Hello, and welcome to the Evercore ISI 2020 Webinar with Dril-Quip. Speaking today from Evercore ISI will be energy analyst, James West. I'd like to remind everyone that the material in this webinar is based upon information considered to be reliable; neither Evercore ISI nor its affiliates guarantee completeness or accuracy. Assumptions, opinions and recommendations contained herein are subject to change without notice. Past performance is not necessarily indicative of future performance. This material is not intended as an offer or solicitation for the purchase or sale of any security, and we will not be disclosing any nonpublic information. Our speakers will be taking questions via the questions window on your webinar control panel. Just send your questions in at any time during the presentation. And now I'll turn the microphone over to James West.

Thanks, Emily. Good morning, everyone, and welcome to our exclusive fireside chat with the executive team for Dril-Quip. The company reported its first quarter results last night, and we're, of course, excited to have the team with us today. Dril-Quip also released a supplemental slide deck, which we're not going to go through today, but I suggest everyone take a look at. Joining me is President and CEO Blake DeBerry; and Senior Vice President of Production Operations and CFO, Jeff Bird. Blake joined Dril-Quip in 1988 and has held a number of management and engineering positions with the company in both domestic and international locations. This includes serving as Senior Vice President, Sales and Engineering and as Vice President for Dril-Quip's Asia Pacific region. He was named CEO in October of 2011. Jeff joined Dril-Quip as Vice President and CFO in 2017. He was promoted to Senior Vice President of Production Operations and CFO in 2019 — joined in 2017. Prior to Dril-Quip, Jeff was the CFO of Frank's International from 2014 to 2017; CFO of Ascend Performance Materials from 2010 to 2014; and prior to Ascend, Jeff served in a variety of accounting and finance roles in the industrial manufacturing sector including as a Division CFO at Danaher. Since Blake and Jeff teamed up, Dril-Quip has undergone a significant organizational shift with footprint reductions, the introduction of lean manufacturing practices, the integration of supply chain and major cost reductions. And as outlined in April, additional measures were released last night to react to the impact of the COVID-19 crisis and the oil price collapse. One thing I know Blake and Jeff are really excited about today is sitting on $343 million in cash and no debt as we go into this downturn. So welcome, gentlemen, and thanks for joining me today.

Thank you, James. Glad to be here.

So I don't want to spend too much time looking backwards here. But since you guys typically don't host an earnings call with the 1Q release, maybe we'll start here for just a minute. So you posted first quarter results last night that did highlight to myself and I think others, the way that COVID-19 impacts have had a negative impact on all areas of global operations and probably will have a much bigger impact in the second quarter. Could you highlight some of the challenges brought on by the pandemic and how you're addressing those?

Yes, sure. First off, our top priority has been the safety of our employees around the world as the pandemic has spread. I am incredibly proud of our employees and their resilience during these rapid changes. Our IT group, in mid-March, went from managing about 700 people in our facilities to getting them working from home. That went off without a hitch, so kudos to them. But I'm most proud of what we consider our essential employees — those who have to come into the plants and work. They've done an incredible job in both the manufacturing organization and our aftermarket organization and our offshore service technicians. They've still been traveling around the world, and they've done a great job. It was disruptive, that's for sure. If you look at our facilities, it all started around the Lunar New Year period when some of our machinists went back to China to visit family and then couldn't get back. That disrupted our Singapore facilities and caused about a one-month disruption there. About the time that finished, the U.S. and the U.K. both started work-at-home orders and lockdowns. We put in our business continuity plans. By that, what we mean is we separated into two or three shifts, depending on the number of people; we didn't have any overlap of personnel; we had staggered lunch and tea breaks. We also vested all employees' PTO and told them if they had special circumstances where they couldn't come in or they felt it was too risky, they could use that time. All those things had an impact on our production hours. We got up and running, and then shortly after that, the Brazilian government shut us down and we were closed for about a week. We worked with Petrobras; Petrobras petitioned the government and we got back up and running in Brazil. Then borders closed between Malaysia and Singapore — we have a significant number of Malaysian employees — and we were scrambling to decide what to do. Singapore hit the circuit breaker because their COVID cases increased, and we had to petition the government for Singapore to stay open. We were successful and that operation continued, but Singapore continued to tighten restrictions. They actually came in and said, "You have 102 direct labor employees here working. Your new number is now 80." So it's been an incredibly fluid, changing environment for our facilities, but we've been managing through that. All of that impacted our Q1 results. We also had some supply chain disruptions: getting materials became more difficult, and logistics — moving materials from place to place — became the bigger challenge. Sea freight became challenging and air freight became almost impossible. Those things impacted us. Our results were also impacted on the accounts receivable side. As we moved to work from home and our customers moved to work from home, we had about $10 million in receivables that we expected to collect, and that had a negative impact on our cash flow.

