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NOW inc (NYSE:DNOW) 2021 Third Quarter Earnings Conference Call, November 3, 2021, 9:00 AM Eastern Time

Good morning, and welcome to the DistributionNOW earnings conference in the third quarter of 2021. My name is Brandon, and I will be your operator today. [Operator Instructions] I will now transfer the call to Brad Wise, Vice President of Digital Strategy and Investor Relations, and you can start, sir.

Brad Wise-Vice President of Digital Strategy and Investor Relations

Well, good morning. Thank you, Brandon, and welcome to the NOW Inc. 2021 third quarter earnings conference call. Thank you for joining us, and thank you for your interest in NOW Inc. With me today are David Cherechinsky, President and Chief Executive Officer; and Mark Johnson, Senior Vice President and Chief Financial Officer. We mainly operate under the Brands of DistributionNOW and DNOW. You will hear us mention DistributionNOW and DNOW in our conversation this morning, which are our stock symbols on the New York Stock Exchange. Please note that some of the statements we made in this call, including answers to your questions, may include predictions, forecasts and estimates, including but not limited to comments on our company’s business prospects.

These are forward-looking statements within the meaning of the U.S. Federal Securities Act and are subject to change based on limited information as of today. They are subject to risks and uncertainties, and actual results may differ materially. No one should assume that these forward-looking statements are still valid later this quarter or later this 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 during the live call. I recommend to you the latest forms 10-K and 10-Q now filed by NOW Inc. with the US Securities and Exchange Commission to discuss the main risk factors affecting our business in more detail.

More information, as well as supplementary financial and operational information, can be found in our earnings release or on our website ir.dnow.com or in the documents we file with the SEC. In order to provide investors with more information related to the results determined by the US GAAP, you will notice that we have also disclosed various non-GAAP financial measures, including EBITDA, excluding other costs, sometimes called EBITDA; net income, not Including other expenses; and diluted earnings per share, excluding other costs. Each item excludes the impact of certain other costs, so it is not calculated in accordance with GAAP. The reconciliation of these non-GAAP financial measures with their most comparable GAAP financial measures is included in our earnings release.

As of this morning, the investor relations section of our website contains an introduction to our quarterly performance and key points. In the next 30 days, a replay of today's conference call will be available on the website. We plan to submit the 10-Q form for the third quarter of 2021 today, which will also be available on our website. Now let me transfer the call to Dave.

Dave Cherechinsky - CEO, President and Director

Thanks, Brad, good morning everyone. First of all, I would like to thank the thousands of DNOW women and men around the world for successfully connecting the manufacturers we support with the customers who rely on us to power the world for a sustainable future. Things are challenging in many ways. The surge in COVID, labor and material shortages, rising transportation costs, and changing political victories. Despite these factors, our performance is still very good.

We see strong demand this quarter, especially in North America. The service we provide to our customers is outstanding. We are using our scale to modernize our geographic footprint and demonstrate agility because we put our customers at the center of every dollar we invest. Our goal is to always be in a good position to help our customers achieve their goals and solve their problems. Although the supply chain environment is under pressure, we are confident in our skills to deal with the ever-changing dynamics. Faced with labor and material shortages, we provide quality services and help our customers minimize interruptions. As the market expands further, we are investing in inventory to seize the growth.

Although we have dealt with the tight supply chain and labor shortages well, the impact of these interruptions on revenue in the third quarter of 2021 will be greater than in the previous quarter, especially in the field of steel pipes and American process solutions. These trends seem to continue in the short term. To solve these problems, we rely on technology, alternative supply sources, and branch initiatives to improve productivity and order fulfillment. With lingering supply chain bottlenecks, the extent and speed of recovery will depend on the impact of COVID, customer budget discipline, ESG initiatives, and the availability of capital, labor, and products.

We have taken action in a constantly changing market, and we see a bright future for DNOW and our customers. Domestically, public E&P spending moderation encourages private E&P to stimulate operations, driving nearly 80% of the increase in the number of rigs in the United States in 2021. The third quarter of 21 was a very good quarter. We achieved a 10% quarter-on-quarter revenue growth and reached our mid-term goal. Single-digit income guide. We achieved a record quarterly gross margin percentage, which promoted a relatively smooth higher-than-expected flow of warehousing, sales, and management expenses. Later, I will introduce how pricing and gross margin drive our strategy. We achieved an EBITDA of US$15 million or 3.4% in revenue of US$439 million.

