Innovex International, Inc. (INVX) FY 2021 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following is management’s discussion and analysis of certain significant factors that have affected aspects of the Company’s financial position, results of operations, comprehensive income 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.

For a discussion of our results of operations for the year ended December 31, 2020 compared to the year ended December 31, 2019, see "Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations" in our Annual Report on Form 10-K for the year ended December 31, 2020.

Overview

Dril-Quip designs, manufactures, sells and services highly engineered drilling and production equipment that is well suited primarily for use in deepwater, harsh environment and severe service applications. The Company’s principal products consist of subsea and surface wellheads, subsea and surface production trees, mudline hanger systems, specialty connectors and associated pipe, drilling and production riser systems, liner hangers, wellhead connectors, diverters and safety valves. Dril-Quip's products are used by major integrated, large independent and foreign national oil and gas companies and drilling contractors throughout the world. 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. In addition, Dril-Quip's customers may rent or purchase running tools from the Company for use in the installation and retrieval of the Company’s products.

Oil and Gas Prices

Both the market for 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.

Although crude oil prices recovered in 2021, we have just started to see an increase in activity from our customers as any recovery in the subsea market generally lags relative to the overall recovery in crude oil prices. Future declines in oil and gas prices or ongoing pricing volatility may further adversely affect the willingness of some oil and gas companies to make capital expenditures on exploration, drilling and production operations, which could have an adverse impact on the Company’s results of operations, financial position and cash flows. Any future deterioration of commodity prices could lead to material impairment charges to tangible or intangible assets or otherwise result in a material adverse effect on the Company's results of operations. 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.”

During 2021, Brent crude oil prices fluctuated significantly, with a high of $85.76 per barrel, a low of $50.37 per barrel, and an average of $70.86 per barrel compared to an average of $41.96 per barrel in 2020. According to the January 2022 release of the Short-Term Energy Outlook published by the EIA, Brent crude oil prices are projected to average $74.95 per barrel in 2022 and $67.50 per barrel in 2023. The International Energy Agency projected the global oil demand to grow by approximately 3.3 million barrels per day to a total of 99.7 million barrels per day in 2022 based on its January 2022 Oil Market Report.

Rig Count

Detailed below is the average contracted offshore rig count (rigs currently drilling as well as rigs committed, but not yet drilling) for the Company’s geographic regions for the years ended December 31, 2021, and 2020. The rig count data includes floating rigs (semi-submersibles and drillships) and jack-up rigs. The Company has included only these types of rigs as they are the primary assets used to deploy the Company’s products.

Source: IHS—Petrodata RigBase— December 31, 2021, and 2020

According to IHS-Petrodata RigBase, as of December 31, 2021, there were 486 rigs contracted for the Company’s geographic regions (137 floating rigs and 349 jack-up rigs), which represents a 5.4% increase from the rig count of 461 rigs (126 floating rigs and 335 jack-up rigs) as of December 31, 2020.

Business Environment

Oil and gas prices and the level of drilling and production activity have been characterized by significant volatility in recent years. Worldwide military, political, economic and other events have contributed to oil and natural gas price volatility and are likely to

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continue to do so in the future. The Company expects continued pressure in both crude oil and natural gas prices, as well as in the level of drilling and production related activities. Even during periods of high prices for oil and natural gas, companies exploring for oil and gas may cancel or curtail programs, seek to renegotiate contract terms, including the price of products and services, or reduce their levels of capital expenditures for exploration and production for a variety of reasons. Any future deterioration of commodity prices could lead to material impairment charges to tangible or intangible assets or otherwise result in a material adverse effect on the Company's results of operations.

The COVID-19 pandemic continues to have a global impact. During the first half of 2021, increased availability of the COVID-19 vaccines to the general population had resulted in a lower rate of new infections, hospitalizations and deaths in the current year, as compared to 2020. In late 2021, some restrictions to mitigate the spread of COVID-19 began to return in many regions, notably Europe, even before the Omicron variant surfaced. The effect of the pandemic and the actions and changes in consumer behavior continue to impact our business and have significantly reduced global economic activity and demand for oil and gas. The pandemic has also affected our supply chain due to logistical bottlenecks and increased transportation costs resulting in significant inflationary trends in the cost of raw materials. We actively review our global production plans with our supply chain and manufacturing groups have adopted contingency plans where possible to minimize the impact of these COVID-19 related disruptions.

