General
The following discussion and analysis of our historical results of operations and financial condition for the three and nine months ended September 30, 2009 and 2008 should be read in conjunction with the condensed consolidated financial statements and related notes included elsewhere in this Form 10-Q and our financial statements and related management's discussion and analysis of financial condition and results of operations included in our Annual Report on Form 10-K for the year ended December 31, 2008.
We operate under one reporting segment, pressure control. Our pressure control business has three product lines: pressure and flow control, wellhead and pipeline, which generated 75%, 18% and 7% of our total revenue for the three months ended September 30, 2009 and 77%, 16% and 7% of our total revenue for the nine months ended September 30, 2009. We offer original equipment products and aftermarket parts and services for each product line. Aftermarket parts and services include all remanufactured products and parts, repair and field services. Original equipment products generated 77% and 82% and aftermarket parts and services generated 23% and 18% of our total revenues for the three and nine months ended September 30, 2009.
Outlook
Our business is driven by the level and complexity of worldwide oil and natural gas drilling and completion, which is, in turn, primarily driven by current and anticipated price levels for oil and natural gas. We believe that oil and gas market prices and the drilling rig count in the United States, Canada and international markets serve as key indirect indicators of demand for the products we manufacture and sell and for the services we provide. The following table sets forth average oil and gas price information and average monthly rig count data for each fiscal quarter for the past two years:

                          WTI        Henry Hub      United States      Canada       International
  Quarter Ended:          Oil           Gas           Rig Count       Rig Count       Rig Count
  September 30, 2007   $  75.46      $    6.25             1,788           348             1,020
  December 31, 2007    $  90.68      $    7.40             1,790           356             1,017
  March 31, 2008       $  97.94      $    8.72             1,770           507             1,046
  June 30, 2008        $ 126.35      $   11.47             1,864           169             1,084
  September 30, 2008   $ 118.05      $    9.00             1,978           432             1,096
  December 31, 2008    $  58.35      $    6.38             1,898           408             1,090
  March 31, 2009       $  42.91      $    4.49             1,326           329             1,025
  June 30, 2009        $  59.44      $    3.80               936            90               982
  September 30, 2009   $  68.20      $    3.42               973           187               969

Source: West Texas Intermediate Crude Average Spot Price for the Quarter indicated: Department of Energy, Energy Information Administration (www.eia.doe.gov); NYMEX Henry Hub Natural Gas Average Spot Price for the Quarter indicated: (www.oilnergy.com); Average Rig count for the Quarter indicated: Baker Hughes, Inc. (www.bakerhughes.com).
As noted in the table above, during the third quarter, the average worldwide rig count increased 6% from the second quarter of 2009; unfortunately, these levels were approximately 39% below their peak quarterly average in the third quarter of 2008. Activity levels were particularly depressed in the United States where average quarterly drilling during 2009 was down approximately 45% from their third quarter 2008 average.
During the quarter, our revenues and earnings declined as our business continued to approach current bookings levels and backlog continued to decline. Our backlog at September 30, 2009 was $41.2 million, which is down $4.2 million from June 30, 2009 and $34.9 million from December 31, 2008. Despite the depressed levels of domestic drilling, we have succeeded in selling product outside of the United States, and approximately