In terms of background, looking back at another year of recovery in 2017, DNOW's revenue exceeded US$2.6 billion, but the full-year EBITDA was only US$7 million. In contrast, we generated US$439 million in revenue in the third quarter of 21. Compared with the full year of 2017, 1/6 of revenue is more than double the EBITDA US$. This is a major achievement and main fulcrum, allowing as a by-product of the modernization of our fulfillment model, greater increments, a more streamlined supply chain, and reduced inventory risk. In the worst recession in history, we quickly took joint action. These achievements prove the hard work of our employees and the focus and determination of our management team to execute the strategy by adjusting the scale of DNOW and reshaping our strategy for the current and future markets.

Although some of our revenue engines are not operating at full speed, we have achieved these results. For example, projects in the US midstream market are still relatively low-key. As the pandemic has affected the demand for oil and natural gas and reduced the withdrawal of some OPEC supplies, international growth has continued to slow. Many carbon management energy transition projects are still in the early planning stages. DNOW has many PVF and engineering solutions that provide future revenue opportunities. As one or more of these cylinders start to start and activities are realized, I believe they will do so, and this will be a tailwind for DNOW's revenue and bottom-line results.

We believe this has laid a good foundation for the stronger 2022 we expect. There are now some regional-based comments. In the United States, revenue has continuously increased by US$16 million. Due to drilling and well completion activities and favorable profit contribution (mainly from steel pipe inflation), US energy revenue has continued to increase. The increase in onshore contracted drilling rigs this quarter was mainly led by private oil and gas producers. DNOW is actively targeting customers and making positive progress. With the sales of drilling, well completion, gathering and transportation pipelines and joints to oil and gas producing areas, our product line sales across the United States have achieved extensive growth.

A significant part of the joining plan is for well sites close to facilities with additional processing capacity, which means that some of our producer customers’ capital expenditures on each well site are lower than in the past, at least for now. Market share increased in the quarter, including a major operator in the Permian, whose drilling rigs remained flat continuously, but revenue from the construction of central fuel tank batteries increased significantly. We expanded PVF sales through several EPCs that built tank batteries in New Mexico, Delaware. Also in this quarter, we focused on private operators and executed several MSAs, which will open up future growth opportunities for their Permian assets.

Through PVF, we have increased the market share of building facilities for private producers and several pipeline sales with a gas utility company. In the downstream field, we provide PVF to a number of chemical processing companies for plant maintenance and major valve upgrade projects in inland oil refineries. In order to emphasize how customers can use our mobility-based technology solutions to improve point-of-sale efficiency, we implemented a customer on-site inventory solution, where customers can access our DNOW app via mobile phones to purchase materials. Customers can also contact our local branch through the mobile application, and the following orders can be picked up or delivered. Turn to American process solutions. Revenues increase in turn with the increase in drilling operations and completion activities due to DUC pressure drop, which creates a higher demand for our prefabricated engineering equipment packages and pump packages for fluid handling.

Engineering packaging units were shipped to the Permian, Eagle Ford, Rocky Mountains, Powder River and Bakken. Products include various ASME pressurized vessels, including heater processors and separators, and oil delivery skids. As the demand for LACT devices, pipeline mixing skids and water delivery devices increased during the quarter, activity in the midstream and water management markets is increasing. In the downstream field, we have provided a large number of pump sets for the refinery applications in the Northern Rockies, and delivered a large number of valve orders related to the Wyoming soda ash project. In terms of municipal water supply, as projects in this end market begin to receive attention, we have seen an increase in the level of quotation activity for pump packages. In the after-sales market, we see a rebound in demand for pumps and air compressor field service products. Our field service work drives the sales of parts and labor, which brings considerable profits to our basic distribution business.

In Canada, revenue in the third quarter was US$68 million, an increase of US$17 million or 33% from the previous quarter, due to seasonal splits leading to continued market share growth. Selected heavy blends in Western Canada averaged US$57 per barrel this quarter, which is stimulating bullish sentiment over the increase in capital expenditure budgets and project activities of major oil sands producers. In addition, with the increase in natural gas prices, the macro is ready for more projects to promote traditional midstream growth. Our pre-assembled kits for wellhead connections and laps brought significant benefits to many of our customers during the quarter. Finally, we continue to see the success of our valve and actuator product line, winning multiple EPC businesses, and our goal is many major E&P and midstream operators. For international business, revenue in the third quarter increased by US$6 million from the previous quarter, an increase of 11% to US$59 million.