Sure. Fair enough. And you also, Blake or Jeff, took a $40 million in restructuring and impairment charges during the first quarter. Could you talk about what the major buckets are related to these charges and impairments?

Jeff, do you want to take that question?

Yes, sure. There are really three large buckets. As we discussed in the press release, as a result of some strategic repositioning on some of our product lines, we're taking an inventory and fixed asset charge of about $24 million. That's really about thinking differently about our footprint. Severance-related charges would be about $8 million. And goodwill — that's the goodwill from TIW — is another $8 million. All of that relates to our view of the current outlook in the market and our need to respond appropriately in today's market.

Okay. That makes sense. So what are the main drivers here of your downturn playbook? Clearly, there's some facility consolidation, disciplined spending, rightsizing the organization. Could you dig deeper into what you're doing with respect to some of those actions?

Yes. I'll be a little sensitive, as you can appreciate, James, in my response here because we want to make sure that we're notifying our employees in locations in an appropriate manner. That's going to roll out over the next month or two, so bear with me if I'm a little vague about locations. When we executed our first transformation program, we left a playbook that said, "If things go down, here's the levers we'll need to pull." Candidly, we had those playbooks in the drawer. At the time, we thought things were bouncing back, so we didn't need to execute them. A lot of these actions were already in queue. Just as an example, on the product side we evaluated a number of product offerings. For our subsea wellheads, today we have 15 different subsea wellheads; we imagine we can get that down to four or five. You can imagine the cost, inventory and footprint shrinkage you achieve from something like that and how that helps take cost out of the business by having a more common manufacturing process. That's one of the things we're pulling from the playbook now and starting to execute on.

Okay. All right. Fair enough. Despite the crash we've had in oil prices, bookings for the quarter held up pretty well — about $60 million — and the backlog is still near recent highs. How would you characterize first customer orders and customer conversations in this current period of uncertainty?

Right now, in our backlog, we're not seeing any cancellations. That's consistent with what we saw in the 2015-2016 time frame. But we do see some push outs of deliveries. A lot of the larger operators are still in planning mode about what their new programs will look like, so I'm not sure we've seen everything from them yet. Independents tend to move faster. To be honest, I've been on executive-level calls on projects we have ongoing to ensure Dril-Quip remains a critical supplier and continues to deliver. It's a mixed bag. On pricing, our customers remember asking for concessions in 2015 and again in 2016, and we complied as best we could. Throughout the cycle we haven't raised prices at all. Dril-Quip has worked hard to restructure and remove cost, which is what we did in the back half of 2018 and through 2019 with our last transformation, enabling us to operate profitably at those pricing levels. Customers understand there's not a lot of room to bring prices down further. So our focus is to show that our new products are designed to save them money, and that's where we'd like to have the conversation — how to become more cost effective.

Okay. So how should we think about non-project inbounds in the near term? You were doing kind of $50 million to $60 million a quarter. Does that take a dip here, or could that be consistent?

