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Edited Transcript of DRQ earnings conference call or presentation 31-Jul-20 3:00pm GMT

Q2 2020 Dril-Quip Inc Earnings Call

HOUSTON Aug 1, 2020 (Thomson StreetEvents) -- Edited Transcript of Dril-Quip Inc earnings conference call or presentation Friday, July 31, 2020 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Blake T. DeBerry

Dril-Quip, Inc. - CEO & Director

* Raj Kumar

Dril-Quip, Inc. - CFO & VP

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Conference Call Participants

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* Sean Christopher Meakim

JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst

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Presentation

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Operator [1]

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Welcome, and thank you all for standing by. I would like to inform all participants that this conference is being recorded (Operator Instructions)

Now I would like to turn the meeting over to Sean Meakim. Thank you. You may now begin.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [2]

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Thank you. Good morning, everyone. I'm Sean Meakim, Oil Services Analyst at JPMorgan. Thanks, everyone, for joining us for this fireside chat with the executive team from Dril-Quip on the back of their 2Q results that were released last night.

In addition to the release, the company has a slide deck available on our website, so be sure to check that out. Joining me today is CEO of Dril-Quip, Blake DeBerry; and recently appointed CFO, Raj Kumar. Blake's been with the company 32 years now, including the last 9 or so as CEO. He's also a director on the Board. And I'll come back to Blake's background in a second.

But first, I wanted to introduce Raj. Raj's tenure is a bit shorter than Blake's. Having joined about 3 years ago from Frank's, taken over the CFO role just in May, when prior CFO, Jeff Bird, was appointed President and COO. Raj followed in Jeff's footsteps from Frank's to Dril-Quip. But interestingly, he has a fairly diverse industry background, which is a relative rarity for oil services, in my experience.

So gentlemen, great to be here. Thank you for joining us.

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Blake T. DeBerry, Dril-Quip, Inc. - CEO & Director [3]

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Thanks, Sean.

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Raj Kumar, Dril-Quip, Inc. - CFO & VP [4]

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Thanks.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [5]

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Well, look, let's just kind of set the table at the start. You reported second quarter results last night. We'll come back to that in a bit. But to open things up, I wanted to maybe just take a step back. I mentioned I'll come back to Blake's background. Blake, you were appointed CEO in my first few months covering the space back in 2011. So you and I go ways back now. But in my time covering the company, it's always struck me that your background in R&D has given you a pretty unique perspective on how to make the most of what's been now a challenging half decade or so of relatively weak offshore activity.

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Questions and Answers

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [1]

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So to kick things off, could you just talk about the underlying thesis that's guided how you position the company here in terms of new product development and how you've been able to compete against what are ultimately much larger competitors?

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Blake T. DeBerry, Dril-Quip, Inc. - CEO & Director [2]

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Certainly. So you're right, Sean. I spent my first 13 years at Dril-Quip in R&D, doing new product development. And that has weighed heavy on my background. But when I became CEO in October of '11, I spent a lot of time looking at what were the products that Dril-Quip was successful in and what ones they weren't in. And it became clear to me that where we had a differentiated technology, that was where we excelled. And that really was in some of the core products right out of the gate: the connectors and the Subsea Wellhead primarily. And then when you look at the SPS space, in tress, we had kind of an [auto-ran] product. It was the same as what other people had. And so it was more difficult to penetrate. So it became clear to me that we had to create some differentiation.

In '12, we were coming off of Macondo. Our customers were demanding much more qualification testing. So we really took a strategy of products and we went back to our core products and started doing additional testing on those to meet customer requirements. But when the downturn in late '14, early '15 came, I really challenged our R&D team and said, "look, I want you to design products that structurally change how our customers drill wells to provide them permanent cost savings." Because my view is this industry is going to come back. And when it comes back, we're going to see that cost inflation happen. Rig rates are going to go back up, everything is going to go up. And so if we can save our customers money in the form of -- I don't have to install a piece of equipment, but I also save them time. And time is an incredibly valuable commodity to our customers. And particularly as cost goes up, if you save time, you're actually saving more money for them.

And with respect to competing with the larger peers, really, Dril-Quip was built on a foundation of innovation, quality and service. And that was really from the 3 founders: Larry Reimert; Gary Smith; and Mike Walker. And we've maintained that all along. We're a little bit smaller company. We're much more nimble, so we can move quickly when our customers change. And we've got dedicated employees really around the globe servicing our customers.

