The following is management's discussion and analysis of certain significant factors that have affected certain aspects of the Company's financial position, results of operations and cash flows during the periods included in the accompanying consolidated financial statements. This discussion should be read in conjunction with the Company's Consolidated Financial Statements and Notes thereto presented elsewhere in this Report.

Overview

Dril-Quip designs, manufactures, sells and services highly engineered offshore drilling and production equipment that 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, subsea control systems and manifolds, mudline hanger systems, specialty connectors and associated pipe, drilling and production riser systems, liner hangers, wellhead connectors and diverters. Dril-Quip also provides technical advisory services on an as-requested basis during installation of its products, as well as rework and reconditioning services and rental of running and installation tools for use in connection with the installation and retrieval of its products.

Both the market for offshore drilling and production equipment and services and the Company's business are substantially dependent on the condition of the oil and gas industry and, in particular, the willingness of oil and gas companies to make capital expenditures on exploration, drilling and production operations offshore. Oil and gas prices and the level of offshore drilling and production activity have historically been characterized by significant volatility. See "Item 1A. Risk Factors-A material or extended decline in expenditures by the oil and gas industry could significantly reduce our revenue and income."

According to the Energy Information Administration ("EIA") of the U.S. Department of Energy, oil (West Texas Intermediate Cushing Crude Oil) and natural gas (Henry Hub Natural Gas) prices are listed below as averages of the daily closing prices for the years 2006, 2007 and 2008:

                                                    Year ended
                                                   December 31,
                                             2006      2007      2008
                  Oil ($/Bbl)               $ 66.02   $ 72.32   $ 99.57
                  Natural gas ($/per Mcf)      6.94      7.18      9.13

In mid July 2008, oil prices spiked to $145.16 per barrel and ended the year in 2008 at $44.60 per barrel. Additionally, by the end of December 2008, gas prices had declined to $5.48 per Mcf. These declines in hydrocarbon prices have adversely affected the willingness of some oil and gas companies to make capital expenditures on exploration, drilling and production operations offshore, which could have an adverse impact on the Company's financial condition and results of operations.

According to the January and February 2009 release of the Short-Term Energy Outlook published by the EIA, West Texas Intermediate crude oil prices are projected to average $43.14 per barrel in 2009 and $54.50 in 2010. In January 2009, the EIA projected Henry Hub gas prices to average $5.78 per Mcf in 2009 and increase to an average of $6.63 per Mcf in 2010. In February 2009 EIA lowered the expectation to $5.01 per Mcf in 2009 and $5.93 per Mcf in 2010. The EIA further predicted OPEC crude oil production to average 30.0 million barrels per day in 2009 and 30.7 million barrels per day in 2010. This estimate was revised downward in February 2009

to 29.4 million barrels per day in 2009 and 30.1 million barrels per day in 2010. In the January 2009 Oil Market Report, the International Energy Agency projected oil demand in 2009 to be 85.3 million barrels per day, compared to an estimated 85.8 million barrels per day in 2008. In February 2009 the International Energy Agency revised the oil demand in 2009 downward to 84.7 million barrels per day.

Detailed below is the average contracted rig count for our geographic regions for the years ended December 31, 2006, 2007 and 2008. The rig count data includes floating rigs (semi-submersibles and drill ships) and jack-ups. We have included only these types of rigs as they are the primary end users of our products.

                                                       Year ended
                                                      December 31,
                                                   2006   2007   2008
                 Western Hemisphere                 230    212    212
                 Eastern Hemisphere                 162    170    172
                 Asia-Pacific                       202    226    249
                 Source: ODS - Petrodata RigBase

The table represents rigs under contract and includes rigs currently drilling as well as rigs committed, but not yet drilling. Since mid-2008 the number of active offshore rigs has declined.

We believe that the number of rigs (semi-submersibles, jack-ups and drill ships) under construction impacts our revenue because our customers generally order some of our products during the construction of such rigs. As a result, an increase in rig construction activity tends to favorably impact our backlog. According to ODS-Petrodata, at the end of December 2006 and 2007, there were 112 and 156 rigs under construction, respectively, compared to 172 at the end of December 2008, which represents an increase of 53.5% and 10.3%, respectively.

