Welcome to the Second Quarter 2021 Earnings Call. My name is John, and I will be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] I will now turn the call over to Vice President, Marketing and Investor Relations, Brad Wise. Mr. Wise, you may begin.

Good morning and welcome to NOW Inc.'s second quarter 2021 earnings conference call. We appreciate you joining us, and thank you for your interest in NOW Inc. With me today is David Cherechinsky, President and Chief Executive Officer; and Mark Johnson, Senior Vice President and Chief Financial Officer. We operate primarily under the DistributionNOW and DNOW brands, and you'll hear us refer to DistributionNOW and DNOW, which is our New York Stock Exchange ticker symbol, during our conversation this morning. Please note that some of the statements we make during the call, including the responses to your questions, may contain forecasts, projections and estimates, including, but not limited to, comments about our outlook for the Company's business. These are forward-looking statements within the meaning of the US federal securities laws based on limited information as of today, which is subject to change. They are subject to risks and uncertainties and actual results may differ materially. No one should assume that these forward-looking statements remain valid later in the quarter or later in the year. We do not undertake any obligation to publicly update or revise any forward-looking statements for any reason. In addition, this conference call contains time-sensitive information that reflects management's best judgment at the time of the live call. I refer you to the latest forms 10-K and 10-Q that NOW Inc. has on file with the US Securities and Exchange Commission, for a more detailed discussion of the major risk factors affecting our business. Further information as well as supplemental financial and operating information may be found within our earnings release, on our website at ir.dnow.com, or in our filings with the SEC. In an effort to provide investors with additional information relative to our results as determined by US GAAP, you'll note that we also disclose various non-GAAP financial measures, including EBITDA, excluding other costs, sometimes referred to as EBITDA, net income, excluding other costs and diluted earnings per share, excluding other costs. Each excludes the impact of certain other costs and therefore have not been calculated in accordance with GAAP. A reconciled of each of these non-GAAP financial measures to its most comparable GAAP financial measure is included in our earnings release. As of this morning, the Investor Relations section of our website contains a presentation covering our results and key takeaways for the quarter. A replay of today's call will be available on the site for the next 30 days. We plan to file our second quarter 2021 Form 10-Q today and it will also available on our website. Now, let me turn the call over to Dave.

Thanks Brad. Good morning, everyone, and thank you for joining us. The second quarter marked another strong quarter for DistributionNOW. From a top-line perspective while global rigs in the quarter were unchanged compared to the same quarter in 2020, our revenues grew 8%. Sequentially, global rigs increased 2% and our revenues grew 11%. Gross margins on the back of 1Q '21 record highs and against our expectations of a modest contraction due to increased project activity and downward pressure from Canadian breakup, gross margins, again reached a new high of 21.3%. It's easier to grow revenues by conceding price. It's harder to grow the business and improve gross margins at the same time. Yeah, we did so for a second consecutive quarter. Moreover 2Q 2021, marks the third sequentially quarterly market expansion since the 3Q 2020 bottom where US rigs had declined by two thirds from the first quarter of 2020. The spending discipline exhibited by our customers, which limits their purchases and in turn our revenue opportunities in the short term, also moderates the extreme volatility we experienced through the cycles. Customer spending restraint curbs, the feast or famine shocks our industry has experienced historically, enabling better inventory management and reduced product obsolescence inevitably resulting from the wild swings, a lack of spending discipline creates. In 2020, our push was to recompose the company amid the steep decline in market activity. While we have work left to do, to align our cost structure to our strategy and to the market, the focus in 2021 is prioritized around revenue retention, market share gains and market diversification and inorganic expansion. We believe the restraint exhibited by public operators lays the groundwork for expanded domestic rig activity for 2022 as EMP balance sheets improve this year, providing more opportunity to finance capital…

