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Significant Accounting Policies (Policies)

9 Months Ended

Sep. 30, 2019

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 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 inventories.

Revenue Recognition

The Company generates revenues through the sale of products, the sale of services and the leasing of installation tools. The Company normally negotiates contracts for products, including those accounted for under the over time method, rental tools and services separately. Modifications to the scope and price of sales contracts may occur in the form of variations and change orders. 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 instead choose to use a third party or its own personnel.

Product and Service Revenues

Product and service revenues are recognized as the Company satisfies the performance obligation by transferring control of the promised good or service to the customer. Revenues are measured based on consideration specified in a contract with a customer and exclude sales incentives and amounts collected on behalf of third parties. In addition, some customers may impose contractually negotiated penalties for late delivery that are excluded from the transaction price.

Management has elected to utilize certain practical expedients allowed under Accounting Standards Codification 606, Revenue from Contracts with Customers (ASC 606). Taxes assessed by a governmental authority that are both imposed on and concurrent with a specific revenue-producing transaction and collected by the entity from a customer are excluded from the measurement of the transaction price. Shipping and handling activities that are performed after a customer obtains control of the good are accounted for as activities to fulfill the promise to transfer the good and thus are excluded from the transaction price.

Product revenues

The Company recognizes product revenues from two methods:

•

product revenues are recognized over time as control is transferred to the customer; and

•

product revenues from the sale of products that do not qualify for the over time method are recognized as point in time.

Revenues recognized under the over time method

The Company uses the over time 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 six months in duration;

•

product requirements cannot be filled directly from the Company’s standard inventory; and

•

The Company has an enforceable right to payment for any work completed to date and the enforceable payment includes a reasonable profit margin.

For each project, the Company prepares a detailed analysis of estimated costs, profit margin, completion date and risk factors which include availability of material, production efficiencies and other factors that may impact the project. On a quarterly basis, management reviews the progress of each project, which may result in revisions of previous estimates, including revenue recognition. The Company calculates the 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 over time 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, 2019 and December 31, 2018, receivables included $76.1 million and $57.0 million of unbilled receivables, respectively. For the three months ended September 30, 2019, there were 29 projects representing approximately 21.9% of the Company's total revenues and approximately 28.9% of its product revenues that were accounted for using over time accounting, compared to eight projects for the three months ended September 30, 2018, which represented approximately 15.7% of the Company's total revenues and approximately 23.1% of its product revenues. For the nine months ended September 30, 2019, there were 31 projects representing approximately 20.5% of the Company’s total revenues and approximately 28.0% of its product revenues that were accounted for using over time accounting, compared to 14 projects for the nine months ended September 30, 2018, which represented approximately 14.0% of the Company’s total revenues and approximately 20.3% of its product revenues.

Revenues recognized under the point in time method

Revenues from the sale of standard inventory products, not accounted for under the over time method, are recorded at the point in time that the customer obtains control of the promised asset and the Company satisfies its performance obligation. This point in time recognition aligns with the time of shipment, which is when the Company typically has a present right to payment, title transfers to the customer, the customer or its carrier has physical possession and the customer has significant risks and rewards of ownership. The Company may provide product storage to some customers. Revenues for these products are recognized at the point in time that control of the product transfers to the customer, the reason for storage is requested by the customer, the product is separately identified, the product is ready for physical transfer to the customer and the Company does not have the ability to use or direct the use of the product. This point in time typically occurs when the products are moved to storage. We receive payment after control of the products has transferred to the customer.

Service revenues

The Company recognizes service revenues from two sources:

•

technical advisory assistance; and

•

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

The Company generally does not install products for its customers, but it does provide technical advisory assistance.

The Company normally negotiates contracts for products, including those accounted for under the over time 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. The contracts for these services are typically considered day-to-day.

