Bank One's base rate from day to day (this facility terminates on October 1, 2001), and (iii) a $10.7 million term loan bearing interest at 1/2% over Bank One's base rate from day to day that matures on July 1, 1999. Indebtedness under the term loan was used for the purchase of land, buildings, equipment and improvements to facilities, as well as other capital expenditures. At June 30, 1997, $29.0 million was outstanding under the Bank One credit facilities, bearing interest at an average rate of 8.85%, and approximately $7.7 million was available for drawdown under the revolving facility. The Company has three term loans with the Bank of Scotland: a June 7, 1996 loan, a September 19, 1994 loan and a December 12, 1991 loan. Each loan has a 120-month maturity. The June 7, 1996 and September 19, 1994 loans each bear interest at 1.75% over the Bank of Scotland's base rate, and the December 12, 1991 loan bears interest at 1.5% over the Bank of Scotland's base rate. Indebtedness under the Bank of Scotland term loans was used for the purchase of land and buildings and to improve the Company's Aberdeen manufacturing facilities. At June 30, 1997, $700,000, $600,000 and $1.7 million were outstanding under the Bank of Scotland term loans, respectively. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." DIVIDEND POLICY The Company paid dividends of $.004 and $.007 per share of Common Stock in 1995 and 1996, respectively. However, the Company does not intend to pay cash dividends on its Common Stock in the foreseeable future. The Company currently intends to retain any earnings for the future operation and development of its business. The Board of Directors will review this policy on a regular basis in light of the Company's earnings, financial condition and market opportunities. The Company's existing credit facilities restrict the payment of dividends. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." 12 DILUTION As of June 30, 1997, the net tangible book value of the Company was approximately $54.8 million, or approximately $3.81 per share of Common Stock. Net tangible book value per share represents the amount of the Company's tangible book value (total book value of tangible assets less total liabilities) divided by the total number of shares of Common Stock outstanding. After giving effect to the receipt of the estimated net proceeds from the Offering (net of estimated underwriting discounts and commissions and Offering expenses) at an assumed initial public offering price of $19.00 per share, the pro forma net tangible book value of the Common Stock outstanding at June 30, 1997 would have been $5.82 per share, representing an immediate increase in net tangible book value of $2.01 per share to current stockholders and an immediate dilution of $13.18 per share (the difference between the assumed initial public offering price and the net tangible book value per share after the Offering) to persons purchasing Common Stock at the assumed initial public offering price. The following table illustrates such per share dilution: Assumed initial public offering price per share................... $19.00 Net tangible book value per share before the Offering........... $3.81 Increase in net tangible book value per share attributable to new investors.................................................. 2.01 ----- Pro forma net tangible book value per share after giving effect to the Offering..................................................... 5.82 ------ Dilution in net tangible book value per share to new investors.... $13.18 ======
The following table sets forth, on a pro forma basis as of June 30, 1997, differences between the number of shares of Common Stock acquired from the Company, the total consideration price and the average price per share paid to the Company by existing stockholders and investors purchasing shares in the Offering (based upon an assumed initial public offering price per share of $19.00).
SHARES AVERAGE PURCHASED(1) TOTAL CONSIDERATION PRICE ------------------ ------------------- PER NUMBER PERCENT AMOUNT PERCENT SHARE ---------- ------- ----------- ------- ------- Current stockholders(2).......... 14,370,000 85.2% $ 144,000 .3% $ .01 New investors(2)................. 2,500,000 14.8 47,500,000 99.7 19.00 ---------- ----- ----------- ----- Total.......................... 16,870,000 100.0% $47,644,000 100.0% ========== ===== =========== =====
- -------- (1) Does not include approximately shares of Common Stock issuable pursuant to options to be granted to officers and employees of the Company at the closing of the Offering. The exercise of such stock options will be dilutive to the interests of new investors. See "Management--Incentive Plan." (2) Sales by the Selling Stockholders in the Offering will reduce the number of shares of Common Stock held by existing stockholders to 11,870,000, or 70.4% of the shares of Common Stock outstanding after the Offering. New investors will hold 29.6% of the shares of Common Stock outstanding after the Offering. 13 CAPITALIZATION The following table sets forth the consolidated short-term debt and total capitalization of the Company (i) as of June 30, 1997 and (ii) as adjusted for the sale of the 2,500,000 shares of Common Stock offered by the Company hereby at an assumed offering price of $19.00 per share and the application of the net proceeds to the Company therefrom (after deducting underwriting discounts and commissions and estimated Offering expenses payable by the Company). See "Use of Proceeds." This table should be read in conjunction with the Company's Consolidated Financial Statements and the related Notes thereto included elsewhere in this Prospectus.
AS OF JUNE 30, 1997 ------------------- ACTUAL AS ADJUSTED ------- ----------- (IN THOUSANDS) Short-term debt: Current maturities of long-term debt:.................... $ 3,522 $ -- ======= ======= Long-term debt, less current maturities:................... $28,967 $ -- Stockholders' equity(1): Preferred stock, $0.01 par value, 10,000,000 shares authorized, none issued and outstanding................. -- -- Common stock, $0.01 par value, 50,000,000 shares authorized, 14,370,000 shares issued and outstanding (actual), 16,870,000 shares outstanding (as adjusted)... 144 169 Additional paid-in capital............................... -- 43,450 Retained earnings........................................ 54,765 54,765 Foreign currency translation adjustment.................. 2 2 ------- ------- Total stockholders' equity............................. 54,911 98,386 ------- ------- Total capitalization................................. $83,878 $98,386 ======= =======
- -------- (1) Does not include approximately shares of Common Stock issuable pursuant to options to be granted to officers and employees of the Company at the closing of the Offering. See "Management--Incentive Plan." 14 SELECTED FINANCIAL DATA The selected financial data as of and for each of the years ended December 31, 1994, 1995 and 1996 are derived from the audited consolidated financial statements of the Company included elsewhere in this Prospectus. The selected financial data presented below as of and for the years ended December 31, 1992 and 1993 are derived from audited consolidated financial statements of the Company not included in this Prospectus. The selected consolidated financial data as of and for the six-month periods ended June 30, 1996 and 1997 are derived from the unaudited consolidated financial statements of the Company that in the opinion of the Company's management reflect all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of its financial condition and results of operations as of such dates and for such periods. The results for the six-month period ended June 30, 1997 are not necessarily indicative of the results that may be expected for the entire year. 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 Prospectus.
SIX MONTHS ENDED YEAR ENDED DECEMBER 31, JUNE 30, --------------------------------------------- -------------------- 1992 1993 1994 1995 1996 1996 1997 ------- ------- ------- -------- -------- ------- ----------- (IN THOUSANDS, EXCEPT PER SHARE DATA) (UNAUDITED) STATEMENT OF OPERATIONS DATA: Revenues................ $65,172 $82,553 $80,548 $108,390 $115,864 $55,346 $ 68,669 Cost of sales........... 48,120 61,704 58,604 76,471 77,863 37,602 47,725 Selling, general and administrative expenses............... 8,074 10,907 11,673 13,597 15,031 7,253 7,839 Engineering and product development expenses... 4,494 5,152 6,069 5,769 6,971 3,245 4,109 ------- ------- ------- -------- -------- ------- -------- 60,688 77,763 76,346 95,837 99,865 48,100 59,673 Operating income........ 4,484 4,790 4,202 12,553 15,999 7,246 8,996 Interest expense........ 1,915 1,494 2,273 2,944 2,647 1,301 1,400 ------- ------- ------- -------- -------- ------- -------- Income before income taxes.................. 2,569 3,296 1,929 9,609 13,352 5,945 7,596 Income tax provision.... 916 886 635 3,023 4,234 1,885 2,483 ------- ------- ------- -------- -------- ------- -------- Net income.............. $ 1,653 $ 2,410 $ 1,294 $ 6,586 $ 9,118 $ 4,060 $ 5,113 ======= ======= ======= ======== ======== ======= ======== Earnings per share...... $ .12 $ .17 $ .09 $ .46 $ .63 $ .28 $ .36 Weighted average shares outstanding............ 14,370 14,370 14,370 14,370 14,370 14,370 14,370 STATEMENT OF CASH FLOWS DATA: Net cash provided by operating activities... $ 776 $ 3,182 $ 2,422 $ 6,466 $ 5,185 $ 1,374 $ 2,437 Net cash used in investing activities... (3,487) (6,413) (4,524) (5,659) (7,006) (2,756) (3,379) Net cash provided by (used in) financing activities............. 3,914 1,448 2,668 560 1,261 (351) 4 OTHER DATA: EBITDA(1)............... $ 8,050 $ 8,549 $ 8,069 $ 17,201 $ 20,387 $ 9,646 $ 11,604 Depreciation and amortization........... 3,566 3,759 3,867 4,648 4,388 2,400 2,608 Capital expenditures.... 4,283 6,592 4,614 6,184 7,228 2,832 3,603 AS OF DECEMBER 31, AS OF --------------------------------------------- JUNE 30, 1992 1993 1994 1995 1996 1997 ------- ------- ------- -------- -------- ----------- (IN THOUSANDS) (UNAUDITED) BALANCE SHEET DATA: Working capital......... $30,135 $30,913 $34,099 $ 40,682 $ 49,524 $ 52,877 Total assets............ 65,712 70,346 79,208 93,186 114,777 113,823 Total debt.............. 26,659 28,100 30,416 31,052 32,536 32,489 Total stockholders' equity................. 28,048 30,267 32,903 39,501 50,882 54,911
- ------- (1) EBITDA, or "earnings from continuing operations before interest expense, interest income, income taxes, depreciation and amortization," is not a generally accepted accounting principle measure, but is a supplemental financial measurement used by the Company in the evaluation of its business. EBITDA should not be construed as an alternative to net income or to cash flow from operations or any other measure of performance in accordance with generally accepted accounting principles, and is presented solely as a supplemental disclosure. EBITDA is a supplemental financial measure commonly used by investors in the oil services industry and is being presented because management believes that EBITDA provides supplemental information about the Company's ability to meet its future requirements for debt service, capital expenditures and working capital. Management monitors the trends in EBITDA closely, as well as the trends in revenues and net income, to aid it in managing the business, controlling costs and increasing revenues. Management believes that recent increases in EBITDA are indicative of the increased level of profitable business activity experienced by the Company. Because EBITDA excludes some, but not all, items that affect net income and this measure may vary among companies, the EBITDA data presented above may not be comparable to similarly titled measures of other companies. 15 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following information should be read in conjunction with the Company's Consolidated Financial Statements and Notes thereto presented elsewhere in this Prospectus. OVERVIEW Dril-Quip manufactures highly engineered offshore drilling and production equipment which is well suited for use in deepwater, harsh environment and severe service applications. The Company designs and manufactures subsea equipment, surface equipment and offshore rig equipment for use by major integrated, large independent and foreign national oil and gas companies in offshore areas throughout the world. The Company's principal products consist of subsea and surface wellheads, subsea and surface production trees, mudline hanger systems, specialty connectors and associated pipe, drilling and production riser systems, wellhead connectors and diverters. Dril-Quip also provides installation and reconditioning services and rents running tools for use in connection with the installation and retrieval of its products. The market for offshore drilling and production equipment and services is fundamentally driven by the exploration, development and production spending of oil and gas companies, particularly with respect to offshore activities worldwide. The Company has experienced increased demand for its products due to the increased drilling and production activity in offshore areas throughout the world during the last several years, particularly in deeper waters. The recent increase in offshore drilling and production activity has been driven by a number of factors, including (i) the prospect for relatively larger hydrocarbon discoveries in deepwater areas and (ii) recent technological advances in offshore drilling and production equipment (including those introduced by Dril-Quip), seismic data collection and interpretation techniques, and drilling techniques, which have enhanced the economics of offshore drilling and production. In addition, several foreign national oil companies have recently opened offshore areas for exploration and development by other parties, including major integrated and large independent oil and gas companies. These factors have contributed to the increase in the Company's backlog from approximately $56 million at December 31, 1996 to approximately $101 million at June 30, 1997, an 80% increase. See "Business--Industry Overview." The Company intends to use the proceeds from the Offering for a three-year capital expansion program to increase manufacturing capacity, improve and expand facilities and manufacture additional running tools for rental. The Company plans to expand its manufacturing capacity by approximately 90% during the three year period 1997 through 1999, approximately two-thirds of which is expected to be completed by the end of 1998. The Company believes that its increased capacity and improved facilities will enable the Company to achieve higher sales volumes. In connection with the capacity expansion, the Company plans to hire additional workers. See "Use of Proceeds" and "Business-- Strategy." Revenues. Dril-Quip's revenues are generated by its two operating groups: the Product Group and the Service Group. The Product Group manufactures offshore drilling and production equipment, and the Service Group provides installation and reconditioning services as well as rental running tools for installation and retrieval of its products. In 1996, the Company derived 82.1% of its revenues from the sale of its products and 17.9% of its revenues from services. Revenues from the Service Group generally correlate to revenues from product sales, as increased product sales generate increased revenues from installation services and rental running tools. Revenues have increased over the last three years principally as a result of increased sales volumes of the Company's established products and services, the introduction of new products and product enhancements and price increases for the Company's products and services. These price increases have occurred due to an increase in demand and capacity constraints experienced by the Company and its competitors. Substantially all of Dril-Quip's sales are made on a purchase order basis. Purchase orders are subject to change and/or termination at the option of the customer. In case of a change or termination, the customer is required to pay the Company for work performed and other costs necessarily incurred as a result of the change or termination. 16 Historically, Dril-Quip recognized revenues upon the delivery of a completed product. As the Company has begun manufacturing larger and more complex projects that have longer manufacturing times, the Company has begun to account for purchase orders covering such projects on a percentage of completion basis. The Company expects that such larger and more complex projects will increase the Company's sales and revenues and afford the Company certain economies of scale because such projects generally utilize the Company's products as component parts. The Company also expects that such projects may have a stabilizing effect on the Company's operations, as the Company will have a longer period of time over which to plan and to allocate its resources. Finally, the Company expects to receive certain periodic payments associated with such projects, rather than payment upon delivery. Because the Company has only recently become involved in such manufacturing projects, the use of percentage of completion accounting does not affect the comparability of financial information to earlier periods. No purchase orders would have been accounted for using the percentage of completion method prior to 1997. For the first six months of 1997, one project representing 8.7% of the Company's revenues was accounted for using percentage of completion accounting. The Company expects that this percentage may increase 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. Amounts received from customers in excess of revenues recognized are classified as a current liability. The Company historically has experienced some seasonality, with revenues and operating income slightly lower during the first and third quarters compared to the second and fourth quarters. The Company's revenues are affected by its customers' capital expenditure budgeting process, which generally results in lower revenues in the first quarter and higher revenues in the fourth quarter. The increase in revenues recognized using percentage of completion accounting may result in less fluctuation in revenues recognized from quarter to quarter. See "Risk Factors--Operating Risks--Percentage of Completion Accounting." As part of its capacity expansion, the Company plans to expand its capacity for forging and heat treatment by adding additional facilities and machinery. In the future, the Company plans to market forgings to third parties to the extent its capacity allows, an activity which it expects will be an additional source of revenues. Foreign sales represent a significant portion of the Company's business. In the six months ended June 30, 1997 and in each of fiscal 1996, 1995 and 1994, the Company generated approximately two-thirds of its revenues from foreign sales. In each period, approximately two-thirds of all products sold were manufactured in the United States. Cost of Sales. The principal elements of cost of sales are labor, raw materials and manufacturing overhead. Variable costs, such as labor, raw materials, supplies and energy, generally account for approximately two-thirds of the Company's cost of sales. The Company has experienced increased labor costs over the past few years due to the limited supply of skilled workers. See "Risk Factors--Dependence on Skilled Machinists and Technical Personnel." Fixed costs, such as the fixed portion of manufacturing overhead, constitute the remainder of the Company's cost of sales. The Company continually seeks to improve its efficiency and cost position. See "Business--Strategy." 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 marginal tax rate has historically been lower than the statutory rate due to benefits from its foreign sales corporation. The Company expects that its marginal tax rate will rise slightly as its income increases. 17 RESULTS OF OPERATIONS The following table sets forth, for the periods indicated, certain statement of operations data expressed as a percentage of net revenues:
SIX MONTHS YEAR ENDED ENDED JUNE DECEMBER 31, 30, ------------------- ------------ 1994 1995 1996 1996 1997 ----- ----- ----- ----- ----- % % % % % Revenues: Product Group............................. 83.0% 83.7% 82.1% 81.1% 85.6% Service Group............................. 17.0 16.3 17.9 18.9 14.4 ----- ----- ----- ----- ----- Total................................... 100.0 100.0 100.0 100.0 100.0 Cost of sales............................... 72.8 70.6 67.2 67.9 69.5 Selling, general and administrative expenses................................... 14.5 12.5 13.0 13.1 11.4 Engineering and product development expenses................................... 7.5 5.3 6.0 5.9 6.0 ----- ----- ----- ----- ----- Operating income............................ 5.2 11.6 13.8 13.1 13.1 Interest expense............................ 2.8 2.7 2.3 2.4 2.0 ----- ----- ----- ----- ----- Income before income taxes.................. 2.4 8.9 11.5 10.7 11.1 Income tax provision........................ 0.8 2.8 3.6 3.4 3.6 ----- ----- ----- ----- ----- Net income.................................. 1.6% 6.1% 7.9% 7.3% 7.4% ===== ===== ===== ===== =====
SIX MONTHS ENDED JUNE 30, 1997 COMPARED TO SIX MONTHS ENDED JUNE 30, 1996 Revenues. Revenues increased by $13.4 million, or 24%, to $68.7 million in the six months ended June 30, 1997 from $55.3 million in the six months ended June 30, 1996. This increase was primarily due to strong market demand, along with increased manufacturing capacity, price increases and an increase in project related sales of new products. Cost of Sales. Cost of sales increased $10.1 million, or 27%, to $47.7 million for the six months ended June 30, 1997 from $37.6 million for the same period in 1996. As a percentage of revenues, cost of sales increased from 68% in 1996 to 69% in 1997. This increase in cost of sales as a percentage of revenues was primarily due to sales of new products, which tend to initially have lower margins, and higher labor costs, which was partially offset by improved pricing. Selling, General and Administrative Expenses. In the first six months of 1997, selling, general and administrative expenses increased by $586,000, or 8%, to $7.8 million from $7.3 million in the 1996 period. The increase was due to an increased number of personnel to support higher sales volumes and increased labor costs. Selling, general and administrative expenses decreased as a percent of revenues from 13% to 11%. Engineering and Product Development Expenses. In the first six months of 1997, engineering and product development expenses increased by $864,000, or 27%, to $4.1 million from $3.2 million in the same period in 1996. The increase primarily reflects an increased number of personnel and, to a lesser extent, increased development testing related to new products. Interest Expense. Interest expense for the six months ended June 30, 1997 was approximately $1.4 million, an increase of $100,000 as compared to the corresponding period in the prior year. Net Income. Net income increased by approximately $1.0 million, or 24%, from $4.1 million in the first six months in 1996 to $5.1 million in 1997 for the reasons set forth above. 18 YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995 Revenues. Revenues increased by $7.5 million, or approximately 7%, to $115.9 million in 1996 from $108.4 million in 1995. This increase was primarily due to a small volume increase plus a slight increase in prices in the last half of the year. There was continued strong market demand for the Company's products and services, but revenues were limited by manufacturing capacity constraints. Domestic sales accounted for $4.8 million, or 64% of the increase. Cost of Sales. Cost of sales increased $1.4 million, or 2%, to $77.9 million for the year ended December 31, 1996 from $76.5 million for the year ended December 31, 1995. Cost of sales increased due to higher sales volumes, offset in part by decreases in costs. As a percentage of revenues, cost of sales decreased from 71% in 1995 to 67% in 1996. This decrease was primarily due to the effect of increased forging operations which resulted in lower per unit costs than in the comparable prior period when more of the Company's forgings were outsourced. In addition, price increases in the last half of the year contributed to the decrease in cost of sales as a percentage of revenues. Selling, General and Administrative Expenses. For the year ended December 31, 1996, selling, general and administrative expenses increased by $1.4 million, or 10%, to $15.0 million from $13.6 million in 1995, but remained at approximately 13% of revenues in each year. This increase was primarily due to the increased number of personnel on a worldwide basis required to meet sales demand. Engineering and Product Development Expenses. For the year ended December 31, 1996, engineering and product development expenses increased by $1.2 million, or 21%, to $7.0 million from $5.8 million in the same period in 1995. The increase was due primarily to the addition of personnel needed to expand new product development. Interest Expense. Interest expense for the year ended December 31, 1996 was $2.6 million, a decrease of $300,000, or 10%, from interest expense of $2.9 million for the prior year. The decrease was due to lower bank interest rates. Net Income. Net income increased by $2.5 million, or 38%, from $6.6 million for the year ended December 31, 1995 to $9.1 million in 1996 for the reasons set forth above. YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994 Revenues. Revenues increased by $27.9 million, or 35%, to $108.4 million in 1995 from $80.5 million in 1994. This increase was due to increased sales volumes of the Company's products and services. Foreign sales accounted for $23.6 million, or 85%, of this increase. Cost of Sales. Cost of sales increased $17.9 million, or 31%, to $76.5 million for the year ended December 31, 1995 from $58.6 million for the year ended December 31, 1994. Cost of sales increased due to higher sales volumes offset in part by decreases in costs. As a percentage of revenues, cost of sales decreased from 73% in 1994 to 71% in 1995. This decrease was primarily due to efficiencies associated with increased manufacturing volume, which allowed allocation of fixed cost over a larger sales base, and increased utilization of the Company's forging and heat treatment facilities, which supplied all of the Company's heat treating requirements and a portion of its forgings in 1995. Selling, General and Administrative Expenses. For the year ended December 31, 1995, selling, general and administrative expenses increased by $1.9 million, or 16%, to $13.6 million from $11.7 million in 1994. The increase was due to the increased number of personnel on a worldwide basis required to meet sales demand and, to a lesser extent, increases in wages paid to personnel. Engineering and Product Development Expenses. For the year ended December 31, 1995, engineering and product development expenses decreased by $300,000, or 5%, to $5.8 million from $6.1 million in the same period in 1994. The decrease was attributable to the large increase in revenues in 1995, which delayed a portion 19 of the Company's new product development and testing. However, the Company continued its product development program with respect to SingleBore(TM) and dual bore subsea trees, platform wellheads and TLP equipment. Interest Expense. Interest expense for the year ended December 31, 1995 was $2.9 million, an increase of $600,000, or 30%, from interest expense of $2.3 million for the prior year. The increase was due to increased bank debt and higher interest rates. Net Income. Net income increased by $5.3 million, or 408%, from $1.3 million for the year ended December 31, 1994 to $6.6 million in 1995 for the reasons set forth above. LIQUIDITY AND CAPITAL RESOURCES The primary liquidity needs of the Company are to fund capital expenditures, such as increasing manufacturing capacity, improving and expanding facilities and manufacturing additional rental running tools; to fund payments of principal and interest on indebtedness; and to fund working capital. The Company's principal sources of funds have been cash flow from operations and bank indebtedness. Net cash provided by operating activities was $2.4 million in 1994, $6.5 million in 1995 and $5.2 million in 1996. For the six months ended June 30, 1997, net cash provided by operating activities was $2.4 million. Improvements in cash flow from operating activities are principally the result of improved operating results, offset in 1995, 1996 and 1997 by increased working capital requirements attributable to increases in accounts receivable and inventory due to increased sales. Accounts receivable at December 31, 1996 increased 27% over December 31, 1995 levels compared to a 7% increase in revenues for the year. The disproportionate increase in accounts receivable was due to timing of cash receipts. Subsequent to December 31, 1996, accounts receivables as a percentage of sales returned to levels more consistent with past periods. Capital expenditures by the Company were $4.6 million, $6.2 million, $7.2 million and $3.6 million in 1994, 1995, 1996 and the six months ended June 30, 1997, respectively. Principal payments on long-term debt were $2.7 million, $2.8 million, $3.2 million and $1.8 million in 1994, 1995, 1996 and the six months ended June 30, 1997, respectively. The Company has planned to spend approximately $50 million over a three-year period for a capital expenditure program to increase manufacturing capacity, improve and expand facilities and manufacture additional rental running tools. Dril-Quip expects that total capital expenditures for these purposes will be approximately $11 million in 1997 and approximately $23 million in 1998. In particular, the Company expects to spend approximately $16 million to complete the planned expansion at its Eldridge site in Houston, Texas, which is expected to be completed in 1999. The Company plans to spend approximately $4.5 million in 1997 to add machine tools at its existing facilities, most of which will be moved to the new facilities upon their completion. The Company plans to use the net proceeds from the Offering to fund these capital expenditures. Pending application of the proceeds for these purposes, the Company intends to use approximately $32 million to repay its bank indebtedness in full and the balance will be used for working capital. Excess cash will be invested in short-term investment grade securities. See "Use of Proceeds." The Company's credit facilities with Bank One are provided through a Credit Agreement dated March 30, 1994, as amended, and currently consist of (i) a $25 million revolving credit facility bearing interest at a rate of 1/4% over Bank One's base rate from day to day (this facility terminates on June 1, 1999), (ii) a $3 million advancing credit facility for the purchase of land and equipment and improvements to facilities bearing interest at a rate of 1/2% over Bank One's base rate from day to day (this facility terminates on October 1, 2001), and (iii) a $10.7 million term loan bearing interest at 1/2% over Bank One's base rate from day to day that matures on July 1, 1999. Indebtedness under the term loan was used for the purchase of land, buildings, equipment and improvements to facilities, as well as other capital expenditures. At June 30, 1997, $29.0 million was outstanding under the Bank One credit facilities, bearing interest at an average rate of 8.85%, and approximately $7.7 million was available for drawdown under the revolving facility. 20 In addition, the Company has three term loans with the Bank of Scotland to finance land, buildings and improvements for its Aberdeen manufacturing facility: a June 7, 1996 loan, a September 19, 1994 loan and a December 12, 1991 loan. Each loan has a 120-month maturity. The June 7, 1996 and September 19, 1994 loans each bear interest at 1.75% over the Bank of Scotland's base rate, and the December 12, 1991 loan bears interest at 1.5% over the Bank of Scotland's base rate. At June 30, 1997, $700,000, $600,000 and $1.7 million were outstanding under these term loans, respectively. BACKLOG Backlog consists of firm customer orders for which a purchase order has been received, satisfactory credit or financing arrangements exist and delivery is scheduled. The Company's backlog at December 31, 1996 and June 30, 1997 was approximately $56 million and approximately $101 million, respectively. The Company expects to fill approximately 50% of the June 30, 1997 backlog by December 31, 1997. The remaining backlog at June 30, 1997 consists of longer- term projects that will be designed and manufactured to customer specifications rather than sold out of inventory. All of the Company's projects currently included in backlog are subject to change and/or termination at the option of the customer. In the case of a change or termination, the customer is required to pay the Company for work performed and other costs necessarily incurred as a result of the change or termination. GEOGRAPHIC AREAS The Company's operations are divided into three geographic areas based upon the locations of its manufacturing facilities: the United States (Houston, Texas); Europe, Middle East and Africa (Aberdeen, Scotland) and Asia-Pacific (Singapore). The United States area includes sales to both North and South America. The area of Europe, Middle East and Africa includes primarily sales to the North Sea with lesser sales to the Middle East and Africa. The Asia- Pacific area includes sales primarily to Australia, Thailand, Malaysia and Indonesia. Revenues for each of these areas are dependent upon the ultimate sale of products and services to the Company's customers. Revenues of the United States area are also influenced by its sale of products to the European and Asia-Pacific subsidiaries. Accordingly, the operating incomes of each area are closely tied to third-party sales, and the operating income of the United States area is also dependent upon its level of intercompany sales. Total revenues increased by $27.9 million, or approximately 35%, to $108.4 million in 1995 from $80.5 million in 1994. This increase was primarily due to revenue increases of $18.3 million in the Europe, Middle East and Africa area and $8.1 million in the Asia-Pacific area, partially offset by a decrease in export sales by the United States area of $2.6 million. Total revenues increased by $7.5 million, or approximately 7%, to $115.9 million in 1996 from $108.4 million in 1995. Domestic sales increases in the United States area accounted for $4.8 million, or approximately 64%, of the increase. Total operating income increased by $8.4 million to $12.6 million in 1995 from $4.2 million in 1994. Of this increase, $7.3 million, or approximately 87%, was due to the United States area, which experienced a modest increase in third party sales coupled with an increase of $17.8 million, or approximately 143%, in intercompany sales in 1996. Total operating income rose by $3.4 million, or approximately 27%, to $16.0 million in 1996 from $12.6 million in 1995. This increase was primarily due to the United States area which contributed $2.7 million, or approximately 79%, of the gain. Most of the increase resulted from an increase of $4.8 million in the United States area's domestic sales. CURRENCY RISK Through its subsidiaries, the Company conducts a portion of business in currencies other than the United States dollar, principally the British pound sterling and the Norwegian kroner. The Company generally attempts to minimize its currency exchange risk by seeking international contracts payable in local currency in amounts 21 equal to the Company's estimated operating costs payable in local currency and in U.S. dollars for the balance of the contract and by contractual purchase price adjustments based on an exchange rate formula related to U.S. dollars. Because of this strategy, the Company has not experienced significant transaction gains or losses associated with changes in currency exchange rates and does not anticipate such exposure to be material in the future. Exchange losses were approximately $167,000 in 1994 and $0 in 1995, net of income taxes. In 1996, the Company had an exchange gain of $163,000. The Company also has significant investments in countries other than the United States, principally its manufacturing operations in Aberdeen, Scotland and, to a lesser extent, Singapore. The functional currency of these foreign operations is the local currency and, accordingly, financial statement assets and liabilities are translated at current exchange rates. Resulting translation adjustments are reflected as a separate component of stockholders' equity and have no current effect on earnings or cash flow. See "Risk Factors-- International Operations." RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In October 1995, the Financial Accounting Standards Board issued SFAS No. 123, which establishes alternative methods of accounting and disclosure for employee stock-based compensation arrangements. The Company intends to account for anticipated stock options using the intrinsic value method of accounting which, based on the expected stock option plan design, will not result in the recognition of compensation expense as the anticipated exercise price of the options will equal or exceed the fair market value of the stock on the date of grant. The Company will provide pro forma disclosure of net income and earnings per share in the notes to the consolidated financial statements as if the fair value based method of accounting had been applied. 