It's challenging because there's so much uncertainty across the entire sector — not just in the OFS space but on the E&P side as well. The best guidance I can give is look back to 2015 to 2017 when we clipped along at about $50 million a quarter bookings. That's about as good as we can say right now. I don't think we'll know the answer until we get a real sense of demand after the COVID-19 issue starts to resolve.

Sure. How much of the inbound over the last several quarters was from new products you've introduced in the market the last several years?

Through 2019, the percentage of inbound bookings that were new products was about 13%; we were targeting 14%, so we were pretty much on target. If you combine new products and new customers, about 30% of our bookings fell into that combined bucket, with some overlap. We were making good traction there, but a lot of that inbound was targeted to the SPS side of the business where we have relatively small market share. That traction was primarily with independents, and independents seem to be the first to slow down. So I think we'll see a slower uptake in new products, particularly on the SPS side, until the market recovers.

Okay. Well, turning to the downturn and the current macro situation: in the supplemental earnings deck it shows a pretty dramatic drop in subsea equipment market demand since February. What kind of macro framework was used to show the significant estimate declines in 2021 through 2023? What oil price or outlook is backing that up?

First off, it's difficult to predict the future, but this is our best guess. The big macro driver is supply and demand. We were already operating at a slight oversupply — producing about 103 million barrels per day and consuming about 100 million. When demand destruction happened, we went down 20% to 35% on the demand side. I like to think of it this way: every three days, enough oil has gone into storage to service the world for a full day at prior pre-COVID consumption. So when demand comes back, there's a massive amount of oil in storage that must be consumed before we see pricing improvement and increased activity. I think that's what's driving those charts.

And so is the way you're thinking about and streamlining the organization based on those charts and that prognostication?

Yes, simply put. As good companies do, we have a plan for the worst and a plan for the better. We've modeled "if it gets worse" and identified the levers to pull so we don't have to start plans in the middle of a crisis. On the other hand, if we get an uptick, we're not destroying any manufacturing capacity that we couldn't put back in place. If things get better, we'll be in a position to respond to the market and supply the products and services it needs.

How much cash do you need? You're in the enviable position of having a lot of cash, which is good. How much cash do you need to run the business in this kind of lowered environment?

I do like having cash on the balance sheet. I'll let Jeff take that one for you.

In the current environment, we probably need $50 million to $75 million of cash to really run the business with current revenue expectations. To be clear, we started the year with around $415 million in cash. We've talked about cash neutrality for the year. To us, that means we started the year with around $415 million and would target ending the year at around $415 million. We have a stock buyback program in place and would balance free cash flow with that program to target ending the year at our starting cash position.

Okay. How are you prioritizing your CapEx at this point? Are you going down to pure maintenance levels?

We have guided a higher number previously, in a different market. Now we're at maintenance CapEx. Maintenance CapEx should be between $10 million and $15 million. Some footprint rationalization will be minimal CapEx, perhaps $1 million to $2 million, but that should fit within the $10 million to $15 million guidance.

And what about R&D spending? You guys are a technology leader. I suspect it does not go to zero. What are you prioritizing for R&D?

Our R&D focus had been really in the SPS space. We have the HPHT facility in Singapore that we started in 2016 and we've used that facility as well as our Houston facility over the past few years. If you look at subsea tree awards, we were at a 300 to 350 trees-per-year pace; I think now we're somewhere in the 100 to 130 range. That market has certainly gotten smaller, so there is less urgency to build that product line out right now. We did just receive an award from OTC for our new subsea tree, which we call VXTe, and I believe this product is significantly differentiated. There may be opportunities to monetize the technology. Currently, our R&D efforts are focused on short-term wins — things we can rapidly commercialize and generate revenue in the next 12 to 18 months — and ensuring the return on that investment is a significant priority.

