NOW Inc.
Q1 2016 Earnings Call Transcript

Published: 5 May 2016

[Operator:]

Welcome to the First Quarter 2016 Earnings Conference Call. My name is Christine, and I will be the operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. I will now turn the call over to Senior Vice President and Chief Financial Officer, Daniel Molinaro. Mr. Molinaro, you may begin.

[Daniel L. Molinaro:]

Thank you, Christine, and welcome everyone to the NOW Inc. first quarter 2016 earnings conference call. We appreciate you joining us this morning and thanks for your interest in NOW Inc. With me, this morning is Robert Workman, President and CEO of NOW Inc.; and Dave Cherechinsky, Corporate Controller and Chief Accounting Officer. NOW Inc. operates primarily under the DistributionNOW and Wilson Export brands, and you'll hear us refer to DistributionNOW and DNOW, which is the New York Stock Exchange ticker symbol throughout our conversations this morning. In addition to these brands, we're very excited about new brands added to the DNOW family during 2015, including MacLean Electrical, Machine Tools Supply, and Odessa Pumps and Equipment, among others. Before we begin this discussion on NOW Inc.'s financial results for the first quarter ended March 31, 2015, please note that some of the statements we make during this call 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 risk and uncertainties and actual results may differ materially. No one should assume that these forward-looking statements remain valid later in the quarter or later in the year. I refer you to the latest Forms 10-K and 10-Q that NOW Inc. has on file with the U.S. Securities and Exchange Commission for a more detailed discussion of the major risk factors affecting our business. Further information regarding these as well as supplemental, financial and operating information may be found within our press release, on our website at www.distributionnow.com, or in our filings with the SEC. As of this morning, the Investor Relations Section of our website contains a supplemental presentation covering our Q1 results and key takeaways, which should assist you in understanding our first quarter performance. A replay of today's call will be available on the site for the next 30 days. It also should be noted that we plan to file our Q1 Form 10-Q later today and it will also be available on our website. Later on this call, I will discuss our financial performance and we will then answer your question. But, first, let me turn the call over to Robert.

[Robert R. Workman:]

Thanks, Dan. Welcome to DistributionNOW's Q1, 2016 earnings call. Tuesday afternoon, our employees at Fort McMurray, Alberta, Canada branch had to evacuate due to a wildfire that has made its way into several of the local communities and the town. Fortunately, all are safe and have found shelter. Before we get started I'd like them to know that our thoughts and prayers are with them. The first quarter of 2016 proved to be as challenging as the many preceding quarters with the U.S. and Canada rig count dropping 23% sequentially and 57% versus the year ago period. While production in the U.S. peaked several months ago, oil storage is proving quite stubborn and is rivaling levels from over 80 years ago. Until production declines translate into meaningful oil inventory storage reductions in the U.S., I believe we will continue to operate in a challenging upstream environment. One of our midstream customers recently hosted their leadership team meeting at my property Northwest of Houston. I first met many of these executives when I was a delivery driver in our Bryan, Texas branch 25 years ago. At that time, a large number of them worked for Union Pacific Resources. Over dinner one evening last week, we were reminiscing about how dire activity was in the Bryan area before the Austin Chalk gained its momentum. Looking back today, we all agree that the word dire is a relative term considering the fact the Bryan area currently has one drilling rig operating today, which is significantly worse than the pre-chalk area from 25 years ago. Without question, today's operating environment is the most challenging any of our teams have experienced. Even though some of our largest revenue streams are being negatively impacted like never before, in part due to wells being drilled but not completed whereby tank batteries or hook ups are not being constructed. And at a time when both onshore and offshore drilling rigs are being stacked or scrapped, providing significant excess inventory available to be cannibalized, our employees continued to produce strong revenues per operating rig by growing share across our customer base. Q1 2016 revenue for global operating rigs remained flat sequentially at $1.3 million and $1.1 million with and without 2015 acquisitions respectively. This is quite an accomplishment by our employees all while a strengthening dollar negatively affected revenues by $6 million and $19 million sequentially and year-over-year respectively. There's nothing I can say that would adequately express my appreciation for the hard work and results our employees continue to produce and what we hope will be and have been the worst industry downturn of our careers. Before moving on to the business, I'd like to thank one person in particular today. I'd like to recognize Merlin Theroy (06

