DNOW Inc. annual report, FY2018

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.

Metric20182017
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

  1. Whether the 2018 earnings and positive operating cash flow are sustainable as commodity prices, rig activity and customer budgets change.
  2. The collection status and exposure associated with the International customer receivable, including the amount accrued against the disclosed potential-loss range.
  3. Whether International segment forecasts maintain sufficient goodwill headroom, and whether any deterioration could trigger impairment.
  4. Current revolver availability, borrowing-base limits and covenant headroom under the $750 million facility.
  5. How working-capital needs, steel prices and tariffs affect margins and cash conversion, and whether planned 2019 capital expenditures remain appropriate.