Good day and thank you for standing by. Welcome to the Dril-Quip First Quarter 2022 Fireside Chat. I would now like to hand the conference over to your speaker today, Mr. Tom Curran from Seaport Research Partners. Sir, please go ahead.

Thank you. Greetings, everyone. Welcome to Dril-Quip's first quarter fireside chat. I am Tom Curran, the Senior Energy Technology Analyst at Seaport Research Partners. And joining me this morning from management are CEO Jeff Bird, and CFO, Kyle McClure. I'm going to pass the mic to Jeff, who will provide a brief summary and touch on some highlights of the results released last night. And then, we'll turn to what will be a deep and expansive discussion. Jeff?

Thanks, Tom and thanks for hosting the fireside chat this morning, looking forward to a robust conversation. Before I jump in, I'd like to say thanks to the global team, for continuing to execute in the quarter. Specifically, our new business leaders, our new product line business leaders, Don, Bruce, and Steve, as they started to lead their respective teams and moving from what's largely been a functional organization since the founding of the company to a more product-oriented company. We continue to be very pleased with the opportunities we see as a result of this reorganization. We believe, in the second half of the year, we'll start to see specific improvements in our ability to service our customers, and also an improvement in our cost position as we go into the second half of the year. And really, we exit 2022 and head into 2023. So just a thanks to those, those three people and their respective teams as well. Looking at the quarter, Q1 was really the middle of the fairway quarter with what we had talked about a couple of months ago. Bookings were in line continued strong bookings definitely larger than what we saw in the middle of the pandemic, so pleased with that. Revenue and EBITDA met expectations. Free cash flow was a headwind. But we always knew that was going to be a headwind going into the quarter. We've got some one-time payments that always happen in the first quarter of the year, so that's always a challenge. We'll see that bouncing back I think later in the year. If you'll step back and look geopolitically, obviously a challenging environment for a lot of people in Ukraine and Russia right now. So as we look at the resulting inflation, the story continues to be an -- inflation continues to be an area of keen focus for us. And our business leaders as we try to match price increases with inbound inflation. And it's really hand-to-hand combat right now, if we think about inflation and what we're seeing there. And despite the inflation headwinds though, the environment overall is very constructive for increased spending. So we're still very optimistic about the order intake over the balance of the year and look forward to a more robust discussion with you, Tom. Thanks.

Great. Let's start with a few questions on this quarter's results and then pivot to a market update and other topics. So the top-line came in at $83 million, as you said essentially, straight down the fairway, but the company realized a gross margin on that revenue of just 23%, which was below expectations. First question on that margin is on mix. Does the margin shortfall partly reflect that you did hit the top-line target, but perhaps with a less favorable mix than anticipated?

Yes. Hey Tom, it's Kyle. All of it can be drummed up to mix in the quarter. Coming out of Q4, we had a 20%, 21.5% gross margin 23% in Q1. We would expect going forward, the orders mix is much improved versus what we saw coming out of Q4, which had a really heavy lean towards pipe and fabrication. We saw that play out in Q1. We would think for the rest of the year, if we look at the orders mix going into Q2 and beyond, you're going to see a much better mix of SPS, wellheads, et cetera. And so we would continue to see gross margins, get up into the mid to high 20s in the back half of the year.

Got it. And so if it was all entirely on the mix side, looking at the cost of sales, it sounds as if you were able to control and manage the challenges, you've been confronting there, at least in 1Q. In general, both over 1Q and through to the present, how is Dril-Quip managing inflationary pressures, and just the supply chain and logistics challenges that are afflicting the whole industrial world?

Yes, so as Jeff mentioned, sort of hand-to-hand combat with some degree on inflation. We do have MSAs where we can ratchet up based upon certain indexes. It's what I call a fluid situation. We are sort of day-to-day thinking about this, but as price increases across the board based upon lists in certain of our business units. Or if it's just we're dealing with a customer-by-customer situation. In addition to supply chain issues, we are certainly looking at these additional productivity that we've announced in the prior earnings call back in February. So it is sort of a very fluid situation, inflation continues to be depending on the business, we're looking at, whether it's downhole tools, or the subsea business, there's sort of two different interfaces happening there. Downhole tools a little bit more real time in terms of what they can do. Subsea a little bit longer-term contracts, but the MSA there should continue to help us. But it is a real time situation that we are doing our best just kind of manage in Q1, I think we did a really good job of that. As the year goes on, we're probably going to continue to see inflationary pressures. And we'll continue to pull price as we can and will continue to pull costs as we need to.