[Daniel L. Molinaro:]

Thanks, Robert. It's been almost two years since we spun off from National Oilwell Varco, and I continue to be proud of the efforts of our wonderful workforce, as we created a standalone world class provider of products and solutions to the energy and industrial market. It is disappointing that for the most part we've been in this downturn in our industry, a downturn which may be considered one of the worst of all time when it's finally over. I am thankful for our dedicated, hardworking employees who make me proud as they continue to emphasize serving our customers despite the industry headwinds they face each day. They are the true assets here at DistributionNOW. We will continue to concentrate on the needs of our customers, while focusing on producing long-term value for our stakeholder. Robert discussed our business and I'll say more about our financials. NOW Inc. reported a net loss of $63 million or $0.59 per fully diluted share on a U.S. GAAP basis for the first quarter of 2016 on $548 million in revenue. This compares with a net loss of $249 million or $2.33 per fully diluted share on $644 million of revenue in the fourth quarter of 2015 which included goodwill, impairment and other costs. When looking at a year-ago quarter, we had a net loss of $10 million or $0.09 per fully diluted share on revenue of $863 million for the first quarter of 2015. The first quarter 2016 results included $4 million in pre-tax acquisition related and severance charges and an after-tax, deferred tax asset valuation allowance of $23 million. Excluding these other costs, our net loss was $38 million or $0.35 per fully diluted share. Also included in the first quarter ended March 31, 2016 results but not characterized as other costs, was a pre-tax charge of $3 million or $0.02 a share for high steel content inventory cost adjustments relating to continued falling steel prices. Gross margin was 15.9% in Q1 compared with 16.5% in the fourth quarter of 2015 reflecting continued inventory cost adjustment and ongoing price pressure. The company generated an operating loss of $65 million in Q1 compared with a loss of $46 million in Q4 after excluding the fourth quarter goodwill impairment charge. First quarter EBITDA excluding other costs was a loss of $51 million. Looking at operating results for our three geographic segments, revenue in the United States was $357 million in the quarter ended March 31, 2016, down 18% from Q4 but less than the 26% sequential decline in the U.S. rig count. Q1 revenue in the U.S. was down 41% from the year ago quarter, with the decline being less than the 60% fall in the year ago U.S. rig count as acquisition revenue improved our position. Reduced customer spending and delayed projects were contributing factors to these revenue declines. First quarter operating profit in the U.S. was a loss of $59 million compared with a $45 million loss in the fourth quarter of 2015 after excluding goodwill impairment and a loss of $12 million in Q1, 2015 reflecting revenue declines and deflationary pressures at these low volumes. In Canada, first quarter revenue decreased 20% sequentially to $63 million and down 46% from Q1 2015, reflecting the declines in the Canadian rig count and well completion. The Canadian dollar continued to weaken relative to the U.S. dollar, adversely impacting revenue, falling 3% in the first quarter of this year and 7% year-over-year. For the three months ended March 31, 2016 Canada's operating loss was $6 million compared with a $1 million operating loss in Q4 and an operating profit of $3 million in the year ago quarter. The decreased operating loss from Q1 2015 was essentially due to deteriorating market activity, partially offset by expense reduction. International operations generated first quarter revenue of $128 million, which was down 3% from the fourth quarter of 2015 versus an international rig count decline of 8% and down 12% from the year ago quarter compared with a 19% rig count decline from the year ago quarter. Additional revenue provided by acquisitions was offset by decreased international rig activity and customers focusing on using owned inventory. International operating profit for the first quarter of 2016 was zero, similar to fourth quarter of 2015 and compares with $1 million in the year ago quarter. Revenue channels for the first quarter shows 75% through our energy centers or stores, as many of us know them, and 25% through our supply chain services location. Looking at our income statement, warehousing, selling and administrative expenses were $152 million, same as the fourth quarter of 2015. These costs include branch and distribution center expenses, as well as corporate costs. It should be remembered that excluding acquisition-related expense, we have reduced our quarterly warehousing, selling and administrative expense by more than 25% since the end of 2014. The effective tax rate for Q1 2016 was 5.2%, based upon the Q1 loss we recorded and an additional deferred tax asset valuation allowance of $23 million after tax. Valuation allowances are recorded per U.S. GAAP when our deferred tax assets may not be realized in future periods therefore may not reduce our provisions for income tax. As we return to profitability, we would be able to adjust the valuation allowance, thus reducing income tax expense in future periods. The effective tax rate for the full year 2016 should be in the mid single-digit. Turning to the balance sheet, NOW Inc. had working capital of approximately $900 million at April 31, 2016, which was 41% of Q1 annualized sales, 35% when cash is excluded. We still strive to get to 25%, again. Accounts receivable was $413 million at the end of the first quarter, a reduction of $72 million during the quarter. Since beginning of last year, we reduced AR approximately $438 million or 51%. We continue to be diligent as bankruptcies are on the rise in our energy space. Inventory was $633 million at the end of Q1 or $60 million lower than year end. We have slowed the inventory replenishment process and should continue to show reduction. Inventory is down $315 million since the start of last year despite increased inventory from our acquisition. Our current day sales outstanding were 59 days which has improved over the mid-80s in the year ago quarter and we continue to work on improving these results to closer to the 60 day range. Inventory turns were 2.9 times. Cash totaled $131 million at March 31, 2016, up $41 million during the quarter with approximately two-thirds of our cash located outside the U.S. We ended the quarter with $55 million borrowed under our credit facility, a reduction of $53 million during the quarter. Our borrowing cost on this debt averages 2.6%. Capital expenditures during Q1 was approximately $1 million. Free cash flow for the first quarter was $88 million. So far in 2015, our worldwide market continues in decline. While we look forward to better time, we will continue to focus on serving our customers with our global footprint. We will continue integrating our recent acquisitions and managing costs. We have confidence in our strategy, in our employees, and in our future as we position NOW Inc. to continue to serve the energy and industrial markets with quality products and solutions. We are an organization with an experienced management team, strong financial resources and we believe this current downturn creates new opportunities for us and our shareholders as we position ourselves for the inevitable upturn. With that, Christine, let's open it up to questions.