With the increase in energy demand, OPEC's idle capacity began to shrink, and international drilling activities began to pick up. DNOW is well positioned in key areas and can take advantage of the increased drilling activities through some of our drilling contractor framework agreements. Some notable international victories include the delivery of electrical, PPE, and MRO products to a major upstream oil and gas operator in Iraq based on various project orders. In the CIS region, we successfully won the PPE project order from Kazakhstan, and at the same time won a significant PFF bid in the EPC of Russia. In Indonesia, we provide valves for the EPC of downstream petrochemical facility projects. In Australia, in addition to winning the control valve project award for a major international natural gas producer, it also won shut-off valves and spare parts from major international oil and gas companies. MacLean International delivered cables for an onshore natural gas expansion project to an Australian engineering and construction company, and delivered a solar panel cable order to an Australian customer.

We have been busy securing future business by implementing a number of key framework agreements for our power business, including a three-year agreement with a major oil and gas producer operating in West Africa and a five-year agreement with global EPC. With the acceleration of projects and MRO business, these agreements provide future opportunities to ensure meaningful electrical product revenue. In Brazil, we delivered a large valve order from EPC for an FPSO project produced by a large national oil company. We also took advantage of our Total Valve Solutions products, including our digital valve asset management solution in cooperation with an offshore Brazilian manufacturer. In addition to notable victories from several offshore drilling contractors, we also won valve orders. Now I want to talk about the impact of global supply chain delays and inflation on our business.

With our PVF product line, we maintain a global sourcing strategy. We source from several preferred domestic and imported manufacturers, which gives us the option to proactively manage our inventory availability to meet customer needs when the supply chain is interrupted. Our purchasing team has excellently ensured the high availability of products in these logistics challenges. For steel pipes and some components assembled as part of our engineering process production and pump packages, some of our packaging products experienced product delays, pushing about US$5 million to US$10 million in orders for the fourth quarter of 21 years to the new year .

Turn to our DigitalNOW program. In terms of our digital commerce channel, we continue to increase customer adoption, and now the SAP revenue related to our digital channel in the third quarter exceeded 44%. During the quarter, we attracted many B2B e-commerce customers from midstream industrial and service companies. We continue to work with digital integration customers to further enhance their e-commerce experience by optimizing their product catalogs and developing customized workflow solutions for our shop.dno.com platform. Our technical sales team in the US process solutions business is using our eSpec product configurator tool to generate revenue.

During the quarter, we saw a 48% increase in active users. Recently, we have enhanced the user experience by combining 3D imaging and the ability to view our packaging units in an augmented reality environment. This allows our customers to better visualize the appearance of the finished package from a 360-degree vantage point. We are using eTrack, our asset management lifecycle tool to improve the accuracy of customer-owned equipment counts to enhance traceability and reduce labor costs associated with required monthly yard reconciliations. We are using eTrack in our material management customer engagement to increase productivity and create more value for both parties. Now I want to talk about some comments related to the energy transition.

As we saw in the third quarter, rising oil and natural gas prices are the result of increased demand for energy supply, which requires continuous investment to expand. For DNOW, we are a key part of our customers' ability to safely and efficiently produce and transport energy to the market. The combination of our distributed products and our efficient supply chain service solutions can help our customers achieve lower production costs when producing and transporting oil and gas.

We are investing in expanding our solutions to help our customers reduce greenhouse gas emissions, as well as solutions around carbon capture, storage, transmission and management. In the third quarter, we used eSpec software to promote more meaningful conversations with customers to reduce greenhouse gas emissions, and pointed out the specific value associated with compressed air system solutions that can directly replace methane gas emission systems. In one example, we provide air compressor and dryer equipment packages to manufacturers working to reduce greenhouse gas emissions from gas pneumatic equipment and replace them with compressed air systems. This is a good example of how DNOW can improve customer ESG profiles by helping customers achieve emission reduction targets.

For additional emission reduction solutions, we provide customers with solutions that focus on upgrading pumps and pump seals to minimize leakage and greenhouse gas emissions in the design of tankless batteries. We are cooperating with manufacturers to develop direct carbon dioxide capture projects and specialized carbon dioxide capture and transmission projects. Therefore, we are excited about our core market and also excited about the emergence of new end markets, which enables DNOW to expand our revenue into the future. With this, let me give it to Mark.