Due to the significant increase in the oil and gas activity over the past several years, the Company has expanded facilities in all of its major manufacturing locations in Houston, Texas; Aberdeen, Scotland, Macae, Brazil and Singapore. With limited manufacturing capacity in the past, the Company has had to focus on which projects submitted by customers to undertake. In making the decision, the Company takes into consideration such factors as manufacturing time, current projects in progress, delivery requirements, projected gross margins, available personnel and availability of material. Based upon these decisions, it is possible for the Company to have variations between quarters and years based upon product mix.

High oil and gas prices from 2005 through mid-2008 resulted in oil operators increasing capital spending for both exploration and development programs. As various geopolitical issues have limited the ability of oil and gas companies to invest in certain geographic areas, such as Russia and the Middle East, an increasing amount of this capital spending has been in the deepwater areas in which the Company operates. However, in mid-2008, oil and gas prices began to decline. This decline has resulted in reduced capital spending by some oil and gas companies and may result in additional reductions in capital spending.

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, acts of terrorism 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. See "Item 1A. Risk Factors-Our international operations expose us to instability and changes in economic and political conditions and other risks inherent to international business, which could have a material adverse effect on our operations or financial condition."

Dril-Quip's revenues are generated from two sources: products and services. Product revenues are derived from the sale of offshore drilling and production equipment. Service revenues are earned when the Company provides technical advisory service for installation of the Company's products, reconditioning services and rental of running tools for installation and retrieval of its products. In 2008, the Company derived 84% of its revenues from the sale of its products and 16% of its revenues from services. Service revenues generally correlate to revenues from product sales because increased product sales normally generate increased revenues from technical advisory services during installation and rental of running tools. The Company has substantial international operations, with approximately 65%, 69% and 69% of its revenues derived from foreign sales in 2006, 2007 and 2008, respectively.

Generally, the Company attempts to raise its prices as its costs increase. However, the actual pricing of the Company's products and services is impacted by a number of factors, including competitive pricing pressure, the level of utilized capacity in the oil service sector, maintenance of market share, the introduction of new products and general market conditions.

The Company accounts for larger and more complex projects that have relatively longer manufacturing time frames on a percentage-of-completion basis. During 2006 and 2007, 10 and 16 projects, respectively representing approximately 12% and 19%, of the Company's total revenues were accounted for using the percentage-of-completion accounting. During 2008, 23 projects representing approximately 25% of the Company's total revenue and 30% of the Company's product revenues were accounted for using percentage-of-completion accounting. This percentage may fluctuate in the future. Revenues accounted for in this manner are generally recognized based upon a calculation of the percentage complete which is used to determine the revenue earned and the appropriate portion of total estimated costs. Accordingly, price and cost estimates are reviewed periodically as the work progresses, and adjustments proportionate to the percent complete are reflected in the period when such estimates are revised. Losses, if any, are recognized when they become known. Amounts received from customers in excess of revenues recognized are classified as a current liability. See "Item 1A. Risk Factors-We may be required to recognize a charge against current earnings because of percentage-of-completion accounting."

Results of Operations

The following table sets forth, for the periods indicated, certain consolidated statements of income data expressed as a percentage of revenues:

                                                       Year Ended December 31,
                                                     2006         2007      2008
     Revenues:
     Products                                          84.1 %      84.3 %    83.5 %
     Services                                          15.9        15.7      16.5

     Total revenues                                   100.0       100.0     100.0
     Cost of sales:
     Products:                                         49.2        48.0      48.0
     Services                                           8.7         9.6       9.5

     Total cost of sales                               57.9        57.6      57.5
     Selling, general and administrative expenses      10.0         9.9      11.5
     Engineering and product development expenses       4.4         4.6       4.9

     Operating income                                  27.7        27.9      26.1
     Interest income                                    0.8         1.7       0.6
     Interest expense                                  (0.2 )      (0.1 )      -