22 BUSINESS GENERAL Dril-Quip is one of the world's leading manufacturers of highly engineered offshore drilling and production equipment which is well suited for use in deepwater, harsh environment and severe service applications. The Company designs and manufactures subsea equipment, surface equipment and offshore rig equipment for use by major integrated, large independent and foreign national oil and gas companies in offshore areas throughout the world. The Company's principal products consist of subsea and surface wellheads, subsea and surface production trees, mudline hanger systems, specialty connectors and associated pipe, drilling and production riser systems, wellhead connectors and diverters. The Company also provides installation and reconditioning services and rents running tools for use in connection with the installation and retrieval of its products. In 1996, the Company derived 82.1% of its revenues from the sale of its products and 17.9% of its revenues from services. Dril-Quip has developed its broad line of subsea equipment, surface equipment and offshore rig equipment exclusively through its internal product development efforts. The Company believes that it has achieved significant market share and brand name recognition with respect to its established products due to the technological capabilities, reliability, cost effectiveness and operational timesaving features of these products. In particular, the Company's Quik-Thread(R) and Quik-Stab(R) specialty connectors, MS-15(R) mudline hanger systems and SS-10(R) and SS-15(R) subsea wellheads are among the most widely used in the industry. The Company believes that, as of June 1, 1997, its subsea wellhead equipment was being used on approximately 70% of the wells being drilled in waters deeper than 3,000 feet worldwide. Since 1991, the Company has introduced a number of new products, including diverters, wellhead connectors, dual-bore and single-bore subsea production trees, subsea and platform valves, platform wellheads, platform trees, drilling risers and Spar and TLP production risers. The Company has grown consistently since its inception in 1981 and has been profitable in every year since 1983. As a result of new product introductions, increased market share in established product lines and increased offshore drilling and production activity, the Company's revenues have increased from $65.2 million in 1992 to $115.9 million in 1996 (an annual growth rate of 15.4%), and its net income has increased from $1.7 million in 1992 to $9.1 million in 1996 (an annual growth rate of 52.1%). From 1995 to 1996, the Company's revenues and net income grew by 7% and 38%, respectively. For the six months ended June 30, 1997, the Company's revenues were $68.7 million and its net income was $5.1 million, representing a 24% increase in revenues and a 26% increase in net income from the comparable period in 1996. The Company has experienced increased demand for its products due to the increased drilling and production activity in offshore areas throughout the world during the last several years, particularly in deeper waters. The increase in offshore drilling and production activity has been driven by a number of factors, including (i) the prospect for relatively larger hydrocarbon discoveries in deepwater areas and (ii) recent technological advances in offshore drilling and production equipment (including those introduced by Dril-Quip), seismic data collection and interpretation techniques, and drilling techniques, which have enhanced the economics of offshore drilling and production. In addition, several foreign national oil companies have recently opened offshore areas for exploration and development by other parties, including major integrated and large independent oil and gas companies. These factors have contributed to the increase in the Company's backlog from approximately $56 million at December 31, 1996 to approximately $101 million at June 30, 1997, an 80% increase. The Company intends to use the proceeds from the Offering to expand its manufacturing capacity in order to satisfy the increased demand for its products. See "Use of Proceeds." Dril-Quip markets its products through its offices and sales representatives located in all of the major international energy markets throughout the world. In 1996, the Company generated approximately 68% of its revenues from foreign sales. The Company manufactures its products at its facilities located in Houston, Texas; Aberdeen, Scotland; and Singapore, and maintains additional facilities for fabrication and/or reconditioning in Norway, Denmark and Australia. Dril-Quip's manufacturing operations are vertically integrated, with the 23 Company performing substantially all of its forging, heat treating, machining, fabrication, inspection, assembly and testing at its own facilities. Unlike essentially all of the Company's competitors, which depend on outside sources for forging and heat treatment services, Dril-Quip owns a forge and heat treatment facility that handles virtually all of the Company's requirements. This vertically integrated manufacturing capability provides Dril-Quip with competitive advantages because the Company is able to (i) control the quality of its products from initial stages, (ii) control the costs of its production and (iii) assure timely delivery of high-volume and customized orders. The Company was co-founded in 1981 by the current Board of Directors, Larry E. Reimert, Gary D. Smith, J. Mike Walker and Gary W. Loveless. Together, Messrs. Reimert, Smith and Walker have over 75 years of combined experience in the oilfield equipment industry, essentially all of which has been with the Company and its major competitors. In addition, key department managers have been with the Company over 10 years, on average. See "Management." After the Offering, the Founders will collectively beneficially own approximately 70% of the outstanding Common Stock (approximately 67% if the over-allotment option is exercised in full). The Company was incorporated as a Delaware corporation on August 12, 1997. The Company's operations represent the original business, which was incorporated as a Texas corporation on March 12, 1981. The Company's principal executive offices are located at 13550 Hempstead Highway, Houston, Texas 77040 and its telephone number is (713) 939-7711. INDUSTRY OVERVIEW The market for offshore drilling and production equipment and services is fundamentally driven by the exploration, development and production spending of oil and gas companies, particularly with respect to offshore activities worldwide. Industry exploration, development and production spending primarily depends on the cash flow of oil and gas producers, which is a function of current and anticipated future oil and gas production volumes and prices and operating costs of oil and gas producers. Oil and gas prices are influenced significantly by a variety of factors beyond the control of oil and gas companies, including worldwide demand for oil and gas, production levels, governmental policies regarding exploration and development of reserves and political factors in production countries. Fundamental economics in the oil and gas sector have improved in recent years and supply and demand for crude oil and natural gas is currently relatively balanced with demand rising and inventories comparatively low. Much of the incremental supply in recent years has come from areas outside OPEC, particularly in offshore regions such as the North Sea, the Gulf of Mexico and offshore Southeast Asia. These factors have contributed to generally higher, and relatively more stable, oil and gas prices during the last several years. Since 1995, offshore exploration, development and production activity has increased considerably due to, among other factors, (i) favorable oil and gas prices, (ii) significant improvement in the financial condition of many oil and gas companies in recent years, (iii) increasing worldwide demand for hydrocarbons, (iv) the potential for relatively large oil and gas discoveries in various offshore areas, particularly previously unexplored deepwater areas, (v) the opening of new offshore areas for foreign investment, including areas offshore of Brazil, China and West Africa, and (vi) royalty relief granted by the U.S. government for oil and gas produced from wells drilled in newly acquired deepwater blocks in the Gulf of Mexico. In addition, technological advances in exploration, development and production techniques, including seismic data collection and interpretation (particularly with respect to 3-D seismic data), drilling techniques (such as the use of deviated, horizontal and multilateral wells), subsea completion and production equipment, and mobile production units have contributed to increased offshore activity by oil and gas companies. These factors have facilitated exploration for and development of new reserves in deepwater and harsh environment offshore areas, allowed the development of oil and gas fields that were considered commercially marginal and extended development and production of reserves from existing fields. The increased exploration, development and production activity in offshore areas has resulted in significant increases in the amount of oil and gas produced from offshore areas in recent years. According to the 24 International Energy Agency, (i) worldwide non-OPEC offshore oil production grew 41% from 10.9 million barrels of oil per day (mmbopd) in 1990 to 15.3 mmbopd in 1996, and (ii) worldwide non-OPEC offshore oil production is anticipated to grow an additional 26% from 15.3 mmbopd in 1996 to 19.3 mmbopd in 2000. This increased activity has resulted in increased demand for drilling and production equipment and services, as evidenced by the increase in the average worldwide contracted utilization rate for all marketed offshore drilling rigs from 76% for the year ended December 31, 1992 to 93% for the first six months of 1997. Increased interest in offshore exploration, development and production is also evidenced by the significant rise in activity in the Gulf of Mexico lease sales held by the Department of the Interior's Mineral Management Service. In the most recent Central Gulf of Mexico lease sale held in March 1997, there were a record 1,790 bids received for 1,032 blocks (out of 5,059 blocks available) at an average price of approximately $799,000 per block. This compares to the May 1995 Central Gulf of Mexico lease sale when only 880 bids were received on 588 blocks (out of 5,810 blocks available) at an average of approximately $523,000 per block. Recently, several offshore drilling contractors have announced plans to upgrade existing rigs to equip them with the capability to drill in deeper water and harsher environments or to build new deepwater capable rigs. At June 30, 1997, there were approximately 31 semisubmersible rigs and ten drillship- type rigs worldwide capable of drilling in greater than 2,450 feet of water. Based on reports from Offshore Data Services related to new drilling rig construction, it is anticipated that by the year 2000 there will be 48 semisubmersible-rigs and 22 drillship-type rigs capable of this deepwater drilling. In addition, there are four new TLPs and three new Spars planned or under construction for utilization by the year 2000. At the end of 1996, there were only six TLPs and one Spar in operation worldwide. In addition, based on industry reports related to new floating production, storage and offloading monohulled moored vessel ("FPSO") construction, the number of FPSO ships will increase from 63 FPSOs in operation worldwide at the end of 1996 to 110 by the year 2001. An increase in the number of wells drilled and produced in deepwater or harsh environments should likewise increase the demand for deepwater offshore equipment and services. The foregoing statements concerning future industry conditions are forward-looking statements, and, although the Company believes that the expectations reflected in such forward-looking statements are reasonable, it can give no assurance that such expectations will be met. See "Risk Factors." STRATEGY The Company's goal is to expand its existing market position in the offshore oil and gas equipment and services sector while at the same time increasing its earnings and cash flow per share to enhance overall stockholder value. Key elements of the Company's strategy for achieving this goal are to: . CONTINUE TO DEVELOP NEW PRODUCTS. The Company plans to utilize its technological expertise to continue to develop and introduce new products and product enhancements in both its existing product lines and new product lines. For example, the Company has recently received purchase orders for drilling risers, production risers and deepwater subsea production trees. In 1996, approximately 30% of the Company's revenues were derived from the sale of products and product enhancements introduced since 1991. Of the Company's approximately $101 million backlog at June 30, 1997, at least 45% was attributable to orders for products and product enhancements developed since 1991. The Company intends to focus its future new product developments and product enhancements on areas where it believes it will be able to achieve a significant market position. The Company believes that the strong brand name recognition and reputation of its existing products will assist it in successfully introducing new products to customers. . INCREASE MANUFACTURING CAPACITY. To maintain and improve market share in its major product lines, Dril-Quip plans to expand its manufacturing capacity by approximately 90% during the three-year period 1997 through 1999, approximately two-thirds of which is expected to be completed by the end of 1998. The Company has been operating at close to full capacity in recent years, and believes that this expansion is essential in order to meet customer demand for its existing products and to continue its strategy of developing new products. The Company owns a 218-acre site in Houston, Texas where it plans to build additional manufacturing facilities during the three-year period 1997 through 1999. To increase 25 manufacturing capacity while the construction of the new facilities is in progress, the Company is adding machine tools at its existing facilities, most of which will be transported to and utilized at the new facilities when they are completed. . CONTINUE TO REDUCE COSTS AND INCREASE OPERATIONAL EFFICIENCIES. Dril-Quip has historically controlled its costs through such activities as performing its own forgings and heat treatment, rebuilding quality used machine tools (rather than purchasing new machine tools) and optimizing manufacturing operations to increase the rate of production. Although it will need to purchase some new machine tools in order to expand its manufacturing capacity as rapidly as planned, the Company has an inventory of used machine tools that it will continue to rebuild and upgrade in order to control overall costs. Dril-Quip also plans to expand its forging capacity and to begin marketing forgings to third parties in addition to supplying its own forging requirements. The Company expects that this will provide additional cost efficiencies as well as additional revenues, thereby contributing to profits. . CONTINUE EXPANSION INTO SELECTED INTERNATIONAL MARKETS. The Company's products are currently utilized primarily in the Gulf of Mexico, the North Sea and in selected markets in Southeast Asia, Australia and South America. The Company has recently engaged international sales representatives in several additional markets, including Mexico, West Africa and the Middle East. Dril-Quip believes that there is significant potential for increased sales through focused marketing efforts in other active offshore areas in the world, such as China, Argentina and the Caspian Sea. . CAPITALIZE ON STRONG BALANCE SHEET. The Company plans to use a portion of the net proceeds from the Offering initially to repay its existing indebtedness. The Company believes that its strong balance sheet will provide it with the financial flexibility to carry out its strategy to design and develop new products, significantly increase manufacturing capacity and expand its international presence. In addition, the Company may investigate potential acquisition opportunities as they arise. However, the Company currently has not identified any such acquisition opportunities, and there can be no assurance that any will arise in the future. PRODUCTS AND SERVICES PRODUCT GROUP Dril-Quip designs, manufactures, fabricates, inspects, assembles, tests and markets subsea equipment, surface equipment and offshore rig equipment. The Company's products are used to explore for oil and gas on offshore drilling rigs, such as floating rigs and jack-ups, and for drilling and production of oil and gas wells on offshore platforms, TLPs, Spars and moored vessels such as FPSOs. TLPs are floating production platforms that are connected to the ocean floor via vertical mooring tethers (called tension legs). A Spar is a floating cylindrical structure approximately six or seven times longer than its diameter that is anchored in place (like a Spar buoy). FPSOs are floating production, storage and offloading monohull moored vessels. Major oil companies are actively pursuing TLPs, Spars and FPSOs as cost-effective means of producing oil and gas from water depths in excess of 1,000 feet. The Company believes that sales of its equipment in connection with TLPs, Spars and FPSOs are potentially important sources of future revenues. The following table illustrates the Company's products and their uses in various methods of exploration, development and production: 26 SUBSEA EQUIPMENT SUBSEA WELLHEADS The subsea wellhead is installed at the ocean floor and is interconnected during drilling to the structure/vessel through the drilling riser. The wellhead system provides a means of supporting and sealing each of the multiple casing strings for well control. Major components include a guide structure, wellhead housing, casing hangers, and seal assemblies configured to specific well requirements. [DIAGRAM OF SUBSEA WELLHEAD APPEARS HERE] Subsea Wellhead MUDLINE HANGER SYSTEMS The mudline hanger system supports the weight of multiple casing strings at the ocean floor while drilling a well. The mudline hanger system incorporates disconnect features for abandonment after the drilling phase and reconnect features for tie-back to a platform or subsea tree for the production phase. [DIAGRAM OF MUDLINE HANGER SYSTEM APPEARS HERE] Mudline Hanger System EXPLORATION OR PRODUCTION STRUCTURE/ VESSEL . Floating Rigs . TLPs . Spars . Jack-up Rigs . Platforms 27 SUBSEA EQUIPMENT (CONTINUED) SPECIALTY CONNECTORS Specialty connectors are used to join lengths of large diameter conductor or casing used in offshore drilling operations. The specialty connector is welded to the pipe prior to shipment offshore and provides fast, easy make- up. [DIAGRAM APPEARS HERE] Quik-Thread/Multi-Thread Connectors [DIAGRAM APPEARS HERE] Quik-Stab Connector SUBSEA PRODUCTION TREES The subsea production tree is used to control the flow of oil and gas from a production well. The main components are remotely controlled valves, wellhead connector, flowline connector, control equipment and tree cap specially designed and configured into an assembly which is installed onto the subsea wellhead at the ocean floor. Subsea production trees typically produce back via flowlines to a central control point located on a production structure/vessel. [DIAGRAM APPEARS HERE] Single Bore Subsea Production Tree [DIAGRAM APPEARS HERE] Dual Bore Subsea Production Tree EXPLORATION OR PRODUCTION STRUCTURE/ VESSEL . Jack-up Rigs . Platforms . Floating Rigs . TLPs . Spars . Platforms . TLPs . Spars . FPSOs 28 SURFACE EQUIPMENT PLATFORM WELLHEADS The platform wellhead is installed at the surface on a platform or production structure/vessel during drilling and provides a means of supporting and sealing each of the multiple casing strings for well control. The system includes a wellhead housing, casing hangers, seal assemblies, and valves which are configured to specific well requirements. [DIAGRAM APPEARS HERE] PLATFORM PRODUCTION TREES The platform production tree is located on the production deck of the platform or production structure/vessel and is used to control the flow of oil and gas from a producing well. The main components are surface controlled valves, manual wellhead connector, controls and tree cap, which are designed and configured into an assembly specific to the well requirements. [DIAGRAM APPEARS HERE] EXPLORATION OR PRODUCTION STRUCTURE/ VESSEL Platform Wellhead . Jack-up Rigs . Platforms . TLPs . Spars Platform Production Trees . Platforms . TLPs . Spars 29 OFFSHORE RIG EQUIPMENT DRILLING AND PRODUCTION RISER SYSTEMS Drilling riser systems provide the vertical conduit between the floating drilling vessel and the subsea wellhead. Through the riser, equipment is guided into the well and drilling fluids are returned to the surface. The drilling riser also provides a means of well control through auxiliary integral high pressure tubes attached to the main riser body. Drilling Riser [DIAGRAM APPEARS HERE] Production riser systems provide the vertical conduit from the subsea wellhead to the floating production platform. Oil and gas flows to the surface for processing through the production riser. [DIAGRAM APPEARS HERE] Production Riser WELLHEAD CONNECTOR The wellhead connector provides remote connection of the drilling riser to the blowout preventer stack (BOP), and the BOP to the wellhead. The wellhead connector is also used to connect the subsea production tree or production riser to the subsea wellhead. [DIAGRAM APPEARS HERE] Wellhead Connector DIVERTERS The diverter is located at the surface and diverts gases off the rig during the drilling operation to provide protection from shallow gas blowouts. [DIAGRAM APPEARS HERE] Diverter EXPLORATION OR PRODUCTION STRUCTURE/ VESSEL . Floating Rigs . TLPs . Spars . TLPs . Spars . Floating Rigs . TLPs . Spars . Jack-up Rigs . Floating Rigs . Platforms . TLPs . Spars 30 Subsea Equipment. Subsea equipment is used in the drilling and production of offshore oil and gas wells around the world. Included in the subsea equipment product line are subsea wellheads, mudline hanger systems, specialty connectors and associated pipe, subsea production trees, valves and TLP and Spar well systems. Management believes that the Company has achieved a current market share of approximately 30% in its subsea wellhead, mudline hanger system and specialty connector markets. Dril-Quip's subsea production tree sales have increased steadily since their introduction in 1992. Subsea wellheads are pressure-containing forged and machined metal housings in which casing hangers are landed and sealed subsea to suspend casing (downhole pipe). As drilling depth increases, successively smaller diameter casing strings are installed, each suspended by an independent casing hanger. Subsea wellheads are utilized when drilling from floating drilling rigs, either semi-submersible or drillship types, and TLPs and Spars. Management believes that Dril-Quip's SS-15(R) and SS-10(R) wellheads are two of the most widely used subsea wellheads in the world. Competitive advantages of the Company's subsea wellheads include proprietary metal-to-metal seal technology and simple installation procedures. These features are ideally suited to subsea applications when a combination of high pressures, elevated temperatures and corrosive environments are present. The Company generally supplies subsea wellheads to customers from inventory. Mudline hanger systems are used in jack-up drilling operations to support the weight of the various casing strings at the ocean floor while drilling a well. They also provide a method to disconnect the casing strings in an orderly manner at the ocean floor after the well has been drilled, and subsequently reconnect to enable production of the well by either tying it back vertically to a subsequently-installed platform or by installing a subsea tree. Dril-Quip's MS-15(R) mudline hanger systems are technologically advanced products designed for simple operation while providing high load and high pressure capacity. The Company believes many customers prefer its mudline hanger systems to those manufactured by its competitors because of their higher pressure and load capacity and field-proven reliability. The Company generally supplies mudline hanger systems to customers from inventory. Large diameter weld-on specialty connectors (threaded or stab type) are used in offshore wells drilled from floating drilling rigs, jack-ups, fixed platforms, TLPs and Spars. Specialty connectors join lengths of conductor or large diameter (16-inch or greater) casing. Specialty connectors provide a more rapid connection than other methods of connecting lengths of pipe, and, although more expensive, their use becomes economically attractive when time savings are considered, particularly as the rig day rate charged by offshore drilling contractors increases. Connectors may be sold individually or as an assembly after being welded to sections of Company or customer supplied pipe. Dril-Quip's weld-on specialty connectors are designed to prevent cross threading and provide a quick, convenient method of joining casing joints with structural integrity compatible with casing strength. The Company generally supplies specialty connectors individually or specialty connectors welded to pipe from inventory. A subsea production tree is an assembly composed of valves, a wellhead connector, control equipment and various other components installed on a subsea wellhead or a mudline hanger system and used to control the flow of oil and gas from a producing well. Subsea trees may be either stand alone satellite type or template mounted cluster arrangements. Both types typically produce via flowlines to a central control point located on a platform, TLP, Spar or FPSO. The use of subsea production trees has become an increasingly important method for producing wells located in hard-to-reach deepwater areas or economically marginal fields located in shallower waters. The Company is an established manufacturer of more complicated dual-bore production trees, which are used in severe service applications. In addition, Dril-Quip manufactures a patented single bore (SingleBore(TM)) subsea completion system which features a hydraulic mechanism instead of a wireline-installed mechanism that allows the operator to plug the tubing hanger annulus remotely from the surface via a hydraulic control line and subsequently unplug it when the well is put on production. This mechanism eliminates the need for an expensive multibore installation and workover riser, thereby saving both cost and installation time. The Company's subsea production trees are generally custom designed and manufactured to customer specifications. 31 Surface Equipment. Surface equipment is principally used for flow control on offshore production platforms, TLPs and Spars. Included in the Company's surface equipment product line are platform wellheads and platform production trees. Dril-Quip's development of platform wellheads and platform production trees was facilitated by adaptation of its existing subsea wellhead and tree technology to surface wellheads and trees. Platform wellheads are pressure-containing forged and machined metal housings in which casing hangers are landed and sealed at the platform deck to suspend casings. The Company emphasizes the use of metal-to-metal sealing wellhead systems with operational time-saving features which can be used in high pressure, high temperature and corrosive drilling and production applications. Dril-Quip believes that its SU-90(R) unitized platform wellheads are superior to typical industry wellheads because they offer time savings, safety and technological benefits to its customers. After installation of the wellhead, platform production trees, consisting of gate valves, a wellhead connector, controls, tree cap and associated equipment, are installed on the wellhead to control and regulate oil or gas production. Platform production trees are similar to subsea production trees but utilize less complex equipment and more manual, rather than hydraulically activated, valves and connectors. Platform wellheads and platform production trees and associated equipment are designed and manufactured in accordance with customer specifications. Offshore Rig Equipment. Offshore rig equipment includes drilling and production riser systems, wellhead connectors and diverters. The drilling riser system consists of (i) lengths of riser pipe and associated riser connectors that secure one to another; (ii) the telescopic joint, which connects the entire drilling riser system to the diverter at the rig and provides a means to compensate for vertical motion of the rig relative to the ocean floor; and (iii) the wellhead connector, which provides a means for remote connection and disconnection of the drilling riser system to and from the BOP stack. Production risers provide a vertical conduit from the subsea wellhead to a TLP, Spar or FPSO. The wellhead connector also provides remote connection/disconnection of the BOP stack, production tree or production riser to/from the wellhead. Diverters are used to provide protection from shallow gas blowouts and to divert gases off of the rig during the drilling operation. Wellhead connectors and drilling and production riser systems are also used on both TLPs and Spars, which are being installed more frequently in deepwater applications. The Company believes that its diverter is the simplest and most reliable currently on the market, and that its DX(R) wellhead connector offers the best combination of structural integrity and operational features of any connector currently on the market. The Company has recently introduced drilling and production risers as new product lines. The principal market for offshore rig equipment is new rigs, rig upgrades, TLPs and Spars. Diverters, drilling and production risers and wellhead connectors are generally designed and manufactured to customer specifications. SERVICE GROUP Dril-Quip's Service Group provides field installation services, reconditioning of its products which are customer-owned, and rental running tools for installation and retrieval of its products. These services are provided from the Company's worldwide locations and represented approximately 18% of revenues in 1996. Field Installation. Dril-Quip provides field installation services through the use of its technicians. These technicians assist in the onsite installation of Company products and are available on a 24-hour call out from the Company's facilities located in Houston, Texas; Aberdeen, Scotland; Stavanger, Norway; Esbjerg, Denmark; Singapore; and Perth, Australia. Reconditioning. The Company provides reconditioning of its products at its facilities in Houston, Texas; Aberdeen, Scotland; Stavanger, Norway; and Singapore. Rental. The Company rents running and installation tools for use in installing its products. These tools are used to install and retrieve Company products which are purchased by customers. Running tools are available from Dril-Quip's locations in Houston, Texas; Aberdeen, Scotland; Stavanger, Norway; Esbjerg, Denmark; Singapore; and Perth, Australia. 32 MANUFACTURING Dril-Quip has major manufacturing facilities in Houston, Texas; Aberdeen, Scotland; and Singapore. Each location conducts a broad variety of processes, including machining, fabrication, inspection, assembly and testing. The Houston facility provides forged and heat treated products to all the major manufacturing facilities. The manufacturing process is illustrated in the following diagram. [MANUFACTURING CHART APPEARS HERE] The Company's Houston and Aberdeen manufacturing plants are ISO 9001 and American Petroleum Institute certified. See "--Properties--Major Manufacturing Facilities." Dril-Quip maintains its high standards of product quality through the use of quality assurance specialists who work with product manufacturing personnel throughout the manufacturing process by inspecting and documenting equipment as it is processed through the Company's manufacturing facilities. The Company has the capability to manufacture various products from each of its product lines at its major manufacturing facilities and believes that this localized manufacturing capability is essential in order to compete with the Company's major competitors. The Company's manufacturing process is vertically integrated, performing, in house, essentially all of its forging, heat treatment, machining, fabrication, inspection, assembly and testing. This vertically integrated manufacturing capability provides competitive advantages because Dril-Quip is able to (i) control the quality of its products from initial stages, (ii) control the cost of its production and (iii) assure timely delivery of high-volume and customized orders. The Company's primary raw material is cast steel ingots, from which it produces steel shaped forgings at its forging and heat treatment facility. The Company routinely purchases four different grades of steel ingots from approximately four suppliers on a purchase order basis and does not have any long-term supply contracts. 33 The Company acquired land and used equipment, and all equipment was rebuilt to essentially "like new" condition to provide the Company with a modern forging and heat treatment facility in Houston. This was done to reduce costs and in anticipation of forging capacity shortages which could result if the demand for forgings increased significantly. Dril-Quip now performs essentially all of its own heat treatment and produces most of its forging requirements. The Company's Houston facility also provides forgings and heat treatment for its Aberdeen and Singapore facilities. The Company's major competitors depend on outside sources for all or a substantial portion of their forging and heat treatment requirements. With the expansion of its forging capacity, the Company plans to begin marketing its forgings to third party customers. Dril-Quip's manufacturing facilities utilize state-of-the-art computer numerically controlled ("CNC") machine tools and equipment, which contribute to the Company's product quality and timely delivery. The Company has also developed a cost effective, in-house machine tool rebuild capability, which produces "like new" machine upgrades with customized features to enhance the economic manufacture of its specialized products. The Company purchases quality used machine tools as they become available and stores them at its facilities to be rebuilt and upgraded as the need arises. Purchasing and rebuilding used machine tools is a competitive advantage, allowing Dril-Quip to add machine tools at lower overall costs than its competitors. Rebuilding used machine tools also allows for greater customization suitable for manufacturing Dril-Quip proprietary product lines. This provides the added advantage of requiring only in-house expertise for repairs and maintenance of these machines. A significant portion of the Company's manufacturing capacity growth has been through the rebuild/upgrade of quality used machine tools, including the replacement of outdated control systems with state-of-the-art CNC controls. In the last two years, as demand for offshore exploration and production equipment has increased significantly, the Company has been operating at close to full capacity. The Company plans to expand its manufacturing capacity by approximately 90% during the three-year period 1997 through 1999, approximately two-thirds of which is expected to be completed by the end of 1998. The first of the additional manufacturing facilities is currently under construction and is expected to be completed by the end of 1998. The Company believes that this capital expansion program will allow it to prudently manage its growth in response to customer demand for its products. The Company has already begun adding machine tools at its existing facilities that it will move to the new facilities when they are completed. In order to expand its capacity as rapidly as planned, the Company expects that it will supplement its inventory of used machine tools, which it plans to rebuild and upgrade, with purchases of new and additional used machine tools. PERCENTAGE OF COMPLETION ACCOUNTING Historically, Drip-Quip recognized revenues upon the delivery of a completed product. As the Company has begun manufacturing larger and more complex projects that have longer manufacturing times, the Company has begun to account for purchase orders covering such projects on a percentage of completion basis. The Company expects that such larger and more complex projects will increase the Company's sales and revenues and afford the Company certain economies of scale because such projects generally utilize the Company's products as component parts. The Company also expects that such projects may have a stabilizing effect on the Company's operations, as the Company will have a longer period of time over which to plan and to allocate its resources. Finally, the Company expects to receive certain periodic payments associated with such projects, rather than payment upon delivery. Because the Company has only recently become involved in such manufacturing projects, the use of percentage of completion accounting does not affect the comparability of financial information to earlier periods. See "Management's Discussion and Analysis of Financial Condition and Results of Operations-- Overview." CUSTOMERS The Company's principal customers are major integrated oil and gas companies, large independent oil and gas companies and foreign national oil and gas companies. Offshore drilling contractors and engineering and construction companies also represent a minor, but steadily increasing, customer base. The Company's customers are generally oil and gas companies that are well-known participants in offshore exploration and production, who 34 depend on high quality, efficient, reliable products, such as those produced by Dril-Quip, for their offshore activities, particularly in deepwater areas. The Company is not dependent on any one customer or group of customers. In 1996, the Company's top 15 customers represented approximately 50% of total revenues, with the Royal Dutch Shell Group of Companies (aggregating orders placed by all of its worldwide affiliates), accounting for approximately 19% of revenues. The number and variety of the Company's products required in a given year by any one customer depends upon the amount of that customer's capital expenditure budget devoted to offshore exploration and production in any single year and on the results of competitive bids for major projects. Consequently, a customer that accounts for a significant portion of revenues in one fiscal year may represent an immaterial portion of revenues in subsequent years. Due to the demanding operating conditions in the offshore drilling and production sector and high costs associated with equipment failure, customers prefer manufacturers of highly reliable products, with established qualifications and experience, such as Dril-Quip. The Company strives to build strong long-term relationships with its customers by maintaining its reputation as a manufacturer of high-quality, efficient and reliable products, by developing new products to meet its customer's needs and by responding promptly