And then on the technology side, we have some competitors that work with us right now. In the downhole tool space, we work with one of our peers down in Ecuador. They subcontract some work to us. And most recently, to be honest, the VXTe, the new subsea tree we came out with, has had a lot of interest and we're looking at how we can monetize that technology. And so we're looking at -- we got a couple of our peers that we're talking to about that technology and how we can supply that to them and give them the advantage of that technology, about spending money on R&D and developing it. And we are a manufacturer. So our view is we want to manufacture components for you that give you the benefits of our technology.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [3]

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Well, thanks for that, Blake. I think that really -- that kind of sets the table well. Because a number of topics that you touched on, we're going to go through in more detail throughout the call.

Maybe just turn it over to Raj for a second. So a similar question for you. You came over more or less with Jeff about 3 years ago. DRQ is already regarded as a pretty well-run offshore equipment manufacturer within the oil services space. But in my experience covering the group, I found that folks with backgrounds outside of the industry are often able to bring new perspectives, new KPIs, new -- fresh thinking around how to enhance performance. And since Jeff has joined, it appeared to us that Blake and Jeff had a pretty good effective partnership. Of course, you were a big part of those initiatives, and now you're taking on the CFO mantle.

So the head start the company had in terms of lean initiatives has clearly served you well into this latest downturn. So we're going to some of the granularities over time. But just, at a high level, can you catch us up on what that work has looked like since you joined the company? Some of those key initiatives and where you think is there still a lot of room to learn?

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Raj Kumar, Dril-Quip, Inc. - CFO & VP [4]

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Yes, absolutely. Thanks, Sean. So I consider myself an insider/outsider. I've been in the industry actually for about 12 years. Before coming to the oil field, I was -- I worked in technology. So absolutely bring that perspective. I was at Dell, a company that was very focused on cost leverage and cash conversion cycle, euphemism for working capital management. I've been working with Jeff for the past 6 years. So we have -- I'm going to say we have a very similar DNA. And he and I worked on, together with Blake, we worked on key initiatives over the past 2 years at Dril-Quip. We've talked about the 2019 transformation, the initial setup of the footprint rationalization, all of which I was involved with as part of the team, both in terms of the planning as well as the execution.

If I were to flip and think about what the focus areas are going to be going forward, it's going to be -- there's going to be a lot of focus on capital allocation with a strong emphasis on working capital management. We're going to continue the cost leverage initiatives that we are always focused on, as well as the -- there are some improvements that we can make probably on the IT side that's going to be a main focus for me in this role. So that's going to be the areas that I'm going to be looking into.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [5]

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I appreciate that. I think that's good. So now we've kind of set the table. We should probably dig into 2Q results a little bit.

Overall, things were pretty in line with expectations. Top line, a little better than consensus. EBITDA pretty in line. Maybe order is a bit of a struggle, but we'll go through that. It's an exceptionally challenging quarter for the sector and for the overall economy. So maybe let's just start with the COVID impact.

Can you just talk a little bit about how the business was impacted, what you've been able to do to mitigate to a degree? Just given what we've heard across the industry, I imagine, the service end was more challenged than products. But both sides wouldn't come out unscathed. Maybe just give us -- let's just start with those impacts, and we can take it them there.

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Blake T. DeBerry, Dril-Quip, Inc. - CEO & Director [6]

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Sure, Sean. When -- it was really kind of mid-March, early March, we instituted our business continuity plan, which was anybody who could work from home, worked from home. And our IT group did an incredible job in a very short period of time, getting 700 people working from home and maintaining connectivity. And then our essential employees that are required to come into the office -- and that's really our manufacturing personnel and aftermarket, the assembly folks and all the fabrication that we do, those people came in. And part of that business continuity plan was we separated the shifts out. We shifted the working hours. There was no typical handover where one machine, as we'd talk together, here ram on this part, there was none of that. We stopped 15 minutes prior to the end of the shift to do a deep cleaning of all the touch points.

