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 or cash flows during the periods included in the accompanying unaudited condensed consolidated financial statements. This discussion should be read in conjunction with the unaudited condensed consolidated financial statements included elsewhere herein, as well as the discussion under "Risk Factors," "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the annual consolidated financial statements included in the Company's Annual Report on Form 10-K for the year ended December 31, 2008.

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 assistance on an as-requested basis during installation of its products, as well as rework and reconditioning services for customer-owned Dril-Quip products and rental of running tools for use in connection with the installation and retrieval of the Company's 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. Declines in oil and gas prices may adversely affect 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 operations, financial position or cash flows.

According to the Energy Information Administration ("EIA") of the U.S. Department of Energy, average crude oil (West Texas Intermediate Cushing) and natural gas (Henry Hub) closing prices are listed below for the periods covered by this report:

                                    Three months ended       Six months ended
                                         June 30,                June 30,
                                     2008         2009        2008       2009
            Crude oil ($/Bbl)     $    123.78    $ 59.61   $   111.13   $ 51.51
            Natural gas ($/Mcf)         11.73       3.83        10.33      4.27

During the second quarter of 2008, crude oil prices ranged between $100.92 per barrel and $139.96 per barrel with an average quarterly price of $123.78. For the second quarter of 2009, crude oil prices ranged between $45.82 per barrel and $72.69 per barrel with an average quarterly price of $59.61. During the six months ended June 30, 2008, crude oil process ranged between $87.16 per barrel and $139.96 per barrel with an average price of $111.13 per barrel, as compared to a range of $34.03 per barrel to $72.69 per barrel with an average price of $51.51 per barrel for the same period in 2009.

According to the July 2009 release of the Short-Term Energy Outlook published by the EIA, West Texas Intermediate crude oil prices are projected to average $60.35 per barrel in 2009 and $72.42 per barrel in 2010.

In its July 2009 report, the EIA revised its projection for Henry Hub natural gas prices to $4.22 per Mcf in 2009 and $5.93 per Mcf in 2010 from its March 2009 projections of $4.67 per Mcf in 2009 and $5.87 per Mcf in 2010. According to the EIA, the monthly average Henry Hub natural gas spot price is expected to remain below $4.00 per Mcf until late in the year given plentiful U.S. natural gas supplies and weak demand, particularly in the industrial sector. At June 30, 2009, OilSpiel reported Henry Hub natural gas prices at a price of $3.73 per Mcf.

In July 2009, the EIA projected that OPEC crude oil production would be 28.6 million barrels per day in the second quarter of 2009, which is down slightly from the first quarter 2009 levels, and down 3.1 million barrels per day from the third quarter of 2008. OPEC crude output is expected to remain near current levels through the end of the year, then trend upward moderately in 2010 in response to projected higher demand. In its July 2009 Oil Market Report, the International Energy Agency projected oil demand in 2009 to be 83.3 million barrels per day, compared to an estimated 85.8 million barrels per day in 2008 and expects the demand to rebound in 2010 by 1.7%, or 1.4 million barrels per day.

Detailed below is the average contracted rig count for our geographic regions for the three and six months ended June 30, 2008 and 2009. The rig count data includes floating rigs (semi-submersibles and drill ships) and jack-ups. The Company has included only these types of rigs as they are the primary end users of the Company's products.

                                         Three months     Six months

                                            ended           ended
                                           June 30,        June 30,
                                         2008     2009   2008    2009
                   Western Hemisphere      188     166     185    171
                   Eastern Hemisphere      161     153     160    157
                   Asia - Pacific          233     233     230    236

                                           582     552     575    564

Source: ODS - Petrodata RigBase - June 30, 2008 and 2009

The table represents rigs under contract and includes rigs currently drilling as well as rigs committed, but not yet drilling.

We believe that the number of rigs (semi-submersibles, drill ships and jack-ups) 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, while a decrease in rig construction activity tends to negatively impact our backlog. According to ODS-Petrodata, at the end of both June 2008 and 2009, there were 186 and 149 rigs, respectively, under construction and the expected delivery dates for the rigs under construction at June 30, 2009 are as follows:

                             Remainder of 2009    33
                             2010                 59
                             2011                 43
                             2012                 12
                             after 2012            2

Revenues. 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 assistance for installation of the Company's products, reconditioning services of customer-owned Dril-Quip products and rental of running tools for installation and retrieval of the Company's products. For each of the six months ended June 30, 2008 and 2009, the Company derived 84% of its revenues from the sale of its products and 16% of its revenues from services. Product contracts are negotiated and sold separately from service contracts. In addition, service contracts are not included in the product contracts or related sales orders and are not offered to the customer as a condition of the sale of the Company's products. The demand for products and services is generally based on world-wide economic conditions in the offshore oil and gas industry, and is not based on a specific relationship between the two contracts. Substantially all of the Company'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.