Mark Johnson-Senior Vice President and Chief Financial Officer

Thank you, Dave, and good morning everyone. Total revenue in the third quarter of 2021 was US$439 million, an increase of 10% over the second quarter of 2021, and exceeded our guidance for mid-single-digit percentage growth. U.S. revenue in the third quarter of 2021 was US$312 million, an increase of US$16 million from the second quarter, reaching the highest level before the pandemic, due to increased customer activity and a significant increase in product profit contribution. Our U.S. Energy Center and Process Solutions revenue channels increased by 5% and 7%, respectively, of which the U.S. Energy Center contributed approximately 80% of total U.S. revenue in the third quarter. Transfer to the Canadian section.

Canada’s revenue in the third quarter of 2021 was US$68 million, an increase of US$17 million or 33% over the second quarter, as we successfully expanded revenue in the upstream and midstream sectors. Compared with the third quarter of 2020, revenue increased by US$26 million or 62% year-on-year. International revenue was US$59 million, an increase of US$6 million or 11% over the second quarter, mainly due to the increase in project activities. Gross profit margin increased by 60 basis points from the previous quarter to 21.9%. This increase was mainly due to higher product profit margins, as inventory expenses remained relatively moderate this quarter at US$2 million.

The inflation trend in the steel market has affected line pipes and high-steel-content fittings and flanges, driving the growth of gross margins, but we have also achieved profit growth in other product lines, albeit at a smaller rate, because we selectively switch to these Products and solutions that provide DNOW with the greatest value. Inventory costs depend on actions taken to adjust our business model to support current and future activities, including changes in customer demand (volume and preference), tilt or decline in the market, and changes in the specifications of available products. We will continue to evaluate our products and locations to adapt to changing market conditions, customer preferences and our strategy, which may affect future charge levels. In the third quarter of 2021, warehousing, sales, and administrative expenses (WSA) were relatively flat, increasing by US$1 million from the previous quarter. Cost reduction measures did not completely offset the reduction in government subsidies during the same period.

The total amount of government subsidies in the third quarter was less than US$1 million, lower than the nearly US$2 million in the second quarter. We expect these benefits will continue to be phased out in the fourth quarter. With this and other ongoing actions in mind, we do expect WSA to remain relatively stable in the fourth quarter, and we expect WSA to decline slightly in the first quarter of 2022 as we see additional traction from long-term plans begin to generate Results. Operating profit in the third quarter was US$10 million. Driven by the increase in gross profit margin due to the decrease in WSA, we achieved good year-on-year operating profit margins in all three divisions.

In the third quarter, we generated operating profits in all three divisions. The last time it was achieved was two years ago, when our revenue increased by 70%, which is a strong indicator that reflects the extent to which we are leveraging a lower cost base. Subsequently, the United States achieved a 44% increase in operating profit margin and an operating profit of 4 million U.S. dollars in the third quarter. As we continue to provide more revenue on our cost basis, this is a significant improvement for the US division. In the third quarter of 2021, the international division’s operating profit was US$1 million, accounting for approximately 2% of revenue. Canada achieved US$5 million in operating profit, accounting for 7% of revenue. Canada’s operating profit rate was 18%. Sexual breakup. GAAP net income for the third quarter was US$5 million or US$0.05 per share. On a non-GAAP basis, net income excluding other costs is $6 million or $0.05 per share. Non-GAAP EBITDA (excluding other costs) for the third quarter of 2021 was $15 million or 3.4%.

As we pointed out in the results of continuous improvement, we have been focusing on continuously identifying and implementing initiatives to transform our operating model, increase our value to customers and maximize our customer service. The hard work and commitment of our employees can be seen in our financial performance today, because on the basis of significantly improved costs, revenue has increased by 35% year-on-year. Our third-quarter EBITDA circulation increased by 23% and 27% year-on-year, respectively. High liquidity combined with higher product profit margins, coupled with our team's continued creation of business efficiencies, thereby achieving greater revenue in our network.