And so the end result of that is you just don't get as much production output. It's really an hour's game. We just don't have people working the same number of hours. And that has continued on through the second quarter. And it's been impacted in different ways. We're still doing our business continuity plan in the U.K.. In Singapore, the Singapore government actually came to us at one point when they hit their circuit breaker and said, "how many people do you have working?" And then told us what the new number of people that we would have working with us, right? And we dropped some headcount there.

And in Houston, we are now back to normal shift patterns and working over time. But we do have occasions where we get an exposure to COVID. And we did have one of those instances that happened in our assembly area, for example, where we can't have social distancing. You've got big heavy parts, multiple people working on assembling things. And we had 1 employee who had an exposure and came into the office. Found out the exposure was after he had come to work. And so we ended up having to shut down and quarantine our assembly folks for 10 or 12 days. And so that's just lost hours, right, in production. And so that's the kind of things that we've highlighted in the investor deck, showing the impacts of this virus.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [7]

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Yes. I appreciate that, Blake. And I think getting some of that -- the anecdotes and the day-to-day realities of it, exactly an hour's game. I think that's helpful context.

So let's talk about the transformation program a bit. There's an update in the slides. $11.5 million of cost out is what you've accomplished to date. The target now is further $9 million for the back half of the year, maybe more front-end loaded in the third quarter. Let's just talk about maybe the progress and plans as we look towards the back half and next year?

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Raj Kumar, Dril-Quip, Inc. - CFO & VP [8]

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Yes, sure, Sean. So we embarked on the planning for the $20 million cost takeout in Q1. We executed in Q2 $11.5 million, as you mentioned. This came primarily from the U.S., with a bit coming from Asia Pacific and Latin America.

Now if we look forward into Q3 and Q4, our focus is going to be Europe, where we're consolidating the tree CoE into Houston. And it's going to take us probably most of Q3 as we work through the backlog in the tree CoE, the current CoE that we have in Aberdeen. And by the end of the year, we should be done with the consolidation of the tree CoE.

So that would mean, Aberdeen will now be left with all of the pipe fabrication, test and assembly and the aftermarket activity. So we will still have a presence in Aberdeen, except that tree CoE would not be located in Houston. And that should result in the remaining $9 million of savings that we are targeting for the second half of the year.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [9]

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Got it. That's really helpful. And then one other thing that was interesting in the slides, you had a new slide emphasizing this emphasis on shrinking your roofline, your footprint. But there's been no shortage of that across this earnings season as folks have been announcing facility closures, et cetera. But what seem a bit unique was that you're not exiting leases and paying cash out. You're looking to monetize real estate assets and harvesting cash. I mean, could we just highlight that? It seems pretty interesting to me.

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Raj Kumar, Dril-Quip, Inc. - CFO & VP [10]

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Okay. Yes. So if you recall, in 2019, we went through what I would deem quite a big transformation, where we realized slightly over $50 million in cost savings. So part of that was rationalization of our global operating footprint, and that was around a 30% reduction in footprint. This is actually the outcome of that whole initiative, with the adoption of our lean operating philosophy. This enabled us to leverage our footprint. And what you're seeing right now, Sean, is we are just going out to monetize this excess roofline that we have.

You talked about leases. We don't have any material -- and I wouldn't say -- we don't have any material leases to speak of. In terms of manufacturing facilities, we own most of these facilities. So that's the only way for us to realize the cash as far as to go ahead and monetize it.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [11]

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Got it. Yes. I think that's certainly different from most of what we heard from the others this quarter.

So let's talk about the order rate. You booked only about $40 million in the quarter. I'm sure it's a little disappointing. You're targeting maybe $50 million to $60 million per quarter. But then again, considering customers literally couldn't come to their offices, I don't know that anyone's going to fault you for a challenged 2Q in terms of inbound. Just -- maybe just a refresh for folks, your comfort level around the $200 million bogey for the full year. And I'd just like to hear generally what your visibility looks like versus maybe where you were 3 months ago, having this type of discussion?

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Blake T. DeBerry, Dril-Quip, Inc. - CEO & Director [12]

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Certainly. So yes, certainly, $40 million was below our initial expectation for the quarter and bookings. And in fact, we were significantly above the $40 million number as we entered the quarter. But what we really saw was things pushed to the right. Now we didn't lose any orders, but we did see our customers hit the pause button given the uncertainty in the economy and the market, which we certainly understand.