Thank you, David and good morning, everyone. Total revenue for the second quarter of 2021 was $400 million an 11% increase over the first quarter outperforming our guided range of mid to high single digit percentage growth. The U S revenue for the second quarter 2021 was $296 million up $44 million or 17% from the first quarter on increased drilling and completions activity. Our US energy centers and process solutions revenue we're up 16% and 23% respectively with US energy center's revenue contributing approximately 80% of total US revenues in the second quarter, relatively in line with the first quarter levels. Moving to the Canadian segment Canada revenue for the second quarter of 2021 was $51 million down $7 million or 12% from the first quarter due to seasonal breakup. International revenue was up to $53 million, an increase of $2 million or 4% from the first quarter, primarily from increased project activity. In addition to DNOW growing revenue, 11% in the quarter, our gross margins improved sequentially 50 basis points to 21.3%. This increase was primarily from inventory charges, declining sequentially from $5 million in the first quarter to $1 million this quarter, partially offset by lower product margins due to product mix and increased transportation costs. Inventory charges in general vary as a product of many factors, including customer demand changes both in volume and preference, the incline or decline in the market, specification changes on available products and actions taken to adjust our business model to support current and future activity. We continue the evaluation of our products and locations to align to the changing market conditions and our customer preferences, which could impact the level of inventory WSA headwind from the non recurrence of the first quarter $2 million bad debt credit from the collected…

Thank you, Mark. Now a bit on our DigitalNOW initiatives are impacting our business. In order to manage the scale of transactions and capture efficiencies across the procure to pay cycle, we offer our customers and suppliers a digital solution for catalogue browsing, transacting sales orders, purchase orders and invoices across the procure to pay process. Many of these processes are unique to the customer's ERP procurement system or involved to third party middleware vendor, demonstrating the flexibility and tailored solutions our DigitalNOW platform provides our customers. During the second quarter of 2021, 43% of our SAP transactions are digital. We are leveraging technology to drive increased efficiencies across our business for our employees, customers and our suppliers. And as incremental transactions and revenue are captured and processed, they provide an increase in employee productivity and system efficiencies. We continue to increase adoption across our digital platform by adding new customers during the quarter. During our last few earnings calls, you've heard us talk about eSpec and eTrack tools. As a refresher eSpec helps customers select, configure and create budgetary prices for 10 unique power service fabricated engineered equipment packages. Our tool automatically generates a real-time budgetary estimate plus a detailed working bill of material, which is used to produce a formal quote. Last quarter, we introduced eTrack our asset tracking that simplifies operator's asset management processes by geo locating an asset, accessing specifications and engineered drawings, compliance certifications and provides the ability to view maintenance and service work history information. For our customers eTrack improves asset transfer timeliness and accuracy, while the inventory report facilitates asset audits. This simplifies our customer's inventory control process, make cycle counting easier and enables the tracking of assets in and out of holding yards as to become working assets. eTrack provides DNOW with…

[Operator instructions] And our first question in from Jon Hunter from Cowen.

I'm doing well. Thank you. So first question I had is just on the revenue progression into third quarter and then fourth quarter mainly on the U.S. side, I'm curious, what is embedded in your revenue expectation in the U.S. for the third quarter versus your expectation for completions? And then as we move into the fourth quarter, it seems like EMPs have been relatively disciplined in their approach to capital spending this year. So I'm wondering what you're expecting in terms of a seasonal drop-off for -- muted seasonal drop off in the fourth quarter?

Okay. So in terms of the third quarter, we're basically hearing from our customers, what they expect to spend in that period. We expect to seasonal incline like we've talked about, but when we look at their -- what they're forecasting for the third quarter, we're getting into that low to mid single digit range for our customers, generally. We think we can make some further ground with the private EMP companies. That's been a big focus for us. They tend to be adding more rigs and doing more of the completions work. So that's a target area for us where we're laser focused on picking up share from traditionally lower or higher hanging fruit for us. We tended to focus on the larger customers historically. So that's where we see our revenue shaken out in the third quarter. In terms of the fourth quarter, it's hard to say. It depends on -- we generally see a fourth quarter slowdown, especially in the month of December. At this point, it's hard to gauge that. We are still seeing -- we've seen rigs go up, for example, for almost every week, the last 50 weeks slow, but steady growth. We're seeing product delays and especially in pipe area now, which could kind of combine with the normal seasonal dip we expect because we might not have the pipe available for the fourth quarter, which is a bigger product line for us in this period. So, we're not guiding to the fourth quarter. There's still a lot of uncertainty with COVID and its impacts, but it could go either way. It just depends on a variety of factors.