Got it. So two levers there that do you expect to be able to continue to use. On the bright side for expenses, SG&A did come in 12%, lower than consensus, engineering and product development expense was right in line. How much of this year's target for productivity and efficiency savings did you harvest in 1Q and sequentially how do you expect the remainder to be achieved over the rest of 2022?

Yes. So we talked about the $15 million back in February, we got about $3 million of that in the quarter, we expect to pick up another $5 million of that in Q2 on an annualized basis. And the remaining piece of that is going to be largely supply chain savings and its operational efficiency improvements and productivity. So I think as we see the year play out, I would probably target around maybe $5 million to $7 million that will pick up this year, it'll be flipped over between cost of goods and G&A. G&A will continue to be a focus for the organization. I think we're sort of laser-focused on that, especially as revenues continue to come back, we want to make sure we get as much of that fall through of the incremental revenue. As you know, we saw when things came down how quickly decremental margins went with it as revenues come back, we expect the incremental margins probably to overshoot, what our expectations are here internally. But as we continue to pull those two levers, whether it's cost or price, we're keenly focused on both right now.

Got it. Turning to bookings, let's zero in on product orders. Inbound orders for products totaled $63 million, which was within that that new hire stepped up guidance range of $60 million to $80 million, but closer to the floor, yet you've just reaffirmed annual bookings guidance for growth of 20% this year and clearly continue to think that forecast has potential variance, it's skewed to the upside. So did you just experience some standard slippage on 1Q in which the timing of certain orders or larger orders simply slid out a few months? And what does your impact full-year 2022 bookings guidance imply for a new expected quarterly product orders range both for 2Q and then what we should see sequentially over the second half?

Yes. So still very optimistic about the 20% year-on-year, and believe that's well within and I think if we looked at it, Tom, on the way into the pandemic, we had more misses to the downside. I think as we exit the pandemic, what we're starting to see now is more opportunities to the upside. So if you look at specifically Q1, the $63 million number there, as I said before, it doesn't take much to move the needle on that, a tree order of three threes is $15 million, and suddenly moves out to the upside. And that's one order as an example. So, I think we'll see some lumpiness quarter-to-quarter depending on how those orders play out. But we would expect to see continued increases Q1, Q2, and throughout the balance of the year. What we're really seeing right now in the market is two things. One, a lot of the conversations that we didn't think were going to happen until Q3, and Q4 are being pulled into the first half of the year. So we're optimistic about that. And furthermore, there's some items that candidly were Cap 2 items, lower probability items this year that we just didn't expect to have real meaningful conversations or see orders for those this years and -- this year and those drop in orders are starting to materialize now in Q2. So we're very optimistic about the 20% and believe there's more likely than not upside to that number.

Got it. You just mentioned how much of a swing factor subsea trees can be from one quarter to the next. I know that you are anticipating a big year for subsea trees with 17 to 19 orders foreseen and the indicated timing of those awards was what underpins your original expectation for how product orders would fall by quarter, which was initially 2022 is expected to have a barbell shape with a bigger 1Q and then 4Q, how many trees did you book in 1Q and what's the latest visibility on how the remaining orders should be distributed?

Yes, I believe there were about three trees booked in 1Q. And the balance -- and that we see a chunkier level of that in really Q2 and Q3 right now. And that's really, on the back of two things, really, to be honest. One is concerns from a supply chain standpoint, from a number of these customers, and also just the underlying economics that you had as well. But I believe the number was three trees in Q1.

And then similar question, when it comes to the latest multi-year Petrobras awards you've gained. What was the 1Q order contribution? And then what level of call off orders should those awards yield this year?

Yes. So we had, so with a total of 87 development and exploration wellheads under that MSA, about 30% of those have already been placed in terms of purchase orders, and we're in the bookings in Q1, that's well ahead of the schedule that we would have expected to see. And candidly, we now expect that probably sometime first half of 2023, there'll be another tender, where we'll see another renewal, if you will, or a flip over if you will, of that MSA. So pretty optimistic, that's a significant improvement what -- to what we would have expected. Those 30 wellheads will really deliver starting September this year, and probably through the first three quarters of next year.

And just broadly, Jeff, you just touch on this to a degree, but it's worth I think, revisiting and delving into a bit more. But what sources are feeling your confidence that there is this positive bias to your 2022 bookings guidance? Is it a combination of customer conversations, what you're seeing in certain geographic regions, you've already touched on both the acceleration you're seeing for certain projects, and the rising probability of materialization for others? Just what's -- what all is behind your conviction that any surprises are likely to be to the upside now?

