Hello, and welcome to the NOW Incorporated First Quarter 2022 Earnings Conference Call. My name is Emily, and I'll be your operator for today's call. [Operator Instructions] I will now turn the call over to Vice President, Marketing and Investor Relations, Brad Wise. Mr. Wise, you may begin.

Thank you, Emily, and good morning, and welcome to NOW Inc.'s First Quarter 2022 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 this 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 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 for 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 may be found within their 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'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. Please refer to the reconciliation of each of these non-GAAP financial measures to its most comparable GAAP financial measure in the supplemental information available at the end of 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 first quarter. A replay of today's call will be available on the site for the next 30 days. We plan to file our first quarter 2022 Form 10-Q today and will also be available on our website. Now, let me turn the call over to Dave.

Thanks, Brad, and good morning, everyone. What a great way to kick off 2022 with the results our team delivered in the first quarter. Today marks just over a third of the way through the year, and I’m encouraged by the momentum building inside DNOW. We are pursuing and capturing desirable market share and significantly improving the earnings power of the company. Over the past 2 years, we have focused on transforming our business with a relentless focus on serving as the connector or critical link of global manufacturers to our customers in providing the products and services they require in a moment of scarcity and pronounced supply chain uncertainties. 2 years ago, at the depths of the downturn, our organization made bold commitments to deliver durable, significantly better financial performance and placing our customers at the center of everything we do. We were selective and became intentional around the suppliers we support in order to improve product availability for our customers and to reduce inventory risk while enhancing gross margins through the cycle. We focused on protecting valuable market share, driving growth and aggressively pursuing financial fitness. And you could see how this transformation has reshaped DNOW and ultimately our financial results. We are reminded, especially in this pivotal geopolitical moment, that the world needs energy. Economies require it to grow, and it is a critical source for national security. We said we would win the market by continuing to increase sales and market share from the careful cultivation of a world-class sales team. We would provide unmatched customer attention with the bias towards solutions and value without relying on price as lure. We said we would simplify our business to regionalize project fulfillment, supplier selection, inventory, procurement and management, and product and project pricing. We transitioned to a…

Thank you, Dave, and good morning, everyone. Total first quarter 2022 revenue was $473 million, a 9.5% increase or $41 million in growth over the fourth quarter of 2021. On a year-over-year basis, we not only saw strong first quarter 2022 performance with revenue growth of $112 million or 31%. We also emphatically improved our profitability with quarterly EBITDA improving $25 million to 5.9%. The U.S. revenue for the first quarter 2022 was $334 million, a 10% increase or $31 million higher than the fourth quarter. Year-over-year, U.S. revenue increased $82 million or 33% from the first quarter of 2021. The U.S. market continued to see increasing U.S. rig count, continued depletion of DUC inventory and a modest sequential increase in completions activity. Our U.S. energy centers contributed approximately 79% of total U.S. revenues in the first quarter, and our U.S. process solutions contributed the balance of 21%. Turning to Canada, for the first quarter revenue was $82 million, up $10 million or 14% from the fourth quarter of 2021. And year-over-year, Canada first quarter revenue increased $24 million or 41%. International revenue in the first quarter of 2022 was $57 million, flat sequentially and up 12% or $6 million compared to the same period of 2021. The stronger U.S. dollar relative to foreign currencies unfavorably impacted sales by approximately $2 million compared to the first quarter of 2021. First quarter gross margins were resilient in the period at 22.6%, above the 21.9% record gross margins benchmark set by the full year of 2021 and above our expectations. Warehousing, selling and administrative expense for the quarter was $84 million, down $7 million sequentially. The strategic actions taken late in the fourth quarter of 2021 were fully visible on the WSA line as we successfully increased efficiency throughout our network while…

Thank you, Mark. We have a strong balance sheet, zero debt and an enviable liquidity position to support organic growth and strategic M&A opportunities. We are maintaining a disciplined approach as we continue to vet opportunities that support our overall growth strategy, generate accretive EBITDA margins, enhance our competitive position and differentiation. We are in various stages of conversations or negotiations, and while we're hungry to do smart deals, expectations around valuations by sellers in this market require patients and finesse in making the right long-term investments for our shareholders. And now turning to our raised outlook. For the second quarter, we expect sequential revenues to increase in the low to mid single-digit percentage range, with EBITDA to revenue flow-throughs expected in the 10% to 15% range. Salary and wages to attract new hires and retain our top talent, and increases in health care costs are expected to impact warehousing, selling and administrative expense in 2Q. While drilling the completion activity in the U.S. continues to expand, we will see a simultaneous seasonally slower second quarter breakup period in Canada. We usually see a DNOW 2Q sequential revenue decline, but strength in the U.S. market should allow for overall growth despite both seasonal Canadian headwinds and winter storms in the north earlier in 2Q. We are raising total company guidance for the full year 2022 with revenue to now increase 20%, with EBITDA to revenue incrementals approximating 20% compared to full year 2021. This is a meaningful upgrade to the forecast with strong bottom line earnings implications. As Mark demonstrated and the numbers reflect, we are really pleased with the significantly improved flow-through profile. We believe full year 2022 gross margins could approximate 2021 gross margin percent levels or better. With our strong performance in the first quarter, we are raising our gross margin expectations for the full year to be in the 22.0% to 22.5% range. Overall, product mix, availability, project size and timing and product and wage inflation, all impacting where we land within our guide -- our guidance. And now I would like to provide recognition on an accomplishment, which makes us very proud, one that impacts all our employees, their families and our customers. We have been working on improving workplace safety and making it a key aspect of how we work. I’m proud to announce that DNOW globally has produced a lower than one total recordable incident rate, or TRIR, 2 years in a row, which have represented the lowest TRIR in DNOW's history. These results were made possible by the prioritization of our safety program at all levels of the organization due to a renewed focus and diligence by our employees. I'm proud of the work we have done in improving safety and the strides we are making in our safety culture that we have invested in and will continue to build upon here at DNOW. With that, let's open the call for questions.