Understood. Thanks, Dave. And shifting to margins, I understand there are some headwinds in the third quarter in terms of supply chain and perhaps some inflationary cost pressure. So I'm curious as we look into the fourth quarter and perhaps into 2022 if you're able to quantify how much of a headwind, those types of things are to third quarter, and then as we look into next year, what's a more normalized type gross margin level we should be thinking about once these things are past us?

Okay. So in the short term, we're seeing the biggest influencer in gross margins for us over the last five quarters has been inventory charges. Now those tend to be higher in a downturn, which we are out of and lower in a recovery, which we're in. So in the first quarter, like Mark had said, we had $5 million in inventory charges in the second quarter. They dropped quite a bit to the first quarter. That all depends on the timing of purchases, customers kind of product preferences, obsolescence, damaged products, et cetera. That's the number one impact. Freight has been a big impact to the second quarter and it probably won't continue into the third. I don't expect that to be a permanent impact. I do believe as a company, we're much more thoughtful about product acquisition by the inventory risk about having what the customer needs, but not getting too heavy into speculative purchases. So I think over time and into 2022, we'd see inventory charges, which like I said, was a big part of our gross margin variability, being fairly low, especially compared to 2020, especially compared to that. So, one thing that's been a positive for us in the last few quarters inventory charges coming down, I expect that to persist. Freight charges, which were high in the second quarter, I expect that to continue into the third, maybe throughout the rest of the year, but that will ease and that will, I believe correct itself. In terms of product margins, which is the main driver for gross margins, we remain very resilient across our product lines, including pipe. Now pipe is growing as a percent of our activity and expect it to grow into the third quarter as we see more projects and pipe is a lower margin project pro product relative to valves and fittings, etcetera. So those are kind of the puts and takes. In terms of where we would be next year, again, not guiding to 2022, but this 20.5 plus range is a good bet and maybe it could be better than that. We continue our process, which we've done for years now, where we focus on higher margin businesses, customers, product lines, etcetera, that continues. The acquisitions we made this year will have margins in excess of what we normally experience. The acquisitions we do later in the year should we be successful, we'll continue that pattern. So high grading gross margins is a big focus around here. Exiting low margin products, disfavoring them is as part of that process as well. So I see more upside in terms of gross margins Jonathan.

Thanks for that. I'll turn it back.

Our next question is from Doug Becker from Northland Capital Markets.

Thanks. Just following on one, a question about gross margin, as revenue starts to approach $2 billion, the changes you're doing in terms of mix and the efficiencies is a 22% gross margin unrealistic off of a $2 billion revenue base?

Well I don't think it's outrageous. I think it's plausible. I think there are many things that would impact that. But we're at 21% and like we alluded to in our opening comments, we do expect a little downward pressure in the third quarter because of the very low inventory charges. But 22% is within the realm of possibility, of course and again, I said, we're very particular about, and if you look at the trend of gross margins for DNOW over the last few years, bringing that number up, focusing on higher margin activity and intentionally not focusing in low margin stuff, and we need to do that because we still need to pull costs out of the business and Mark alluded to that as well. So I do think 22% is in the realm of possibility and it's, it's a target for us, for sure.

Yeah. That makes sense. And how does that play into the M&A opportunities obviously looking for margin accretive but any particular areas of focus?

Well the companies we're looking at of course are our most important metric is how much earnings power they have. So you could have a higher gross -- a lower gross margin business, but very strong EBITDA. We would not walk away from those possibilities. Those couldn't be dilutive to gross margins, but all the deals we're looking at, I believe have gross margins in excess of where we operate today. And that's not the main determinant. EBITDA percentages would be the main determinant, but we're focused on higher margin products, as kind of a mainstay of organic and inorganic opportunities.

Okay. And then just another really strong quarter on managing working capital, last quarter you were talking about trying to keep networking capital as a percent of revenue closer to 15% came in at 12.3% this quarter, how much of that was a function of maybe delays receiving some of the inventory. And should we still be thinking about inventory growing $30 million to $40 million over the course of the year?