to customer orders. See "Risk Factors--Reliance on Significant Customers" and "--Competition." MARKETING AND SALES Dril-Quip markets its products and services throughout the world directly through its sales personnel in two domestic and six international locations. In addition, in certain foreign markets where the Company does not maintain offices, it utilizes independent sales representatives to enhance its marketing and sales efforts. Locations in which Dril-Quip has sales representatives include the United Arab Emirates, Saudi Arabia, China, Canada, the Philippines, Brazil, Indonesia, Malaysia, Kuwait, Brunei, Oman, Qatar and West Africa. Although they do not have authority to contractually bind the Company, these representatives market the Company's products in their respective territories in return for sales commissions. The Company also places print advertising from time to time in trade and technical publications targeted to its customer base. It also participates in industry conferences and trade shows to enhance industry awareness of its products. The Company's customers generally order products on a purchase order basis. Orders are typically filled within two weeks to three months after receipt of a purchase order, depending on the type of product and whether it is sold out of inventory or requires some customization. Contracts for certain of the Company's larger, more complex products, such as subsea production trees, drilling risers and equipment for TLPs and Spars can take a year or more to complete. The primary factors influencing a customer's decision to purchase the Company's products are the quality, reliability and reputation of the product, price and technologically superior features. Timely delivery of equipment is also very important to customer operations and the Company maintains an experienced sales coordination staff to help assure such delivery. For large drilling and production system orders, project management teams coordinate customer needs with engineering, manufacturing and service organizations, as well as with subcontractors and vendors. The Company historically has experienced some seasonality, with revenues and operating income slightly lower during the first and third quarters compared to the second and fourth quarters. The Company's revenues are affected by its customers' capital expenditure budgeting process, which generally results in lower revenues in the first quarter and higher revenues in the fourth quarter. PRODUCT DEVELOPMENT AND ENGINEERING The technological demands of the oil and gas industry continue to increase as offshore exploration and drilling expand into more hostile environments. Conditions encountered in these environments include well 35 pressures of up to 15,000 psi (pounds per square inch), mixed flows of oil and gas under high pressure that may also be highly corrosive and water depths in excess of 5,000 feet. Since its founding, Dril-Quip has actively engaged in continuing product development to generate new products and improve existing products. When developing new products, the Company typically seeks to design the most technologically advanced version for a particular application to establish its reputation and qualification in that product. Thereafter, the Company leverages its expertise in the more technologically advanced product to produce less costly and complex versions of the product for less demanding applications. The Company also focuses its activities on reducing the overall cost to the customer, which includes not only the initial capital cost but also operating costs associated with its products. The reliable performance of Dril-Quip's products during installation and during the life of the field is one of the most important factors to the customer. All of the Company's products have been developed from internally generated designs, and the Company has continually introduced new products and product enhancements since its founding in 1981. Product developments that began in 1991 have led to a series of new products, including diverters, wellhead connectors, SingleBore(TM) subsea trees, improved severe service dual bore subsea trees, subsea and platform valves, platform wellheads, platform trees, subsea tree workover riser systems, drilling risers and TLP and Spar production riser systems. For the year ended December 31, 1996, more than 30% of the Company's total revenues were from the sales of products and product enhancements developed since 1991. In addition, of the Company's approximately $101 million backlog at June 30, 1997, at least 45% was attributable to orders for products and product enhancements developed since 1991. Dril-Quip's product development work is conducted at its facilities in Houston, Texas and Aberdeen, Scotland. In addition to the work of its product development staff, the Company's application engineering staff provides engineering services to customers in connection with the design and sales of its products. The Company believes that the success of its business depends more on the technical competence, creativity and marketing abilities of its employees than on any individual patent, trademark or copyright. Nevertheless, as part of its ongoing product development and manufacturing activities, Dril-Quip's policy has been to seek patents when appropriate on inventions concerning new products and product improvements. As of June 30, 1997, the Company held 36 United States patents and 77 foreign patents and had applications pending for four United States patents and 17 foreign patents. All patent rights for products developed by employees are assigned to the Company. Virtually all of the Company's products have components that are covered by patents. Dril-Quip has 13 registered trademarks, including Dril-Quip(R), Quik- Thread(R), Quick-Stab(R), Multi-Thread(R), MS-15(R), SS-15(R), SS-10(R), SU- 90(R) and DX(R). The Company has registered its trademarks in the countries where such registration is deemed material. Although in the aggregate the Company's patents and trademarks are of considerable importance to the manufacturing and marketing of many of its products, the Company does not consider any single patent or trademark or group of patents or trademarks to be material to its business as a whole, except the Dril-Quip(R) trademark. The Company also relies on trade secret protection for its confidential and proprietary information. The Company routinely enters into confidentiality agreements with its employees and suppliers. There can be no assurance, however, that others will not independently obtain similar information or otherwise gain access to the Company's trade secrets. COMPETITION Dril-Quip faces significant competition from other manufacturers of exploration and production equipment. Several of its primary competitors are diversified multinational companies with substantially larger operating staffs and greater capital resources than those of the Company and which, in many instances, have been engaged in the manufacturing business for a much longer time than the Company. However, Dril-Quip believes it has a significant position in its oil and gas drilling and production equipment markets, particularly with respect to its high performance and time-saving products. In these markets, the Company competes principally with ABB 36 Vetco Gray Inc. (a subsidiary of Asea Brown Boveri, more commonly referred to as ABB), the petroleum production equipment segment of Cooper Cameron Corporation, the Petroleum Equipment Group of FMC Corporation and Kvaerner National Ltd. (a division of Kvaerner A.S.). Because of their relative size and diversity of products, several of these companies have the ability to provide "turnkey" services for offshore drilling and production applications, which enables them to use their own products to the exclusion of Dril-Quip's products. The Company also competes to a lesser extent with a number of other companies in various products. The principal competitive factors in the petroleum drilling and production equipment markets are quality, reliability and reputation of the product, price, technology, service and timely delivery. See "Risk Factors--Competition." PROPERTIES MAJOR MANUFACTURING FACILITIES
BUILDING SIZE LAND (APPROXIMATE (APPROXIMATE LOCATION SQUARE FEET) ACREAGE) OWNED OR LEASED -------- ------------ ------------ ---------------- Houston, Texas --13550 Hempstead Highway.......... 175,000 15 Owned 12,000 -- Leased (offices) --6401 N. Eldridge Parkway......... 280,000 218 Owned Aberdeen, Scotland................... 110,000 10 Owned 9,400 -- Leased (offices) Singapore............................ 13,000 1.8 Leased
Dril-Quip's manufacturing facilities in Houston and Aberdeen are capable of manufacturing each of its products, and the facility in Singapore is capable of manufacturing most of the Company's established products. The Company's Eldridge site in Houston, Texas consists of 218 acres, of which approximately 70% is available for additional buildings and machine tools. The Company plans to focus its domestic capacity expansion at the Eldridge site. SALES, SERVICE AND RECONDITIONING FACILITIES
BUILDING SIZE LAND (APPROXIMATE (APPROXIMATE LEASED LOCATION SQUARE FEET) ACREAGE) ACTIVITY --------------- ------------ ------------ ----------------------------- New Orleans, Louisiana.. 2,300 -- Sales/Service Beverwijk, Holland...... 5,200 0.2 Sales/Warehouse Perth, Australia........ 13,300 1.4 Sales/Service/ Reconditioning/Warehouse Stavanger, Norway....... 15,700 2.4 Sales/Service/Reconditioning/ Warehouse/Fabrication Esbjerg, Denmark........ 7,800 0.5 Sales/Service/Reconditioning/ Warehouse
The Company also performs sales, service and reconditioning activities at its facilities in Houston, Aberdeen and Singapore. As part of its capital expansion, the Company plans to expand its facilities in Stavanger to meet growing demands for its products and services. Under the Company's existing credit facilities, substantially all of the properties and assets of the Company are subject to mortgages and security interests in favor of the Company's lenders. 37 EMPLOYEES The total number of the Company's employees as of June 30, 1997 was 926. Of these, 580 were located in the United States. The Company's employees are not covered by collective bargaining agreements, and the Company considers its employee relations to be good. GOVERNMENTAL REGULATIONS Many aspects of the Company's operations are affected by political developments and are subject to both domestic and foreign governmental regulations, including those relating to oilfield operations, worker safety and the protection of the environment. In addition, the Company depends on the demand for its services from the oil and gas industry and, therefore, is affected by changing taxes, price controls and other laws and regulations relating to the oil and gas industry generally, including those specifically directed to offshore operations. The adoption of laws and regulations curtailing exploration and development drilling for oil and gas for economic or other policy reasons could adversely affect the Company's operations by limiting demand for the Company's products. Recently, increased concern has been raised over the protection of the environment. Offshore drilling in certain areas has been opposed by environmental groups and, in certain areas, has been restricted. To the extent that new laws or other governmental actions prohibit or restrict offshore drilling or impose additional environmental protection requirements that result in increased costs to the oil and gas industry in general and the offshore drilling industry in particular, the business of the Company could be adversely affected. The Company cannot determine to what extent its future operations and earnings may be affected by new legislation, new regulations or changes in existing regulations. The Company's operations are affected by numerous foreign, federal, state and local environmental laws and regulations. The technical requirements of these laws and regulations are becoming increasingly expensive, complex and stringent. These laws may provide for "strict liability" for damages to natural resources or threats to public health and safety, rendering a party liable for the environmental damage without regard to negligence or fault on the part of such party. Sanctions for noncompliance may include revocation of permits, corrective action orders, administrative or civil penalties and criminal prosecution. Certain environmental laws provide for joint and several strict liability for remediation of spills and releases of hazardous substances. In addition, companies may be subject to claims alleging personal injury or property damage as a result of alleged exposure to hazardous substances, as well as damage to natural resources. Such laws and regulations may also expose the Company to liability for the conduct of or conditions caused by others, or for acts of the Company that were in compliance with all applicable laws at the time such acts were performed. Compliance with environmental laws and regulations may require the Company to obtain permits or other authorizations for certain activities and to comply with various standards or procedural requirements. The Company believes that its facilities are in substantial compliance with current regulatory standards. Based on the Company's experience to date, the Company does not currently anticipate any material adverse effect on its business or consolidated financial position as a result of future compliance with existing environmental laws and regulations controlling the discharge of materials into the environment. However, future events, such as changes in existing laws and regulations or their interpretation, more vigorous enforcement policies of regulatory agencies, or stricter or different interpretations of existing laws and regulations, may require additional expenditures by the Company, which may be material. LEGAL PROCEEDINGS The Company is not a party to, nor is any of its property the subject of, any pending legal proceedings, which, in the opinion of management, are expected to have a material adverse effect on the Company's consolidated results of operations or financial position. 38 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The following table sets forth the names, ages (as of August 31, 1997) and positions of the Company's directors, the person nominated to become a director of the Company upon completion of the Offering and the Company's executive officers:
DIRECTOR'S TERM NAME AGE POSITION ENDING ---- --- -------- ---------- Larry E. Reimert........... 50 Co-Chairman of the Board and Director 2000 Gary D. Smith.............. 55 Co-Chairman of the Board and Director 2000 J. Mike Walker............. 54 Co-Chairman of the Board and Director 1999 Gary W. Loveless........... 54 Director 1999 James M. Alexander......... 45 Director(1) 1998 Jerry M. Brooks............ 45 Chief Accounting Officer
- -------- (1) Appointment will become effective upon completion of the Offering. The Company's Board of Directors is divided into three classes with staggered terms of office, initially ending as set forth above. Thereafter, the term for each class will expire on the date of the third annual stockholders' meeting for the election of directors following the most recent election of directors for such class. Each director holds office until the next annual meeting of stockholders for the election of directors of his class and until his successor has been duly elected and qualified. Officers serve at the discretion of the Board of Directors. Larry E. Reimert is Co-Chairman of the Board with principal responsibility for engineering, product development and finance. He has been the Director-- Engineering, Product Development and Finance, as well as a member of the Board of Directors, since the Company's inception in 1981. Prior to that, he worked for Vetco Offshore, Inc. in various capacities, including as Vice President of Technical Operations, Vice President of Engineering and Manager of Engineering. Mr. Reimert holds a BSME degree from the University of Houston and a MBA degree from Pepperdine University. Gary D. Smith is Co-Chairman of the Board with principal responsibility for sales, service, training and administration. He has been the Director--Sales, Service, Training and Administration, as well as a member of the Board of Directors, since the Company's inception in 1981. Prior to that, he worked for Vetco Offshore, Inc. in various capacities, including as General Manager and Vice President of Sales and Service. J. Mike Walker is Co-Chairman of the Board with principal responsibility for manufacturing, purchasing and facilities. He has been the Director-- Manufacturing, Purchasing and Facilities, as well as a member of the Board of Directors, since the Company's inception in 1981. Prior to that, he served as the Director of Engineering, Manager of Engineering and Manager of Research and Development with Vetco Offshore, Inc. Mr. Walker holds a BSME degree from Texas A&M University, a MSME degree from the University of Texas at Austin and a Ph.D. in mechanical engineering from Texas A&M University. Gary W. Loveless has been an outside director since the Company's inception in 1981. From 1986 to 1997, he held various positions with Great Western Resources Corporation, most recently as Chief Executive Officer and Director. In 1997, Great Western Resources Corporation was purchased by Forcenegy Inc., and Mr. Loveless currently serves as Vice President/Onshore Exploration and Production of Forcenegy Inc. He holds a BSME from Texas A&M University and a MSME from the University of Texas at Austin. James M. Alexander will become an outside director of the Company upon completion of the Offering. Since December 1996, he has served as the Vice President, Chief Financial Officer and Secretary of Spinnaker Exploration Company, L.L.C. From November 1995 to December 1996, Mr. Alexander was President of 39 Alexander Consulting, Inc. He was the Senior Vice President and Chief Financial Officer of Enron Global Power & Pipelines L.L.C. from November 1994 to June 1995, and served as its President from June until November 1995. Prior to that time, Mr. Alexander was President of Alexander Corporate Financial Consulting, Inc. from June 1992 to November 1994. Mr. Alexander holds a BA from Yale College and an MBA from Harvard University. Jerry M. Brooks has been Chief Accounting Officer since he joined the Company in 1992. From 1980 to 1991, he held various positions with Chiles Offshore Corporation, most recently as Chief Financial Officer, Secretary and Treasurer. Mr. Brooks holds a BBA in Accounting and an MBA from the University of Texas at Austin. He is a certified public accountant. Upon completion of the Offering, there will be two committees of the Board of Directors: an Audit Committee and a Compensation Committee. The initial members of the Audit Committee will be Mr. Loveless and Mr. Alexander. The Audit Committee will recommend the appointment of independent public accountants to conduct audits of the Company's financial statements and review with the independent accountants the plan and results of the auditing engagement. The Audit Committee will also review the scope and results of procedures for internal auditing of the Company and the adequacy of the Company's system of internal accounting controls. The initial members of the Compensation Committee will be Mr. Loveless and Mr. Alexander. The Compensation Committee will approve, or in some cases, recommend to the Board, remuneration arrangements and other compensation plans involving the Company's directors, executive officers and certain other employees whose compensation exceeds specified levels. The Compensation Committee will also act on the granting of stock options, including grants made under the Incentive Plan to the Company's directors and executive officers. DIRECTOR COMPENSATION Gary W. Loveless, one of the Company's directors, was paid fees totaling $25,000 for his services as a director of the Company for the year ended December 31, 1996. Commencing with the consummation of the Offering, each director who is not an employee of the Company (a "Nonemployee Director") and who is elected or appointed on or after completion of the Offering will receive an annual fee of $35,000, plus a fee of $1,000 for attendance at each Board of Directors meeting and $1,000 for each committee meeting (unless held on the same day as a Board of Directors meeting). All directors will be reimbursed for out-of-pocket expenses incurred in attending meetings of the Board of Directors or committees thereof and for other expenses incurred in their capacity as directors. Directors who are employees of the Company will not receive additional compensation for serving as directors. OFFICER AND DIRECTOR INDEMNIFICATION The Company's Bylaws provide for the indemnification of its officers and directors, and the advancement to them of expenses in connection with proceedings and claims, to the fullest extent permitted by the Delaware General Corporation Law. The Bylaws include related provisions meant to facilitate the indemnitee's receipt of such benefits. These provisions cover, among other things: (i) specification of the method of determining entitlement to indemnification and the selection of independent counsel that will in some cases make such determination; (ii) specification of certain time periods by which certain payments or determinations must be made and actions must be taken; and (iii) the establishment of certain presumptions in favor of an indemnitee. The benefits of certain of these provisions are available to an indemnitee only if there has been a change in control (as defined therein). The Company has entered into indemnification agreements with its directors and officers that provide for similar protections. EXECUTIVE COMPENSATION Summary Compensation Table. The following table sets forth certain summary information concerning the compensation paid or accrued by the Company during the year ended December 31, 1996 to the Company's 40 executive officers whose combined salary and bonus from the Company during such period exceeded $100,000 (collectively, the "named executive officers"). SUMMARY COMPENSATION TABLE
ANNUAL COMPENSATION(1) ----------------- ALL OTHER NAME AND PRINCIPAL POSITION SALARY BONUS COMPENSATION(2) --------------------------- ------ -------- --------------- Larry E. Reimert............................. $413,462 $200,000 $3,000 Co-Chairman of the Board Gary D. Smith................................ $413,462 $200,000 $3,000 Co-Chairman of the Board J. Mike Walker............................... $413,462 $200,000 $3,000 Co-Chairman of the Board Jerry M. Brooks.............................. $107,566 $ 15,000 $2,151 Chief Accounting Officer
- -------- (1) Other annual compensation for each named executive officer during 1996 did not exceed the lesser of $50,000 or 10% of the annual compensation earned by such individual. (2) The amounts shown represent contributions by the Company under its 401(k) Profit Sharing Plan and Company payments of life insurance premiums. EMPLOYMENT AGREEMENTS Prior to the completion of the Offering, the Company expects to enter into employment agreements with each of Messrs. Reimert, Smith and Walker. The following summary of these agreements, which will be effective on the closing of the Offering, does not purport to be complete and is qualified by reference to them, copies of which have been filed as exhibits to the Registration Statement of which this Prospectus is a part. Each of these agreements provides for an annual base salary in an amount not less than $350,000, and will entitle the employee to participate in all of the Company's incentive, savings, retirement and welfare benefit plans in which other executive officers of the Company participate. Each agreement also provides for an annual performance bonus equal to up to 120% of the executive's annual base salary, with the precise amount of the bonus determined based on specific Company performance goals. The performance goals, which are equally weighted, are based on (i) the Company's annual earnings before interest and taxes ("EBIT") measured against the Company's annual budget or plan, and (ii) the Company's annual return on capital (defined as EBIT divided by total assets less current liabilities) compared to a peer group of companies. In addition, each agreement provides that the employee will receive an annual grant of a number of Options (as defined below) under the Incentive Plan equal to the employee's base salary multiplied by three and divided by the market price of the Common Stock on the grant date. Each agreement provides that the employee's compensation, including his annual base salary, annual performance bonus and annual grant of Options, shall be reviewed at least annually and shall be increased at any time and from time to time as shall be substantially consistent with increases in compensation generally awarded in the ordinary course of business to executives of the Company. Each of the employment agreements has an initial five-year term, provided that at the end of the second year of such initial term and on every anniversary thereafter, the term will be automatically extended for one year, such that the remaining term of the agreement shall never be less than three years. Each agreement will be subject to the right of the Company and the employee to terminate the employee's employment at any time. Each agreement provides that, upon termination of employment because of death or disability, or if employment is terminated by the Company for any reason (except under certain limited circumstances defined as "for cause" in the agreement), or if employment is terminated by the employee subsequent to a change of control (as defined) or with good reason (as defined), the employee will generally be entitled to (i) a lump sum cash payment equal to the employee's base salary through the date of termination, together with any deferred compensation previously awarded and any accrued vacation time, (ii) a lump sum cash payment equal to the greater of (a) the 41 annual base salary that would have been paid to the employee beginning on the date of termination and ending on the latest possible date of termination of the employment in accordance with the agreement or (b) three times the then current base salary, (iii) at the employee's option, a lump sum cash payment equal to (a) the annual cash bonus calculated in accordance with the agreement for the remaining employment period (such amount to be adjusted upward (but not downward) to reflect the actual results of the Company each year) or (b) three times the highest cash bonus paid during the last three fiscal years prior to the date of termination, (iv) immediate vesting of any stock options or restricted stock previously granted to such employee and outstanding as of the time immediately prior to the date of his termination, or a cash payment in lieu thereof, and (v) continued participation in medical, dental and life insurance coverage until the employee receives equivalent coverage and benefits under other plans of a subsequent employer or the later of the death of the employee, the death of the employee's spouse and the youngest child of the employee reaching age 21. The Company will also pay the employee any such amount as may be necessary to hold the employee harmless from the consequences of any resulting excise or other similar purpose tax relating to "parachute payments" under the Internal Revenue Code of 1986, as amended. Each agreement also provides that, during the term of the agreement and after termination thereof, the employee shall not divulge any of the Company's confidential information, knowledge or data. In addition, each agreement requires the employee to disclose and assign to the Company any and all conceptions and ideas for inventions, improvements and valuable discoveries made by the employee which pertain primarily to the material business activities of the Company. Each agreement also provides that, in the event that the agreement is terminated for cause or the employee voluntarily resigns (other than following a change of control or for good reason), for one year thereafter the employee will not within any country with respect to which he has devoted substantial attention to the material business interests of the Company, (i) accept employment or render services to a competitor of the Company or (ii) enter into or take part in business that would be competitive with the Company. INCENTIVE PLAN Prior to the completion of the Offering, the Company expects to adopt the Incentive Plan. The objectives of the Incentive Plan are (i) to attract and retain key employees, (ii) to encourage the sense of proprietorship of these persons in the Company and (iii) to stimulate the active interest of these persons in the development and financial success of, the Company by making awards ("Awards") under the Incentive Plan. The Company plans to reserve 1,700,000 shares of Common Stock to use in connection with the Incentive Plan. Persons eligible for Awards are employees holding positions of responsibility with the Company or any of its subsidiaries and whose performance can have a significant effect on the success of the Company. The Board of Directors will administer the Incentive Plan with respect to all employees other than executive officers. The Compensation Committee will administer the Incentive Plan with respect to executive officers. The Board has the exclusive power to administer the Incentive Plan, to take all actions specifically contemplated thereby or necessary or appropriate in connection with the administration thereof, to interpret the Incentive Plan and to adopt such rules, regulations and guidelines for carrying out its purposes as the Board may deem necessary or proper, all of which powers will be exercised in the best interests of the Company and in keeping with the objectives of such plan. The Board may, in its discretion, among other things, (i) extend or accelerate the exercisability of, accelerate the vesting of, or eliminate or make less restrictive any restrictions contained in, any Award, (ii) waive any restriction or other provision of the Incentive Plan or in any Award or (iii) otherwise amend or modify any Award in any manner that is either not adverse to that participant holding the Award or consented to by that participant. The Board also may delegate to certain senior officers of the Company its duties under the Incentive Plan. The Board of Directors may amend, modify, suspend or terminate the Incentive Plan for the purpose of addressing any changes in legal requirements or for any other lawful purpose, except that no amendment or alteration that would adversely affect the rights of any participant under any Award previously granted to such participant shall be made without the consent of such participant. The Board of Directors may make certain 42 adjustments in the event of any subdivision, split or combination of outstanding shares of Common Stock, any declaration of a stock dividend payable in shares of Common Stock, any recapitalization or capital reorganization of the Company, any consolidation or merger of the Company with another corporation or entity, any adoption by the Company of any plan of exchange affecting the Common Stock or any distribution to holders of Common Stock of securities or property (other than normal cash dividends). Awards to employees may be in the form of (i) rights to purchase a specified number of shares of Common Stock at a specified price ("Options"), (ii) rights to receive a payment, in cash or Common Stock, equal to the excess of the fair market value or other specified value of a number of shares of Common Stock on the date the right is exercised over a specified strike price, (iii) grants of restricted or unrestricted Common Stock or units denominated in Common Stock, (iv) grants denominated in cash and (v) grants denominated in cash, Common Stock, units denominated in Common Stock or any other property which are made subject to the attainment of one or more performance goals ("Performance Awards"). An Option may be either an incentive stock option ("ISO") that qualifies, or a nonqualified stock option ("NSO") that does not qualify, with the requirements of Section 422 of the Internal Revenue Code. The Committee will determine the employees to receive Awards and the terms, conditions and limitations applicable to each such Award, which conditions may, but need not, include continuous service with the Company, achievement of specific business objectives, attainment of specified growth rates, increases in specified indices or other comparable measures of performance. Performance Awards may include more than one performance goal, and a performance goal may be based on one or more business criteria applicable to the grantee, the Company as a whole or one or more of the Company's business units and may include one or more of the following: increased revenues, net income, stock price, market share, earnings per share, return on equity or assets or decrease in costs. On the date the Offering closes, Options under the Incentive Plan will be granted to certain employees of the Company to purchase a total of approximately shares of Common Stock at an exercise price per share equal to the initial public offering price per share set forth on the cover page of this Prospectus. These awards include Options to be granted to each of Messrs. Reimert, Smith and Walker to purchase 55,263 shares of Common Stock (assuming an initial public offering price of $19.00 per share). All such Options will have a term of ten years and become exercisable in cumulative annual increments of one-fourth of the total number of shares of Common Stock subject thereto, beginning on the first anniversary of the date of the grant. The foregoing description summarizes the principal terms and conditions of the Incentive Plan, does not purport to be complete and is qualified in its entirety by reference to the Incentive Plan, a copy of which has been filed as an exhibit to the Registration Statement of which this Prospectus is a part. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION Upon completion of the Offering, the Company will establish a Compensation Committee. In the past, matters with respect to the compensation of executive officers of the Company were determined by the members of the Board of Directors as a whole. Messrs. Reimert, Smith and Walker, who were members of the Board of Directors, participated in deliberations concerning compensation. 43 CERTAIN TRANSACTIONS REGISTRATION RIGHTS AGREEMENT In connection with the Offering, the Company will enter into a registration rights agreement among the Company and Messrs. Reimert, Smith, Walker, Loveless, Reimert Family Partners, Ltd., Four Smith's Company, Ltd. and Loveless Enterprises, Ltd. (the "Registration Rights Agreement"). The Registration Rights Agreement will provide for registration rights pursuant to which, upon the request of any of Messrs. Reimert, Smith and Walker (the "Requesting Holders"), the Company will file a registration statement under the Securities Act to register the Common Stock subject to the agreement ("Registrable Securities") held by such Requesting Holders and any other stockholders who are parties to the Registration Rights Agreement and who desire to sell Registrable Securities pursuant to such registration statement, subject to a maximum of two requests by each of Messrs. Reimert, Smith and Walker or their successors and assigns. The first such request may not be made until after 180 days following the closing of the Offering. In addition, subject to certain conditions and limitations, the Registration Rights Agreement will provide that Messrs. Reimert, Smith, Walker and Loveless may participate in any registration by the Company (including any registration resulting from any exercise of a demand right under the Registration Rights Agreement) of any of its equity securities in an underwritten offering. The registration rights covered by the Registration Rights Agreement will generally be transferable to transferees (whether by assignment or by death of the holder) of the Registrable Securities covered thereby. The Registration Rights Agreement will terminate when all Registrable Securities have been (i) distributed to the public pursuant to a registration statement covering such securities that has been declared effective under the Securities Act, or (ii) distributed to the public in accordance with the provisions of Rule 144 (or any similar provision then in force) under the Securities Act. An aggregate of 11,870,000 outstanding shares of Common Stock and 165,789 shares of Common Stock issuable upon exercise of outstanding options (assuming an initial public offering price of $19.00 per share) will be subject to the Registration Rights Agreement. STOCKHOLDERS AGREEMENT Messrs. Reimert, Smith, Walker, Reimert Family Partners, Ltd. and Four Smith's Company, Ltd. are parties to a stockholders agreement (the "Stockholders Agreement") pursuant to which each party has agreed to vote the shares of Common Stock held by such party to elect to the Company's Board of Directors one designee of Mr. Reimert and Reimert Family Partners, Ltd. (the "Reimert Stockholders"), one designee of Mr. Smith and Four Smith's Company, Ltd. (the "Smith Stockholders") and one designee of Mr. Walker. The rights under the Stockholders Agreement are transferable to any heir or legal representative of Messrs. Reimert, Smith or Walker who acquires Common Stock upon the death of such stockholder and who agrees to be bound by the provisions of such Agreement. In the event the Reimert Stockholders, collectively, the Smith Stockholders, collectively, or Mr. Walker (or their permitted transferees as described in the preceding sentence), own less than 10% of the total number of issued and outstanding shares of Common Stock of the Company, the rights and obligations of such person under the Stockholders Agreement are terminated. 44 PRINCIPAL AND SELLING STOCKHOLDERS The following table sets forth certain information with respect to the current beneficial ownership of shares of Common Stock, and as adjusted to reflect the sale of shares offered hereby, by (i) each person who is known by the Company to own beneficially more than 5% of the Common Stock, (ii) each of the Company's directors and named executive officers, (iii) all current executive officers and directors as a group and (iv) each of the Selling Stockholders. See "Risk Factors--Control by Certain Stockholders."
