Earnings Call Transcript - DNOW Q1 2022

Operator, Operator

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

Brad Wise, Vice President, Marketing and Investor Relations

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 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. 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.

David Cherechinsky, President and Chief Executive Officer

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 a 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 model that maximizes physical proximity to customers while gaining operational efficiencies. Those commitments have been kept and the results are showing up in the numbers. For example, EBITDA, excluding other costs, for the first quarter of 2022 was $28 million or 5.9% of revenue. We grew inventory by $46 million since year-end to $296 million as we ready for summer project activity and growth in the second and third quarters. About half of the added inventory comes from our strength in sourcing high-demand pipe and the remainder of the growth is destined for specific customer demands for future periods. Like we said on our last call, even though revenues were better than we guided to in the first quarter and we now expect to be even better for the full year, our expectations to be cash flow positive in 2022 stand. We believe we will consume cash in the first half of the year and generate cash in the second half and full year 2022. We are focused on building for the future. In the first quarter of 2022, we achieved the single best EBITDA to revenue results yet, while turning our working capital, excluding cash, more than 7 times a year. In the Bakken, we are imminently standing up our third new major supercenter in less than a year. Customers are seeking better visibility in the supply chain and more accountability in the commitments their partners make around availability of material critical to project completion and maintenance schedules. They're asking for more transparency around the quality of process and integrity in global manufacturers' operations. They are asking for deeper commitments as integrated supply partners with better tools to understand their installed and surplus assets. These customers are finding value in our solutions to ensure projects are completed on time, within the budgeted timeframe and that maintenance schedules critical to production revenues are met. These are the areas where our processes and culture are more aligned with where our customers see value. And now for some color on the results. We generated $473 million in revenue in the first quarter, up $41 million or 9.5% sequentially. Our gross margin remained near record levels at 22.6%, well above our record 2021 gross margins of 21.9% and better than expected. In the United States, revenue was $334 million, up 10% sequentially. U.S. growth was captured through expanded sales of pipe, valves and fittings essential for producers to grow oil and gas production or offset declining production used for new well tie-ins, refracs of existing wells, gathering lines and tank battery construction used to separate and measure crude oil, gas, condensate and produced water. Some of the successes we had during the quarter include a contract renewal of one of our top 10 customers for a 5-year commitment that helps them achieve their production targets and optimize their supply chain. And with one of our top 10 customers, we captured growth due to a combination of increased drilling activity and the completion of a large central production facility in South Texas. We experienced growth across a number of our mid to large cap customers in the Permian, Eagle Ford, Powder River and Williston Basin, and recognize the general increase in plant activity and maintenance work performed during the quarter across a number of producers. And with a large independent producer, we continue to expand our relationship and develop smart workflow tools, which communicate status and the tracking of orders through a data exchange platform. Where our customers experience growth, we have responded by deploying various strategic investments, and they are bearing fruit. For example, within our Permian operations, we’ve been expanding our sales and commercial teams, high-grading our product lines and customer accounts, optimizing our regional footprint, where, for example, last quarter, we opened up our new PVF+ supercenter and regionalized the project team. This has led to tremendous momentum and excitement not only in the Permian, but also in other areas across the U.S. and Canada as the fundamentals of our end markets are strong. We have been operational at our Casper, Wyoming PVF+ supercenter for almost a quarter, and the results are equally promising. We are scaling our Houston PVF+ supercenter to support the Gulf Coast and just recently secured our new Williston, North Dakota PVF+ supercenter. And now a few comments on pipe. We continue to see strong demand across most pipe product lines. As a leading line pipe distributor for our upstream and midstream market, our pipe margins continue to be a bright spot due to the combination of increased demand and limited market availability. Our pipe inventory grew during the quarter to support increased customer demand, primarily driven by an increase in seamless line pipe. In the midstream space, we worked closely with the customer to reduce emissions and prevent flaring as we supplied PVF in addition to automated and actuated valves for a compressor station bench stack replacement project for a Utah-based midstream gas transmission company. On the gathering and processing side, we were awarded several thousand feet of line pipe in addition to the PVF for 8 dehydration units for a project in North Dakota from a midstream operator. With another large integrated midstream operator, we were awarded multiple PVF projects for a launch and receiver package for a Permian Basin pipeline that exports natural gas to Mexico, a Bakken 12-inch pipeline, an 18 well brine project and 3 well connect assets in the midcontinent region. We were successful in onboarding a new midstream customer for a Permian gathering station and project. We are winning business and expanding PVF+ sales with several gas utility companies as we continue to target these customers in the Northeast and Midwest. In the downstream market, we saw revenue improve from the fourth quarter with increased sales of PVF and mill tool and safety products to capital projects into a number of planned maintenance and scheduling refining, plant