Welcome to the Third Quarter 2019 Earnings Conference Call. My name is Sylvia, and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session [Operator Instructions]. I will now turn the call over to Senior Vice President and Chief Financial Officer, Dave Cherechinsky. Mr. Cherechinsky, you may begin.

Thank you. And welcome to the NOW Inc. third quarter 2019 earnings conference call. We appreciate you joining us this morning, and thank you for your interest in NOW Inc. With me today is Dick Alario, Interim Chief Executive Officer. NOW Inc. operates primarily under the DistributionNOW and Wilson Export brands, and you'll hear us refer to DistributionNOW and DNOW, which is our New York Stock Exchange ticker symbol, during our conversation this morning. Before we begin this discussion on financial results for the third quarter of 2019, please note that some of the statements we make during this call, including the answers to your questions, may contain forecasts, projections and estimates, including, but not limited to, comments about our outlook for the company's business. These are forward-looking statements within the meaning of the U.S. Federal Securities Laws based on limited information as of today, which is subject to change. They are subject to risks and uncertainties, and the actual results may differ materially. No one should assume that these forward-looking statements remain valid later in the year. We do not undertake any obligation to publicly update or revise any forward-looking statements for any reason. In addition, this conference call contains time-sensitive information that reflects management's best judgment at the time of live call. I refer you to the latest Forms 10-K and 10-Q that NOW Inc. has on file with the U.S. Securities and Exchange Commission, for a more detailed discussion of the major risk factors affecting our business. Further information, as well as supplemental, financial and operating information, may be found within our earnings release, on our Web site at ir.distributionnow.com, or in our filings with the SEC. In an effort to provide investors with additional information relative to our results as determined by U.S. GAAP, you'll note that we also disclose various non-GAAP financial measures, including EBITDA, excluding other costs, sometimes referred to as EBITDA; net income, excluding other costs; and diluted EPS, excluding other costs. Each excludes the impact of certain other costs and therefore, has not been calculated in accordance with GAAP. A reconciliation of each of these non-GAAP financial measures to its most comparable GAAP financial measure is included in our earnings release. As of this morning, the Investor Relations section of our Web site contains a presentation covering our results and key takeaways for the quarter. A replay of today's call will be available on the site for the next 30 days. We plan to file our third quarter 2019 Form 10-Q today, and it will also be available on our Web site. Now please let me introduce and welcome to the call our recently appointed Interim CEO, Dick Alario.

Thank you, Dave. Good morning, everyone and welcome. I want to kick off this morning, letting everyone know that, especially with regard to serving our customers and executing on our strategy, is business as usual at DNOW. Our proven and long serving executive team is very clear about DNOW's vision for the future, and our Board is fully supportive of our current strategy. Because of its enviable balance sheet, a very strong customer base, our global reach and especially because of our hard-working employees, managers and executives, the company is well-positioned to continue to improve its market position. I'm grateful for the opportunity and the responsibility that the Board has entrusted to me in this interim capacity. And I'm very excited to join DNOW's outstanding team. As I get up to speed in my new role, I look forward to meeting and working with our dedicated employees and other stakeholders. And let me emphasize, DNOW is fortunate to have this proven and long-serving leadership team and employee base already in place, and I'm ready to work beside them. Given my brief time in new capacity, I'll defer to Dave this morning to dive into the details of the third quarter results. But I would like to start on our strategy and then highlight a few key themes. First, I'd like our talk you about some reasons the team here perhaps has a more positive outlook than others as we face the current market. In any market, especially when uncertainty is pronounced, it's paramount to focus on what you can control, and NOW is no different. DNOW's promise and focus has been and will continue to be delivering superior customer service, financial discipline and exercising sound judgment to deliver results without sacrificing our core principles and values. Now for a few…