Although crude oil prices recovered during 2021, the extent of the impact of the pandemic, including economic impacts that may persist despite the widespread deployment of vaccines, and the uncertainty in the sustainability of current oil prices on our operational and financial performance will depend on future developments. An extended period of economic disruption and uncertain conditions in the oil and gas industry could have a material adverse impact on our business, results of operations, access to sources of liquidity and overall financial condition.

As a larger proportion of the population is vaccinated from increased availability of the COVID-19 vaccines, some jurisdictions in which the Company operates have eased safety protocols such as face mask and social distancing requirements. Customer mandates for fully vaccinated offshore technicians started to become a reality in the third quarter of 2021 and by the fourth quarter of 2021 more than 50% of our customers started requiring our technicians to be fully vaccinated, which we accommodated with some impact to our business. The Company will continue to implement safety measures as recommended by government health agencies until we have determined that the COVID-19 pandemic has been adequately contained. We continue to enact safety measures, including implementing social distancing protocols, mandatory masks for unvaccinated employees, requiring remote work arrangements where possible, staggering shifts, suspending travel, and extensively and frequently disinfecting our workspaces. Additionally, as COVID-19 vaccines became available in the first quarter of 2021, the Company organized administration of the vaccines on site to our employees and their families in the US. Globally, we have achieved more than 80% vaccination rate for our employees which includes the supplemental booster vaccine. Furthermore, we have also utilized government employee support packages where available, in an effort to retain employees during this uncertain period.

All our facilities currently remain operational with staggered shifts which has impacted production output. We expect the constraints and limits imposed on our operations to slow or diminish our research and development activities and qualification activities with our customers. We do not believe that remote work arrangements have adversely affected our ability to maintain financial reporting systems, internal controls over financial reporting and disclosure controls and procedures. The Company has taken steps and adjusted its workforce to be in line with the current situation as we continue to monitor ongoing market conditions. The extent to which our future results are affected by these externalities will depend on various factors and circumstances beyond our control, such as the duration and scope of the pandemic, additional actions by businesses and governments in response to the pandemic, the speed and effectiveness of containing the virus and developments in the global oil markets. We believe the COVID-19 pandemic will continue to negatively impact oilfield activity in 2022. Similarly, we expect that the uncertainty in the sustainability of current oil prices will continue to have a negative impact on oil and gas activities.

During 2020, the Company took advantage of the Payroll Tax Deferral provided by the Coronavirus, Aid, Relief and Economic Security Act (“CARES Act”). The Payroll Tax Deferral allows the Company to defer the payment of the Company’s share of FICA taxes of 6.2%. As such, the Company was able to defer its share of FICA taxes for the period beginning March 27, 2020 and ending December 31, 2020. This resulted in approximately $2.9 million in FICA cash tax payments being deferred to 2021 and 2022. The Company must still deposit its share of the Medicare hospital insurance tax of 1.45% as well as all of the employee’s share of the payroll taxes withheld. The CARES Act also provides for the five-year carryback of Net Operating Losses (“NOLs”) generated in the 2018, 2019 and 2020 taxable years. In addition, the taxable income limitation is temporarily removed, allowing NOLs to fully offset net taxable income. The Company filed returns to carryback its NOLs to generate a refund of $31.0 million and receivable of $14.8 million.

During 2020 and 2021, the Company also took advantage of job support schemes as they became available in Singapore, Australia, the U.K. and Denmark under which the governments introduced a plan to help businesses co-fund wages of workers to encourage employers to retain their workers. The Company recorded an estimated benefit of $1.1 million and $3.1 million for the year ending December 31, 2021, and 2020, respectively.

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The Company operates its business and markets its products and services in most 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.