SHARES BENEFICIALLY SHARES BENEFICIALLY OWNED BEFORE OWNED AFTER OFFERING(1) NUMBER OF OFFERING(1) (2) NAME OF BENEFICIAL --------------------- SHARES --------------------- OWNER(3)(4) NUMBER PERCENTAGE OFFERED NUMBER PERCENTAGE ------------------ ---------- ---------- --------- ---------- ---------- Larry E. Reimert(5)...... 4,311,000 30% 750,000 3,561,000 21.11% Gary D. Smith(6)......... 4,311,000 30 750,000 3,561,000 21.11 J. Mike Walker........... 4,311,000 30 750,000 3,561,000 21.11 Gary W. Loveless(7)...... 1,437,000 10 250,000 1,187,000 7.04 James M. Alexander....... -- -- -- -- -- Jerry M. Brooks.......... -- -- -- -- -- All directors and execu- tive officers as a group (6 persons)............. 14,370,000 100% 2,500,000 11,870,000 70.37%
- -------- (1) Shares of Common Stock subject to options that are expected to become exercisable upon the consummation of the Offering are deemed outstanding for computing the percentage ownership of the person holding such options, but are not deemed outstanding for computing the percentage ownership of any other person. (2) Assumes no exercise of the Underwriters' over-allotment option. (3) Except as indicated in the footnotes to this table and pursuant to applicable community property laws, the persons named in the table have sole voting and investment power with respect to all shares of Common Stock. (4) The address of each such person is 13550 Hempstead Highway, Houston, Texas 77040. (5) Includes 4,310,545 shares of Common Stock held by Reimert Family Partners, Ltd., a limited partnership of which Mr. Reimert is the Managing General Partner, and with respect to which he exercises voting and investment power with respect to such shares. (6) Includes 4,310,545 shares of Common Stock held by Four Smith's Company, Ltd., a limited partnership of which Mr. Smith is the Managing General Partner, and with respect to which he exercises voting and investment power with respect to such shares. (7) Includes 1,436,848 shares of Common Stock held by Loveless Enterprises, Ltd., a limited partnership of which Mr. Loveless is the Managing General Partner, and with respect to which he exercises voting and investment power with respect to such shares. 45 SHARES ELIGIBLE FOR FUTURE SALE Upon consummation of the Offering, approximately 16,870,000 shares of Common Stock will be outstanding. The shares of Common Stock sold in the Offering will be freely tradeable without restriction or further registration under the Securities Act, except for certain manner of sale, volume limitations and other restrictions with respect to any shares purchased in the Offering by an affiliate of the Company (a "Company Affiliate"), which will be subject to the resale limitations of Rule 144 under the Securities Act. Under Rule 144 under the Securities Act, a person is an affiliate of an entity if such person directly or indirectly controls or is controlled by or is under common control with such entity and may include certain officers and directors, principal stockholders and certain other stockholders with special relationships. This Prospectus may not be used by Company Affiliates in connection with any resale of shares of Common Stock acquired in the manner described above. In general, under Rule 144 as currently in effect, if a minimum of one year has elapsed since the later of the date of acquisition of the restricted securities from the issuer or from an affiliate of the issuer, a person (or persons whose shares of Common Stock are aggregated), including persons who may be deemed "affiliates" of the Company, would be entitled to sell within any three-month period a number of shares of Common Stock that does not exceed the greater of (i) 1% of the then-outstanding shares of Common Stock (i.e., 168,700 shares immediately after consummation of the Offering) and (ii) the average weekly trading volume during the four calendar weeks preceding the date on which notice of the sale is filed with the Commission. Sales under Rule 144 are also subject to certain provisions as to the manner of sale, notice requirements and the availability of current public information about the Company. In addition, under Rule 144(k), if a period of at least two years has elapsed since the later of the date restricted securities were acquired from the Company or the date they were acquired from an affiliate of the Company, a stockholder who is not an affiliate of the Company at the time of sale and who has not been an affiliate for at least three months prior to the sale would be entitled to sell shares of Common Stock in the public market immediately without compliance with the foregoing requirements under Rule 144. Rule 144 does not require the same person to have held the securities for the applicable periods. The foregoing summary of Rule 144 is not intended to be a complete description thereof. Upon the consummation of the Offering, 11,870,000 shares of Common Stock outstanding will be restricted securities as that term is defined by Rule 144, and, subject to the conditions thereof, including volume limitations, will become eligible for sale 90 days after the Offering. The Company will enter into a Registration Rights Agreement upon the consummation of the Offering whereby it will agree to register under the Securities Act shares of Common Stock held by Messrs. Reimert, Smith, Walker and Loveless and certain of their related family limited partnerships. See "Certain Transactions." The Company intends to file a registration statement on Form S-8 under the Securities Act to register the shares of Common Stock reserved or to be available for issuance pursuant to the Incentive Plan. Shares of Common Stock issued pursuant to such plan generally will be available for sale in the open market by holders who are not Company Affiliates and, subject to the volume and other limitations of Rule 144, by holders who are Company Affiliates. Subject to certain exceptions, each of the Company and the directors, executive officers and certain other stockholders of the Company has agreed that, without the prior written consent of Morgan Stanley & Co. Incorporated on behalf of the Underwriters, it will not, during the period ending 180 days after the date of this Prospectus, (i) offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase or otherwise transfer, lend or dispose of, directly or indirectly, any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock or (ii) enter into any swap or other arrangements that transfers to another, in whole or in part, any of the economic consequences of ownership of the Common Stock, whether any such transaction described in clause (i) or (ii) above is to be settled by delivery of Common Stock or other securities, in cash or otherwise. See "Underwriters." 46 Prior to the Offering, there has been no public market for the Common Stock and no prediction can be made of the effect, if any, that sales of Common Stock or the availability of shares for sale will have on the market price prevailing from time to time. Following the Offering, sales of substantial amounts of Common Stock in the public market or otherwise, or the perception that such sales could occur, could adversely affect the prevailing market price for the Common Stock. DESCRIPTION OF CAPITAL STOCK The Company's authorized capital stock consists of 50,000,000 shares of Common Stock, par value $0.01 per share, and 10,000,000 shares of Preferred Stock, par value $0.01 per share. Following consummation of the Offering there will be approximately 16,870,000 shares of Common Stock outstanding (assuming the over-allotment option is not exercised), and no shares of Preferred Stock will be outstanding. The following summary does not purport to be complete, and reference is made to the more detailed provisions of the Company's Certificate of Incorporation (the "Certificate of Incorporation") and Bylaws, which are filed as exhibits to the registration statement of which this Prospectus is a part. COMMON STOCK The Common Stock possesses ordinary voting rights for the election of directors and in respect of other corporate matters, each share being entitled to one vote. There are no cumulative voting rights, meaning that the holders of a majority of the shares voting for the election of directors can elect all the directors if they choose to do so. The Common Stock carries no preemptive rights and is not convertible, redeemable or assessable, or entitled to the benefits of any sinking fund. The holders of Common Stock are entitled to dividends in such amounts and at such times as may be declared by the Board of Directors out of funds legally available therefor. See "Dividend Policy" for information regarding dividend policy. PREFERRED STOCK The Board of Directors of the Company is empowered, without approval of the stockholders, to cause shares of Preferred Stock to be issued in one or more series, with the numbers of shares of each series to be determined by it. The Board of Directors is authorized to fix and determine the powers, designations, preferences and relative, participating, optional or other rights (including, without limitation, voting powers, full or limited, preferential rights to receive dividends or assets upon liquidation, rights of conversion or exchange into Common Stock, Preferred Stock of any Series or other securities, redemption provisions and sinking fund provisions) between series and between the Preferred Stock or any series thereof and the Common Stock, and the qualifications, limitations or restrictions of such rights. Although the Company has no present intention to issue shares of Preferred Stock, the issuance of shares of Preferred Stock, or the issuance of rights to purchase such shares, could be used to discourage an unsolicited acquisition proposal. For instance, the issuance of a series of Preferred Stock might impede a business combination by including class voting rights that would enable the holders to block such a transaction; or such issuance might facilitate a business combination by including voting rights that would provide a required percentage vote of the stockholders. In addition, under certain circumstances, the issuance of Preferred Stock could adversely affect the voting power of the holders of the Common Stock. Although the Board of Directors is required to make any determination to issue such stock based on its judgment as to the best interests of the stockholders of the Company, the Board of Directors could act in a manner that would discourage an acquisition attempt or other transaction that some or even a majority of the stockholders might believe to be in their best interests or in which stockholders might receive a premium for their stock over the then market price of such stock. The Board of Directors does not at present intend to seek stockholder approval prior to any issuance of currently authorized stock, unless otherwise required by law or the rules of any market on which the Company's securities are traded. 47 For purposes of the Rights Agreement described below, the Company Board has authorized the creation of a series of Preferred Stock designated as "Series A Junior Participating Preferred Stock" (the "Series A Preferred Stock"). An aggregate of 500,000 shares of Preferred Stock have been reserved for issuance as Series A Preferred Stock. Series A Preferred Stock will rank junior to all other series of Preferred Stock that have been or may be established by the Company Board with respect to the payment of dividends and the distribution of assets upon liquidation. In general, the voting, dividend and liquidation rights of Series A Preferred Stock are designed in such a way that one one- hundredth of a share of Series A Preferred Stock will be substantially equivalent from an economic point of view to one share of Common Stock. For a statement of the rights and privileges of Series A Preferred Stock, reference is made to the form of Certificate of Designations which is included as an exhibit to this Registration Statement. STOCKHOLDER RIGHTS PLAN Each share of Common Stock offered hereby includes one right ("Right") to purchase from the Company a unit consisting of one one-hundredth of a share (a "Fractional Share") of Series A Preferred Stock at a specified purchase price per Fractional Share, subject to adjustment in certain events (the "Purchase Price"). The following summary description of the Rights does not purport to be complete and is qualified in its entirety by reference to the Rights Agreement between the Company and a Rights Agent (the "Rights Agreement"), the form of which is filed as an exhibit to the Registration Statement of which this Prospectus is a part and is incorporated herein by reference. Initially, the Rights will attach to all certificates representing outstanding shares of Common Stock, including the shares of Common Stock offered hereby, and no separate certificates for the Rights ("Rights Certificates") will be distributed. The Rights will separate from the Common Stock and a "Distribution Date" will, with certain exceptions, occur upon the earlier of (i) 10 days following a public announcement that a person or group of affiliated or associated persons (an "Acquiring Person") has acquired, or obtained the right to acquire, beneficial ownership of 15% or more of the outstanding shares of Common Stock (the date of the announcement being the "Stock Acquisition Date") or (ii) 10 business days following the commencement of a tender offer or exchange offer that would result in a person's becoming an Acquiring Person. Larry E. Reimert, Gary D. Smith, J. Mike Walker, Reimert Family Partners, Ltd. and Four Smith's Company, Ltd. (the "Major Stockholders"), each of whom will both prior to and, immediately after consummation of the Offering be the beneficial owner of more than 15% of the outstanding shares of Common Stock, will not be deemed to be an Acquiring Person as a result of such ownership position or any subsequent increase in ownership position. In certain circumstances the Distribution Date may be deferred by the Board of Directors. Certain inadvertent acquisitions will not result in a person's becoming an Acquiring Person if the person promptly divests itself of sufficient Common Stock. Until the Distribution Date, (a) the Rights will be evidenced by the Common Stock certificates and will be transferred with and only with those certificates, (b) Common Stock certificates will contain a notation incorporating the Rights Agreement by reference and (c) the surrender for transfer of any certificate for Common Stock also will constitute the transfer of the Rights associated with the stock represented by such certificate. The Rights are not exercisable until the Distribution Date and will expire at the close of business on the date that is the tenth anniversary of the adoption of the Rights Plan, unless earlier redeemed or exchanged by the Company as described below. As soon as practicable after the Distribution Date, Rights Certificates will be mailed to holders of record of Common Stock as of the close of business on the Distribution Date and, from and after the Distribution Date, the separate Rights Certificates alone will represent the Rights. All shares of Common Stock issued prior to the Distribution Date will be issued with Rights. Shares of Common Stock issued after the Distribution Date in connection with certain employee benefit plans or upon conversion of certain securities will be issued with Rights. Except as otherwise determined by the Board of Directors, no other shares of Common Stock issued after the Distribution Date will be issued with Rights. 48 In the event (a "Flip-In Event") that a person becomes an Acquiring Person (except pursuant to a tender or exchange offer for all outstanding shares of Common Stock at a price and on terms that a majority of directors of the Company who are unaffiliated with an Acquiring Person or offeror determines to be fair to and otherwise in the best interests of the Company and its stockholders (a "Permitted Offer")), each holder of a Right will thereafter have the right to receive, upon exercise of such Right, a number of shares of Common Stock (or, in certain circumstances, cash, property or other securities of the Company) having a Current Market Price (as defined in the Rights Agreement) equal to two times the exercise price of the Right. Notwithstanding the foregoing, following the occurrence of any Triggering Event (as defined below), all Rights that are, or (under certain circumstances specified in the Rights Agreement) were, beneficially owned by or transferred to an Acquiring Person (or by certain related parties) will be null and void in the circumstances set forth in the Rights Agreement. Rights are not exercisable following the occurrence of any Flip-In Event until such time as the Rights are no longer redeemable by the Company as set forth below. In the event (a "Flip-Over Event") that, at any time from and after the time an Acquiring Person becomes such, (i) the Company is acquired in a merger or other business combination transaction (other than certain mergers that follow a Permitted Offer) or (ii) 50% or more of the Company's assets or earning power is sold or transferred, each holder of a Right (except Rights that are voided as set forth above) shall thereafter have the right to receive, upon exercise, a number of shares of common stock of the acquiring company having a Current Market Price equal to two times the exercise price of the Right. Flip- In Events and Flip-Over Events are collectively referred to as "Triggering Events." The number of outstanding Rights associated with a share of Common Stock, or the number of Fractional Shares of Preferred Stock issuable upon exercise of a Right and the Purchase Price, are subject to adjustment in the event of a stock dividend on, or a subdivision, combination or reclassification of, the Common Stock occurring prior to the Distribution Date. The Purchase Price payable, and the number of Fractional Shares of Preferred Stock or other securities or property issuable, upon exercise of the Rights are subject to adjustment from time to time to prevent dilution in the event of certain transactions affecting the Preferred Stock. With certain exceptions, no adjustment in the Purchase Price will be required until cumulative adjustments amount to at least 1% of the Purchase Price. No fractional shares of Series A Preferred Stock that are not integral multiples of a Fractional Share are required to be issued and, in lieu thereof, an adjustment in cash may be made based on the market price of the Series A Preferred Stock on the last trading date prior to the date of exercise. Pursuant to the Rights Agreement, the Company reserves the right to require prior to the occurrence of a Triggering Event that, upon any exercise of Rights, a number of Rights be exercised so that only whole shares of Series A Preferred Stock will be issued. At any time until 10 days following the first date of public announcement of the occurrence of a Flip-In Event, the Company may redeem the Rights in whole, but not in part, at a price of $.01 per Right, payable, at the option of the Company, in cash, shares of the Common Stock or such other consideration as the Board of Directors of the Company may determine. Immediately upon the effectiveness of the action of the Board of Directors ordering redemption of the Rights, the Rights will terminate and the only right of the holders of Rights will be to receive the $.01 redemption price. At any time after the occurrence of a Flip-In Event and prior to a person's becoming the beneficial owner of 50% or more of the shares of Common Stock then outstanding or the occurrence of a Flip-Over Event, the Company may, at its option, exchange the Rights (other than Rights owned by an Acquiring Person or an affiliate or an associate of an Acquiring Person, which will have become void), in whole or in part, at an exchange ratio of one share of Common Stock, and/or other equity securities deemed to have the same value as one share of Common Stock, per Right, subject to adjustment. Other than the redemption price, any of the provisions of the Rights Agreement may be amended by the Board of Directors as long as the Rights are redeemable. Thereafter, the provisions of the Rights Agreement other than the redemption price may be amended by the Board of Directors in order to cure any ambiguity, defect 49 or inconsistency, to make changes that do not materially adversely affect the interests of holders of Rights (excluding the interests of any Acquiring Person), or to shorten or lengthen any time period under the Rights Agreement; provided, however, that no amendment to lengthen the time period governing redemption shall be made at such time as the Rights are not redeemable. Until a Right is exercised, the holder thereof, as such, will have no rights to vote or to receive dividends or any other rights as a stockholder of the Company. The Rights will have certain antitakeover effects. They will cause substantial dilution to any person or group that attempts to acquire the Company without the approval of the Company's Board of Directors. As a result, the overall effect of the Rights may be to render more difficult or discourage any attempt to acquire the Company, even if such acquisition may be favorable to the interests of the Company's stockholders. Because the Board of Directors can redeem the Rights or approve a Permitted Offer, the Rights should not interfere with a merger or other business combination approved by the Board. The Rights are being issued to protect the Company's stockholders from coercive or abusive takeover tactics and to afford the Company's Board of Directors more negotiating leverage in dealing with prospective acquirors. OTHER MATTERS Delaware law authorizes corporations to limit or eliminate the personal liability of directors to corporations and their stockholders for monetary damages for breach of directors' fiduciary duty of care. The duty of care requires that, when acting on behalf of the corporation, directors must exercise an informed business judgment based on all material information reasonably available to them. Absent the limitations authorized by Delaware law, directors are accountable to corporations and their stockholders for monetary damages for conduct constituting gross negligence in the exercise of their duty of care. Delaware law enables corporations to limit available relief to equitable remedies such as injunction or rescission. The Certificate of Incorporation limits the liability of directors of the Company to the Company or its stockholders to the fullest extent permitted by Delaware law. Specifically, directors of the Company will not be personally liable for monetary damages for breach of a director's fiduciary duty as a director, except for liability (i) for any breach of the director's duty of loyalty to the Company or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) for unlawful payments of dividends or unlawful stock repurchases or redemptions as provided in Section 174 of the Delaware General Corporation Law or (iv) for any transaction from which the director derived an improper personal benefit. The inclusion of this provision in the Certificate of Incorporation may have the effect of reducing the likelihood of derivative litigation against directors, and may discourage or deter stockholders or management from bringing a lawsuit against directors for breach of their duty of care, even though such an action, if successful, might otherwise have benefited the Company and its stockholders. The Company's Bylaws provide indemnification to the Company's officers and directors and certain other persons with respect to certain matters, and the Company has entered into agreements with each of its directors providing for indemnification with respect to certain matters. The Certificate of Incorporation provides that stockholders may act only at an annual or special meeting of stockholders and may not act by written consent. The Bylaws provide that special meetings of the stockholders can be called only by the Chairman of the Board, the President or a majority of the Board of Directors of the Company. Pursuant to the Certificate of Incorporation, certain transactions involving, among other persons, any person who is a beneficial owner of 10% or more of the aggregate voting power of all outstanding stock of the Company (a "related person") require the affirmative vote of the holders of both (i) at least 80% of the outstanding voting stock and (ii) at least 66% of the outstanding voting stock not beneficially owned by the related person. Transactions subject to such approval include certain mergers or consolidations of the Company or sales or transfers of assets and properties having an aggregate fair market value of $10 million or more. Notwithstanding the foregoing, the Certificate of Incorporation provides that none of Messrs. Reimert, Smith and Walker, their 50 related family limited partnerships or their transferees by virtue of the laws of descent and distribution shall be a related person. Consequently, the current stockholders of the Company are not related persons for these purposes. The Certificate of Incorporation provides that the Board of Directors shall consist of three classes of directors serving for staggered three-year terms. As a result, approximately one-third of the Company's Board of Directors will be elected each year. The classified board provision could prevent a party who acquires control of a majority of the outstanding voting stock of the Company from obtaining control of the Board of Directors until the second annual stockholders' meeting following the date the acquiror obtains the controlling interest. See "Management." The Certificate of Incorporation provides that the number of directors will be no greater than 12 and no less than 3. The Certificate of Incorporation further provides that directors may be removed only for cause (as defined in the Certificate of Incorporation), and then only by the affirmative vote of the holders of at least a majority of all outstanding voting stock entitled to vote. This provision, in conjunction with the provisions of the Certificate of Incorporation authorizing the Board of Directors to fill vacant directorships, will prevent stockholders from removing incumbent directors without cause and filling the resulting vacancies with their own nominees. In addition, the Bylaws provide that the Compensation Committee will consist solely of members who are not employees of the Company and the Audit Committee will include at least a majority of members who are not employees of the Company. The Company is a Delaware corporation and is subject to Section 203 of the Delaware General Corporation Law. In general, Section 203 prevents an "interested stockholder" (defined generally as a person owning 15% or more of a corporation's outstanding voting stock) from engaging in a "business combination" (as defined) with a Delaware corporation for three years following the date such person became an interested stockholder unless (i) before such person became an interested stockholder, the board of directors of the corporation approved the transaction in which the interested stockholder became an interested stockholder or approved the business combination, (ii) upon consummation of the transaction that resulted in the interested stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced (excluding stock held by directors who are also officers of the corporation and by employee stock plans that do not provide employees with the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer) or (iii) following the transaction in which such person became an interested stockholder, the business combination was approved by the board of directors of the corporation and authorized at a meeting of stockholders by the affirmative vote of the holders of two-thirds of the outstanding voting stock of the corporation not owned by the interested stockholder. Under Section 203, the restrictions described above also do not apply to certain business combinations proposed by an interested stockholder following the announcement or notification of one of certain extraordinary transactions involving the corporation and a person who had not been an interested stockholder during the previous three years or who became an interested stockholder with the approval of a majority of the corporation's directors, if such extraordinary transaction is approved or not opposed by a majority of the directors who were directors prior to any person becoming an interested stockholder during the previous three years or were recommended for election or elected to succeed such directors by a majority of such directors. STOCKHOLDER PROPOSALS The Company's Bylaws contain provisions requiring that advance notice be delivered to the Company of any business to be brought by a stockholder before an annual meeting of stockholders, and providing for certain procedures to be followed by stockholders in nominating persons for election to the Board of Directors of the Company. Generally, such advance notice provisions provide that written notice must be given to the Secretary of the Company by a stockholder (i) in the event of business to be brought by a stockholder before an annual meeting, not less than 90 days prior to the anniversary date of the immediately preceding annual meeting of stockholders of the Company (with certain exceptions if the date of the annual meeting is different by more than specified amounts from the anniversary date) and (ii) in the event of nominations of persons for election to the Board of Directors by any stockholder, (a) with respect to an election to be held at the annual meeting of 51 stockholders, not less than 90 days prior to the anniversary date of the immediately preceding annual meeting of stockholders of the Company (with certain exceptions if the date of the annual meeting is different by more than specified amounts from the anniversary date) and (b) with respect to an election to be held at a special meeting of stockholders for the election of directors, not later than the close of business on the tenth day following the day on which notice of the date of the special meeting was mailed to stockholders or public disclosure of the date of the special meeting was made, whichever first occurs. Such notice must set forth specific information regarding such stockholder and such business or director nominee, as described in the Company's Bylaws. TRANSFER AGENT AND REGISTRAR The transfer agent and registrar for the Common Stock is ChaseMellon Shareholder Services, L.L.C. 52 UNDERWRITERS Under the terms and subject to conditions contained in an Underwriting Agreement dated the date hereof (the "Underwriting Agreement"), the Underwriters named below, for whom Morgan Stanley & Co. Incorporated and Donaldson, Lufkin & Jenrette Securities Corporation are acting as Representatives, have severally agreed to purchase, and the Company and the Selling Stockholders have agreed to sell to them, severally, the respective number of shares of Common Stock set forth opposite the names of such Underwriters below:
NUMBER OF NAME SHARES ---- --------- Morgan Stanley & Co. Incorporated..................................... Donaldson, Lufkin & Jenrette Securities Corporation................... --------- Total............................................................... 5,000,000 =========
The Underwriting Agreement provides that the obligations of the several Underwriters to pay for and accept delivery of the shares of Common Stock offered hereby are subject to the approval of certain legal matters by their counsel and to certain other conditions. The Underwriters are obligated to take and pay for all of the shares of Common Stock offered hereby (other than those covered by the Underwriters' over-allotment option described below) if any such shares are taken. The Underwriters initially propose to offer part of the shares of Common Stock directly to the public at the public offering price set forth on the cover page hereof and part to certain dealers at a price that represents a concession not in excess of $ a share under the public offering price. Any Underwriter may allow, and such dealers may reallow, a concession not in excess of $ a share to other Underwriters or to certain other dealers. After the initial offering of the shares of Common Stock, the offering price and other selling terms may from time to time be varied by the Representatives. The Company and the Selling Stockholders have granted to the Underwriters an option, exercisable for 30 days from the date of this Prospectus, to purchase up to an aggregate of 750,000 additional shares of Common Stock at the public offering price set forth on the cover page hereof, less underwriting discounts and commissions. The Underwriters may exercise such option solely for the purpose of covering over-allotments, if any, made in connection with the offering of the shares of Common Stock offered hereby. To the extent such option is exercised, each Underwriter will become obligated, subject to certain conditions, to purchase approximately the same percentage of such additional shares of Common Stock as the number set forth next to such Underwriter's name in the preceding table bears to the total number of shares of Common Stock set forth next to the names of all Underwriters in the preceding table. Morgan Stanley & Co. Incorporated and Donaldson, Lufkin & Jenrette Securities Corporation have informed the Company that they do not intend sales to discretionary accounts to exceed five percent of the total number of shares of Common Stock offered by them. 53 Application has been made for listing of the Common Stock on The New York Stock Exchange under the symbol "DRQ". Each of the Company and the directors, executive officers and certain other stockholders of the Company has agreed that, without the prior written consent of Morgan Stanley & Co. Incorporated on behalf of the Underwriters, it will not, during the period ending 180 days after the date of this Prospectus, (i) offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase or otherwise transfer, lend or dispose of, directly or indirectly, any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock or (ii) enter into any swap or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of the Common Stock, whether any such transaction described in clause (i) or (ii) above is to be settled by delivery of Common Stock or such other securities, in cash or otherwise. The restrictions in this paragraph do not apply to (w) Common Stock issued or options granted pursuant to the Company's Incentive Plan, (x) the sale of Shares to the Underwriters, (y) the issuance by the Company of shares of Common Stock upon the exercise of an option or warrant or the conversion of a security outstanding on the date of this Prospectus of which the Underwriters have been advised in writing or (z) transactions by any person other than the Company relating to shares of Common Stock or other securities acquired in open market transactions after the completion of the Offering of the Shares. In order to facilitate the offering of the Common Stock, the Underwriters may engage in transactions that stabilize, maintain or otherwise affect the price of the Common Stock. Specifically, the Underwriters may over-allot in connection with the offering, creating a short position in the Common Stock for their own account. In addition, to cover over-allotments or to stabilize the price of the Common Stock, the Underwriters may bid for, and purchase, shares of Common Stock in the open market. Finally, the underwriting syndicate may reclaim selling concessions allowed to an Underwriter or a dealer for distributing the Common Stock in the Offering, if the syndicate repurchases previously distributed Common Stock in transactions to cover syndicate short positions, in stabilization transactions or otherwise. Any of these activities may stabilize or maintain the market price of the Common Stock above independent market levels. The Underwriters are not required to engage in these activities, and may end any of these activities at any time. The Company, the Selling Stockholders and the Underwriters have agreed to indemnify each other against certain liabilities, including liabilities under the Securities Act. PRICING OF THE OFFERING Prior to the Offering, there has been no public market for the Common Stock. The initial public offering price will be determined by negotiations between the Company and the Representatives. Among the factors to be considered in determining the initial public offering price will be the future prospects of the Company and its industry in general, sales, earnings and certain other financial operating information of the Company in recent periods, and the price-earnings ratios, price-sales ratios, market prices of securities and certain financial and operating information of companies engaged in activities similar to those of the Company. The estimated initial public offering price range set forth on the cover page of this Preliminary Prospectus is subject to change as a result of market conditions and other factors. 54 LEGAL MATTERS The validity of the shares of Common Stock offered by this Prospectus will be passed upon for the Company by Baker & Botts, L.L.P., Houston, Texas. Certain legal matters in connection with the sale of the Common Stock offered hereby will be passed upon for the Underwriters by Andrews & Kurth L.L.P., Houston, Texas. EXPERTS The consolidated financial statements of the Company at December 31, 1996 and 1995, and for each of the three years in the period ended December 31, 1996, appearing in this Prospectus and Registration Statement have been audited by Ernst & Young LLP, independent auditors, as set forth in their report given upon the authority of such firm as experts in accounting and auditing. ADDITIONAL INFORMATION The Company has not previously been subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Upon completion of the Offering, the Company will be subject to the informational requirements of the Exchange Act, and in accordance therewith, will be required to file periodic reports and other information with the Commission. Such information can be inspected without charge after the Offering at the public reference facilities of the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the regional offices of the Commission located at Suite 1400, Northwest Atrium Center, 500 West Madison Street, Chicago, Illinois 60661 and Seven World Trade Center, 13th Floor, New York, New York 10048. Copies of such material may also be obtained at prescribed rates from the Public Reference Section of the Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. The Commission also maintains a Web site (http://www.sec.gov) that will contain all information filed electronically by the Company with the Commission. The Company has filed the Registration Statement with the Commission under the Securities Act with respect to the shares of Common Stock offered hereby. This Prospectus, which constitutes a part of the Registration Statement, does not contain all of the information set forth in the Registration Statement, including the exhibits and schedules thereto. For further information with respect to the Company and the Common Stock offered hereby, reference is made to the Registration Statement, exhibits and schedules. Statements contained in this Prospectus as to the contents of any contract or other document are not necessarily complete, and, with respect to each such contract or document filed as an exhibit to the Registration Statement, reference is made to the copy of such contract or document filed as an exhibit to the Registration Statement, and each such statement is qualified in all respects by such reference. A copy of the Registration Statement, including the exhibits and schedules thereto, may be inspected and copies thereof may be obtained as described in the preceding paragraph with respect to periodic reports and other information to be filed by the Company under the Exchange Act. 55 INDEX TO FINANCIAL STATEMENTS Report of Independent Auditors............................................. F-2 Consolidated Balance Sheets as of December 31, 1996 and 1997, and as of June 30, 1997 (unaudited)................................................. F-3 Consolidated Statements of Income for the Three Years in the Period Ended December 31, 1996 and for the Six Months Ended June 30, 1996 and 1997 (unaudited)............................................................... F-4 Consolidated Statements of Cash Flows for the Three Years in the Period Ended December 31, 1996 and for the Six Months Ended June 30, 1996 and 1997 (unaudited).......................................................... F-5 Consolidated Statements of Changes in Stockholders' Equity for the Three Years in the Period Ended December 31, 1996 and for the Six Months Ended June 30, 1997 (unaudited)................................................. F-6 Notes to Consolidated Financial Statements................................. F-7