[Operator:]

Thank you. Our first question comes from Ryan Cieslak from KeyBanc Capital. Please go ahead.

[Robert R. Workman:]

Hey, Ryan.

[Ryan Cieslak:]

Hi, good morning everyone.

[Robert R. Workman:]

Morning.

[Ryan Cieslak:]

So I guess maybe the first question is, I want to get maybe a better sense of how to think about the recent Power Service's acquisition. Any color you can provide, maybe on the type of sales they had, the margin profile? I know that hasn't closed yet, but any additional information on that would be helpful.

[Robert R. Workman:]

Yeah, so we haven't closed yet and it's impossible to forecast when it actually will close since it's now in the government's hands. But they run – I think in 2014 they published, they ran $270 million of revenue and they're selling to the same customers we are and so we're off by half so I would imagine they'll be off about half this year. And, obviously, their margins are pressured just like ours right now so right now, they're running low single-digit EBITDA but that will definitely improve, back to their historical levels whenever the market recovers.

[Ryan Cieslak:]

And is there – the way to think about the geographic breakout, I mean I'm assuming that's concentrated in the U.S. but is there any Canadian exposure or how much directionally if they have any Canadian exposure would that be?

[Robert R. Workman:]

So they've grown their business considerably over the last three or four years by focusing on most of the plays that are in the Rockies and the North Dakota Bakken. One of the exciting things about this is that by using our supply chain services customers' agreements, by leveraging our Canadian infrastructure which they don't have, we believe organically – and Odessa Pumps on top of that – we believe organically we can grow this thing pretty considerably.

[Ryan Cieslak:]

Okay. And then thinking about the pricing environment, it sounded like things remained depressed but aren't getting any worse. You commented on the steel prices starting to tick up here. How do we think about maybe how, if we continue to see an uptick in steel prices, how that would actually flow through in terms of maybe starting to realize some price increases in terms of maybe just what the lag would be at the end of the day?

