DNOW Inc. (NYSE: DNOW) — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; unaudited. DNOW distributes energy and industrial products and provides supply-chain services through its U.S., Canada and International segments.
Financial results
| Metric | Q1 2016 | Q1 2015 |
|---|---|---|
| Revenue | $548 million | $863 million |
| Operating loss | $65 million | $8 million |
| Operating margin | (11.9%) | (0.9%) |
| Net loss | $63 million | $10 million |
| Diluted loss per share | $0.59 | $0.09 |
| Operating cash flow | $89 million | $(13) million |
| Capital expenditures | $1 million | $3 million |
- Revenue declined 36.5% year over year. Cost of products was $461 million versus $708 million; warehousing, selling and administrative expense was $152 million versus $163 million.
- Cash and equivalents were $131 million at quarter-end, up from $90 million at December 31, 2015. Current assets were $1.20 billion and current liabilities were $302 million.
- Long-term debt was $55 million, down from $108 million at year-end. The company had $750 million of revolving-facility commitments, subject to borrowing conditions, and reported covenant compliance.
- Cash from operations benefited from working-capital reductions, including $72 million from lower receivables and $55 million from lower inventory. Financing cash outflow was $57 million; investing cash flow was approximately zero.
- Foreign-currency translation generated $23 million of other comprehensive income. The effective tax rate was 5.2%, compared with 19.0% a year earlier.
Material changes and operating environment
- Severe industry contraction was reflected in average worldwide rig counts down 41.2% year over year and U.S. rig counts down 59.8%; average WTI crude and natural gas prices were down 31.6% and 31.0%, respectively.
- U.S. revenue fell 40.6% to $357 million, and the segment recorded a $59 million operating loss. Management cited lower volumes and increased inventory charges; acquisitions contributed about $40 million of revenue.
- Canada revenue fell 45.7% to $63 million and the segment recorded a $6 million operating loss, reflecting lower activity and U.S.-dollar strength, partly offset by cost reductions.
- International revenue declined 12.3% to $128 million; the segment broke even. Lower drilling activity and customer spending were partly offset by reduced acquisition-related costs.
- Management reported cost-cutting efforts, but adjusted operating costs did not offset the sharp sales decline. EBITDA excluding other costs, a non-GAAP measure, was a loss of $51 million versus income of $4 million.
Outlook, risks and notable items
- No specific earnings or revenue guidance was provided. Management said visibility into a market recovery was limited, described managing quarter to quarter, and emphasized controllable costs and strategic acquisitions.
- The January 2016 credit amendment suspended the minimum interest-coverage covenant until the company elects otherwise, added a minimum asset-coverage ratio of 1.50:1, lowered the maximum capitalization ratio from 50% to 45%, and increased borrowing and commitment fees. The company pledged substantially all U.S. assets and approximately 65% of first-tier foreign-subsidiary equity.
- About $90 million of cash was held by foreign subsidiaries and intended to be permanently reinvested; repatriation could result in additional taxes. The company said cash, operating cash flow and facility availability should fund expected needs.
- Management estimated reasonably possible losses of $0–$18 million, primarily relating to one International-segment customer’s receivable, and said it had accrued its best estimate. The filing does not state the accrued amount clearly. Recorded contingent liabilities for other matters were described as immaterial.
- A 2015 acquisition included contingent consideration of up to $6 million; estimated fair value at March 31, 2016 was approximately $1 million. Standby letters of credit and related bonds totaled approximately $8 million of contingent liability.
- Subsequent to quarter-end, DNOW agreed to acquire Power Service businesses, subject to customary closing conditions, including regulatory approval; purchase price was not provided in the filing text.
- Key risks include continued weak oil-and-gas activity and prices, customer demand, inventory and receivable exposures, foreign-exchange and steel-price movements, potential goodwill or intangible impairment, acquisition execution, and higher borrowing costs.
Important facts for investors to verify
- Whether revenue, margins and segment losses stabilize as rig counts and customer spending change.
- The status and collectability of the International customer receivable and the amount accrued against the stated $0–$18 million possible-loss range.
- Ongoing compliance with amended credit-facility covenants, borrowing availability and the impact of higher facility pricing and collateral requirements.
- The extent to which operating cash flow reflects sustainable performance versus temporary working-capital reductions.
- Closing terms, purchase price, financing and integration risks for the announced Power Service acquisition.
- Potential tax costs if foreign cash is repatriated, and any impairment indicators amid continued adverse market conditions.