F-1 REPORT OF INDEPENDENT AUDITORS Board of Directors Dril-Quip, Inc. We have audited the accompanying consolidated balance sheets of Dril-Quip, Inc., as of December 31, 1996 and 1995, and the related consolidated statements of income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 1996. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Dril-Quip, Inc., at December 31, 1996 and 1995, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. Houston, Texas April 3, 1997, except Note 11 as to which the date is , 1997 - ------------------------------------------------------------------------------- The foregoing report is in the form that will be signed upon the completion of the reorganization described in Note 11 to the Financial Statements. Ernst & Young LLP Houston, Texas September 18, 1997 F-2 DRIL-QUIP, INC. CONSOLIDATED BALANCE SHEETS
DECEMBER 31 (UNAUDITED) ----------------- JUNE 30, ASSETS 1995 1996 1997 ------ ------- -------- ----------- (IN THOUSANDS) Current assets: Cash....................................... $ 2,579 $ 1,361 $ 766 Trade receivables.......................... 20,150 25,514 24,514 Inventories................................ 38,670 51,571 51,858 Deferred taxes............................. 3,088 3,739 3,741 Prepaids and other current assets.......... 619 789 816 ------- -------- -------- Total current assets..................... 65,106 82,974 81,695 Property, plant, and equipment, net.......... 27,602 31,384 31,675 Other assets................................. 478 419 453 ------- -------- -------- Total assets............................. $93,186 $114,777 $113,823 ======= ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ Current liabilities: Accounts payable........................... $11,807 $ 14,965 $ 11,021 Current maturities of long-term debt....... 3,090 3,537 3,522 Accrued income taxes....................... 1,753 2,712 2,027 Customer prepayments....................... 1,104 7,215 6,610 Accrued compensation....................... 2,830 1,887 2,260 Other accrued liabilities.................. 3,840 3,134 3,378 ------- -------- -------- Total current liabilities................ 24,424 33,450 28,818 Long-term debt............................... 27,962 28,999 28,967 Deferred taxes............................... 1,299 1,446 1,127 ------- -------- -------- Total liabilities........................ 53,685 63,895 58,912 Stockholders' equity: Preferred stock, 10,000,000 shares authorized at $0.01 par value (none issued)................................... -- -- -- Common stock: 50,000,000 shares authorized at $0.01 par value (14,370,000 shares issued)......... 144 144 144 Additional paid-in capital................. -- -- -- Retained earnings.......................... 40,634 49,652 54,765 Foreign currency translation adjustment.... (1,277) 1,086 2 ------- -------- -------- Total stockholders' equity............... 39,501 50,882 54,911 ------- -------- -------- Total liabilities and stockholders' equity.................................. $93,186 $114,777 $113,823 ======= ======== ========
The accompanying notes are an integral part of these statements. F-3 DRIL-QUIP, INC. CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED) SIX MONTHS ENDED YEAR ENDED DECEMBER 31 JUNE 30 -------------------------------- --------------------- 1994 1995 1996 1996 1997 ---------- ---------- ---------- ---------- ---------- (IN THOUSANDS, EXCEPT SHARE AMOUNTS) Revenues................ $ 80,548 $ 108,390 $ 115,864 $ 55,346 $ 68,669 Cost and expenses: Cost of sales......... 58,604 76,471 77,863 37,602 47,725 Selling, general, and administrative....... 11,673 13,597 15,031 7,253 7,839 Engineering and product development.......... 6,069 5,769 6,971 3,245 4,109 ---------- ---------- ---------- ---------- ---------- 76,346 95,837 99,865 48,100 59,673 ---------- ---------- ---------- ---------- ---------- Operating income........ 4,202 12,553 15,999 7,246 8,996 Interest expense........ 2,273 2,944 2,647 1,301 1,400 ---------- ---------- ---------- ---------- ---------- Income before income taxes.................. 1,929 9,609 13,352 5,945 7,596 Income tax provision.... 635 3,023 4,234 1,885 2,483 ---------- ---------- ---------- ---------- ---------- Net income.............. $ 1,294 $ 6,586 $ 9,118 $ 4,060 $ 5,113 ========== ========== ========== ========== ========== Earnings per share...... $ 0.09 $ 0.46 $ 0.63 $ 0.28 $ 0.36 ========== ========== ========== ========== ========== Weighted average shares. 14,370,000 14,370,000 14,370,000 14,370,000 14,370,000 ========== ========== ========== ========== ==========
The accompanying notes are an integral part of these statements. F-4 DRIL-QUIP, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED) SIX MONTHS YEAR ENDED DECEMBER 31 ENDED JUNE 30 -------------------------- ---------------- 1994 1995 1996 1996 1997 ------- ------- -------- ------- ------- (IN THOUSANDS) OPERATING ACTIVITIES Net income...................... $ 1,294 $ 6,586 $ 9,118 $ 4,060 $ 5,113 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization. 3,867 4,648 4,388 2,400 2,608 Loss (gain) on sale of equipment.................... (31) (111) (82) 18 (126) Deferred income taxes......... (118) (426) (505) (710) (336) Changes in operating assets and liabilities: Trade receivables........... 8 (4,025) (4,553) (2,836) 502 Inventories................. (5,755) (6,663) (10,815) (2,826) (1,146) Prepaids and other assets... (447) 556 (144) (464) (18) Trade accounts payable and accrued expenses........... 3,604 5,901 7,778 1,732 (4,160) ------- ------- -------- ------- ------- Net cash provided by operating activities..................... 2,422 6,466 5,185 1,374 2,437 INVESTING ACTIVITIES Purchase of property, plant, and equipment...................... (4,614) (6,184) (7,228) (2,832) (3,603) Proceeds from sale of equipment. 90 525 222 76 224 ------- ------- -------- ------- ------- Net cash used in investing ac- tivities....................... (4,524) (5,659) (7,006) (2,756) (3,379) FINANCING ACTIVITIES Proceeds from revolving line of credit and long-term borrowings..................... 5,400 3,436 4,564 1,156 1,773 Principal payments on long-term debt........................... (2,679) (2,823) (3,203) (1,507) (1,769) Dividends paid.................. (53) (53) (100) -- -- ------- ------- -------- ------- ------- Net cash provided by (used in) financing activities........... 2,668 560 1,261 (351) 4 Effect of exchange rate changes on cash activities............. (971) (232) (658) (265) 343 ------- ------- -------- ------- ------- Increase (decrease) in cash..... (405) 1,135 (1,218) (1,998) (595) Cash at beginning of period..... 1,849 1,444 2,579 2,579 1,361 ------- ------- -------- ------- ------- Cash at end of period........... $ 1,444 $ 2,579 $ 1,361 $ 581 $ 766 ======= ======= ======== ======= =======
The accompanying notes are an integral part of these statements. F-5 DRIL-QUIP, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
UNREALIZED COMMON PAID-IN RETAINED TRANSLATION STOCK CAPITAL EARNINGS ADJUSTMENT TOTAL ------ ------- -------- ----------- ------- (IN THOUSANDS) Balance at December 31, 1993...... $144 $-- $32,860 $(2,737) $30,267 Net income...................... -- -- 1,294 -- 1,294 Translation adjustment.......... -- -- -- 1,395 1,395 Dividends ($.004 per share)..... -- -- (53) -- (53) ---- --- ------- ------- ------- Balance at December 31, 1994...... 144 -- 34,101 (1,342) 32,903 Net income...................... -- -- 6,586 -- 6,586 Translation adjustment.......... -- -- -- 65 65 Dividends ($.004 per share)..... -- -- (53) -- (53) ---- --- ------- ------- ------- Balance at December 31, 1995...... 144 -- 40,634 (1,277) 39,501 Net income...................... -- -- 9,118 -- 9,118 Translation adjustment.......... -- -- -- 2,363 2,363 Dividends ($.007 per share)..... -- -- (100) -- (100) ---- --- ------- ------- ------- Balance at December 31, 1996...... 144 -- 49,652 1,086 50,882 Net income (unaudited).......... -- -- 5,113 -- 5,113 Translation adjustment (unaudited).................... -- -- -- (1,084) (1,084) ---- --- ------- ------- ------- Balance at June 30, 1997 (unau- dited)........................... $144 $-- $54,765 $ 2 $54,911 ==== === ======= ======= =======
The accompanying notes are an integral part of these statements. F-6 DRIL-QUIP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1996 1. ORGANIZATION Dril-Quip, Inc. (the "Company"), manufactures offshore drilling and production equipment which is well suited for use in deepwater, harsh environment and severe service applications. The Company's principal products consist of subsea and surface wellheads, subsea and surface production trees, mudline hanger systems, specialty connectors and associated pipe, drilling and production riser systems, wellhead 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 has three subsidiaries that manufacture and market the Company's products abroad. Dril-Quip (Europe) Limited is located in Aberdeen, Scotland, with branches in Norway, Holland, and Denmark. Dril-Quip Asia Pacific PTE Ltd. is located in Singapore. DQ Holdings PTY Ltd. is located in Perth, Australia. 2. SIGNIFICANT ACCOUNTING POLICIES Principles of Consolidation The consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany accounts and transactions have been eliminated. Interim Information In the opinion of management, the unaudited consolidated interim financial statements include all adjustments, consisting solely of normal recurring adjustments, necessary for a fair presentation of the financial position as of June 30, 1997, and the results of operations and cash flows for each of the six-month periods ended June 30, 1997 and 1996. 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 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 six-month period ended June 30, 1997 are not necessarily indicative of the results to be expected for the full year. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Accounting measurements at interim dates inherently involve greater reliance on estimates than at year-end. Actual results could differ from those estimates. Fair Value of Financial Instruments The Company's financial instruments consist primarily of cash and cash equivalents, receivables, payables, and debt instruments. Cash equivalents include only those investments having a maturity of three months or less at the time of purchase. The carrying values of these financial instruments approximate their respective fair values. Inventories The Company's inventories are reported at the lower of cost (first-in, first-out method) or market. F-7 DRIL-QUIP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Property, Plant, and Equipment Property, plant, and equipment are carried at cost, with depreciation provided on a straight-line basis over their estimated useful lives. Income Taxes The Company accounts for income taxes using the liability method. Deferred income taxes are provided on income and expenses which are reported in different periods for income tax and financial reporting purposes. Revenue Recognition The Company delivers most of its products on an as-needed basis by its customers and records revenues as the products are shipped. Certain revenues are derived from long-term contracts which generally require more than one year to fulfill. Revenues and profits on long-term contracts are recognized under the percentage-of-completion method based on a cost-incurred basis. Losses, if any, on contracts are recognized when they become known. 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 shareholders' equity and have no current effect on earnings or cash flows. These adjustments amounted to a gain of $1,395,000 in 1994, a gain of $65,000 in 1995, and a gain of $2,363,000 in 1996, net of allocated income taxes of $79,000, $37,000, and $458,000, respectively. Foreign currency exchange transactions are recorded using the exchange rate at the date of the settlement. Exchange losses were approximately $167,000 in 1994 and $-0- in 1995, net of income taxes. In 1996, the Company had an exchange gain of $163,000. These amounts are included in the consolidated statements of income. Earnings Per Share Earnings per share amounts are based on weighted average number of shares and common stock equivalents outstanding. Earnings per share on a fully diluted basis are not presented since the effect is not material. 3. INVENTORIES Inventories consist of the following:
DECEMBER 31 (UNAUDITED) --------------- JUNE 30, 1995 1996 1997 ------- ------- ---------- (IN THOUSANDS) Raw materials and supplies.................... $10,028 $15,164 $16,851 Work in progress.............................. 7,208 13,356 17,769 Finished goods and purchased supplies......... 21,434 23,051 17,238 ------- ------- ------- $38,670 $51,571 $51,858 ======= ======= =======
F-8 DRIL-QUIP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 4. PROPERTY, PLANT, AND EQUIPMENT Property, plant, and equipment consist of:
ESTIMATED DECEMBER 31 USEFUL --------------- LIVES 1995 1996 ----------- ------- ------- (IN THOUSANDS) Land and improvements........................ 10-25 years $ 5,798 $ 6,910 Buildings.................................... 15-40 years 12,987 14,759 Machinery and equipment...................... 3-10 years 34,018 39,051 ------- ------- 52,803 60,720 Less accumulated depreciation................ 25,201 29,336 ------- ------- $27,602 $31,384 ======= =======
5. LONG-TERM DEBT Long-term debt consists of the following:
DECEMBER 31 --------------- 1995 1996 ------- ------- (IN THOUSANDS) Revolving lines of credit................................ $14,900 $16,600 Notes payable to bank.................................... 15,872 15,502 Other.................................................... 280 434 ------- ------- 31,052 32,536 Less current portion..................................... 3,090 3,537 ------- ------- $27,962 $28,999 ======= =======
Subsequent to December 31, 1996, the Company renewed the terms of its revolving line of credit. Accordingly, the debt, as of December 31, 1996, is classified in accordance with the terms of the new agreement. The Company's revolving lines of credit provide for borrowings of up to $25,000,000, with a maturity date of June 1, 1999. Additionally, the Company has an advancing credit note providing borrowings of up to $3,000,000 at prime plus 1/2% which matures on October 1, 2001. At December 31, 1996, there were no borrowings under this note. Notes payable to bank include a note with an interest rate of prime plus 1/2%, maturing in July 1999, and a note with an interest rate of the Bank's base rate plus 1 1/2% to 1 3/4%, maturing from February 2002 through December 2006. Substantially all of the Company's assets are pledged under various lending agreements. Interest paid on long-term debt for the years ended December 31, 1994, 1995, and 1996 was $2,352,000, $2,883,000, and $2,695,000, respectively. Scheduled maturities of long-term debt are as follows: 1997--$3,537,000; 1998--$3,486,000; 1999--$23,592,000; 2000--$623,000; 2001--$528,000; and thereafter--$770,000. F-9 DRIL-QUIP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 6. INCOME TAXES Income before income taxes consisted of the following:
1994 1995 1996 ------ ------ ------- Domestic........................................... $2,130 $5,634 $ 9,068 Foreign............................................ (201) 3,975 4,284 ------ ------ ------- Total............................................ $1,929 $9,609 $13,352 ====== ====== =======
The income tax provision consists of the following:
1994 1995 1996 ----- ------ ------ (IN THOUSANDS) Current: Federal.......................................... $ 620 $2,671 $3,408 Foreign.......................................... 133 778 1,331 ----- ------ ------ Total current.................................. 753 3,449 4,739 Deferred: Federal.......................................... 110 (825) (505) Foreign.......................................... (228) 399 -- ----- ------ ------ Total deferred................................. (118) (426) (505) ----- ------ ------ $635 $3,023 $4,234 ===== ====== ======
The difference between the effective tax rate reflected in the provision for income taxes and the U.S. federal statutory rate was as follows:
1994 1995 1996 ---- ---- ---- Federal income tax statutory rate....................... 34.0% 34.0% 34.0% Benefit of foreign sales corporation.................... (2.6) (1.4) (1.8) Other................................................... 1.5 (1.1) (.5) ---- ---- ---- Effective tax rate...................................... 32.9% 31.5% 31.7% ==== ==== ====
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred tax liabilities and assets are as follows:
DECEMBER 31 ------------- 1995 1996 ------ ------ (IN THOUSANDS) Deferred tax liability: Fixed assets............................................. $1,299 $1,446 Deferred tax assets: Deferred profit on intercompany sales.................... 1,913 2,499 Other--net............................................... 1,175 1,240 ------ ------ Total deferred tax assets.................................. 3,088 3,739 ------ ------ Net deferred tax asset..................................... $1,789 $2,293 ====== ======
F-10 DRIL-QUIP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) Undistributed earnings of the Company's foreign subsidiaries are considered to be indefinitely reinvested and, accordingly, no provision for U.S. federal income taxes has been provided thereon. Upon distribution of those earnings in the form of dividends or otherwise, the Company would be subject to both U.S. income taxes (subject to an adjustment for foreign tax credits) and withholding taxes payable to the various foreign countries. Determination of the amount of unrecognized deferred U.S. income tax liability is not practicable. The Company paid approximately $1,708,000, $1,909,000, and $4,314,000 in income taxes in 1994, 1995, and 1996, respectively. 7. EMPLOYEE BENEFIT PLANS The Company has a defined-contribution 401(k) plan covering domestic employees and a defined-contribution pension plan covering certain foreign employees. The Company generally makes contributions to the plans equal to each participant's eligible contributions for the plan year up to a specified percentage of the participant's annual compensation. The Company's contribution expense was $440,000, $501,000, and $548,000 in 1994, 1995, and 1996, respectively. 8. COMMITMENTS AND CONTINGENCIES The Company leases certain office, shop, and warehouse facilities; automobiles; and equipment and expenses all lease payments when incurred. Total lease expense incurred was $1,076,000, $923,000, and $853,000 in 1994, 1995, and 1996, respectively. Annual minimum lease commitments at December 31, 1996 are as follows: 1997--$546,000; 1998--$491,000; 1999--$267,000; and 2000--$35,000. The Company operates its business and markets its products and services in most of the significant oil and gas producing areas in the world and is, therefore, subject to the risk customarily attendant to international operations and dependency on the condition of the oil and gas industry. Additionally, products of the Company are used in potentially hazardous drilling, completion, and production applications that can cause personal injury, product liability, and environmental claims. Although exposure to such risk has not resulted in any significant problems in the past, there can be no assurance that future developments will not adversely impact the Company. 9. STOCKHOLDERS' EQUITY In August 1996, the Company revised its capital structure and retired all outstanding common stock and issued new common stock. The new common stock includes shares with voting and nonvoting rights. These changes in the capital structure have been retroactively reflected in the financial statements. Earnings per share and dividends per share in prior years have been restated to reflect the change in the capital structure. F-11 DRIL-QUIP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 10. GEOGRAPHIC AREAS
1994 1995 1996 ------- -------- -------- Revenues United States: Domestic......................................... $27,710 $ 31,945 $ 36,759 Export........................................... 8,520 5,938 7,561 Intercompany..................................... 12,464 30,243 28,188 ------- -------- -------- Total United States............................ 48,694 68,126 72,508 Europe, Middle East, and Africa.................... 34,629 52,978 54,728 Asia-Pacific....................................... 10,005 18,150 16,944 Eliminations....................................... (12,780) (30,864) (28,316) ------- -------- -------- Total.......................................... $80,548 $108,390 $115,864 ======= ======== ======== Operating Income United States...................................... $ 3,670 $ 10,944 $ 13,693 Europe, Middle East, and Africa.................... 392 2,948 3,309 Asia-Pacific....................................... 86 2,113 1,825 Eliminations....................................... 54 (3,452) (2,828) ------- -------- -------- Total.......................................... $ 4,202 $ 12,553 $ 15,999 ======= ======== ======== Identifiable Assets United States...................................... $42,265 $ 44,627 $ 50,664 Europe, Middle East, and Africa.................... 30,405 39,823 59,564 Asia-Pacific....................................... 8,621 12,730 9,700 Eliminations....................................... (2,083) (3,994) (5,151) ------- -------- -------- Total.......................................... $79,208 $ 93,186 $114,777 ======= ======== ========
Export sales from the United States to unaffiliated customers consist of sales to South America, Latin America, and Canada. Europe, Middle East and Africa area consists of manufacturing operations located in Europe with sales primarily to Europe's North Sea and limited export sales to Africa and the Middle East. Asia-Pacific's sales are primarily to Australia, Thailand, Malaysia, and Indonesia. Eliminations of operating profits are related to intercompany inventory transfers that are deferred until shipment is made to third-party customers. General corporate expense is generally allocated to geographic areas based on revenues. One of the Company's customers, the Royal Dutch Shell Group of Companies accounted for approximately 12%, 11% and 19% of consolidated sales in 1994, 1995, and 1996, respectively. F-12 DRIL-QUIP, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED) 11. INITIAL PUBLIC OFFERING The Company filed a registration statement with the Securities and Exchange Commission in August 1997 to register the sale of 5,000,000 shares of its common stock (the "Offering"). Of the 5,000,000 shares, 2,500,000 shares are being sold by the Company and 2,500,000 shares are being sold by Selling Stockholders. Before the consummation of the Offering, the Company effected a recapitalization wherein each outstanding share of its non-voting common stock was converted into 0.95 shares of its voting common stock. Thereafter, each outstanding share of its voting common stock was converted into 15.12472 shares of voting common stock, resulting in 14,370,000 outstanding shares. The existing corporation, Dril-Quip, Inc., a Texas corporation ("Dril-Quip-- Texas"), was merged (the "Merger") into Dril-Quip, Inc., a Delaware corporation ("Dril-Quip--Delaware"). The Merger resulted in the Company's reincorporation from Texas to Delaware. The Company anticipates authorized common stock of 50 million shares, par value $0.01 per share, and 10 million shares of preferred stock, par value $0.01 per share. The financial statements have been retroactively restated to give effect to the recapitalization. In addition, prior to the consummation of the Offering, the Company adopted the Dril-Quip, Inc. 1997 Incentive Plan (the "Incentive Plan"). The Company has reserved 1,700,000 shares of Common Stock for use in connection with the Incentive Plan. Persons eligible for awards under the Incentive Plan are employees holding positions of responsibility with the Company or any subsidiaries and whose performance can have a significant effect on the success of the Company. To date, no awards have been made under the Incentive Plan. F-13 PART II INFORMATION NOT REQUIRED IN PROSPECTUS ITEM 13. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION. The following are the estimated expenses (other than underwriting discounts and commission) of the issuance and distribution of the securities being registered, all of which shall be paid by the Company: Securities and Exchange Commission Registration Fee............. $ 31,364 NASD Filing Fee................................................. 10,850 New York Stock Exchange Fees.................................... 126,600 Printing Expenses............................................... 100,000 Legal Fees and Expenses......................................... 225,000 Accountants' Fees and Expenses.................................. 125,000 Blue Sky Fees and Expenses...................................... 5,000 Transfer Agent and Registrar Fees............................... 12,100 Miscellaneous Expenses.......................................... 64,086 -------- Total......................................................... $700,000 ========
- -------- * To be furnished by amendment. ITEM 14. INDEMNIFICATION OF DIRECTORS AND OFFICERS. Delaware General Corporation Law Section 145(a) of the General Corporation Law of the State of Delaware (the "DGCL") provides that a corporation may indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation) by reason of the fact that such person is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys' fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by such person in connection with such action, suit or proceeding if such person acted in good faith and in a manner such person reasonably believed to be in or not opposed to the best interests of the corporation and, with respect to any criminal action or proceeding, had no reasonable cause to believe such person's conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement or conviction or upon a plea of nolo contendere or its equivalent shall not, of itself, create a presumption that the person did not act in good faith and in a manner which such person reasonably believed to be in or not opposed to the best interests of the corporation and, with respect to any criminal action or proceeding, had reasonable cause to believe that such person's conduct was unlawful. Section 145(b) of the DGCL states that a corporation may indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the corporation to procure a judgment in its favor by reason of the fact that such person is or was a director, officer, employee or agent of the corporation, or is serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against expenses (including action or suit if such person acted in good faith and in a manner such person reasonably believed to be in or not opposed to the best interests of the corporation and except that no indemnification shall be made in respect of any claim, issue or matter as to which such person shall have been adjudged to be liable to the corporation unless and only to the extent that the Court of Chancery or the court in which such action or suit was brought shall determine upon application that, despite the adjudication of liability but in view of all the circumstances of the case, such person is fairly and reasonably entitled to indemnity for such expenses that the Court of Chancery or such other court shall deem proper. II-1 Section 145(c) of the DGCL provides that to the extent that a present or former director or officer of a corporation has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in subsections (a) and (b) of Section 145, or in defense of any claim, issue or matter therein, such person shall be indemnified against expenses (including attorneys' fees) actually and reasonably incurred by such person in connection therewith. Section 145(d) of the DGCL states that any indemnification under subsections (a) and (b) of Section 145 (unless ordered by a court) shall be made by the corporation only as authorized in the specific case upon a determination that indemnification of the present or former director, officer, employee or agent is proper in the circumstances because such person has met the applicable standard of conduct set forth in subsections (a) and (b). Such determination shall be made, with respect to a person who is a director or officer at the time of such determination, (1) by the board of directors by a majority vote of the directors who were not parties to such action, suit or proceeding, even though less than a quorum or (2) by a committee of such directors designated by majority vote of such directors, even though less than a quorum or (3) if such a quorum is not obtainable or, even if obtainable, a quorum of disinterested directors so directs, by independent legal counsel in a written opinion or (4) by the stockholders. Section 145(e) of the DGCL provides that expenses (including attorneys' fees) incurred by an officer or director in defending any civil, criminal, administrative or investigative action, suit or proceeding may be paid by the corporation in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of such director or officer to repay such amount if it ultimately is determined that such person is not entitled to be indemnified by the corporation as authorized in Section 145. Such expenses (including attorneys' fees) incurred by former directors and officers or other employees and agents may be so paid upon such terms and conditions, if any, as the corporation deems appropriate. Section 145(f) of the DGCL states that the indemnification and advancement of expenses provided by, or granted pursuant to, the other subsections of Section 145 shall not be deemed exclusive of any other rights to which those seeking indemnification or advancement of expenses may be entitled under any bylaw, agreement, vote of stockholders or disinterested directors or otherwise, both as to action in such person's official capacity and as to action in another capacity while holding such office. Section 145(g) of the DGCL provides that a corporation shall have the power to purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against any liability asserted against such person and incurred by such person in any such capacity, or arising out of such person's status as such, whether or not the corporation would have the power to indemnify such person against such liability under the provisions of Section 145. Section 145(j) of the DGCL states that the indemnification and advancement of expenses provided by, or granted pursuant to, Section 145 shall, unless otherwise provided when authorized or ratified, continue as to a person who has ceased to be a director, officer, employee or agent and shall inure to the benefit of the heirs, executors and administrators of such a person. Certificate of Incorporation The Certificate of Incorporation of the Company provides that a director of the Company shall not be personally liable to the Company or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liability (i) for any breach of the director's duty of loyalty to the Company or its stockholders, (ii) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) under Section 174 of the DGCL or (iv) for any transaction from which the director derived an improper personal benefit. If the DGCL is amended to authorize the further elimination or limitation of the liability of directors, then the liability of a director of the Company, in addition to the limitation on personal liability described above, shall be limited to the fullest extent permitted by the amended DGCL. Further, any repeal or II-2 modification of such provision of the Restated Certificate of Incorporation by the stockholders of the Company shall be prospective only, and shall not adversely affect any limitation on the personal liability of a director of the Company existing at the time of such repeal or modification. Bylaws The Bylaws of the Company provide that each person who was or is made a party or is threatened to be made a party to or is involved in any action, suit or proceeding, whether civil, criminal, administrative or investigative, by reason of the fact that he or she, or a person of whom he or she is the legal representative, is or was or has agreed to become a director or officer of the Company or is or was serving or has agreed to serve at the request of the Company as a director, officer, employee or agent of another corporation or of a partnership, joint venture, trust or other enterprise, including service with respect to employee benefit plans, whether the basis of such proceeding is alleged action in an official capacity as a director or officer or in any other capacity while serving or having agreed to serve as a director or officer, shall be indemnified and held harmless by the Company to the fullest extent authorized by the DGCL, as the same exists or may thereafter be amended (but, in the case of any such amendment, only to the extent that such amendment permits the Company to provide broader indemnification rights than said law permitted the Company to provide prior to such amendment) against all expense, liability and loss (including, without limitation, attorneys' fees, judgments, fines, ERISA excise taxes or penalties and amounts paid or to be paid in settlement) reasonably incurred or suffered by such person in connection therewith and such indemnification shall continue as to a person who has ceased to serve in the capacity which initially entitled such person to indemnity thereunder, and shall inure to the benefit of his or her heirs, executors and administrators; provided, however, that the Company shall indemnify any such person seeking indemnification in connection with a proceeding (or part thereof) initiated by such person only if such proceeding (or part thereof) was authorized by the board of directors of the Company. The Bylaws further provide that the right to indemnification conferred thereby shall be a contract right and shall include the right to be paid by the Company the expenses incurred in defending any such proceeding in advance of its final disposition; provided, however, that, if the DGCL requires, the payment of such expenses incurred by a current, former or proposed director or officer in his or her capacity as a director or officer or proposed director or officer (and not in any other capacity in which service was or is or has been agreed to be rendered by such person while a director or officer, including, without limitation, service to an employee benefit plan) in advance of the final disposition of a proceeding, shall be made only upon delivery to the Company of an undertaking, by or on behalf of such indemnified person, to repay all amounts so advanced if it shall ultimately be determined that such indemnified person is not entitled to be indemnified under the Bylaws or otherwise. In addition, the Bylaws provide that the Company may, by action of its board of directors, provide indemnification to employees and agents of the Company, individually or as a group, with the same scope and effect as the indemnification to employees and agents of the Company, individually or as a group, with the same scope and effect as the indemnification of directors and officers provided for in the Bylaws. The Bylaws include related provisions meant to facilitate the indemnitee's receipt of such benefits. These provisions cover, among other things: (i) specification of the method of determining entitlement to indemnification and the selection of independent counsel that will in some cases make such determination; (ii) specification of certain time periods by which certain payments or determinations must be made and actions must be taken; and (iii) the establishment of certain presumptions in favor of an indemnitee. The benefits of certain of these provisions are available to an indemnitee only if there has been a change in control (as defined therein). Underwriting Agreement The Underwriting Agreement provides for the indemnification of the directors and officers of the Company in certain circumstances. Insurance The Company intends to obtain a policy of liability insurance to insure its officers and directors against losses resulting from certain acts committed by them in their capacities as officers and directors of the Company. II-3 ITEM 15. RECENT SALES OF UNREGISTERED SECURITIES. None. ITEM 16. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES. (a) Exhibits.
EXHIBIT NUMBER DESCRIPTION ------- ----------- *1.1 --Form of Underwriting Agreement. +2.1 --Form of Agreement and Plan of Merger by and Between Dril-Quip, Inc., a Texas corporation, and Dril-Quip, Inc., a Delaware corporation. *3.1 --Certificate of Incorporation of the Company. +3.2 --Form of Amended and Restated Certificate of Incorporation of the Company. *3.3 --Bylaws of the Company. +3.4 --Form of Certificate of Designations for Series A Junior Participating Preferred Stock. +4.1 --Form of certificate representing Common Stock. +4.2 --Form of Registration Rights Agreement among Dril-Quip, Inc. and certain stockholders. +4.3 --Form of Rights Agreement between Dril-Quip, Inc. and ChaseMellon Shareholder Services, L.L.C., as rights agent. +5.1 --Opinion of Baker & Botts, L.L.P. 10.1 --Credit Agreement between Bank One Texas, National Association and Dril-Quip, Inc., dated March 30, 1994. 10.2 --First Amendment to Credit Agreement between Dril-Quip, Inc. and Bank One Texas, National Association, dated December 20, 1994. 10.3 --Second Amendment to Credit Agreement between Dril-Quip, Inc. and Bank One Texas, National Association, dated December 13, 1995. 10.4 --Third Amendment to Credit Agreement between Dril-Quip, Inc. and Bank One Texas, National Association, dated February 14, 1997. 10.5 --Credit Agreement between Bank One Texas, National Association, and Dril-Quip (Europe) Ltd., dated March 30, 1994. 10.6 --First Amendment to Credit Agreement between Dril-Quip (Europe) Ltd. and Bank One Texas, National Association, dated December 20, 1994. 10.7 --Second Amendment to Credit Agreement between Dril-Quip (Europe) Ltd. and Bank One Texas, National Association, dated December 13, 1995. 10.8 --Third Amendment to Credit Agreement between Dril-Quip (Europe) Ltd. and Bank One Texas, National Association, dated February 14, 1997. 10.9 --Loan Agreement between Dril-Quip (Europe) Ltd. and the Bank of Scotland, dated June 7, 1996. 10.10 --Loan Agreement between Dril-Quip (Europe) Ltd. and the Bank of Scotland, dated September 19, 1994. 10.11 --Loan Agreement between Dril-Quip (Europe) Ltd. and the Bank of Scotland, dated December 12, 1991. +10.12 --Form of Employment Agreement between Dril-Quip, Inc. and each of Messrs. Reimers, Smith and Walker. +10.13 --Form of Dril-Quip, Inc. 1997 Incentive Plan. 21.1 --Subsidiaries of the Company. *23.1 --Consent of Ernst & Young LLP. +23.2 --Consent of Baker & Botts, L.L.P. (included in Exhibit 5.1). 23.3 --Consent of James M. Alexander to be named as a director. 24.1 --Powers of Attorney (included on signature page). *27.1 --Financial Data Schedule.
- -------- * Filed herewith. + To be filed by amendment. II-4 (b) Financial Statement Schedules. All schedules are omitted because they are not applicable or because the required information is contained in the financial statements or notes thereto included in this Registration Statement. ITEM 17. UNDERTAKINGS. The undersigned registrant hereby undertakes to provide to the Underwriters, at the closing specified in the Underwriting Agreement, certificates representing the shares of Common Stock offered hereby in such denominations and registered in such names as required by the Underwriters to permit prompt delivery to each purchaser. Insofar as indemnification for liabilities arising under the Securities Act of 1933 may be permitted to directors, officers and controlling persons of the registrant pursuant to the foregoing provisions, or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrant of expenses incurred or paid by a director, officer or controlling person of the registrant in the successful defense of any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with securities being registered, the registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the Act and will be governed by the final adjudication of such issue. The undersigned registrant hereby undertakes that: (1) For the purposes of determining any liability under the Securities Act of 1933, the information omitted from the form of Prospectus filed as a part of this Registration Statement in reliance upon Rule 430A and contained in a form of Prospectus filed by the registrant pursuant to Rule 424(b)(1) or (4) or 497(h) under the Securities Act shall be deemed to be part of this Registration Statement as of the time it was declared effective. (2) For the purpose of determining any liability under the Securities Act of 1933, each post-effective amendment that contains a form of Prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof. II-5 SIGNATURES PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THE REGISTRANT HAS DULY CAUSED THIS AMENDMENT TO REGISTRATION STATEMENT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, IN THE CITY OF HOUSTON, STATE OF TEXAS, ON THE 19TH DAY OF SEPTEMBER, 1997. DRIL-QUIP, INC. /s/ J. Mike Walker By __________________________________ J. Mike Walker Co-Chairman of the Board PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1933, THIS AMENDMENT TO THE REGISTRATION STATEMENT HAS BEEN SIGNED BY THE FOLLOWING PERSONS IN THE CAPACITIES INDICATED ON SEPTEMBER 19, 1997.