The Company accounts for larger and more complex projects that have relatively longer manufacturing time frames on a percentage-of-completion basis. For the first six months of 2009, 15 projects representing approximately 18% of the Company's total revenues and 21% of its product revenues were accounted for using percentage-of-completion accounting compared to 21 projects representing approximately 30% of the Company's total revenue and 36% of its product revenue for the first six months of 2008. This percentage may fluctuate in the future. For revenues accounted for under the percentage-of-completion method, the Company calculates the percentage complete and applies the percentage to determine earned revenues and the appropriate portion of total estimated costs. Losses, if any, are recognized when they first become known. Amounts received from customers in excess of revenues recognized are classified as a current liability.

The Company has substantial international operations, with approximately 72% and 69% of its revenues derived from foreign sales for the three-months ended June 30, 2008 and 2009, respectively and 70% and 61% for the six months ended June 30, 2008 and 2009, respectively.

Cost of Sales. The principal elements of cost of sales are labor, raw materials and manufacturing overhead. Cost of sales as a percentage of revenues is influenced by the product mix sold in any particular period 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, stock option expense, legal expenses, foreign currency transaction gains and losses 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.

Results of Operations

The following table sets forth, for the periods indicated, certain statement of
operations data expressed as a percentage of revenues:



                                                    Three months ended               Six months ended
                                                         June 30,                        June 30,
                                                   2008            2009            2008            2009
Revenues:
Products                                             82.6 %          85.1 %          83.6 %          83.8 %
Services                                             17.4            14.9            16.4            16.2

Total revenues                                      100.0           100.0           100.0           100.0
Cost of sales:
Products                                             49.0            49.3            49.3            48.2
Services                                              9.7             8.8             9.5             9.1

Total cost of sales                                  58.7            58.1            58.8            57.3
Selling, general and administrative expenses         10.1             9.7            10.1            10.6
Engineering and product development expenses          4.8             4.9             4.8             4.9

Operating income                                     26.4            27.3            26.3            27.2
Interest income                                       0.7             0.1             1.0             0.1
Interest expense                                       -               -               -               -

Income before income taxes                           27.1            27.4            27.3            27.3
Income tax provision                                  7.7             7.3             8.0             7.6

Net income                                           19.4 %          20.1 %          19.3 %          19.7 %

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

                                      Three months ended       Six months ended
                                           June 30,                June 30,
                                       2008         2009        2008       2009
                                                    (In millions)
           Revenues:
           Products
           Subsea equipment         $     83.1    $   84.2   $    153.8   $ 159.8
           Surface equipment               7.8         8.6         14.7      15.0
           Offshore rig equipment         26.8        20.6         61.4      43.7

           Total products                117.7       113.4        229.9     218.5
           Services                       24.8        19.8         45.1      42.2

           Total revenues           $    142.5    $  133.2   $    275.0   $ 260.7

Three Months Ended June 30, 2009 Compared to Three Months Ended June 30, 2008.

Revenues. Revenues decreased by $9.3 million, or approximately 6.5%, to $133.2 million in the three months ended June 30, 2009 from $142.5 million in the three months ended June 30, 2008. Product revenues decreased by approximately $4.3 million for the three months ended June 30, 2009 compared to the same period in 2008 as a result of decreased revenues of $6.2 million in offshore rig equipment, partially offset by increases of

Cost of Sales. Cost of sales decreased by $6.3 million, or approximately 7.5%, to $77.4 million for the three months ended June 30, 2009 from $83.7 million for the same period in 2008. As a percentage of revenues, cost of sales were approximately 58.1% and 58.7% for the three-month period ended June 30, 2009 and 2008, respectively. The decrease in cost of sales as a percentage of revenues resulted from a reduction in sales volume and changes in product mix.

Selling, General and Administrative Expenses. For the three months ended June 30, 2009, selling, general and administrative expenses decreased by approximately $1.3 million, or 9.2%, to $12.9 million from $14.2 million in the 2008 period. The decrease in selling, general and administrative expenses was primarily due to the effect of foreign currency transaction gains and decreased legal and professional fees, partially offset by increased stock option expenses. The Company experienced approximately $1.5 million in foreign currency transaction gains in the second quarter of 2009 as compared to $1.1 million in foreign currency transaction gains in the second quarter of 2008. Legal and professional fees decreased to $900,000 for the three months ended June 30, 2009, from $1.5 million for the same period in 2008. Stock option expense for the second quarter of 2009 totaled $912,000 compared to $740,000 in the second quarter of 2008. Selling, general and administrative expenses as a percentage of revenues decreased from 10.1% in 2008 to 9.7% in 2009.

Engineering and Product Development Expenses. For the three months ended June 30, 2009, engineering and product development expenses decreased by approximately $300,000, or 4.3%, to $6.6 million from $6.9 million in the same period of 2008. Engineering and product development expenses as a percentage of revenues increased from 4.8% in 2008 to 4.9% in 2009.

Interest Income. Interest income for the three months ended June 30, 2009 was approximately $132,000 as compared to $929,000 for the three-month period ended June 30, 2008. This decrease was due to reduced interest earned on short-term investments due to lower interest rates and reduced balances in short-term investments. Due to the current 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.

Interest expense. Interest expense for the three months ended June 30, 2009 was $ 29,000 compared to $44,000 for the same period in 2008.

