DNOW Inc. (DNOW) FY 2022 MD&A

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Basis of Presentation

The accompanying consolidated financial information include the accounts of the Company and its consolidated subsidiaries. All significant intercompany transactions and accounts have been eliminated. Variable interest entities for which the Company is the primary beneficiary are fully consolidated with the equity held by the outside stockholders and their portion of net income (loss) reflected as noncontrolling interest in the accompanying consolidated financial statements.

General Overview

We are a global distributor to the oil and gas and industrial markets with a legacy of over 160 years. We operate primarily under the DistributionNOW and DNOW brands. Through our network of approximately 170 locations and approximately 2,425 employees worldwide, we stock and sell a comprehensive offering of energy products as well as a selection of products for industrial applications. Our energy product offering is consumed throughout all sectors of the oil and gas industry – from upstream drilling and completion, E&P, midstream infrastructure development to downstream petrochemical and petroleum refining – as well as in other industries, such as chemical processing, mining, utilities and renewables. The industrial distribution end markets include refineries and engineering and construction firms. We also provide supply chain and materials management solutions to the same markets where we sell products.

Our global product offering includes consumable MRO supplies, pipe, manual and automated valves, fittings, flanges, gaskets, fasteners, electrical, instrumentation, artificial lift, pumping solutions, and modular process, production, measurement and control equipment. We also offer procurement, warehouse and inventory management solutions as part of our supply chain and materials management offering. We have developed expertise in providing application systems, work processes, parts integration, optimization solutions and after-sales support.

Our solutions include outsourcing portions or entire functions of our customers’ procurement, warehouse and inventory management, logistics, point of issue technology, project management, business process and performance metrics reporting. These solutions allow us to leverage the infrastructure of our SAP™ ERP system and other technologies to streamline our customers’ purchasing process, from requisition to procurement to payment, by digitally managing workflow, improving approval routing and providing robust reporting functionality.

We support land and offshore operations for the major oil and gas producing regions around the world through our network of locations. Our key markets, beyond North America, include South America, Europe, the Middle East, Asia Pacific, Central Asia and West and North Africa. Products sold through our locations support greenfield expansion upstream capital projects, midstream infrastructure and transmission and MRO consumables used in day-to-day production. We provide downstream energy and industrial products for petroleum refining, chemical processing, LNG, power generation utilities and customer on-site locations.

Our supplier network consists of thousands of vendors in approximately 40 countries. From our operations in approximately 20 countries, we sell to customers operating in approximately 80 countries. The supplies and equipment stocked by each of our branches are customized to meet varied and changing local customer demands. The breadth and scale of our offering enhances our value proposition to our customers, suppliers and shareholders.

We employ advanced information technologies, including a common ERP platform across most of our business, to provide complete procurement, warehouse and inventory management and logistics coordination to our customers around the globe. Having a common ERP platform allows immediate visibility into our inventory assets, operations and financials worldwide, enhancing decision making and efficiency.

Our revenue and operating results are related to the level of worldwide oil and gas drilling and production activities and the profitability and cash flow of oil and gas companies and drilling contractors, which in turn are affected by current and anticipated prices of oil and gas. Oil and gas prices have been and are likely to continue to be volatile. See Item 1A. “Risk Factors.” We conduct our operations through three business segments: U.S., Canada and International. See Item 1. “Business—Summary of Reportable Segments” for a discussion of each of these business segments.

Unless indicated otherwise, results of operations data are presented in accordance with accounting principles generally accepted in the United States (“GAAP”). In an effort to provide investors with additional information regarding our results as determined by GAAP, we may disclose non-GAAP financial measures. The primary non-GAAP financial measure we focus on is earnings before interest, taxes, depreciation and amortization, excluding other costs (“EBITDA excluding other costs”). This financial measure excludes the impact of certain amounts and is not calculated in accordance with GAAP. See “Non-GAAP Financial Measures and Reconciliations” in Results of Operations for an explanation of our use of non-GAAP financial measures and reconciliations to the corresponding measures calculated in accordance with GAAP.

25

Operating Environment Overview

Our results are dependent on, among other things, the level of worldwide oil and gas drilling and completions, well remediation activity, crude and natural gas prices, capital spending by oilfield service companies and drilling contractors, and the worldwide oil and gas inventory levels. Key industry indicators for the past three years include the following:

* Averages for the years indicated. See sources on following page.

