Welcome to the NOW Incorporated Fourth Quarter and Full Year 2021 Earnings Conference Call. My name is Sheryl 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 of Digital Strategy and Investor Relations, Brad Wise. Mr. Wise, you may begin.

Thank you, Sheryl. Good morning, and welcome to NOW Inc.'s fourth quarter and full year 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 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. now 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 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…

Thanks, Brad and good morning, everyone. On our earnings call one year ago, as we were emerging from a year when the industry had experienced the worst market and conditions, DNOW responded swiftly and resolutely to defend its bottom-line and lay the groundwork for prosperity in the future. We believe then that the market and our customer spending habits had fundamentally changed, demanding decisive action to redefine our supplier, sales and customer engagement playbook, and adjust our operating model to thrive as the economy began to recover. Downturns motivate change and I see here this morning, amazed at how the highly talented caring customer focus women and men of DNOW have not just embraced, but have driven it. The results of our decisions these past two years are evident, not only in the night and day improvement in financial performance, but in the competence, enthusiasm and competence in our team that provides superior solutions our customers crave in a supply chain stressed environment. During the first quarter of this year, we began operations at our new Permian Supercenter in Odessa, Texas. This facility expands our position and investment in the heart at one of the busiest oil producing regions in the US. It's a formidable presence of our energy locations and the complementary asset strength of Odessa pumps, flex flow, power service, and TSNM fiberglass, strong valuable customer appealing names, fortifying our brand in Permian. During this quarter, we plan to open a new express center in the area to support our customers as their drilling plans ramp up. This location will be primarily supported by the super center as a means to regionalize fulfillment and drive efficiencies and deepen intimacy with target customers. Now, moving on to our results, fourth quarter revenue was down 2% at $432 million at…

Thank you, Dave, and good morning, everyone. Fourth quarter 2021 revenue was $432 million, a 2% decrease from the third quarter mainly due to the normal seasonal decline from holiday impacts and fewer working days at the better end of our guided expectation. The US revenue for the fourth quarter 2021 was $303 million down $9 million or 3% from the third quarter. Our US energy centers contributed approximately 79% of total US revenues in the fourth quarter, sequentially revenue was down approximately 4% and the US process solutions revenue was up 2% sequentially. Moving to the Canadian segment. Canada revenue for the fourth quarter of 2021 was $72 million up $4 million or 6% from the third quarter. Year-over-year, revenue was up $24 million or 50% from the fourth quarter of 2020. Canada's strong Q4 performance was propelled by improving demand in the Canadian energy market, paired with the value our customers see and distribution now as model as a trusted and established technical solutions provider. International revenue was $57 million, slightly down sequentially with a decline of $2 million or relatively flat from the third quarter when considering unfavorable impacts from weaker foreign currencies relative to the US dollar. International increased revenue 21% in the fourth quarter or $10 million compared to the same period of 2020. Gross margins improved from the third quarter by a 150 basis points to 23.4%. This increase in gross margins came from several drivers in the quarter. About a third of the sequential gross margin basis point improvement or approximately $2 million favorable was attributable to lower transportation costs and lower inventory charges each by approximately $1 million in the fourth quarter with both expected revert back towards the mean in the first quarter. So far in 2022, we see our transportation…

Thank you, Mark. And now some comments on M&A, a top priority with respect to capital deployment continues to be on margin accretive inorganic opportunities. Through M&A, we are targeting businesses that strengthen and expand our product, geographic or solutions offering to our customers, and position the organizations to take advantage of the market recovery and build on earnings throughout the business cycle. We continue active engagement with potential targets as we evaluate opportunities in our strategic areas of focus, notably for process solutions and differentiating product lines as well as the industrial markets. For every prospect of deal, there are two parties involved. So getting to a conclusion takes time and finess, with $90 oil and a relatively strong general economy seller expectations are heightened, but we are looking for durable and solid financial nperformance at the acquired company through the cycle. Not just when the commodity prices are high. We are evaluating numerous opportunities in our pipeline and we’ll continue to be selective and strategic in what we pursue and ultimately take across the finish line. Over the previous six quarters, oil producers have worked to reduce the global oil inventory surplus, achieved through the combination of North American E&P capital discipline and OPEC+ supply curtailments. This behavior has led to higher commodity prices, improved balance sheets and better financial performance for most of our customers. As their financial health improves, we anticipate additional CapEx investment to maintain and grow production, increased activity will lead to more demand for our PVF products and engineered equipment packages as customers ramp up. I'm optimistic that the current recovery and pace will continue in driving higher demand for our products and services while delivering improved profitability. For our US segment, I expect solid growth on a year-over-year basis as market fundamentals…

