# DNOW Inc. (DNOW) FY 2021 MD&A

Verbatim Item 7 Management's Discussion and Analysis from DNOW Inc.'s 10-K for fiscal year 2021.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1599617/000095017022001400/dnow-20211231.htm
Accession: 0000950170-22-001400
Filing date: 2022-02-17
Report date: 2021-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/DNOW/
All MD&A years: /company/DNOW/mda/
Next year: /company/DNOW/mda/fy2022/ (FY 2022)

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.

General Overview

We are a global distributor to the oil and gas and industrial markets with a legacy of over 150 years. We operate primarily under the DistributionNOW and DNOW brands. Through our network of approximately 180 locations and approximately 2,350 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, valves, fittings, flanges, gaskets, fasteners, electrical, instrumentation, artificial lift, pumping solutions, valve actuation and modular process, 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 all the major oil and gas producing regions around the world through our network of locations. Our key markets, beyond North America, include South America, the North Sea, the Middle East, Asia Pacific, the FSU and 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 terminals, power generation utilities and customer on-site locations.

We stock or sell approximately 300,000 SKUs through our branch network. Our supplier network consists of thousands of vendors in approximately 40 countries. From our operations in over 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.

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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:

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

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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, 2021:

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 0.7% (from 1,352 rigs to 1,361 rigs) and the U.S. increased 8.9% (from 436 rigs to 475 rigs) in 2021 compared to 2020. The average price of WTI crude increased 73.3% (from $39.23 per barrel to $67.99 per barrel), and natural gas prices increased 91.7% (from $2.04 per MMBtu to $3.91 per MMBtu) in 2021 compared to 2020. The average price of Hot-Rolled Coil increased 171.7% (from $574.67 per short ton to $1,561.23 per short ton) in 2021 compared to 2020.

U.S. rig count at January 21, 2022 was 604 rigs, up 129 rigs from the 2021 average. The price for WTI crude was $85.16 per barrel at January 21, 2022, up 25.3% from the 2021 average. The price for natural gas was $4.11 per MMBtu at January 21, 2022, up 5.1% from the 2021 average. The price for Hot-Rolled Coil was $1,500.00 per short ton at January 24, 2022, down 3.9% from the 2021 average.

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Executive Summary

For the year ended December 31, 2021, the Company generated net income of $5 million, or $0.05 per fully diluted share on $1,632 million in revenue. Net income increased for the year ended December 31, 2021, by $432 million when compared to the corresponding period of 2020. Revenue increased for the year ended December 31, 2021, by $13 million, or 0.8%, when compared to the corresponding period of 2020. For the year ended December 31, 2021, operating profit was $9 million compared to operating loss of $420 million for the corresponding period of 2020.

For the fourth quarter ended December 31, 2021, the Company generated net income of $12 million, or $0.11 per fully diluted share on $432 million in revenue. Net income increased for the fourth quarter ended December 31, 2021, by $56 million when compared to the corresponding period of 2020. Revenue increased for the fourth quarter ended December 31, 2021, by $113 million, or 35.4%, when compared to the corresponding period of 2020. For the fourth quarter ended December 31, 2021, operating profit was $7 million, compared to operating loss of $37 million for the corresponding period of 2020.

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 prices and natural gas as well as crude oil and natural gas storage levels are primary catalysts for determining customer activity.

Continuing to the date of this filing, uncertainty still exists concerning the duration of the COVID-19 pandemic and its impact on the economy and global oil and gas demand. Amid these dynamics, we will continue to optimize our operations, advance our strategic goals and manage the Company based on market conditions. To navigate this challenging environment, we have undergone a significant cost transformation by taking decisive actions to cut costs, accelerate structural changes and deploy various technologies to optimize processes, increase productivity and continue to support our customers and grow revenue. We will continue to optimize our operations and adapt to market activity as appropriate to position the Company for the market ahead. As market conditions evolve, our response may result in various charges in future periods.

We see the rise in energy transition 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 transition investments. A number of our larger customers are leading the investments in energy transition projects where we expect to continue to supply them while expanding our offerings to meet their changing requirements. We are also targeting new customers that are not traditional oil and gas customers, those that will play a part in the future of energy transition.

Results of Operations

Consolidated Results

Years Ended December 31, 2021 and December 31, 2020

A summary of the Company’s revenue and operating profit (loss) by segment in 2021 and 2020 follows (in millions):

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United States

Revenue was $1,163 million for the year ended December 31, 2021, an increase of $10 million or 0.9% compared to the year ended December 31, 2020. The slight improvement in the period was primarily driven by the fluctuations in U.S. drilling and completions activity.

Operating loss was $8 million for the year ended December 31, 2021, an improvement of $273 million compared to operating loss of $281 million for the year ended December 31, 2020. Operating loss improved in 2021 primarily due to a $183 million reduction in impairment, coupled with lower inventory charges and employee-related expenses.

Canada

Revenue was $249 million for the year ended December 31, 2021, an increase of $40 million or 19.1% compared to the year ended December 31, 2020. The increase was primarily driven by the improvement in Canadian rig count and favorable foreign exchange rate impact.

