DNOW Inc. (NOW Inc.) — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. NOW is a global distributor of energy and industrial products, operating through U.S., Canada and International segments. Amounts below are in millions of dollars unless stated otherwise.
Financial results
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $520 | $753 | $1,569 | $2,366 |
| Operating loss | $(53) | $(291) | $(175) | $(326) |
| Operating margin | (10.2%) | (38.6%) | (11.2%) | (13.8%) |
| Net loss | $(56) | $(224) | $(163) | $(253) |
| Basic and diluted loss per share | $(0.53) | $(2.09) | $(1.52) | $(2.36) |
| EBITDA excluding other costs (non-GAAP) | $(40) | $(20) | $(133) | $(33) |
Nine-month operating cash flow was $186, versus $244 in 2015. Investing cash outflow was $191, including $182 for acquisitions; financing provided $33. Cash rose to $131 at September 30 from $90 at year-end 2015. Capital expenditures were $3 for the nine-month period.
At September 30, current assets were $1,024 and current liabilities $292. Long-term debt was $145, drawn under the revolving credit facility; the company reported compliance with its financial covenants. Total assets were $1,711 and stockholders’ equity was $1,268. Approximately $109 of cash was held by foreign subsidiaries, with no current plans to repatriate it.
Changes and operating drivers
- Revenue fell 30.9% in Q3 and 33.7% for the first nine months year over year. Management cited depressed energy activity and reduced customer spending. In Q3, U.S. revenue declined 25.2%, Canada 28.7%, and International 50.0%; nine-month declines were 33.1%, 38.1%, and 32.8%, respectively.
- Operating losses narrowed substantially against 2015, primarily because the comparable periods included a $255 goodwill impairment charge. There was no goodwill impairment in 2016. Lower inventory charges and cost reductions also helped, partially offset by lower volumes.
- Q3 2016 included approximately $44 of incremental revenue from acquisitions; the nine-month impact was approximately $132. Cost-cutting initiatives reduced warehousing, selling and administrative costs, partly offset by acquired-company expenses.
- The company acquired Power Service in June for net purchase-price consideration of $176. Preliminary purchase accounting included $129 of goodwill and $46 of intangible assets; valuations remained subject to change.
- Industry conditions remained weak versus 2015: average worldwide rig count was down 29.8% and U.S. rig count down 44.6%. Rig activity improved from Q2 2016, while WTI averaged $44.85 per barrel in Q3.
Outlook, risks and unusual items
Management gave no quantified earnings or revenue guidance. It said the outlook remains tied to worldwide rig counts, particularly in North America, and that market recovery timing is uncertain. Management described a quarter-to-quarter operating approach, continued cost focus and interest in strategic acquisitions.
- The January 2016 credit-facility amendment suspended the minimum interest-coverage covenant until the company elects otherwise, added a minimum asset-coverage ratio of 1.50:1, reduced the maximum capitalization ratio from 50% to 45%, and increased borrowing costs. The $750 facility expires April 18, 2019; borrowings above 75% of commitments are subject to an additional fixed-charge-ratio condition. U.S. assets and approximately 65% of first-tier foreign subsidiary equity were pledged as security.
- Management estimated reasonably possible losses of $0–$18, primarily related to one International-segment customer’s receivable, and said its best estimate was accrued. It stated other recorded contingent liabilities were immaterial and did not expect pending matters to materially affect financial position, cash flow or results.
- The company’s income-tax benefit was $19 for the first nine months, compared with $79 in 2015; the Q3 2016 tax benefit was approximately zero. The effective tax rate was 10.3% for the nine months. Because of industry uncertainty, the company used a year-to-date effective-tax-rate method and will reassess it quarterly.
- Foreign-currency forward contracts had $77 notional value at quarter-end. A hypothetical 10% currency-rate change was estimated to change year-to-date net loss by approximately $3. A one-percentage-point interest-rate change would affect quarterly cash interest expense by less than $1.
- Management warned that oil and gas prices, customer demand, rig activity, acquisition integration, goodwill or intangible impairment, regulations, foreign exchange and financing conditions could affect results. It noted adverse market conditions could trigger further goodwill impairment testing.
Important facts for investors to verify
- Whether revenue and operating performance stabilize as rig counts and customer spending change, particularly in North America and International markets.
- Whether Power Service integration and preliminary goodwill and intangible-asset valuations change, and whether the acquisition delivers expected benefits.
- Liquidity, borrowing availability and ongoing covenant compliance under the amended secured credit facility.
- Collection and ultimate loss exposure related to the International customer receivable, including the reported $0–$18 possible-loss range.
- Potential effects of foreign-cash repatriation taxes, valuation allowances and the possible Section 338(h)(10) tax election for Power Service.
- Whether market conditions or reporting-unit performance require further goodwill impairment charges.