I'd like to dig in on some of the new products you've introduced over the last couple of years that have won Technology Spotlight Awards at OTC: the Big Bore Wellhead, the Wellhead Connector, the Double Expansion Liner Hanger, and the vertical tree XTe you mentioned. How has the introduction of those been into the market? Could you parse between the products on customer acceptance and are you winning new customers? I think you mentioned some good acceptance recently with some customers you hadn't worked with in a while.

There's a common theme among all those products. When we started this process, I challenged our R&D engineers to design equipment that structurally changes how customers drill wells offshore and that gives them permanent cost savings. This was focused on structurally changing operations — eliminating trips and minimizing days offshore — rather than just supply-chain efficiencies. Our view is that eventually prices will recover and rig rates will go up, so if we can save time, that's significantly more valuable. Every one of these products is focused on time savings. The VXTe vertical tree system we won the Spotlight Award for — we took that to a major operator, and their subject matter expert pulled out a piece of paper, started scribbling, and said, "You just saved me $3 million to $4 million per completion." That's meaningful. We were seeing uptick on new products like BigBore-IIe and several independents were converting existing inventory to BigBore-IIe. The DXe wellhead connector will be significant in the 20,000-foot development space and has been selected as the profile and connector of choice. The XPak liner has customers asking for it; it significantly eliminates risk when running big-bore liner hangers through wellheads. All these products have generated interest. Major operators may be more willing to look at these new systems because they're more risk-averse than independents, but now they need to pull cost out. I'm hopeful we can engage at the executive level and push this messaging down to get more traction introducing these products into major operator programs.

Are you seeing differences in behavior between the large IOCs, the NOCs and the independents as we get into the downturn?

We are. The difference was almost stark. Within a week, many independents said their go-forward plans were paused. If you break CapEx reductions down by those three categories, you'll see that play out. Independents very quickly curtailed activity, though there are a few independents saying it's cheap to drill now and they will continue. IOCs are more pragmatic and take a little longer to decide, so we're seeing delays and push-outs from those customers. NOCs are a mixed bag — it depends if they are exporters or net importers. In the 2008-2009 financial crisis when I was in Asia Pacific, some NOCs kept drilling because it's for internal consumption. We've seen some increase in NOC activity and some wind-downs for exporters.

Let's hop around the world on some key markets and start with Brazil. You have a great relationship with Petrobras. How are you feeling about that market as we go through this year?

We have a good relationship with Petrobras and a strong position in that market. Historically, the wellhead providers in Brazil have been Dril-Quip and the VECO portion of Baker Hughes; we tended to split that business about 60/40 with Dril-Quip getting roughly 40%. Currently Petrobras is running around 18 rigs and Dril-Quip wellheads are on 12 of them, so consumption of Dril-Quip wellheads is moving at a quicker pace, which is a positive sign. Petrobras has announced some cuts to exploration, but they are involved in 17 production sharing agreements with significant majors that seem to be continuing. We did win an award from an IOC in Brazil last year that we are executing now. Even though Petrobras announced some delays, we expect some replenishment in wellhead demand in Brazil in the second half of the year.

What about Europe and the Gulf of Mexico? I know you had some unfavorable mix in these markets last quarter. Is that temporary, and does it improve going forward, perhaps with lower volumes but better mix?

We haven't experienced significant cancellations globally, but the Gulf of Mexico was probably the most impacted because independents reacted quickly, so activity there is more muted. There are bright spots in the west: Mexico is still active with committed wells, Exxon in Guyana remains hot and we're working to secure wellhead and tubing head awards there, and Brazil as we discussed. On mix, anyone who's followed us knows we make a product called a fabricated joint: we manufacture connectors and buy the pipe. The pipe is a relatively low-margin pass-through and the profit is in the connectors and fabrication. When consolidated margins are dragged down by higher pipe sales, I view that as a potential positive indicator because it can mean wellheads are being consumed from inventory and we're getting closer to a reorder cycle. I expect the mix dynamic to be transitory — it may persist through Q2 and possibly Q3. In Europe, we're seeing the largest number of delays, but not cancellations, especially in West Africa. Surprisingly, Norway is a bright spot with exploration announced by ConocoPhillips, so we expect some activity there once COVID delays ease.