     Income before income taxes                        28.3        29.5      26.7
     Income tax provision                               8.7         7.7       7.3

     Net income                                        19.6 %      21.8 %    19.4 %

The following table sets forth, for the periods indicated, a breakdown of our products and service revenues:

                                            2006      2007      2008
                                                  (In millions)
                  Revenues:
                  Products
                  Subsea equipment         $ 337.6   $ 316.7   $ 318.2
                  Surface equipment           30.6      38.1      30.6
                  Offshore rig equipment       4.3      63.2     104.5

                  Total products             372.5     418.0     453.3
                  Services                    70.2      77.6      89.5

                  Total revenues           $ 442.7   $ 495.6   $ 542.8

Year ended December 31, 2008 Compared to Year Ended December 31, 2007

Revenues. Revenues increased by $47.2 million, or approximately 9.5%, to $542.8 million in 2008 from $495.6 million in 2007. Product revenues increased by approximately $35.3 million for the year ended December 31, 2008 compared to the same period in 2007 as a result of increased revenues of $41.3 million in offshore rig equipment and $1.5 million in subsea equipment offset by a $7.5 million decrease in surface equipment. The increase in offshore rig equipment was primarily due to the increase in the number of long-term projects. During 2007 there were 16 projects, compared to 23 projects during 2008 and the majority of these projects related to offshore rig equipment. Of the Company's total product revenues, product revenues increased in the Western Hemisphere, Eastern Hemisphere and Asia-Pacific by $26.5 million, $6.0 million and $2.8 million, respectively. Service revenues increased by approximately $11.9 million from increased service revenues in the Western Hemisphere of $4.8 million, Eastern Hemisphere of $2.0 million Asia-Pacific of $5.1 million. The majority of the increases in service revenues related to an increase in technical advisory assistance and reconditioning services.

Cost of Sales. Cost of sales increased by $27.0 million, or approximately 9.5%, to $312.3 million for 2008 from $285.3 million for the same period in 2007. As a percentage of revenues, cost of sales were approximately 57.6% in 2007 and 57.5% in 2008. Cost of sales as a percentage of revenue remained relatively consistent between 2007 and 2008. The increase in cost of sales in 2008 as compared to 2007 is basically consistent with the increase in revenue.

Selling, General and Administrative Expenses. For 2008, selling, general and administrative expenses increased by approximately $13.1 million, or 26.6%, to $62.4 million from $49.3 million in 2007. The increase in selling, general and administrative expenses were due to increased labor and overhead expenses resulting from increased staffing levels in the areas of sales and administration, increases in legal and professional fees, stock option expenses and the effect of foreign currency transaction gains and losses. The Company experienced approximately $3.0 million in pre-tax foreign currency transaction gains during 2007 versus approximately $2.1 million in pre-tax foreign currency transaction losses during 2008. The loss in 2008 is primarily due to the increasing strength of the U.S. dollar in the later part of 2008 as compared to the Brazilian real. Selling, general and administrative expenses as a percentage of revenues were 9.9% in 2007 and 11.5% in 2008.

Engineering and Product Development Expenses. For 2008, engineering and product development expenses increased by $3.8 million, or approximately 16.8%, to approximately $26.4 million from $22.6 million in 2007. This increase was due primarily to an increase in personnel and associated operating expenses. Engineering and product development expenses as a percentage of revenues increased from 4.6% in 2007 to 4.9% in 2008.

Interest Income. Interest income for 2008 was $3.5 million as compared to $8.3 million in 2007. This decrease was due to a reduction in interest earned on short-term investments caused by lower interest rates and reduced balances in short-term investments. Due to the global financial crisis, the Company has transferred the

majority of its short-term investments to funds which invest in U.S. Treasury obligations, which normally earn lower interest rates than money market funds. Short-term investment balances declined primarily as a result of expenditures of $100 million related to the Company's share repurchase program.

Interest expense. Interest expense for 2008 was $182,000 compared to $370,000 in 2007.