26

The following table details the U.S., Canadian, and international rig activity and West Texas Intermediate (“WTI”) oil prices for the past nine quarters ended December 31, 2022:

Sources: Rig count: Baker Hughes, Inc. (www.bakerhughes.com); West Texas Intermediate Crude and Natural Gas Prices: Department of Energy, Energy Information Administration (www.eia.doe.gov); Hot-Rolled Coil Prices: SteelBenchmarker™ Hot Roll Coil USA (www.steelbenchmarker.com).

The worldwide average rig count increased 28.4% (from 1,361 rigs to 1,748 rigs) and the U.S. increased 51.8% (from 475 rigs to 721 rigs) in 2022 compared to 2021. The average price of WTI crude increased 39.4% (from $67.99 per barrel to $94.79 per barrel), and natural gas prices increased 64.2% (from $3.91 per MMBtu to $6.42 per MMBtu) in 2022 compared to 2021. The average price of Hot-Rolled Coil declined 29.7% (from $1,561.23 per short ton to $1,097.24 per short ton) in 2022 compared to 2021.

U.S. rig count at January 20, 2023 was 771 rigs, up 50 rigs from the 2022 average. The price for WTI crude was $81.27 per barrel at January 20, 2023, down 14.3% from the 2022 average. The price for natural gas was $3.15 per MMBtu at January 20, 2023, down 50.9% from the 2022 average. The price for Hot-Rolled Coil was $737.00 per short ton at January 23, 2023, down 32.8% from the 2022 average.

27

Executive Summary

For the year ended December 31, 2022, the Company generated net income of $128 million, or $1.13 per fully diluted share on $2,136 million in revenue. Net income increased for the year ended December 31, 2022, by $123 million when compared to the corresponding period of 2021. Revenue increased for the year ended December 31, 2022, by $504 million, or 30.9%, when compared to the corresponding period of 2021. For the year ended December 31, 2022, operating profit was $131 million compared to operating profit of $9 million for the corresponding period of 2021.

For the fourth quarter ended December 31, 2022, the Company generated net income of $32 million, or $0.28 per fully diluted share on $547 million in revenue. Net income increased for the fourth quarter ended December 31, 2022, by $20 million when compared to the corresponding period of 2021. Revenue increased for the fourth quarter ended December 31, 2022, by $115 million, or 26.6%, when compared to the corresponding period of 2021. For the fourth quarter ended December 31, 2022, operating profit was $35 million, compared to operating profit of $7 million for the corresponding period of 2021.

Outlook

Our outlook for the Company remains tied to crude oil and natural gas commodity prices, global oil and gas drilling and completions activity, oil and gas spending, and global demand for oil, its refined petroleum products, crude oil, natural gas liquids and natural gas production and decline rates. Crude oil and natural gas prices as well as crude oil and natural gas storage levels are primary catalysts for determining customer activity and we expect oil and gas demand to grow over the next several years.

The impact on our business from the COVID-19 pandemic and changing macroeconomic factors continue to unfold. In addition, inflationary pressures and efforts to combat it, threats of recession, changes to production limits, supply chain shortages and geopolitical conflicts, including the invasion of Ukraine by Russia and the sanctions imposed in response to this conflict, have increased the level of market volatility. Amid these dynamics, we will continue to support our customers, optimize our operations, advance our strategic goals and manage the Company based on market conditions.

We see the rise in energy evolution investments as an opportunity for us to supply many of the current products and services we provide, as well as an opportunity to partner and source from new suppliers to expand our offering, to meet our customers’ needs for their energy evolution investments. A number of our larger customers are leading the investments in energy evolution projects where we expect to continue to support them while expanding our product and solution offerings to meet their changing requirements. We are also targeting new customers that are not traditional oil and gas customers, but are those that will play a part in the future as our customers discover and invest in new sources of energy.

Results of Operations

Consolidated Results

Years Ended December 31, 2022 and December 31, 2021

The results of operations are presented before consideration of the noncontrolling interest. A summary of the Company’s revenue and operating profit (loss) by segment in 2022 and 2021 follows (in millions):

28

United States

Revenue was $1,591 million for the year ended December 31, 2022, an increase of $428 million or 36.8% compared to the year ended December 31, 2021. The increase in the period was primarily driven by the strengthening in U.S. drilling and completions activity.