I will also point out that the low operating profit and other expenses for the quarter included approximately $1 million in expenses related to the increase in the fair value of estimated contingent consideration liabilities. As of the end of the third quarter, our net cash position was US$312 million, an increase of US$19 million from the end of June. As of September 30, 2021, total debt is still 0, including 0 withdrawals, and total liquidity is calculated as the total available amount of undrawn credit lines of US$248 million, plus cash on hand, which equals US$560 million. Accounts receivable was US$299 million, an increase of 10% from the second quarter. Inventories were US$244 million, a decrease of US$6 million from the second quarter. The inventory turnover rate is now 5.6 times, the best quarter.

Accounts payable was US$243 million, an increase of 12% over the second quarter. As of September 30, 2021, working capital, excluding cash, accounted for 10.6% of our annualized revenue in the third quarter. Since the estimated fair value of the contingent consideration is US$19 million, the reduction in working capital this year may change. We do expect that the working capital ratio will increase somewhat because we intend to increase the working capital to promote the growth of this business. . Our commitment to working capital efficiency is reflected in the new 62-day quarterly best cash conversion cycle, which marks five consecutive quarters of improvement. The main driver of these working capital efficiency gains is the increase in inventory turnover, which helps to minimize the cash required to fund our continuous revenue growth. Free cash flow for the quarter was $22 million.

Looking back on three years, we have generated approximately US$500 million or more precisely US$486 million in free cash flow. We are committed to balance sheet management, investing in high-quality inventory, making strategic acquisitions and maximizing asset health to promote future development. We celebrate the successful quarter with optimism about the future. We have the talent, resources and perseverance to improve our bottom line, develop a more flexible business and create sustainable value for our customers and shareholders. With this, I will turn the call back to Dave.

Dave Cherechinsky - CEO, President and Director

Thank you, Mark, now let’s talk about mergers and acquisitions and the fourth quarter. We remain focused on deploying capital to capture the organic and inorganic opportunities of DNOW. Through mergers and acquisitions, our goal is to increase profitable businesses that provide non-commercialized solutions in line with our strategy. As we evaluate opportunities in strategic priority areas, we will continue to actively participate in potential targets. One of the key areas is to strengthen the process solutions product line by adding companies that create competitive advantages, differentiate and establish barriers to entry for DNOW. Another key area is to help diversify our end markets to provide more differentiated services in the market.

As you can see, I am very pleased that the company once again achieved better-than-expected continuous revenue growth of 10%, the third consecutive quarter of record gross profit margin and EBITDA, excluding other costs of 15 million US dollars, far exceeding expectations. The execution of our strategy accelerated these results and generated $22 million in free cash flow during the cash-consuming period in our history. Looking forward to the near term in the fourth quarter, we usually see a slowdown in customer spending due to budget exhaustion and reduced customer activity due to the November and December holidays. This usually brings seasonal headwinds to continuous income growth.

In addition, delays in the transportation of imported products and insufficient product supply may delay revenue. With this in mind, our view is that as we experience seasonal headwinds that are not expected to repeat in the first quarter of 22, revenue in the fourth quarter will be flat to mid-single digits. We expect full-year EBITDA to improve in 2021. In 2020, it will reach nearly 90 million US dollars, which means that the company's capabilities and its profit potential have undergone a fundamental transformation. Once again laying the foundation for a strong 2022. Looking ahead, as global energy demand improves and oil and natural gas energy supply is expected to grow after years of underinvestment, we expect our business fundamentals to continue to improve.

We are excited about 2022, especially because some industry analysts predict double-digit growth in 2022. Some call it the beginning of a multi-year energy super cycle, leading to continued growth. Finally, I want to close gross margins and pricing, and really do it. We attach great importance to high ratings of our business. What I mean is to focus on manufacturers, companies, product lines, locations, events, end markets, and customers with higher profit margins to continuously improve product profit margins. Like every organization, we have limited resources, so we must choose where to allocate time, talent, and wealth.

We are selecting suppliers, looking forward to cooperation and mutual benefit, promise them expenditure, fulfill our promise, promote their brand and deliberately increase value, concentrate our inventory investment, and concentrate our precious human capital on opportunities for higher profits. We focus our talents on the places that customers think are valuable, and customers are willing to pay for the value we provide. On the contrary, we have not paid attention to and disliked opportunities for lower profit margins. In the case where the customer does not see value, the allocation of precious resources, inventory and human capital is irrelevant. I want to emphasize what this focus means for revenue.