Revenues. Dril-Quip’s revenues are generated from three sources: products, services and leasing. Product revenues are derived from the sale of drilling and production equipment. Service revenues are earned when the Company provides technical advisory assistance and rework and reconditioning services. Leasing revenues are derived from rental tools used during installation and retrieval of the Company’s products and from leasing our forging facility. In 2021, the Company derived 66.1% of its revenues from the sale of its products, 23.0% of its revenues from services and 10.9% from leasing revenues, compared to 70.9%, 20.7% and 8.4% for products, services and leasing in 2020, respectively. Service and leasing revenues generally correlate to revenues from product sales because increased product sales typically generate increased demand for technical advisory assistance services during installation and rental of running tools. However, customer stocking and destocking can affect the correlation between demand for services and product sales. The Company has substantial international operations, with approximately 63.8% of its revenues derived from foreign sales in 2021 and 66.7% in 2020. Substantially all of the Company’s domestic revenue relates to operations in the U.S. Gulf of Mexico. Domestic revenue approximated 36.2% of the Company’s total revenues in 2021 and 35.0% in 2020.

Product contracts are typically negotiated and sold separately from service contracts. In addition, service contracts are not typically 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 worldwide economic conditions in the 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.

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 global oil prices, 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 an over time basis. During 2021, there were 54 projects that were accounted for using the over time method, which represented approximately 21.7% of the Company’s total revenues and 32.7% of the Company’s product revenues. During 2020, there were 57 projects that were accounted for using the over time method, which represented approximately 33.2% of the Company’s total revenues and 46.9% of the Company’s product revenues. These percentages 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 cost of sales. Accordingly, price and cost estimates are reviewed periodically as the work progresses, and adjustments proportionate to the percentage complete are reflected in the period when such estimates are revised. Losses, if any, are recorded in full in the period 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 over time method of accounting.”

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, costs from projects accounted for under the over time method, over/under manufacturing overhead absorption 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, business development expenses, compensation expense, stock-based compensation expense, legal expenses 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.

Impairment. During 2020, impairment losses consist of a full impairment of our goodwill balance of $7.7 million, which occurred in connection with our preparation and review of financial statements during the first quarter of 2020.

Restructuring and Other Charges. Restructuring and other charges consist of costs associated with our global strategic plan that was initiated in 2018 to better align our operations with market conditions. During 2021, we continued to incur restructuring charges under the 2018 global strategic plan as we exited from certain underperforming countries and markets and shifted from manufacturing in-house to a vendor outsourcing model which resulted in inventory write-downs of approximately $19.3 million, severance charges of

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$2.7 million and other charges of $4.0 million, consisting of facilities-related market exit costs and consulting fees. This concluded our 2018 global strategic plan as of the third quarter of 2021. In the fourth quarter of 2021, in an effort to realign our subsea product business with the market conditions, we initiated a 2021 global strategic plan. As part of the 2021 global strategic plan we discontinued certain product categories which resulted in inventory write-downs, long-lived asset write-downs and severance charges of approximately $47.7 million, $4.2 million, and $1.0 million, respectively, during the fourth quarter of 2021.

(Gain) Loss on Sale of Assets. Gain or loss on sale of assets consists of sales of certain property, plant and equipment.

Foreign Currency Transaction (Gains) and Losses. Foreign currency transaction (gains) and losses result from a change in exchange rates between the functional currency and the currency in which a foreign currency transaction is denominated. The Company’s foreign subsidiaries, whose functional currency is the local currency, conduct a portion of their operations in U.S. dollars. As a result, these subsidiaries hold significant monetary assets denominated in U.S. dollars. These monetary assets are subject to changes in exchange rates between the U.S. dollar and the local currency.

Income Tax Provision. The Company’s effective income tax rate fluctuates from the U.S. statutory tax rate based on, among other factors, changes in pretax income in jurisdictions with varying statutory tax rates, impact of valuation allowances, changes in tax legislation, and other permanent differences related to the recognition of income and expense between U.S. GAAP and applicable tax rules.