Operating profit was $103 million for the year ended December 31, 2022, an improvement of $111 million compared to operating loss of $8 million for the year ended December 31, 2021. Operating profit improved in 2022 primarily due to the increase in revenue discussed above, coupled with improved product margins, partially offset by increases in employee related expenses and legal fees for litigation matters that were not ordinary or routine to the operations of the business where the Company is seeking damages.

Canada

Revenue was $315 million for the year ended December 31, 2022, an increase of $66 million or 26.5% compared to the year ended December 31, 2021. The increase was primarily driven by the increase in Canadian rig count, partially offset by unfavorable foreign exchange rate impacts.

Our Canadian revenue was approximately 15% of total revenue in 2022, similar to 2021. We are subject to fluctuations in foreign currency exchange rates relative to the U.S. dollar. Our Canadian revenue is favorably impacted as the U.S. dollar weakens relative to the Canadian dollar, and unfavorably impacted as the U.S. dollar strengthens relative to the Canadian dollar. Our Canadian segment revenue was unfavorably impacted by approximately $12 million due to changes in foreign currency exchange rates over the prior year.

Operating profit was $30 million for the year ended December 31, 2022, an increase of $13 million compared to operating profit of $17 million for the year ended December 31, 2021. Operating profit increased primarily due to the increase in revenue discussed above, partially offset by higher employee related expenses and no benefit from the Canada Emergency Wage Subsidy in 2022.

International

Revenue was $230 million for the year ended December 31, 2022, an increase of $10 million or 4.5% compared to the year ended December 31, 2021. The increase was driven by the increase in international rig count and stronger project activity, partially offset by unfavorable foreign exchange rate impacts.

Our international revenue was approximately 11% of total revenue in 2022, compared to 14% to 2021. We are subject to fluctuations in foreign currency exchange rates relative to the U.S. dollar. Our international revenue is favorably impacted as the U.S. dollar weakens relative to other foreign currencies, and unfavorably impacted as the U.S dollar strengthens relative to other foreign currencies. Our international segment revenue was unfavorably impacted by approximately $16 million due to changes in foreign currency exchange rates over the prior year.

Operating loss was $2 million for the year ended December 31, 2022, a decline of $2 million compared to operating profit of nil for the year ended December 31, 2021. For the year ended December 31, 2022, we recognized approximately $10 million of foreign currency translation losses as a result of substantially completing the liquidation of certain foreign subsidiaries reflected in impairment and other charges in the consolidated statements of operations, which was partially offset by a reduction in employee related expenses and increased revenue discussed above.

Cost of products

Cost of products was $1,630 million for the year ended December 31, 2022 compared to $1,275 million for the year ended December 31, 2021, an increase of $355 million. The increase was primarily due to the increase in revenue in the period. Cost of products includes the cost of inventory sold and related items, such as vendor consideration, inventory allowances, amortization of intangibles and inbound and outbound freight.

Warehousing, selling and administrative expenses

Warehousing, selling and administrative expenses were $365 million for the year ended December 31, 2022 compared to $341 million for the year ended December 31, 2021, an increase of $24 million. The increase was primarily driven by employee related expenses and legal fees for litigation matters that were not ordinary or routine to the operations of the business where the Company is seeking damages and reductions in government wage subsidies realized in the corresponding period of 2021. Warehousing, selling and administrative expenses include branch location, distribution center and regional expenses (including costs such as compensation, benefits and rent) as well as corporate general selling and administrative expenses.

29

Impairment and other charges

Impairment and other charges were $10 million for the year ended December 31, 2022 compared to $7 million for the year ended December 31, 2021. For the year ended December 31, 2022, the Company recognized approximately $10 million of foreign currency translation losses as a result of substantially completing the liquidation of certain foreign subsidiaries in the International segment. For the year ended December 31, 2021, the Company recognized approximately $2 million of impairment related to intangible assets and $8 million of impairment related primarily to operating right-of-use assets. These charges were partially offset by a net gain of $3 million related to the sales of held-for-sale facilities.

Other income (expense)

Other income was $8 million for the year ended December 31, 2022, compared to other income of $3 million for the year ended December 31, 2021. For the year ended December 31, 2022, other income was primarily attributable to a benefit of approximately $13 million related to the decrease of contingent consideration liability associated with a prior year acquisition, partially offset by unfavorable foreign exchange rate impacts.