Product profit margins for the past six years have been 18%, 19%, and 20% for two consecutive years starting from 2016, because market activity in 2019 is lower than 2018 levels, 21% in 2020, and now 22% year-to-date 2021 basis. This is not accidental. This is not market-derived. In fact, many of the increases in the profit margins of these products were realized during periods of deflation. This is intentional. As a result created entirely by the women and men of DNOW, our organization has found its place in the hearts of customers, where they see value and focus our precious resources on the right opportunities. Combining this strategy with a leaner and leaner business now results in greater lasting profitability than we have been able to achieve in the past. With this, let's start asking questions.

Thank you. [Operator Instructions] Doug Becker from Benchmark Research.

Doug Becker-Benchmark Research-Analyst

Dave, I want to continue with marginal comments, and given that there are multiple active parts, it may be possible to get a deeper understanding of your views on the fourth quarter. But in the long run, last quarter, you were still talking about 22% as the target. Given the performance of the quarter, it does seem to be an easy goal to achieve. Maybe your latest thoughts and long-term profit margins on this.

Dave Cherechinsky - CEO, President and Director

Yes. Good morning, Doug, thanks for your question. Yes, I did say that 22% is the target. I did not expect the profit margin to appreciate as we did in the third quarter. In fact, we guided some compression. We have our management team-I tried to point this out at the end of my opening remarks. Just like any family, any business, any organization, we have limited resources and we have to make choices. When we migrate to meet customer requirements, we allocate resources to higher-margin activities in everything we do.

We are negotiating new deals with long-term suppliers and long-term manufacturers, and we are working hard to get the most favorable price. We try to give them all of our business and let them understand reciprocity. Then we are changing the way we price. In the past, many people in our company had pricing power. We are changing this situation so that we can maximize the delivery of suitable products to our customers with substantial profits. We are doing this across the board. The company we are buying-the company we bought this year has higher gross margins and better expenses because it is related to revenue. Like I said, we don’t like people on the other end of the spectrum. Therefore, although 22% is a record for us, I don’t think it is the lowest point because we do enjoy the benefits of pipeline pricing. In such a period, product supply is scarce and it comes down to the distribution of products to customers.

If we can acquire it, as a large oil and gas distributor, we have a better position in product acquisition, and we can get a higher price for first owning the product. So 22% is still our goal. Can we build on this? I believe we can. This is our organizational effort to pursue value for our customers. We meet them where they see the value of DNOW. We have allocated our resources to these efforts, not to those for whom they see no value. So I think there will be greater profit margins in the future. However, in the third quarter, we did see the benefits of the pipeline, and we can talk a little more.

Doug Becker-Benchmark Research-Analyst

Many things will definitely appear in the numbers. Maybe it's just a little bit more about the pipeline, because it is only related to the fourth quarter. Given that revenue may be flat or slightly down, do you expect the gross margin in the fourth quarter to be compressed?

Dave Cherechinsky - CEO, President and Director

Yes. I think this is implicit in our guidelines, so although we are very good at meeting customer requirements, the situation has declined in some key areas. Again, we are working hard to fill these gaps and ensure that we can maximize customer service and product availability. But in the field of steel pipes, we are using all our resources around the world, important domestic pipeline resources to obtain pipelines. We have seen some decline in product availability. So this may mean higher profit margins, but lower revenues.

So mixed, we see a mixed problem, our pipeline sales may decline in terms of total sales, which will have a negative impact on profit margins. Therefore, this is one of the reasons why we may see a reduction in gross margin in the fourth quarter. Secondly, we are looking for alternative sources. For alternative products, if there are alternatives, we may seek a sourcing strategy, buy from competitors or main distributors, and we pay more for the products. We get revenue, but we see a lower gross margin. So to answer your question, yes, we want some compression.

I have been talking about it for a few quarters. I was pleasantly surprised. But I gave some colors in my opening comment, that is, how do we see items or orders of 5 million to 10 million US dollars, these items or orders are mainly due to wait for the product to arrive and slip into the new year. These are often our product lines with higher profit margins. So I think the answer is, yes, we will see some compression, which may be due to these reasons. I think of it as short-term margin compression. Regarding your initial question, I think we can return to the 22% range in the new year.

Doug Becker-Benchmark Research-Analyst

The last one, just can't help but notice the traction you get within the global valve. This is where you are targeting certain acquisitions. Any background information on the current scale and how big the business might eventually grow?