50% of third quarter revenues came from orders destined for use outside of the United States. Overall booking levels appear to have stabilized, and we booked approximately $43.3 million in the third quarter, up from $41.8 million during the second quarter of 2009. Although fourth quarter bookings may seasonally decline as companies postpone certain orders during the holiday season, we believe the longer-term trend is positive. During the quarter, revenues for repair, remanufacturing and service work, which typically increases ahead of our main product lines, all improved. Beyond 2009, we believe the long-term outlook for our industry remains positive, although the timing for a recovery is uncertain.
Results of Operations
Three Months ended September 30, 2009 Compared with Three Months ended September 30, 2008
Revenues. Revenues decreased $22.3 million, or 32.0%, in the three months ended September 30, 2009 compared to the three months ended September 30, 2008. Our pressure and flow control products revenue decreased approximately $13.9 million, or 28.1%, from the three months ended September 30, 2008, primarily due to decreased purchases by our customers, which is attributable to decreased demand resulting from the depressed global economy and consequent lower commodity prices and their effects on drilling activities. Our wellhead product line revenues decreased approximately $2.5 million, or 22.1%, from the three months ended September 30, 2008, primarily due to decreased purchases by our customers, which is due to the depressed global economy and resulting lower activity in 2009 with certain larger customers. Our pipeline product line revenues decreased approximately $5.9 million, or 65.2%, from the three months ended September 30, 2008, due to a decrease in bookings for larger pipeline-related projects quarter-over-quarter, which is a result of the depressed global economy. Across all three product lines, we have experienced pricing pressures that have resulted in a decrease in our standard pricing on some of our product offerings. Additionally, our wellhead and pipeline product line businesses are closely tied to North American drilling and production activities, and the drop in their revenues resulted from the 52% decrease in the third quarter of 2009 average North American rig counts from their third quarter of 2008 high.
Gross Profit. Gross profit as a percentage of revenues was 35.0% in the three months ended September 30, 2009 compared to 37.7% in the three months ended September 30, 2008. Gross profit margin was lower in 2009 primarily due to pricing pressure across all three product lines, an increase in our slow-moving inventory reserve for our wellhead product line and delays in our ability to secure low-cost country sourcing for some of our wellhead product offerings. Our gross profit margins for our pressure and flow control, wellhead and pipeline product lines were 36.3%, 29.8% and 29.0% for the three months ended September 30, 2009 compared to 37.6%, 40.9% and 34.1% for the three months ended September 30, 2008.
Selling, General and Administrative Expenses. Selling, general and administrative expenses decreased $2.8 million, or 18%, in the three months ended September 30, 2009 compared to the three months ended September 30, 2008. Selling, general and administrative expenses for the three months ended September 30, 2008 included $2.2 million of costs related to the pursuit of strategic alternatives. Selling, general and administrative expenses, excluding the strategic alternative costs in 2008, decreased $0.6 million during the three months ended September 30, 2009 primarily due to a $0.3 million decrease in bad debt expense and a $0.2 million decrease in legal and environmental expenses.
Interest Expense. Interest expense for the three months ended September 30, 2009 was $0.2 million compared to $0.5 million in the three months ended September 30, 2008. The decrease was attributable to lower outstanding debt levels during the three months ending September 30, 2009.
Equity in Earnings (Loss) of Unconsolidated Affiliates. Equity in earnings
(loss) of unconsolidated affiliates for the three months ended September 30, 2009 was $0.4 million compared to ($0.2) million in the three months ended September 30, 2008. The increase was attributable to our share of the earnings of our joint ventures in Mexico and Dubai during the three months ending September 30, 2009. Other Income, Net. Other income, net for the three months ended September 30, 2009 was $1.2 million compared to $42,000 in the three months ended September 30, 2008. The increase was primarily attributable to income of $1.1 million related to the settlement of a business interruption insurance claim for Hurricane Ike.