Well, I said it in my opening comments I think a small part of it's due to delays an inventory, not a big part of it. We've been -- I said it before that if you look at our experience in 2020, our EBITDA for the year, I believe was a minus $57 million for 2020, the worst year in our history. And we lost $57 million in EBITDA and our inventory charges are over $54 million. So that tells us we need to be very smart about inventory. Mark told you earlier that we had a five turn in the first quarter and the second quarter, we've never had a five turn. I don't believe. So we're focused on making sure that we can keep those margins high, keep those turns strong. And we believe we were able to fulfil customer requirements in the second quarter. It didn't have pent up goods, receipts issues. We do expect that to begin to trickle into the third quarter. We are finding some of the pipe we're ordering, taking longer to get here, which could have a negative impact in the second half relative to the growth we projected in the third quarter. But we're starting to, we may start to feel a little bit on pipe and less so in the other product categories. In terms of our working capital center revenue at 12% or 12.3%, which is a working capital turn of 8%, that is a -- and we guided that to expand a little bit that's just a function of collecting our bills as fast as possible, working with our suppliers in terms of pain a little bit later, and being good at managing inventory, which historically we've been less than good. So I still think 15% to 20% working capital revenues is a good range, but… Are we out there?

Yes, you're back.

Okay. So I think I answered that last question. Sorry. We had some technical difficulties. Did you have any other questions Doug?

If you could reprompt if you did further questions. Okay. And we have Doug back.

No problem. So just wanted to tie a bow on that 15% to 20% of revenue is still reasonable target going forward.

I believe so.

Okay. That's it. Thank you. You're welcome. Sorry about the technical snafu.

Okay. And we have next is Nathan Jones from Stifel.

Good morning. This is Adam Farley on for Nathan.

Good morning, Adam, or good evening wherever you might be.

Good morning out here in Denver back on to the group margins and pricing, how accepting is the market of price increases associated with inflation? And do you think higher prices have impacted demand at all?

Well, here's what we're seeing so far. Our customers like we talked about, talked about exhaustedly are very focused on cash maximization and that includes price of goods. So we are getting pushback from customers on increasing price. We are seeing that. Now so far, we've been able to push customers to substitutes which might, which would enable us to capture the sale and to keep them interested in that transaction but we are seeing some customers push back. As lead times, expand, we'll see less of that resistance from customers because they'll be more interested in getting the product than paying a few pennies more than they had historically, but there is a little pressure along those lines.

Okay. That makes sense. Turning over to the WSA spend, I believe you gave us a run rate outlook for 2021, but maybe longer term, how do you expect expenses to layer back in with growth?

So in the short term, so in 2020, we were very focused on resizing the business in a market that had shrunk by 70% in five months and you talk about the metaphor catching a falling knife and how difficult that is. We believe we caught that knife and I sat up two or three quarters ago that we're going to be circumspect. We're going to be thoughtful. We're going to be careful to preserve our position in the market when you reduce your workforce by 45%. And when you close 50 branches out of 250 branches, you forego revenue opportunity. So right now we're focused primarily on growing the business, taking market share and making smart inorganic purchases and workforce. Secondarily, over a period of time realize and are focused on modernizing our branches, relying more so on central distribution where we can push more volume across fewer people with better flow-throughs and better WSA, but over time, that WSA number needs to come down relative to the current level of revenues. So it's not just WSA needs to come down as a percent of revenue. The absolute value needs to come down all other things equal. So, in the coming quarters, we're still working on, I call it a migration to a centralized model. I call it migration because it takes some time. And so we'll see those numbers come down in the future, but they won't. Like Mark said, we expect them at least for the third quarter to be about worth where they were in the second.

And we have no further questions at this time. I'll turn the call back over to David Cherechinsky, CEO and President for closing statements.

I want to thank everyone for joining us today. Apologize for the technical snafu. But we look forward to seeing you in a few months and have a great quarter.

Thank you, ladies and gentlemen, that concludes today's call. Thank you for participating and you may now disconnect.