Logo of jester cap with thought bubble.

Image source: The Motley Fool.

Dril-Quip (NYSE:DRQ)
Q4 2019 Earnings Call
Feb 28, 2020, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Operator

Ladies and gentlemen, thank you for standing by. Welcome to Dril-Quip's conference call. [Operator instructions] An updated investor deck was posted under the Investors tab on the company's website yesterday along with earnings release and will be referenced during today's call. The conference is being recorded, and a replay will be made available on the company's website following the call.

Before we begin, I would like to remind you that Dril-Quip's comments may include forward-looking statements and discuss non-GAAP financial measures. It should be noted that a variety of factors could cause Dril-Quip's actual results to differ materially from anticipated results or expectations expressed in these forward-looking statements. Please refer to the fourth-quarter 2019 financial and operational results announcement we released yesterday for a full disclosure on forward-looking statements and reconciliations of non-GAAP measures. I would now like to turn the conference over to Blake DeBerry, Dril-Quip's president and chief executive officer.

Please go ahead, sir.

Blake DeBerry -- President and Chief Executive Officer

Thank you. On behalf of the management team, I would like to welcome all of you to today's year-end conference call. Last February, we hosted our initial conference call, and said we believe that hosting these calls annually made the most sense for Dril-Quip and the investment community. We received positive feedback from that call, along with our plan to do them once per year, and are pleased to have you join us again this year to discuss the strong results we had in 2019.

I will begin with a high-level review of our 2019 results and highlight many accomplishments that we were able to deliver, including a detailed review of our highly successful transformation launched in late 2018. I will then turn the call over to Jeff Bird, senior vice president of production operations and chief financial officer, to review the financial results and give general guidance for 2020. I will then provide some closing comments and open the call to questions. I'm particularly proud of the many achievements we made in an improving, but still uncertain, offshore energy environment over this past year.

Our employees and management team continued to provide new products, which deliver permanent cost savings to our customers, transform our operating model to drive efficiencies, execute operationally and generate free cash flow. While we reduce cost and rationalize our global footprint, as part of our transformation, our commitment to our customers remained unchanged, and we continue to provide the highest level of service and support to our expanding customer base. Our operational focus and execution led to a $30 million or 8% year-over-year growth in revenue to $415 million. We saw revenue growth throughout 2019, with Q1 2019 revenue at $94 million and Q4 2019 revenue at $109 million.

More importantly, though, we translated the revenue growth to quarterly adjusted EBITDA increases as well. Our adjusted EBITDA grew by $36 million or 209% year over year to $53.8 million. Many of the financial and operational gains we achieved were directly attributable to our ability to deliver on our ambitious sales transformation and cost savings initiatives. As we previously announced, in 2018, we began implementation of a full business transformation centered around a structured approach to sales and cost performance.

We see the results of these efforts in our 2019 operating performance. Our retooled commercial teams delivered increases in product bookings, created an organization to specifically target new customers and expand sales of new products and solutions to our existing client base. The changes we made were systemic, and are now part of our DNA moving forward. We initially announced a target of $40 million to $50 million of total annualized cost savings from our companywide initiatives to reduce operating costs and improve efficiencies.

I'm very pleased that through the efforts of our global workforce, we were able to deliver annualized savings of $52 million, above the high end of our expectations. We maintained a footprint in key markets, while leveraging an integrated supply chain model, which will create more flexibility in addressing our customers' needs. The sustainable cost savings initiatives we accomplished are optimizing and improving our infrastructure across manufacturing, supply chain, SG&A, engineering and R&D and have certainly contributed to the strong growth in adjusted EBITDA we generated in 2019. As we look to 2020 and beyond, we will focus on productivity improvements and further leveraging our supply chain and procurement capability.

The fourth quarter saw revenue continued to increase to $109 million and adjusted EBITDA grow to nearly $16 million. In addition to strong revenue and adjusted EBITDA growth, we were also able to sustainably grow our product bookings. The fourth quarter of 2019 was the first time in 22 quarters that we achieved non-project product bookings above $100 million. For the full year of 2019, we saw our product bookings increase year over year by $144 million or 59% to $388 million.

Our innovative and award-winning R&D remains a key component to the future growth and continued commercial excellence. New technology product bookings grew in 2019 to approximately 13% of total product bookings or $51 million, more than tripling the $15 million we achieved in 2018. In 2019, we received orders for our new BigBore IIe wellhead system, specifying the DXe profile as well as for high-strength, high-fatigue Badger connectors. We also received another spotlight on new technology award from OTC for the XPAK DE Liner system, which is the industry's first double expansion system and is particularly well suited for large diameter casing strings used when drilling wells in deepwater.

In October 2018, we entered into a front-end engineering and design or FEED contract and frame agreement with Premier Oil Exploration and Production Limited, in relation to the Subsea Production Systems for the Sea Lion Phase I development located offshore the Falkland Islands. This project has continued to move forward toward project sanction, and we continue to work with Premier on post-FEED clarification and project development to conclude fully termed contract agreements for project execution. We are encouraged that this project continues to move forward. As we announced last year, in February of 2019, our board authorized an additional $100 million share repurchase program.

