Hello, and welcome to the Fourth Quarter and Full Year 2020 Earnings Conference Call. My name is Cheryl, 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] Please note that due to the recent severe weather conditions, if the speakers and the call get disconnected please standby and we will work to reestablish their connection. I will now turn the call over to Vice President, Marketing and Investor Relations, Brad Wise. Sir, you may begin.

Good morning, and welcome to NOW Inc.'s Fourth Quarter and Full Year 2020 earnings conference call. We appreciate you joining us, and thank you for your interest in NOW Inc. Please note, should there be connectivity issues during the current severe weather conditions in the Houston area, I wanted to remind everyone listening today that a replay will be available through our website later today. Now 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 responses to your questions, may contain forecasts, projections and estimates, including, but not limited to, comments about the 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 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 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 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'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 on each of these non-GAAP financial measures to its most comparable GAAP financial measure is included within 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 and full year. As I mentioned at the top of the call, a replay of today's call will be available on the site for the next 30 days. We plan to file our fourth quarter and full year 2020 Form 10-K today and it will also be available on our website. Now let me turn the call over to Dave.

Thanks Brad. Good morning, everyone, and thank you for joining us. Before I get into strategy and talk a bit about the quarter, I want to take a moment to thank our employees and acknowledge their hard work, their dedication to serving our customers and supporting our key suppliers, for making safety a priority and for their perseverance overcoming a year that few will remember fondly. It goes without saying 2020 was a year of change. But as we round the corner, my view is one of expanding opportunities and optimism moving from a period of duress to a period of stabilization and growth. DNOW stands in a cherished financial position and is on firm footing. This is no longer a moment of extreme uncertainty and concern, but a period of promise, prosperity and possibility. Our focus is on providing the market with the innovative solutions and products to power the world for a sustainable future. What this means is we will be a trusted partner to help our customers unlock the power of energy and pursue sustainability by expanding our innovative solutions in support of our customers' ESG goals. Last year, we laid out a strategy to recompose our brick-and-mortar infrastructure. As we transition away from a distribution model tuned to a 2,000 U.S. rig environment to a model suited for 400 rigs cognizant that our customers are consolidating and driving procurement centrally and that consumers and companies buying habits have changed abruptly. These changes necessitate that our fulfillment design will continue to transform. Our branches will be smaller, leaner and utility oriented, which means stocking the staples our local customers expect, but not stocking locally, speculative items or quantities for projects or large dollar orders. We are laying the groundwork for long-term profitable growth by standardizing the branch…

Thank you, Dave, and good morning, everyone. As Dave mentioned, we entered 2021 with relief and optimism, relief that one of the most difficult years in the Company's 159-year history is behind us and optimistic for our future given the significant actions taken and underway. We are encouraged by the recent worldwide deployment of COVID-19 vaccines, improved crude oil prices and the progress we are making on our strategy. For the fourth quarter of 2020, our revenue outperformed, our guided revenue percentage declined of high single digits, with revenue of $319 million or down 2% sequentially. The U.S. segment fourth quarter 2020 revenue was $224 million, down $4 million or 2% from the third quarter of 2020. As our traditional 4Q headwinds of fewer business days, extended vacations, customer budget exhaustion plus COVID impacts were partially offset by increased rig count and completions activity. Our U.S. energy branch revenue was up 1% from the third quarter as we captured increased drilling and completion activity during the end of the fourth quarter, partially offset by the expected seasonal declines due to less billing days and customer activity around the holidays. U.S. Energy revenue accounted for 81% of the U.S. segment revenue in the fourth quarter compared to 79% in the third quarter of 2020. Our U.S. Process Solutions revenue was down 13% from the third quarter mainly a result of seasonality and customers' continued order deferrals as they draw down their surplus pumps, vessels and fabricated inventory. With the increase in rig and completions noted at the end of the fourth quarter through today, we began to see some life from customers in terms of future activity increases and project work. Both should create opportunities for pump and vessel orders in the first half of 2021. In our Canadian segment, fourth…