Income Taxes. Income tax expense for the three months ended September 30, 2009 was $1.1 million as compared to $5.4 million in the three months ended September 30, 2008. Our effective tax rate was 21.3% for the three months ended September 30, 2009 compared to 53.2% for the three months ended September 30, 2008. The tax rate was lower than the statutory rate in 2009 primarily due to $0.5 million of tax benefits from prior periods that were realized as a result of the expiration of the statute of limitations in the U.S. The tax rate in 2008 was higher than the statutory rate primarily due to $2.6 million of non-recurring non-deductible costs, of which $0.4 million of these costs were recorded in the second quarter of 2008, related to the pursuit of strategic alternatives.
Income from Continuing Operations. Income from continuing operations was $4.1 million in the three months ended September 30, 2009 compared with $4.7 million in the three months ended September 30, 2008 as a result of the foregoing factors.
Nine Months ended September 30, 2009 Compared with Nine Months ended September 30, 2008
Revenues. Revenues decreased $40.7 million, or 19.7%, in the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008. Our pressure and flow control products revenue decreased approximately $20.7 million, or 13.9%, from the nine months ended September 30, 2008, primarily due to decreased purchases by our customers, which is attributable to decreased demand for our pressure and flow control products and services resulting from the depressed global economy and consequent lower commodity prices and their effects on drilling activities. Our wellhead product line revenues decreased approximately $4.6 million, or 14.8%, from the nine months ended September 30, 2008, primarily due to decreased purchases by our customers, which is due to the depressed global economy and resulting lower activity in 2009 with certain larger customers. Our pipeline product line revenues decreased approximately $15.4 million, or 58.2%, from the nine months ended September 30, 2008, due to a decrease in bookings for larger pipeline-related projects period-over-period, which is a result of the depressed global economy. Across all three product lines, we have experienced pricing pressures that have resulted in a decrease in our standard pricing on some of our product offerings. Additionally, our wellhead and pipeline product line businesses are closely tied to North American drilling and production activities, and the drop in their revenues resulted from the 47% decrease in year-to-date average North American rig counts from their third quarter of 2008 high.
Gross Profit. Gross profit as a percentage of revenues was 36.9% in the nine months ended September 30, 2009 compared to 39.0% in the nine months ended September 30, 2008. Gross profit margin was lower in 2009 primarily due to pricing pressure across all three product lines, an increase in our slow-moving inventory reserve for our wellhead product line and delays in our ability to secure low-cost country sourcing for some of our wellhead product offerings. Our gross profit margins for our pressure and flow control, wellhead and pipeline product lines were 38.7%, 30.6% and 30.0% for the nine months ended September 30, 2009 compared to 38.9%, 40.8% and 37.5% for the nine months ended September 30, 2008.
Selling, General and Administrative Expenses. Selling, general and administrative expenses increased $0.2 million, or 0.4%, in the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008. Selling, general and administrative expenses for the nine months ended September 30, 2009 included $3.9 million of separation costs for our former President, Chief Executive Officer and Chairman of the Board, as well as $0.1 million related to Azura acquisition costs. Selling, general and administrative expenses for the nine months ended September 30, 2008 included $4.7 million of costs related to the pursuit of strategic alternatives. Selling, general and administrative expenses, excluding the separation and Azura costs in 2009 and the strategic alternatives costs in 2008, increased $0.9 million primarily due to increased employee stock-based compensation expense of $0.4 million, abandoned acquisition costs of $0.2 million and facility closing costs of $0.1 million.
Interest Expense. Interest expense for the nine months ended September 30, 2009 was $0.6 million compared to $1.9 million in the nine months ended September 30, 2008. The decrease was attributable to lower outstanding debt levels during the nine months ending September 30, 2009.

Equity in Earnings of Unconsolidated Affiliates. Equity in earnings of unconsolidated affiliates for the nine months ended September 30, 2009 was $0.9 million compared to $0.2 million in the nine months ended September 30, 2008. The increase was attributable to our share of the earnings of our joint ventures in Mexico and Dubai during the nine months ending September 30, 2009.
Other Income, Net. Other income, net for the nine months ended September 30, 2009 was $1.5 million compared to $0.2 million in the nine months ended September 30, 2008. The increase was primarily attributable to income of $1.5 million related to the settlement of business interruption insurance claims for Hurricanes Gustav and Ike.
Income Taxes. Income tax expense for the nine months ended September 30, 2009 was $5.9 million as compared to $13.1 million in the nine months ended September 30, 2008. The decrease was primarily due to a decrease in income before taxes. Our effective tax rate was 31.4% for the nine months ended September 30, 2009 compared to 37.7% for the nine months ended September 30, 2008. The tax rate was lower than the statutory tax rate in 2009 primarily due to $0.5 million of tax benefits from prior years that were realized as a result of the expiration of the statute of limitations in the U.S. The tax rate in 2008 was higher than the statutory rate primarily due to $2.6 million of non-recurring non-deductible costs incurred in 2008 related to the pursuit of strategic alternatives as well as non-deductible employee compensation costs. These were partially offset by extraterritorial income tax deductions.
Income from Continuing Operations. Income from continuing operations was $12.8 million in the nine months ended September 30, 2009 compared with $21.7 million in the nine months ended September 30, 2008 as a result of the foregoing factors.
Liquidity and Capital Resources
At September 30, 2009, we had working capital of $69.3 million, no long-term debt and stockholders' equity of $232.8 million. Historically, our principal liquidity requirements and uses of cash have been for debt service, capital expenditures, working capital and acquisitions, and our principal sources of liquidity and cash have been from cash flows from operations, borrowings under our senior credit facility and issuances of equity securities.
Net Cash Provided by Operating Activities. Net cash provided by operating activities was $31.8 million for the nine months ended September 30, 2009 compared to $27.3 million for the nine months ended September 30, 2008. The increase in net cash provided by operating activities was primarily attributable to improved accounts receivable collections and increased customer prepayments for our products, partially offset by decreased profit and reductions in accounts payable.
Net Cash Used in Investing Activities. Our principal uses of cash are for capital expenditures and acquisitions. For the nine months ended September 30, 2009 and 2008, we made capital expenditures of approximately $4.2 million and $7.5 million. We made equity investments in our unconsolidated affiliates of $2.0 million for the nine months ended September 30, 2009, with no such investments for the nine months ended September 30, 2008. Cash consideration paid for business acquisitions, net of cash acquired, was $7.5 million and $2.7 million for the nine months ended September 30, 2009 and 2008 (see Note 2 to our condensed consolidated financial statements).
Net Cash Used in Financing Activities. Sources of cash from financing activities primarily include borrowings under our senior credit facility and proceeds from the exercise of warrants and stock options. Principal uses of cash include payments on our senior credit facility. Financing activities used net cash of $16.3 million for the nine months ended September 30, 2009 compared to $24.9 million for the nine months ended September 30, 2008. We made net repayments under our senior credit facility of $18.8 million and $29.6 million during the nine months ended September 30, 2009 and 2008. We had proceeds from the exercise of stock options of $2.4 million and $3.1 million and from the excess tax benefits from stock-based compensation of $0.1 million and $1.7 million during the nine months ended September 30, 2009 and 2008.