turnarounds during the quarter. U.S. Process Solutions captured growing customer demand for our engineered pump packages, process and production equipment. We are also seeing increased activity from customer inquiries as customers look to secure access to products. During the quarter, we provided a variety of fabricated equipment to producers across numerous plays. We shipped a large order of pipe racks and modular metering kits to the Delaware Basin for a major Permian operator in addition to a number of separators to another large Permian operator from our Tomball, Texas fabrication facility. We shipped separator packages to a large independent producer with assets in the Powder River Basin. We continue to provide a wide assortment of process, production and measurement packages, including LACT units, oil and water and booster skids, water transfer kits and SWDs. In Canada, revenue grew to $82 million for the quarter, a 14% sequential improvement. We continue to perform well in Canada, led by a strong management team and our exceptional employees who put the customer at the center of our service model and then outperform their expectations. One of our top joint contractor customers added rigs, which helped drive incremental revenue growth. This customer procures all of their drilling OEM equipment and MRO consumables for each operating rig using our b2bshop.dno.com eCommerce platform, equipped with a customized workflow to match the customer's approval process, while providing visibility that drives procurement efficiencies. We experienced revenue growth from several major oil sands producers in addition to EPCs who are executing on projects. We shipped a large number of orders for sucker rods in artificial lift applications from several major producers during the quarter. And outside of oil and gas, we provide an assortment of PVF, while expanding market share with a potash fertilizer mining company, based in Saskatchewan. Our International segment revenue was flat sequentially at $57 million. In the U.K. and Europe, we continue to see the MRO and brownfield markets picking up with an increase of interest and activity within the joint market as operators look for rigs for potential drilling campaigns. Of note, we extended an existing supply agreement for an IOC to supply electrical material for West Africa, where our electrical and MRO product exports for IOCs remain strong. The Russian invasion of Ukraine is causing many European nations to reevaluate the security and the reliability of their sources of energy that drive their economies, which translates into replacing imported oil and gas from Russia with more domestic or imported options, generating added demand for our products in those regions. As such, we have ceased operations in Russia, where revenues and net assets each represented less than 1% of DNOW totals. In Kazakhstan, activity at the Tengiz field picked up with EPC contractors recruiting and mobilizing personnel, which led to additional activity. In Australia, we are seeing an increase in drilling and maintenance activity with both valve and pump service for both Brisbane and Roma areas. Our supply chain team has been focused on minimizing supply disruption by ensuring we have product available to support our customers' increasing demands. We have been successful leveraging our global and regional spend to ensure we have preferred access to the products and volume required. Not only have we worked hard to obtain manufacturer allocations, we have provided suitable alternatives to customers who increasingly depend on DNOW to find solutions that meet their requirements. This has resulted in several of our customers expanding their approved manufacturers list adopting DNOW's AML. On the engineered packaged equipment side, we are experiencing delays from some of our OEM equipment and electric component suppliers. Moving to our Digital NOW initiatives. Digital transacted revenue remained at 42% of total SAP revenue. Last quarter, I spoke about our AccessNow product line, which represents a suite and unattended inventory control and intelligent inventory management solution. We are deploying our AccessNow port to an upstream producer in the Permian Basin. This remote warehouse solution is a technology-enabled, unattended inventory solution that increases visibility, reduces servicing time and cost and ultimately enables a more efficient replenishment option for our customer. On the asset management front, we continue to expand our database of customer assets. Our eTrack software is used to track and manage our customers' fabricated process and production assets. And our Mercury software is used to track and manage our customers' valves, enabling DNOW to provide more efficient services and expedite the ability to provide replacement parts or replace the asset entirely if it is at the end of its useful life. Our eSpec engineered equipment configurator and budget estimator continues to drive revenue through the sales cycle, and many customers are using this tool for our industrial compressed air skids that help reduce their greenhouse gas scope 1 emissions. And now I would like to briefly touch on our energy transition initiatives. As we have mentioned on previous calls, many of the products we sell today fit nicely into a number of energy transition projects. For example, during the quarter, we were the tactical supplier of choice to a major refinery in California that is reconfiguring their facility to process renewable diesel, renewable gasoline and sustainable jet fuel from used cooking oils, fats, greases and soybean oils. We are also successful in supplying a broad range of PVF for several additional biodiesel projects located at refineries across the U.S. as those operators move their refining and petroleum distribution business forward to meet the new renewable fuel standards. On the carbon capture, sequestration and storage side, we continue to assist customers with projects which are in various stages of planning, engineering and design. We expect these opportunities to contribute to future revenue growth as the projects progress. We are also selling engineered instrument compressed air packages to a producer in the DJ Basin who is replacing their existing gas pneumatic systems in order to eliminate greenhouse gas emissions to the atmosphere. ESG and energy transition are new frontiers for today's energy producers and DNOW is being sought after as a trusted partner to provide that same transparency and integrity in greenfield projects and energy transition ventures.