[Operator Instructions] Our first question today comes from Nathan Jones with Stifel. Nathan, your line is open.

Good morning, everyone.

Good morning, Nathan.

I wanted to start off with a question about cash flow. Typically, at this point in the cycle, the business would be a pretty heavy consumer of cash. And despite the improved growth outlook, you're still talking about being positive on cash flow this year. I know there are a multitude of things that contribute to that in the improvement in the operations of the business. Would love to get some detail on what the major things are that have improved and that have structurally changed in the business over the last 10 years that will allow you to produce positive free cash flow despite the big growth numbers in '22?

Okay. So here are some of the changes that have taken place that improve our ability to produce cash even in a year where we'll probably see revenues expand beyond $300 million versus the prior year. So if you look at our working capital velocity over the last couple of years, it's gotten to be in the 12%, 13% where working capital, excluding cash as a percent of revenue has been in the 12% to 15% range. That allows us to turn working capital 7x or 8x a year. So there's so much more velocity or the cash conversion cycle is so much lower that enables us to invest less cash in the balance sheet even as we grow. Our earnings profile. Mark talked about how and I think it was the third quarter of 2019, we produced EBITDA of $28 million, but we had hundreds of millions more in revenue and a lot more expense associated with delivering $28 million in EBITDA. So we're a leaner organization or a leaner organization with ample inventory to see growth, but a lot less inventory we had the last time we produced $28 million in EBITDA. We have more facilities closer to our customer. However, some of them are smaller today because we've kind of changed what each location does in terms of servicing the customer. So working capital velocity, the timing aspects as well, Nathan. So we said we'd probably consume half a cash in the first part of the year, first half, and we do expect to grow in the second and third quarters. The fourth quarter might be a little light, so we might get some relief on the accounts receivable side. But I think it's how we manage our balance sheet, where we distribute risk. So, we won't have 2,000 items stocked in all the branches anymore, we will tend to regionalize that risk and have an expert approach to managing that inventory. So I think those are the main things driving it. Plus, finally, while we engage thousands of suppliers to take care of our customers for the main brands and the most important commodities to our customers, we have really focused on fewer suppliers where we would have better costing, better freight privileges, return policies, et cetera. So even as things slow down, we could substitute other projects -- products and get idle inventory off the book. So all that coming together means improved P&L performance and the chance, and we feel pretty good about generating cash in 2022.

Thanks for that. I guess my follow-up on capital allocation, and you touched on it here, you obviously have the low firepower and the balance sheet. But historically, during these up cycles has not been the most -- the best time to buy assets. Typically, it's been when the markets are generally lower. Maybe you can just talk about how you're thinking about that? Does it mean you're less likely to consummate some deals this year and next year, given the market size, sellers expectations for prices are going to be higher. Are you better off kind of just sitting on the cash for the time being and waiting for better opportunities?

There's no doubt in my mind that we will close acquisitions this year. Now the ones on the table right now are smaller. And to your point, we tend to be able to buy at lower prices in a downturn. But there are opportunities out there. We've got some we think, we could close pretty soon. They tend to be small right now. But we have plenty of cash and a strong balance sheet, and we are very active looking for deals. We made two acquisitions last year, and I think we will do that or better this year. So we are -- but you know how that goes. We are -- it's not -- never done until it's done, but we'll make acquisitions this year. Now I often get the question about are there other ways to return cash to shareholders, and we do discuss other options as well as a possibility. And while we believe we will produce cash, this market can get even stronger. And so we do have a reserve amount of cash we want to hold on to, to seize growth, to equip our locations to take market share and to grow the business at high margins. So I think we've got a lot of flexibility, but we are actively pursuing acquisitions right now.

And just one more. I wanted to ask about rig count versus DUC count. We've seen the rig count go up, but we've also seen the DUC count go down considerably as low as it's been over the last at least decade. Does that pertain for an even bigger increase in the rig count here? Are your customers telling you that they're looking at deploying more rigs into the market as these uncompleted wells are pretty rapidly disappearing?