Provision for income taxes

The effective tax rate for the years ended December 31, 2022, and December 31, 2021 was 7.2% and 54.8%, respectively. In general, the effective tax rate differs from the U.S. statutory rate due to recurring items, such as differing tax rates on income earned in foreign jurisdictions, nondeductible expenses, state income taxes and the change in valuation allowance recorded against deferred tax assets. For the year ended December 31, 2022, the effective tax rate was primarily driven by the recognition of tax expense from earnings in Canada offset by current year realization of deferred tax assets and corresponding release of valuation allowance in the U.S., as well as impairment charges incurred as a result of substantially completing the liquidation of certain foreign subsidiaries with no associated tax benefit. For the year ended December 31, 2021, the effective tax rate was primarily driven by the low level of consolidated pre-tax income and the recognition of tax expense from earnings in Canada, which was not able to be offset by benefits recognized on losses in other jurisdictions.

Consolidated Results

Years Ended December 31, 2021 and December 31, 2020

For discussion related to the results of operations and changes in financial condition for the year ended December 31, 2021 compared to the year ended December 31, 2020 refer to Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in our 2021 Form 10-K, which was filed with the United States Securities and Exchange Commission on February 17, 2022.

30

Non-GAAP Financial Measures and Reconciliations

In an effort to provide investors with additional information regarding our results of operations as determined by GAAP, we disclose non-GAAP financial measures. The primary non-GAAP financial measure we disclose is earnings before interest, taxes, depreciation and amortization, excluding other costs (“EBITDA excluding other costs”). This financial measure excludes the impact of certain amounts and is not calculated in accordance with GAAP. A reconciliation of this non-GAAP financial measure, to its most comparable GAAP financial measure, is included below.

We use EBITDA excluding other costs internally to evaluate and manage the Company’s operations because we believe it provides useful supplemental information regarding the Company’s ongoing economic performance. We have chosen to provide this information to investors to enable them to perform more meaningful comparisons of operating results. In an effort to better align with management’s evaluation of the Company’s performance and to facilitate comparison of our results to those of peer companies, beginning for the year ended December 31, 2021, EBITDA excluding other costs excludes non-cash stock-based compensation expense. Prior periods presented have been adjusted to conform with the current period presentation.

The following table sets forth the reconciliations of EBITDA excluding other costs to the most comparable GAAP financial measures (in millions):

(1)
We believe that net income (loss) attributable to NOW Inc. is the financial measure calculated and presented in accordance with GAAP that is most directly comparable to EBITDA excluding other costs. EBITDA excluding other costs measures the Company’s operating performance without regard to certain expenses. EBITDA excluding other costs is not a presentation made in accordance with GAAP and the Company’s computation of EBITDA excluding other costs may vary from others in the industry. EBITDA excluding other costs has important limitations as an analytical tool and should not be considered in isolation or as a substitute for analysis of the Company’s results as reported under GAAP.

(2)
Stock-based compensation excludes net credits of $4 million for 2020 as such separation amounts were reported in Other.

(3)
Other includes certain income and expenses not included in stock-based compensation.

For the year ended December 31, 2022, Other included approximately $10 million (included in impairment and other charges) related to the reclassification of accumulated foreign currency translation losses due to the substantial liquidation of certain foreign subsidiaries; as well as, approximately $10 million (included in warehousing, selling and administrative), of which approximately $5 million related to legal fees for litigation matters that were not ordinary or routine to the operations of the business where the Company is seeking damages and approximately $5 million related to separation and transaction-related charges; partially offset by a benefit of approximately $13 million (included in other income) related to the decrease of contingent consideration liability.

For the year ended December 31, 2021, Other primarily included $7 million of impairment and other charges and $5 million in separation and transaction-related expenses (included in operating profit), partially offset by a benefit of $10 million (included in other income) related to the decrease in the fair value of contingent consideration liabilities.

For the year ended December 31, 2020, Other included $321 million of impairment and other charges as well as $18 million in separation and transaction-related expenses (included in operating loss), and $6 million in pension expense (included in other expense) related to the de-risking of our defined benefit plans

(4)
EBITDA % excluding other costs is defined as EBITDA excluding other costs divided by Revenue.

31

Liquidity and Capital Resources

We assess liquidity in terms of our ability to generate cash to fund operating, investing and financing activities. We expect resources to be available to reinvest in existing businesses, strategic acquisitions and capital expenditures to meet short and long-term objectives. We believe that cash on hand, cash generated from expected results of operations and amounts available under our revolving credit facility will be sufficient to fund operations, anticipated working capital needs and other cash requirements, including capital expenditures and our share repurchase program.