Yes, so just a couple of things. There is a little bit of everything as you said. We first myself and the business leaders have been having a number of what I'd characterize is very fruitful customer visit, customer discussions. And almost every one of those discussions that we have with customers is all about pulling things in and doing things earlier than we had originally expected. And some of that's pricing. But some of that is also, hey, we're worried about supply chains. We want to get the early lead items out there and get that done. So that's 1A, although a little bit more anecdotal probably. The other thing is we have a very robust process where every two weeks we have what we call a war board meeting with each of our regional leaders with each of our product leaders, where we go through literally order-by-order with an update on what was the last conversation. The customer said it was going to be Q4, now it's Q2. So those conversations are literally every two weeks. The customer conversations with myself and the business leaders are really once every quarter. So as an example, I did a European trip in Q1, got a lot of positive feedback from that. In Q2, we'll be doing an Asia tour and expect to get some positive comments there. The one area that's kind of weak right now that we see at least is Asia-Pac. Europe seems strong. Brazil is very strong. Gulf of Mexico is picking up. LATAM is picking up. It's really Asia-Pac. So I'll be interested to see the feedback we get when we're on that tour out there.

Right. I know you just went through Europe and that was a very encouraging trip it sounds like. Moving on to the pillars of your growth strategy, you've made impressive headway with the collaboration approach, since you first introduced the concept a few years ago. How have the collaborations with Proserv and OneSubsea respectively performed so far? And what portion of 2020 bookings are you counting on them to deliver?

Yes, so let me divide it between Proserv and OneSubsea. If I think about Proserv, those are obviously the controls that go on the trees that we sell. We'll book as you said 17 to 19 trees this year. About half of the trees that we will book will have Proserv controls on them. So that's a very strong statement, I think about that collaboration agreement. In some cases, we're bringing Proserv to the table. But look, in some cases Proserv is bringing us to the table as well. So we really view that as a mutually beneficial relationship about half of those trees. If you think about the OneSubsea collaboration agreement, that really gives us exposure to EPCI and development wells. The challenge is that Dril-Quip's portion of the overall EPCI contract is pretty small, when you look at the total scope there. So we'll probably won't target anything specific around that OneSubsea collaboration agreement right now, I won't talk about it right now. We'll probably talk about those things as they happen. Because to be perfectly honest, it's all about OneSubsea winning, we're a small portion of that overall EPCI. The other thing I'd say is, is that we talk pretty openly on the legacy side. We talk pretty openly about Proserv and OneSubsea. There's a number of other what I would characterize as quiet collaboration agreements that are happening at the same time specifically around the wellheads. And we believe bills will start to materialize last three quarters of these -- this year as well. We're careful about putting a target out there just because of the relationship with OneSubsea and how dependent we are on their when to be honest.

Got it. The newest collaboration that Dril-Quip has entered with Aker Solutions was actually formed for the new energy side specifically CCUS, carbon capture utilization storage. Through that collaboration, you'll be participating in the NASA led consortium that's been selected as one of two co-finalist as to provide a fee package for the Northern Endurance partnerships, East Coast cluster and UK North Sea. Between that opportunity and my understanding of some other prospects, you have traction with it. It seems as if 2022 could be a breakthrough year for Dril-Quip's emerging realms CCUS? What's the estimated offshore CCUS tam for Dril-Quip and how much of that you aim or aspire to eventually capture?

Yes. So if we think about. First, let me talk a little bit about the agreement. And then I'll give you a size -- a market size and kind of what we think about. Obviously very pleased with the Aker Solutions collaboration agreement. And to be honest, the minute we announced that it was somewhat surprising, we got two or three other large inbound calls, asking about that collaboration agreement and asking us to participate in a joint bid with Aker Solutions. The other thing that was somewhat surprising, we had some other OFS companies that called us and said hey, we really believe we can work with you as well, in a collaboration agreement around that same segment. So we're very, very, very pleased with that. If you think about the size of the market and it's all about a slow ramp up to this number. But by 2030, it's easy to see where you'd have 200 annually 200 CCUS wells, and then ramping from there. We -- if you look at what Aker share, and if you just assume that Aker subsea tree share is similar and CCUS you'd be around a 15% to 20% share, could be higher than that, could be lower than that, could be a little higher, to be honest, just because you think about their European influence and where CCUS is likely to takeoff first. But just think about it, it's 15% of those 200 by 2030. We started to feed the feed started two weeks ago. We've ring-fenced the resources around that. I joke a little bit; our Director of Energy Transition is now gone from a team of one to a growing team as we jointly work on that team with Aker solution. We probably won't see orders from that Tom until 2023 because the fee is going to take some time this year. The bid will happen later this year. And I don't think the award will happen till next year. So you'll likely see this in terms of bookings 2023 and real revenue starting in probably like 2023/2024 timeframe.