And Asia — as the COVID disruptions clear, how does that market look?

Asia is actually a bright spot for us. CNOOC is speeding up and we have four tenders in-house for CNOOC, which is positive. Myanmar still has activity with both Woodside and PTTEP, and that work seems to be holding up. For us, Asia Pacific also includes the Middle East. There have been some COVID delays, but we see opportunities coming out of the Middle East. We have a big tender for tubulars for Kuwait Oil Company, and surface wellheads and mudline equipment opportunity in Saudi and UAE. Our liner hangers from TIW have a good presence in that area as well.

You historically have acted quickly on share repurchases. I was a bit surprised to see you buy $25 million worth of stock in the quarter. You have a strong balance sheet, so I'm not worried, but can you walk through your thinking around the timing of the buyback and why you went ahead and acted now instead of conserving that cash?

Yes. Sorry about the interruption, Blake.

Yes. As I mentioned earlier, we have a philosophy of cash neutrality for the year. We started the year thinking about it that way. Candidly, the macro environment at the start of the year and at the end of the quarter were different. That was the underlying premise for the buyback. We thought the stock was a good buy at the beginning of the year; I think we ended up a little over $30 per share on the total buyback. Going forward through the next two quarters, we'll be cautious and watch the market and full-year free cash flow unfold. We're relatively confident we'll end the year near the $415 million cash level that we started with, but if things play out differently, we'll rethink the balance of the year on the buyback.

With the pristine balance sheet, you're one of the few companies that could execute M&A swiftly. Others will need to be more considerate. What are your guiding principles on M&A? Are there certain technologies you may focus on? How do you think about new technologies coming into the oilfield like AI and machine learning?

Transactions in this environment are challenging; it's hard to put your head around valuation. I'm relatively skeptical something will happen in the short term. Guiding principles: first, we will not risk the balance sheet — we're not going to risk that rock-solid position. Any transaction would have to be free cash flow neutral quickly. We would never make an acquisition where we bleed cash for 12 to 18 months. Second, it has to provide significant scale to be relevant in the current market. We wouldn't make an acquisition where the target has a tiny share in an already crowded market; we'd look at targets that have maybe a 15% to 20% market share in their market. Third, we just completed our strategic plan, so any acquisition would need a clear strategic rationale and value creation in terms of customer behavior. We spent a lot of time on voice of the customer to understand what customers want. Finally, the deal would have to be transactional and executable in the current market. While we have a strong balance sheet and can be opportunistic, I don't see an acquisition in the next six to nine months, candidly.

Anything on new technology that fits into that kind of target list?

We're always looking at small tuck-in acquisitions. Right now we're very focused on near-term revenue and profitability. If a technology would be a quick tuck-in and quickly monetizable, we'd be open to it. But we're not looking for acquisitions where we expect a five-to-ten-year realization on the top line; it would be short-term and transactional.

Understood. Well, gentlemen, that's all I had for today. I told you we'd keep it under 45 minutes and we actually did. I appreciate you joining. Any parting thoughts, Blake or Jeff, before I let you go?

I'd just say that it never feels good to be in a downturn. But if I'm going to be in a downturn, I want to do it with the balance sheet we have — no debt and cash in place. We are keenly focused on execution and free cash flow to preserve our strength. We have a history of returning value to shareholders, and we'll continue to do that in the future.

Okay. Great. Well, Blake, Jeff, thanks for joining me today. Hang in there as this downturn unfolds. You obviously have the rock-solid balance sheet to get you through. We look forward to watching how this plays out. Congrats on keeping that fortress balance sheet, and we'll talk again soon.

Thanks, James.

Thank you, James.

Okay. Thanks, everybody.