This was in addition to the $100 million share repurchase program that we completed in 2018. In 2019, we repurchased over 615,000 common shares for a total of $26.6 million under the current program. As you can see, we still have over $70 million of available remaining to opportunistically buy back more shares. With a debt-free balance sheet, and $399 million in cash at year-end 2019, we have significant dry powder for future repurchases as well as investing in possible funding needed for key projects, supporting an upturn and pursuing strategic acquisitions.

As you can see, we worked hard in 2019, executing on our business and sales transformations, and remain focused on achieving our strategic goals, while operating efficiently and generating free cash flow through this downturn. With that, I will turn the call over to Jeff to review the financials and provide more details on our cost-cutting initiatives.

Jeff Bird -- Senior Vice President of Production Operations and Chief Financial Officer

Thank you, Blake, and good morning, everyone. Our financial results for the fourth quarter showed continued improvement. Revenue for the fourth quarter increased from the prior quarter to $109 million. This was at the high end of our guidance range of $100 million to $110 million, and was primarily driven by increased service and leasing activity.

For the full-year 2019, our revenues were $415 million, an increase versus 2018 of about 8%. On a segment basis, our Western Hemisphere revenue for the fourth quarter of 2019 continued to increase from the prior quarter by $5 million or 8%, primarily driven by increases in subsea wellheads and trees as well as aftermarket revenue in the Gulf of Mexico and parts of Latin America. Our Eastern Hemisphere revenue decreased by approximately $4 million or 14% in the fourth quarter compared to the prior quarter due to timing of product sales. Asia Pacific revenue was flat sequentially.

We continue to see that our cost initiatives translated to stronger overall operating margins. For the full-year 2019, gross operating margin was 29%, which was up from the 24% we realized in 2018. As a reminder, revenue increased over $30 million, yet cost of sales only increased $1.4 million. This is despite a negative mix impact from higher fabricated joint revenue mostly seen in the second half of 2019.

Moving to SG&A expenses. For the fourth quarter of 2019, SG&A was $21 million, a reduction of $6.5 million compared to the third quarter, primarily due to a onetime year-end adjustment to stock compensation expense. For the full-year 2019, SG&A expenses decreased to $97 million from $101 million in 2018. We captured meaningful savings in 2019 and brought our organization in line with anticipated future needs.

These gains were partially offset by salary inflation as we return to a more normalized merit cycle. Despite these headwinds, SG&A expenses as a percentage of revenues decreased to 23% for 2019, down from 26% for 2018. As we move into 2020, we would expect SG&A expenses to average approximately $25 million a quarter. As Blake discussed, we have delivered transformational cost savings that helped us expand our ability to generate adjusted EBITDA in 2019.

And we expect the full impact of many of these savings will be seen in 2020. If you look at the presentation we posted to the website, on Slide 10, you'll see that we ambitiously set our savings goal at $40 million to $50 million, and we were able to exceed that goal by methodically executing our transformation initiative, while optimizing our operating capability. We delivered $52 million in annualized savings, and we break that out by area where we'll be able to capture those savings. We are continuing to transform the way we do business with a view toward leveraging operating costs, while ensuring we meet and exceed customer expectations.

Early in 2019, we began our lean journey. This journey has touched every location and every function within our business. This past year, 230 employees participated in 70 events across our four major manufacturing locations. And we are on pace to double that amount in 2020.

Probably the most important element of this transformation is our daily Gemba walks. Each day at every one of our manufacturing facilities, cross-functional teams walk the shop floor, reviewing performance from the prior day. This allows us to quickly understand and react to problems in real time. Earlier, I used the word journey.

This was intentional. The tools our employees learned and embraced in 2019 will continue to reap benefits in 2020 and beyond. We expect to see additional gains in productivity across all aspects of our business as they continue to apply the tools learned in 2019. To be clear, we realized approximately $30 million of savings in 2019, and expect the balance of the $52 million to be realized in 2020.

In addition, we are targeting 8% to 10% gross productivity improvement that will benefit 2021. Looking ahead to 2020, the recent coronavirus outbreak has resulted in supply disruptions, weakening commodity prices and causing uncertainty for global demand for oil and gas. We are proactively taking steps to minimize our supply disruptions. The newly built out supply chain organization and operating model allow us to shift production to our facilities in Aberdeen, Houston and Macae.

This will help mitigate any disruption to our Singapore facility, but more importantly, allow our employees to focus on more urgent personal needs. Looking at net income. For the fourth quarter of 2019, we reported net income of $7.4 million or $0.21 per diluted share. Adjusted net income for the fourth quarter was $8.1 million or $0.23 per diluted share.

As shown on Slide 21, in the fourth quarter of 2019, our capex totaled $3 million and for the full year, it was $12 million. We estimate our normal annual maintenance capex to run between $10 million and $15 million per year. However, as a result of the rapid acceptance of our new products, we will invest $5 million to $10 million in new running tools in 2020. This would bring our full-year capex guidance to $15 million to $25 million in 2020.