Okay. So we'll stay tuned for that. That was a very helpful overview. And then I can't believe I actually used capture that that -- that term was not intended in terms of future share win. You've previously spoken to focal areas for additional collaborations, liner hangers, the VSTE. Just maybe revisit those and provide an update on where you're at in pursuing them and perhaps a distinction between big theme, a potential big theme, additional collaborations, and then what you just clarify for us which is these quieter emerging collaborations around the wellhead just, should we think of those as two different categories? Or perhaps just an overall update on how collaboration should evolve from here?

Yes. So let me go through the three segments and I'll kind of explain the quiet collaboration agreement versus more of a what I characterize as a headline collaboration agreement. So if you start with our downhole tool business, we do a lot of work, a lot of work with all the major service providers around the world. So that would include your normal cast of characters in a Schlumberger and Halliburton, and a Weatherford and Baker and depending on the region of the world, we just have a better kit, and better availability than they might have internally. So there's a number of cases we're in all of, with all of those major service providers, we're providing liner hangers today. It's not a headline collaboration agreement, it's more country-by-country, region-by-region, we're working with them. And candidly, those are very successful, and we see those growing right now. So that's really that downhole tool business where we're starting to, I'd say approach, how we think about it. In subsea wellheads in by approach, I mean on the OneSubsea side, we're literally sit down and jointly have a review of all the open tenders and how we're approaching it, we're starting to get down that path as well with liner hanger. So, and we're expecting that growth in liner hangers to come this year, as a result of that. If I think about other areas for collaboration outside of that, the most likely right now is really around our connector. And if you think about that, there's some major pipe providers that don't have a connector. And obviously, we buy and pass-through the pipes. So there's really some opportunities there and we're constantly looking at those opportunities. It likely wouldn't be a global collaboration agreement, it would likely be a regional specific, depending on the pipe supplier collaboration agreement. But we're constantly looking at that. As it relates to the VXTe, I don't think you'll see a collaboration agreement, specifically on VXTe, until we likely get that first installation. Unfortunately, we had expected to have an installation in Q1 of this year, that was a dryhole. So we're kind of back to square one on that first installation. Realistically now, we're probably looking at the middle of next year, at the earliest for that first installation. So we still continue to have conversation with some of the majors that are very excited about it, still continue to have conversations with other tree providers that are very excited about it. But really step one in getting those people to move in a more meaningful way is really about that first installation. So I suspect on a collaboration agreement there, you wouldn't see one until probably late 2023 after first installation.

All right. So that that next milestone will look for its progress towards a potential collaboration will be getting the first tree?

That's exactly right, yes.

Turning to another pillar of your strategic growth plan, downhole tools. I know that's one of your highest margin product lines, and it seems therefore given what gross margin came in on a consolidated basis in 1Q that downhole tools might have had a bit of a late start to the year in 1Q relative to your expectations for the full-year. Do you still see double-digit growth for downhole tools this year and what should be the drivers of that growth rate?

Yes, yes. We're still very optimistic about double-digit growth for downhole tools this year. The drivers are really three categories. XPak De continues to be a nice growth driver for us new product, as you're aware, we won an OTC award and I think a couple of years ago, continue to see growth there. We expect to start to get back some of the share that we had lost in the Middle East. If you think about the original TIW they had a very strong presence in the Middle East lost that over time, we're starting to see that return right now. So there'll be some share gain in the Middle East. And then really just Latin America, in general, inclusive of Mexico, Latin America, in general is just a very, very, very strong market right now. So that's not so much a share as a rising tide. So think about it as XPak De starting to share penetration there. Think about it as Saudi share gains there and then think about it as Latin America, inclusive of Mexico really a rising tide, if you will, in just a very strong market.

Yes, they did have a tough Q1, Tom. But they do expect to grow pretty nicely in Q2 and maintain that growth throughout the rest of year. So that'll be a helpful margin tailwind for us heading forward.

Got it. You just touched on VXTe; you talked about timing expectations for that first VXTe installation. How about just an update on further installations and adoption of your new technology suite? Where are some of the other offerings at this point?

Yes look, so while VXTe is a disappointment right now from an installation standpoint, the track record for the E-series continues to build, I just talked about that, that E as you mentioned, and we just installed our BigBore II-E 20K system in the Gulf of Mexico, that'll actually be featured next week at OTC. And then if you think about BigBore II-E in general, we would expect as we get to the end of the year to probably have 60% to 70% of our orders are wellhead orders around that specific product. So you'll recall, we went from 15 wellhead systems to four wellhead systems. We will now even inside those four wellhead systems that we've got BigBore II-E is the dominant system that we're seeing where right now. So still very optimistic about that as a standard system. And that's really been until XPak De started to get the installs. Now, that's really been a very, very nice surprise for us from a new product standpoint.