[Operator Instructions]. And our first question comes from Nathan Jones from Stifel.

This is Adam Farley on for Nathan. First on gross margins with inflation likely peaking in the first half, does DNOW expect to see gross margins peak with some pressure on gross margins as the year progresses, which would usually be typical as inflation moderates?

Well, it depends on the product line in question. One of the big product lines where we have probably had the most success in terms of gains in gross margins, although we have had very broad price appreciation beyond pipe. Pipe is one where we still have pipe prices rising for seamless pipe, which is the primary pipe, steel pipe we sell and that could be experienced further into years beyond the first half. One of the issues though and I mentioned it in my opening comments was the timing of receipt of products is not completely certain. So we could receive some product later in the year, not just us, of course, but our competition and our customers. And that could extend what we expect to see as kind of a premium margin for that particular product line. We are seeing broad-based inflation continuing. To your point, Adam, that could kind of ebb midyear. But for pipe in particular, I don't know that that's the case and for a lot of the product lines we support there are still some long lead times. So I think we have guided our gross margins very high for 2022 and that's pretty much at the same level of 2021, where we saw four consecutive quarterly records. So it's a timing question in terms of receipt of goods. And it depends on how strong our market is and when the inflection point occurs. I mean, I talked earlier about January starting off pretty slow and I think things will get a little more hot here and that should mean a little more scarcity issues in the first half and maybe lingering into second half.

And then turning to exiting lower margin product lines, we are in the process at DNOW exiting lower margin business. And is there significant work still to be done or is most of the heavy lifting done?

Well, we're well down that path and I'll say it this way. So to me, we have areas, regions that have strong financial performance due to rig movements and customer budgets and customer consolidations, and those things all affect the success or the contrary for locations product lines customers, et cetera, that's always changing. To me, this is a gardening effort around making sure we're focused on the right things, making sure we apply limited resources to where we could make money for our shareholders, so we couold prepare for the future and continue to grow the company. So I just think it's an ongoing reality of business, no matter what business you're in, that you always have to kind of fertilize and weed and replant and kind of always situate the business where the sweet spot is in the industry. So that's just an ongoing thing. In terms of major structural changes, I think we're done there. I think we're out of the cost reduction mode. We are in the kind of the phase I call it a kind of fulfillment migration where we do want to regionalized most of our fulfillment to major centers of opportunity like for standing up in Williston, in Houston, and Odessa, and Casper, et cetera. We want those to be high volume locations with well-trained people focused on one thing that's taking care of the customer, whether it's walk-in business, everyday business, large projects, speculative activity. We want that to be regionalized. We want top talent managing those supply chains, and we want more kind of nodes or express centers or small local locations being intimate with the customer. So I see that's still happening but it's kind of speeding up right now and real excited about it.

[Operator Instructions] Our next question comes from Tommy Moll from Stephens.

Dave, I wanted to start on WSA, it a sounds like the guidance is pretty clear for first quarter, maybe in the range of third quarter from last year. I wonder if you can just refresh us on the higher level philosophy here, I think last quarter you said, for every dollar of revenue you're looking at $0.03 to $0.05 of incremental WSA. So if you could just refresh us on that and give us any signal of how that expense line might progress sequentially throughout the year? That'd be helpful.

