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 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 and Industry Outlook

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.

                                    Three months ended       Nine months ended
                                      September 30,            September 30,
                                     2008         2009        2008        2009
            Crude Oil ($/Bbl)     $    118.25    $ 68.14   $    113.54   $ 57.59
            Natural gas ($/Mcf)          9.29       3.26          9.98      3.93

During the third quarter of 2008, West Texas Intermediate crude oil prices ranged between $91.15 per barrel and $145.66 per barrel with an average quarterly price of $118.25. For the third quarter of 2009, West Texas Intermediate crude oil prices ranged between $59.52 per barrel and $73.82 per barrel with an average quarterly price of $68.14. During the nine months ended September 30, 2008, West Texas Intermediate crude oil process ranged between $87.15 per barrel and $145.66 per barrel with an average price of $113.54 per barrel, as compared to a range of $33.98 per barrel to $73.82 per barrel with an average price of $57.59 per barrel for the same period in 2009.

According to the October 6, 2009 release of the Short-Term Energy Outlook published by the EIA, West Texas Intermediate crude oil prices are projected to average $59.90 per barrel in 2009 and $72.42 per barrel in 2010. These projections are slightly lower for 2009 and unchanged for 2010 compared to the EIA's July 7, 2009 projections of $60.35 per barrel for 2009 and $72.42 per barrel for 2010. The EIA expects West Texas Intermediate crude oil to average $70.00 per barrel through March 2010. At September 30, 2009 the EIA reported West Texas Intermediate crude oil at a price of $70.61 per barrel.

In its October 6, 2009 report, the EIA revised its projection for Henry Hub natural gas prices to $3.85 per Mcf in 2009 and $5.02 per Mcf in 2010 from its July 7, 2009 projections of $4.22 per Mcf in 2009 and $5.93 per Mcf in 2010. According to the EIA, natural gas inventories are expected to set a new record by October 31, 2009 reaching more than 3.8 trillion cubic feet. At September 30, 2009, OilSpiel™ reported Henry Hub natural gas prices at a price of $4.84 per Mcf.

In its October 6, 2009 report, the EIA noted that OPEC crude oil production was 28.7 million barrels per day in the first half of 2009, down 2.6 million barrels per day from year-earlier levels. EIA expects OPEC production to rise gradually over the second half of 2009 in response to an anticipated rebound in demand, unless prices fall sharply from current levels. EIA projects OPEC crude oil production to climb to 29.3 million barrels per day in the second half of 2009 and then average 29.2 million barrels per day in 2010. In its October 9, 2009 Oil Market Report, the International Energy Agency projected oil demand in 2009 to be 84.6 million barrels per day and to increase in 2010 to 86.1 million barrels per day.

Detailed below is the average contracted rig count for our geographic regions for the three and nine months ended September 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 ended     Nine months ended
                                    September 30,          September 30,
                                   2008        2009       2008       2009
            Western Hemisphere         189        156        187        166
            Eastern Hemisphere         162        143        161        152
            Asia - Pacific             243        227        236        233

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

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

                             Remainder of 2009    21
                             2010                 60
                             2011                 43
                             2012                 19
                             after 2012            6

In mid-2008, crude oil and natural gas prices began to decline significantly. This decline resulted in reduced capital spending by some oil and gas companies, many of which are our customers. Additional capital expenditure reductions could have an adverse impact on the Company's financial condition, results of operations and new customer orders. The Company believes that its backlog should help mitigate the impact of current market conditions; however, a prolonged decline in commodity prices or an extended continuation of the downturn in the global economy could have a negative impact on the Company. The Company's backlog at September 30, 2009 was approximately $623 million compared to approximately $528 million at September 30, 2008. The Company can give no assurance that backlog will remain at current levels. All of the Company's projects currently included in its backlog are subject to change and/or termination at the option of the customer. In the 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. In the past, terminations and cancellations have been immaterial to the Company's overall operating results.

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 the 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 nine-month periods ended September 30, 2008 and 2009, the Company derived 83% and 84%, respectively, of its revenues from the sale of its products and 17% and 16%, respectively, 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 types of 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 nine months ended September 30, 2009, 16 projects representing approximately 15% of the Company's total revenue and approximately 18% of its product revenues were accounted for using percentage-of-completion accounting, compared to 23 projects representing approximately 26% of the Company's total revenue and 32% of its product revenues for the first nine 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.

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.

Income Tax Provision. Dril-Quip's effective income tax rate has historically been lower than the statutory rate primarily due to foreign income tax rate differentials, research and development credits and deductions related to domestic production activities.

