DNOW Inc. quarterly report, Q2 FY2018

Business context and reporting period

NOW Inc. (operating primarily as DistributionNOW and Wilson Export) is a global distributor of energy and industrial products and supply-chain services. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2018; comparisons are with the corresponding 2017 periods unless noted. Amounts are in U.S. dollars.

Financial performance and liquidity

• Revenue rose 19.4% in Q2 and 20.2% for the first six months. Operating margin was 2.3% in Q2 and 1.6% year to date, versus losses of 2.2% and 2.7%, respectively, in 2017.
• Approximate gross margin, calculated as revenue less cost of products, was 20.2% in Q2 and 19.8% year to date, compared with 19.0% and 18.6% in 2017.
• Company-reported non-GAAP EBITDA excluding other costs was $29 million (3.7% of revenue) in Q2 and $45 million (2.9%) year to date, versus losses of $2 million and $11 million, respectively. This measure is not GAAP and should not be considered in isolation.
• Operating cash flow was negative $25 million for the six months, improving from negative $74 million in 2017. Receivables increased $79 million and inventories $25 million, partly offset by a $31 million increase in accounts payable and accrued liabilities. Investing cash flow was negative $2 million; financing cash flow was positive $25 million.
• Cash was $91 million at June 30, 2018, down from $98 million at year-end 2017; approximately $76 million was held by foreign subsidiaries. Current assets were $1.213 billion and current liabilities $420 million.
• Long-term debt was $195 million, up from $162 million at year-end. The new five-year secured revolving facility provides up to $750 million; reported availability was approximately $332 million, and the company said it was compliant with covenants. Interest rates are variable.

Material changes and segment results

• The U.S. drove most of the improvement: Q2 revenue increased 24.7% to $600 million, and operating profit was $16 million versus a $16 million loss. Year-to-date revenue increased 26.3% to $1.162 billion, with $19 million operating profit versus a $42 million loss.
• Canada Q2 revenue declined 5.1% to $75 million, attributed to lower rig activity; operating profit was $1 million versus $2 million. Six-month revenue was $177 million and operating profit $5 million, broadly in line with 2017.
• International Q2 revenue rose 12.1% to $102 million, with operating profit of $1 million. Six-month revenue rose 8.0% to $202 million, but operating profit fell to $1 million from $2 million, primarily due to increased bad-debt charges.
• The company replaced its prior revolving credit facility on April 30, 2018. Foreign currency translation generated a $19 million loss in other comprehensive income for the first six months.

Outlook, risks and unusual items

Management provided no numerical earnings or revenue guidance. It said performance remains tied to global rig counts, drilling and completion spending, oil prices and U.S. oil storage levels. Its stated approach is to rationalize costs and capital in weaker markets and invest where activity is expanding; management expects cash, operating cash generation and credit-facility availability to cover operations, working capital and capital needs.

• Key risks include energy-market and customer-demand volatility, steel-price changes, foreign-exchange movements, competition, borrowing costs, potential goodwill or intangible-asset impairment, and regulatory or environmental changes. Management noted that market conditions remain uncertain.
• For certain international matters, primarily receivables from one customer, management estimated reasonably possible losses of $0–$15 million and said it accrued its best estimate. The filing does not specify that accrued amount. Other claims and regulatory matters were described as not expected to materially affect results, though outcomes are uncertain.
• The company adopted revenue-recognition Topic 606 on January 1, 2018; it reported no material effect on revenue measurement or recognition, but recorded $5 million of additional receivables and deferred revenue related to unconditional payment rights. Adoption of the lease standard in 2019 was expected to increase reported assets and liabilities, with no material effect expected on earnings or cash flows.
• Tax accounting for the 2017 Tax Cuts and Jobs Act remained provisional. The company recorded a provisional GILTI tax expense of less than $1 million, fully offset by prior-year losses. It used a year-to-date effective-tax-rate method because of industry uncertainty.
• Disclosure controls were concluded effective at a reasonable-assurance level; no material change in internal control over financial reporting was reported during the quarter.

Important facts for investors to verify

• Whether sales growth converts to sustained operating profitability and stronger operating cash flow, given the substantial working-capital use.
• Receivables quality and the outcome of the international customer exposure, including the eventual loss versus the estimated $0–$15 million range.
• Actual borrowing availability, covenant headroom and variable-rate interest costs under the new secured facility.
• The effect of market activity, steel prices and foreign exchange on margins and segment performance.
• Final tax effects of the Tax Cuts and Jobs Act and the balance-sheet impact of adopting the lease standard.