Results of Operations

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

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

Year Ended December 31, 2021 Compared to Year Ended December 31, 2020

Revenues. Revenues decreased by $42.1 million, or approximately 11.5%, to $322.9 million in 2021 from $365.0 million in 2020. The overall decrease in revenue was driven by decreased product revenues of $45.1 million and decreased service revenues of $1.5 million, partially offset by increased leasing revenues of $4.5 million. Product revenues decreased by approximately $45.1 million for the year ended December 31, 2021 compared to the same period in 2020 as a result of decreased revenues of $55.3 million in subsea equipment, $2.9 million in offshore rig equipment, and $0.7 million in surface equipment, partially offset by increased revenues of $13.8 million in downhole tools. Total revenues decreased in the Eastern Hemisphere by $26.8 million, in the Asia-Pacific region by $13.1 million, and in the Western Hemisphere by $2.1 million. Although crude oil prices recovered during 2021, there were instances of uncertain demand growth due to surges in COVID-19 variants. Furthermore, shifts in customer allocation of working capital resulted in reduced investment in exploratory wells, a segment which significantly drives demand for Dril-Quip equipment. These circumstances resulted in reduced demand for our products and thus negatively impacted revenues for the year ending December 31, 2021. In any given time period, the revenues recognized between the various product lines and geographic areas will vary depending upon the timing of shipments to customers, completion status of the projects accounted for under the over-time accounting method, market conditions and customer demand.

Service revenues decreased by approximately $1.5 million resulting mainly from decreased service revenues in Eastern Hemisphere of $4.1 million, partially offset by increased service revenues of $2.5 million in the Asia-Pacific region and $0.1 million in the Western Hemisphere. Lower service revenues in the Eastern Hemisphere resulted primarily from COVID-19 disruptions, developments in the global oil markets, and regional demand for drilling activity. Global travel restrictions also impacted service revenue, especially in the Eastern Hemisphere. Increase in service revenues in the Asia-Pacific region and the Western Hemisphere is mainly due to customer specific increases in technical advisory services and maintenance requests.

Leasing revenues increased by approximately $4.5 million for the year ended December 31, 2021 compared to the same period in 2020 mainly from increased leasing revenues in the Asia-Pacific region of $3.6 million, in the Western Hemisphere of $2.5 million partially offset by decreased leasing revenues in the Eastern Hemisphere of $1.6 million. Increase in leasing revenues in the Asia-Pacific region and the Western Hemisphere were due to customer specific increases in rental tool utilization. The majority of the decrease in the Eastern Hemisphere is related to decreased subsea rental tool utilization due to timing of customer drilling activity and COVID-19 related travel restrictions.

Cost of Sales. Cost of sales decreased by $27.3 million, or 10.1%, to $242.4 million in 2021 from $269.7 million in 2020. The decrease in costs of sales were mainly in line with the decrease in revenue for the year ended December 31, 2021. Cost of sales as a percentage of revenue, excluding a one-time expense related to the termination of our forge facility lease agreement with AFGlobal, was largely unchanged at 74.3% as compared to 73.9% in 2020. We were able to achieve these margins despite inflationary pressures for materials largely due to savings resulting from our business transformation activities.

Selling, General and Administrative Expenses. For 2021, selling, general and administrative expenses increased by approximately $20.0 million, or 21.0%, to $115.0 million from $95.1 million in 2020. This increase was attributable mainly to higher legal expenses in the current period related to costs incurred in connection with the FMC Technologies, Inc. lawsuit, reinstatement of employee short-term incentive plan for the current year, an importation tax settlement under a Brazilian tax amnesty program introduced in the first quarter of 2021 and severance payout to our former Chief Executive Officer, pursuant to a separation agreement entered into with him during the fourth quarter of 2021.

Engineering and Product Development Expenses. For 2021, engineering and product development expenses decreased by approximately $3.8 million, or 20.2%, to $15.1 million from $18.9 million in 2020. Engineering and product development expenses as

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a percentage of revenues decreased to 4.7% in 2021 from 5.2% in 2020. This decrease was attributable mainly to lower spend on research and development activities as we completed certain strategic projects.

Impairments. In March 2020, the overall offshore market conditions declined primarily due to the COVID-19 pandemic and unfavorable developments in the global oil markets. This decline was evidenced by lower commodity prices, decline in expected offshore rig counts, decrease in our customers’ capital budgets and potential delays or cancellations of contracts. As a result, an interim goodwill impairment analysis was performed in connection with the preparation and review of financial statements during the first quarter of 2020. Based on this analysis, we fully impaired our goodwill balance of $7.7 million, all of which was in the Eastern Hemisphere reporting unit. For further information, see "Goodwill," Note 8 of Notes to Consolidated Financial Statements.