Mark Johnson, Senior Vice President and Chief Financial Officer

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 growing revenue. The primary driver or about 3/4 of the WSA improvement was a direct result of the facility and workforce optimization efforts completed late last year. While the balance, about $2 million, should be considered more temporary in nature as we experienced lower-than-expected health care costs in the first quarter, compounded with the benefit related to fewer payroll days sequentially. Taking those last two transient benefits into account, we do expect WSA to increase modestly by a few million dollars from the 1Q level of $84 million. Operating profit for the first quarter was $23 million, and we recognized favorable year-over-year and sequential operating margin flow-through across all three segments. The U.S. contributed $14 million in operating profit in the first quarter. Meanwhile, the International segment reported $2 million in operating profit or approximately 4% of revenue while Canada delivered $7 million in operating profit or approximately 9% of revenue, a record level for our Canadian segment and a commendable job by them. Moving below operating profit. Other income in the first quarter was $10 million compared to an expense of $1 million in the corresponding period of 2021. The change is primarily attributable to a benefit of approximately $13 million related to the decrease of contingent consideration liability, and such gain is excluded in our non-GAAP measures. GAAP net income for the first quarter was $30 million or $0.27 per share. And on a non-GAAP basis, net income, excluding other costs, was $15 million or $0.14 per share. Non-GAAP EBITDA, excluding other costs, or EBITDA was $28 million and a record-setting 5.9% of revenue, our highest since being public. To highlight the financial improvements being generated as a result of our recent transformation, we can compare our current EBITDA results of $28 million with the pre-pandemic third quarter of 2019 period that also delivered $28 million in EBITDA. That period, just 2 years ago, posted $52 million more in WSA costs than the first quarter of 2022 and $280 million more or 58% more in terms of quarterly revenue needed to achieve the same EBITDA dollars we achieved in the first quarter of 2022. A clear upgrade in our earnings driven by improved flow-through from our team's execution and strategic focus on where our customers see value with the DNOW structure that makes it easier for our team to efficiently take care of our customers. This is clear proof the efforts and actions our organization has taken collectively have meaningfully shifted our company's composition and equipped our business for through-cycle profitability. I want to thank each of our loyal employees for these accomplishments that set the stage for DNOW's continued success. Now moving to the balance sheet. We ended the first quarter in a net cash position of $293 million, including zero debt and zero draws in the quarter, resulting in total liquidity of $582 million, comprising the $293 million of cash on hand plus $289 million in additional credit facility availability. Accounts receivable was $341 million, an increase of 12% or $37 million from the fourth quarter, reflecting strong customer demand. In this period of global supply chain constraints, we continue to meticulously source and maintain access to the products our customers require, largely because of our long-established and trusted partnerships with critical industry-leading suppliers. This capability provides maneuverability and reliability that differentiates DNOW in the marketplace. Our commitment to support our customers can be seen on our balance sheet this quarter as we were able to secure an additional $46 million in inventory and maintained a strong quarterly inventory turn rate of 4.9 times. Cash used in operating activities during the first quarter was $22 million as a result of our working capital build. In the first quarter, capital expenditures were nil. As of March 31, 2022, working capital excluding cash as a percentage of first quarter annualized revenue was 13.6%. As Dave discussed earlier, we do expect working capital to increase in this ratio to expand some as we drive growth with reliable product availability to support our customers. We celebrate again a successful quarter, optimistic for the future, possessing the talent, resources and strength to deliver sustained value for our customers and shareholders. And with that, I will turn the call back to David.