So our view is the work is still out there. The potential is still there. But the decisions just weren't made in the second quarter, and they pushed that decision down to Q3 or Q4. And so that helps us with the outlook for the year on the $200 million bogey for the full year.

And to be honest, our frequency of contact with our customers has remained steady, not so much face to face, but certainly virtual contact. We have a few customers that have entered the office and so we get face-to-face with them. So we haven't just seen a whole lot of difference with respect to 3 months ago and now. There still seems to be a fair level of uncertainty. And one thing that I think is a little bit different, you've seen all of our customer base cut their CapEx budgets for the year. And so internally, there's this competition for whose -- for that capital allocation. Which project is going to get that capital allocation? And so I think that's where we are, customers are still deciding where are they going to deploy that reduced capital.

The other thing is the -- from a tree standpoint, that's probably an area where we have the biggest disappointment. The independents just cut their plans quickly. To be honest, when we entered the year, we were tracking, I think, 32 potential subsea trees with -- and we thought we would book 15. And that stuff just vaporized almost instantly when this virus hit, and the demand dropped and the price of oil dropped because the independents reacted pretty quickly.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [13]

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Right. Yes. We'll talk more about that as well. I think that's an important dynamic.

So let's just dig into the results a little bit more, just to provide some more context. As I mentioned, top line and margin pretty in line. Curious to get your thoughts on the back half of the year. Street modeling, some modest revenue decline, but flat to up EBITDA. So assuming more costs out that's consistent with what Raj laid out earlier. Just how are you all seeing the P&L for the back half of the year?

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Raj Kumar, Dril-Quip, Inc. - CFO & VP [14]

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So revenue expectations should be fairly unchanged. I mean, if you look at first half, I think you're going to see that trend sort of continue into the second half. In terms of EBITDA and margin, yes, you're absolutely right. We should see the cost take-out start to be seen in Q3 and Q4 as we progress these. However, on the services side, we do expect some headwinds given COVID restrictions and challenges related to COVID, where our personnel -- our service technician personnel may have interruptions in terms of executing to work with travel restrictions. And this is going to have a bearing on service revenue. And service revenue tends to have a higher-margin in terms of mix. And I see that being a headwind going into the second half of the year.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [15]

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So Raj, just to kind of put a button on that. The service is more challenged in terms of just getting work done. So more COVID impact. That depends on the higher-margin business, but you also have the cost coming out. Maybe you could just talk a little bit about how you distinguish between mix from a gross margin perspective and then how we -- think about the cost savings as well on an EBITDA basis? What -- what's kind of the end result? How should we think about that blend?

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Raj Kumar, Dril-Quip, Inc. - CFO & VP [16]

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So if you think about it, a fair assumption to make is the cost take-out is going to be -- part of it's going to be gross margin level and the other part is going to be SG&A. And if you think about the service revenue and the impact, the headwind, you're going to see that, that's going to be an impact to your gross margin. Because that's going to be a top line hit from a service perspective. So if I'm looking out second half of the year, depending on how service activities play out -- and at this juncture, it's hard to say. Because rig delays are something that's ongoing. Sometimes it works in our favor. Like in this quarter, we saw instances where our service technicians were quarantined and we had -- and we were able to make sure that they were compensated adequately for that. But that phenomena may or may not continue going into the second half of the year.

So if I'm looking at margins going forward, the impact of the cost takeout should help mitigate the negative impact that we're expecting from service margin loss.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [17]

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Got it. Yes. I think that's helpful. I appreciate you providing that framework.

So the balance sheet is still pristine, as I'm sure you're well aware. You're about breakeven on free cash for the quarter so big sequential improvement. Probably some restructuring costs were dragging that number a little bit. Working capital, generally helpful on seasonality. So good progress. But the cash balance stands at about $345 million. So decent wood to chop in the back half to get back to that $415 million watermark that you had set out to start 2020. Maybe just could you walk through anything that you think is worth calling out in the quarter? And then expectations for the back half towards keeping that cash flow neutrality target?

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Raj Kumar, Dril-Quip, Inc. - CFO & VP [18]

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Yes. Sure, Sean. So yes, Q2 collection -- it was a good collections quarter for us. So we collected close to $100 million. And the focus on collections is going to continue. If you think about where we had some build, it was inventory, right? And that -- a lot of that was COVID-related. We had COVID-related inventory delays that were a headwind to working capital in Q2.