Shifting gears now to the company's ongoing transformation you've had underway, you do continue to implement changes to the organizational structure. How are you progressing at this point in, at the high-level, the changes you're making in terms of leadership and teams?

Yes, so if I think about in teams, I mentioned the three current business leaders to you, so in terms of subsea products, we've now got very specific business unit managers, around wellheads, around our SPS franchise, and service equipment/connectors. Those gentlemen are all doing a great job of starting to build out their teams. And we've really now communicated to every individual in the organization, what team they're on. And as we start to divide and think about those teams, we're finding real opportunity that we're breaking barriers where handoffs might have created problems, either in terms of cost, inside the system, or in terms of just customer responsiveness and ability to improve our on-time delivery. Right now those are teams sitting in separate areas on the campus. So the communications improving over the course of the next three to six months, you're going to see those teams start to colocate on the campus. And I'm optimistic that as those teams colocate, we're just going to see even more benefits in the back half of the year, both in terms of improved on-time delivery, improved customer responsiveness, and really just margin improvement as we start to attack costs in a meaningful way.

And in last quarter, in the fourth quarter, you did take a $53 million charge related to restructuring in sort of a big initial step towards the product line rationalization, you'll be executing, could you expound on where you're at with that? Have you already identified some of the product lines, you'll be exiting and will you be giving us updates on how that should run its course?

Yes, so as far as product line exit, we went through a grow harvest kill plan with every single product line. We were executing on that right now the $53 million charge that you saw in the fourth quarter was a result of that. The example I would give on an update on that, as you know, as I said earlier, we had 15 wellhead systems and went to four wellhead systems. Obviously, when you eliminate 11 wellhead systems, there's a lot of inventory and assets that go along with eliminating that. And that's just an example of what we've done. You're not going to see us say, hey, we're exiting one of the product lines we've got today either in terms of wellhead SPS, surface products, downhole tools we're very confident we like those products and we like our position there. This was more around pruning within those respective product lines, as opposed to, hey; we're going to do a wholesale exit of one of those product lines.

Do you foresee wholesale exits as a potential or already planned next step?

No, no. We think -- we think we've proven these product lines to the right level, and that -- and it's just more focused. I mean, I keep coming back to that 15 to four. It just much more focused, candidly, it helps our customers a great deal, especially in the supply chain world that we live in today. We can be much more thoughtful around stocking programs and things like that and that allows us to bypass perhaps some of the supply chain and logistics issues that we've seen before. So it's really more that type of consolidation than it is really exiting one of those product lines.

Understood. Another aspect of the transformation underway is the rightsizing of your footprint. How much of the eventual expected $40 million to $60 million in targeted property divestiture proceeds do you expect to achieve in 2022?

Yes. So we've got the project in flight right now, so in fact the $40 million to $60 million -- the $40 million to $60 million is probably over a longer, much longer period of time, if you will. I would say probably by year-end, or somewhere the nine month horizon, we should be in a position to at least announce perhaps are either closing or somewhere around there our first piece of that property reduction. But in terms of how much we think we're going to pull in this year, it's a little bit tough to tell right now with what's going on the market and different pieces of property have different values and so forth. So, I'd hate to put a number out there at this point in time.

I think what you will see though; you'll see that, we'll have for sale signs, if you will, on probably around 85 to 90 acres of the Houston campus within the next 30 to 60 days. If not already, by the way, some of its already there, but more to come there.

Yes, predicting the cash and when that's going to happen is a bit tough right now.

Yes.

Okay. And, in general, should we think about these restructuring and rightsizing improvements as separate from your targeted productivity and efficiency savings goal for 2022 of $15 million?

Yes, it's independent of that. Yes. So that's -- that's one workstream, we've got, which is the $15 million in productivity. The property is completely different workstream. But the $15 million to $20 million, we would talk about in terms of longer-term saving, as a part of the property reductions, getting our footprint smaller, overhead goes down significantly, things like property taxes and fixed costs. We anticipate somewhere in the neighborhood $5 million in savings with that. Beyond that, we're going to take the cash likely from the proceeds of the sale of getting campus a little bit smaller. We're going to put that towards our manufacturing. We think maybe a nice investment in manufacturing around sort of $20 million ish right now will have a roughly a two-year payback for us. But we think that $15 million to $20 million is both in combination of fixed costs, we think we'll see a reduction of about $5 million in additional productivity that that we'll see what the manufacturing investments somewhere in that $15 million to $20 million range. We will pick up annually, but that probably won't kick in until probably towards late 2023 beginning of 2024. But those longer-term productivity goals for us associated with the campus reduction, and then subsequent investment in manufacturing.