David Cherechinsky, President and Chief Executive Officer

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 patience 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 the second quarter. While drilling and 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 second quarter 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 the second quarter. 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, 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 will all impact where we land within our guidance. And now I would like to provide recognition on an accomplishment that 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, for 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, Operator

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

Nathan Jones, Analyst

Good morning, everyone.

David Cherechinsky, President and Chief Executive Officer

Good morning, Nathan.

Nathan Jones, Analyst

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. I 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?

David Cherechinsky, President and Chief Executive Officer

Here are some changes that have enhanced our ability to generate cash, even in a year where revenues are expected to exceed $300 million compared to the previous year. Our working capital velocity has improved over the last couple of years, reaching around 12% to 13%, with working capital, excluding cash, being between 12% and 15% of revenue. This allows us to turn working capital seven to eight times a year. The cash conversion cycle is significantly shorter, enabling us to invest less cash on the balance sheet during our growth period. When it comes to our earnings profile, back in the third quarter of 2019, we generated $28 million in EBITDA, but that was associated with substantially higher revenues and expenses. Today, we are a leaner organization with sufficient inventory to support our growth, yet we maintain a much lower inventory level than when we previously reported $28 million in EBITDA. We have also established more facilities closer to our customers, although some of these locations are smaller, as we have refined their roles in servicing our customers. In terms of working capital velocity and timing, we anticipate consuming about half of our cash in the first half of the year, with expectations of growth in the second and third quarters. The fourth quarter may be slightly weaker, potentially providing some relief regarding accounts receivable. The way we manage our balance sheet and distribute risk has evolved. We no longer stock 2,000 items in all branches; instead, we are regionalizing that risk and adopting a more expert approach to inventory management. Additionally, while we collaborate with numerous suppliers for essential brands and commodities, we are concentrating our efforts on fewer suppliers to achieve better costs and terms. As things slow down, we can pivot to substitute products and effectively manage idle inventory. All these factors combined contribute to improved overall performance and a strong outlook for cash generation in 2022.

Nathan Jones, Analyst

Thank you for that. I have a follow-up question regarding capital allocation. You've mentioned having strong financial resources. Historically, during economic upswings, it has not been the ideal time to acquire assets, as opportunities typically arise when markets are weaker. Could you share your thoughts on this? Does it suggest you may be less inclined to pursue deals this year and next, considering higher seller price expectations? Would it be more prudent to hold onto cash for now and wait for more favorable opportunities?

David Cherechinsky, President and Chief Executive Officer

I am confident that we will complete acquisitions this year. The deals we are considering right now are on the smaller side. As you mentioned, we typically find better buying opportunities at lower prices during downturns. However, there are chances available, and we believe we could finalize some acquisitions soon. While these tend to be smaller currently, we have ample cash and a solid balance sheet, and we are actively seeking deals. Last year, we made two acquisitions, and I anticipate we will match or exceed that this year. It's important to remember that nothing is finalized until it is complete, but we are planning to make acquisitions this year. I often receive inquiries about alternative ways to return cash to shareholders, and we are exploring various options. Although we expect to generate cash, the market could become even more favorable. Therefore, we want to keep a portion of our cash reserved for growth opportunities, to enhance our locations, capture market share, and grow the business with high margins. We have significant flexibility and are vigorously pursuing acquisitions at this time.

Nathan Jones, Analyst

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 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?