Yes. I mean I think we like to see a lot of DUCs there because it's kind of a backlog for us as those DUCs are completed it provides immediate revenue opportunity. But as those DUCs are depleted, I think the future opportunity for increased spending by our customers is out there. Now it's hard for us to gauge what that impact will be when it takes place. But we think the reduction in DUCs means our customers will spend more in the future should the economy continue to expand like this.

Great. Thanks. I will pass it on.

Thank you, Nathan.

Our next question is from Tommy Moll with Stephens. Tommy, please go ahead.

Good morning and thanks for taking my questions.

Hi, Tommy.

Dave, I want to start on the regionalized fulfillment strategy. You've given us several updates today and you have in recent quarters. But my real question is how far into that rollout are we -- are you pretty well there or is there more to come?

Yes. I think by the end of this year, we probably will have stood up 5 supercenters. So I think we are -- we are not done, but we’ve largely hit that -- we’ve hit the hottest areas. It will be Houston, Casper, Wyoming, Odessa, Williston and then a new supercenter in the Edmonton area in Canada. So those will hit the hotspots. Now some of our larger branches and some of them are really large, tend to serve in that capacity as well. But I'd say we are more than halfway done with that process. Just for some color on the benefits from the supercenters, they're not really warehouses. They're singular customer-focused enterprises. They tend to be large in big areas where we really push project. The project business, which was usually handled by all the branches to regional areas. The opportunity there is we can have project inventory in fewer places. You can have -- push more volume in one location and reduced operating costs for each transaction. And because we have products available in abundance, we can command better margins. So I think we are more than halfway done. We are really seeing the benefits of that strategy. And I want to say that we also want to maintain proximity to customers. So we are not in -- we are not in a cost-cutting mode. We are in efficiency gaining mode. We want to keep our branches open and close to our customers and kind of form that model differently as we go into the future.

Appreciate that, Dave. Shifting gears to your WS&A line. I think, Mark, I heard you say in the prepared remarks, we should expect in dollar terms, maybe up a few million dollars into Q2. But if you could just clarify whether I heard that right. And then more broadly, just wanted to refresh on overall philosophy there on WS&A in an up cycle. So as revenue grows, how do you think about the rate of growth there for WS&A?

Sure. Yes. And I did mention in the prepared remarks, you're right, a couple of million dollar build into 2Q. We ended last year kind of expecting 1Q to come in around $86 million, similar to how it was in 3Q '21. And clearly, we were able to beat that. And one of those was related to some tailwinds, which are going to erode here likely into the second quarter. And then Dave talked about some of the inflation items hitting that number. But I think the amount of efficiency we pulled out of the business, especially if we're talking about 2022 to 2021 in those flow-through numbers in the guide, it has a very low percentage increase in WSA to -- in those models. And so I think we are positioning ourselves with the guide number to have kind of moderated WSA growth into -- clearly into next quarter and then that could continue into the second half some.

Yes. I think one way to look at it, Tom, is as we kind of do our internal modeling, we are calling for revenue to go up 20% year-over-year. And we might see WSA for the full year go up 1% to 2%. One thing that we are facing like every other company is, we are seeking talent to grow the business, to upgrade our skills, to improve our -- increase the staffing for our sales force and our technical salespeople, et cetera. And that comes with the cost. So we are seeing -- while we are seeing product scarcity and product inflation, we are seeing scarcity of people to help grow our business. So that's going to have some headwinds. But just to put it in perspective, we might see revenues grow 20% and WSA full year grow 1% to 2%. So we are still very much on an efficiency track, but we are also very, very much wanting to make sure we have the people and the products close to customers to grow this business. That gives you kind of some additional context on our thinking along expenses in the business.

Yes. Thank you. And if I could toss one more in here, high level, just looking at the commodity environment. I think it's safe to say we're in a fairly robust part of the cycle here.

Yes.

That said, we are coming off a very low base from 2020, 2021. So maybe commodities have run quicker than the opportunities have been realized for yourselves and others selling into the oil and gas end market. One way of saying, is there not an embedded call option on pricing for your business at this point? I understand that you can't realize price one for one with commodities in real time, but it does appear that there's some substantial upside potential, if not this quarter or next quarter, just over the reasonable planning horizon here.

Well, I think so. I mean we went through each of the quarters last year with gross margins beating what we expected. And -- but we did guide down gross margins, which were driven primarily by pricing secondarily by rebates, which we kind of topped off in the fourth quarter, we expected gross margins to come down and they did. I do think there's more opportunities for price appreciation, but it depends on the rate of growth and our customer spending depends on supply and demand, balance for product availability and competing factors. But could there be greater price depreciation in what we've guided to possibly. But we expected a decline in the first quarter, and we saw it, but we are upgrading what we expect for full year gross margins.

I appreciate it. I will turn it back.

Did that answer your question? Okay. Thank you.

It does. It does, yes.

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

Thank you, Emily. Thank you for your interest in DNOW, and we look forward to talking to everyone in the second quarter. Thank you.

Thank you, everyone, for joining us today. This concludes our call. You may now disconnect.