Income tax provision. Income tax expense for the three months ended June 30, 2009 was $9.7 million on income before taxes of $36.4 million, resulting in an effective tax rate of approximately 27%. Income tax expense for the three months ended June 30, 2008 was $10.9 million on income before taxes of $38.6 million, resulting in an effective tax rate of approximately 28%. The decrease in the effective income tax rate reflects the difference in income before income taxes among the Company's three geographic areas, which have different income tax rates.

Six Months Ended June 30, 2009 Compared to Six Months Ended June 30, 2008.

Revenues. Revenues decreased by $14.3 million, or approximately 5.2%, to $260.7 million in the six months ended June 30, 2009 from $275.0 million in the six months ended June 30, 2008. Product revenues decreased by approximately $11.4 million for the six months ended June 30, 2009 compared to the same period in 2008 as a result of decreased revenues of $17.7 million in offshore rig equipment, partially offset by increases in subsea equipment of $6.0 million and $300,000 in surface equipment. The decrease in offshore rig equipment was primarily due to decreases in revenues as a result of a decrease in the number of long-term projects. During the first six months of 2008, the Company recognized revenues related to 21 projects, compared to 15 projects during the same period of 2009. The majority of these projects related to offshore rig equipment. In the first six months of 2008, projects accounted for using the percentage-of-completion method represented 30% of the Company's total revenues compared to 18% of total revenues for the same period in 2009. Product revenues decreased in the Western Hemisphere and Eastern Hemisphere by $10.0 million and $5.1 million, respectively, partially offset by an increase in product revenues in the Asia-Pacific of $3.7 million. Service revenues decreased by approximately $2.9 million from decreased service revenues in the Western Hemisphere of $2.4 million and Asia-Pacific of $1.5 million, partially offset by an increase in the Eastern Hemisphere of $1.0 million. The majority of the decrease in service revenues related to a decrease in the rental of running tools.

Cost of Sales. Cost of sales decreased by $12.1 million, or approximately 7.5%, to $149.4 million for the six months ended June 30, 2009 from $161.5 million for the same period in 2008. As a percentage of revenues, cost of sales were approximately 57.3% and 58.8% for the six-month periods ended June 30, 2009 and 2008, respectively. The decrease in cost of sales as a percentage of revenues resulted primarily from changes in product mix.

Selling, General and Administrative Expenses. For the six months ended June 30, 2009, selling, general and administrative expenses decreased by approximately $400,000, or 1.4%, to $27.4 million from $27.8 million in the 2008 period. The decrease in selling, general and administrative expenses was primarily due to lower legal and professional fees, partially offset by the effect of foreign currency transaction gains and increased stock option expenses. Legal and professional fees decreased to $1.8 million for the six months ended June 30, 2009, from $2.6 million for the same period in 2008. The Company experienced approximately $1.6 million in foreign currency transaction gains in the first six months of 2008 compared to $1.4 in foreign currency transactions gains in the first six months of 2009. Stock option expense of the first six months of 2009 totaled $1.9 million compared to $1.5 million in the first six months of 2008. Selling, general and administrative expenses as a percentage of revenues increased from 10.1% in 2008 to 10.6% in 2009.

Engineering and Product Development Expenses. For the six months ended June 30, 2009, engineering and product development expenses decreased by $200,000, or approximately 1.5%, to $12.9 million from $13.1 million in the same period of 2008. Engineering and product development expenses as a percentage of revenues increased from 4.8% in 2008 to 4.9% in 2009.

Interest Income. Interest income for the six months ended June 30, 2009 was $344,000 as compared to $2.6 million for the six-month period ended June 30, 2008. This decrease was due to reduced interest earned on short-term investments due to lower interest rates and reduced balances in short-term investments. Due to the current 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.

Interest Expense. Interest expense for the six months ended June 30, 2009 was $77,000 compared to $102,000 for the same period in 2008.

Net Income. Net income was approximately $51.4 million for the six months ended June 30, 2009 and $53.1 million for the same period in 2008, for the reasons set forth above.

Liquidity and Capital Resources

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



                                                             Six months ended
                                                                 June 30,
                                                           2008           2009
                                                              (In thousands)
    Operating activities                                 $   6,437      $  44,165
    Investing activities                                   (29,521 )      (21,968 )
    Financing activities                                   (67,524 )         (207 )

                                                           (90,608 )       21,990
    Effect of exchange rate changes on cash activities      (1,670 )       (1,954 )

    Increase (decrease) in cash and cash equivalents     $ (92,278 )    $  20,036

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 period, as these are noncash changes. As a result, changes reflected in certain accounts on the Condensed Consolidated Statements of Cash Flows may not reflect the changes in corresponding accounts on the Condensed 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 the six months ended June 30, 2009, the Company generated $44.2 million of cash from operations as compared to $6.4 million for the same period in 2008. The primary reasons for the increase were the changes in operating assets and liabilities during the first six months of 2009 as compared to the same period in 2008. The increase in operating assets and liabilities during the first six months of 2009 primarily reflected an increase in inventory and a decrease in . . .