Some of the inventory was also built related to strategic stocking for our downhole tools business. And this is -- when we go into the second half of the year, you're going to see that the downhole tools business is -- continues to show resiliency. And we wanted to make sure that we had the relevant inventory to support for that.

Going forward, I expect extended vendor payment terms to be more sizable. And speaking about lean and that sort of philosophy, we've implemented some lean techniques in the way we do our invoicing. And we've reduced our invoicing turnaround time, and we continue to make improvements there. And that's going to help with our collections due.

On the inventory side, I'm going to say that right now, it's a bit of an area where we need to be managing it. But COVID seems to be an area that we need to be watching because that's causing some delays, and we need to have the right amount of inventory support to meet market demand.

And going into the second half, we will see some help from a tax refund related to the CARES Act, and that's going to help us, too. I'm still confident in holding to that $400 million target that we had in terms of cash neutrality, given all of these factors that we're working on.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [19]

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Got it. And so you mentioned a lot of initiatives, right? So going into this pandemic, you were already targeting a pretty robust unlocking of cash out of your working capital on the balance sheet. So you went through -- a lot of the initiatives were already underway. It seemed pretty ambitious at the start. But again, there was -- it seemed like there was a lot of value to unlock. It gets a lot harder in an environment like this to affect a lot of those things. It gets tougher to make collections. As you said, inventory can go the other way for some period. Do you have any update in terms of how you think about those long-term targets and achieving them, considering perhaps things are a little -- it's a little bit tougher road here in the next couple of quarters?

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Raj Kumar, Dril-Quip, Inc. - CFO & VP [20]

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Yes. So the mantra that I have, we're going to control what we can control, Sean. So the ability to invoice at a much higher -- at a much compressed frequency is going to help, right? And that's something we control. The ability to go out and get more favorable terms with our vendor some ventures is something we can control. So that's what we're going to pursue. In terms of projects, yes, at the beginning of the year, you will recall that I talked about increasing milestones frequency. And that's probably going to be a challenge in this environment. However, we're not going to not ask. If -- we are still going to ask our customers for support, because at the end of the day, we have a working capital target to meet, and we have a business to sort of run, right? So it's going to be important area for us to focus on.

And while I'm not as confident that we will get as many milestone payments as we were targeting, I'm confident that we will get some.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [21]

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Right. No, that seems very fair to me. I want to make sure we touched base on the Proserv agreement. That was kind of the big highlight in the quarter. Maybe I'd just -- to start, it would be great just to hear the rationale for this collaboration from a customer perspective as well as from a DRQ perspective, of course. Maybe it's not a direct savings, but it sounds like it eliminates the need for some future organic R&D that was kind of on the horizon. So can you maybe just walk through some of that?

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Blake T. DeBerry, Dril-Quip, Inc. - CEO & Director [22]

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Certainly, Sean. Look, I think just to make clear, we have a subsea controls business that the company has had for quite some time. It was relatively low penetration in market share. But it had reached a point that, that business required some R&D spend in order to get the technology up to the current technology and be competitive in the market. And we were planning to spend overall in controls. The additional R&D plus just the headcount and overheads for that controls group was somewhere between $8 million and $10 million a year that we were going to carry. And so we were looking for alternatives given the low market share.

And when we saw the downturn in the market, quite honestly, it was just a good capital allocation decision. Because we would invest a substantial amount of money to get our controls up to speed but then we would see the return on that capital was moving further out just because we're waiting for a market to recover. So that was the reason that we reached out to Proserv. I've had a relationship with the Proserv folks. We would sit down, usually twice a year, and just visit and try and -- because we have trees and they had control. They were always trying to -- we were trying to leverage each other's customer base. And so it just seemed to make sense we reached out to them. They have excellent technology in the control space. And they've taken over our -- the bulk of -- or some of our controls backlogs. A few things that -- we're finishing out a few things, but they're taking over the longer-term stuff and novating contracts to Proserv. And that allowed us to just remove that, one, the R&D spend out, but also the cost of the personnel and the overhead out of our business.