Our Canadian revenue was approximately 15% of total revenue in 2021, similar to 2020. 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 favorably impacted by approximately $15 million due to changes in foreign currency exchange rates over the prior year.

Operating profit was $17 million for the year ended December 31, 2021, an increase of $77 million compared to operating loss of $60 million for the year ended December 31, 2020. Operating profit increased primarily due to a $59 million reduction in impairment and increase in revenue discussed above.

International

Revenue was $220 million for the year ended December 31, 2021, a decline of $37 million or 14.4% compared to the year ended December 31, 2020. The decline was driven by softer project activity, partially offset by favorable foreign exchange rate impacts.

Our international revenue was approximately 14% of total revenue in 2021, similar to 2020. 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 favorably impacted by approximately $9 million due to changes in foreign currency exchange rates over the prior year.

Operating profit was nil for the year ended December 31, 2021, an improvement of $79 million compared to operating loss of $79 million for the year ended December 31, 2020. Operating profit increased primarily due to a $72 million reduction in impairment and lower operating expenses.

Cost of products

Cost of products was $1,275 million for the year ended December 31, 2021 compared to $1,327 million for the year ended December 31, 2020, a decrease of $52 million. The decrease was primarily due to lower inventory charges 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 $341 million for the year ended December 31, 2021 compared to $391 million for the year ended December 31, 2020, a decrease of $50 million. The decrease was primarily due to improved operating efficiencies, mainly workforce reductions. 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.

Impairment and other charges

Impairment and other charges were $7 million for the year ended December 31, 2021 compared to $321 million for the year ended December 31, 2020. 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.

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Other income (expense)

Other income was $3 million for the year ended December 31, 2021, compared to other expense of $10 million for the year ended December 31, 2020. For the year ended December 31, 2021, other income mainly attributable to a benefit of $10 million related to the decrease in the fair value of contingent consideration liabilities, partially offset by unfavorable foreign exchange rate impacts. For the year ended December 31, 2020, other expense primarily included approximately $6 million related to our pension plans.

Provision for income taxes

The effective tax rate for the years ended December 31, 2021, and December 31, 2020 was 54.8% and 0.6%, 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, 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. For the year ended December 31, 2020, the effective tax rate was impacted by nondeductible goodwill impairment.

Consolidated Results

Years Ended December 31, 2020 and December 31, 2019

For discussion related to the results of operations and changes in financial condition for the year ended December 31, 2020 compared to the year ended December 31, 2019 refer to Part II, Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in our 2020 Form 10-K, which was filed with the United States Securities and Exchange Commission on February 17, 2021.

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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):

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(1)
We believe that net income (loss) 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 and $1 million for 2020 and 2019, respectively, as such separation amounts were reported in Other.

(3)
Other includes certain income and expenses not included in stock-based compensation. Other for 2021 primarily included $7 million of impairment and other charges and $5 million in separation and transaction-related expenses, which were included in operating profit (loss), partially offset by a benefit of $10 million related to the decrease in the fair value of contingent consideration liabilities, which was included in other income (expense). Other for 2020 included $321 million of impairment and other charges and $18 million in net separation and transaction-related expenses, which were included in operating profit (loss). Other for 2020 also included $6 million in pension expense related to the de-risking of our defined benefit plans which was included in other income (expense). Other for 2019 included $128 million of impairment and other charges and $7 million in net separation and transaction-related expenses, approximately half of which are related to the CEO departure, which were included in operating profit (loss).

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

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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 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.

At December 31, 2021 and 2020, we had cash and cash equivalents of $313 million and $387 million, respectively. As of December 31, 2021, $112 million of our cash and cash equivalents was maintained in our various foreign subsidiaries. For the year ended December 31, 2021, we repatriated $13 million from our Canadian operations. 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, 2021, we had no borrowings against our revolving credit facility and had $359 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 $248 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, 2021, 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.

As of December 31, 2021, we had $13 million of contingent consideration liabilities based on our current forecast, which was recorded in other current liabilities in the consolidated balance sheets, and the undiscounted range of outcomes was $0 to $45 million. Changes in business conditions or other events could result in material changes to the fair value of the contingent consideration. See Note 19 “Transactions” of the Notes to Consolidated Financial Statements (Part IV, Item 15 of this Form 10-K) for additional information.

See Note 11 “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):

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Fiscal Year 2021 Compared to Fiscal Year 2020

Net cash provided by operating activities was $30 million in 2021 compared to $189 million in 2020. The decrease in cash provided by operating activities in 2021 compared to 2020 was primarily driven by a net increase in working capital, partially offset by improved operating results in 2021 compared to 2020, as a result of growing market activities. The increase in working capital used cash of $33 million in 2021 compared to the decrease in working capital provided $170 million cash in 2020.

Net cash used in investing activities was $96 million in 2021 compared to net cash provided by investing activities of $22 million in 2020. In 2021, net cash used in investing activities was primarily related to business acquisitions for $96 million (net of cash acquired). In 2020, net cash provided by investing activities was primarily related to net proceeds of $26 million related to business divestitures.