SIGNATURE TITLE --------- ----- /s/ Larry E. Reimert Director and Co-Chairman of the Board ____________________________________ (Co-Principal Executive Officer and Larry E. Reimert Principal Financial Officer) /s/ Gary D. Smith Director and Co-Chairman of the Board ____________________________________ (Co-Principal Executive Officer) Gary D. Smith /s/ J. Mike Walker Director and Co-Chairman of the Board ____________________________________ (Co-Principal Executive Officer) J. Mike Walker /s/ Jerry Brooks Chief Accounting Officer ____________________________________ (Principal Accounting Officer) Jerry M. Brooks /s/ Gary W. Loveless Director ____________________________________ Gary W. Loveless
II-6 EX-1.1 2 FORM OF UNDERWRITING AGREEMENT EXHIBIT 1.1 5,000,000 Shares DRIL-QUIP, INC. COMMON STOCK, $.01 PAR VALUE UNDERWRITING AGREEMENT __________________ __, 1997 _______________ __, 1997 Morgan Stanley & Co. Incorporated Donaldson, Lufkin & Jenrette Securities Corporation c/o Morgan Stanley & Co. Incorporated 1585 Broadway New York, New York 10036 Dear Sirs and Mesdames: Dril-Quip, Inc., a Delaware corporation (the "Company"), proposes to issue and sell to the several Underwriters named in Schedule II hereto (the "Underwriters"), and certain shareholders of the Company (the "Selling Shareholders") named in Schedule I hereto severally propose to sell to the several Underwriters, an aggregate of 5,000,000 shares of the Common Stock, par value $.01 per share, of the Company (the "Firm Shares"), of which 2,500,000 shares are to be issued and sold by the Company and 2,500,000 shares are to be sold by the Selling Shareholders, each Selling Shareholder selling the amount set forth opposite such Selling Shareholder's name under the column entitled "Number of Firm Shares To be Sold" in Schedule I hereto. The Company also proposes to issue and sell to the several Underwriters not more than an additional 750,000 shares of its Common Stock, $.01 par value per share (the "Additional Shares"), if and to the extent that you, as managers of the offering (the "Managers"), shall have determined to exercise, on behalf of the Underwriters, the right to purchase such shares of common stock granted to the Underwriters in Section 3 hereof. The Firm Shares and the Additional Shares are hereinafter collectively referred to as the "Shares." The shares of Common Stock, $.01 par value per share, of the Company to be outstanding after giving effect to the sales contemplated hereby are hereinafter referred to as the "Common Stock." The Company and the Selling Shareholders are hereinafter sometimes collectively referred to as the "Sellers." The Company has filed with the Securities and Exchange Commission (the "Commission") a registration statement, including a prospectus, relating to the Shares. The registration statement as amended at the time it becomes effective, including the information (if any) deemed to be part of the registration statement at the time of effectiveness pursuant to Rule 430A under the Securities Act of 1933, as amended (the "Securities Act"), is hereinafter referred to as the "Registration Statement;" the prospectus in the form first used to confirm sales of Shares is hereinafter referred to as the "Prospectus." If the Company has filed an abbreviated registration statement to register additional shares of Common Stock pursuant to Rule 462(b) under the Securities Act (the "Rule 462 Registration Statement"), then any reference herein to the term "Registration Statement" shall be deemed to include such Rule 462 Registration Statement. Capitalized terms used but not defined herein shall have the meanings set forth in the Prospectus. 1. REPRESENTATIONS AND WARRANTIES OF THE COMPANY. The Company represents and warrants to and agrees with each of the Underwriters that: (a) The Registration Statement has become effective; no stop order suspending the effectiveness of the Registration Statement is in effect, and no proceedings for such purpose are pending before or, to the Company's knowledge, threatened, by the Commission. (b) (i) The Registration Statement, when it became effective, did not contain and, as amended or supplemented, if applicable, will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein not misleading, (ii) the Registration Statement and the Prospectus comply and, as amended or supplemented, if applicable, will comply in all material respects with the Securities Act and the applicable rules and regulations of the Commission thereunder and (iii) the Prospectus does not contain and, as amended or supplemented, if applicable, will not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading, except that the representations and warranties set forth in this paragraph 1(b) do not apply to statements or omissions in the Registration Statement or the Prospectus as amended or supplemented, as applicable, based upon information relating to any Underwriter furnished to the Company in writing by such Underwriter through you expressly for use therein. (c) The Company has been duly incorporated, is validly existing as a corporation in good standing under the laws of the State of Delaware, has the corporate power and authority to own its property and to conduct its business as described in the Prospectus and is duly qualified to transact business and is in good standing in each jurisdiction in which the conduct of its business or its ownership or leasing of property requires such qualification, except to the extent that the failure to be so qualified or be in good standing would not have a material adverse effect on the Company and its subsidiaries, taken as a whole. (d) Each subsidiary of the Company has been duly organized, is validly existing as a private limited company in good standing under the laws of the jurisdiction of its incorporation, has the corporate power and authority to own its property and to conduct its business as described in the Prospectus and has complied with the applicable requirements for it to conduct business in each jurisdiction in which it conducts business or owns or leases -2- property, except to the extent that the failure to so comply would not have a material adverse effect on the Company and its subsidiaries, taken as a whole. (e) All of the outstanding shares of capital stock of each subsidiary of the Company that is a private limited company are validly issued and outstanding and, except as may be disclosed in the Prospectus, all of the shares of each subsidiary of the Company are owned, directly or indirectly, by the Company, free and clear of any liens, charges or encumbrances or any other claim of any third party. (f) This Agreement has been duly authorized, executed and delivered by the Company . (g) The authorized capital stock of the Company conforms as to legal matters in all material respects to the description thereof contained in the Prospectus. (h) The shares of Common Stock (including the Shares to be sold by the Selling Shareholders) outstanding prior to the issuance of the Shares to be sold by the Company have been duly authorized and are validly issued, fully paid and non-assessable. (i) The Shares to be sold by the Company have been duly authorized and, when issued and delivered to the Underwriters against payment therefor in accordance with the terms of this Agreement, will be validly issued, fully paid and non-assessable, and the issuance of such Shares will not be subject to any preemptive or similar rights. (j) There has not occurred any material adverse change, or any development involving a prospective material adverse change, in the condition, financial or otherwise, or in the earnings, business or operations of the Company and its subsidiaries, taken as a whole, from that set forth in the Prospectus (exclusive of any amendments or supplements thereto subsequent to the date of this Agreement). (k) The execution and delivery by the Company of, and the performance by the Company of its obligations under, this Agreement will not contravene any provision of (i) the Certificate of Incorporation or Bylaws of the Company, (ii) any agreement or other instrument binding upon the Company or any of its subsidiaries, (iii) any law applicable to the Company and its subsidiaries or (iv) any judgment, order or decree of any governmental body, agency or court having jurisdiction over the Company or any subsidiary which contravention, in the case of clauses (ii), (iii) or (iv), would have a material adverse effect on the condition, financial or otherwise, or the earnings, business or operations of the Company and its subsidiaries, taken as a whole, and no consent, approval, authorization or order of, or qualification with, any governmental body or agency is required for the performance by the Company of its obligations under this Agreement, except such as may be required by the securities or Blue Sky laws of the various states in connection with the offer and sale of the Shares, the registration of the Shares under the Securities Act, the -3- registration of the Common Stock under the Exchange Act, the clearance of the offering of the Shares with the National Association of Securities Dealers, Inc. ("NASD"), and the consent of Bank One, Texas, National Association, pursuant to the Bank One Credit Facilities (which consent has been obtained). (l) The financial statements included in the Registration Statement and the Prospectus present fairly in all material respects the financial position, results of operations and cash flows of the Company and its subsidiaries, in each case at the dates and for the periods presented, and have been prepared in conformity with generally accepted accounting principles applied on a consistent basis throughout the periods presented, except as disclosed therein. Since the respective dates of such financial statements, there has been no material adverse change in the condition or general affairs, financial or otherwise, of the Company and its subsidiaries taken as a whole, other than as described in the Prospectus. (m) Ernst & Young LLP, whose report appears in the Registration Statement and the Prospectus, were, as of the date of such report, and are, as of the date hereof, independent public accountants with respect to the Company and its subsidiaries, as required by the Securities Act and the applicable rules and regulations of the Commission thereunder. (n) Subsequent to the respective dates as of which information is given in the Registration Statement and the Prospectus, (1) the Company and its subsidiaries have not incurred any material liability or obligation, direct or contingent, nor entered into any material transaction not in the ordinary course of business; (2) the Company has not purchased any of its outstanding capital stock, nor declared, paid or otherwise made any dividend or distribution of any kind on its capital stock other than ordinary and customary dividends; and (3) there has not been any material change in the capital stock, short-term debt or long-term debt of the Company and its consolidated subsidiaries, except in each case as described in or contemplated by the Prospectus. (o) The Company and its subsidiaries have good and indefeasible title in fee simple to all real property and good title to all personal property owned by them which is material to the business of the Company and its subsidiaries, in each case free and clear of all liens, encumbrances and defects except such as are provided pursuant to the Bank One Credit Facilities, such as are described in the Prospectus or such as do not materially affect the value of such property and do not interfere with the use made and proposed to be made of such property by the Company and its subsidiaries; and any real property and buildings held under lease by the Company and its subsidiaries are held by them under valid, subsisting and enforceable leases with such exceptions as are not material and do not interfere with the use made and proposed to be made of such property and buildings by the Company and its subsidiaries, in each case except as described in or contemplated by the Prospectus. -4- (p) The Company and its subsidiaries own or possess, or can acquire on reasonable terms, all material patents, patent rights, licenses, inventions, copyrights, know-how (including trade secrets and other unpatented and/or unpatentable proprietary or confidential information, systems or procedures), trademarks, service marks and trade names currently employed by them in connection with their business as described in the Prospectus other than those which if not so owned or possessed would not have a material adverse effect on the condition, financial or otherwise, or on the earnings, business or operations of the Company and its subsidiaries, taken as a whole; and neither the Company nor any of its subsidiaries has received any notice of infringement of or conflict with asserted rights of others with respect to any patent, patent rights, licenses, inventions, copyrights, know-how (including trade secrets and other unpatented and/or unpatentable proprietary or confidential information, systems or procedures), trademarks, service marks and trade names currently employed by them in connection with their business as described in the Prospectus which, singly or in the aggregate, if the subject of an unfavorable decision, ruling or finding, would result in any material adverse change in the condition, financial or otherwise, or in the earnings, business or operations of the Company and its subsidiaries, taken as a whole. (q) No material labor dispute with the employees of the Company or any of its subsidiaries exists, except as described in or contemplated by the Prospectus, or, to the knowledge of the Company, is imminent. (r) The Company and each of its subsidiaries maintains insurance against such losses and risks and in such amounts as are customary in the businesses in which they are engaged; neither the Company nor any such subsidiary has within the last five years been refused any insurance coverage sought or applied for; and neither the Company nor any such subsidiary has any reason to believe that it will not be able to renew its existing insurance coverage as and when such coverage expires or to obtain similar coverage from similar insurers as may be necessary to continue its business at a cost that would not materially and adversely affect the condition, financial or otherwise, or the earnings, business or operations of the Company and its subsidiaries, taken as a whole, except as described in or contemplated by the Prospectus. (s) The Company and its subsidiaries possess all certificates, authorizations and permits issued by the appropriate federal, state or foreign regulatory authorities necessary to conduct their respective businesses as described in the Prospectus, except for certificates, authorizations and permits which, if not obtained, would not, individually or in the aggregate, have a material adverse effect on the ability of the Company and its subsidiaries, taken as a whole, to conduct their businesses as described in the Prospectus; and neither the Company nor any such subsidiary has received any notice of proceedings relating to the revocation or modification of any such certificate, authorization or permit which, singly or in the aggregate, if the subject of an unfavorable decision, ruling or finding, would result in a material adverse change in the condition, financial or otherwise, or in the earnings, business -5- or operations of the Company and its subsidiaries, taken as a whole, except as described in or contemplated by the Prospectus. (t) There are no legal or governmental proceedings pending or, to the Company's knowledge, threatened, to which the Company or any of its subsidiaries is a party or to which any of the properties of the Company or any of its subsidiaries is subject that are required to be described in the Registration Statement or the Prospectus and are not so described or any statutes, regulations, contracts or other documents that are required to be described in the Registration Statement or the Prospectus or to be filed as exhibits to the Registration Statement that are not described or filed as required. (u) The preliminary prospectus, dated ____________, 1997, filed as part of the Registration Statement complied when so filed in all material respects with the Securities Act and the applicable rules and regulations of the Commission thereunder. (v) The Company is not and, after giving effect to the offering and sale of the Shares and the application of the proceeds thereof as described in the Prospectus under the caption "Use of Proceeds", will not be an "investment company" as such term is defined in the Investment Company Act of 1940, as amended. (w) The Company and its subsidiaries (i) are in compliance with any and all applicable foreign, federal, state and local laws and regulations relating to the protection of human health and safety, the environment or hazardous or toxic substances or wastes, pollutants or contaminants ("Environmental Laws"), (ii) have received all permits, licenses or other approvals required of them under applicable Environmental Laws to conduct their respective businesses and (iii) are in compliance with all terms and conditions of any such permit, license or approval, except where such noncompliance with Environmental Laws, failure to receive required permits, licenses or other approvals or failure to comply with the terms and conditions of such permits, licenses or approvals would not, singly or in the aggregate, have a material adverse effect on the Company and its subsidiaries, taken as a whole. (x) There are no costs or liabilities associated with Environmental Laws (including, without limitation, any capital or operating expenditures required for clean-up, closure of properties or compliance with Environmental Laws or any permit, license or approval, any related constraints on operating activities and any potential liabilities to third parties) which would, singly or in the aggregate, have a material adverse effect on the Company and its subsidiaries, taken as a whole. (y) Except as described in the Prospectus, there are no contracts, agreements or understandings between the Company and any person granting such person the right to require the Company to file a registration statement under the Securities Act with respect to -6- any securities of the Company or to require the Company to include such securities with the Shares registered pursuant to the Registration Statement. (z) The Company and each of its subsidiaries maintain a system of internal accounting controls sufficient to provide reasonable assurances that (i) transactions are executed in accordance with management's general or specific authorizations, (ii) transactions are recorded as necessary to permit preparation of financial statements in conformity with generally accepted accounting principles and to maintain accountability for assets, (iii) access to assets is permitted only in accordance with management's general or specific authorization and (iv) the recorded accountability for assets is compared with existing assets at reasonable intervals and appropriate action is taken with respect to any differences. (aa) The Company has complied with all provisions of Section 517.075, Florida Statutes relating to doing business with the Government of Cuba or with any person or affiliate located in Cuba. (bb) The Company has not taken and shall not take, directly or indirectly, any action designed to cause or result in, or which has constituted or which might reasonably be expected to constitute, the stabilization or manipulation of the price of the shares of Common Stock to facilitate the sale or resale of the Shares. 2. AGREEMENTS TO SELL AND PURCHASE. Each Seller, severally and not jointly, hereby agrees to sell to the several Underwriters, and each Underwriter, upon the basis of the representations and warranties herein contained, but subject to the conditions hereinafter stated, agrees, severally and not jointly, to purchase from such Seller at $__________________ a share (the "Purchase Price") the number of Firm Shares (subject to such adjustments to eliminate fractional shares as you may determine) that bears the same proportion to the number of Firm Shares to be sold by such Seller as the number of Firm Shares set forth in Schedule II hereto opposite the name of such Underwriter bears to the total number of Firm Shares. On the basis of the representations and warranties contained in this Agreement, and subject to its terms and conditions, (i) the Company agrees to sell to the Underwriters 375,000 Additional Shares, and the Underwriters shall have a one-time right to purchase, severally and not jointly, up to 375,000 Additional Shares from the Company at the Purchase Price and (ii) each Selling Shareholder agrees to sell, severally and not jointly, the number of Additional Shares set -7- forth opposite such Selling Shareholder's name under the column entitled "Number of Additional Shares to be Sold" in Schedule I hereto. If you, on behalf of the Underwriters, elect to exercise such option, you shall so notify the Sellers in writing not later than 30 days after the date of this Agreement, which notice shall specify the number of Additional Shares to be purchased by the Underwriters and the date on which such shares are to be purchased. Such date may be the same as the Closing Date but not earlier than the Closing Date nor later than ten business days after the date of such notice. Additional Shares may be purchased as provided in Section 4 hereof solely for the purpose of covering over-allotments made in connection with the offering of the Firm Shares. If any Additional Shares are to be purchased, each Underwriter agrees, severally and not jointly, to purchase the number of Additional Shares (subject to such adjustments to eliminate fractional shares as you may determine) that bears the same proportion to the total number of Additional Shares to be purchased as the number of Firm Shares set forth in Schedule II hereto opposite the name of such Underwriter bears to the total number of Firm Shares. If less than all of the Additional Shares are to be purchased, the number of Additional Shares to be sold by each of the Company and the Selling Shareholders shall be that number of Additional Shares that bears the same proportion to the total number of Firm Shares to be sold by each of the Company and the Selling Shareholders. Each Seller hereby agrees that, without the prior written consent of Morgan Stanley on behalf of the Underwriters, it will not, during the period ending 180 days after the date of the Prospectus, (i) offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase or otherwise transfer or dispose of, directly or indirectly, any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock or (ii) enter into any swap or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of the Common Stock, whether any such transaction described in clause (i) or (ii) above is to be settled by delivery of Common Stock or such other securities, in cash or otherwise. The foregoing sentence shall not apply to (A) the Shares to be sold hereunder, (B) any shares of Common Stock issued by the Company upon the exercise of an option or warrant or the conversion of a security outstanding on the date hereof of which the Underwriters have been advised in writing or (C) grants of options and issuances of Common Stock pursuant to employee benefit plans described in the Prospectus. In addition, each Selling Shareholder, agrees that, without the prior written consent of Morgan Stanley on behalf of the Underwriters, it will not, during the period ending 180 days after the date of the Prospectus, make any demand for, or exercise any right with respect to, the registration of any shares of Common Stock or any security convertible into or exercisable or exchangeable for Common Stock. 3. TERMS OF PUBLIC OFFERING. The Sellers are advised by you that the Underwriters propose to make a public offering of their respective portions of the Shares as soon after the Registration Statement and this Agreement have become effective as in your judgment is advisable. The Sellers are further advised by you that the Shares are to be offered to the public initially at $__________________ a share (the "Public Offering Price") and to certain dealers selected by you at a price that represents a concession not in excess of $__________________ a share under the Public Offering -8- Price, and that any Underwriter may allow, and such dealers may reallow, a concession, not in excess of $__________________ a share, to any Underwriter or to certain other dealers. 4. PAYMENT AND DELIVERY. Payment for the Firm Shares to be sold by each Seller shall be made to such Seller in federal or other funds immediately available in New York City against delivery of such Firm Shares for the respective accounts of the several Underwriters at 10:00 A.M., New York City time, on ___________________________, 1997, or at such other time on the same or such other date, not later than ___________________________, 1997, as shall be designated in writing by you. The time and date of such payment are hereinafter referred to as the "Closing Date." Payment for any Additional Shares shall be made to the Company in federal or other funds immediately available in New York City against delivery of such Additional Shares for the respective accounts of the several Underwriters at 10:00 A.M., New York City time, on the date specified in the notice described in Section 3 or on such other date, in any event not later than ___________________________, 1997, as shall be designated in writing by you. The time and date of such payment are hereinafter referred to as the "Option Closing Date." Certificates for the Firm Shares and the Additional Shares shall be in definitive form and registered in such names and in such denominations as you shall request in writing not later than one full business day prior to the Closing Date or the Option Closing Date, as the case may be. The certificates evidencing the Firm Shares and Additional Shares shall be delivered to you on the Closing Date or the Option Closing Date, as the case may be, for the respective accounts of the several Underwriters, with any transfer taxes payable in connection with the transfer of the Shares to the Underwriters duly paid, against payment of the Purchase Price therefor. 5. CONDITIONS TO THE UNDERWRITERS' OBLIGATIONS. The obligations of the Sellers to sell the Shares to the Underwriters and the several obligations of the Underwriters to purchase and pay for the Shares on the Closing Date are subject to the condition that the Registration Statement shall have become effective not later than 5:30 p.m. (New York City time) on the date hereof. The several obligations of the Underwriters are subject to the following further conditions: (a) Subsequent to the execution and delivery of this Agreement and prior to the Closing Date there shall not have occurred any change, or any development involving a prospective change, in the condition, financial or otherwise, or in the earnings, business or operations of the Company and its subsidiaries, taken as a whole, from that set forth in the Prospectus (exclusive of any amendments or supplements thereto subsequent to the date of this Agreement) that, in your judgment, is material and adverse and that makes it, in your judgment, impracticable to market the Shares on the terms and in the manner contemplated in the Prospectus. -9- (b) The Underwriters shall have received on the Closing Date a certificate, dated the Closing Date and signed by an executive officer of the Company, to the effect that the representations and warranties of the Company contained in this Agreement are true and correct as of the Closing Date and that the Company has complied with all of the agreements and satisfied all of the conditions on its part to be performed or satisfied hereunder on or before the Closing Date. The officer signing and delivering such certificate may rely upon the best of his or her knowledge as to proceedings threatened. (c) The Underwriters shall have received on the Closing Date an opinion of Baker & Botts L.L.P., outside counsel for the Company, dated the Closing Date, to the effect that: (i) the Company has been duly incorporated, is validly existing as a corporation in good standing under the laws of the State of Delaware, has the corporate power and authority to own its property and to conduct its business as described in the Prospectus and is duly qualified to transact business as a foreign corporation and is in good standing in the State of Texas; (ii) the authorized capital stock of the Company conforms in all material respects as to legal matters to the description thereof contained in the Prospectus under the caption "Description of Capital Stock;" (iii) the shares of Common Stock (including the Shares to be sold by the Selling Shareholders) outstanding prior to the issuance of the Shares to be sold by the Company have been duly authorized and are validly issued, fully paid and non-assessable; (iv) the Shares to be sold to the Underwriters by the Company have been duly authorized and, when issued and delivered to the Underwriters against payment therefor in accordance with the terms of this Agreement, will be validly issued, fully paid and non-assessable, and the issuance of such Shares will not be subject to any preemptive rights arising under the Company's Certificate of Incorporation or Bylaws or under the DGCL or, to the knowledge of such counsel, similar rights that entitle or will entitle any person to acquire any Shares upon the issuance of such shares of capital stock by the Company; (v) this Agreement has been duly authorized, executed and delivered by the Company; (vi) the execution and delivery by the Company of, and the performance by the Company of its obligations under, this Agreement will not contravene any provision of (i) the Certificate of Incorporation or Bylaws of the Company, (ii) to -10- such counsel's knowledge, any agreement or other instrument binding upon the Company or any of its subsidiaries, (iii) to such counsel's knowledge, any judgment, order or decree of any governmental body, agency or court of the United States, Delaware or Texas having jurisdiction over the Company or any subsidiary or (iv) any law of the United States, the State of Texas or the Delaware General Corporation Law ("DGCL") which contravention, in the case of clauses (ii), (iii) or (iv), would have a material adverse effect on the condition, financial or otherwise, or the earnings, business or operations of the Company and its subsidiaries, taken as a whole, and no consent, approval, authorization or order of, or qualification with, any governmental body or agency of the United States, Delaware or Texas is required for the performance by the Company of its obligations under this Agreement, except such as may be required by the securities or Blue Sky laws of the various states in connection with the offer and sale of the Shares and the clearance of the offering of the Shares with the NASD, as to which such counsel need express no opinion, and except for the registration of the Shares under the Securities Act, the registration of the Common Stock under the Exchange Act and the consent of Bank One, Texas, National Association, pursuant to the Bank One Credit Facilities, which have been obtained; (vii) the statements (A) in the Prospectus under the caption "Description of Capital Stock" and (B) in the Registration Statement in Items 14 and 15, in each case insofar as such statements constitute summaries of the legal matters, documents or proceedings referred to therein, present in all material respects the information called for with respect to such legal matters, documents and proceedings; (viii) after due inquiry, such counsel does not know of any legal or governmental proceedings pending or threatened to which the Company or any of its subsidiaries is a party or to which any of the properties of the Company or any of its subsidiaries is subject that, in such counsel's judgment, are required to be described in the Registration Statement or the Prospectus and are not so described or of any contracts or other documents that, in such counsel's judgment, are required to be described in the Registration Statement or the Prospectus or to be filed as exhibits to the Registration Statement that are not described or filed as required; (ix) the Company is not and, after giving effect to the offering and sale of the Shares and the application of the proceeds therefor as described in the Prospectus, will not be an "investment company" as such term is defined in the Investment Company Act of 1940, as amended; and (x) the Registration Statement and Prospectus (except for financial statements and schedules (including the notes thereto and the auditors' report thereon) and other financial and statistical data included therein, and the exhibits thereto, as to which such counsel need not express any opinion) comply as to form -11- in all material respects with the Securities Act and the applicable rules and regulations of the Commission thereunder. In rendering such opinion, such counsel may rely, to the extent they deem such reliance proper, as to matters of fact upon certificates of officers of the Company and of government officials; provided that copies of such certificates shall be delivered to you. Such counsel shall also be entitled to state that its opinion is limited to the federal laws of the United States of America, the laws of the State of Texas and the DGCL. In addition to the opinion set forth above, such counsel shall state the following: Such counsel has participated in conferences with officers and other representatives of the Company, representatives of the independent public accountants of the Company and your representatives at which the contents of the Registration Statement and the Prospectus and related matters were discussed. Although such counsel is not passing upon, and does not assume any responsibility for, the accuracy, completeness or fairness of the statements contained in the Registration Statement and the Prospectus, such counsel advises you that, on the basis of the foregoing, no facts have come to the attention of such counsel which lead such counsel to believe that the Registration Statement (other than (i) the financial statements and schedules (including the notes thereto and the auditors' reports thereon) included therein and (ii) the other financial and statistical information included therein, as to which such counsel has not been asked to comment), as of the time it became effective, contained any untrue statement of a material fact or omitted to state any material fact required to be stated therein or necessary to make the statements therein not misleading or that the Prospectus (other than (i) the financial statements and schedules (including the notes thereto and the auditors' reports thereon) included therein and (ii) the other financial and statistical information included therein, as to which such counsel has not been asked to comment), as of the issue date thereof and as of the Closing Date, contained any untrue statement of a material fact or omitted to state any material fact required to be stated therein or necessary to make the statements therein, in light of the circumstances in which they were made, not misleading. (d) The Underwriters shall have received on the Closing Date an opinion of Baker & Botts L.L.P., counsel for the Selling Shareholders, dated the Closing Date, to the effect that: (i) this Agreement has been duly authorized, executed and delivered by or on behalf of each of the Selling Shareholders; (ii) the execution and delivery by each Selling Shareholder of, and the performance by such Selling Shareholder of its obligations under, this Agreement will not contravene (i) any provision of such Selling Shareholder's agreement of limited partnership (if such Selling Shareholder is a partnership), (ii) to such counsel's knowledge, any agreement or other instrument binding upon such Selling -12- Shareholder, (iii) to such counsel's knowledge, any law of the United States, the State of Texas or the DGCL applicable to such Selling Shareholder or (iv) to such counsel's knowledge, any judgment, order or decree of any governmental body, agency or court of the United States, Delaware or Texas having jurisdiction over such Selling Shareholder, and no consent, approval, authorization or order of, or qualification with, any governmental body or agency of the United States, Delaware or Texas is required for the performance by such Selling Shareholder of its obligations under this Agreement, except such as may be required by the securities or Blue Sky laws of the various states in connection with offer and sale of the Shares and the clearance of the offering of the Shares with the NASD, as to which such counsel need express no opinion, and except for the registration of the Shares under the Securities Act, the registration of the Common Stock under the Exchange Act and the consent of Bank One, Texas, National Association, pursuant to the Bank One Credit Facilities, which have been obtained; (iii) each of the Selling Shareholders has valid title to the Shares to be sold by such Selling Shareholder and has the legal right, power and capacity (if such Selling Shareholder is an individual) and partnership power and authority (if such Selling Shareholder is a partnership), to enter into this Agreement and to sell, transfer and deliver the Shares to be sold by such Selling Shareholder; and (iv) Assuming that each of the several Underwriters purchasing Shares from the Selling Shareholders pursuant to this Agreement purchases the Shares for value in good faith without notice of any adverse claim within the meaning of the Uniform Commercial Code, delivery of the Shares to be sold by each Selling Shareholder pursuant to this Agreement will pass title to such Shares free and clear of any security interests, claims, liens, equities and other encumbrances. In rendering such opinion, such counsel may rely upon an opinion or opinions of counsel for any Selling Shareholders and, to the extent such counsel deems appropriate, as to matters of fact upon certificates of the Selling Shareholders and of government officials; provided that (A) each such counsel for the Selling Shareholders is satisfactory to your counsel, (B) a copy of each opinion so relied upon is delivered to you and is in the form and substance satisfactory to your counsel and (C) copies of such certificates shall be delivered to you. Such counsel shall also be entitled to state that its opinion is limited to the federal laws of the United States of America, the laws of the State of Texas and the DGCL. (e) The Underwriters shall have received on the Closing Date an opinion of Andrews & Kurth L.L.P., counsel for the Underwriters, dated the Closing Date, covering the matters referred to in subparagraphs (iv), (v), (vii) (but only as to the statements in the Prospectus under "Description of Capital Stock" and "Underwriters") and the last paragraph of paragraph (c) above. -13- With respect to the last paragraph of paragraph (c) above, Andrews & Kurth L.L.P., may state that their opinion and belief are based upon their participation in the preparation of the Registration Statement and Prospectus and any amendments or supplements thereto and review and discussion of the contents thereof, but are without independent check or verification, except as specified. The opinions of Baker & Botts L.L.P. described in paragraphs (c) and (d) above (and any opinions of counsel for any Selling Shareholder referred to in the immediately preceding paragraph) shall be rendered to the Underwriters at the request of the Company or one or more of the Selling Shareholders, as the case may be, and shall so state therein. (f) The Underwriters shall have received, on each of the date hereof and the Closing Date, a letter dated the date hereof or the Closing Date, as the case may be, in form and substance satisfactory to the Underwriters, from Ernst & Young LLP, independent public accountants, containing statements and information of the type ordinarily included in accountants' "comfort letters" to underwriters with respect to the financial statements and certain financial information contained in the Registration Statement and the Prospectus; provided that the letter delivered on the Closing Date shall use a "cut-off" date not earlier than the date hereof. (g) The "lock up" agreements, each substantially in the form of Exhibit A hereto, between you and each officer and director of the Company that is not a Seller relating to sales and certain other dispositions of shares of Common Stock or certain other securities, delivered to you on or before the date hereof, shall be in full force and effect on the Closing Date. (h) The Shares shall have been approved for listing on the New York Stock Exchange, subject only to official notice of issuance. The several obligations of the Underwriters to purchase Additional Shares hereunder are subject to the delivery to you on the Option Closing Date of such documents as you may reasonably request with respect to the good standing of the Company, the due authorization and issuance of the Additional Shares and other matters related to the issuance of the Additional Shares. 7. COVENANTS OF THE COMPANY. In further consideration of the agreements of the Underwriters herein contained, the Company covenants with each Underwriter as follows: (a) To furnish to you, without charge, three signed copies of the Registration Statement (including exhibits thereto) and for delivery to each other Underwriter a conformed copy of the Registration Statement (without exhibits thereto) and to furnish to you in New York City, without charge, prior to 5:00 P.M. New York City time on the business day next succeeding the date of this Agreement and during the period mentioned -14- in paragraph (c) below, as many copies of the Prospectus and any supplements and amendments thereto or to the Registration Statement as you may reasonably request. (b) Before amending or supplementing the Registration Statement or the Prospectus, to furnish to you a copy of each such proposed amendment or supplement and not to file any such proposed amendment or supplement to which you reasonably object, and to file with the Commission within the applicable period specified in Rule 424(b) under the Securities Act any prospectus required to be filed pursuant to such Rule. (c) If, during such period after the first date of the public offering of the Shares as in the opinion of counsel for the Underwriters the Prospectus is required by law to be delivered in connection with sales by an Underwriter or dealer, any event shall occur or condition exist as a result of which it is necessary to amend or supplement the Prospectus in order to make the statements therein, in the light of the circumstances when the Prospectus is delivered to a purchaser, not misleading, or if, in the opinion of counsel for the Underwriters, it is necessary to amend or supplement the Prospectus to comply with applicable law, forthwith to prepare, file with the Commission and furnish, at its own expense, to the Underwriters and to the dealers (whose names and addresses you will furnish to the Company) to which Shares may have been sold by you on behalf of the Underwriters and to any other dealers upon request, either amendments or supplements to the Prospectus so that the statements in the Prospectus as so amended or supplemented will not, in the light of the circumstances when the Prospectus is delivered to a purchaser, be misleading or so that the Prospectus, as amended or supplemented, will comply with law. (d) To endeavor to qualify the Shares for offer and sale under the securities or Blue Sky laws of such jurisdictions as you shall reasonably request; provided, however, that the Company shall not be required to qualify to do business or file a general consent to service of process in any such jurisdictions. (e) To make generally available to the Company's security holders and to you as soon as practicable an earnings statement covering the twelve- month period ending December 31, 1998 that satisfies the provisions of Section 11(a) of the Securities Act and the rules and regulations of the Commission thereunder. 8. EXPENSES. Whether or not the transactions contemplated in this Agreement are consummated or this Agreement is terminated, the Company agrees to pay or cause to be paid all expenses incident to the performance of the obligations of the Sellers under this Agreement, including: (i) the fees, disbursements and expenses of the Company's counsel, the Company's accountants and counsel for the Selling Shareholders in connection with the registration and delivery of the Shares under the Securities Act and all other fees or expenses in connection with the preparation and filing of the Registration Statement, any preliminary prospectus, the Prospectus and amendments and supplements to any of the foregoing, including all printing costs associated -15- therewith, and the mailing and delivering of copies thereof to the Underwriters and dealers, in the quantities hereinabove specified, (ii) all costs and expenses related to the transfer and delivery of the Shares to the Underwriters, including any transfer or other taxes payable thereon, (iii) the cost of printing or producing any Blue Sky or Legal Investment memorandum in connection with the offer and sale of the Shares under state securities laws and all expenses in connection with the qualification of the Shares for offer and sale under state securities laws as provided in Section 7(d) hereof, including filing fees and the reasonable fees and disbursements of counsel for the Underwriters in connection with such qualification and in connection with the Blue Sky or Legal Investment memorandum, (iv) all filing fees and disbursements of counsel to the Underwriters incurred in connection with the review and qualification of the offering of the Shares by the NASD, (v) all fees and expenses in connection with the preparation and filing of the registration statement on Form 8-A relating to the Common Stock and all costs and expenses incident to listing the Shares on the New York Stock Exchange, (vi) the cost of printing certificates representing the Shares, (vii) the costs and charges of any transfer agent, registrar or depositary, (viii) the costs and expenses of the Company relating to investor presentations on any "road show" undertaken in connection with the marketing of the offering of the Shares, including, without limitation, expenses associated with the production of road show slides and graphics, fees and expenses of any consultants engaged in connection with the road show presentations with the prior approval of the Company, travel and lodging expenses of the representatives and officers of the Company and any such consultants, and the cost of any aircraft chartered in connection with the road show, and (ix) all other costs and expenses incident to the performance of the obligations of the Company hereunder for which provision is not otherwise made in this Section. It is understood, however, that except as provided in this Section, Section 9 entitled "Indemnity and Contribution", and the last paragraph of Section 11 below, the Underwriters will pay all of their costs and expenses, including fees and disbursements of their counsel, stock transfer taxes payable on resale of any of the Shares by them, costs and expenses of the Underwriters in connection with any "road show" including, without limitation, their travel and lodging expenses and any advertising expenses connected with any offers they may make. The provisions of this Section shall not supersede or otherwise affect any agreement that the Sellers may otherwise have for the allocation of such expenses among themselves. 