And when it comes to transformation, we've talked a lot thus far about where you're pruning, shrinking, looking to monetize. But there's also a growth enhancement side to it right where the new organization should have benefits in terms of where you'll be concentrating and hopefully, more effectively pursuing growth opportunities, specifically for the new energy transition team in addition to the CCUS products that you'll be pushing through the Aker collaboration. Are there other areas of transition you're interested in exploring?

Yes, there are and we're actively engaging in evaluating those markets right now. It's really about matching up our core competency. So if you think about high pressure, high temperature metal-to-metal seal things like that. It's really about evaluating those core competencies and seeing where those match in a number of energy transition areas. We've got some of those identified right now. But to be honest, it's a little too early to start to have those conversations right now, because we're still in the very early stages of evaluating our ability to win in those markets. There is a lot of whitespace in the markets we're looking at. It's just making sure that we've got the right match in there and the right formula, if you will, for success. And probably we'll be talking more about those in the coming quarters, but just not ready, evaluating doing a lot of work, but not ready to talk about yet.

Got it. Maybe you've reaffirmed all of the prior guidance you've provided for 2022. But returning to how 1Q came in and the resulting effect on expectations for 2Q and the sequential progression over the remainder of the year. Could we just clarify both margin expectation for 2Q and then top-line as well for revenue, still expecting to achieve 10% year-over-year top-line growth? But just what -- where should we see 2Q now come in both in terms of the margin inflection expectations, and then its contribution to that full-year 10% growth?

Yes. So we would see revenues in Q2, probably a minimum growth of about 10%. Our expectation is revenue is going to start with a 9% in Q2 and beyond, which will put us back in the 90s for the first time since really, for the middle part of 2020. Teams I think very optimistic about the remainder of the year. And I think we'd see margins continue to tick up to call it somewhere between 25% and 30%, depending on the mix that comes through next quarter. But I think we're pretty optimistic that we'll at least see 10% growth in Q2, and then gross margins would continue to tick up call it 450 basis points Q-on-Q is what the expectation is. And as I said earlier, we'll continue to keep a pretty close eye on SG&A. And we want to see that margin flow through. We think as we've talked about earlier, on the way up, just like we saw on the way down we're probably going to overshoot some of the incrementals just because of the cost that's been taken out. In addition, just now we're getting to a certain revenue threshold or level that we're picking up on the fixed cost base here. And so for every dollar we kind of bring in an incremental revenue standpoint, I think we're going to see some pretty nice flow through.

And longer-term, once you have completed these reorganization and rightsizing modifications, where do you think products gross margin should normalize?

I think overall gross margins we will talk to that and then we'll come back to product, but overall gross margins, probably somewhere in the mid-30s. If you take a look at the productivity we're targeting and getting revenues much further north than here, we would think that the gross margins on products are an overall would be somewhere in the mid to high 30s is kind of what we would take a look at from a historical standpoint, in addition to sort of the math we've done internally. On the product side of the house, if you look across both downhole tools, in addition to subsea products, again, I think you're probably going to see that probably in the low to mid 30s with service bringing us up to that kind of mid to high 30s.

You had warned Kyle that the free cash flow would be negative for 1Q. And it came in at a negative $13 million. And yet, as part of the reiterated guidance, you remain competent in the ability to achieve a positive free cash flow margin for 2022 of 3% to 5%. What does give you the conviction that over the next three quarters, you'll be able to reverse that and ultimately end up in that positive range for free cash flow for the year?

Well, I think just underlying improvement in the business was obviously helpful. The lack of one-time payments that we typically have in Q1 will dissipate into Q2. So I think as we think about Q2, getting us back to what I'd say is free cash break-even in the quarter. And then as Q3 and Q4 happen, I think we expect to see a nice tailwind of around various components of working capital. In addition, we have perhaps some tax refunds from time-to-time and flowing through and so forth that'll probably help bridge that gap. But I think we're pretty confident that that 10 to 15 number is achievable if we do the math on the sort of 3% to 5% free cash. You talk about Q1; it actually came in much better than our internal forecasts. So I think we're pleased we're off to a good start. DSO is down nicely Q4 to Q1 by about 17 days or so. We're going to try to hang on to that as we move throughout the year. As you know, the business is growing here. We are going to be consuming cash and working capital functions. Inventory and AR, we are going to obviously continue to -- we've made great improvements in 2021 as it relates to the DSO and inventory, we're going to continue to hang on to those and try to improve those further.