Results of Operations

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



                                                    Three months ended              Nine months ended
                                                      September 30,                   September 30,
                                                   2008            2009            2008            2009
Revenues:
Products                                             82.1 %          85.1 %          83.1 %          84.3 %
Services                                             17.9            14.9            16.9            15.7

Total revenues:                                     100.0           100.0           100.0           100.0
Cost of sales:
Products                                             45.1            47.9            47.9            48.1
Services                                             11.0             8.7            10.0             9.0

Total cost of sales:                                 56.1            56.6            57.9            57.1
Selling, general and administrative expenses         11.9             9.5            10.7            10.2
Engineering and product development expenses          4.9             5.1             4.8             5.0
Special item                                           -              3.8              -              1.3

Operating income                                     27.1            25.0            26.6            26.4
Interest income                                       0.3              -              0.8             0.1
Interest expense                                       -               -               -               -

Income before income taxes                           27.4            25.0            27.4            26.5
Income tax provision                                  6.7             6.8             7.6             7.3

Net income                                           20.7 %          18.2 %          19.8 %          19.2 %

                                   Three months ended         Nine months ended
                                      September 30,             September 30,
                                    2008         2009         2008          2009
                                                   (In millions)
        Revenues:
        Products
        Subsea equipment         $     80.6    $    98.1   $    234.4    $    257.9
        Surface equipment               6.7          9.2         21.3          24.2
        Offshore rig equipment         21.3         10.2         82.7          53.9

        Total products                108.6        117.5        338.4         336.0
        Services                       23.7         20.7         68.8          62.9

        Total revenues           $    132.3    $   138.2   $    407.2    $    398.9

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

Revenues. Revenues increased by $5.9 million, or approximately 4.5%, to $138.2 million in the three months ended September 30, 2009 from $132.3 million in the three months ended September 30, 2008. Product revenues increased by approximately $8.9 million for the three months ended September 30, 2009 compared to the same period in 2008 as a result of increased revenues of $17.5 million in subsea equipment and $2.5 million in surface equipment, partially offset by $11.1 million decrease in offshore rig equipment. The decrease in offshore equipment was primarily due to decreases in the number of long-term projects. During the third quarter of 2008, the Company recognized revenues related to 23 projects, compared to 16 projects during the same period of 2009. The majority of these projects related to offshore rig equipment. In the third quarter of 2008, projects accounted for using the percentage-of-completion method represented 18% of the Company's total revenues compared to 9% of total revenues for the same period in 2009. Product revenues increased in the Eastern Hemisphere by $10.3 million partially offset by decreases in product revenues in Asia-Pacific of $1.4 million. Service revenues decreased by approximately $3.0 million from decreased service revenues in the Western Hemisphere of $1.4 million and the Eastern Hemisphere of $2.3 million, partially offset by an increase in Asia-Pacific of $700,000. The majority of the decrease in service revenues related to decreases in the rental of running tools.

Cost of Sales. Cost of sales increased by $4.1 million, or approximately 5.5%, to $78.3 million for the three months ended September 30, 2009 from $74.2 million for the same period in 2008. As a percentage of revenues, cost of sales were approximately 56.6% and 56.1% for the three-month periods ended September 30, 2009 and 2008, respectively. The increase in cost of sales as a percentage of revenues resulted from an increase in manufacturing overhead expenses.

Selling, General and Administrative Expenses. For the three months ended September 30, 2009, selling, general and administrative expenses decreased by approximately $2.4 million, or 15.3%, to $13.3 million from $15.7 million in the 2008 period. The decrease in selling, general and administrative expenses was primarily due to the effect of foreign currency transaction gains, partially offset by increased stock option expenses. The Company experienced approximately $2.1 million in foreign currency transaction gains in the third quarter of 2009 as compared to $850,000 in foreign currency transaction losses in the third quarter of 2008. Stock option expense for the third quarter of 2009 totaled $1.0 million compared to $770,000 in the third quarter of 2008. Selling, general and administrative expenses as a percentage of revenues decreased from 11.9% in 2008 to 9.5% in 2009.

Engineering and Product Development Expenses. For the three months ended September 30, 2009, engineering and product development expenses increased by approximately $500,000, or 7.7%, to $7.0 million

Special Item. In September 2009, Gary D. Smith, one of the Company's Co-Chief Executive Officers, unexpectedly passed away. Under the terms of Mr. Smith's employment contract, the Company was obligated to pay Mr. Smith's base salary, including accrued vacation, and his annual bonus through the remaining employment period (October 27, 2012). In addition, stock options owned by Mr. Smith that were outstanding at the date of his death were immediately vested under the terms of the contract. Accordingly, the Company recognized a pre-tax expense of $5,224,000 during the third quarter of 2009. The contractual obligation, including related payroll taxes, totaled $4,386,000, of which $434,000 had been previously accrued. The acceleration of the vesting increased non-cash expenses by $1,272,000.

Interest Income. Interest income for the three months ended September 30, 2009 was approximately $66,000 as compared to $497,000 for the three-month period ended September 30, 2008. This decrease was due to reduced interest earned on short-term investments from lower interest rates and reduced balances in short-term investments. Due to the global financial crisis, the Company 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 September 30, 2009 was $20,000 compared to approximately $47,000 for the same period in 2008.