Income tax provision. Income tax expense for 2008 was $39.4 million on income before taxes of $145.0 million, resulting in an effective income tax rate of approximately 27.2%. Income tax expense in 2007 was $38.3 million on income before taxes of $146.3 million, resulting in an effective tax rate of approximately 26.2%. In the fourth quarter of 2007 the Company benefited from a foreign development tax incentive which resulted in a reduction in income taxes of approximately $4.7 million.

Net Income. Net income was approximately $105.6 million in 2008 and $107.9 million in 2007, for the reasons set forth above.

Year ended December 31, 2007 Compared to Year Ended December 31, 2006

Revenues. Revenues increased by $52.9 million, or approximately 11.9%, to $495.6 million in 2007 from $442.7 million in 2006. Product revenues increased by approximately $45.5 million for 2007 as compared to 2006 as a result of increased revenues of $58.9 million in offshore rig equipment and $7.5 million in surface equipment offset by a decrease of $20.9 million in subsea equipment. The increase in offshore rig equipment was primarily due to the increase in the number of long-term projects. During 2006 there were 10 projects, compared to 16 projects during 2007 and the majority of these projects related to offshore rig equipment. On a geographic basis, product revenues increased in the Western Hemisphere, Eastern Hemisphere and Asia-Pacific by $12.7 million, $12.3 million and $20.5 million, respectively. Service revenues increased by approximately $7.4 million from increased service revenues in the Western Hemisphere of $5.0 million and Eastern Hemisphere of $3.7 million and slightly offset by a decrease in Asia-Pacific of $1.3 million. The majority of the increase in service revenues was due to higher technical advisory assistance and reconditioning services.

Cost of Sales. Cost of sales increased by $28.6 million, or approximately 11.1%, to $285.3 million for 2007 from $256.7 million for the same period in 2006. As a percentage of revenues, cost of sales were approximately 57.9% in 2006 and 57.6% in 2007. The reduction in cost of sales as a percentage of revenues resulted primarily from changes in product mix.

Selling, General and Administrative Expenses. For 2007, selling, general and administrative expenses increased by approximately $5.2 million, or 11.8%, to $49.3 million from $44.1 million in 2006. The increase in selling, general and administrative expenses was primarily due to increased labor and overhead expenses resulting from increased staffing levels in the areas of sales and administration and increases in legal and professional fees. The Company experienced approximately $2.2 million in pre-tax foreign currency transaction gains during 2006 versus approximately $3.0 million in pre-tax foreign currency transaction gains during 2007. Selling, general and administrative expenses as a percentage of revenues were 10.0% in 2006 and 9.9% in 2007.

Engineering and Product Development Expenses. For 2007, engineering and product development expenses increased by $3.0 million, or approximately 15.3%, to approximately $22.6 million from $19.6 million in 2006. This increase was due primarily to an increase in personnel and associated operating expenses. Engineering and product development expenses as a percentage of revenues increased from 4.4% in 2006 to 4.6% in 2007.

Interest Income. Interest income for 2007 was $8.3 million as compared to $3.6 million in 2006. The increase was due to interest earned on short-term investments resulting from excess cash flows generated.

Interest expense. Interest expense for 2007 was $370,000 compared to $669,000 in 2006. This decrease was due to the partial pay down of long-term debt and a reduction in commitment fee expenses related to the Company's unsecured revolving line of credit.

Income tax provision. Income tax expense for 2007 was $38.3 million on income before taxes of $146.3 million, resulting in an effective income tax rate of approximately 26.2%. Income tax expense in 2006 was $38.5 million on income before taxes of $125.4 million, resulting in an effective tax rate of approximately 30.7%. This decrease in the effective tax rate reflects a reduction in foreign tax rates resulting from a foreign development tax incentive and increased tax benefits for manufacturing companies located in the United States of America.

Net Income. Net income was approximately $107.9 million in 2007 and $86.9 million in 2006, for the reasons set forth above.