At December 31, 2022 and 2021, we had cash and cash equivalents of $212 million and $313 million, respectively. As of December 31, 2022, $86 million of our cash and cash equivalents was maintained in our various foreign subsidiaries. For the year ended December 31, 2022, we repatriated $14 million from our foreign subsidiaries. The Company makes a determination each period concerning its intent and ability to indefinitely reinvest the cash held by its foreign subsidiaries. The Company has not recorded deferred income taxes on undistributed foreign earnings that it considers to be indefinitely reinvested. The Company makes a determination each period whether to indefinitely reinvest these earnings. If, as a result of these reassessments, the Company distributes these earnings in the future, additional tax liabilities offset by any available foreign tax credits may result.

We maintain a $500 million five-year senior secured revolving credit facility that will mature on December 14, 2026. Availability under the revolving credit facility is determined by a borrowing base comprised of eligible receivables, eligible inventory and certain pledged deposits in the U.S. and Canada. As of December 31, 2022, we had no borrowings against our revolving credit facility and had approximately $482 million in availability (as defined in the Credit Agreement) resulting in the excess availability (as defined in the Credit Agreement) of 99%, subject to certain restrictions. Availability excluding certain cash deposits was approximately $352 million. Borrowings that result in the excess availability dropping below the greater of 10% of the borrowing base or $40 million are conditioned upon compliance with or waiver of a minimum fixed charge ratio (as defined in the Credit Agreement). The credit facility contains usual and customary affirmative and negative covenants for credit facilities of this type including financial covenants. As of December 31, 2022, we were in compliance with all covenants. We continuously monitor compliance with debt covenants. A default, if not waived or amended, may prevent us from taking certain actions, such as incurring additional debt.

See Note 12 “Leases” of the Notes to Consolidated Financial Statements (Part IV, Item 15 of this Form 10-K) for additional information on our obligations and timing of expected future lease payments.

We are often party to certain transactions that require off-balance sheet arrangements such as standby letters of credit and performance bonds and guarantees that are not reflected in our consolidated balance sheets. These arrangements are made in our normal course of business and they are not reasonably likely to have a current or future material adverse effect on our financial condition, results of operations, liquidity or cash flows.

The following table summarizes our net cash provided by (used in) operating activities, net cash provided by (used in) investing activities and net cash provided by (used in) financing activities for the periods presented (in millions):

Fiscal Year 2022 Compared to Fiscal Year 2021

Net cash provided by operating activities was nil in 2022 compared to $30 million in 2021. The decrease in cash provided by operating activities is primarily due to a net increase in working capital as a result of growing market activities, partially offset by improved operating results.

Net cash used in investing activities was $87 million in 2022 compared to $96 million in 2021. Cash used primarily related to business acquisitions of $80 million in 2022 compared to $96 million in 2021. Additionally, the Company used $9 million to purchase property, plant and equipment in 2022 compared to $5 million in 2021.

Net cash used in financing activities was $10 million in 2022 compared to $6 million in 2021. In 2022, the Company purchased $7 million in shares under the share repurchase program and used $5 million for payments related to finance leases, partially offset by receipts of $2 million from the exercise of stock options. In 2021, the Company used $6 million in payments for finance leases.

Effect of the Change in Exchange Rates

The effect of the change in exchange rates on cash flows was a decrease of $4 million and a decrease of $2 million for the years ended December 31, 2022 and 2021, respectively.

32

Capital Spending

We intend to pursue additional acquisition candidates, but the timing, size or success of any acquisition effort and the related potential capital commitments cannot be predicted. We continue to expect to fund future cash acquisitions primarily with cash flow from operations and the usage of the available portion of the revolving credit facility. We expect capital expenditures for fiscal year 2023 to be approximately $15 million, primarily related to purchases of property, plant and equipment. We will continue to maintain capital discipline and monitor market dynamics, and we may adjust our capital expenditures accordingly.

Share Repurchase Program

On August 3, 2022, the Company’s Board of Directors approved a share repurchase program, under which the Company is authorized to purchase up to $80 million of its outstanding common stock through December 31, 2024. We expect to fund share repurchases primarily with cash on hand, cash flow from operations and the usage of the available portion of the revolving credit facility. The timing and amount of any repurchases will be made at our discretion, taking into account a number of factors, including market conditions. For the year ended December 31, 2022, we have repurchased 653,819 shares of our common stock for a total of $7 million. All shares repurchased shall be retired pursuant to the terms of the share repurchase program.