So I think on the last call, I said a few things that we still have a list of projects we're working on to improve efficiency of the business. And I said that we had a plan to reduce WSA in the 12 to 15 range in 2022. And as we also said -- I also said that for each incremental revenue dollar above what last year's level we'd add $0.03 to $0.05 in expense, off-setting those reductions we're making. In the meantime, especially in the last several months, I think it's been over a hundred days since we talked to the public, the impact of -- on one hand, we've benefited quite nicely. I believe most of it's our cultivation strategy and focusing on the right things from improved pricing, that comes from product inflation, product scarcity, lack of availability. And of course, we experienced that in the labor market as well. And so that's kind of a new layer of attraction or retention costs that we experience that's layered into our guidance for 2022. But our philosophy is to significantly bring down WSA as a percent of revenue, to continue down a path of improved efficiencies. From 2021 to 2022, we'll probably reduce WSA by at least 200 basis points as a percent of revenue. Like I said for several quarters, we are in a build mode. We're in a growth mode. We are prioritizing growth over cost containment, but we are -- like I said, in the answer to last question, we're focused on changing our model and we're really making good head way on that path. So we did kind of guide the first quarter to around $86 million. It gets a little murky going forward because we are -- although we guide to it I think very tightly in our overall guidance on flow throughs and revenues, et cetera. But we're going to be focused on having the best people in the business. We're focused on beating the competition. We're focused on growth. We're focused on higher margins and cultivating new business, and biasing those efforts towards higher margins cost a little more. So that percentage is percent of revenue will come down. Our projects to pull costs out of the business are underway. But we are also, like I said, we're standing up a location this quarter. We're investing in new super centers for the future to grow the business and those will be kind of offsetting costs. But we understand how important it is to be lean that'll help us in good times and bad, and we're still going down that path for sure.

And just as a follow up on your supercenter comment there, Dave. You are in a growth market now and you pointed out you'll get increasing leverage on the WSA line up standing you're investing there. So I'm curious the philosophy when you green light those investments, like what you just called out on the supercenter, what are the set of conditions you want to see to have the confidence to move forward and make that incremental investment?

So for example, the Permian basin, which to me DNOW has a really strong physician in the Permian basin, not just from our standard branch business, which we're evolving, but from like I said, flex flow of Odessa pumps, TSNM fiberglass, and power service. We've got a really strong presence there with great brands, and we think we have a real good position. Now in the last quarter, in the fourth quarter of 2021, we consolidated 10 locations in the Permian into five, in one part of the Permian. We think from that we'll have more inventory for our customers. We'll be able to manage projects from fewer locations, from people who deal in volume where we can get the expense per revenue dollar down, we won't have distributed inventory risk what I call when you have inventory strew about a network kind of exponential inventory risk, you'll have less inventory risk in the next downturn and you'll have a much more efficient business. So we're growing in the Permian, we're standing up, we're growing in the Permian, we just stood up a supercenter, but we're consolidating, we're doing it smartly. And we're going to be better able to take care of our customers, have more inventory to do so with less inventory risks. So that's an example of we are pulling cost out and getting better and getting strong in the market.

And Dave hope I'm not overstaying my welcome here. But just on that point you made, so using the Permian as an example. If you -- net of everything you just described and pro forma for the super center, is it fair to say that revenue per employee and revenue per square foot of roofline versus before the downturn should be higher, notwithstanding the fact, like you said that you consolidated 10 to 5 branches?

I think so. Now, the roofline comment, I'm not sure about. We might actually have more space today. So I'm not going to comment on that, but we should see improved, really improved earnings per employee. Because I'd be more interested in the bottom line impacts of the investments we make or choose to walk away from than the top-line. But generally that top-line should follow soon, but I'd be more interested in watching the bottom-line.

Our next question comes from Jon Hunter from Cowen & Company.

So first question is just going back to the margins. The guidance seems to imply you are at like high 21 margin in the first quarter, and that's what you're aiming for for the year to be inline with 2021. So I'm curious how you see margin progressing? It seems flattish based on this outlook. But you've got HRC pricing that's gone down quite a bit since the peak in September. I'm curious of things that you are doing to offset some of that pipe inflation. And then as it relates to 21.9%, is that a level of gross margin you think you can maintain on a multi-year basis, I guess, as we go into '23 and '24.