[David A. Cherechinsky:]

Hey, Ryan. This is Dave. I think we're excited about what looks like some uptick in pricing. What we're still seeing though is we're seeing a lot of enquiries and not a lot of orders, so the demand hasn't caught up with that. We're a little nervous that those price increases won't be permanent but if we start to see some improvement, we see the slack come out of the industry inventory and our inventory, then we would expect to see nice forward progression in pricing and gross margin and reduce inventory charges as we start to see that river of product flow expand. So, it really depends on the inventory that's in the market, customer demand and the timing of any kind of recovery in sales there.

[Ryan Cieslak:]

And are you seeing anything on the initial price increases on the valve and fitting side or is it still too early at this point to see a price increase on that product line, at this point?

[David A. Cherechinsky:]

Generally, we're not seeing product increases on product lines except for you know steel producers trying to put a floor on the pricing they have. So, no, we're not seeing forward movement otherwise except in pipe and that has yet to stick in terms of pricing on actual orders delivered.

[Ryan Cieslak:]

Okay. And then maybe just the last question and I'll hop back in the queue is I think there was some commentary in the prepared remarks about bad debt cost. I'd just be curious to know how incremental that was in the quarter relative to maybe in the fourth quarter even on a year-over-year basis.

[David A. Cherechinsky:]

Sequentially, it was about $1 million increase. Year-over-year I don't have that figure handy, but you know what we're seeing is our customers being more stressed financially, as you would expect. And customers are demanding longer terms and some simply can't pay their bills, so we're seeing an uptick in that expense. Again, as the market bottoms and that we see some recovery, hopefully that will abate but that would be sequential increase.

[Ryan Cieslak:]

Okay. Thanks for the time guys.

[Robert R. Workman:]

Thank you.

[Operator:]

Thank you. Our next question comes from Sean Meakim from JPMorgan. Please go ahead.

[Sean C. Meakim:]

Hey. Good morning.

[Daniel L. Molinaro:]

Hey, Sean.

[Robert R. Workman:]

Good morning Sean.

[Sean C. Meakim:]

So you guys had good working capital release and free cash in the quarter, but as you noted, we're still at 35% working capital-to-sales given the drop in the top line. So I just was curious, if you had a better sense of, as we go through 2016, how much working capital release do you think is still available. And then do you expect that ratio can improve pretty meaningfully if we even just get to a stabilization in activity?

[Robert R. Workman:]

Yeah. So we still expect $150 million to $200 million of cash generation from operations for the full year, and yes we would expect the ratio to improve as revenue stopped dropping. Obviously, in the calculation, if revenue is headed downward, it exaggerates the working capital as a percent of revenue calculation.

[Sean C. Meakim:]

Exactly, okay. And then just to touch on the Power Service deal, you noted some synergies in the prepared remarks with respect to some customer pull through demand on that side, just for some new offerings, specifically. Just curious, how does that competition look in that area in terms of how unique this offering set is relative to what else is in the marketplace?

[Robert R. Workman:]

Yes, it's very unique. In fact, one of our top three customers came to me, specifically, about three years ago, asking us to come up with some solution, whereby we could prefab and speed up the time it takes to build a tank battery. So after the frac crew leaves the tank battery, typically what happens is that the operator will call somebody and order the tank and somebody order the heater treaters and oil water separators and power construction crews and then call DNOW or one of our competitors to deliver many, many trailer loads of pipe, valves and fittings and then they build a facility onsite. And so, they're not producing oil and gas that's available for 30 to 60 to 90 days depending on the size of the facility. What this company does is they prefab and modify these modulized units and have them ready to go. So whenever the frac crew leaves the site, they deliver several skids that do the same thing that this home-built system does and then they plumb it together with a control unit and you can drastically expedite the amount of time that the customer can get their oil and gas in the pipeline and start making money.

[Sean C. Meakim:]

Yeah, that sounds like a pretty substantial savings. Okay, great. Thank you.

[Robert R. Workman:]

Thank you.

[Operator:]

Thank you. Our next question comes from David Manthey from Robert W. Baird. Please go ahead.

[David J. Manthey:]

Hi, good morning guys.

[Robert R. Workman:]

Hi, Dave.

