Good morning and welcome to the Third Quarter 2021 DistributionNOW Earnings Conference. My name is Brandon and I will be your operator for today. 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 of Digital Strategy and Investor Relations, Brad Wise. And you may begin, sir.

Well, good morning. Thank you, Brandon. And welcome to NOW Inc.’s third 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 will 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 U.S. 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. now has on file with the U.S. 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 maybe found within our earnings release or 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 U.S. GAAP, you will note that we also disclosed 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 reconciliation 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 third quarter 2021 Form 10-Q today and it will also be available on our website. Now, let me turn the call over to Dave.

Thanks, Brad and good morning, everyone. I’d like to begin this call with a big thank you to the thousands of DNOW women and men around the world who successfully connect the manufacturers we support to the customers who rely on us to power the world for a sustainable future. Things are challenging on many fronts, the COVID surge, labor and material shortages, elevated transportation costs, and changing political wins among other things. Despite these factors, we performed very well. We have seen strong demand this quarter, especially in North America. Our service to customers has been exceptional. We are leveraging our scale, modernizing our geographic footprint, and demonstrating agility as we keep the customer at the center of every dollar we invest. Our goal is to always be in an advantage position to help our customers achieve their goals and solve their problems. While the supply chain environment is stressed, we are confident in our skills to respond the evolving dynamics. In the face of labor and material shortages, we are providing superior service and helping our customers minimize disruptions. We are investing in inventory to seize growth as the market expands further. While we navigate tight supply chains and labor shortages quite well, these disruptions impacted revenues a bit more in the third quarter of 2021 than in the previous quarter, especially in the area of steel pipe and for products in U.S. process solutions. These trends seem likely to endure in the short-term. To address these we are leaning on technology, alternative supply sources and branch initiatives to improve productivity in order fulfillment. The degree and pace of recovery is contingent upon COVID impacts, customer budget discipline, ESG initiatives and availability of capital, labor and products amid the lingering supply chain bottlenecks. We have taken action in…

Thank you, Dave and good morning everyone. Total third quarter 2021 revenue was $439 million, a 10% increase over the second quarter of 2021 outperforming our guided mid single-digit percentage growth. The U.S. revenue for the third quarter 2021 was $312 million, up $16 million from the second quarter and to our highest level since before the pandemic on increased customer activity and significantly improved product margin contribution. Our U.S. energy centers and process solutions revenue channels were up 5% and 7% respectively, with U.S. energy centers contributing approximately 80% of total U.S. revenues in the third quarter. Moving to the Canadian segment, Canada revenue for the third quarter of 2021 was $68 million, up $17 million or 33% from the second quarter as we successfully expanded our revenue in both the upstream and midstream space. Year-over-year, revenue was up $26 million or 62% from the third quarter of 2020. International revenue was $59 million, an increase of $6 million or 11% from the second quarter, primarily from increased project activity. Gross margins improved sequentially 60 basis points to 21.9%. This increase was primarily from higher product margins as inventory charges remained relatively modest at $2 million in the quarter. Gross margin gains were fueled by the inflationary currents in the steel market, impacting line pipe and high steel content fittings and flanges, but we also captured margin growth, albeit to a lesser extent across our other product lines as we selectively migrate towards those products and solutions that provide the greatest value to DNOW. Inventory charges vary depending on the actions taken to adjust our business model to support current and future activity, including customer demand changes both in volume and preference, the incline or decline in the market and specification changes on available products. We continue to evaluate…

Thank you, Mark. And now a view on M&A in the fourth quarter, we remain focused on deploying capital to capture organic and inorganic opportunities for DNOW. Through M&A, we are targeting accretive margin businesses that provide non-commoditized solutions that fit within our strategy. We continue our active engagement with potential targets as we evaluate opportunities in our strategic areas of focus. One area of focus is on strengthening our process solutions product lines, by adding companies which create competitive advantage, differentiation and build barriers to entry for DNOW. Another area of focus is on businesses that help diversify our end markets to provide greater market differentiation. As you can tell, I am excited that the company once again achieved solid results, with better than expected sequential revenue growth of 10%, a third consecutive quarter of record-breaking gross margins, and EBITDA excluding other cost of $15 million, well above expectations. Our strategic execution accelerated these results and generated $22 million in free cash flow in a period, where we would have historically consumed cash. Looking near-term at the fourth quarter, we typically see customer expenditures slowed down due to a combination of budget exhaustion and reduced customer activity due to the holidays in November and December. This typically creates seasonal headwinds to sequential top line growth. Furthermore, shipping delays on imported products and the lack of product availability has the potential to delay revenues. Taking this into account, our view is that the revenue in the fourth quarter will be flat to down mid single-digits sequentially as we experienced seasonal headwinds that we don’t expect to repeat into 1Q ‘22. We anticipate full year 2021 EBITDA improvement over full year 2020 to be nearly $90 million, representing a fundamental shift in the capabilities of the company and its earnings potential,…