Critical Accounting Policies and Estimates

In preparing the financial statements, the Company makes assumptions, estimates and judgments that affect the amounts reported. The Company periodically evaluates its estimates and judgments that are most critical in nature, which are related to allowance for doubtful accounts, inventory reserves, purchase price allocation of acquisitions, vendor consideration and income taxes. Its estimates are based on historical experience and on its future expectations that the Company believes are reasonable. The combination of these factors forms the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results are likely to differ from our current estimates and those differences may be material.

Allowance for Doubtful Accounts

The Company grants credit to its customers, which operate primarily in the energy, industrial and manufacturing markets. Concentrations of credit risk are limited because the Company has a large number of geographically diverse customers, thus spreading trade credit risk. The Company controls credit risk through credit evaluations, credit limits and monitoring procedures. The Company performs periodic credit evaluations of its customers’ financial condition and, generally, does not require collateral but may require letters of credit or prepayments for certain sales. Allowances for doubtful accounts ("AFDA") are established based on an evaluation of accounts receivable aging, and where applicable, specific reserves on an individual customer basis. The estimated AFDA reflects the Company’s immediate recognition of current expected credit losses by incorporating the historical loss experience, as well as current and future market conditions that are reasonably available. Judgments in the estimate of AFDA include global economic and business conditions, oil and gas industry and market conditions, customers’ financial conditions and account receivables past due. At December 31, 2022 and 2021, allowance for doubtful accounts totaled $25 million in both periods, or 5.9% and 7.6% of gross accounts receivable, respectively.

Inventory Reserves

Inventories consist primarily of oilfield and industrial finished goods. Inventories are stated at the lower of cost or net realizable value and using average cost methods. Allowances for excess and obsolete inventories are determined based on the Company’s historical usage of inventory on hand as well as its future expectations. The Company’s estimated carrying value of inventory therefore depends upon demand driven by oil and gas spending activity, which depends in turn upon oil, gas and steel prices, the general outlook for economic growth worldwide, available financing for the Company’s customers, political stability in major oil and gas producing areas and the potential obsolescence of various inventory items the Company stocks, among other factors. At December 31, 2022 and 2021, inventory reserves totaled $20 million and $32 million, or 5.0% and 11.3% of gross inventory, respectively. Changes in our estimates can be material under different market conditions.

Purchase Price Allocation of Acquisitions

The Company allocates the fair value of the purchase price consideration of an acquired business to its identifiable assets and liabilities based on estimated fair values. The excess of the purchase price over the fair value of the acquired assets and liabilities, if any, is recorded as goodwill. The Company uses all available information to estimate fair values including quoted market prices, the carrying value of acquired assets, and widely accepted valuation techniques such as discounted cash flows. The Company engages third-party valuation advisors to assist in fair value determination of inventories, identifiable intangible assets and any other significant assets or liabilities when appropriate. The judgments made in determining the estimated fair value assigned to each class of assets acquired and liabilities assumed, as well as asset lives, could materially impact the Company’s results of operations.

33

Vendor Consideration

The Company receives funds from vendors in the normal course of business, principally as a result of purchase volumes. Generally, these vendor funds do not represent the reimbursement of specific, incremental and identifiable costs incurred by the Company to sell the vendor’s product. Therefore, the Company treats these funds as a reduction of inventory when purchased and once these goods are sold to third parties the associated amount is credited to cost of sales. The Company develops accrual rates for vendor consideration based on the provisions of the arrangements in place, historical trends, purchases and future expectations. Due to the complexity and diversity of the individual vendor agreements, the Company performs analyses and reviews historical trends throughout the year and confirms actual amounts with select vendors to ensure the amounts earned are appropriately recorded. Amounts accrued throughout the year could be impacted if actual purchase volumes differ from projected annual purchase volumes, especially in the case of programs that provide for increased funding when graduated purchase volumes are met.

Income Taxes

The Company is a U.S. registered company and is subject to income taxes in the U.S. The Company operates through various subsidiaries in a number of countries throughout the world. Income taxes are based upon the tax laws and rates of the countries in which the Company operates and earns income.