We view that transaction as a win-win collaboration. It's good for Proserv, it's good for Dril-Quip. We get access to a very latest technology in controls. But we -- but the 2 of us together also get access to each other's customer base. So we're now pulling them in with -- and we're selling trees, we're pulling Proserv personnel and to sell them controls. And vice versa, they're bringing us into for opportunities where they're selling controls so we can bring the trees in. So I think it's going to be -- it's a win-win for us. Like I said, and actually, the feedback we're getting from customers is mostly positive. So it was a good outcome for everyone around.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [23]

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Any early anecdotes on the customer side? I know it's still early day here, but anything else that you can share on that front?

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Blake T. DeBerry, Dril-Quip, Inc. - CEO & Director [24]

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It's just -- I think from our customer base, most of them said, hey, this is a good solution for Dril-Quip and for Proserv. We're happy to have Proserv come in there. Proserv is actually going to take over some of the maintenance of Dril-Quip legacy controls in the field. And so like I said, I think we're in the early stages. So our anecdote is, we're now bidding something that we weren't bidding before, but our teams are collaborating regularly. And so I think it's going to be a positive move, I really do.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [25]

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I appreciate that. So let's maybe spend most of the rest of our time looking forward. The next 4 to 6 quarters look pretty challenging. The global economy is going to try to recover to something approximating pre-COVID levels. It doesn't look like there's going to be a significant call on the upstream, let alone for offshore barrels. For now, OPEC will be engaged in this delicate dance of adding barrels back to the market without hopefully being too disruptive to price. But if we look beyond that period, there should be eventually a call on the upstream again.

Last cycle, Shell had the vast majority of the market share of that incremental call on the upstream. The offshore complex has done a lot though to improve its economics, shortened cycle times.

So first, if we just talk about the next 1 to 2 years, Blake, what's your outlook for the market and DRQ's order potential? And I noticed in the slide deck, your assumptions got a little better from last quarter, but it's really not up to like 2023. Largely a pretty unchanged view. A lot can happen between now and then. Just what's your feel about the next few quarters?

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Blake T. DeBerry, Dril-Quip, Inc. - CEO & Director [26]

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Yes. Just, Sean, in the next few quarters, given the -- there's no doubt it's going to remain challenging. And we really believe it's looking like 2022 or 2023 before we see an inflection in the offshore sector. I just like -- our position is we're in a good spot with the new products that we have and with our balance sheet and our backlog. And I think we may be able to ride this storm out.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [27]

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No, that's right. Yes, certainly a tough market. We spoke about this earlier, but not in too much detail. Not every operator is acting in lockstep. You mentioned a little bit tougher time for the independents out of the gate here. Just maybe can you talk about how you're seeing behavior between IOCs, NOCs and independents and how that's impacting your business?

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Blake T. DeBerry, Dril-Quip, Inc. - CEO & Director [28]

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Sure. Yes. So it was -- there's a stark difference between those three. And particularly independents. They -- like any other business, it's probably a balance sheet-related game, right? So the independents reacted quickly and dramatically, cutting CapEx. And I think we have a slide in the investor deck showing the level of CapEx cut in the independents and it was substantially higher than both IOCs and NOCs. And the IOCs also did a cut in their CapEx, but I don't think they've done -- they've cut their CapEx budget. But I don't think they said where is that spend coming from. So we're still in a discussion phase of, hey, can we push this delivery out and I won't bring this in or this project is going to go. So their activity level is dropping, but we don't know exactly which way it's going to go.

On the NOCs, it's an interesting dynamic. I think it depends, are you a oil importer or an exporter. We've seen the likes of CNOOC, for example, they've actually accelerated some of their drilling campaigns. Because for them, this is a cheap time to drill and they're -- if they can bring it in domestically, they'd rather do that. Petrobras also, while not accelerating, but they certainly are -- did not decelerate as much as a lot of the IOCs. And so we've had strong work from Petrobras. And in fact, they're still on track to bid a 70 wellhead tender towards the end of this year.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [29]

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No, that's helpful. You've kind of round out the rest of the geography. So but for you, Brazil feels relatively constructive. It sounds like Asia, generally not as bad. North Sea is probably still doing okay, right? We've got some tailwinds there, that are a bit idiosyncratic. Guyana is probably still quite constructive. So you've got some pockets there that you can really hang your hat on. Some other areas, Gulf of Mexico is probably -- seems a little more challenged. West Africa, certainly -- maybe should we just kind of walk around rest of the world on how you see things?