And homing in on working capital. What's the likely evolution of it quarter-by-quarter? What should we expect in terms of draw versus contribution to cash flow in 2Q and then over 3Q and 4Q?

I'd say Q2; we'll call it working capital break-even. And then beyond that, we should see some pickup in Q, in the back half of the year probably sizing that somewhere in the $10 million range from working capital. But Q2 probably break-even on the working capital lines and then picking up about $10 million in the back half of the year.

And when it comes to your priorities for capital allocation, in descending order of importance, they've been number one CapEx that that has been and will remain the top priority, where you've just reaffirmed an annual budget of $15 million to $17 million. Two would be M&A which you've -- where you described being open to both energy and energy adjacent transactions. And then three would be share repurchases. Let's start with two. Could you elucidate on what you mean by energy adjacent? And what all we might see you consider in terms of M&A on that front?

Yes, sure. So I think when you look at the OFS the landscape, it's there today and you will get in a very traditional sense, whether it's public companies or large private companies that we're all familiar with. They have large almost 100% all of that exposure. In some cases, challenge balance sheets, challenge markets, challenge situations. I think what we're really looking for, if you think about an ideal acquisition for us, if you open that aperture and say, hey, I want something that has energy exposure, and that most likely our core OFS business you will. That's great. But it'd be ideally, we're finding something that has that OFS exposure, but also has non-OFS exposure as well. That gives us just better a little bit more diversity, if you will, around products, but still plays to our mechanical engineering, and manufacturing and footprint strengths that we've got around the world. So we're in process of starting to evaluate what those end markets would look like. We're being very thoughtful about that. We really want to look out. We understand OFS very well. Well, we want to make sure is we're just as thoughtful about the non-OFS side of the business as well. So that's likely going to develop over the next two or three quarters, a more thoughtful communication around what our guiding principles are there and how we're thinking about it.

Got it. And on the energy side, could we see you potentially execute a transaction with a focus on new energy opportunities. Is -- are there any technologies or products that you already have identified that ideally you would add as part of your pursuit of CCUS for example?

Yes, I think CCUS is the obvious. We've got a, kind of a robust product development plan on what we think we need to do around CCUS to make sure that the fulsome offering for us. There may be cases as we look at that product roadmap where we say, hey you know what, a lot smarter to go out and buy this, as opposed to try to develop it internally and be very thoughtful around how we approach that. So that's the most likely acquisition and it probably be a little more technology-related, as opposed to a large business or something like that. The challenge candidly that I see as you look out at new energy right now is infinite multiples in some case. So I think that's probably a challenge market for us right now. As we expand outside of CCUS, we may find some opportunities. But right now if you think about new energy it's more likely to be something from a product standpoint on the CCUS side.

Got it. And then jumping now to the top priority CapEx the reiterative budget of $15 million to $17 million. Kyle, could you just refresh us on how that $15 million to $17 million should break down?

Yes, hang on one second here. We're largely going to be in the rental tool space associated with the previous analysis work in Brazil. We've got quite a bit build out there. Yes, it's largely rental tools followed by we have a small pieces of IT, we're going be taking on this year, in addition to just normal maintenance CapEx, but it's going to be we're heavily weighted towards rental tools this year.

That's primarily a combination of downhole tools. And I think some BigBore II-E tools as well. So if you think about where we're growing, those are really growth CapEx projects if you will for us, Tom. And the one -- the other thing to keep in mind by the way about that $15 million to $17 million is it does not include or contemplate a manufacturing investment, the $20 million manufacturing investment that Kyle spoke about. It does not contemplate that now, obviously, given the lead times for those products and things like that. It's impossible that all $20 million would happen this year. But you could have an initial down payment or something like that this year for that.

And once that $20 million spend does get underway what sort of timeframe should we assume it'll happen over?

Yes, so I can talk about delivery of equipment, we haven't negotiated, obviously terms and things like that. We're looking at a number of machines first delivery, I think on that first machine is 48 weeks, once we place the order. There's been no order placed yet. And then you'd see every couple of months, one more machine coming in total of seven machines, I believe total coming in. So think about that as once we hit go 48 weeks first delivery of machine, and then every two months after that. So most of the spend on that would likely happen in we bleed in the 2023. And maybe even the 2024 depending on the timing of the approval that $20 million.

Yes, as we get that approved internally, then we'll update on our guidance on cash flow and CapEx accordingly.