I do. I mean, so 2021 was our best gross margin year. Each quarter had successive improvements in gross margins. So while we wanted to come into this call saying 22% in 2022, we are a little bit cautious about over guiding on gross margins, because we had such success in 2021. And to the points about hot rolled, coil steel prices, declining inflation, maybe ebbing midyear, which I think would be later in the year generally and maybe even later in the year for pipe, there are some offset to that. But in terms of maintaining it over time, I believe we can. And here is what I mean. We didn't talk about it in our prepared remarks and we didn't talk about it in the Q&A yet. But during 2021, we in fact, mostly in the fourth quarter of 2021, we exited consolidated 15 locations. And today, we have over 125 fewer people than we did at the end of 2020, in part, because we walked away from some low lower margin business. We didn't see, we are trying to be more efficient as a company. The efforts underway for those folks wasn't generating kind of margins. So we walked away from maybe $30 million of business. What that means is, we have our people focused on the higher margin stuff. We don't have our people focused on lower margin stuff. We are able to generate much better flow throughs from the activity in an environment where it's hard to, and we have to deal with labor inflation as well as process inflation. So I think, it's a matter -- it's not just the market that's driving our gross margin performance. In fact, I made a big deal about it in the last call, we've made year-over-year product margin improvements for the last five years. If that's a matter to me of careful cultivation of what you're not going to do in the market to make sure you have the right people focused on the right thing. So I do think that these gross margins can be sustained. And in terms of how it flows during the year, I think we're just going to have to see, I think it's -- if some of our higher margin products are less available, then of course, we'll see a mix issue and that would be depressive to margins. But we've guided for very strong gross margins. I do believe it's sustainable, and it comes from real laser focus of what we're not going to do as a company.

Switching gears a little bit, I guess to the top-line side of things. So you guided ‘22 revenues are up low to mid-teens. To me, it seems like it could be a little bit conservative. I mean, the rig count's tracking up 30% year-over-year, US is maybe 70% of your business. So just based on that, you're up 20%. Now, I know, there's a little bit of public versus private customer mix going on, but you also said that Canada and international should be up in 2022. So curious, if you can help me kind of look into the moving pieces regionally in the 2022 outlook for revenue to be up low to mid-teens?

So we're basing that on what we see in terms of what's happened in the first 45 days of the quarter. We're basing that on what we see in terms of the influx of products. We're basing that on what our customers are telling us and we're looking at some of our peers and how they're seeing the market. And we think that's -- I don't see that -- we gave a range of load and mid-teens in terms of revenues. I think most of that by the way will happen -- I think we'll see the strongest growth in the US, seconded by Canada and then more modest growth internationally. But there is -- if you look at rig count and completions, and some of the things we traditionally looked at, there's been a decoupling in terms of customer budgets from those numbers for several quarters now. We expect that to persist. And so we're guiding -- we're given this our best effort of what we think the growth's going to be. And like I said earlier, to see the kind of gross margin progression we've delivered and to continue to kind of prune the business and pull out costs where the value is not being added, we've walked away from probably $30 million in revenue. So that would be 2% or 3% more revenues that we would've enjoyed in 2022, but that we wouldn't have benefited from the bottom-line. So I think that's a good range and it depends on how the year flows, and so I think we're sticking with that. I don't think it's conservative. I think it's certainly at the top end is a pretty strong number.

And then last one for me, you expect to generate free cash in 2022. Do you think you can do better than the 25 million you did in 2021, and how does working cap consumption work into that outlook?

I think it's in that range. I mean, the one wild card there is in the seat and timing of inventory -- this is what kind of the one thing driving, whether that'll be more or less than $25 million, but I think we can beat 25 million. There are scenarios where we're ahead of that, and scenarios where we're a little bit behind it, but we do plan to be well prepared for the growth in the coming months.

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

Okay. Thank you for interest in DNOW. And I look forward to talking to everyone on our first quarter call in May. Have a good day.

Thank you, ladies and gentlemen for participating in today's conference. This concludes our event. You may now disconnect.