Thank you, sir. We will now begin the question-and-answer session. [Operator Instructions] And from Benchmark Research, we have Doug Becker. Please go ahead.

Thanks. Dave, I would like to continue on the margin commentary, just maybe a little more insight into what you see for the fourth quarter given the multiple moving parts. But then even longer term, last quarter, you were still talking about 22% being a target. Given this quarter’s results, it certainly looks like a readily achievable target and just maybe your latest thoughts on that and margins longer term?

Yes. Good morning, Doug. Thanks for the question. Yes, I did say 2022 – 22% as a target, I didn’t expect to see margin appreciations like we did in the third quarter. In fact, we guided to some compression. We have our management team – I tried to make the point towards the end of my opening comments, like any family, any business, any organization, we all have limited resources, we have to make choices. As we migrate, how we fulfill customer requirements, we tasks our – task, our resources pointed at them, the higher margin activity in everything we do. We are negotiating new deals with long-term customers, suppliers, long-term manufacturers, we are trying to get the best possible price. We are trying to give them all of our business, so they understand reciprocation. And then we are changing how we price things. In the past, a lot of people on our company had pricing authority, we are changing that, so that we can maximize the delivery of the right products to our customers at a good margin. That’s, we are doing that across the board. We are buying companies with – the companies we bought this year anyway, with better gross margins, better expense as it relates to revenue. And we are, like I have said, disfavoring, those at the other end of the spectrum. So, while 22% is a record for us, I don’t see this as a floor yet, because we did enjoy the benefits of pipe pricing. In a period like this, where product availability is scarce, it comes down to allocating products to customers. And if we can acquire it, and as a large oil and gas distributor, we have – and we have a better position in terms of product acquisition, we command the higher price for having the products in the first place. So, 22% remains our target, can we build on that, I believe we can. It is an organizational effort that we pursue the value for our customers. We meet them where they see the value in DNOW. We have to allocate our resources to those efforts and then not to those where they don’t see the value. So, I think the opportunity is for greater margins in the future. In the third quarter however, we did see a benefit from pie and we could talk a little bit about – more about that as well.

Well, lots of things that are certainly showing up in the numbers. Maybe just talking a little bit more about piping as it relates to just the fourth quarter. Would you expect a little gross margin compression in the fourth quarter, just given revenues that might be flat to slightly down?

Yes. I think that’s implicit in our guide, because – so, while we have been very good at fulfilling customer requirements, we are – things are slipping a little bit in a few key areas. Again, we are working to fill those gaps to make sure we can maximize customer service and product availability. But in the areas of steel pipe, we are tapping all of our resources around the world, important domestic pipe sources to acquire pipe. And we are seeing some slippage in terms of product availability. So, that could mean better margins, but lower revenues. So, the mix, we would see a mix issue there where our pipe sales could go down in terms of total sales, which would have a negative impact on margins. So, that’s one reason why we might see some gross margin compression in the fourth quarter. Secondarily, we do – we are seeking alternate sources. And for fungible goods, where alternatives are available, we might seek a sourcing strategy where we buy from competitors or master distributors, and we pay a little bit more for the product. We get the revenue, but we see a little bit less in terms of gross margins. So, to answer your question, yes, we expect a little bit of compression. I have said that for a few quarters, I have been pleasantly surprised. But I gave a little color on my opening comments about how we are seeing, $5 million to $10 million in projects, or orders that are slipping into the New Year, basically due to waiting on products to arrive. And those tend to be our higher margin product lines. So, I guess the answer is yes, we will see some compression and likely due to those reasons. I feel as a short-term margin compression and to your original question, I think we can get back into that 22% range into the New Year.