Restructuring and Other Charges. Restructuring and other charges consist of costs associated with our global strategic plan that was initiated in 2018 to better align our operations with market conditions. During 2021, the Company incurred additional costs under the 2018 global strategic plan as we exited from certain underperforming countries and markets and shifted from manufacturing in-house to a vendor outsourcing model which resulted in inventory write-downs of approximately $19.3 million, severance charges of $2.7 million and other charges of $4.0 million, consisting of facilities-related market exit costs and consulting fees. This concluded our 2018 global strategic plan as of the third quarter of 2021. In the fourth quarter of 2021, in an effort to realign our subsea product business with the market conditions, we initiated a 2021 global strategic plan. As part of the 2021 global strategic plan we discontinued certain product categories which resulted in inventory write-downs, long-lived asset write-downs and severance charges of approximately $47.7 million, $4.2 million, and $1.0 million, respectively, during the fourth quarter of 2021.

During 2020, as a result of unfavorable market conditions primarily due to the COVID-19 pandemic and developments in the global oil markets, which triggered historically low crude oil prices and decreases in our customers’ capital budgets, we incurred additional costs under our existing 2018 global strategic plan primarily focused on workforce reductions and to realign our manufacturing facilities during the first quarter of 2020. We recorded inventory write-downs, severance charges, long-lived asset write-downs and other charges of $35.4 million during the year 2020.

Gain on Sale of Assets. For the year ended December 31, 2021, gain on sale of assets was approximately $4.5 million, primarily related to the sale of two of our buildings in Singapore. During 2020, gain on sale of assets was $0.6 million, which consisted primarily of a gain on sale of our TIW Oklahoma facility.

Foreign Currency Transaction (Gains) and Losses. Foreign exchange loss for 2021 was $0.8 million as compared to a loss of $2.3 million for the same period in 2020.

Income Tax Provision. Income tax expense for 2021 was $2.9 million on a loss before taxes of $125.1 million, resulting in an effective income tax rate of (2.4%). Income tax expense was different than the U.S. federal statutory income tax rate of 21% primarily due to changes in valuation allowances, nondeductible compensation, foreign income inclusions, foreign tax withholdings and credits, and other general business credits and incentives. Income tax benefit in 2020 was $31.3 million on an loss before taxes of $62.0 million, resulting in an effective tax rate of approximately 50.4%. The change in the effective income tax rate from 2020 to 2021 was primarily driven by the NOL benefit of the CARES Act legislation recorded in 2020, change in valuation allowance against the net U.S. deferred tax assets as well as those in various foreign countries, the mix of foreign income taxed at different statutory rates, an increase in non-taxable income, non-deductible expenses, foreign income inclusions and foreign tax credits.

Net Loss. Net loss was approximately $128.0 million in 2021, compared to a net loss of $30.8 million in 2020, for the reasons set forth above.

Non-GAAP Financial Measures

We have performed a detailed analysis of the non-GAAP measures that are relevant to our business and its operations and determined that the appropriate unit of measure to analyze our performance is Adjusted EBITDA (earnings before interest, taxes, depreciation and amortization, as well as other significant non-cash items and other adjustments for certain charges and credits). The Company believes that the exclusion of these charges and credits from these financial measures enables it to evaluate more effectively the Company's operations period over period and to identify operating trends that could otherwise be masked by excluded items. It is our determination that Adjusted EBITDA is a more relevant measure of how the Company reviews its ability to meet commitments and pursue capital projects.

Adjusted EBITDA

We calculate Adjusted EBITDA as one of the indicators to evaluate and compare the results of our operations from period to period by removing the effect of our capital structure from our operating structure and certain other items, including those that affect the comparability of operating results. This measurement is used in concert with operating income, its most directly comparable financial measure, and net cash from operating activities, which measures actual cash generated in the period. In addition, we believe that Adjusted EBITDA is a supplemental measurement tool used by analysts and investors to help evaluate overall operating performance, ability to pursue and service possible debt opportunities and analyze possible future capital expenditures. Adjusted

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EBITDA does not represent funds available for our discretionary use and is not intended to represent or to be used as a substitute for net income, as measured under U.S. generally accepted accounting principles. The items excluded from Adjusted EBITDA, but included in the calculation of reported net income, are significant components of the Consolidated Statements of Income (Loss) and must be considered in performing a comprehensive assessment of overall financial performance. Our calculation of Adjusted EBITDA may not be consistent with calculations of Adjusted EBITDA used by other companies.