Dave Cherechinsky - CEO, President and Director

Well, I think in terms of our total sales today, valves discretely account for about 20% of our business. Now there are places where we do matching, they are part of the project, and these values ​​may not be considered there. But for me, it is a matter of the right valve type and the correct profitability of the production line we carry. But we think this is one of them-it is one of the few products we have a high brand preference. We have almost no brand preference for pipes, fittings and flanges.

But for valves, there is a brand preference. Therefore, if we reach the right agreement with the supplier, and as we promote the valve service business, we can see this situation continue to grow. We have not yet set the scale for this part of the business, but we think this is a huge opportunity to manage a fleet of various competing valves to provide valve and drive services, which is becoming more and more important to our customers In progress.

Doug Becker-Benchmark Research-Analyst

From Cowen, we have Jon Hunter.

Jon Hunter-Cowan-Analyst

Good morning, thank you. So I want to end the discussion about 2022, I mean, you seem to start the new year with a gross margin of 22%. You mentioned in your comment earlier that revenue will see double-digit growth. I believe that some of the larger OFS companies are talking about a 20% increase in exploration and production expenditures in North America next year. I am curious whether DNOW agrees with this view? Or, if you see an opportunity for market share, is there a potential benefit? I know you are a bit aggressively targeting private individuals, so this may be an area of ​​opportunity. So yes, if you can talk about it, that would be very helpful.

Dave Cherechinsky - CEO, President and Director

Yes. I think what we said in 2022, of course, we are not going to provide guidance on 2022, but there is a lot of optimism. Most people are talking about 10% or higher growth. Some numbers enter-enter teenagers. We haven't arrived yet. So there are two things. In the opening comments on the concept of limited resources, I was very blunt and focused on really selecting the opportunities with the highest profit margin and highest EBITDA profit margin in terms of product line focus.

This may mean that we will transfer some product lines, which may have an adverse effect on the new year's revenue, but will lead to profit growth. So while I believe, I mean, we haven't set a budget yet, that is, 10% may be a good starting point for the new year. It may be more materially powerful than this. Of course, there are many factors that affect this. But we are optimistic about 2022. I think we will definitely see growth in this range.

Jon Hunter-Cowan-Analyst

This is very helpful. After following up, WSA was a bit flat in the fourth quarter, and then there are some opportunities to reduce it in the first quarter of 2022. Do you think you can reduce it to a $80 million type? What is the operating rate of WSA before the end of the year? Or what background should we consider for your goals on the WSA line in 2022?

Dave Cherechinsky - CEO, President and Director

Well, let me answer this question like this, because growth will affect the direction of the WSA line. If we can make some acquisitions now, of course, all of these will have an impact on it. But we have made plans, and as we stand up in the super centers in Casper and Odessa, Texas, and Williston, North Dakota, these are the three major investments that span the spine of American oil fields. Should continue to see cost improvements in the structure. For the time being, we expect to deduct US$12 million from the business when revenue is flat.

Therefore, this may reduce WSA by $3 million per quarter. Now, if our growth is much higher than 7% to 10%, then the WSA numbers will change. Therefore, the greater the growth you or we might predict, the more adverse the impact on WSA numbers, right? Obviously, if the growth is stronger than our forecast, this number will be higher. But we do have efficiency measures that we will achieve in 2022, and now they are between US$12 million and US$15 million.

Jon Hunter-Cowan-Analyst

great. Then the last one for me is that the free cash flow for the quarter is impressive. I look forward to a little bit of working capital construction. You actually released a bit. Curious, when you consider 2022 and your inventory needs, how should we consider the consumption of working capital in the fourth quarter or early 2022?

Dave Cherechinsky - CEO, President and Director

So, the biggest factor that affects whether we produce or consume free cash flow in the fourth quarter is the time of receipt. So we have tens of millions of dollars in order inventory, as we often do, but like I said, we are eager to get some of these product lines into here faster. These will offset the free cash flow in the fourth quarter. But our current model shows that we will generate cash in the fourth quarter. It may be 0 to several million dollars. Now last quarter, I think we said that we will consume as much as US$30 million to US$40 million in the second half of this year. It turns out that we may produce US$30 million in the second half of the year.

Therefore, in the third quarter, we calculated the working capital by 9 times the annual rate, which is unheard of for inventory-intensive and accounts receivable-intensive companies. We sell goods to customers on terms, and we must invest in large amounts of inventory to generate the kind of sales we generate. We transferred our working capital 9 times. So this will be something difficult to maintain, and we may not maintain it. In this way, our working capital turnover will not be so good. But it is possible, and this may be a good choice, we will generate a certain level of cash in the fourth quarter, may be 0, but may be a little more, instead of consuming cash as we previously expected.