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Blake T. DeBerry, Dril-Quip, Inc. - CEO & Director [30]

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Yes. So you're right. So Asia has been -- and I'm going to call it a bright spot, but it's a glowing ember on a candle, right? I mean it's brighter than the rest. But there seems to be a level of activity. I think some of the gas plays in the LNG stuff is still moving forward. We're seeing currently, Woodside still talking about doing a development in Myanmar, which is a gas development. I spoke about CNOOC accelerating. The North Sea has been okay as well. We've seen pretty steady work out of the North Sea. The Gulf of Mexico definitely is the biggest hit. And I think a lot of that ties back to the independents. They were becoming pretty active.

In Guyana, we don't do a lot of work there. We are pursuing some work and bidding some work in Guyana, but we're not a major contributor. We are although providing wellheads in Suriname. So I think we know who that is. And recently, we've seen an uptick in Mexico in our downhole tools business and -- as well as in Ecuador. And to be honest, overall, that downhole tool business has been pretty resilient. I mean it's going to be flat year-on-year, which is -- given the circumstances, that's actually like being up.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [31]

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That's right. Yes, flat is the new up. Well, thanks for that.

So then let's look beyond the next few quarters. At some point, the world gets back to some form of normality. And I'm curious to get your outlook on offshore taking a bigger seat at the table next cycle. So just to put some parameters around it, if you could use subsea tree is a proxy. The market averaged 370 trees from 2010 to 2014, the peak of about 550 in 2013. This cycle, 2015 to 2019, is a little over 200 trees. So down about 45%. And the peak was a little over 300 in '18, trough below 116. So that's kind of where we've been. Just curious, if we look beyond the next couple of years, where do you see activity cycle over cycle for offshore?

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Blake T. DeBerry, Dril-Quip, Inc. - CEO & Director [32]

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Yes. So it's interesting. I think the U.S. land unconventional definitely took a large portion of the capital and the marginal barrels in the space and probably reduced the importance of offshore sun. But what we're seeing now, with the calls for capital discipline in these shale-based companies, I'm not sure it's going to come back and be a bigger player as before. I think those people that are in the good rock will continue to work and produce. But the capital discipline is going to limit some of the others from coming back and getting that production up that high.

So the offshoot to that is we're pretty bullish in the longer term on offshore globally. I think we're going to get a bigger seat at that table, if our view on the unconventionals plays out as I described.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [33]

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Well, fair enough. And so one -- an important area for Dril-Quip we haven't touched enough on yet is new products introductions and customer adoption. So it's a big initiative. We discussed this at the top, right? You put a lot of time and energy into bringing products to market with unique value propositions. I'd love just to get kind of latest feedback, customer acceptance, qualification, installations, things like that you'd like to call out. I mean we've got the BigBore-IIe Wellhead, DXe Connector, the double expansion Liner Hanger. And then, certainly, the VXTe -- we're down at your R&D facility for our technology tour not too long ago, pre-pandemic, obviously. And that was really the most exciting thing we've learned about on that tour.

OTC Spotlight awards have been very kind to you in the last couple of years. Could we just get maybe an update kind of around the horn on those. I think that would be really helpful.

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Blake T. DeBerry, Dril-Quip, Inc. - CEO & Director [34]

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Yes. Yes. So it's -- look, just talking about those products more broadly, we just called the E series of products. I think it goes back to when I said I challenge our R&D teams, I wanted you to develop products that structurally change how our customers drill wells for permanent cost savings. And that's the outcome of that challenge, is those products we've just announced. All of them either save direct dollars from not having to run equipment for same time, which is time is money, or they eliminate risk. And so all of those things are important to our customer base. And you're right, we've been recognized by OTC, all those products did receive a Spotlight on New Technology award.

Look, interestingly, our strategy has always been to reach out to the independents, get the new products run by the independents, prove -- get that serial #1 hurdle behind us. And this downturn has made that challenging. But because of the cost savings, and these products we're estimating about $5 million per well if you use the whole suite of products, which is pretty significant cost reduction.

We're actually getting some pickup from majors looking on, so -- looking at the new product. So we're working with Chevron on Big Bore II-e. We're working with Shell on the double expanding Liner Hanger. VXTe is Chevron's looking at that. And so the independents have been challenging because they cut their budgets so substantially. But it's not all downside, there's still some upside.