Thank you, Mark. And now I'd like to shift the focus to the first quarter. Looking ahead, there is cause for optimism with oil trading in the high $50 range and North American activity continuing to improve, playing off fourth quarter momentum. In the U.S., companies continue to add rigs and frac spreads, but some customers seem restrained as they meter rapid production growth in favor of returns to shareholders. We expect midstream gathering systems to follow suit, favoring modernization projects over capacity expansion. Domestic refinery runs are currently at their highest since the start of the pandemic. We expect the U.S. to improve sequentially in the first quarter as customers complete recently drilled wells, convert DUCs than build out tank batteries and gathering systems. The Canadian market continues to be structurally challenged with the Keystone XL pipeline paused again in the heavy oil coming in by rail. However, the current market we do expect sequential improvement in revenue as we build on our market presence and capture increased activity with our customers. Internationally, the visibility is uncertain into the first quarter as we await an inflection point to start a recovery and therefore, guide international revenue lower sequentially. The global uncertainty related to COVID-19 and the possibility of future industry and economic volatility certainly temper our ability to forecast deep into the year. As more vaccines are administered we expect greater energy demand, yet the pace of vaccines remain slow, thus the impact on a full year outlook remains cloudy. Except for unknown weather impacts related to the current deep freeze in the U.S. 1Q '21 DNOW sequential revenue could expand into the mid- to high single-digit percentage range. In closing, I'm encouraged by the DNOW transformation underway and its success to-date, although the global COVID pandemic has had…

Thank you. We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from Jon Hunter from Cowen. Your line is now open.

So my first question is just as it relates to your guidance for the first quarter of up mid-single to high single digits sequentially. It seems like that doesn't include any impact for the weather that we've seen just recently here, so curious if you've attempted to kind of quantify what kind of impact that may have on your outlook? So that's the first question. And then the second one is, just as it relates to the guidance you put out there for the first quarter, how are we tracking so far either through the end of January or currently through mid-February here? Thanks.

You're welcome. Okay. So in terms of the weather impact, so right now, we have about 60 locations closed, which will probably be three or four days closed due to lack of power, lack of water, either in the business location itself or for the people that work in those locations, same for our customers. So, we came into this earnings call expecting, like we said in our guidance that we'd see sequential revenue growth in the mid- to high single digits. But I qualified it in the language as it relates to this weather snap. It's a pretty destructive one. We will lose revenues for several days. They'll be diminished significantly for several days. We don't know to what extent we'll see some sort of snapback, the necessity for more valves and more repair commodity products that we sell that could help us on the positive side. We don't know if that would be enough to make -- to fill the gap for the revenue shortfall in the meantime. So we kept stuck with our guidance, low to mid sequential improvements because we think things will improve in March, for example. Now in terms of how are things going, January actually was a little lighter than December, December end ended up being a pretty good month in the fourth quarter. I never expect December to be a strong month, but December, interestingly, was a little bit better than October, November. And January, it was a little down. February is tracking along the lines of January, but March is a good long month. We'll be out of the weather doldrums. We'll start to see matriculation with vaccines and forward progress there. So, I think we can get to the guidance we talk about. But the weather impact, we just we don't measure that. And by the way, someone's telling me that I said low to mid, we gave guidance low to mid. The guidance was mid- to high single digits with the qualification that weather impacts could impact that number. Did I answer that?

Yes, yes. That's helpful. And then next one is as it relates to gross margins. Obviously, you had the elevated inventory charges here. How should we think about the level of inventory charges going forward in 2021 and your ability to get to 20% plus gross profit margins and whether that's in you think you can get there in the first quarter, second quarter? Or is that later on in the year?

Okay. That's a great question. So I just want to give some color, which we didn't include in our opening remarks. Our EBITDA loss for the year, I think, was around $56 million, which includes the negative impact of inventory charges of about $54 million. So if you -- I think those are good numbers, Mark?

Yes, $57 million for the year.