Principal Debt Instruments. Our senior credit facility provides for a $180 million revolving line of credit, maturing October 26, 2012, that we can increase by up to $70 million (not to exceed a total commitment of $250 million) with the approval of the senior lenders. The senior credit facility consists of a U.S. revolving credit facility that includes a swing line subfacility and letter of credit subfacility up to $25 million and $50 million. We expect to use the proceeds from any advances made pursuant to the senior credit facility for working capital purposes, for capital expenditures, to fund acquisitions and for general corporate purposes. As of September 30, 2009, we had no outstanding balances under our senior credit facility and debt instruments entered into or assumed in connection with acquisitions, as well as other bank financings. As of September 30, 2009, availability under our senior credit facility was $151.5 million.
Our availability in future periods is limited to the lesser of (a) three times our EBITDA on a trailing-twelve-months basis, which totals $151.8 million at September 30, 2009, less our outstanding borrowings, standby letters of credits and other debt (as each of these terms are defined under our senior credit facility) and (b) the amount of additional borrowings that would result in interest payments on all of our debt that exceed one third of our EBITDA on a trailing-twelve-months basis. As such, given the decline in our EBITDA from the second to the third quarter, and the industry outlook for the remainder of the year, we expect availability to continue to decrease in 2009.
Our leverage ratio governs the applicable interest rate of the senior credit facility and ranges from the Base Rate (as defined in the senior credit facility) to the Base Rate plus 1.25% or LIBOR plus 1.00% to LIBOR plus 2.25%. We have the option to choose between Base Rate and LIBOR when borrowing under the revolver portion of our senior credit facility, whereas any borrowings under the swing line portion of our senior credit facility are at prime. At September 30, 2009, we had no outstanding borrowings under the revolver and swing line portions of our senior credit facility. The effective interest rate of our senior credit facility, including amortization of deferred loan costs, was 5.7% during the first nine months of 2009. The effective interest rate, excluding amortization of deferred loan costs, was 4.5% during the first nine months of 2009. We are required to prepay the senior credit facility under certain circumstances with the net cash proceeds of certain asset sales, insurance proceeds and equity issuances subject to certain conditions. The senior credit facility also limits our ability to secure additional forms of debt, with the exception of secured debt (including capital leases) with a principal amount not exceeding 10% of our consolidated net worth at any time. The senior credit facility provides, among other covenants and restrictions, that we comply with the following financial covenants: a minimum interest coverage ratio of 3.0 to 1.0, a maximum leverage ratio of 3.0 to 1.0 and a limitation on capital expenditures of no more than 75% of current year EBITDA. As of September 30, 2009, we were in compliance with the covenants under the senior credit facility, with an interest coverage ratio of 50.2 to 1.0, a leverage ratio of 0.01 to 1.0, and year-to-date capital expenditures of $4.2 million, which represents 14% of current year EBITDA. Substantially all of our assets collateralize the senior credit facility.
Our senior credit facility also provides for a separate Canadian revolving credit facility, which includes a swing line subfacility of up to U.S. $5.0 million and a letter of credit subfacility of up to U.S. $5.0 million. As of September 30, 2009, there was no outstanding balance on our Canadian revolving credit facility.
We believe that cash generated from operations and amounts available under our senior credit facility will be sufficient to fund existing operations, working capital needs, capital expenditure requirements, continued new product development and expansion of our geographic areas of operation, and financing obligations during 2009.
We intend to make strategic acquisitions but cannot predict the timing, size or success of any strategic acquisition and the related potential capital commitments. We expect to fund future acquisitions primarily with cash flow from operations and borrowings, including the unborrowed portion of our senior credit facility or new debt issuances, but we may also issue additional equity either directly or in connection with an acquisition. There can be no assurance that acquisition funds will be available at terms acceptable to us.
Off-Balance Sheet Arrangements. We had no off-balance sheet arrangements as of September 30, 2009.

