Significant Accounting Policies

Principles of Consolidation

The condensed consolidated financial statements include the accounts of the Company and its subsidiaries. All material intercompany accounts and transactions have been eliminated.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Some of the Company’s more significant estimates are those affected by critical accounting policies for revenue recognition and valuation of inventories, contingent liabilities and fixed assets.

Revenue Recognition

Product revenues

The Company recognizes product revenues from two methods:


•	product revenues recognized under the percentage-of-completion method; and


•	product revenues from the sale of products that do not qualify for the percentage-of-completion method.

Revenues recognized under the percentage-of-completion method

The Company uses the percentage-of-completion method on long-term project contracts that have the following characteristics:


•	the contracts call for products which are designed to customer specifications;


•	the structural designs are unique and require significant engineering and manufacturing efforts generally requiring more than one year in duration;


•	the contracts contain specific terms as to milestones, progress billings and delivery dates; and


•	product requirements cannot be filled directly from the Company’s standard inventory.

For each project, the Company prepares a detailed analysis of estimated costs, profit margin, completion date and risk factors which include availability of material, production efficiencies and other factors that may impact the project. On a quarterly basis, management reviews the progress of each project, which may result in revisions of previous estimates, including revenue recognition. The Company, using the efforts-expended method, calculates the percentage complete and applies the percentage to determine the revenues earned and the appropriate portion of total estimated costs to be recognized. Losses, if any, are recorded in full in the period they become known. Historically, the Company’s estimates of total costs and costs to complete have approximated actual costs incurred to complete the project.

Under the percentage-of-completion method, billings may not correlate directly to the revenue recognized. Based upon the terms of the specific contract, billings may be in excess of the revenue recognized, in which case the amounts are included in customer prepayments as a liability on the Condensed Consolidated Balance Sheets. Likewise, revenue recognized may exceed customer billings in which case the amounts are reported in trade receivables. Unbilled revenues are expected to be billed and collected within one year. At September 30, 2017 and December 31, 2016, receivables included $44.1 million and $56.8 million of unbilled receivables, respectively. For the three months ended September 30, 2017, there were seven projects representing approximately 20% of the Company's total revenues and approximately 15% of the Company's product revenues that were accounted for using percentage-of-completion accounting, compared to four projects for the three months ended September 30, 2016, which represented approximately 12% of the Company's total revenues and approximately 14% of its product revenues. For the nine months ended September 30, 2017, there were eight projects representing approximately 15% of the Company’s total revenues and approximately 19% of its product revenues that were accounted for using percentage-of-completion accounting, compared to 10 projects for the nine months ended September 30, 2016, which represented approximately 14% of the Company’s total revenues and approximately 17% of its product revenues.

Revenues not recognized under the percentage-of-completion method

Revenues from the sale of inventory products, not accounted for under the percentage-of-completion method, are recorded at the time the manufacturing processes are complete and ownership is transferred to the customer.

Service revenues

The Company recognizes service revenues from three sources:


•	technical advisory assistance;


•	rental of running tools; and


•	rework and reconditioning of customer-owned Dril-Quip products.

The Company does not install products for its customers, but it does provide technical advisory assistance. At the time of delivery of the product, the customer is not obligated to buy or rent the Company’s running tools and the Company is not obligated to perform any subsequent services relating to installation. Technical advisory assistance service revenue is recorded at the time the service is rendered. Service revenues associated with the rental of running and installation tools are recorded as earned. Rework and reconditioning service revenues are recorded when the refurbishment process is complete.

The Company normally negotiates contracts for products, including those accounted for under the percentage-of-completion method, and services separately. For all product sales, it is the customer’s decision as to the timing of the product installation as well as whether Dril-Quip running tools will be purchased or rented. Furthermore, the customer is under no obligation to utilize the Company’s technical advisory assistance services. The customer may use a third party or their own personnel.

Fair Value of Financial Instruments

The Company’s financial instruments consist primarily of cash and cash equivalents, receivables and payables. The carrying values of these financial instruments approximate their respective fair values as they are short-term in nature.

Earnings Per Share

Basic earnings per common share is computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per common share is computed considering the dilutive effect of stock options and awards using the treasury stock method.

In each relevant period, the net income used in the basic and dilutive earnings per share calculations is the same. The following table reconciles the weighted average basic number of common shares outstanding and the weighted average diluted number of common shares outstanding for the purpose of calculating basic and diluted earnings per share:



	Three months ended September 30,		Nine months ended September 30,
	2017	2016	2017	2016
	(In thousands)
Weighted average common shares outstanding—basic	37,528	37,371	37,527	37,562
Dilutive effect of common stock options and awards	—	183	—	137
Weighted average common shares outstanding—diluted	37,528	37,554	37,527	37,699

For the three and nine month period ended September 30, 2017, the Company has excluded the following common stock options and awards because their impact on the loss per share is anti-dilutive (in thousands on a weighted average basis):



	Three Months Ended September 30,		Nine months ended September 30,
	2017	2016	2017	2016
	(In thousands)
Director stock awards	15	—	13	—
Stock options	328	—	333	—
Performance share units	212	—	207	—
Restricted stock awards	315	—	293	—