Okay. So, this is the worst year in history, perhaps since the great depression in terms of the impacts to the energy industry, and if you take out those inventory charges, we broke even. Now we don't take out inventory charges when we compute EBITDA because it's a valid expense as it relates to this business. But we went from an environment where we had 800 rigs in the U.S., 2,000 rigs globally. And since then, we've seen 50% to 70% rig declines around the world. So I first want to say we did awesome job in converting inventory to cash and dealing with the blowback of going from an environment like that for the market, the bottom falls out. In terms of answering your question specifically, we won't see $54 million inventory charges in 2021, but they could remain elevated. So in my prepared remarks, I talked about we're still in the transformation mode for this company. We want to have our field network of locations being situated close to our customers, but the utility of those locations will change. I do expect inventory charges to be elevated, but nothing like what we saw in the fourth quarter. I expect them to revert to the mean at some point later year, and generally, we see inventory charges approximating 1% of revenue. They'll be higher than that this year. So later in the year, I think we'll get to a point where we've gotten to rationalize which countries we exit if we exited, which locations we're going to downsize and move? How we stand up our supercenters and situate close to our customers, but with a different inventory backdrop, that will all impact gross margin. So -- but that's a long-winded answer, John, but our inventory charges will diminish, but they could still be elevated as we transform the Company.

Thank you. Our next question comes from Sean Meakim from JPMorgan. Your line is now open.

So Dave, I'd like to touch on margin progression. Gross margin looks pretty good if we back out the impact of those inventory charges, a lot of progress on cost out last year, of course. G&A is guided flat in 1Q. So think about expectations of margin progression, excluding inventory charges as we've covered that and then what is this -- are we expecting kind of a steady state for G&A, and you'll adjust further based on what the market gives you? Think about there's two levers as it pertains to margin progression in '21.

So that's a good question, Sean. So except for acquisitions, so we did a small one, and that will have limited impact on SG&A. So I'm not even go to speak to it, but our WSA should be coming down each quarter, except for acquisitions. So that line needs to continue to go down, and that's going to come from the evolutionary nature of transforming the business. We've done a lot of heavy lifting, a lot of the harder things early in the process, but I expect that number to come down even despite growth in revenues. So that's a challenge for us. Now speaking to what that number is as the quarters progress, we're really only speaking to the first quarter right now. And I think Mark said that, that's basically going to be flat. But the fourth quarter, which was lower than we expected. And I think it was $3 million lower than we expected. So I think we'll be flat in that regard. But to answer your question generally, the WSA numbers should come down each quarter, outside of acquisitions, and there are some things like pipe prices that will impact product margins. But like we've said for several quarters now, our pricing and our product margins have been really resilient. So I think there could be some lift there. Now to the extent we do large projects, you know that projects would drag down margins a little bit. But I'm pretty comfortable that product margins will remain resilient. It's just a matter of what kind of inventory charges will endure in the coming quarters. So that's kind of the cadence. Increased revenues will give a little more flavor to that in the next 90 days. Hopefully, we'll be in a much better position to guide the rest of the year. But that should be the trajectory, continued reduction in operating costs in WSA flat to improved gross margins and elevation and revenues as well.

Understood, that's helpful. And then thinking about working capital, you've generated a lot of cash last year. I think that's expected given the countercyclical cash flow profile of the business, your working capital metrics at the moment or also helped somewhat by those inventory write-downs, right, and about 1/4 of the reduction in inventory over the past year, we've talked about that issue. So if we're generating, let's say, nominal EBITDA and we're growing volumes. There's likely some reinvestment required in working capital, as just receivables but also getting in the right inventory. What's your confidence level about generating free cash in '21?

Okay. So if you look at our inventory balance, and you're right, I mean I think Mark cited our working capital, excluding cash as a percent of revenue, about 15%, 16%, which is a very low number. You add back the $24 million in inventory charges. Of course, it gets closer to 18% or 19%. But that's still -- that's turning working capital five times, that's solid. To the extent we see revenue growth, and we're forecasting that in the first quarter, there's a lot -- we're going to start rebuilding our inventory. We're in a pivot mode, where although we're going to see -- we're not speaking to revenue inflection beyond the first quarter. We're going to see some revenue build and our stocks. Our shelves are pretty not bearing, but we're ready to replenish. We're going to see -- we're going to consume cash as it relates to inventory as it relates to receivables, and we could consume cash, not generate free cash flow as early as the first quarter. So that's how I see things going. Now, if the revenues are flat, we could generate cash quarter-to-quarter. While we're not forecasting that and we're hoping against it. We're hoping we see revenue growth, and we're hoping we have the right planning in place to get ahead of demand to make sure we have the products our customers need at the right cost for us so we can maximize gross margins. Mark, do you have anything to add on that?