We will continue to monitor global demand and adjust our capital expenditures accordingly. Free cash flow for the fourth quarter of 2019 was $5 million and the full-year 2019 was $3 million, despite strategically investing in subsea tree and downhole tools inventory. As Blake noted, free cash flow is a key priority of ours, and we remain focused on generating positive free cash flow. This is the seventh consecutive year of positive free cash flow.

Through a combination of our new operating model and focused efforts of our lean tools, we are targeting reductions in overall working capital between now and mid-2021. If you look at Slide 13 in the presentation, you will see that we are targeting a 45- to 60-day reduction in our cash-to-cash cycle across all elements of working capital. For 2020, we have redesigned our compensation metrics to include working capital turns as a key objective. At year end, we had cash on hand of $399 million, and $33 million available in our ABL facility, resulting in approximately $432 million of available liquidity.

We remain committed to investing for the long term, returning cash to shareholders and pursuing strategic acquisitions. We are well positioned to capitalize on opportunities in the future and remain focused on continuing to optimize our operating model and allocate capital efficiently. With that said, I will turn the call back over to Blake.

Blake DeBerry -- President and Chief Executive Officer

Thanks, Jeff. As we look to 2020 and beyond, we remain cautiously optimistic about the offshore energy recovery, despite the recent decline in oil pricing and downward pressure on global demand due to the coronavirus. Our proactive approach in 2019 to focus on our bottoms-up strategic plan with a vision toward the long-term viability of Dril-Quip has made us a stronger company with the flexibility to adapt to changing markets. While we experienced some supply delays due to the coronavirus, we are able to ramp up our production in facilities outside of the Asia Pacific region to meet our customers' demands.

This near-term disruption has us forecasting revenue for the first quarter of 2020 to be between $95 million and $105 million. Prior to this, we were expecting to provide a more favorable guidance in the range of $110 million to $115 million. Despite these uncertainties, I am encouraged that our product bookings estimate for the first quarter remains between $85 million and $105 million. We spent the past 18 months reevaluating our overall business and product lines, and believe that we realigned and reorganized our entire company to operate more efficiently in any macro environment.

We will no longer manufacture everything in every location, but instead, we will find the cost-effective manufacturing solutions that leverage our newly created supply chain capability and ensure our customers get quality products, while maximizing the returns for the company. We will continue to make strides in fine-tuning our supply chain to ensure that we capture long-term sustainable improvements. We have an experienced results-driven organization, delivering first-class service and a strong, clean balance sheet with nearly $400 million in cash on hand. We will continue to focus on R&D and leverage our technologically innovative products to grow revenue and product bookings.

Most recently, we are getting interest from both independents and majors regarding our impressive new product pipeline. As a result, we expect to spend an incremental $8 million to $10 million on research and development in 2020 to accelerate product development and future growth and revenue for these new products. Therefore, we estimate quarterly engineering expense to now average around $7 million. Finally, we will build on our long history of generating free cash flow and delivering profitable growth, which should meaningfully add value to our shareholders.

With that, I will turn the call over to the operator to open the line up for questions.

Questions & Answers:


Operator

Thank you. [Operator instructions] And our first question will come from David Anderson of Barclays. Please go ahead.

David Anderson -- Barclays -- Analyst

Thanks. Good morning, Blake. So a question on Brazil. In your presentation, you had highlighted, Brazil as one of the main growth areas through 2023.

It seems to be one of the few offshore markets that's actually starting to move right now. So I guess, two questions there. One, can you remind us where you stand now, kind of contracts for wellheads with your customers? I think there was a big carryover from some of these contracts from last cycle. So I'm just kind of curious, is there any left on those contracts? Or do they need to be renewed? And then secondarily, can you give us a status on your inventory on the ground at Macae? Maybe I missed it, but I think you said something about taking some of those wells from Macae to supply other parts.

And as I recall, there's a lot of inventory on the ground. I think it was already paid for, but never installed. Can you just kind of refresh our memory here on where we stand on that?

Blake DeBerry -- President and Chief Executive Officer

Absolutely. Thanks, David. So on your first question with respect to existing contracts, primarily with Petrobras in Brazil, that contract did expire, Petrobras. If you remember, we renegotiated the contract.

Petrobras had an obligation to acquire a minimum, place purchase orders for a minimum amount of products for the extended period, they have fulfilled that requirement. And so that contract, although we may still supply some items under, I don't expect that we'll get any new orders under that contract specifically. Secondly, with respect to inventory, your recollection is pretty good. I think it was about two years ago, we were down in Macae.

And at that point, Petrobras commented to us that they had 300 wellhead systems in inventory at that time. They have been burning through that inventory. It's actually been quite positive for us. We've worked hard to try and make Dril-Quip the preferred provider in there.

I think, currently, five out of every six wells that Petrobras drills uses a Dril-Quip wellhead. So the good news is they're consuming our wellheads at a faster pace. And we are hearing indications that Petrobras is going to come out for a tender for about 70 wellhead systems sometime in 2020. So we're looking forward to them resuming a more normal purchase and consumption operation.

David Anderson -- Barclays -- Analyst

That's great. That was actually my next question, if any tenders are on the horizon. So that's great to hear. Second, kind of a different subject altogether.