[David J. Manthey:]

Robert, you said you expect $5 million to $7 million lower costs ex-acquisitions, I believe. And is that a quarterly run rate from the first quarter levels and after you include costs related to acquisitions that have already been done, what is the net reduction that you would expect there?

[Robert R. Workman:]

Well, Dave, it is $5 million to $7 million down or compared sequentially to Q1. That assumes that the charges we've been taking for inventory and for bad debt continue in Q2 so that would be upside if that doesn't repeat and then we would expect to continue to cut. So we're going to cut costs in Q2 so you'll see even more in Q3, but it all depends on what happens with some of our customers' accounts receivable with us.

[David J. Manthey:]

Okay. And I assume that $5 million to $7 million – you're saying that excludes acquisitions. Clearly that excludes the new Power Service acquisition as well. Will you readdress that at a later time?

[Robert R. Workman:]

I definitely will. I'm not really addressing what you should consider for Power Service in the current quarter because the government's got at least a month that they'll be working on it. Then we have to get it closed and so we're only talking about a few weeks of impact, so it's really going to be negligible.

[David J. Manthey:]

Got it. Okay. And then you clearly saw a negative impact from lower supplier incentives on gross margin. Could you quantify that for us relative to what you saw a year ago?

[David A. Cherechinsky:]

Well, listen, Dave, we don't really disclose that kind of information. We consider it proprietary commercial, it's a pricing kind of information. So it's a function of volume really. And what we've seen is we're still burning off inventory and our purchases are declining. So I'd really rather not cite a number, but – and it usually doesn't have that kind of impact on the activity but we're projecting lower sales in the first half of the year so it's driving that number down.

[David J. Manthey:]

Okay. So, but the majority of the change would be related to mix or price or something else?

[David A. Cherechinsky:]

That's right, that's right.

[David J. Manthey:]

Okay. All right, thank you.

[Operator:]

Thank you. Our next question comes from Matt Duncan from Stephens. Please go ahead.

[Matt Duncan:]

Hey, good morning, guys.

[Robert R. Workman:]

Hey, Matt.

[Daniel L. Molinaro:]

Hi, Matt.

[Matt Duncan:]

Robert, you had a little commentary in your prepared remarks about sort of the challenges in 2Q versus 1Q and some of the benefits that you'll have there. I guess it sounds like net-net we should expect sales to be down. Do you have any thoughts on sort of the percentage decline sequentially in revenues that you would expect based on sort of where rig count is and what you're seeing in the business?

[Robert R. Workman:]

Matt, that really depends on what rig count does for the next two months. We've been consistently putting out around $1.3 million of revenue per rig. So it's anybody's best guess what happens with the rig count. So if you make up your rig count forecast, you can apply the number and that should be pretty close.

[Matt Duncan:]

Okay. And then in terms of oil price and where it would drive increased activity, just want to think through sort of how this impacts your business. So it sounds like mid-$40s are better. If we sustain that level, we'll see these DUCs start getting completed. That's going to result in tank battery work. Theoretically, the acquisition of Power Secure or Power Service rather, then becomes very, very well timed. So would you expect to see the revenue per rig go up from that $1.3 million level, given that rig count wouldn't yet be recovering but you would start to see some of that tank battery work come through?

[Robert R. Workman:]

Yeah. My assumption would be and – there's a lot of variables in this, but if what happens is some of these companies in the $45 to $50 range start completing the DUCs, but no one picks up rigs, you might see a weird blip in our revenue per rig being exceptionally high because all that revenue would come in with no corresponding rig count.

[Matt Duncan:]

Right. And then it sounds like it's sort of a $50-plus level before you're going to see any kind of movement in rig count, right?

[Robert R. Workman:]

Yeah. I read all of our customers' reports and they tell us all the same thing publicly, but I haven't seen anyone say they're going to pick up rigs at less than $50. And some are saying, they won't pick up rigs until we get to $65. So in the $50 to $65 range if it's sustainable, I think you're going to see people start adding back rigs.