Final one just can’t help in notice the traction you are getting within valves globally, it’s an area where you are targeting some acquisitions, just any context about the current size and how big that business might be – might ultimately become?

Well, I think in terms of our total sales today, valves discreetly represent about 20% of our business. Now, that there is also where we do kitting, and they are part of a project and those values may not be considered there. But to me, it’s a matter of the right kind of valves and the right kind of profitability for the lines we carry. But we see that as one of the more – it’s one of the few products we carry that where there is a high brand preference for. We have very little brand preference, preference for pipe, and fittings and flanges. But for valves, there is a brand preference there. So, we get the right agreements with our suppliers. And as we grow our actuation about service business, we can see that continue to grow. We haven’t set a size, that size of the – that part of the business. But we see it as a big opportunity for us to manage a fleet of various competing valves out there to do a valve and actuation services and to become more and more important to our customers in that process.

Got it. Thank you.

Thank you, Doug.

From Cowen, we have Jon Hunter. Please go ahead.

Good morning. Thank you.

Good morning.

So, I guess to round out the discussion on 2022. I mean, it seems like you will start the year at the 22% type gross margins. You alluded earlier in the commentary for double-digit type increases, in the top line, I believe. Some of the larger OFS companies are talking about 20% increase in E&P spending next year in North America. I am curious if DNOW agrees with that outlook, or is there a potential upside to that if you see market share opportunities, I know you are kind of actively targeting the private, so that could be an area of opportunity. So yes, if you could just speak to that that would be helpful.

Yes. I think what we were saying in terms of 2022, of course, we are not prepared to give guidance on 2022. But there is a lot of optimism. And most people are talking about 10% growth or greater, some of the numbers get into – well into the teens. We are not there yet. But so there is two things there. We are – I was pretty outspoken on the opening comments about this notion of limited resources and a focus on really cherry picking the highest margin, highest EBITDA margin opportunities in terms of product line focus. That could mean, we move away some product lines. And that could be a headwind to revenues in the New Year, but a boom to earnings at the bottom line. So, while I believe again, we haven’t fashioned a budget, that 10% is probably a good starting point for the New Year. And it could be materially stronger than that. And there are many things impact in that, of course. But we are bullish on 2022. And I think we should see growth in that range for sure.

Thanks. Thanks, Dave. That’s helpful. And following up on that, the WSA is kind of flat in the fourth quarter, and then there are some opportunities to reduce that in the first quarter of 2022. Is – do you think you can whittle that down to kind of an $80 million type run rate on WSA by the end of the year, or what kind of context should we be thinking about for your target on the WSA line in 2022?

Well, let me answer the question this way, because growth will impact how much where that WSA line goes, if we are able to land some of the acquisitions we have on the table right now. Of course, all of that’s going to impact that. But we have plans in place to, as we standup our super centers in Casper, Wyoming, and Odessa, Texas, in Williston, North Dakota. Three major investments across the spine of the U.S. oilfield, we should continue to see improvements in our cost structure. As it stands right now, we expect to pull $12 million of expense out of the business at a flat level of revenues. So, that can – that would potentially being WSA down by $3 million a quarter. Now, if our growth is much higher than 7% to 10% and that will change that WSA number. So, the greater the growth, you or we might project will impact that WSA number unfavorably, right. That WSA number will be a little higher if the growth was stronger than we forecast. But we do have efficiency measures that we will achieve in 2022. And they are in the $12 million to $15 million range right now.

Great. Thank you for that. And then last one for me is the free cash flow in the quarter was impressive. I was expecting a little bit of a working capital build, you actually released a little bit. So curious, as you think about 2022 and your inventory needs, how should we be thinking about working capital consumption in the fourth quarter, or perhaps early in 2022?

Well, so the biggest thing impacting whether we produce or consume free cash flow in the fourth quarter is the timing of receipt of goods. So, we have tens of millions of dollars of inventory on order, as we often do, but we are like I have said, we were clamoring to get some of this product lines in here faster. Those would be offsets to free cash flow in the fourth quarter. But our current modeling shows that we will generate cash in the fourth quarter. It will be zero to a few million dollars, probably. Now, last quarter, I think we said we would consume up to $30 million to $40 million in the second half of the year. It could be that we produce $30 million in the second half of the year, as it turns out. So, in the third quarter, we turned our working capital 9x on an annualized basis, which is unheard of for an inventory intensive accounts receivable intensive company. We sell goods to our customers on terms and we have to invest a lot of inventory to generate the kind of sales we generate. We turned our working capital 9x. So, that’s something that’s going to be hard to maintain, likely we won’t maintain it. But so that our working capital turns will get a little less great. But it’s possible, and it’s probably a good bet. We will be generating cash to some level in the fourth quarter. It could be could be zero, but could be a little bit more than instead of consuming cash like we had expected earlier on.