We did install our first horizontal tree last week successfully. So that's good news. And I appreciate the good work that our teams have done to get to that point. And our first VXTe is still on schedule to be installed in Q4 2020 or Q4 2021. So we're still going to make some penetration. I think it's just a little bit slower than what we had hoped, and that's just really more market-driven.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [35]

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Yes. I think absolutely fair. Also as we're kind of wrapping up a bit here, the other major point is to talk about capital.

(technical difficulty)

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Operator [36]

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I'm sorry. Sean actually just got disconnected. Allow me to go ahead and check for his line.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [37]

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I'm back. Well, this is work-from-home at its finest.

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Raj Kumar, Dril-Quip, Inc. - CFO & VP [38]

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Well, Sean. It happened to me earlier on the call.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [39]

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Yes. So just based on what -- as we're kind of winding down the call here, just wanted to talk a little bit about capital allocation.

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Raj Kumar, Dril-Quip, Inc. - CFO & VP [40]

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Yes. So I can go through the -- very quickly give you a rundown of -- to your point, $350 million of cash right now. If you think about CapEx, it's going to be -- in the near term, it's going to be maintenance level, say, $12 million to $15 million. R&D is probably going to be in the, I would say, $15 million to $20 million range given the recent Proserv collaboration. It's going to help us avoid some of the R&D costs related to controls, which was quite sizable. And then we always set aside some cash for -- to support any potential upturn, as you know and you mentioned earlier, we are a projects-based business. So we know that the initial client of any upturn, there's going to be some build in working capital that we will need to address.

We do keep -- set aside some cash as dry powder for any potential M&A. However, if you look at the industry right now, it's a need of severe -- it's in need of consolidation, right? And anything that we would want to do, our cash levels are not going to be sufficient to fully fund it. So there's going to -- we're going to be a bit more creative in the different forms of currency to go ahead and do an M&A transaction. But as with M&A, you need to have a willing buyer and a willing seller. So we'll have to see how this market pans out over the next couple of years.

Whatever we do in terms of M&A, it's going to have to be something that consolidates and has meaningful market share. And we will be very focused in ensuring that the business that's acquired is able to generate free cash flow and we're not taking on a business that's going to be consuming cash for the near term, at least. We're quite maniacally focus, we make sure that through integration we'll be able to very quickly make it a cash flow generating business soon.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [41]

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Well, great. Well, technical issues aside, I think this was a pretty constructive discussion. So I think that just about does it for my questions. Just as we wrap up and we're getting close to noon on a summer Friday in the East. So gentlemen, any concluding remarks or key messages you'd like to leave us as the weekend beckons?

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Blake T. DeBerry, Dril-Quip, Inc. - CEO & Director [42]

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Yes, Sean, I would. I'd just first like to recognize all the employees at Dril-Quip who have done an incredible job, adapting to this pandemic. And the essential workers that are coming in every single day and doing the hard work of delivering products to our customers. But also the people that are working from home. OTC got canceled. That was a big show, coming-out party for VXTe, our marketing and sales department flipped, and we did OTC online, virtually. And we actually did 50 online presentations to almost 600 customers and many major operators that weren't aware of that VXTe product are now aware and we're getting significant traction from them.

And we're also getting significant traction on those products from our peer groups, wanting to see if they can leverage our technology in the tree business. So I'm just really proud of the Dril-Quip organization. And I still believe that we've got -- we're in a really good spot. We're definitely going to survive the outcome or this pandemic and downturn, and I think we're going to be a much better company on the other side.

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Sean Christopher Meakim, JPMorgan Chase & Co, Research Division - Senior Equity Research Analyst [43]

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Well, look, we certainly agree. Blake, Raj, again, great to spend time with you guys today. And thanks, everyone, for joining us. I'm Sean Meakim from JPMorgan. Everyone, have a great weekend. Thank you.

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Raj Kumar, Dril-Quip, Inc. - CFO & VP [44]

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Thank you, Sean.

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Blake T. DeBerry, Dril-Quip, Inc. - CEO & Director [45]

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Thank you, Sean.

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Operator [46]

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And that concludes today's conference. Thank you all for joining. You may now disconnect. Speakers, please standby for post-conference.