Innovex International, Inc. annual report, FY2011

Filing identity and reporting period

Important mismatch: The supplied filing is Dril-Quip, Inc.’s Form 10-K for the fiscal year ended December 31, 2011, filed February 24, 2012. It is not an Innovex International, Inc. filing. The filing includes unaudited quarterly results for Q4 2011.

Business context

Dril-Quip designs, manufactures, sells and services engineered offshore drilling and production equipment, including subsea and surface wellheads and trees, control systems, manifolds and risers. It reports three geographic segments: Western Hemisphere, Eastern Hemisphere and Asia-Pacific. Foreign sales were approximately 69% of 2011 revenue, versus 61% in 2010.

Financial performance and liquidity

Revenue rose 6.2%, while operating income declined 6.5% and net income declined 6.8%. Gross margin fell to approximately 39.8% from 43.0%; operating margin was 21.6% versus 24.5%, and net margin was 15.8% versus 18.1%. Management attributed the higher cost of sales as a share of revenue to product mix and unabsorbed manufacturing overhead. Operating cash flow less capital expenditures was approximately $45.6 million in 2011, compared with $32.3 million in 2010.

Q4 2011 revenue was $171.6 million, operating income $36.8 million and net income $28.1 million; Q4 2010 amounts were $141.6 million, $27.1 million and $20.9 million, respectively. The 2011 Q4 results included the $4.7 million pre-tax CEO retirement charge.

Material changes and unusual items

• Product revenue increased $25.5 million, led by a $53.1 million increase in subsea equipment; offshore rig equipment revenue decreased $28.1 million. Services revenue increased $9.5 million.
• SG&A increased 15.4% to $70.5 million, including $3.5 million of pre-tax foreign-currency transaction losses, compared with $1.4 million of gains in 2010. Engineering and product development expense rose 18.5% to $34.6 million.
• Special items were $4.7 million in 2011, primarily severance and accelerated option vesting associated with J. Mike Walker’s retirement. Special items were $14.7 million in 2010, including executive severance and Brazilian tax-related charges.
• Backlog increased 14% to approximately $716 million at year-end, from $627 million in 2010. Management expected to fulfill approximately 68% during 2012; backlog is cancellable or changeable by customers and is not a direct predictor of revenue.

Outlook, risks and contingencies

Management said cash on hand and operating cash generation should fund operations, working capital and anticipated capital expenditures for the next 12 months. It did not provide specific company revenue or earnings guidance. It expected continued oil and gas price volatility and saw ongoing global demand for specialized offshore equipment, while noting that Gulf of Mexico permitting delays could weigh on subsea and, to a lesser extent, surface equipment revenue in 2012.

• Deepwater Horizon: The court dismissed claims against Dril-Quip in the relevant proceedings with prejudice on January 20, 2012. No liability was accrued. The company noted that further claims or investigations remained possible and that insurers had issued a reservation-of-rights letter. Its disclosed $100 million aggregate coverage limit applied at the time of the incident.
• Brazilian tax assessments: The contested assessments were approximately BRL19.4 million, or $11.3 million, including interest, penalties and possible restatement fees as of February 2012. No liability was accrued; management said it could not reasonably estimate a loss range.
• Key operating exposures include offshore spending and oil-price cycles, post-Deepwater Horizon regulation and testing, customer concentration (Petrobras represented approximately 15% of 2011 revenue), raw-material and labor costs, fixed-price project overruns, international political and currency risks, and dependence on third-party technology and suppliers.
• The company reported effective internal control over financial reporting; its auditor issued unqualified opinions on the financial statements and internal controls.

Important facts for investors to verify

• Confirm the issuer: this source is Dril-Quip, not Innovex International.
• Review whether margin pressure, product mix and higher manufacturing overhead continued after 2011.
• Track conversion, cancellations and timing of the $716 million backlog, especially the expected 2012 deliveries.
• Assess the effects of Gulf of Mexico permitting, safety rules and product testing requirements on orders and services.
• Check subsequent developments in Brazilian tax proceedings, Deepwater Horizon-related matters and insurance coverage.
• Monitor customer concentration, foreign-exchange exposure and capital spending needs.