Income tax provision. Income tax expense for the three months ended September 30, 2009 was $9.4 million on income before taxes of $34.5 million, resulting in an effective income tax rate of approximately 27%. Income tax expense for the three months ended September 30, 2008 was $8.8 million on income before taxes of $36.3 million, resulting in an effective tax rate of approximately 24%. The increase 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.

Net Income. Net income was approximately $25.1 million for the three months ended September 30, 2009 and $27.4 million for the same period in 2008, for the reasons set forth above.

Nine Months Ended September 30, 2009 Compared to Nine Months Ended September 30, 2008.

Revenues. Revenues decreased by $8.3 million, or approximately 2.0%, to $398.9 million in the nine months ended September 30, 2009 from $407.2 million in the nine months ended September 30, 2008. Product revenues decreased by approximately $2.4 million for the nine months ended September 30, 2009 compared to the same period in 2008 as a result of decreased revenues of $28.8 million in offshore rig equipment, partially offset by increases in subsea equipment of $23.5 million and $2.9 million in surface equipment. The decrease in offshore rig equipment was primarily due to decreases in the number of long-term projects. During the first nine months of 2008, the Company recognized revenues related to 23 projects, compared to 16 projects during the same period of 2009. The majority of these projects related to offshore rig equipment. In the first nine months of 2008, projects accounted for using the percentage-of-completion method represented 26% of the Company's total revenues compared to 15% of total revenues for the same period in 2009. Product revenues decreased in the Western Hemisphere by $9.8 million, partially offset by an increase in the Eastern Hemisphere of $5.1 million and in Asia-Pacific of $2.3 million. Service revenues decreased by approximately $5.9 million from decreased service revenues in the Western Hemisphere of $3.8 million, Eastern Hemisphere of $1.3 million and Asia-Pacific of $800,000. The majority of the decrease in service revenues related to decreases in the rental of running tools.

Cost of Sales. Cost of sales decreased by $8.1 million, or approximately 3.4%, to $227.7 million for the nine months ended September 30, 2009 from $235.8 million for the same period in 2008. As a percentage of

Selling, General and Administrative Expenses. For the nine months ended September 30, 2009, selling, general and administrative expenses decreased by approximately $2.8 million, or 6.4%, to $40.7 million from $43.5 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 lower legal and professional fees, partially offset by increased stock option expenses. The Company experienced approximately $800,000 in foreign currency transaction gains in the first nine months of 2008 compared to $3.5 million in foreign currency transactions gains in the first nine months of 2009. Legal and professional fees for the nine months ended September 30, 2009 totaled $2.7 million compared to $3.6 million for the same period in 2008. Stock option expense for the first nine months of 2009 totaled $2.9 million compared to $2.3 million in the first nine months of 2008. Selling, general and administrative expenses as a percentage of revenues decreased from 10.7% in 2008 to 10.2% in 2009.

Engineering and Product Development Expenses. For the nine months ended September 30, 2009, engineering and product development expenses increased by $300,000, or approximately 1.5%, to approximately $19.9 million from $19.6 million in the same period of 2008. Engineering and product development expenses as a percentage of revenues increased from 4.8% in 2008 to 5.0% in 2009.

Special Item. In September 2009, Gary D. Smith, one of the Company's Co-Chief Executive Officers, unexpectedly passed away. Under the terms of Mr. Smith's employment contract, the Company was obligated to pay Mr. Smith's base salary, including accrued vacation, and his annual bonus through the remaining employment period (October 27, 2012). In addition, stock options owned by Mr. Smith that were outstanding at the date of his death were immediately vested under the terms of the contract. Accordingly, the Company recognized a pre-tax expense of $5,224,000 during the third quarter of 2009. The contractual obligation, including related payroll taxes, totaled $4,386,000, of which $434,000 had been previously accrued. The acceleration of the vesting increased non-cash expenses by $1,272,000.

Interest Income. Interest income for the nine months ended September 30, 2009 was $410,000 as compared to $3.1 million for the nine-month period ended September 30, 2008. This decrease was due to a reduced interest earned on short-term investments from lower interest rates and reduced balances in short-term investments. Due to the global financial crisis, the Company 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 nine months ended September 30, 2009 was $97,000 compared to $149,000 for the same period in 2008.

Income tax provision. Income tax expense for the nine months ended September 30, 2009 was $29.3 million on income before taxes of $105.7 million, resulting in an effective income tax rate of approximately 28%. Income tax expense for the nine months ended September 30, 2008 was $30.7 million on income before taxes of $111.3 million, resulting in an effective income tax rate of approximately 28%.

Net Income. Net income was approximately $76.5 million for the nine months ended September 30, 2009 and $80.5 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:



                                                            Nine months ended
                                                              September 30,
                                                           2008           2009
                                                              (In thousands)
    Operating activities                                 $  45,094      $  76,158
. . .