The following table reconciles our reported net income to Adjusted EBITDA for each of the respective periods:

(1) Adjusted EBITDA does not measure financial performance under GAAP and, accordingly, should not be considered as an alternative to net income as an indicator of operating performance.

(2) Restructuring and other charges include legal expenses related to the FMC lawsuit, severance charges related to our former Chief Executive Officer and a one-time provision for settlement of certain receivables.

Liquidity and Capital Resources

Cash Flows

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

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 non-cash 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, (ii) to fund working capital and (iii) to fund the repurchase of the Company's shares. The Company’s principal source of funds is cash flows from operations. The Company may use its liquidity for, among other things, the support of the Company's research and development efforts, the funding of key projects and spending required by any upturn in the Company's business and the pursuit of possible acquisitions.

Net cash provided by operating activities in 2021 increased by approximately $59.5 million primarily due to increases resulting from the change in operating assets and liabilities of $142.2 million and a net increase of $14.5 million in non-cash movements. This was partially offset by an increase in net loss of $97.2 million.

The change in operating assets and liabilities during 2021 resulted in a $142.2 million increase in cash as compared to the change in operating assets and liabilities during 2020. The decrease in unbilled receivables by $37.5 million was mainly due to

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progress and completion of some of our major projects that are accounted for on an over-time basis. The $35.6 million prepaids and other assets decrease was primarily due to receipt of tax receivables and the reimbursement of the security amounts deposited with the Brazilian courts related to the tax amnesty program. The increase in accounts payable and accrued expenses of $23.4 million was mainly related to the reinstatement of our short-term incentive plan in 2021, restructuring related market exit costs accruals and severance accruals. The decrease in trade receivables by $22.9 million was primarily due to our continued focus on global cash collections by improving our invoicing cycle time and increasing collection efforts across all business units. The decrease in inventory of $22.8 million was mainly related to our continued focus on inventory management and consumption during the year.

Net loss changed by $97.2 million to a net loss of $128.0 million in 2021 from a net loss of $30.8 million in 2020. The reasons for the changes in net income or losses are set forth in the “Results of Operations” section above.

Net cash used in investing activities decreased by approximately $2.4 million due to lower capital expenditure spend and increased proceeds related to sales of assets. Capital expenditures by the Company were $10.0 million and $11.9 million in 2021 and 2020, respectively. Capital expenditures in 2021 included $4.6 million for machinery and equipment, $3.7 million for rental tools and other expenditures of $1.7 million. Capital expenditures in 2021 were primarily to support our current and recently developed products and to support the restructuring of our downhole tools business where we exited certain underperforming markets. Capital expenditures in 2020 included $5.1 million for rental tools, $3.9 million for machinery and equipment and other expenditures of $2.9 million. Capital expenditures in 2020 were primarily for rental tools to support our current and recently developed products, our downhole tools segment and machinery and equipment required for the consolidation of our manufacturing facilities from the Eastern Hemisphere to the Western Hemisphere.

Repurchase of Equity Securities

On February 26, 2019, the Company announced that the Board of Directors had authorized a new stock repurchase program under which the Company is authorized to repurchase up to $100 million of its common stock. The repurchase program has no set expiration date. Repurchases under the program will be made through open market purchases, privately negotiated transactions or plans, instructions or contracts established under Rule 10b5-1 under the Exchange Act. The manner, timing and amount of any purchase will be determined by management based on an evaluation of market conditions, stock price, liquidity and other factors. The program does not obligate the Company to acquire any particular amount of common stock and may be modified or superseded at any time at the Company’s discretion.

During the year ended December 31, 2021, the Company purchased 1,109,187 shares under the share repurchase plan at an average price of approximately $21.79 per share totaling approximately $24.2 million and has retired such shares.