The Company’s annual tax provision is based on taxable income, statutory rates, and the interpretation of the tax laws in the various jurisdictions in which the Company operates. It requires significant judgment and the use of estimates and assumptions regarding significant future events such as the amount, timing and character of income, deductions and tax credits. Changes in tax laws, regulations and treaties, foreign currency exchange restrictions or the Company’s level of operations or profitability in each jurisdiction could impact the tax liability in any given year. The Company also operates in many jurisdictions where the tax laws relating to the pricing of transactions between related parties are open to interpretation, which could potentially result in aggressive tax authorities asserting additional tax liabilities with no offsetting tax recovery in other countries.

The Company determined the provision for income taxes under the asset and liability approach, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Under this method, deferred tax assets and liabilities are determined on the basis of the differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date.

Deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, which will result in taxable or deductible amounts in the future. The Company recognizes deferred tax assets to the extent that the Company believes these assets are more-likely-than-not to be realized. If the Company determines that it would be able to realize its deferred tax assets in the future in excess of their net recorded amount, the Company would make an adjustment to the deferred tax asset valuation allowance, which would reduce the provision for income taxes. In evaluating the Company’s ability to recover deferred tax assets within the jurisdiction from which they arise, the Company considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax-planning strategies and results of operations. In projecting future taxable income, the Company begins with historical results adjusted for the results of discontinued operations and incorporates assumptions about the amount of future state, federal and foreign pretax operating income adjusted for items that do not have tax consequences. The assumptions about future taxable income require significant judgment and are consistent with the plans and estimates the Company is using to manage the underlying businesses.

The Company remains in a three-year cumulative loss position at the end of 2022. As a result, management believes that it is not more-likely-than-not that the Company would be able to realize the benefits of its deferred tax assets in the U.S., Canada and other foreign jurisdictions and accordingly recognized a valuation allowance for the year ended December 31, 2022. The change during the year in the valuation allowance was a reduction of $27 million in the U.S. and $1 million in other foreign jurisdictions resulting from a corresponding reduction in deferred tax assets. The Company intends to continue to recognize a valuation allowance on these deferred tax assets until there is sufficient evidence to support the reversal of all or some portion of the allowance. However, if current commodity prices are sustained and absent any additional objective negative evidence, it is reasonably possible that sufficient positive evidence will exist in the next 12 months to adjust our valuation allowance position. Exact timing and amount of the adjustment to the valuation allowance is not certain at this time.

The Company records unrecognized tax benefits as liabilities in accordance with ASC 740 and adjusts these liabilities when judgment changes as a result of the evaluation of new information not previously available in jurisdictions of operation. The Company records uncertain tax positions in accordance with ASC 740 on the basis of a two-step process whereby (1) the Company determines whether it is more-likely-than-not that the tax positions will be sustained on the basis of the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold, the Company recognizes the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority. The annual tax provision includes

34

the impact of income tax provisions and benefits for changes to liabilities that the Company considers appropriate, as well as related interest.

The Company is subject to audits by federal, state and foreign jurisdictions which may result in proposed assessments. Because of the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from the current estimate of the unrecognized tax benefit liabilities. The Company reviews these liabilities quarterly and to the extent audits or other events result in an adjustment to the liability accrued for a prior year, the effect will be recognized in the period of the event.

As of December 31, 2022, the Company has an immaterial amount of undistributed foreign earnings that may be subject to taxation upon a future distribution. The Company has not recorded deferred income taxes on undistributed foreign earnings that it considers to be indefinitely reinvested. The Company makes a determination each period whether to indefinitely reinvest these earnings. If, as a result of these reassessments, the Company distributes these earnings in the future, additional tax liabilities may result, offset by any available foreign tax credits.

Recently Adopted Accounting Standards

In March 2020, the Financial Accounting Standards Board issued Accounting Standards Update 2020-04, Reference Rate Reform (Topic 848), which provides optional expedients and exceptions to contracts, hedging relationships, and other transactions that reference London Interbank Offered Rate ("LIBOR") or another reference rate expected to be discontinued because of reference rate reform. The guidance is effective upon issuance and the expedients and exceptions may be applied prospectively through December 31, 2022. The Company has completed its evaluation of significant contracts. The Company adopted Topic 848 during the fourth quarter of 2022 with no material impact in its consolidated financial statements. On December 29, 2022, the Company entered into a second amendment to its existing senior secured revolving credit facility which, among other things, replaced LIBOR with the Secured Overnight Financing Rate ("SOFR") as the interest rate benchmark. See Note 10 “Debt” of the Notes to Consolidated Financial Statements (Part IV, Item 15 of this Form 10-K) for additional information.

35