DNOW Inc. (NOW Inc.) — Q2 2016 Form 10-Q
Reporting period: Three and six months ended June 30, 2016; filed August 3, 2016. Amounts are in millions except per-share data. NOW distributes energy and industrial products and provides supply-chain services through U.S., Canadian and international operations.
Financial performance
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Revenue | $501 | $750 | $1,049 | $1,613 |
| Operating loss | $(57) | $(27) | $(122) | $(35) |
| Operating margin | (11.4%) | (3.6%) | (11.6%) | (2.2%) |
| Net loss | $(44) | $(19) | $(107) | $(29) |
| Basic and diluted loss per share | $(0.40) | $(0.18) | $(0.99) | $(0.27) |
| EBITDA excluding other costs (non-GAAP) | $(42) | $(17) | $(93) | $(13) |
Revenue fell 33.2% in Q2 and 35.0% year to date. Management attributed the declines principally to weaker drilling activity and customer spending; U.S. rig count was down 54% year over year in Q2. Operating losses worsened as lower volumes outweighed cost reductions. Warehousing, selling and administrative expense declined to $140 million in Q2 and $292 million year to date, partly offset by costs at acquired businesses. Cost of products was $418 million and $879 million, respectively, and included inventory-related adjustments.
Cash flow: Operating cash flow was $155 million for the first six months, versus $81 million a year earlier, supported by $115 million from lower receivables and $104 million from lower inventories. Investing used $190 million, including $182 million for acquisitions; financing provided $68 million. Cash increased to $136 million from $90 million at year-end 2015.
Balance sheet and liquidity: At June 30, cash was $136 million, current assets $1.108 billion, current liabilities $304 million, and long-term debt $180 million. Total liabilities were $492 million and stockholders’ equity $1.322 billion. About $100 million of cash was held by foreign subsidiaries; management said it intended to permanently reinvest those funds and had no current repatriation plans.
Material changes and significant items
- On June 1, 2016, NOW acquired Power Service for net purchase consideration of $176 million; cash paid was $182 million, including a $6 million working-capital adjustment. The acquisition added a U.S. well-hookup and process-solutions business. Preliminary purchase accounting included $130 million of goodwill and $46 million of identifiable net assets, including intangible assets; allocations remain subject to refinement.
- In January 2016, the revolving-credit agreement was amended: the minimum interest-coverage covenant was suspended until the company elects otherwise; a 1.50:1.00 minimum asset-coverage ratio was added; the maximum capitalization ratio was reduced from 50% to 45%; and borrowing margins and commitment fees increased. Substantially all U.S. assets and approximately 65% of first-tier foreign subsidiary equity were pledged. NOW reported covenant compliance at quarter-end.
- The $750 million revolving facility expires April 18, 2019; borrowings above 75% of commitments require compliance with a minimum fixed-charge ratio. The facility also has a $250 million accordion feature.
- Regional revenue declined across all segments. Q2 U.S. revenue was $337 million, Canada $55 million and International $109 million; all three segments recorded operating losses. U.S. and Canadian losses increased, while International moved from a small prior-year profit to a loss.
- Foreign-currency translation produced a $15 million gain in other comprehensive income for the six-month period. Foreign-exchange forward contracts generated a $5 million gain for the period; the contracts are economic hedges, not designated accounting hedges.
Outlook, risks and contingencies
Management gave no quantified revenue, earnings or cash-flow guidance. It said outlook remains tied to worldwide rig counts, especially North America, and cited limited visibility on market recovery. Its stated approach was quarter-to-quarter cost and operating management while pursuing strategic acquisitions and longer-term goals. Management believed cash, operating cash generation and revolver availability would fund operations, working capital and capital needs, but noted acquisition timing and financing availability are uncertain.
- Key risks include sustained weak oil and gas activity, customer demand and spending, acquisition integration, borrowing costs, foreign-exchange movements, steel prices, and potential goodwill or intangible-asset impairment.
- Management estimated reasonably possible losses of $0–$18 million, primarily related to one International-segment customer receivable, and said it had accrued its best estimate. Other legal and regulatory contingencies were described as immaterial or not expected to materially affect results, though outcomes can differ from estimates.
- Standby letters of credit and related bonds totaled approximately $11 million within credit arrangements of about $51 million. Contingent acquisition consideration had an estimated fair value of less than $1 million, with payments of up to $6 million possible if specified milestones are met through February 2018.
- The company used a year-to-date effective tax-rate method because of industry uncertainty. It recorded a $19 million deferred tax liability related to the Power Service acquisition; a possible future Section 338(h)(10) election could change tax basis and deferred taxes.
Most important facts for investors to verify
- Whether revenue and operating performance stabilize as rig counts and customer spending change, particularly in North America.
- Whether Power Service integration delivers expected benefits and whether preliminary purchase accounting, including $130 million of goodwill, changes.
- Revolver covenant headroom, borrowing costs and continued compliance under the amended, secured facility.
- Collections and recoverability of the International customer receivable underlying the disclosed $0–$18 million possible-loss range.
- Cash availability and tax consequences associated with the approximately $100 million held by foreign subsidiaries.
- Whether further acquisition spending can be funded without materially weakening liquidity or increasing financing risk.