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Net cash used in financing activities was $6 million in 2021 compared to $8 million in 2020. In both 2021 and 2020, net cash used in financing activities was primarily related to payments associated with finance leases.

Effect of the Change in Exchange Rates

The effect of the change in exchange rates on cash flows was a decrease of $2 million and an increase of $1 million for the years ended December 31, 2021 and 2020, respectively.

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 2022 to be approximately $15 million, primarily related to purchases of property, plant and equipment.

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, goodwill, intangible assets, contingent consideration, 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 are established based on an evaluation of accounts receivable aging, and, where applicable, specific reserves on a customer-by-customer basis. With the adoption of Accounting Standards Codification ("ASC") Topic 326 "Financial Instruments - Credit Losses", the estimated allowance for doubtful accounts (“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, customer’s financial conditions and accounts receivable past due. At December 31, 2021 and 2020, allowance for doubtful accounts totaled $25 million and $28 million, or 7.6% and 12.4% 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, 2021 and 2020, inventory reserves totaled $32 million and $39 million, or 11.3% and 13.0% of gross inventory, respectively. Changes in our estimates can be material under different market conditions.

Goodwill and Long-lived Assets

The Company conducts goodwill impairment testing at the reporting unit level annually in the fourth quarter of each fiscal year, and more frequently on an interim basis when an event occurs or changes in circumstances indicate that the fair value of a reporting unit may have declined below its carrying value.

The fair values of reporting units are determined based on valuation techniques using the best available information, primarily discounted cash flow projections and multiple-based market approach for comparable companies, where applicable. The two main assumptions that could impact the impairment analysis include the cash flow based on management’s short-term and long-term forecast of operating performance for each reporting unit and the discount rate. The starting point for the reporting unit’s projected

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cash flow from operations is the detailed annual plan or updated forecast, which takes into consideration a multitude of factors including worldwide rig activity, inflationary forces, pricing strategies, customer analysis, operational issues, competitor analysis, capital spending requirements, working capital requirements and customer needs among other items which impact the individual reporting unit projections. Cash flows beyond the specific operating plans are estimated using a terminal value calculation, which incorporates historical and forecasted financial cyclical trends for each reporting unit and also considers long-term earnings growth rates. The financial and credit market volatility impacts the fair value measurement by adjusting the discount rate.

As of December 31, 2021, the Company has $67 million goodwill in its U.S. Process Solutions reporting unit and no goodwill in other reporting units. During the fourth quarter of 2021, we performed our annual goodwill impairment test resulting in no impairment. The excess of the reporting unit's estimated fair value over carrying value (expressed as a percentage of carrying value) was approximately 25%. Adverse changes in the future could reduce the underlying cash flows used to estimate fair values and could trigger future impairment charges.

Our long-lived assets include property, plant and equipment, operating right-of-use assets and intangible assets. The Company evaluates impairment of long-lived assets whenever events or circumstances indicate that the carrying amount of such assets may not be recoverable. Recoverability of these assets is measured by a comparison of the carrying amounts to the future undiscounted cash flows the assets are expected to generate. If such review indicates that the carrying amount of long-lived assets is not recoverable, the carrying amount of such assets is reduced to fair value. The fair values of long-lived assets are primarily determined using discounted cash flow projections, and market approach, where applicable, based on market observable data and quotes for certain assets.

For the year ended December 31, 2021 we recognized approximately $10 million of impairments for long-lived assets primarily relating to exiting certain property and right-of-use operating leases.

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.

Contingent Consideration

The fair value of acquisition-related contingent consideration is determined using the Monte Carlo simulation based on estimated future cash flow projections, the probability of achievement and the estimated discount rates, all of which are classified as level 3 inputs under the fair value hierarchy. The fair value of the contingent consideration is highly subjective if different estimates and assumptions are used. Changes in business conditions or other events could result in material changes to the fair value of the contingent consideration.

As of December 31, 2021, we had $13 million of contingent consideration liabilities based on our current forecast, which was recorded in other current liabilities in the consolidated balance sheets and the undiscounted estimated range of outcomes was $0 to $45 million. A hypothetical 5% change in the forecasted EBITDA (as defined in the acquisition agreement) would change the estimated fair value by approximately 30%.

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.

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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 2021. 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, 2021. The change during the year in the valuation allowance was nil in the U.S. and $2 million in other foreign jurisdictions.

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 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, 2021, the amount of undistributed earnings of foreign subsidiaries was approximately $1 million. 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.

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Recently Issued Accounting Standards

In March 2020, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2020-04, Reference Rate Reform (Topic 848), which provides optional expedients and exceptions to contracts, hedging relationships, and other transactions that reference LIBOR or another reference rate expected to be discontinued because of reference rate reform. Entities that elect the relief are required to disclose the nature of the optional expedients and exceptions that are adopted and the reasons for the adoptions. The guidance is effective upon issuance and the expedients and exceptions may be applied prospectively through December 31, 2022. The Company is currently assessing the impact of ASU 2020-04 on its consolidated financial statements but does not expect the adoption of this standard to have a material effect on its consolidated financial statements.

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