On the subsea tree side, can you just tell us how much of the kind of 2019 orders came from trees? But just kind of a little bit bigger picture here, subsea tree market looks probably flat again for 2020. Is it fair to say kind of any material orders for you guys is unlikely? I would think the big three guys out there are pretty aggressive. It's not typically a game you guys like to play. So is it fair to say that probably '21 is probably a better time frame for some of these orders on the tree side?

Blake DeBerry -- President and Chief Executive Officer

Actually, no. So 2019, we had a pretty successful year. We booked nine subsea trees in 2019. So we were pleased with that result.

And for 2020, we're actually internally expecting a little bit better bookings. Should the macro environment hold, we're expecting a little bit better bookings than 9. So we're pretty positive about that. That's one of the reasons that we've guided up our R&D.

We've spent a lot of time on the subsea tree space, trying to get a differentiated product. I believe we have one. We've sold the first one of those. We call that VXTe.

So you can watch this space at OTC. We're going to unveil that product at OTC this year. And that product has gotten a lot of interest, both from independents, but more importantly, for major operators because it does provide a significant differentiation that can save them some money during the installation. And we have sold the first of those products, and we expect to deliver that in the third quarter and hopefully get that installed in the fourth quarter of 2020.

David Anderson -- Barclays -- Analyst

That's great, Blake. So I've been covering you guys for 15 years now, and this is the first time I've ever asked a question on one of your calls. So I'm asking a third question. I think I've waited long enough.

So I'm just curious on the supply chain. You talked about that a couple of times. Can you just give us an update on your forging operations? It's now being run by AFGlobal. Is that transition complete? How has it gone? Kind of what's your, I guess, thoughts and kind of where we stand right now?

Blake DeBerry -- President and Chief Executive Officer

Sure. Actually, it's very positive. So the transition is complete. AFGlobal is fully operational in that forge facility.

We do have a supply contract from them. Our supply chain people interact with AFGlobal probably almost daily looking at forward demand. They're setting up a stocking program for us. So we believe the lease arrangement of that forge facility at AFGlobal is beneficial to both companies.

And quite honestly, Jeff and I meet with the leaders at AFGlobal on a regular basis just to do a health check to make sure things are going well because our view is, this arrangement is beneficial to both companies.

David Anderson -- Barclays -- Analyst

Thank you very much.

Operator

Our next question will come from Sean Meakim of JP Morgan. Please go ahead.

Sean Meakim -- J.P. Morgan -- Analyst

Thank you. Hey. Good morning. So maybe to start off.

Can you just help us think about how the lower expectations for 1Q revenue flow into the rest of the year? In other words, is there a catch-up opportunity? Or does the rest just get pushed to the right in terms of the cadence? And is there a margin impact from the shift away from Singapore in the near term?

Blake DeBerry -- President and Chief Executive Officer

Jeff, do you want to take that?

Jeff Bird -- Senior Vice President of Production Operations and Chief Financial Officer

Yes. So what we're experiencing in Q1 candidly is just a temporary disruption. And candidly, that's just a result of an extended lunar new year and a number of our workers in Singapore go back to China for that new year. And as they came back in, we essentially lost about three weeks worth of production, and then kind of a slow ramp from there.

We are setting up operations in Houston to mitigate any future risks there. There will be really an immaterial impact from a margin standpoint. It will primarily be, as we're setting that up in Q1, Q2, less than $1 million, I would imagine. And right now, we view this as very temporary.

We'll be up and running in Houston by the end of the first quarter, beginning of the second quarter, and we're fully operational in Singapore now again.

Sean Meakim -- J.P. Morgan -- Analyst

Got it. Very helpful. Thank you. And then I was just thinking, a lot of the heavy lifting on self-help last year.

In our recent discussions, you talked about M&A being potentially back on the table. You bought back a decent amount of stock in the fourth quarter. Your long-term business view hasn't changed. That made your stock a lot cheaper, as we've seen the move in the rest of the market.

Maybe if I could just get your latest thoughts on uses of cash beyond organic capex and how that's evolving, considering what's happening with your stock versus maybe what sellers are expecting out there in the M&A space?

Blake DeBerry -- President and Chief Executive Officer

Sure. So first off, through 2019, we were intently focused on the cost-out program. I mean, we did not spend a lot of energies on anything other than let's execute on the cost out. And quite honestly, that shows in the results that we had.

We exceeded the top end of our target. As we roll into 2020, we're stepping back and we're doing just a bottoms-up strategic review again based on what's the market doing. What are our new capabilities? And quite honestly, as Jeff and I have said before, through this self-help program, we basically integrated ourselves. And in so doing, developed a lot more skills within our management team that changes how we view acquisitions going forward.

So we're going to hit the pause button here and do that strategic review and see where that takes us as we go forward. Share repurchase will probably always be in the mix. That is our preferred method to return cash to the shareholders due to the cyclical nature of our business. But we want to do that strategic review first and have a more broader look at what the market is offering before we make the call.

Sean Meakim -- J.P. Morgan -- Analyst

Great. Thank you, guys.

Blake DeBerry -- President and Chief Executive Officer

Thank you, Sean.

Operator

Our next question will come from Marc Bianchi with Simmons, pardon me, with Cowen. Please go ahead.