Okay, we'll stay tuned for more on that. And then concluding the discussion of capital allocation priorities with the third priority, the buyback in 1Q, you spent $5.8 million on the repurchase of just under 274,000 shares, my math is correct. That would leave you with $102 million remaining under the existing authorization. Could you tell us just should we expect that there should just be continual refreshments of the authorization is as that remains your third priority for capital allocation and go to for excess cash flow here or there?

Yes, I mean so I think it's the authorizations at $118 million at this point in time with the reopening of $100 million at the end of last year. And I think we've chatted internally about this. I think we there's a lot of uncertainty in the marketplace right now with the geopolitical skew that I think Jeff touched on earlier. We're going to continue to look at it, depending on how cash flows are trending and so forth. We will continue to support the stock. It'll just be if you look historically, as the company has done, this has been what I call perhaps opportunistic at times, did so in Q4, and the beginning parts of Q1, but we'll continue to keep this as part of our capital allocation policy. There's a lot of uncertainty in the marketplace right now. So I think we're taking a pause here for the time being.

Got it, thanks for that correction, I guess an additional $10 million or so, there is $118 million remaining under the current authorization?

Yes.

Got it. And then is the approach there is expected to remain opportunistic, it sounds like; you don't plan on putting any kind of 5B or program in place for algorithmic time.

Yes, so just to clarify, when we say opportunistic, I mean we do put, we do put formulas and grids and things like that in place. When we take that approach, I think the thing that we're monitoring very closely right now, it's tough to understand the market right now when you've got the challenge in Ukraine, the challenge in Russia, the shutdowns that we see kind of spreading through China, it's just making sure that we understand the underlying environment when we're making that decision. And obviously, that's a challenge right now. We're certainly not afraid, as we've shown in the past to pull that trigger. And when we do pull that trigger, it'll be in the form of a thoughtful grid, that will roll out and what we typically do in those cases, we roll out a grid and roll out a dollar amount and roll through it that way. But to Kyle's point, we tend to match, we tend to match free cash flow and buyback just as a philosophical point.

Sure, makes sense. And then returning to the Subsea tree order expectations for this year. I know the high degree of reliable visibility, you've had partly stems from specific projects, such as BHP, Shenzi North, Harbour Energy's capture field, could you perhaps split how those 17 to 19 million trees should fall between major projects that are either Greenfield or moving into a new phase of development versus incremental trees on established, installed production house?

Yes, I'm going to say about 75% of them are probably build on some existing projects. So it'd be a tree five, six, seven, eight or in the case of capture tree 27 things were in the 20s there. There's a small portion that are new one-off trees. Those aren't large Greenfield project, we tend not to participate in those large Greenfield projects, we tend to participate well with what I characterize as the independents and larger independents as opposed to major IOCs. The nice thing about by the way, the fact that those are largely knock on trees from previous orders is that what you find is that serial number one tree is always challenging . From an operational standpoint, you're learning a lot, when you get to trees, three, four, or five, or in the case of capture trees 20, something, you can be a lot more efficient from an operating standpoint. So we're happy -- we're pretty pleased about that actually, as we progress to the year.

Got it, yes, it's consistent with sort of how we've seen the overall subsea tree market up cycle progress in terms of where the majority of demand is originating from. Why don't I wrap with my questions here turn it back over to you, Jeff, and Kyle, and allow you to use these last few minutes to share some concluding remarks.

Yes, sure. So, if we look at Q2, we're very optimistic about orders. As Kyle stated earlier, we would expect our revenue numbers start with a nine. We believe that's going to have some strong incrementals with it as we start that March backup. We believe once we hit that number, we will only see a rising number from there for the balance of the year, very pleased with where the order trend is, and believe that 20% strong from a order standpoint year-on-year. Very focused on our growth pillars. We've talked a lot in this call about collaboration. And we're very pleased with those and see a lot of success for those. In some cases, it's laying the foundation now and orders next year in the case of CCUS. And in some cases, in the case of what we see with downhole tools or wellheads it'll likely mean real orders this year. We're focused on our cost base and focused on executing with our customers. We've talked about shrinking that footprint and getting the organization aligned. We're well on our way to doing that. I'm pleased and I think in the back half of the year, that we'll start seeing further upside from that, but not quite ready to talk about that, overall middle of the fairway quarter understand, it might have been a wide fairway, but a middle of the fairway quarter but opportunistic about Q2 and beyond.

Great. I think we'll conclude there. Thank you to Jeff and Kyle for joining me for the first quarter fireside chat and to all of you for listening in.

Okay. Thanks, Tom.

Thanks, Tom.

This concludes today's conference call. Thank you for participating. You may now disconnect.