Critical Accounting Policies and Estimates The preparation of our financial statements requires us to make certain estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Our estimation process generally relates to potential bad debts, obsolete and slow moving inventory, and the valuation of goodwill and other long-lived assets. Our estimates are based on historical experience and on our future expectations that we believe to be reasonable under the circumstances. The combination of these factors results in the amounts shown as carrying values of assets and liabilities in the financial statements and accompanying notes. Actual results could differ from our current estimates and those differences may be material.
During the quarter ended March 31, 2009, we changed the date of our annual goodwill impairment assessment from December 31 to October 1. This change was effected to allow more time and better support the completion of the assessment prior to our filing requirement for the Annual Report on Form 10-K as an accelerated filer. We believe that the resulting change in accounting principle related to the annual testing date will not delay, accelerate or avoid an impairment charge. We determined that the change in accounting principle related to the annual testing date is preferable under the circumstances and does not result in adjustments to the financial statements when applied retrospectively.
We recognized $23.5 million of goodwill impairment for our pressure and flow control reporting unit for the year ended December 31, 2008. At December 31, 2008, the wellhead and pipeline reporting units were not considered to be impaired as the estimated fair value exceeded the recorded net book value of these reporting units by 6% and 23%. At September 30, 2009, goodwill by reporting unit was $71.4 million, $13.6 million and $3.6 million for the pressure and flow control, wellhead and pipeline reporting units.
During the first nine months of 2009, we assessed the following indicators of impairment, and determined there were no triggering events that would require an interim goodwill impairment test:
• further, and sustained, deterioration in global economic conditions;

• changes in our outlook for future profits and cash flows;

• further reductions in the market price of our stock;

• increased costs of capital; and/or

• reductions in valuations of other public companies within our industry or valuations observed in acquisition transactions within our industry.

We have no indefinite-lived intangible assets. We test for the impairment of other long-lived assets upon the occurrence of a triggering event based upon indicators such as:
• changes in the nature of the assets;

• changes in the future economic benefit of the assets; and/or

• changes in any historical or future profitability measurements and other external market conditions or factors that may be present.

We have assessed the current market conditions and have concluded, at the present time, that no triggering events requiring an impairment analysis of long-lived assets have occurred in 2009. We will continue to monitor for events or conditions that could change this assessment.
These critical accounting estimates may change as events occur, as additional information is obtained and as our operating environment changes. Other than disclosed above, there have been no material changes or developments in our evaluation of the accounting estimates and the underlying assumptions or methodologies that we believe to be Critical Accounting Policies and Estimates from those as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2008.

New Accounting Pronouncements
In September 2006, new accounting principles were issued that define fair value, establish a framework for measuring fair value under generally accepted accounting principles, and expand disclosures about fair value measurements. The initial application of these new principles is limited to financial assets and liabilities and non-financial assets and liabilities recognized at fair value on a recurring basis. We adopted these principles on January 1, 2008. The adoption of the new principles did not have any impact on our consolidated financial position, results of operations and cash flows. On January 1, 2009, these new principles became effective on a prospective basis for non-financial assets and liabilities in which companies do not measure fair value on a recurring basis. The application of the new principles to our non-financial assets and liabilities will primarily relate to assets acquired and liabilities assumed in a business combination and asset impairments, including goodwill and long-lived assets. We do not expect this application of the new principles to have a material impact on our consolidated financial position, results of operations and cash flows. . . .