9. INDEMNITY AND CONTRIBUTION. (a) The Company agrees to indemnify and hold harmless each Underwriter and each person, if any, who controls any Underwriter within the meaning of either Section 15 of the Securities Act or Section 20 of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), from and against any and all losses, claims, damages and liabilities (including, without limitation, any legal or other expenses reasonably incurred by any Underwriter or any such controlling person in connection with defending or investigating any such action or claim) caused by any untrue statement or alleged untrue statement of a material fact contained in the Registration Statement or any amendment thereof, any preliminary prospectus or the Prospectus (as amended or supplemented if the Company shall have furnished any amendments or supplements thereto), or caused by any omission or alleged omission to state therein a material fact required to be stated -16- therein or necessary to make the statements therein not misleading, except insofar as such losses, claims, damages or liabilities are caused by any such untrue statement or omission or alleged untrue statement or omission based upon information relating to any Underwriter furnished to the Company in writing by such Underwriter through you expressly for use therein; provided, however, that the foregoing indemnity agreement with respect to any preliminary prospectus shall not inure to the benefit of any Underwriter from whom the person asserting any such losses, claims, damages or liabilities purchased Shares, or any person controlling such Underwriter, if a copy of the Prospectus (as then amended or supplemented if the Company shall have furnished any amendments or supplements thereto) was not sent or given by or on behalf of such Underwriter to such person if required by law to have been so delivered at or prior to the written confirmation of the sale of the Shares to such person, and if the Prospectus (as so amended or supplemented) would have cured the defect giving rise to such losses, claims, damages or liabilities, unless such failure is the result of noncompliance by the Company with Section 7(a) hereof. (b) Each Underwriter agrees, severally and not jointly, to indemnify and hold harmless the Company, the Selling Shareholders, the directors of the Company, the officers of the Company who sign the Registration Statement and each person, if any, who controls the Company or any Selling Shareholder within the meaning of either Section 15 of the Securities Act or Section 20 of the Exchange Act from and against any and all losses, claims, damages and liabilities (including, without limitation, any legal or other expenses reasonably incurred in connection with defending or investigating any such action or claim) caused by any untrue statement or alleged untrue statement of a material fact contained in the Registration Statement or any amendment thereof, any preliminary prospectus or the Prospectus (as amended or supplemented if the Company shall have furnished any amendments or supplements thereto), or caused by any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein not misleading, but only with reference to information relating to such Underwriter furnished to the Company in writing by such Underwriter through you expressly for use in the Registration Statement, any preliminary prospectus, the Prospectus or any amendments or supplements thereto. (c) In case any proceeding (including any governmental investigation) shall be instituted involving any person in respect of which indemnity may be sought pursuant to paragraph (a) or (b) of this Section 9, such person (the "indemnified party") shall promptly notify the person against whom such indemnity may be sought (the "indemnifying party") in writing, and the indemnifying party, upon request of the indemnified party, shall retain counsel reasonably satisfactory to the indemnified party to represent the indemnified party and any others the indemnifying party may designate in such proceeding and shall pay the fees and disbursements of such counsel related to such proceeding. In any such proceeding, any indemnified party shall have the right to retain its own counsel, but the fees and expenses of such counsel shall be at the expense of such indemnified party unless (i) the indemnifying party and the indemnified party shall have mutually agreed to the retention of such counsel or (ii) the named parties to any such proceeding (including any impleaded parties) include both the indemnifying party and the indemnified party and representation of both parties by the same counsel would be inappropriate due to actual or potential -17- differing interests between them. It is understood that the indemnifying party shall not, in respect of the legal expenses of any indemnified party in connection with any proceeding or related proceedings in the same jurisdiction, be liable for (i) the fees and expenses of more than one separate firm (in addition to any local counsel) for all Underwriters and all persons, if any, who control any Underwriter within the meaning of either Section 15 of the Securities Act or Section 20 of the Exchange Act, (ii) the fees and expenses of more than one separate firm (in addition to any local counsel) for the Company, its directors, its officers who sign the Registration Statement and each person, if any, who controls the Company within the meaning of either Section 15 of the Securities Act or Section 20 of the Exchange Act and (iii) the fees and expenses of more than one separate firm (in addition to any local counsel) for all Selling Shareholders and all persons, if any, who control any Selling Shareholder within the meaning of either Section 15 of the Securities Act or Section 20 of the Exchange Act, and that all such fees and expenses shall be reimbursed as they are incurred. In the case of any such separate firm for the Underwriters and such control persons of any Underwriters, such firm shall be designated in writing by Morgan Stanley. In the case of any such separate firm for the Company, and such directors, officers and control persons of the Company, such firm shall be designated in writing by the Company. In the case of any such separate firm for the Selling Shareholders and such control persons of any Selling Shareholders, such firm shall be designated in writing by Selling Shareholders holding a majority of the Shares sold by all Selling Shareholders hereunder. The indemnifying party shall not be liable for any settlement of any proceeding effected without its written consent, but if settled with such consent or if there be a final judgment for the plaintiff, the indemnifying party agrees to indemnify the indemnified party from and against any loss or liability by reason of such settlement or judgment. No indemnifying party shall, without the prior written consent of the indemnified party, effect any settlement of any pending or threatened proceeding in respect of which any indemnified party is or could have been a party and indemnity could have been sought hereunder by such indemnified party, unless such settlement includes an unconditional release of such indemnified party from all liability on claims that are the subject matter of such proceeding. (d) To the extent the indemnification provided for in paragraph (a) or (b) of this Section 9 is unavailable to an indemnified party or insufficient in respect of any losses, claims, damages or liabilities referred to therein, then each indemnifying party under such paragraph, in lieu of indemnifying such indemnified party thereunder, shall contribute to the amount paid or payable by such indemnified party as a result of such losses, claims, damages or liabilities (i) in such proportion as is appropriate to reflect the relative benefits received by the indemnifying party or parties on the one hand and the indemnified party or parties on the other hand from the offering of the Shares or (ii) if the allocation provided by clause (i) above is not permitted by applicable law, in such proportion as is appropriate to reflect not only the relative benefits referred to in clause (i) above but also the relative fault of the indemnifying party or parties on the one hand and of the indemnified party or parties on the other hand in connection with the statements or omissions that resulted in such losses, claims, damages or liabilities, as well as any other relevant equitable considerations. The relative benefits received by the Company on the one hand and the Underwriters on the other hand in connection with the offering of the Shares shall be deemed to be in the same respective proportions as the net proceeds from the offering of the Shares (before deducting -18- expenses) received by the Sellers and the total underwriting discounts and commissions received by the Underwriters, in each case as set forth in the table on the cover of the Prospectus, bear to the aggregate Public Offering Price of the Shares. The relative fault of the Company on the one hand and the Underwriters on the other hand shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Sellers or by the Underwriters and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such statement or omission. The Underwriters' respective obligations to contribute pursuant to this Section 9 are several in proportion to the respective number of Shares they have purchased hereunder, and not joint. (e) The Company and the Underwriters agree that it would not be just or equitable if contribution pursuant to this Section 9 were determined by pro rata allocation (even if the Underwriters were treated as one entity for such purpose) or by any other method of allocation that does not take account of the equitable considerations referred to in paragraph (d) of this Section 9. The amount paid or payable by an indemnified party as a result of the losses, claims, damages and liabilities referred to in the immediately preceding paragraph shall be deemed to include, subject to the limitations set forth above, any legal or other expenses reasonably incurred by such indemnified party in connection with investigating or defending any such action or claim. Notwithstanding the provisions of this Section 9, no Underwriter shall be required to contribute any amount in excess of the amount by which the total price at which the Shares underwritten by it and distributed to the public were offered to the public exceeds the amount of any damages that such Underwriter has otherwise been required to pay by reason of such untrue or alleged untrue statement or omission or alleged omission. No person guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from any person who was not guilty of such fraudulent misrepresentation. The remedies provided for in this Section 9 are not exclusive and shall not limit any rights or remedies which may otherwise be available to any indemnified party at law or in equity. (f) The indemnity and contribution provisions contained in this Section 9 and the representations, warranties and other statements of the Company contained in this Agreement shall remain operative and in full force and effect regardless of (i) any termination of this Agreement, (ii) any investigation made by or on behalf of any Underwriter or any person controlling any Underwriter, any Selling Shareholder or any person controlling any Selling Shareholder, or the Company, its officers or directors or any person controlling the Company and (iii) acceptance of and payment for any of the Shares. 10. TERMINATION. This Agreement shall be subject to termination by notice given by you to the Company, if (a) after the execution and delivery of this Agreement and prior to the Closing Date (i) trading generally shall have been suspended or materially limited on or by, as the case may be, any of the New York Stock Exchange, the American Stock Exchange, the National Association of Securities Dealers, Inc., the Chicago Board of Options Exchange, the Chicago -19- Mercantile Exchange or the Chicago Board of Trade, (ii) trading of any securities of the Company shall have been suspended on any exchange or in any over-the-counter market, (iii) a general moratorium on commercial banking activities in New York shall have been declared by either Federal or New York State authorities or (iv) there shall have occurred any outbreak or escalation of hostilities or any change in financial markets or any calamity or crisis that, in your judgment, is material and adverse and (b) in the case of any of the events specified in clauses (a)(i) through (iv), such event, singly or together with any other such event, makes it, in your judgment, impracticable to market the Shares on the terms and in the manner contemplated in the Prospectus. 11. EFFECTIVENESS; DEFAULTING UNDERWRITERS. This Agreement shall become effective upon the execution and delivery hereof by the parties hereto. If, on the Closing Date or the Option Closing Date, as the case may be, any one or more of the Underwriters shall fail or refuse to purchase Shares that it has or they have agreed to purchase hereunder on such date, and the aggregate number of Shares which such defaulting Underwriter or Underwriters agreed but failed or refused to purchase is not more than one-tenth of the aggregate number of the Shares to be purchased on such date, the other Underwriters shall be obligated severally in the proportions that the number of Firm Shares set forth opposite their respective names in Schedule II bears to the aggregate number of Firm Shares set forth opposite the names of all such non-defaulting Underwriters, or in such other proportions as you may specify, to purchase the Shares which such defaulting Underwriter or Underwriters agreed but failed or refused to purchase on such date; provided that in no event shall the number of Shares that any Underwriter has agreed to purchase pursuant to this Agreement be increased pursuant to this Section 11 by an amount in excess of one-ninth of such number of Shares without the written consent of such Underwriter. If, on the Closing Date, any Underwriter or Underwriters shall fail or refuse to purchase Firm Shares and the aggregate number of Firm Shares with respect to which such default occurs is more than one-tenth of the aggregate number of Firm Shares to be purchased, and arrangements satisfactory to you, the Company and the Selling Shareholders for the purchase of such Firm Shares are not made within 36 hours after such default, this Agreement shall terminate without liability on the part of any non-defaulting Underwriter, the Company or the Selling Shareholders. In any such case either you or the relevant Sellers shall have the right to postpone the Closing Date, but in no event for longer than seven days, in order that the required changes, if any, in the Registration Statement and in the Prospectus or in any other documents or arrangements may be effected. If, on the Option Closing Date, any Underwriter or Underwriters shall fail or refuse to purchase Additional Shares and the aggregate number of Additional Shares with respect to which such default occurs is more than one-tenth of the aggregate number of Additional Shares to be purchased, the non-defaulting Underwriters shall have the option to (i) terminate their obligation hereunder to purchase Additional Shares or (ii) purchase not less than the number of Additional Shares that such non-defaulting Underwriters would have been obligated to purchase in the absence of such default. Any action taken under this paragraph shall not relieve any defaulting Underwriter from liability in respect of any default of such Underwriter under this Agreement. -20- If this Agreement shall be terminated by the Underwriters, or any of them, because of any failure or refusal on the part of any Seller to comply with the terms or to fulfill any of the conditions of this Agreement, or if for any reason any Seller shall be unable to perform its obligations under this Agreement, the Sellers will reimburse the Underwriters or such Underwriters as have so terminated this Agreement with respect to themselves, severally, for all out of pocket expenses (including the fees and disbursements of their counsel) reasonably incurred by such Underwriters in connection with this Agreement or the offering contemplated hereunder. 12. Notwithstanding anything in this Agreement, it is agreed and understood by all parties hereto that the representations and warranties of, and any liability of and indemnity by, the Selling Shareholders, shall be governed solely by those certain letter agreements of even date herewith between each Selling Shareholder and the Underwriters, and that the Selling Shareholders make no representations and warranties, nor agreements to indemnify any party hereunder. 13. COUNTERPARTS. This Agreement may be signed in two or more counterparts, each of which shall be an original, with the same effect as if the signatures thereto and hereto were upon the same instrument. 14. APPLICABLE LAW. This Agreement shall be governed by and construed in accordance with the internal laws of the State of New York. -21- 15. HEADINGS. The headings of the sections of this Agreement have been inserted for convenience of reference only and shall not be deemed a part of this Agreement. Very truly yours, DRIL-QUIP, INC. By: ______________________________ Name: Title: __________________________________ J. Mike Walker REIMERT FAMILY PARTNERS, LTD. By: ______________________________ Larry E. Reimert, Managing General Partner FOUR SMITH'S COMPANY, LTD. By: ______________________________ Gary D. Smith, Managing General Partner LOVELESS FAMILY PARTNERS, LTD. By: ______________________________ Gary W. Loveless, Managing General Partner -22- Accepted as of the date hereof Morgan Stanley & Co. Incorporated Donaldson, Lufkin & Jenrette Securities Corporation Acting severally on behalf of themselves and the several Underwriters named herein. By: Morgan Stanley & Co. Incorporated By: _____________________________ Name: Title: -23- SCHEDULE I NUMBER OF NUMBER OF ADDITIONAL FIRM SHARES SHARES SELLING SHAREHOLDER TO BE SOLD TO BE SOLD ------------------- ----------- ---------- J. Mike Walker................................. 750,000 112,500 Reimert Family Partners, Ltd................... 750,000 112,500 Four Smith's Company, Ltd...................... 750,000 112,500 Loveless Family Partners, Ltd.................. 250,000 37,500 --------- --------- Total.......................................... 2,500,000 375,000 ========= ========= -24- SCHEDULE II NUMBER OF FIRM SHARES UNDERWRITER TO BE PURCHASED ----------- --------------- Morgan Stanley & Co. Incorporated........................... Donaldson, Lufkin & Jenrette Securities Corporation......... _________ Total................................................ 5,000,000 ========= -25- EXHIBIT A ______________ __, 1997 Morgan Stanley & Co. Incorporated Donaldson, Lufkin & Jenrette Securities Corporation c/o Morgan Stanley & Co. Incorporated 1585 Broadway New York, NY 10036 Dear Sirs: The undersigned understands that Morgan Stanley & Co. Incorporated ("Morgan Stanley") and Donaldson, Lufkin & Jenrette Securities Corporation ("DLJ") as Representatives of the several Underwriters, propose to enter into an Underwriting Agreement (the "Underwriting Agreement") with Dril-Quip, Inc. (the "Company") providing for the public offering (the "Public Offering") by the several Underwriters, including yourselves (the "Underwriters"), of 5,000,000 shares (the "Shares") of the Common Stock, par value $.01 per share, of the Company (the "Common Stock"). To induce the Underwriters that may participate in the Public Offering to continue their efforts in connection with the Public Offering, the undersigned hereby agrees that, without the prior written consent of Morgan Stanley on behalf of the Underwriters, it will not, during the period commencing on the date hereof and ending 180 days after the date of the final prospectus relating to the Public Offering (the "Prospectus"), (1) offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, or otherwise transfer or dispose of, directly or indirectly, any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock (provided such shares or securities are either now owned by the undersigned or are hereafter acquired prior to or in connection with the Public Offering), or (2) enter into any swap or other arrangement that transfers to another, in whole or in part, any of the economic consequences of ownership of such shares of Common Stock, whether any such transaction described in clause (1) or (2) above is to be settled by delivery of Common Stock or such other securities, in cash or otherwise. The foregoing sentence shall not apply to the sale of any Shares to the Underwriters pursuant to the Underwriting Agreement. In addition, the undersigned agrees that, without the prior written consent of Morgan Stanley on behalf of the Underwriters, it will not, during the period commencing on the date hereof and ending 180 days after the date of the Prospectus, make any demand for or exercise any right with respect to, the registration of any shares of Common Stock or any security convertible into or exercisable or exchangeable for Common Stock. Whether or not the Public Offering actually occurs depends on a number of factors, including market conditions. Any Public Offering will only be made pursuant to an Underwriting Agreement, the terms of which are subject to agreement between the Company and the Underwriters. Very truly yours, __________________________________ (Name) __________________________________ (Address) Accepted as of the date first set forth above: Morgan Stanley & Co. Incorporated By: _____________________________ EX-3.1 3 CERTIFICATE OF INCORPORATION Exhibit 3.1 CERTIFICATE OF INCORPORATION OF DRIL-QUIP, INC. FIRST: The name of the corporation is Dril-Quip, Inc. (the "Corporation"). SECOND: The address of the registered office of the Corporation in the State of Delaware is 1209 Orange Street in the City of Wilmington, County of New Castle, 19801. The name of its registered agent at such address is The Corporation Trust Company. THIRD: The purpose of the corporation is to engage in, carry on and conduct any lawful business, act or activity for which corporations may be organized under the General Corporation Law of the State of Delaware (the "DGCL"). FOURTH: The aggregate number of shares of capital stock that the Corporation shall have authority to issue is one thousand (1,000) shares of common stock, par value $0.01 per share ("Common Stock"). Each share of Common Stock shall entitle the holder thereof to one vote at all meetings of the stockholders of the Corporation. Shares of Common Stock may be issued for such consideration and for such corporate purposes as the Board of Directors of the Corporation may from time to time determine. In the event of voluntary or involuntary liquidation, distribution or sale of assets, dissolution or winding- up of the Corporation, the holders of the Common Stock shall be entitled to receive all the assets of the Corporation, tangible and intangible, of whatever kind available for distribution to stockholders, ratably in proportion to the number of shares of Common Stock held by each. FIFTH: The name and mailing address of the incorporator are as follows: Name Mailing Address ---- --------------- Kelly B. Rose 3000 One Shell Plaza 910 Louisiana Houston, Texas 77002-4995 SIXTH: The powers of the incorporator shall terminate upon the filing of this Certificate of Incorporation and the name and mailing address of the persons to serve as directors of the Corporation until the first annual meeting of the stockholders or until their successors are duly elected and qualified are: Name Mailing Address ---- --------------- Larry E. Reimert 13550 Hempstead Highway Houston, Texas 77040 Gary D. Smith 13550 Hempstead Highway Houston, Texas 77040 J. Mike Walker 13550 Hempstead Highway Houston, Texas 77040 Gary W. Loveless 13550 Hempstead Highway Houston, Texas 77040 SEVENTH: (1) In General. The business and affairs of the Corporation shall be managed by or under the direction of the Board of Directors of the Corporation. In addition to the authority and powers conferred upon the Board of Directors of the Corporation by the DGCL or by the provisions of this Certificate of Incorporation, the Board of Directors of the Corporation is hereby authorized and empowered to exercise all such powers and do all such acts and things as may be exercised or done by the Corporation, subject to the provisions of the DGCL, this Certificate of Incorporation and any Bylaws adopted by the stockholders of the Corporation. (2) Number, Election and Terms of Directors. The number of directors that shall constitute the whole Board of Directors of the Corporation shall be as from time to time fixed by, or in the manner provided in, the Bylaws of the Corporation. Election of directors need not be by written ballot unless the Bylaws of the Corporation shall so provide. Each director shall hold office for the full term for which such director is elected and until such director's successor shall have been duly elected and qualified or until his earlier death, resignation or removal. EIGHTH: The Board of Directors of the Corporation is expressly empowered to adopt, amend or repeal the Bylaws of the Corporation. NINTH: A director of the Corporation shall not be personally liable to the Corporation or any of its stockholders for monetary damages for breach of fiduciary duty as a director, except for liability (a) for any breach of the director's duty of loyalty to the Corporation or its stockholders, (b) for acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (c) under Section 174 of the DGCL, as the same exists or hereafter may be amended, supplemented or replaced or (d) for any transaction from which the director -2- derived an improper personal benefit. If the DGCL is amended after the date of filing of this Certificate of Incorporation to authorize corporate action further eliminating or limiting the personal liability of directors, then the liability of a director of the Corporation, in addition to the limitation on personal liability provided herein, shall be limited to the fullest extent permitted by the amended DGCL. Any repeal or modification of this Article NINTH by the stockholders of the Corporation shall be prospective only, and shall not adversely affect any limitation on the personal liability of a director of the Corporation existing at the time of such repeal or modification. * * * I, the undersigned, being the incorporator hereinbefore named, for the purpose of forming a corporation pursuant to the DGCL, do make this certificate, hereby declaring that this is my act and deed, and that the facts herein stated are true, and accordingly have hereunto set my hand this 12th day of August, 1997. /S/ Kelly B. Rose _______________________________ Kelly B. Rose -3- EX-3.3 4 BYLAWS Exhibit 3.3 BYLAWS OF DRIL-QUIP, INC. ARTICLE I OFFICES 1.1 Registered Office. The registered office of Dril-Quip, Inc. (the "Corporation") required by the General Corporation Law of the State of Delaware or any successor statute (the "DGCL"), to be maintained in the State of Delaware, shall be the registered office named in the Certificate of Incorporation of the Corporation, as it may be amended or restated in accordance with the DGCL from time to time (the "Certificate of Incorporation"), or such other office as may be designated from time to time by the Board of Directors of the Corporation (the "Board of Directors") in the manner provided by law. Should the Corporation maintain a principal office within the State of Delaware such registered office need not be identical to such principal office of the Corporation. 1.2 Other Offices. The Corporation may also have offices at such other places both within and without the State of Delaware as the Board of Directors may determine from time to time or as the business of the Corporation may require. ARTICLE II MEETINGS OF STOCKHOLDERS 2.1 Place of Meetings. Meetings of stockholders shall be held at such place within or without the State of Delaware as may be designated by the Board of Directors or the officer calling the meeting. 2.2 Annual Meeting. An annual meeting of the stockholders, for the election of directors to succeed those whose terms expire and for the transaction of such other business as may properly come before the meeting, shall be held at such place, within or without the State of Delaware, on such date, and at such time as the Board of Directors shall fix and set forth in the notice of the meeting, which date shall be within thirteen months subsequent to the last annual meeting of stockholders. At the annual meeting of the stockholders, only such business shall be conducted as shall have been properly brought before the annual meeting as set forth in Section 2.8 hereof. Failure to hold the annual meeting at the designated time shall not work a dissolution of the Corporation. 1 2.3 Special Meetings. Special meetings of the stockholders may be called at any time by the Chairman of the Board, the President (if any) or the Board of Directors pursuant to a resolution approved by the affirmative vote of a majority of the entire Board of Directors. Upon written request of any person or persons who have duly called a special meeting, it shall be the duty of the Secretary of the Corporation to fix the date of the meeting to be held not less than ten nor more than 60 days after the receipt of the request and to give due notice thereof. If the Secretary shall neglect or refuse to fix the date of the meeting and give notice thereof, the person or persons calling the meeting may do so. Every special meeting of the stockholders shall be held at such place within or without the State of Delaware as the Board of Directors may designate, or, in the absence of such designation, at the registered office of the Corporation in the State of Delaware. 2.4 Notice of Meeting. Written or printed notice of all meetings stating the place, day and hour of the meeting and, in the case of a special meeting, the purpose or purposes for which the meeting is called, shall be delivered not less than ten nor more than 60 days before the date of the meeting, either personally or by mail, by or at the direction of the Chairman of the Board, President (if any) or Secretary of the Corporation, to each stockholder entitled to vote at such meeting. If mailed, such notice shall be deemed to be delivered to a stockholder when deposited in the United States mail addressed to such stockholder at such stockholder's address as it appears on the stock transfer records of the Corporation, with postage thereon prepaid. 2.5 Registered Holders of Shares; Closing of Share Transfer Records; and Record Date. (a) Registered Holders as Owners. Unless otherwise provided under Delaware law, the Corporation may regard the person in whose name any shares issued by the Corporation are registered in the stock transfer records of the Corporation at any particular time (including, without limitation, as of a record date fixed pursuant to paragraph (b) of this Section 2.5) as the owner of those shares at that time for purposes of voting those shares, receiving distributions thereon or notices in respect thereof, transferring those shares, exercising rights of dissent with respect to those shares, entering into agreements with respect to those shares, or giving proxies with respect to those shares; and neither the Corporation nor any of its officers, directors, employees or agents shall be liable for regarding that person as the owner of those shares at that time for those purposes, regardless of whether that person possesses a certificate for those shares. (b) Record Date. For the purpose of determining stockholders entitled to notice of or to vote at any meeting of stockholders or any adjournment thereof, or entitled to receive a distribution by the Corporation (other than a distribution involving a purchase or redemption by the Corporation of any of its own shares) or a share dividend, or in order to make a determination of stockholders for any other proper purpose, the Board of Directors may fix in advance a date as the record date for 2 any such determination of stockholders, such date in any case to be not more than 60 days and, in the case of a meeting of stockholders, not less than ten days, prior to the date on which the particular action requiring such determination of stockholders is to be taken. The Board of Directors shall not close the books of the Corporation against transfers of shares during the whole or any part of such period. If the Board of Directors does not fix a record date for any meeting of the stockholders, the record date for determining stockholders entitled to notice of or to vote at such meeting shall be at the close of business on the day next preceding the day on which notice is given, or, if in accordance with Section 7.3 of these Bylaws notice is waived, at the close of business on the day next preceding the day on which the meeting is held. 2.6 Quorum of Stockholders; Adjournment. Unless otherwise provided in the Certificate of Incorporation, a majority of the outstanding shares of capital stock of the Corporation entitled to vote, present in person or represented by proxy, shall constitute a quorum at any meeting of the stockholders, and the stockholders present at any duly convened meeting may continue to do business until adjournment notwithstanding any withdrawal from the meeting of holders of shares counted in determining the existence of a quorum. Unless otherwise provided in the Certificate of Incorporation or these Bylaws, any meeting of the stockholders may be adjourned from time to time by the chairman of the meeting or the holders of a majority of the issued and outstanding stock, present in person or represented by proxy, whether or not a quorum is present, without notice other than by announcement at the meeting at which such adjournment is taken, and at any such adjourned meeting at which a quorum shall be present any action may be taken that could have been taken at the meeting originally called; provided that if the adjournment is for more than 30 days, or if after the adjournment a new record date is fixed for the adjourned meeting, a notice of the adjourned meeting shall be given to each stockholder of record entitled to vote at the adjourned meeting. 2.7 Voting by Stockholders. (a) Voting on Matters Other than the Election of Directors. With respect to any matters as to which no other voting requirement is specified by the DGCL, the Certificate of Incorporation or these Bylaws, the affirmative vote required for stockholder action shall be that of a majority of the shares present in person or represented by proxy at the meeting (as counted for purposes of determining the existence of a quorum at the meeting). In the case of a matter submitted for a vote of the stockholders as to which a stockholder approval requirement is applicable under the stockholder approval policy of any stock exchange or quotation system on which the capital stock of the Corporation is traded or quoted, the requirements of Rule 16b-3 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), or any provision of the Internal Revenue Code, in each case for 3 which no higher voting requirement is specified by the DGCL, the Certificate of Incorporation or these Bylaws, the vote required for approval shall be the requisite vote specified in such stockholder approval policy, Rule 16b-3 or Internal Revenue Code provision, as the case may be (or the highest such requirement if more than one is applicable). For the approval of the appointment of independent public accountants (if submitted for a vote of the stockholders), the vote required for approval shall be a majority of the votes cast on the matter. (b) Voting in the Election of Directors. Unless otherwise provided in the Certificate of Incorporation or these Bylaws in accordance with the DGCL, directors shall be elected by a plurality of the votes cast by the holders of outstanding shares of capital stock of the Corporation entitled to vote in the election of directors at a meeting of stockholders at which a quorum is present. 2.8 Business to be Conducted. (a) At an annual meeting of stockholders, only such business shall be conducted, and only such proposals shall be acted upon, as shall have been brought before the annual meeting (i) by or at the direction of the Board of Directors or (ii) by any stockholder of the Corporation who is a stockholder of record at the time of the giving of such stockholder's notice provided for in this Section 2.8, who shall be entitled to vote at such meeting and who complies with the requirements of this Section 2.8 and as shall otherwise be proper subjects for stockholder action and shall be properly introduced at the meeting. For a proposal to be properly brought before an annual meeting by a stockholder, in addition to any other applicable requirements, the stockholder must have given timely advance notice thereof in writing to the Secretary of the Corporation. To be timely, a stockholder's notice must be delivered to, or mailed and received at, the principal executive offices of the Corporation not later than the close of business on the 90th day prior to the first anniversary of the preceding year's annual meeting; provided, however, that in the event that the date of the annual meeting is more than 30 days before or more than 60 days after such anniversary date, notice by the stockholder to be timely must be so delivered not later than the close of business on the later of the 90th day prior to such annual meeting or the 10th day following the day on which public announcement of the date of such meeting is first made by the Corporation. Any such stockholder's notice to the Secretary of the Corporation shall set forth as to each matter the stockholder proposes to bring before the annual meeting (i) a description of the proposal desired to be brought before the annual meeting and the reasons for conducting such business at the annual meeting, (ii) the name and address, as they appear on the Corporation's books, of the stockholder proposing such business and any other stockholders known by such stockholder to be supporting such proposal, (iii) the class and number of shares of the Corporation's stock that are beneficially owned by the stockholder on the date of such notice, 4 (iv) any financial interest of the stockholder in such proposal and (v) a representation that the stockholder intends to appear in person or by proxy at the meeting to bring the proposed business before the annual meeting. The presiding officer of the annual meeting shall determine whether the requirements of this paragraph (a) have been met with respect to any stockholder proposal. If the presiding officer determines that a stockholder proposal was not made in accordance with the terms of this paragraph (a), he shall so declare at the meeting and any such proposal shall not be acted upon at the meeting. At a special meeting of stockholders, only such business shall be acted upon as shall have been set forth in the notice relating to the meeting required by Section 2.4 hereof or as shall constitute matters incident to the conduct of the meeting as the presiding officer of the meeting shall determine to be appropriate. (b) Notwithstanding the foregoing provisions of this Section 2.8, a stockholder shall also comply with all applicable requirements of the Exchange Act and the rules and regulations thereunder with respect to the matters set forth in this Section 2.8. 2.9 Proxies. Each stockholder entitled to vote at a meeting of stockholders may authorize another person or persons to act for him by proxy. Proxies for use at any meeting of stockholders shall be filed with the Secretary, or such other officer as the Board of Directors may from time to time determine by resolution, before or at the time of the meeting. All proxies shall be received and taken charge of and all ballots shall be received and canvassed by the secretary of the meeting who shall decide all questions relating to the qualification of voters, the validity of the proxies, and the acceptance or rejection of votes, unless an inspector or inspectors shall have been appointed by the chairman of the meeting, in which event such inspector or inspectors shall decide all such questions. 2.10 Approval or Ratification of Acts or Contracts by Stockholders. The Board of Directors in its discretion may submit any act or contract for approval or ratification at any annual meeting of the stockholders, or at any special meeting of the stockholders called for the purpose of considering any such act or contract, and any act or contract that shall be approved or be ratified by the vote of the stockholders holding a majority of the issued and outstanding shares of stock of the Corporation entitled to vote and present in person or by proxy at such meeting (provided that a quorum is present), shall be as valid and as binding upon the Corporation and upon all the stockholders as if it has been approved or ratified by every stockholder of the Corporation. 5 ARTICLE III DIRECTORS 3.1 Number, Classification and Tenure and Composition. (a) The powers of the Corporation shall be exercised by or under the authority of, and the business and affairs of the Corporation shall be managed under the direction of, the Board of Directors. From and after the first date of the closing of the initial public offering of the Common Stock to the public for cash that has been registered on a registration statement that has been filed with and declared effective by the Securities and Exchange Commission (the "Initial Public Offering Date"), the Board of Directors shall be divided into three classes as provided in the Certificate of Incorporation. Each director shall hold office for the full term for which such director is elected and until such director's successor shall have been duly elected and qualified or until his earlier death or resignation or removal in accordance with the Certificate of Incorporation or these Bylaws. (b) Within the limits specified in the Certificate of Incorporation, the number of directors that shall constitute the whole Board of Directors shall be fixed by, and may be increased or decreased from time to time by, the affirmative vote of a majority of the members at any time constituting the Board of Directors. Except as provided in the Certificate of Incorporation, newly created directorships resulting from any increase in the number of directors and any vacancies on the Board of Directors resulting from death, resignation, disqualification, removal or other cause shall be filled by the affirmative vote of a majority of the remaining directors then in office, even though less than a quorum of the Board of Directors. Any director elected in accordance with the preceding sentence shall hold office for the remainder of the full term of the class of directors in which the new directorship was created or the vacancy occurred and until such director's successor shall have been elected and qualified or until his earlier death, resignation or removal. No decrease in the number of directors constituting the Board of Directors shall shorten the term of any incumbent director. 3.2 Qualifications. Directors need not be residents of the State of Delaware or stockholders of the Corporation. 3.3 Nomination of Directors. Subject to such rights of the holders of one or more outstanding series of Preferred Stock of the Corporation to elect one or more directors in case of arrearages in the payment of dividends or other defaults as shall be prescribed in the Certificate of Incorporation or in the resolutions of the Board of Directors providing for the establishment of any such series, only persons who are nominated in accordance with the procedures set forth in this Section 3.3 shall be eligible for election as, and to serve 6 as, directors. Nominations of persons for election to the Board of Directors may be made at a meeting of the stockholders at which Directors are to be elected (i) by or at the direction of the Board of Directors or (ii) by any stockholder of the Corporation who is a stockholder of record at the time of the giving of such stockholder's notice provided for in this Section 3.3, who shall be entitled to vote at such meeting in the election of directors and who complies with the requirements of this Section 3.3. Such nominations, other than those made by or at the direction of the Board of Directors, shall be preceded by timely advance notice in writing to the Secretary of the Corporation. To be timely, a stockholder's notice shall be delivered to, or mailed and received at, the principal executive offices of the Corporation (i) with respect to an election to be held at the annual meeting of the stockholders of the Corporation, not later than the close of business on the 90th day prior to the first anniversary of the preceding year's annual meeting; provided, however, that in the event that the date of the annual meeting is more than 30 days before or more than 60 days after such anniversary date, notice by the stockholder to be timely must be so delivered not later than the close of business on the later of the 90th day prior to such annual meeting or the 10th day following the day on which public announcement of the date of such meeting is first made by the Corporation; and (ii) with respect to an election to be held at a special meeting of stockholders of the Corporation for the election of directors not later than the close of business on the tenth day following the day on which notice of the date of the special meeting was mailed to stockholders of the Corporation as provided in Section 2.4 hereof or public disclosure of the date of the special meeting was made, whichever first occurs. Any such stockholder's notice to the Secretary of the Corporation shall set forth (x) as to each person whom the stockholder proposes to nominate for election or re- election as a director, (i) the name, age, business address and residence address of such person, (ii) the principal occupation or employment of such person, (iii) the number of shares of each class of capital stock of the Corporation beneficially owned by such person, (iv) the written consent of such person to having such person's name placed in nomination at the meeting and to serve as a director if elected and (v) any other information relating to such person that is required to be disclosed in solicitations of proxies for election of directors, or is otherwise required, pursuant to Regulation 14A under the Exchange Act, and (y) as to the stockholder giving the notice, (i) the name and address, as they appear on the Corporation's books, of such stockholder and (ii) the number of shares of each class of voting stock of the Corporation that are then beneficially owned by such stockholder. The presiding officer of the meeting of stockholders shall determine whether the requirements of this Section 3.3 have been met with respect to any nomination or intended nomination. If the presiding officer determines that any nomination was not made in accordance with the requirements of this Section 3.3, he shall so declare at the meeting and the defective nomination shall be disregarded. Notwithstanding the foregoing provisions of this Section 3.3, a stockholder shall also comply with all applicable requirements of the Exchange Act and the rules and regulations thereunder with respect to the matters set forth in this Section 3.3. 