Rework and reconditioning service revenues are recorded using the over time method based on the remaining steps that need to be completed as the refurbishment process is performed. The measurement of progress considers, among other things, the time necessary for completion of each step in the reconditioning plan, the materials to be purchased, labor and ordering procedures. We receive payment after the services have been performed by billing customers periodically (typically monthly).

Lease revenues

The Company earns lease revenues from the rental of running tools. Rental revenues are recognized within leasing revenues on a day rate basis over the lease term, which is generally between one to three months.

Practical Expedients

We do not disclose the value of unsatisfied performance obligations for contracts with an original expected length of one year or less.

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.

Restructuring and Other Charges

In the third quarter of 2018, we initiated a global strategic plan to better align our operations with current market conditions and finalized this plan during the second quarter of 2019. As a result of this plan, during the three and nine months ended September 30, 2019, we incurred restructuring and other charges of approximately $0.5 million and $4.0 million, respectively. All of these charges primarily relate to employee termination benefits and consulting fees.

Treasury Shares

On February 26, 2019, the Board of Directors authorized a share repurchase plan under which the Company can repurchase up to $100 million of its common stock. The repurchase plan has no set expiration date and any repurchased shares are expected to be cancelled. For the three months ended September 30, 2019, the Company purchased 75,737 shares under the share repurchase plan at an average price of approximately $44.45 per share totaling approximately $3.4 million and has retired such shares.

For the nine months ended September 30, 2019, the Company purchased 125,888 shares under the share repurchase plan at an average price of approximately $42.60 per share totaling approximately $5.4 million and has retired such shares. The Company continues to evaluate current market conditions on an on-going basis as it relates to executing its share buyback program.

Earnings Per Share

Basic earnings per common share is computed by dividing net income (loss) 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 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				Nine months ended
	September 30,				September 30,
	2019		2018		2019		2018
	(In thousands)
Weighted average common shares outstanding - basic		35,559		37,119		35,827		37,349
Dilutive effect of common stock awards		-		-		-		-
Weighted average common shares outstanding – diluted		35,559		37,119		35,827		37,349

For the three and nine months ended September 30, 2019, the Company has excluded the following common stock options and awards because their impact on the income/(loss) per share is anti-dilutive (in thousands on a weighted average basis):

	Three months ended				Nine months ended
	September 30,				September 30,
	2019		2018		2019		2018
	(In thousands)
Director stock awards		39		11		37		9
Stock options		170		181		200		196
Performance share units		298		126		298		90
Restricted stock awards		332		172		343		125

Reclassifications

Reclassifications. As a result of our global business transformation, certain prior period amounts have been reclassified to conform to the current period presentation as it related to product engineering and quality assurance cost. We reclassified approximately $4.8 million and $15.0 million of engineering cost from our engineering and product development cost and approximately $0.7 million and $2.3 million of quality assurance cost from selling, general and administrative to product cost of sales during the three and nine months ended September 30, 2018, respectively. These reclassifications did not have an impact on our Condensed Consolidated Statements of Income (Loss), Condensed Consolidated Balance Sheets, Condensed Consolidated Statements of Comprehensive Income (Loss), Condensed Consolidated Statements of Stockholders’ Equity and Condensed Consolidated Statements of Cash Flows. Engineering costs were approximately $3.9 million and $12.2 million for the three and nine months ended September 30, 2019. Quality assurance costs were approximately $0.7 million and $2.3 million for the three and nine months ended September 30, 2019, respectively.

During the three months ended September 30, 2019, the Company identified errors related to a product contract in which the performance obligation was satisfied in the three months ended June 30, 2019 and product costs of sales were incorrectly eliminated at June 30, 2019. The Company recorded in the three months ended September 30, 2019 out-of-period adjustments, which increased product revenue by $3.4 million and decreased net income (loss) by $1.5 million. Management determined the errors were not material to the previously issued condensed consolidated interim financial statements as of and for the three and six months ended June 30, 2019. In addition, the correction of the errors in the three months ended September 30, 2019 is not material on either a quantitative basis or a qualitative basis.