Marc Bianchi -- Cowen and Company -- Analyst

Thank you. I wanted to ask on the order outlook. You guys tempered the revenue outlook for obvious operational reasons. I'm curious, if we didn't have this virus concern and kind of the concern on the oil price, would your order outlook look any different? And Blake, I know it's early days here with the impact of the virus.

Can you kind of talk to any customer conversations you've had and how customers might be thinking about what to do from here?

Blake DeBerry -- President and Chief Executive Officer

Sure. Thanks, Mark. Look, as we said in the call, we were prepared to forecast a Q1 revenue kind of in the $110 million to $115 million range. We were entering 2020 very optimistic.

We've done the heavy lifting. Our sales transformation and execution is paying dividends and still is. We did not change our bookings forecast for the quarter. We're having conversations with our customer.

Most of our customers are still in the wait-and-see mode. Most believe this is transitory. It's going to come and go. And particularly in the offshore space, unlike the shorter cycle business, our customer views are much longer term and from plan to development and first oil, it's just a broader time period.

So I'm hoping that we don't really see any change in our bookings profile as the year progresses.

Marc Bianchi -- Cowen and Company -- Analyst

OK. That's encouraging. On the margin side for first quarter. Jeff, you mentioned the $1 million related to this repositioning of throughput.

Just the other factor, I think, that's going on or maybe there's a couple of factors. You had the higher fab joint mix in the second half of '19, so it sounds like maybe that could be a tailwind to margins as that rolls to a lower share going into '20. But I'm also wondering if new products are also a tailwind. Could you kind of talk about how that progresses here into the first quarter and beyond? And maybe quantify, to the extent you can, how much that could help?

Jeff Bird -- Senior Vice President of Production Operations and Chief Financial Officer

Yes. So on the fab joints, we would see that high level of fab joints really continue into the first quarter of 2020. And then as we get near the end of the year, we'll start to see that go back to a more normalized level, but that will only probably happen in the back half of the year. And from a quantify standpoint, given we're not giving full-year guidance right now, probably not going to comment on an exact number there.

And then the other spot on margins, the $1 million you mentioned in the first quarter. It will probably be below that $1 million in the first quarter, but that will be transitory in the first quarter.

Blake DeBerry -- President and Chief Executive Officer

I would say, Marc, this is Blake jumping here. I would say that the product mix to more fab joints, we actually view as encouraging because the dynamic that's happening there is that our customers are consuming wellheads that they have in inventory, buying the tubular products to go with that. And so that means that inventory is drawing down and indicating a likely increase in demand for the wellhead products, which will improve the mix.

Marc Bianchi -- Cowen and Company -- Analyst

Right. Right. OK. Guys, thanks for that.

I'll turn it back.

Operator

And our next question will come from Ian MacPherson with Simmons. Please go ahead.

Ian MacPherson -- Simmons Energy -- Analyst

Thanks. Good morning, Blake and Jeff. I also just wanted — sorry to flog the horse here on margins. So there is a lot that's moving.

And Jeff, you still have $20-plus million of annualized benefits to capture this year. But I'm struggling to bridge from Q4 to Q1, given there will be some decremental with the revenue decline. And then you've got G&A and your engineering and product development expenditures higher as well. So in my mind, I am seeing $5 million to $10 million of EBITDA decrement from Q4 into Q1.

Is that too extreme or not?

Jeff Bird -- Senior Vice President of Production Operations and Chief Financial Officer

That's too extreme. And we're talking about it on an adjusted EBITDA basis. So let me just talk about the different elements there. If I look at it on the margin side, a little bit of headwind as we reposition the manufacturing from Singapore to Houston.

That's $1 million which we spoke about. On the SG&A side, because of the onetime nature of the stock comp charge, that makes that number look artificially low in the fourth quarter. But if you think about the $25 million that we guided on SG&A, that's really in line with exactly what we did on a full-year 2019. So that's $25 million a quarter.

And that's in spite of the fact that we're returning to a more normal merit cycle. And then when you get to R&D or engineering, you're right to say there will be some headwinds there. On the engineering side, we said we're going to invest $8 million to $10 million in incremental R&D projects this year. That will ramp up throughout the year.

Probably starting on the low side in Q1 and then ramping up to a full number by the fourth quarter. So if you think about that as, call it, $2 million to $2.5 million a quarter, it will start on that low side in Q1 and probably wouldn't be at the full $2.5 million run rate until the fourth quarter.

Ian MacPherson -- Simmons Energy -- Analyst

Perfect. That's super helpful. On the working capital side, you've already made a lot of improvement over the past couple of years in your inventory turns coming down from, I guess, preternaturally high levels, so closer to the normal levels for your business now, but still some more ways to go there. But then on the receivables, that's been moving away from you recently.

Can you just talk about what you think are the easier and harder objectives within working capital this year that you're going after?

Jeff Bird -- Senior Vice President of Production Operations and Chief Financial Officer

Yes. So if you look at the presentation that we posted on Slide 13, we walked through kind of the cash-to-cash improvement that we expect over the next year and half. If I look at the easy things, the easy things, candidly, are probably going to be the bottom two, which is inventory reduction and improved vendor payments. We did invest a little bit in inventory in 2019, and we'll invest a little bit more in 2020, but not much more.