[Matt Duncan:]

Okay. And then last thing, just back to the Power Service deal. So it sounds like there's maybe a pretty meaningful cross-sell opportunity there in this tank battery market. I'm assuming that we can, obviously, guess who the competitor would be for the PVF on those tank batteries that you'd be maybe able to take some business from. Talk about the competition in the pump/package market in that fabrication business. Who else is building those packages for tank batteries? Is anyone else really targeting that market or is there something that Power Service does really well that others aren't really targeting as much?

[Robert R. Workman:]

I've visited lots of folks that are trying to pull this together. I've seen companies that are trying to form alliances so you have a fabricator and a tank manufacturer and a pump distributor all getting together, trying to pull together a joint venture per se. I haven't seen it come to fruition. I've only seen one other company that actually does what Power Service does and the quality isn't nearly as high and they're not nearly as successful in this space. So I think they really standout right now in the market around their position. They've almost invented this particular solution on their own back starting about seven years ago. And so there's a lot of good synergies because so Power Service, as you can imagine, when they fabricate a skid unit, they buy a lot of pipe, valves and fittings. I mean it's one of their biggest spend categories and currently that's going to one of my competitors, so that will be brought in house. They're paying resale price so their margins will improve as they utilize our vendors in our costing, that we will use our sales force that have all these operator relationships to grow their share organically. And then one of the most sexy parts about this is the fact that they have distributorships for some really important pump lines for all of the Western U.S. that will really benefit Odessa Pumps.

[Matt Duncan:]

Okay. And then last question on this then, what is your revenue content right now in a typical tank battery and what is their revenue content in a typical tank battery? Just trying to gauge how much it's going to increase your average revenue in a tank battery?

[Robert R. Workman:]

You know what, Matt, I don't know. I've never asked them what their typical revenue per tank battery is. I know ours ranges from 200 to 400 (48

[Matt Duncan:]

Okay. All right, no worries, thanks guys.

[Operator:]

Thank you. Our next question comes from Walter Liptak from Seaport Global. Please go ahead.

[Walter Scott Liptak:]

Hi, thanks. Good morning everyone.

[Robert R. Workman:]

Good morning, Walt.

[Daniel L. Molinaro:]

Hey, Walt.

[Walter Scott Liptak:]

I want to ask about the – you started the commentary about the Fort McMurray fires and I just wondered if you're thinking that there's going to be disruption in the second quarter, what kind of impact that could have on revenue.

[Robert R. Workman:]

But it's kind of early to forecast but I can't imagine that that fire is not going to create all sorts of troubles for everyone working in the oil sands. I mean there's one road in and there's one road out and a big part of that town has now been pretty much burnt. People have evacuated, so our branch is shutdown, operators have evacuated some of the camps that house the employees that work in the oil sands, those have been burned down. So it's really early to tell but I would be blown away if it didn't impact that particular region negatively for some time to come.

[Walter Scott Liptak:]

Okay. Could you help size it for us like in 2015 how much revenue came out of that region?

[Robert R. Workman:]

I really don't know, Walter, what our revenue is for the oil sands standalone. We've never actually gotten. I've never had that data before.

[Daniel L. Molinaro:]

But if you look at total Canada, I mean Canada surely has been lagging though I mean it's a small number. It's a small piece of the total pie, all of Canada is a small piece. So then you get into this, I don't want to minimize the importance here and we certainly need to be conscious of our people and all the people there, but I don't think it's going to move the needle, Walt.

[Robert R. Workman:]

Yeah. I would say Walt, our largest revenue in Canada is probably Saskatchewan and then BC and then the Alberta oil fields and then the oil sand.

[Walter Scott Liptak:]

Okay, okay, great, fair enough. On the acquisition, have you announced what the price is yet, that you negotiated?

[Robert R. Workman:]

Yeah, we've not disclosed any of that.

[Walter Scott Liptak:]

Okay, great. Thank you.

[Robert R. Workman:]

Thank you.

[Daniel L. Molinaro:]

Take care, Walt.

[Operator:]

Thank you. I will now turn the call back over to Robert Workman, President and CEO for closing statements.

[Robert R. Workman:]

Okay. I'd like to thank everyone for your interest in DNOW and we look forward to talking to you about our second quarter results for 2016.

[Operator:]

Thank you. And thank you ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.