No. I think as you pointed out, the metrics at the end of the year were record efficiencies on working capital.

So then adding back the inventory charge to, Sean, is a good one.

Exactly. And so, I think you're right, the easing there on some of those metrics. And we actually have the cash to fund that growth that Dave mentioned to make sure we do have that inventory deployed. So, I think that's free cash flow generation for us is really just the stellar job in the past 12 months by our team.

So just to put a button on it, would you be able to give us a sense, a target of working capital of sales exiting '21. So we don't quite know the sales number. That's not -- there's some uncertainty in terms of what volumes look like. So, how about a target for working capital sales exiting '21?

Yes, I think it's going to be -- it will be around 20%. Now, let me give a little color on that. So we'll be prepositioning inventory. So, you could see that working capital to revenue ratio will be higher than 20%, but it should kind of gravitate towards that number. But in the early parts of recovery, we'll stock up, we'll see receivables grow and those ratios going to extend a little bit. We'll curb that in several quarters into the future, but it will be around 20%, Sean, maybe a little higher.

Thank you. Our next question comes from Nathan Jones from Stifel. Your line is now open.

I have a follow-up on the WSA side of this. Dave, as we've gone along through this recession here, have targeted being at least breakeven and maybe profitable at the bottom of cycles. If we're looking at the second half of '20, run rate of revenue is about $1.3 billion in the second half of '20. Let's say, 20% product margins, would mean that you'd need to get down into probably the mid- to upper 60s on WSA. And you've talked today about continuing to drive that number down. Is kind of getting that down under $70 million, a reasonable target as we go through 2021?

Yes. Certainly not -- let me speak to what we've guided. We've talked to about the first quarter, and we won't get to $70 million in the first quarter. Mark has given some color there. It depends on the revenues. I mean, my gut response is, no, we won't get to $70 million this year, in part because we're going to be layering -- I hope to come to you 90 days now and say, we did another deal, and I hope it's a bigger deal. Except for that getting to $70 million this year, I don't know as possible. If we did, if we got to a level that low, you'd see more inventory charges because we would more quickly, push that transformation envelope. I'm going to give a little color there, Nathan, because we've done a lot of things in the last 12 months. And I said on a three or six months ago that I want to take this journey with our customers. I want to retain those relationships with our customers as we do some pretty tough stuff to the business. So getting down to $70 million in EBITDA, I don't see that happening in 2021. It's possible. But right now, we don't have a forecasted number of that low.

That helps. And I guess my follow-up question is, you've made a real transformation to the business model here with less inventory at local locations, more essentially held, more online, which means that we're probably not going to see costs to return to the business in the same way that they have done in past cycles. So maybe you could give us some help on how you envision WSA coming back into the business, kind of how much revenue could you layer on to where you're at today, where you're going to get to in 2021 before you really have to add some costs back? And then maybe if you've got any idea of incremental dollars of WSA per dollar of revenue growth as we get out further? Because my assumption here is that, that's going to be lower than what it's been historically.

I agree completely. So, they'll be -- we've experienced late 2016, 2017 and '18, kind of an uneven recovery. So, we added locations. We added people. We'll see that similar phenomenon going forward. But on an incremental basis, for example, we just opened a branch in Canada because we believe we're taking market share there around the offense, and we're going to add costs where we need to. Now there are other parts of Canada, where we're still pulling out costs, and we'll continue to do that. But generally, as we add revenue dollars, almost all of those gross margin dollars should go to the bottom line. We generally historically have flow-throughs EBITDA to revenue in the 10% to 15% range. The WSA increase with each revenue dollar should be $0.02 to $0.05 or less because we should see flow-throughs in the 15% to 20% range. So I said earlier that I expect WSA is not a perfect every quarter on a perfect every quarter basis, but to come down quarter after quarter even as revenues grow. So, I expect really strong flow-throughs nearing that 20% level.

Ladies and gentlemen, we have 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 closing statements.

Okay. Well, thank you, everyone, for joining us. Thanks everyone listening on the call who prepped us without having power and water and all the hard work done giving this here, but thank you, everyone. We'll see you next quarter. Thank you.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for your participation. You may now disconnect.