There's a lot of opportunity there, though, as we get ourselves set up and we burn through some of the excess inventory in those cells to move from a model where we might have been speculatively buying product, we're not buying this close to actual production time. So that's what we're working on there. And that 20 to 25 days, a reduction that you see there. The vendor payment terms actually is a side benefit of the supply chain work that we did in 2019.

So we did a lot of good work in 2019 to drive cost down there. But at the same time we were doing that work to drive cost down, we're also being more aggressive around vendor terms. So you did see an improvement from 2018 to 2019 in DPO. We believe we can expand that even further over the next 12 to 18 months.

The tougher part, because it's not within our control, is the vendor milestone payments. And candidly, we get a lot of questions around price as it relates to our customers. What we don't get a lot of questions around are payment terms. And candidly, just as payment, as price was pushed during the downturn, payment terms were also pushed during the downturn as well.

So what we're looking at this year is the first step back, if you think about a pricing environment. One of the first step back in gaining price is really starting to gain more reasonable terms. So we're going to be working a lot with that on our customers this year just from a milestone payment. Blake mentioned the nine trees, being more aggressive around milestone payments around those trees.

But then there's also an opportunity with a number of our customers to really work hand-in-hand with them on with some of our lean tools and reducing that billing cycle and the number of errors we see between ourselves and our customers. It's actually a couple of customers that we've actually had joint Kaizens with while we're working on those type of projects. So hopefully that's helpful.

Ian MacPherson -- Simmons Energy -- Analyst

Very helpful, go forth and conquer. Thanks for the answers today.

Jeff Bird -- Senior Vice President of Production Operations and Chief Financial Officer

Thank you, Ian.

Operator

And our next question will come from George O'Leary with Tudor, Pickering, Holt & Co. Please go ahead.

George O'Leary -- Tudor, Pickering, Holt & Co. -- Analyst

Morning, guys. The increased spend on R&D makes a lot of sense to me as you guys have always been innovators and always very focused on the technology side of the equation. I wonder if you could share a little bit about kind of where that R&D spend, that incremental R&D spend year over year is directed and what types of problems your customers are looking for you to solve? Just any incremental color on where you guys are focused on deploying that incremental R&D spend would be super interesting.

Blake DeBerry -- President and Chief Executive Officer

Certainly. So first off, let's just say, we've invested in R&D throughout the downturn. That's one of the benefits of having the balance sheet that we have and the free cash flow. And our focus really has been on developing products that structurally change the way our customers drill wells, to provide them permanent cost savings going forward.

So what you're really talking about there is giving them time, right? You're giving them back time, you're reducing installation time, which is incredibly meaningful to them. It helps on both the IRR space. And quite honestly, it helps their ESG, right? If I spend less days offshore, I got a smaller carbon footprint. So looking at 2019, I talked about the new VXTe product and really our tree products in general.

We've got a lot of traction in that SPS space. And as we looked at that, one of the things that we evaluated is the whole package of trees, which includes subsea controls. We do have a subsea controls business. And we haven't been funding R&D in that subsea controls space as much as we have the hardware products.

And so the bulk of this R&D is really focused on our subsea controls product line and business to update that controls, modernize it and also make it a much more flexible product going forward. And we believe that's going to help us in the entire SPS space, right, selling trees and controls in an integrated package.

George O'Leary -- Tudor, Pickering, Holt & Co. -- Analyst

Very interesting. I appreciate that color, Blake. And then you guys mentioned on the call, you're kind of looking at your manufacturing footprint and moving to a model where you don't make everything everywhere. I wondered if you could provide some examples of some products that once upon a time you were making at a certain facility, and now you'll only be making them at one or two facilities and kind of how that translates into cost savings for you guys as I just thought that was an interesting comment.

Blake DeBerry -- President and Chief Executive Officer

I might hand that one to Jeff. This is his bailiwick.

Jeff Bird -- Senior Vice President of Production Operations and Chief Financial Officer

So if we look at our facilities, we've really set it up as centers of excellence. So if you step back and you went back to 2018, virtually every facility made product for their region, and that made them inefficient, different products going over different machines, a little bit more complicated, not able to rearrange the shop floor in a way that's most efficient for specific products. So we started '19 really looking at a center of excellence, and these are the large products, obviously, as center of excellence for wellheads in Houston. And we rearranged, candidly rearranged machines so that the machines were closer together to make producing just wellheads in Houston much simpler.

So the example we often give is, pre this rearrangement, a wellhead would have traveled two and a half miles in our Houston facility beginning to end. And now, it's literally a matter of feet that it travels beginning to end. And so you can imagine the opportunity there, forklifts and inventory and expeditors and all the things that happen there. So that's Houston.

We manufacture our connectors, largely all our connectors now in Singapore. And those cells are up and running, and we're continuing to optimize those cells, and we'll expect some more savings from those in the future as well. And then we manufacture our subsea trees in Aberdeen. Now that cell is not quite up and running yet because we had to make some capital investment there.

