Dril-Quip Inc. ( DRQ - Analyst Report ) has reported second-quarter 2012 earnings of 74 cents per share, comfortably beating the Zacks Consensus Estimate by 3 cents and increasing more than 34% from the year-ago profit level of 55 cents. The increase was mainly backed by growth in product and service revenues as demand for offshore equipment climbs.

The company registered total revenue of $176.6 million in the quarter, up 28.9% from the year-ago level of $137.0 million. The reported figure also surpassed the Zacks Consensus Estimate of $172.0 million.

Operating income expanded 35.9% to $41.3 million from the year-earlier level of $30.4 million. On the cost front, on an annualized basis, selling, general and administrative expenses rose 8.6% to $17.4 million from the year-earlier level of $16.0 million, while its engineering and product development costs rose 11.1%. Notably, depreciation and amortization expenses increased 31.4% to $6.4 million.

Backlog

As of June 30, 2012, the company had a backlog of $697 million, compared with $727 million in the prior-year quarter.

Capex

Capital expenditures in the quarter were $13.9 million, compared with $13.0 million in the year-earlier quarter.

Guidance

For the third quarter of 2012, the offshore drilling equipment maker − Dril-Quip − expects earnings between 65 cents and 75 cents per diluted share, excluding any unusual or special charges. Additionally, based on the current improved market conditions, Dril-Quip increased its full-year adjusted earnings per share expectation to $2.75–$2.95 from the prior expectation of $2.60–$2.80.

Our Take

We are maintaining our long-term Neutral recommendation on Dril-Quip, supported by a Zacks #3 Rank (short-term Hold rating) - reflecting its exposure to the highly volatile oil and gas sector fundamentals.

The company reported impressive second quarter results fueled by growth in demand for offshore equipments. Increased deepwater activity, recent capacity additions in Brazil and Singapore, as well as ongoing capacity expansions are expected to prove beneficial over time.

The planned investment of Brazil's state-run energy giant Petroleo Brasileiro S.A., or Petrobras ( PBR - Analyst Report ) in the country’s offshore market over the next five years will also likely prove beneficial for Dril-Quip, which is well positioned to take advantage of the project. Hence, beyond 2012, the company remains well suited for Petrobras' planned newbuilds and continued, general secular growth. Petrobras has also increased its contract term to 4 years from 3 and Dril-Quip is likely to benefit from the potential renewal of its expiring 3-year, $180 million subsea wellhead contract with the former.

We remain concerned about company-specific risks, which include new product growth challenges, manufacturing difficulties and potential backlog losses. Additionally, delays in deepwater infrastructure contracts may also hinder the growth prospect of Dril-Quip.