7 3.4 Place of Meeting; Order of Business. Except as otherwise provided by law, meetings of the Board of Directors, regular or special, may be held either within or without the State of Delaware, at whatever place is specified by the person or persons calling the meeting. In the absence of specific designation, the meetings shall be held at the principal office of the Corporation. At all meetings of the Board of Directors, business shall be transacted in such order as shall from time to time be determined by the Chairman of the Board, or in his absence by the President (if any), or by resolution of the Board of Directors. 3.5 Regular Meetings. Regular meetings of the Board of Directors shall be held at such place or places within or without the State of Delaware, at such hour and on such day as may be fixed by resolution of the Board of Directors, without further notice of such meetings. The time or place of holding regular meetings of the Board of Directors may be changed by the Chairman of the Board, or the President (if any), by giving written notice thereof as provided in Section 3.7 hereof. 3.6 Special Meetings. Special meetings of the Board of Directors shall be held, whenever called by the Chairman of the Board, the President (if any) or by a written notice signed by a majority of the members of the Board of Directors, at such place or places within or without the State of Delaware as may be stated in the notice of the meeting. 3.7 Attendance at and Notice of Meetings. Written notice of the time and place of, and general nature of the business to be transacted at, all special meetings of the Board of Directors, and written notice of any change in the time or place of holding the regular meetings of the Board of Directors, shall be given to each director and may be given by any of the following methods: (a) by mail or telegram sent to the last known business address of such director at least four days before the meeting, (b) by facsimile to the business facsimile number of such director transmitted at least one day before the meeting or (c) orally at least one day before the meeting. For purposes of the foregoing sentence, notice shall be deemed given (i) by mail, when deposited in the U.S. mail, postage prepaid, or by telegram, when the telegram is delivered to the telegraph company for transmittal, (ii) by facsimile, when transmittal is confirmed by the sending facsimile machine and (iii) orally, when communicated in person or by telephone to the director or to a person at the business telephone number of the director who may reasonably be expected to communicate it to the director. In calculating the number of days notice received by a director, the date the notice is given by any of the foregoing methods shall be counted, but the date of the meeting to which the notice relates shall not be counted. Notice of the time, place and purpose of a meeting may be waived in writing before or after such meeting, and shall be equivalent to the giving of notice. Participation in a meeting of the Board of Directors shall constitute presence in person at such meeting, except when a person participates in the meeting for the express purpose of objecting to the transaction of any business on the ground that the meeting is not lawfully called or convened. Except as otherwise herein provided, neither the business to be transacted at, nor the purpose of, 8 any regular or special meeting of the Board of Directors need be specified in the notice or waiver of notice of such meeting. 3.8 Quorum of and Action by Directors. A majority of the directors in office shall constitute a quorum of the Board of Directors for the transaction of business; but a lesser number may adjourn from day to day until a quorum is present. Except as otherwise provided by law or in these Bylaws, all questions shall be decided by the vote of a majority of the directors present. 3.9 Board and Committee Action Without a Meeting. Unless otherwise restricted by the Certificate of Incorporation or these Bylaws, any action required or permitted to be taken at a meeting of the Board of Directors or any committee thereof may be taken without a meeting if a consent in writing, setting forth the action so taken, is signed by all the members of the Board of Directors or such committee, as the case may be, and shall be filed with the Secretary of the Corporation. 3.10 Board and Committee Telephone Meetings. Subject to the provisions required or permitted by the DGCL for notice of meetings, unless otherwise restricted by the Certificate of Incorporation or these Bylaws, members of the Board of Directors, or members of any committee designated by the Board of Directors, may participate in and hold a meeting of such Board of Directors or committee by means of conference telephone or similar communications equipment by means of which all persons participating in the meeting can hear each other, and participation in a meeting pursuant to this Section 3.10 shall constitute presence in person at such meeting, except when a person participates in the meeting for the express purpose of objecting to the transaction of any business on the ground that the meeting is not lawfully called or convened. 3.11 Compensation. Directors shall receive such compensation for their services as shall be determined by the Board of Directors. 3.12 Removal. No director of the Corporation shall be removed from office as a director by vote or other action of the stockholders or otherwise except for cause, and then only by the affirmative vote of the holders of at least a majority of the voting power of all outstanding shares of capital stock of the Corporation generally entitled to vote in the election of directors, voting together as a single class. Cause for removal of a director shall be as provided by law or in the Certificate of Incorporation. Any proposal by a stockholder to remove a director of the Corporation, in order to be validly acted upon at any meeting, shall comply with paragraph (a) of Section 2.8 hereof. Notwithstanding the first paragraph of this Section 3.12, whenever holders of outstanding shares of one or more series of Preferred Stock are entitled to elect members of the Board of Directors pursuant to the provisions applicable in the case of arrearages in the payment of dividends or other defaults contained in the resolution or resolutions of 9 the Board of Directors providing for the establishment of any such series, any such director of the Corporation so elected may be removed in accordance with the provision of such resolution or resolutions. 3.13 Committees of the Board of Directors. (a) The Board of Directors, by resolution adopted by the Board of Directors, may designate from among its members one or more committees, each of which shall be comprised of one or more of its members, and may designate one or more of its members as alternate members of any committee, who may, subject to any limitations by the Board of Directors, replace absent or disqualified members at any meeting of that committee. Any such committee, to the extent provided in such resolution, the Certificate of Incorporation or these Bylaws, shall have and may exercise all of the authority of the Board of Directors to the extent permitted by the DGCL. Any such committee may authorize the seal of the Corporation to be affixed to all papers that may require it. In addition to the above, such committee or committees shall have such other powers and limitations of authority as may be determined from time to time by resolution adopted by the Board of Directors. (b) The Board of Directors shall have the power at any time to change the membership of any such committee and to fill vacancies in it. A majority of the number of members of any such committee shall constitute a quorum for the transaction of business unless a greater number is required by a resolution adopted by the Board of Directors. The act of the majority of the members of a committee present at any meeting at which a quorum is present shall be the act of such committee, unless the act of a greater number is required by a resolution adopted by the Board of Directors. Each such committee may elect a chairman and appoint such subcommittees and assistants as it may deem necessary. Except as otherwise provided by the Board of Directors, meetings of any committee shall be conducted in accordance with Sections 3.5, 3.6, 3.7, 3.8, 3.9, 3.10 and 7.3 hereof. In the absence or disqualification of a member of a committee, the member or members present at any meeting and not disqualified from voting, whether or not such member or members constitute a quorum, may unanimously appoint another member of the board of directors to act at the meeting in the place of any such absent or disqualified member. Any member of any such committee elected or appointed by the Board of Directors may be removed by the Board of Directors whenever in its judgment the best interests of the Corporation will be served thereby, but such removal shall be without prejudice to the contract rights, if any, of the person so removed. Election or appointment of a member of a committee shall not of itself create contract rights. 10 (c) Any action taken by any committee of the Board of Directors shall promptly be recorded in the minutes and filed with the Secretary of the Corporation. ARTICLE IV OFFICERS 4.1 Designation. The officers of the Corporation shall consist of one or more Chairmen of the Board and a Secretary, and may include a President, Treasurer and such Executive, Senior or other Vice Presidents, Assistant Secretaries and other officers as may be elected or appointed by the Board of Directors. The corporation shall initially have three Co-Chairmen of the Board and Co-Chief Executive Officers, and references herein to the "Chairman of the Board" and the "chief executive officer" shall mean any of such persons. Any number of offices may be held by the same person. 4.2 Powers and Duties. The officers of the Corporation shall have such powers and duties as generally pertain to their offices, except as modified herein or by the Board of Directors, as well as such powers and duties as from time to time may be conferred by the Board of Directors. The Chairman of the Board shall be the chief executive officer of the Corporation, shall have general supervision over the business, affairs and property of the Corporation, shall have such duties as may be assigned to him by the Board of Directors and shall preside at meetings of the Board of Directors and at meetings of the stockholders. 4.3 Vacancies. Whenever any vacancies shall occur in any office by death, resignation, increase in the number of offices of the Corporation, or otherwise, the same shall be filled by the Board of Directors, and the officer so elected shall hold office until such officer's successor is elected or appointed or until his earlier death, resignation or removal. 4.4 Removal. Any officer or agent elected or appointed by the Board of Directors may be removed by the Board of Directors whenever in its judgment the best interests of the Corporation will be served thereby, but such removal shall be without prejudice to the contract rights, if any, of the person so removed. Election or appointment of an officer or agent shall not of itself create contract rights. 4.5 Action with Respect to Securities of Other Corporations. Unless otherwise directed by the Board of Directors, the Chairman of the Board, or any President, Vice President or Treasurer of the Corporation shall each have power to vote and otherwise act on behalf of the Corporation, in person or by proxy, at any meeting of security holders of or with respect to any action of security holders of any other corporation in which this Corporation may hold securities and otherwise to exercise any and all rights and powers that this 11 Corporation may possess by reason of its ownership of securities in such other corporation. ARTICLE V CAPITAL STOCK 5.1 Certificates for Shares. The certificates for shares of the capital stock of the Corporation shall be in such form as may be approved by the Board of Directors or any duly authorized committee thereof or may be uncertificated shares. In the case of certificated shares, the Corporation shall deliver certificates representing shares to which stockholders are entitled. Certificates representing such certificated shares shall be signed by one of the Chairmen of the Board, or a President or a Vice President (if any) and either the Secretary or an Assistant Secretary of the Corporation, and may bear the seal of the Corporation or a facsimile thereof. The signatures of such officers upon a certificate may be facsimiles. The stock record books and the blank stock certificate books shall be kept by the Secretary of the Corporation, or at the office of such transfer agent or transfer agents as the Board of Directors may from time to time by resolution determine. In case any officer who has signed or whose facsimile signature has been placed upon such certificate shall have ceased to be such officer before such certificate is issued, it may be issued by the Corporation with the same effect as if such person were such officer at the date of its issuance. 5.2 Transfer of Shares. The shares of stock of the Corporation shall be transferable only on the books of the Corporation by the holders thereof in person or by their duly authorized attorneys or legal representatives upon surrender and cancellation of certificates for a like number of shares. 5.3 Ownership of Shares. The Corporation shall be entitled to treat the holder of record of any share or shares of capital stock of the Corporation as the holder in fact thereof and, accordingly, shall not be bound to recognize any equitable or other claim to or interest in such share or shares on the part of any other person, whether or not it shall have express or other notice thereof, except as otherwise provided by the laws of the State of Delaware. 5.4 Regulations Regarding Certificates. The Board of Directors shall have the power and authority to make all such rules and regulations as they may deem expedient concerning the issue, transfer and registration or the replacement of certificates for shares of capital stock of the Corporation. 5.5 Lost or Destroyed Certificates. The Board of Directors may determine the conditions upon which a new certificate of stock may be issued in place of a certificate that is alleged to have been lost, stolen or destroyed; and may, in its discretion, require the owner of such certificate or his legal representative to give bond, with sufficient surety, to indemnify the 12 Corporation and each transfer agent and registrar against any and all losses or claims that may arise by reason of the issue of a new certificate in the place of the one so lost, stolen or destroyed. ARTICLE VI INDEMNIFICATION 6.1 General. The Corporation shall, to the fullest extent permitted by applicable law in effect on the date of effectiveness of these Bylaws, and to such greater extent as applicable law may thereafter permit, within 30 days after written demand is presented to the Corporation, indemnify and hold Indemnitee (as this and all other capitalized words used in this Article VI not previously defined in these Bylaws are defined in Section 6.16 hereof) harmless from and against any and all losses, liabilities, claims, damages and, subject to Section 6.2, Expenses, whatsoever arising out of any event or occurrence related to the fact that Indemnitee is or was a director or officer of the Corporation or is or was serving in another Corporate Status. 6.2 Expenses. If Indemnitee is, by reason of his Corporate Status, a party to and is successful, on the merits or otherwise, in any Proceeding, he shall be indemnified against all Expenses actually and reasonably incurred by him or on his behalf in connection therewith. If Indemnitee is not wholly successful in such Proceeding but is successful, on the merits or otherwise, as to any Matter in such Proceeding, the Corporation shall indemnify Indemnitee against all Expenses actually and reasonably incurred by him or on his behalf relating to such Matter. The termination of any Matter in such a Proceeding by dismissal, with or without prejudice, shall be deemed to be a successful result as to such Matter. To the extent that the Indemnitee is, by reason of his Corporate Status, a witness in any Proceeding, he shall be indemnified against all Expenses actually and reasonably incurred by him or on his behalf in connection therewith. 6.3 Advances. In the event of any threatened or pending action, suit or proceeding in which Indemnitee is a party or is involved and that may give rise to a right of indemnification under this Article VI, following written request to the Corporation by Indemnitee, the Corporation shall promptly pay to Indemnitee amounts to cover expenses reasonably incurred by Indemnitee in such proceeding in advance of its final disposition upon the receipt by the Corporation of (i) a written undertaking executed by or on behalf of Indemnitee providing that Indemnitee will repay the advance if it shall ultimately be determined that Indemnitee is not entitled to be indemnified by the Corporation as provided in this Agreement and (ii) satisfactory evidence as to the amount of such expenses. 13 6.4 Repayment of Advances or Other Expenses. Indemnitee agrees that Indemnitee shall reimburse the Corporation for all expenses paid by the Corporation in defending any civil, criminal, administrative or investigative action, suit or proceeding against Indemnitee in the event and only to the extent that it shall be determined pursuant to the provisions of this Article VI or by final judgment or other final adjudication under the provisions of any applicable law that Indemnitee is not entitled to be indemnified by the Corporation for such expenses. 6.5 Request for Indemnification. To obtain indemnification, Indemnitee shall submit to the Secretary of the Corporation a written claim or request. Such written claim or request shall contain sufficient information to reasonably inform the Corporation about the nature and extent of the indemnification or advance sought by Indemnitee. The Secretary of the Corporation shall promptly advise the Board of Directors of such request. 6.6 Determination of Entitlement; No Change of Control. If there has been no Change of Control at the time the request for indemnification is submitted, Indemnitee's entitlement to indemnification shall be determined in accordance with Section 145(d) of the DGCL. If entitlement to indemnification is to be determined by Independent Counsel, the Corporation shall furnish written notice to Indemnitee within 10 days after receipt of the request for indemnification, specifying the identity and address of Independent Counsel. The Indemnitee may, within ten days after such written notice of selection shall have been given, deliver to the Corporation a written objection to such selection; provided, however, that such objection may be asserted only on the ground that the Independent Counsel so selected does not meet the requirements of "Independent Counsel" as defined in Section 6.16 hereof, and the objection shall set forth with particularity the factual basis of such assertion. If such written objection is so made and substantiated, the Independent Counsel so selected may not serve as Independent Counsel unless and until such objection is withdrawn or a court has determined that such objection is without merit. If (i) the determination of entitled to indemnification is to be made by Independent Counsel pursuant to this Section and (ii) within 20 days after submission by Indemnitee of a written request for indemnification pursuant to Section 6.5, no Independent Counsel shall have been selected and not objected to, the Corporation or the Indemnitee may petition the Court of Chancery or other court of competent jurisdiction for resolution of any objection which shall have been made by the Indemnitee to the Corporation's selection of Independent Counsel and/or for the appointment as Independent Counsel of a person selected by the petitioned court or by such other person as the petitioned court shall designate, and the person with respect to whom all objections are so resolved or the person so appointed shall act as Independent Counsel under this Section. If (i) Independent Counsel does not make any determination respecting Indemnitee's entitlement to indemnification hereunder within 90 days after receipt by the Corporation of a written request therefor and (ii) any judicial proceeding or arbitration pursuant to Section 6.10 is then commenced, Independent Counsel shall be discharged and relieved of any further responsibility in such capacity (subject to the applicable standards of professional conduct then prevailing). 14 6.7 Determination of Entitlement; Change of Control. If there has been a Change of Control at the time the request for indemnification is submitted, Indemnitee's entitlement to indemnification shall be determined in a written opinion by Independent Counsel selected by Indemnitee. Indemnitee shall give the Corporation written notice advising of the identity and address of the Independent Counsel so selected. The Corporation may, within ten days after such written notice of selection shall have been given, deliver to the Indemnitee a written objection to such selection; provided, however, that such objection may be asserted only on the ground that the Independent Counsel so selected does not meet the requirements of "Independent Counsel" as defined in Section 6.16 hereof, and the objection shall set forth with particularity the factual basis of such assertion. If such written objection is so made and substantiated, the Independent Counsel so selected may not serve as Independent Counsel unless and until such objection is withdrawn or a court has determined that such objection is without merit. If (i) the determination of entitlement to indemnification is to be made by Independent Counsel pursuant to this Section and (ii) within 20 days after submission by Indemnitee of a written request for indemnification pursuant to Section 6.5, no Independent Counsel shall have been selected and not objected to, the Corporation or the Indemnitee may petition the Court of Chancery or other court of competent jurisdiction for resolution of any objection which shall have been made by the Corporation to the Indemnitee's selection of Independent Counsel and/or for the appointment as Independent Counsel of a person selected by the petitioned court or by such other person as the petitioned court shall designate, and the person with respect to whom all objections are so resolved or the person so appointed shall act as Independent Counsel under this Section, if (i) Independent Counsel does not make any determination respecting Indemnitee's entitlement to indemnification hereunder within 90 days after receipt by the Corporation of a written request therefor and (ii) any judicial proceeding or arbitration pursuant to Section 6.10 is then commenced, Independent Counsel shall be discharged and relieved of any further responsibility in such capacity (subject to the applicable standards of professional conduct then prevailing). 6.8 Procedures of Independent Counsel. If a Change of Control shall have occurred before the request for indemnification is sent by Indemnitee, Indemnitee shall be presumed (except as otherwise expressly provided in this Article VI) to be entitled to indemnification upon submission of a request for indemnification in accordance with Section 6.5 hereof, and thereafter the Corporation shall have the burden of proof to overcome the presumption in reaching a determination contrary to the presumption. The presumption shall be used by Independent Counsel as a basis for a determination of entitlement to indemnification unless the Corporation provides information sufficient to overcome such presumption by clear and convincing evidence or the investigation, review and analysis of Independent Counsel convinces him by clear and convincing evidence that the presumption should not apply. 15 Except in the event that the determination of entitlement to indemnification is to be made by Independent Counsel, if the person or persons empowered under Section 6.6 or 6.7 hereof to determine entitlement to indemnification shall not have made and furnished to Indemnitee in writing a determination within 60 days after receipt by the Corporation of the request therefor, the requisite determination of entitlement to indemnification shall be deemed to have been made and Indemnitee shall be entitled to such indemnification unless Indemnitee knowingly misrepresented a material fact in connection with the request for indemnification or such indemnification is prohibited by applicable law. The termination of any Proceeding or of any Matter therein, by judgment, order, settlement or conviction, or upon a plea of nolo contendere or its equivalent, shall not (except as otherwise expressly provided in this Article VI) of itself adversely affect the right of Indemnitee to indemnification or create a presumption that Indemnitee did not act in good faith and in a manner that he reasonably believed to be in or not opposed to the best interests of the Corporation, or with respect to any criminal Proceeding, that Indemnitee had reasonable cause to believe that his conduct was unlawful. A person who acted in good faith and in a manner he reasonably believed to be in the interest of the participants and beneficiaries of an employee benefit plan of the Corporation shall be deemed to have acted in a manner not opposed to the best interests of the Corporation. For purposes of any determination hereunder, a person shall be deemed to have acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation, or, with respect to any criminal action or Proceeding, to have had no reasonable cause to believe his conduct was unlawful, if his action is based on the records or books of account of the Corporation or another enterprise or on information supplied to him by the officers of the Corporation or another enterprise in the course of their duties or on the advice of legal counsel for the Corporation or another enterprise or on information or records given or reports made to the Corporation or another enterprise by an independent certified public accountant or by an appraiser or other expert selected with reasonable care by the Corporation or another enterprise. The term "another enterprise" as used in this Section shall mean any other corporation or any partnership, limited liability company, association, joint venture, trust, employee benefit plan or other enterprise of which such person is or was serving at the request of the Corporation as a director, officer, employee or agent. The provisions of this paragraph shall not be deemed to be exclusive or to limit in any way the circumstances in which an Indemnitee may be deemed to have met the applicable standards of conduct for determining entitlement to rights under this Article. 6.9 Independent Counsel Expenses. The Corporation shall pay any and all reasonable fees and expenses of Independent Counsel incurred acting pursuant to this Article VI and in any proceeding to which it is a party or witness in respect of its investigation and written report and shall pay all reasonable fees and expenses incident to the procedures in which such Independent Counsel was selected or appointed. No Independent Counsel may serve 16 if a timely objection has been made to his selection until a court has determined that such objection is without a reasonable basis. 6.10 Adjudication. In the event that (i) a determination is made pursuant to Section 6.6 or 6.7 hereof that Indemnitee is not entitled to indemnification under this Article VI; (ii) advancement of Expenses is not timely made pursuant to Section 6.3 hereof; (iii) Independent Counsel is to determine Indemnitee's entitlement to indemnification hereunder, but does not make that determination within 90 days after receipt by the Corporation of the request for that indemnification; or (iv) payment of indemnification is not made within five days after a determination of entitlement to indemnification has been made or deemed to have been made pursuant to Section 6.6, 6.7 or 6.8 hereof, Indemnitee shall be entitled to an adjudication in an appropriate court of the State of Delaware, or in any other court of competent jurisdiction, of his entitlement to such indemnification or advancement of Expenses. In the event that a determination shall have been made that Indemnitee is not entitled to indemnification, any judicial proceeding or arbitration commenced pursuant to this Section 6.10 shall be conducted in all respects as a de novo trial on the merits and Indemnitee shall not be prejudiced by reason of that adverse determination. If a Change of Control shall have occurred, in any judicial proceeding commenced pursuant to this Section 6.10, the Corporation shall have the burden of proving that Indemnitee is not entitled to indemnification or advancement of Expenses, as the case may be. If a determination shall have been made or deemed to have been made that Indemnitee is entitled to indemnification, the Corporation shall be bound by such determination in any judicial proceeding commenced pursuant to this Section 6.10, or otherwise, unless Indemnitee knowingly misrepresented a material fact in connection with the request for indemnification, or such indemnification is prohibited by law. The Corporation shall be precluded from asserting in any judicial proceeding commenced pursuant to this Section 6.10 that the procedures and presumptions of this Article VI are not valid, binding and enforceable and shall stipulate in any such proceeding that the Corporation is bound by all provisions of this Article VI. In the event that Indemnitee, pursuant to this Section 6.10, seeks a judicial adjudication to enforce his rights under, or to recover damages for breach of, this Article VI, Indemnitee shall be entitled to recover from the Corporation, and shall be indemnified by the Corporation against, any and all Expenses actually and reasonably incurred by him in such judicial adjudication, but only if he prevails therein. If it shall be determined in such judicial adjudication that Indemnitee is entitled to receive part but not all of the indemnification or advancement of Expenses sought, the Expenses incurred by Indemnitee in connection with such judicial adjudication or arbitration shall be appropriately prorated. 6.11 Participation by the Corporation. With respect to any such claim, action, suit, proceeding or investigation as to which Indemnitee notifies the Corporation of the commencement thereof: (a) the Corporation will be entitled to participate therein at its own expense; (b) except as otherwise provided below, to the extent that it may wish, the Corporation 17 (jointly with any other indemnifying party similarly notified) will be entitled to assume the defense thereof, with counsel reasonably satisfactory to Indemnitee. After receipt of notice from the Corporation to Indemnitee of the Corporation's election so to assume the defense thereof, the Corporation will not be liable to Indemnitee under this Article VI for any legal or other expenses subsequently incurred by Indemnitee in connection with the defense thereof other than reasonable costs of investigation or as otherwise provided below. Indemnitee shall have the right to employ his own counsel in such action, suit, proceeding or investigation but the fees and expenses of such counsel incurred after notice from the Corporation of its assumption of the defense thereof shall be at the expense of Indemnitee unless (i) the employment of counsel by Indemnitee has been authorized by the Corporation, (ii) Indemnitee shall have reasonably concluded that there is a conflict of interest between the Corporation and Indemnitee in the conduct of the defense of such action or (iii) the Corporation shall not in fact have employed counsel to assume the defense of such action, in each of which cases the fees and expenses of counsel employed by Indemnitee shall be subject to indemnification pursuant to the terms of this Article VI. The Corporation shall not be entitled to assume the defense of any action, suit, proceeding or investigation brought in the name of or on behalf of the Corporation or as to which Indemnitee shall have made the conclusion provided for in (ii) above; and (c) the Corporation shall not be liable to indemnify Indemnitee under this Article VI for any amounts paid in settlement of any action or claim effected without its written consent, which consent shall not be unreasonably withheld. The Corporation shall not settle any action or claim in any manner that would impose any limitation or unindemnified penalty on Indemnitee without Indemnitee's written consent, which consent shall not be unreasonably withheld. 6.12 Nonexclusivity of Rights. The rights of indemnification and advancement of Expenses as provided by this Article VI shall not be deemed exclusive of any other rights to which Indemnitee may at any time be entitled to under applicable law, the Certificate of Incorporation, the Bylaws, any agreement, a vote of stockholders or a resolution of directors, or otherwise. No amendment, alteration or repeal of this Article VI or any provision hereof shall be effective as to any Indemnitee for acts, events and circumstances that occurred, in whole or in part, before such amendment, alteration or repeal. The provisions of this Article VI shall continue as to an Indemnitee whose Corporate Status has ceased for any reason and shall inure to the benefit of his heirs, executors and administrators. Neither the provisions of this Article VI or those of any agreement to which the Corporation is a party shall be deemed to preclude the indemnification of any person who is not specified in this Article VI as having the right to receive indemnification or is not a party to any such agreement, but whom the Corporation has the power or obligation to indemnify under the provisions of the DGCL. 6.13 Insurance and Subrogation. The Corporation shall not be liable under this Article VI to make any payment of amounts otherwise indemnifiable hereunder if, but only to the extent 18 that, Indemnitee has otherwise actually received such payment under any insurance policy, contract, agreement or otherwise. In the event of any payment hereunder, the Corporation shall be subrogated to the extent of such payment to all the rights of recovery of Indemnitee, who shall execute all papers required and take all action reasonably requested by the Corporation to secure such rights, including execution of such documents as are necessary to enable the Corporation to bring suit to enforce such rights. 6.14 Severability. If any provision or provisions of this Article VI shall be held to be invalid, illegal or unenforceable for any reason whatsoever, the validity, legality and enforceability of the remaining provisions shall not in any way be affected or impaired thereby; and, to the fullest extent possible, the provisions of this Article VI shall be construed so as to give effect to the intent manifested by the provision held invalid, illegal or unenforceable. 6.15 Certain Actions For Which Indemnification Is Not Provided. Notwithstanding any other provision of this Article VI, no person shall be entitled to indemnification or advancement of Expenses under this Article VI with respect to any Proceeding, or any Matter therein, brought or made by such person against the Corporation. 6.16 Definitions. For purposes of this Article VI: "Change of Control" means a change in control of the Corporation after both the Initial Public Offering Date and after the date Indemnitee acquired his Corporate Status, which shall be deemed to have occurred in any one of the following circumstances occurring after such date: (i) there shall have occurred an event required to be reported with respect to the Corporation in response to Item 6(e) of Schedule 14A of Regulation 14A (or in response to any similar item on any similar schedule or form) promulgated under the Exchange Act, whether or not the Corporation is then subject to such reporting requirement; (ii) any "person" (as such term is used in Sections 13(d) and 14(d) of the Exchange Act) shall have become the "beneficial owner" (as defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the Corporation representing 30% or more of the combined voting power of the Corporation's then outstanding voting securities; (iii) the Corporation is a party to a merger, consolidation, sale of assets or other reorganization, or a proxy contest, as a consequence of which members of the Board of Directors in office immediately prior to such transaction or event constitute less than a majority of the Board of Directors thereafter; or (iv) during any period of two consecutive years, individuals who at the beginning of such period constituted the Board of Directors (including, for this purpose, any new director whose election or nomination for election by the Corporation's stockholders was approved by a vote of at least two-thirds of the directors then still in office who were directors at the beginning of such period) cease for any reason to constitute at least a majority of the Board of Directors. 19 "Corporate Status" describes the status of Indemnitee as a director, officer, employee, agent or fiduciary of the Corporation or of any other corporation, partnership, limited liability company, association, joint venture, trust, employee benefit plan or other enterprise that Indemnitee is or was serving at the request of the Corporation. "Court" means the Court of Chancery of the State of Delaware or any other court of competent jurisdiction. "Expenses" shall include all reasonable attorneys' fees, retainers, court costs, transcript costs, fees of experts, witness fees, travel expenses, duplicating costs, printing and binding costs, telephone charges, postage, delivery service fees, and all other disbursements or expenses of the types customarily incurred in connection with prosecuting, defending, preparing to prosecute or defend, investigating, or being or preparing to be a witness in a Proceeding. "Indemnitee" includes any officer or director of the Corporation who is, or is threatened to be made, a witness in or a party to any Proceeding as described in Section 6.1 or 6.2 hereof by reason of his Corporate Status. "Independent Counsel" means a law firm, or a member of a law firm, that is experienced in matters of corporation law and neither presently is, nor in the five years previous to his selection or appointment has been, retained to represent: (i) the Corporation or Indemnitee in any matter material to either such party or (ii) any other party to the Proceeding giving rise to a claim for indemnification hereunder. "Matter" is a claim, a material issue or a substantial request for relief. "Proceeding" includes any action, suit, arbitration, alternate dispute resolution mechanism, investigation, administrative hearing or any other proceeding, whether civil, criminal, administrative or investigative, except one initiated by an Indemnitee pursuant to Section 6.10 hereof to enforce his rights under this Article VI. 6.17 Notices. Promptly after receipt by Indemnitee of notice of the commencement of any action, suit or proceeding, Indemnitee shall, if he anticipates or contemplates making a claim for expenses or an advance pursuant to the terms of this Article VI, notify the Corporation of the commencement of such action, suit or proceeding; provided, however, that any delay in so notifying the Corporation shall not constitute a waiver or release by Indemnitee of rights hereunder and that any omission by Indemnitee to so notify the Corporation shall not relieve the Corporation from any liability that it may have to Indemnitee otherwise than under this Article VI. Any communication required or permitted to the Corporation shall be addressed to the Secretary of the Corporation and any such communication to Indemnitee shall be addressed to Indemnitee's address as shown on the Corporation's records unless he specifies otherwise and shall be personally 20 delivered or delivered by overnight mail delivery. Any such notice shall be effective upon receipt. 6.18 Contractual Rights. The right to be indemnified or to the advancement or reimbursement of Expenses (i) is a contract right based upon good and valuable consideration, pursuant to which Indemnitee may sue as if these provisions were set forth in a separate written contract between Indemnitee and the Corporation, (ii) is and is intended to be retroactive and shall be available as to events occurring prior to the adoption of these provisions and (iii) shall continue after any rescission or restrictive modification of such provisions as to events occurring prior thereto. 6.19 Indemnification of Employees, Agents and Fiduciaries. The Corporation, by adoption of a resolution of the Board of Directors, may indemnify and advance expenses to a person who is an employee, agent or fiduciary of the Corporation including any such person who is or was serving at the request of the Corporation as a director, officer, employee, agent or fiduciary of any other corporation, partnership, joint venture, limited liability company, trust, employee benefit plan or other enterprise to the same extent and subject to the same conditions (or to such greater or lesser extent and/or subject to lesser or greater conditions as the Board of Directors may determine) under which it may indemnify and advance expenses to an Indemnitee under this Article VI. ARTICLE VII MISCELLANEOUS PROVISIONS 7.1 Bylaw Amendments. The Board of Directors shall have the power to adopt, amend and repeal from time to time the Bylaws of the Corporation, subject to the right of stockholders entitled to vote with respect thereto to amend or repeal such Bylaws as adopted or amended by the Board of Directors. Bylaws of the Corporation may be adopted, amended or repealed by the affirmative vote of the holders of at least two-thirds of the combined voting power of the outstanding shares of all classes of stock of the Corporation entitled to vote generally in the election of directors, voting together as a single class, at any annual meeting, or at any special meeting if notice of the proposed amendment be contained in the notice of said special meeting, or by the Board of Directors as specified in the preceding sentence. 7.2 Books and Records. The Corporation shall keep books and records of account and shall keep minutes of the proceedings of its stockholders, its Board of Directors and each committee of its Board of Directors. 7.3 Waiver of Notice. Whenever any notice is required to be given to any stockholder, director or committee member under the provisions of the DGCL or under the Certificate 21 of Incorporation, as amended, or these Bylaws, said notice shall be deemed to be sufficient if given (i) by telegraphic, facsimile, cable or wireless transmission or (ii) by deposit of the same in a post office box in a sealed prepaid wrapper addressed to the person entitled thereto at his post office address, as it appears on the records of the Corporation, and such notice shall be deemed to have been given on the day of such transmission or mailing, as the case may be. Whenever any notice is required to be given to any stockholder, director or committee member under the provisions of the DGCL or under the Certificate of Incorporation, as amended, or these Bylaws, a waiver thereof in writing signed by the person or persons entitled to such notice, whether before or after the time stated therein, shall be equivalent to the giving of such notice. Attendance of a person at a meeting shall constitute a waiver of notice of such meeting, except when the person attends a meeting for the express purpose of objecting, at the beginning of the meeting, to the transaction of any business because the meeting is not lawfully called or convened. Neither the business to be transacted at, nor the purpose of, any regular or special meeting of the stockholders, directors, or members of a committee of directors need be specified in any written waiver of notice unless so required by the Certificate of Incorporation or these Bylaws. 7.4 Resignations. Any director or officer may resign at any time. Such resignations shall be made in writing and shall take effect at the time specified therein, or, if no time be specified, at the time of its receipt by the Chairman of the Board, the President (if any) or the Secretary of the Corporation. The acceptance of a resignation shall not be necessary to make it effective, unless expressly so provided in the resignation. 7.5 Seal. The seal of the Corporation shall be in such form as the Board of Directors may adopt. 7.6 Fiscal Year. The fiscal year of the Corporation shall end on the 31st day of December of each year or as otherwise provided by a resolution adopted by the Board of Directors. 7.7 Facsimile Signatures. In addition to the provisions for the use of facsimile signatures elsewhere specifically authorized in these Bylaws, facsimile signatures of any officer or officers of the Corporation may be used whenever and as authorized by the Board of Directors. 7.8 Reliance upon Books, Reports and Records. Each director and each member of any committee designated by the Board of Directors shall, in the performance of his duties, be fully protected in relying in good faith upon the books of account or reports made to the Corporation by any of its officers, or by an independent certified public accountant, or by an appraiser selected with reasonable care by the Board of Directors or by any such committee, or in relying in good faith upon other records of the Corporation. 22 EX-23.1 5 CONSENT OF ERNST & YOUNG LLP EXHIBIT 23.1 CONSENT OF INDEPENDENT AUDITORS We consent to the reference of our firm under the caption "Experts" and to the use of our report dated April 3, 1997 (except Note 11, as to which the date is , 1997), in the Registration Statement (Form S-1) and related Prospectus of Dril-Quip, Inc. dated September 19, 1997. Houston, Texas - ------------------------------------------------------------------------------- The foregoing consent is in the form that will be signed upon the completion of the restatement of capital accounts described in Note 11 to the financial statements. Houston, Texas September 18, 1997 Ernst & Young LLP EX-27.1 6 FINANCIAL DATA SCHEDULE
5 12-MOS 6-MOS DEC-31-1996 DEC-31-1997 DEC-31-1996 JUN-30-1997 1,361 766 0 0 25,514 24,514 0 0 51,571 51,858 82,974 81,695 60,720 62,903 (29,336) (31,228) 114,777 113,823 33,450 28,818 0 0 0 0 0 0 144 144 50,738 54,767 114,777 113,823 115,864 68,669 115,864 68,669 77,863 47,725 99,865 59,673 0 0 0 0 2,647 1,400 13,352 7,596 4,234 2,483 9,118 5,113 0 0 0 0 0 0 9,118 5,113 .63 .36 .63 .36
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