David Cherechinsky, President and Chief Executive Officer

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.

Nathan Jones, Analyst

Great. Thanks. I will pass it on.

David Cherechinsky, President and Chief Executive Officer

Thank you, Nathan.

Operator, Operator

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

Tommy Moll, Analyst

Good morning and thanks for taking my questions.

David Cherechinsky, President and Chief Executive Officer

Hi, Tommy.

Tommy Moll, Analyst

Dave, I want to start on the regionalized fulfillment strategy. You've provided several updates today and in previous quarters. But my main question is about the progress of the rollout. Are we close to completion or is there still more to come?

David Cherechinsky, President and Chief Executive Officer

Yes. By the end of this year, we expect to have established five supercenters. We are not finished, but we have primarily focused on the most important areas. These will be located in Houston, Casper, Wyoming, Odessa, Williston, and a new supercenter in the Edmonton area of Canada. These locations will cover the key areas. Some of our larger branches also serve a similar purpose. I would say we are more than halfway through this process. To provide some insight on the benefits of the supercenters, they are not just warehouses; they are customer-focused operations. They are located in larger markets where we can effectively push our project business, which used to be managed by all the branches across regional areas. This approach allows us to consolidate project inventory in fewer locations, enabling us to handle more volume in a single site while lowering operating costs per transaction. Additionally, since we have a wide range of products available, we can achieve better margins. We are indeed seeing the advantages of this strategy, and I want to emphasize that we aim to maintain our closeness to customers. We are not in a cost-cutting mindset; rather, we are focused on improving efficiency. We intend to keep our branches open and accessible to our customers, and we will adapt our model as we move forward.

Tommy Moll, Analyst

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?

Mark Johnson, Senior Vice President and Chief Financial Officer

Sure. In the prepared remarks, I mentioned a couple of million dollars added to Q2. At the end of last year, we expected Q1 to be around $86 million, similar to Q3 '21, and we were able to surpass that. Some of this was due to favorable conditions that are likely to fade in the second quarter. Additionally, Dave pointed out the impact of inflation on those figures. However, the efficiency we've achieved in the business, particularly when comparing 2022 to 2021 in the flow-through numbers in our guidance, shows a very low percentage increase in WSA in those models. We're setting our guidance to reflect a moderate WSA growth, which will clearly carry into the next quarter and may continue into the second half of the year.

David Cherechinsky, President and Chief Executive Officer

Yes. One way to view it, Tom, is that in our internal modeling, we expect revenue to increase by 20% year-over-year. We anticipate WS&A for the full year to rise by 1% to 2%. Like many companies, we are striving to attract talent to grow the business, enhance our skills, and expand the staffing of our sales force and technical sales team, which incurs costs. We are encountering product scarcity and inflation, as well as a shortage of personnel to support our business growth, which will present some challenges. To put it in perspective, we're projecting a 20% increase in revenues and a 1% to 2% growth in WS&A for the year. We are focused on efficiency, while also ensuring we have the right people and products available to our customers to drive this business forward. This provides some additional context regarding our considerations around expenses in the business.

Tommy Moll, Analyst

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.

David Cherechinsky, President and Chief Executive Officer

Yes.

Tommy Moll, Analyst

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.

David Cherechinsky, President and Chief Executive Officer

I believe so. Last year, we saw gross margins exceed our expectations in each quarter. However, we did reduce our guidance for gross margins, mainly due to pricing and, to a lesser extent, rebates, which we mostly addressed in the fourth quarter. We anticipated a decline in gross margins, and that happened. I do believe there are additional opportunities for price increases, but they will depend on growth rates, customer spending, supply and demand, and product availability, among other factors. While there could be greater price decreases than what we've projected, we expected a drop in the first quarter, which we observed, but we are now optimistic about our full-year gross margin expectations.

Tommy Moll, Analyst

I appreciate it. I will turn it back.

David Cherechinsky, President and Chief Executive Officer

Did that answer your question? Okay. Thank you.

Tommy Moll, Analyst

It does. It does, yes.

Operator, Operator

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.

David Cherechinsky, President and Chief Executive Officer

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

Operator, Operator

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