Great. Thank you. I will turn it back.

Thanks, Jon.

[Operator Instructions] And from Stifel, we have Nathan Jones. Please go ahead.

Good morning, everyone.

Good morning, Nathan.

Following up a little bit on the WSA commentary, that you obviously, you said obviously that WSA number is going to depend on what growth is, maybe you could give us a little bit more color on what kind of WSA you would be looking to add back per dollar of revenue increase. So, if you increase revenue by $1, do you need to add $0.10 of WSA, $0.05 of WSA, any kind of color you can give us on that?

Okay. I will make a stab there. To me, every dollar of revenue should include no more than $0.05 in WSA. And again, I have said for many quarters, that our expense or WSA as a percent of revenue remains too high. I have also said that once we bought – once the market bottomed, that we were primarily focused on growing the business, on taking market share, on growing gross margins in a highly – hotly contested competitive environment. And we are doing those things. So, I am most urgently concerned about our position in the market and growing the business. And that could entail some additional expense. Expense as a percent of revenue in 2020, won’t go down. We are going to be careful about not adding expense. I have talked a moment ago about I plan to pull $12 million to $15 million of expense out of the business at current revenue levels. But to answer your question, discreetly, $0.03 to $0.05 per each dollar would probably be acceptable, but we also need to get our expense more in line with our targets long-term.

Okay. So, we take the $12 million to $15 million out on the – once the super centers are stood up. And then from there, each dollar should add $0.03 to $0.05 of WSA. If you are doing gross margins of, let’s say 21%, and you are adding $0.03 to $0.05 back of WSA per a dollar of revenue, does that maybe we should be looking at kind of an upper-teens incremental EBITDA margin as volume grows, adjusted for the initial $12 million to $15 million of super center settings?

Yes. So historically, and we have generated 10% to 15% incremental is when we grow. But to answer your question, those incrementals should be in the 15% plus range. They should be closer to the high-teens, especially in a period where we have product scarcity, which is a real boost to gross margins in the short-term. But those incrementals should be in the teens and potentially in the high-teens.

Great, that’s very helpful. One more, you talked about the private guys really being the driving force behind the increase in drilling at the moment, what’s your expectation around the public guys? I mean, I think historically, private guys getting first followed by the public guys, but the public guys have had religion forced upon them by investors, when it comes to spending a lot of capital relative to previous cycles. So, maybe you could comment on your expectations there as we go forward?

Okay. Well, like we have seen for the last few quarters, I do think the privates will be first in and do more of the drilling. We would like to see that change a little bit in 2022. I don’t know that it will, it probably won’t, we will still see the privates driving the joint investments anyway. We like the bigger guys, because the risk profile is different. We have historically focused on the Shell’s and the Chevron’s and the Oxy’s and the big companies, because our risk level is different. On the smaller private companies, we have to be very careful there. And we are making nice inroads there, but the risk profile is different. I think everyone is going to spend more money next year. It’s hard to gauge though, because especially the public companies are very disciplined to a degree we have never seen before. And that all – that hurts us in the short-term, because as oil prices are in the $80 range, we think our customers would normally spend more at this time in the cycle, but it will help us a lot in the long-term as we won’t see the kind of volatility due to the sloppiness we have seen in the past. So, I think it will be more private. But we are waiting to see what our customers are going to put in their budgets and we will shape our focus accordingly.

Great. Thanks for taking my questions.

Thanks, Nathan.

Thank you. And ladies and gentlemen, we reached the end of our time for the question-and-answer session. I will now turn the call over to David Cherechinsky, CEO and President for a closing statement.

Well, I would like to thank everyone for calling in today. Thanks for taking the time. Thanks for your interest in DNOW. And I look forward to talking to everyone in early 2022. Have a good day.

Thank you. Ladies and gentlemen, this concludes today’s conference. Thank you for joining. You may now disconnect.