Liquidity and Capital Resources

Cash flows provided by (used in) operations by type of activity were as follows:

                                                   Year ended
                                                  December 31,
                                       2006          2007           2008
                                                 (In thousands)
              Operating activities   $  93,482     $  82,663     $   40,677
              Investing activities     (23,290 )     (24,854 )      (49,527 )
              Financing activities      36,851        10,160       (100,075 )

Statements of cash flows for entities with international operations that are local currency functional exclude the effects of the changes in foreign currency exchange rates that occur during any given year, as these are noncash changes. As a result, changes reflected in certain accounts on the consolidated statements of cash flows may not reflect the changes in corresponding accounts on the Consolidated Balance Sheets.

The primary liquidity needs of the Company are (i) to fund capital expenditures to improve and expand facilities and manufacture additional running tools and
(ii) to fund working capital. Recently, the Company's principal sources of funds have been cash flows from operations.

During 2008, the Company generated $40.7 million of cash from operations as compared to $82.7 million for the same period in 2007. The primary reasons for the decrease were the changes in operating assets and liabilities during 2008 as compared to the same period in 2007. Cash totaling approximately $84.5 million was utilized during 2008 to increase operating assets and liabilities, compared to a $42.3 million increase in operating assets and liabilities during the same period in 2007. The increase in operating assets and liabilities during 2008 primarily reflected an increase of $62.1 million in inventories due to a $174 million increase in backlog. Customer prepayments, included in trade accounts payable and other accrued expenses, increased over $25 million in 2008 due to the increase in the number of projects. Also, an increase in accounts receivable of $46.9 million was largely due to increases in unbilled project receivables.

Capital expenditures by the Company were $24.1 million, $25.2 million and $50.1 million in 2006, 2007 and 2008, respectively. Capital expenditures in 2006 and 2007 included expanding manufacturing facilities in the Western Hemisphere and increased expenditures on machinery and equipment and running tools due to expanded operations. The capital expenditures for 2008 were primarily $16.8 million for machinery and equipment, $20.8 million for facilities and $9.3 million running tools and other expenditures of $3.2 million. Principal payments on long-term debt were approximately $800,000, $900,000 and $800,000 in 2006, 2007 and 2008, respectively.

In May 2008 the Company announced that its Board of Directors had authorized a share repurchase program under which the Company could repurchase up to $100 million of its common stock. At the end of the third quarter of 2008, the Company had repurchased 1,799,928 shares at an average price of $55.58 per share (including commissions) for a total of approximately $100 million. All repurchased shares have been retired.

The following table presents long-term contractual obligations of the Company and the related payments, excluding the effects of interest, due in total and by year as of December 31, 2008:

                                                              Payments due by year
                                                                                         After
Contractual Obligations                 2009      2010       2011      2012     2013     2013      Total
                                                                 (In thousands)
Long-term debt and capital leases      $   636   $   636   $    235   $    25   $  -    $    -    $  1,532
Operating lease obligations (1)          1,742       787     18,697     2,956     131     2,305     26,618
Estimated interest payments (2)             45        25         10         7       1        -          88

Total                                  $ 2,423   $ 1,448   $ 18,942   $ 2,988   $ 132   $ 2,305   $ 28,238

(1) Includes certain minimum lease obligations for investments in machinery, leasehold improvements and buildings.

(2) Interest rates for leases were calculated using the interest portion of the lease payment. Interest payments for variable rate debt were calculated using the interest rate and exchange rate in effect at December 31, 2008.

The Company has a credit facility with Guaranty Bank, FSB providing an unsecured revolving line of credit of up to $10 million. At the option of the Company, borrowing under this facility bears interest at either a rate equal to LIBOR (London Interbank Offered Rate) plus 1.75% or the Guaranty Bank base rate. The facility calls for quarterly interest payments and terminates on June 1, 2009. The facility also contains certain covenants including maintaining minimum tangible net worth levels, not exceeding specified funded debt amounts and required interest coverage ratios. As of December 31, 2007 and 2008, the Company had no borrowings under this facility and was in compliance with all loan covenants.

Dril-Quip (Europe) Limited has a credit agreement with the Bank of Scotland dated March 21, 2001 in the original amount of U.K. Pounds Sterling 4.0 million (approximately U.S. $5.8 million). Borrowing under this facility bears interest . . .