Business context and reporting period
NOW Inc. (NYSE: DNOW) filed this Form 10-K for the year ended December 31, 2018, including fourth-quarter results. The company distributes energy and industrial products and provides supply-chain services through approximately 265 locations and 4,500 employees. It reports three segments: United States, Canada and International.
Financial performance and liquidity
Amounts are in millions of dollars, except per-share data and percentages.
| Metric | 2018 | 2017 |
|---|---|---|
| Revenue | $3,127 | $2,648 |
| Operating profit (loss) | $73 | $(41) |
| Net income (loss) | $52 | $(52) |
| Diluted EPS | $0.47 | $(0.48) |
| Cash from operating activities | $73 | $(115) |
| Cash and cash equivalents, year-end | $116 | $98 |
| Long-term debt, year-end | $132 | $162 |
| Working capital, year-end | $778 | $735 |
Revenue increased 18.1%. Operating margin was 2.3%, versus negative 1.5% in 2017; net margin was approximately 1.7%, versus negative 2.0%. EBITDA excluding other costs, a non-GAAP measure, was $109 million (3.5% of revenue), compared with $7 million (0.3%) in 2017.
Fourth-quarter revenue was $764 million, up 14.2% from $669 million a year earlier. Operating profit was $22 million, compared with approximately zero; net income was $16 million versus a $3 million loss, and diluted EPS was $0.14 versus a $0.03 loss.
Year-end current assets were $1,219 million and current liabilities $441 million. The company had $385 million of availability under its revolving credit facility, in addition to $116 million in cash; $95 million of cash was held by foreign subsidiaries. It reported compliance with credit covenants. Operating cash flow turned positive as earnings improved and inventory investment slowed; capital spending was $11 million. The company paid no dividends in 2017 or 2018.
Material changes versus prior comparable period
- U.S. revenue rose 23.9% to $2,371 million, and operating results improved from a $53 million loss to $57 million profit, principally reflecting stronger activity, pricing and commodity-related inflation.
- Canada revenue was nearly flat at $358 million; operating profit increased to $14 million from $13 million. International revenue grew 5.3% to $398 million and operating profit improved to $2 million from a $1 million loss.
- Worldwide average rig count increased 8.9%; average WTI crude prices rose 27.6% and hot-rolled coil steel prices rose 33.4%. The company cited improved activity and pricing, while higher steel costs and customer/product mix remain relevant to margins.
- Operating cash flow improved by $188 million year over year. Inventory growth was $30 million, down from $110 million in 2017, while receivables increased $69 million.
- Foreign-currency translation produced a $38 million loss in other comprehensive income, versus a $37 million gain in 2017. Goodwill and intangible assets declined to $314 million and $144 million, respectively.
Outlook, risks and unusual items
Management said the 2019 outlook remains linked to global rig counts and oil-and-gas spending, particularly in North America. Oil-price volatility and uncertainty about customer budgets could cause activity to fluctuate. The company plans to adjust operations to market conditions and expects approximately $20 million of 2019 capital expenditures. It stated that cash, expected operating cash flow and facility availability should fund operations and anticipated requirements.
- Market exposure: Demand depends on energy-sector spending, commodity prices and broader economic conditions. Competition, pricing pressure, steel-price changes and U.S. tariffs or retaliatory trade measures may affect sales, costs and margins.
- Credit and contingencies: Management estimated reasonably possible losses of zero to $16 million in the International segment, primarily related to one customer’s receivable, and said it accrued its best estimate; the filing does not state that estimate’s amount. Outstanding standby letters of credit and surety bonds were approximately $10 million. Management did not expect pending ordinary-course legal matters to materially affect the company.
- Goodwill sensitivity: No impairment was recorded in 2018. International reporting-unit fair value exceeded carrying value by approximately 5%, making it comparatively sensitive to weaker forecasts or adverse market changes.
- Tax matters: A valuation allowance remained against deferred tax assets despite 2018 profitability, given cumulative losses. The effective tax rate was 10.7%; tax effects included the Tax Cuts and Jobs Act and foreign tax credits.
- Leases: Adoption of the new lease standard on January 1, 2019 was expected to increase balance-sheet assets and liabilities by less than $100 million; management did not expect a material effect on earnings or cash flows.
- Other exposure: The filing highlights foreign-exchange, cyber, supply-chain, environmental, product-liability, regulatory and international-operating risks. A 10% foreign-exchange movement was estimated to change 2018 net income by approximately $2 million.
The financial statements received an unqualified audit opinion, and the auditor also gave an unqualified opinion on internal control over financial reporting.
Most important facts for investors to verify
- Whether the 2018 earnings and positive operating cash flow are sustainable as commodity prices, rig activity and customer budgets change.
- The collection status and exposure associated with the International customer receivable, including the amount accrued against the disclosed potential-loss range.
- Whether International segment forecasts maintain sufficient goodwill headroom, and whether any deterioration could trigger impairment.
- Current revolver availability, borrowing-base limits and covenant headroom under the $750 million facility.
- How working-capital needs, steel prices and tariffs affect margins and cash conversion, and whether planned 2019 capital expenditures remain appropriate.