That should be up and running by the middle of this year. So we should see benefit as that comes up and running. There will be benefit, obviously, in Aberdeen, but there'll be knock-on benefit because some of the other regions that are helping them produce those trees right now are running less efficient than they will post when that COE is up and running. So hopefully, that's helpful.

George O'Leary -- Tudor, Pickering, Holt & Co. -- Analyst

Yes. Very helpful. Thanks for that color.

Operator

And our next question will come from Connor Lynagh of Morgan Stanley. Please go ahead.

Connor Lynagh -- Morgan Stanley -- Analyst

Yes. Thanks. Morning. I was wondering if we could expand a little more on the incremental engineering expense.

I mean, how would you think about growing your addressable market or what incremental revenue could look like from some of these things you're investing in? Just any way to think of the return on that investment?

Blake DeBerry -- President and Chief Executive Officer

Sure. So if you take a subsea tree, the controls portion of that is going to add about additional $1.5 million to $2 million per tree. So that's the price, right? So as you grow your SPS business, you're basically going to add $1.5 million to $2 million per tree in the controls side that's additive to the sales price of the tree.

Jeff Bird -- Senior Vice President of Production Operations and Chief Financial Officer

And then I think the other knock-on effect is that's the controls piece. But then as you have a world-class tree and you have the controls built out as well and you look at the fact that we booked nine trees in 2019, and you look at a market that's essentially 300-plus trees awarded every year, there's an opportunity really for us to drive share gain there as well. So that's really the win is, A, get more every time you sell a tree, but also the opportunity to drive share in the tree market as well.

Connor Lynagh -- Morgan Stanley -- Analyst

OK. That makes sense. I mean do you guys have any higher level targets for, if we're in a relatively flat market, just for the sake of argument, how much would you expect market share, innovation, etc. to drive growth relative to that market, might frame that up?

Blake DeBerry -- President and Chief Executive Officer

So right now, our market share is relatively low in trees, sub-5%. And so there's just a lot of runway there. And the other challenge that we've had is the breadth of the subsea tree products. We couldn't fulfill all the different varieties that our customer needs.

So what we've first seen is we've expanded our available market. So of the 300 to 350 trees a year, maybe we had 15% of them was our available market. We're moving that up now to the 20%, 30%, 40% of the available market. And that's just giving us more to bid on.

There are still some areas that are always challenging because of local content. So there are some areas that we won't participate in. But we believe with our new products, we definitely have a differentiated product that's attractive to our customers. Right now, we have four major operators reviewing our VXTe design as we make the first one, so that they can quickly qualify it and get it accepted, giving us an opportunity to bid.

And that's something that we haven't had in the past, right? We've been really good with the independents, but getting a major operator interested in Dril-Quip's subsea production systems has been elusive. And like I said, we got four of them interested at the present moment.

Connor Lynagh -- Morgan Stanley -- Analyst

Got it. That's helpful. Just to sneak one more in here and just the broader market, more on the wellhead side of things. I think you guys have talked about for the past couple of years, there's been a bit of a catch-up ordering effect, sort of a restocking.

Would you say that's played out at this point? Or is there a little more to go? And I appreciate the uncertainty on the oil price puts an...

Blake DeBerry -- President and Chief Executive Officer

Yes, I mean so let's set the oil price aside. I think every customer has a little bit different inventory position. I think it is winding, most of them are winding down. We're getting feedback even from the independents, hey, it's time to reorder.

And these are people that have been dormant for three or four years in the offshore arena that are picking back up and consuming inventory they've had. And so our view going forward is we're more back to a more normal order consumption portion in the cycle.

Connor Lynagh -- Morgan Stanley -- Analyst

All right. Thanks very much.

Operator

And our next question will come from Vebs Vaishnav of Scotiabank. Please go ahead.

Vebs Vaishnav -- Scotiabank -- Analyst

Good morning and thank you. So typically, you get about 40% of any product bookings in Brazil? Any reason why that should not hold the same for that 70-wellhead tender you spoke about in Brazil coming up this year?

Blake DeBerry -- President and Chief Executive Officer

So Brazil is interesting. They're changing their model a bit. And so they're going to a more shorter cycle, shorter quantity, but broader tender based. So I think the model of the past is waning, Vebs.

I think it's a competitive bid process. And a lot of it, I think, is because they're partnering with so many IOCs that it's changed their bidding model. I will say that our relationship with Petrobras is very, very good. We've done a lot of work to allow them to consume their existing inventory, even though they've changed their own technical specifications.

We've done some additional qualification, made some new products, and that's what's allowed them to or driven them to use more of our wellheads on a per well basis. So we're optimistic about the tender, but yes, there's going to be an open tender process, not necessarily a split arrangement as they've done in the past.

Vebs Vaishnav -- Scotiabank -- Analyst

Got it. OK. If we have seen increased product bookings, has the mix shifted any one way or the other? If you can talk about that.

Blake DeBerry -- President and Chief Executive Officer

You mean in our backlog, within our backlog?

Vebs Vaishnav -- Scotiabank -- Analyst

Within new orders and backlog, yes.