During the year ended December 31, 2020, the Company purchased 808,389 shares at an average price of $30.91 per share totaling approximately $25.0 million. All repurchased shares have been cancelled as of December 31, 2020. Refer to "Item 5 - Market for Registrant's Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities" for further discussion.

The Company believes that cash generated from operations plus cash on hand will be sufficient to fund operations, working capital needs and anticipated capital expenditure requirements for the next twelve months at current activity levels. However, if work activity increases, we expect further working capital investment will be required.

Asset Backed Loan (ABL) Credit Facility

On February 23, 2018, the Company, as borrower, and the Company’s subsidiaries TIW Corporation and Honing, Inc., as guarantors, entered into a five-year senior secured revolving credit facility (the “ABL Credit Facility”) with JPMorgan Chase Bank, N.A., as administrative agent, and other financial institutions as lenders with total commitments of $100.0 million, including up to $10.0 million available for letters of credit. The maximum amount that the Company may borrow under the ABL Credit Facility is subject to the borrowing base, which is based on a percentage of eligible accounts receivable and eligible inventory, subject to reserves and other adjustments.

The Company's ABL Credit Facility, dated February 23, 2018, as amended was terminated effective February 22, 2022 and otherwise would have matured on February 23, 2023. We have approximately $0.2 million of unamortized debt issuance costs as of December 31, 2021 that will be written off upon early termination of the credit facility. In addition, we opened a new account with JP Morgan Chase Bank, N.A., to facilitate our existing and future letters of credit. We transferred approximately $7.1 million of letters of credit upon termination of our ABL Credit Facility to JP Morgan Chase, N.A.

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Contractual Obligations

For information with respect to this item, see "Leases and Lease Commitments," Note 10 of Notes to the Consolidated Financial Statements in Item 8 of Part II, which is incorporated herein by reference.

Backlog

Backlog typically consists of firm customer orders of Dril-Quip products for which a purchase order, signed contract or letter of award has been received, satisfactory credit or financing arrangements exist and delivery is scheduled. Historically, the Company’s revenues for a specific period have not been directly related to its backlog as stated at a particular point in time.

The Company believes that its backlog should help mitigate the impact of negative market conditions; however, slow recovery in the commodity prices or an extended downturn in the global economy or future restrictions on, or declines in, oil and gas exploration and production could have a negative impact on the Company and its backlog. The Company’s product backlog was approximately $210.1 million at December 31, 2021 and $195.7 million at December 31, 2020. The backlog at the end of 2021 represents an increase of approximately $14.5 million, or 7.4%, from the end of 2020. The Company’s backlog balance was initially negatively impacted due to the COVID-19 pandemic resulting in a depressed global economic environment that led to weakness in oil prices. In the latter half of 2021 as we saw improvements in the global markets and recovery of crude oil prices with vaccinations being deployed resulting in positive market trends, our product bookings increased in the fourth quarter of 2021. In addition, we had approximately $11.6 million in cancellations during the year.

The following table represent the change in backlog.

(1) The backlog data shown above includes all bookings as of December 31, 2021, including contract awards and signed purchase orders for which the contracts would not be considered enforceable or qualify for the practical expedient under ASC 606. As a result, this table will not agree to the disclosed performance obligations of $65.8 million as of December 31, 2021, within "Revenue Recognition,” Note 4 of Notes to Consolidated Financial Statements.

The Company expects to fill approximately 70% to 80% of the December 31, 2021 product backlog by December 31, 2022. The remaining backlog at December 31, 2021 consists of longer-term projects which are being designed and manufactured to customer specifications requiring longer lead times.

See “Item 1A. Risk Factors—Our backlog is subject to unexpected adjustments and cancellations and is, therefore, an uncertain indicator of our future revenues and earnings.”

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Geographic Segments

The Company’s operations are organized into three geographic segments—Western Hemisphere (including North and South America; headquartered in Houston, Texas), Eastern Hemisphere (including Europe and Africa; headquartered in Aberdeen, Scotland) and Asia-Pacific (including the Pacific Rim, Southeast Asia, Australia, India and the Middle East; headquartered in Singapore). Each of these segments sells similar products and services, and the Company has manufacturing facilities in all three of its regional headquarter locations as well as in Macae, Brazil. Revenues for each of these segments are dependent upon the ultimate sale of products and services to the Company’s customers. For information on revenues by geographic segment, see "Geographic Segments," Note 16 of Notes to Consolidated Financial Statements.