Jon Hunter-Cowan-Analyst

Great, thank you, I will turn it back.

[Operator Instructions] Stifel has Nathan Jones.

Nathan Jones - Stifel - Analyst

Good morning everybody. Follow up on WSA's comments. You obviously-you said, obviously, the WSA numbers will depend on what the growth is. Maybe you can give us more information about what color of WSA you want to increase for every dollar of income. Therefore, if you increase your income by 1 USD, do you need to add 0.10 USD WSA USD 0.05 USD WSA, what color can you provide us?

Dave Cherechinsky - CEO, President and Director

OK. I will stab it there. For me, every dollar of income should include no more than $0.05 of WSA. Again, I have said that for many quarters, our expenses or WSA as a percentage of revenue are still too high. I also said that once the market hits the bottom, we mainly focus on developing our business and gaining market share through increasing gross margins in a highly competitive environment. We are doing these things. So what I am most concerned about is our position in the market and the growth of our business.

This may require some additional costs. Expenses as a percentage of revenue will decline in 2022. We must be careful not to increase the cost. I just talked about a plan to withdraw between US$12 million and US$15 million from the business at the current level of income. But to answer your question carefully, 0.03 to 0.05 US dollars per US dollar may be acceptable, but we also need to make our fees more in line with our long-term goals.

Nathan Jones - Stifel - Analyst

OK. Therefore, once the super center is completed, we will spend 12 to 15 million US dollars. Then from there, every dollar should increase by 0.03 to 0.05 dollars of WSA. If your gross profit margin is 21%, and every dollar of revenue increases by US$0.03 to US$0.05 of WSA, does this mean that we should consider increasing EBITDA margins as sales grow, based on the initial US$12 million to US$15 million Adjustment of super center savings?

Dave Cherechinsky - CEO, President and Director

Yes. So historically, when we grow, we have already generated an increase of 10% to 15%. But to answer your question, these increments should be in the range of more than 15%. They should meet when they are close to their teens, especially when our products are scarce, which really improves gross margins in the short term. But these increases should be in the teens, and possibly in the teens.

Nathan Jones - Stifel - Analyst

great. This is very helpful. Furthermore, you have mentioned that private personnel are indeed the driving force behind the increase in drilling. What do you expect from public figures? I mean, I think historically, private investors go first, followed by public investors, but when it comes to spending a lot of money relative to previous cycles, investors have imposed religious beliefs on them. So maybe you can comment on your expectations as we move forward.

Dave Cherechinsky - CEO, President and Director

OK. Well, as we have seen in the past few quarters, I do think that private individuals will get in first and do more drilling. We hope to see this change in 2022. I don't know if it will happen. It may not. In any case, we will still see private investment in drilling. We like big men because of different risk profiles. We have always focused on Shell, Chevron, OXY and large companies because of our different levels of risk. For smaller private companies, we have to be very careful. We have made good progress there, but the risk profile is different. I think everyone will spend more money next year.

However, this is difficult to measure, because the discipline of listed companies in particular is very strict, reaching a level that we have never seen before. This will hurt us in the short term because since oil prices are in the $80 range, we think our customers will usually spend more at this time in the cycle. But in the long run, it will help us a lot, because we will not see the kind of volatility caused by the sloppy we have seen in the past. So I think it will be more private. But we are waiting to see what our customers will invest in their budgets, and we will adjust our focus accordingly.

Nathan Jones - Stifel - Analyst

Great, thank you for answering my question.

Thank you. Ladies and gentlemen, our Q&A session is over. I will now transfer the call to CEO and President David Cherechinsky to make a concluding statement.

Dave Cherechinsky - CEO, President and Director

Well, I want to thank everyone for calling today. Thank you for taking the time. Thank you for your interest in DNOW, and I look forward to talking with you in early 2022. have a beautiful day.

Brad Wise-Vice President of Digital Strategy and Investor Relations

Dave Cherechinsky - CEO, President and Director

Mark Johnson-Senior Vice President and Chief Financial Officer

Doug Becker-Benchmark Research-Analyst

Jon Hunter-Cowan-Analyst

Nathan Jones - Stifel - Analyst

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