Blake DeBerry -- President and Chief Executive Officer

Yes. So yes, in 2019, we have seen a little bit higher percentage booking on the subsea wellheads, which gives us confidence that as we roll into 2020. As Jeff spoke earlier, we're going to shift more to the normal mix.

Vebs Vaishnav -- Scotiabank -- Analyst

Got it. And maybe a question for Jeff. So if I'm thinking about this correctly, you're talking about $100 million SG&A and maybe $8 million to $10 million of higher R&D? That is despite $40 million to $50 million of cost savings that you guys had. Can you help me bridge the gap between the two?

Jeff Bird -- Senior Vice President of Production Operations and Chief Financial Officer

So the $100 million SG&A and the $28 million R&D, the SG&A is flat year on year, the R&D is up. That $40 million to $50 million of cost savings comes across all lines, not just those lines. And the vast majority of that actually comes more on the manufacturing and supply chain side.

Vebs Vaishnav -- Scotiabank -- Analyst

Got it.

Jeff Bird -- Senior Vice President of Production Operations and Chief Financial Officer

Versus the SG&A and engineering. There were some very early wins on SG&A and engineering, Vebs, but those really happened in late '18, early '19. So the full-year savings from those would have been booked in late '18 and you add that full-year savings there. So you're not going to see incremental savings, not much incremental savings in SG&A and R&D from '19 to '20.

Most of that remaining $20 million that needs to come out is going to be in manufacturing and supply chain.

Vebs Vaishnav -- Scotiabank -- Analyst

And is the implication that, yes, in the first quarter, the margins would have some headwinds because of the shift in due to coronavirus, but beyond that, margins should get back to where we saw second half '19 or maybe better?

Jeff Bird -- Senior Vice President of Production Operations and Chief Financial Officer

Yes. I mean I think the profile that you'd see is there will be a little bit of headwinds on margins because of that. And then, look, just the lower volume, obviously, puts a little bit of pressure on margins as well. But candidly, as you go back to the back end of the year and you start to see the $20 million roll through, that should improve the margins as well through the back half of the year.

So you'll probably start with a little bit of margin headwind in Q1 and ramping up through Q4.

Vebs Vaishnav -- Scotiabank -- Analyst

Thank you for taking my call.

Operator

We have time for one more question, and that will come from Blake Gendron of Wolfe Research. Please go ahead.

Blake Gendron -- Wolfe Research -- Analyst

Hey. Good morning, guys. You mentioned M&A as a use of cash. You've typically done smaller tuck-in deals.

I'm just wondering in light of the R&D comments and wanting to make your SPS offering a little bit more marketable here, if you could potentially go for something a little bit larger, maybe on the controls side? Or just given your R&D budget is going to be larger this year if you're going to just go at it organically? I'm just trying to understand what the opportunity set is out there for the SPS?

Jeff Bird -- Senior Vice President of Production Operations and Chief Financial Officer

Yes. So thanks for the question. So the way that we look at it is we have a very clear SPS road map that does include controls. We are always evaluating if it's faster and easier to get there inorganically versus organically, but we're not going to sit around and wait for the perfect inorganic opportunity to come along.

It's got to be the right price and the right value. And if it's not the right price and the right value, candidly, we've demonstrated that we can develop R&D. And we've done that with the OTC spotlight awards that you've seen over the last two or three years, and we would expect to have the same success on the controls side. If you talk about larger acquisitions, as Blake mentioned earlier, we've largely got the transformation piece behind us now.

We're doing another kind of 18 months later and other bottoms-up strategic plan. And I fully expect what will come out of that is a capital allocation strategy that talks a little bit more around what size M&A projects we'd look at in the future.

Blake Gendron -- Wolfe Research -- Analyst

Got you. That's totally fair. So that's all to say that this framework, as it currently stands, doesn't preclude any larger deals? Or would you like to keep it kind of small?

Jeff Bird -- Senior Vice President of Production Operations and Chief Financial Officer

No, it does not preclude larger deals. I think as we look at where we are in the cycle right now and what's going on in our industry, I think everything is on the table as it relates to acquisitions.

Operator

I would now like to turn the conference back over to Blake DeBerry for any closing remarks.

Blake DeBerry -- President and Chief Executive Officer

Just in closing, I am extremely proud of our organization, our efforts on the cost out, exceeding performance, our sales organization for incredible bookings year. We look forward to 2020, and we look forward to catching up with you as the year progresses. Thanks for attending the call.

Operator

[Operator signoff]

Duration: 55 minutes

Call participants:

Blake DeBerry -- President and Chief Executive Officer

Jeff Bird -- Senior Vice President of Production Operations and Chief Financial Officer

David Anderson -- Barclays -- Analyst

Sean Meakim -- J.P. Morgan -- Analyst

Marc Bianchi -- Cowen and Company -- Analyst

Ian MacPherson -- Simmons Energy -- Analyst

George O'Leary -- Tudor, Pickering, Holt & Co. -- Analyst

Connor Lynagh -- Morgan Stanley -- Analyst

Vebs Vaishnav -- Scotiabank -- Analyst

Blake Gendron -- Wolfe Research -- Analyst

More DRQ analysis

All earnings call transcripts