Currency Risk

The Company has operations in various countries around the world and conducts business in a number of different currencies other than the U.S. dollar, principally the British pound sterling, Mexican peso and the Brazilian real. Our significant foreign subsidiaries may also have monetary assets and liabilities not denominated in their functional currency. These monetary assets and liabilities are exposed to changes in currency exchange rates which may result in non-cash gains and losses primarily due to fluctuations between the U.S. dollar and each subsidiary’s functional currency.

The Company generally attempts to minimize its currency exchange risk by seeking international contracts payable in local currency in amounts equal to the Company’s estimated operating costs payable in local currency and in U.S. dollars for the balance of the contracts. The Company had, net of income taxes, a transaction loss of $0.7 million in 2021 and a transaction gain of $1.9 million in 2020. There is no assurance that the Company will be able to protect itself against such fluctuations in the future. The Company has put in place an active cash management process to convert excess foreign currency and concentrate this cash in certain of our holding company bank accounts to minimize foreign currency risk and increase investment income.

The Company conducts business in certain countries that limit repatriation of earnings. Further, there can be no assurance that the countries in which the Company currently operates will not adopt policies limiting repatriation of earnings in the future. The Company also has significant investments in countries other than the United States, principally its manufacturing operations in Scotland, Singapore, Brazil and, to a lesser extent, Norway. The functional currency of these foreign operations is the local currency except for Singapore, where the U.S. dollar is used. Financial statement assets and liabilities in the functional currency are translated at the end of the period exchange rates. Resulting translation adjustments are reflected as a separate component of stockholders’ equity and have no current effect on earnings or cash flow.

Critical Accounting Policies

The Company’s discussion and analysis of its financial condition and results of operations are based on the Company’s consolidated financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States of America. The preparation of the consolidated financial statements requires the Company to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. There can be no assurance that actual results will not differ from those estimates. The Company believes the following accounting policies affect its more significant judgments and estimates used in preparation of its consolidated financial statements.

Revenue Recognition

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;

•
the contracts contain specific terms as to milestones, progress billings and delivery dates;

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

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•
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 Consolidated Balance Sheets. Likewise, revenue recognized may exceed customer billings in which case the amounts are reported in unbilled receivables. Unbilled revenues are expected to be billed and collected within one year.

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 when the product is available to the customer, 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).

Leasing revenues

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

On April 30, 2021, as a result of lower activity stemming from the COVID-19 pandemic, AFGlobal Corporation provided a 90-day written notice of termination of the lease agreement between the Company and AFGlobal in relation to the Company’s forge facility and equipment at its Houston Eldridge campus. Based on the initial 5-year term of the lease agreement, the Company had straight-lined the total anticipated lease revenue for that initial term into equal monthly lease revenue. As a result of the lease termination, the Company had approximately $2.3 million in unbilled revenue that was expensed in second quarter of 2021. The Company has numerous other forging suppliers and does not expect any disruptions in forging supply as a result of the lease termination.

Inventories

Inventory costs are determined principally by the use of the first-in, first-out (FIFO) costing method and are stated at the lower of cost or net realizable value. Company manufactured inventory is valued principally using standard costs, which are calculated based

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upon direct costs incurred and overhead allocations and approximate actual costs. Inventory purchased from third-party vendors is principally valued at the weighted average cost.

Inventory Reserves

Periodically, obsolescence reviews are performed on slow moving and excess inventories and reserves are established based on current assessments about future demands and market conditions. The Company determines the reserve percentages based on an analysis of stocking levels, historical sales levels and future sales forecasts anticipated for inventory items by product type. If market conditions are less favorable than those projected by management, additional inventory reserves may be required.

Off-Balance Sheet Arrangements

The Company has no derivative instruments and no off-balance sheet hedging or financing arrangements, contracts or operations.

New Accounting Standards

The information set forth under Note 3 of Notes to Consolidated Financial Statements under the caption "New Accounting Standards" is incorporated herein by reference.