Thanks Dick. For the third quarter of 2019, we generated $751 million in revenue, down $71 million or 9% compared to the same period in 2018. Sequentially, revenue declined $25 million or 3%. The U.S. represents approximately three quarters of our revenue and in the U.S., rigs declined 7% sequentially while our revenues fared better than that declining 6%. And when compared to the same quarter 2018, U.S. rigs declined 12% with our revenues dropping less by 10% year-over-year. Sequential and year-over-year growth in Power Service, part of U.S. Process Solutions, limited the revenue decline. It is worth noting that U.S. rigs declined 12 to 13 rigs in the third quarter, now with 124 fewer active rigs since our last earnings call and 260 fewer rigs since year end 2018. U.S. revenues were $567 million, where U.S. energy centers contributing 51%, U.S. supply chain services 29%, and U.S. process solutions 20% of the third quarter 2019 revenue. We have successfully completed the integrations of two second quarter of U.S. Process Solutions acquisitions, and customer interest in our recently acquired Houston area fabrication business continues to grow. As an example, during the quarter, we booked an order from a top customer for 30 test separators testing for the Eagle Ford. This additional fabrication capacity allows for shorter lead time deliveries, which are more attracted to our customers with the work done closer to the action. In the quarter, we won a new multiyear midstream customer contract in the Permian estimated to be $20 million to $30 million a year. We will be providing solutions, as well as all the midstream products, like high yield fittings, valves and line pipe. This new customer will have numerous midstream projects that will be continuing throughout 2020, as they will be very active in the…

Thanks, Dave. Looking ahead, we expect seasonal and rig count declines, customer budget exhaustion and CapEx discipline to continue to impact the top-line of our business during the remainder of the year. Through the first nine months of the year, our revenues declined $51 million or 2% compared to the same period in 2018, within the range we guided to back in February. Given persistent North American active rig declines, we expect the fourth quarter to be down seasonally from the third quarter, normally a 5% to 10% decline, and now expect that it will be at least at the high-end of that range. And before I move on to recognize one of our dedicated employees I'd like to emphasize some of the progress the team here at DNOW made in the execution of our strategy in the third quarter. We continue to optimize our footprint with facility consolidations, focus on margin discipline in a challenging U.S. land market and invest in technology to increase our quote to order time. We're leveraging our distribution centers and optimizing our logistics, which is resulting in reduced inventory and better turns. Our sourcing strategy is structured to respond to changes in import tariffs, reducing working capital as a percent of revenue and leveraging our acquisitions through cross-selling opportunities. The success of these is evidenced by generating $97 million in free cash flow in the quarter. And so it's easy to see that the outstanding leadership team and employees at DNOW have made excellent progress on our strategic objectives. Our healthy balance sheet provides the wherewithal for inorganic growth options, such as the two small acquisitions that we closed last quarter. And now, it's my pleasure to continue the DNOW tradition and recognize one of the employees' daily hard work and dedication to enable…

Thank you. We will now begin the question-and-answer session [Operator instructions]. And our first question comes from Walter Liptak from Seaport Global. Please go ahead.

Hi, thanks. Good morning guys. And good job on the EBITDA this quarter. I wanted to ask about some of the numbers with cash flow, and the cash flow was really strong this quarter. And I wonder what the fourth quarter is going to look like, typically accounts payable, those come down in the fourth quarter, and with your DSOs, looks like there could be more room on DSOs. Where do you think you can get those?

We're going into the fourth quarter and we talked about the seasonality effect and the expected decline in revenue. So we think will continue to reduce inventory meaningfully. Our teams have done an excellent job at that all year long. We had the highest turn rates in the third quarter, we've had since we've fun and we made very nice progress there. In terms of accounts receivable, I think the way the quarter will go is we'll start the quarter off with October being the highest in revenues and things slowing down as you would expect throughout the season. In the meantime, rig counts are declining and so things will really slow down towards the second half. So collections will be better in the fourth quarter than usual given the timing of revenues. Accounts payable, we will maintain those probably at the same number of days we usually do. So we expect a strong cash generation quarter given the decline in revenues and the focus our whole organization has on managing the balance sheet.

And I think one of the things that we're learning about is the cost control and the discipline that you guys have had. And I wondered if we could talk a little bit more about the WSA and your comment of getting below the $130 million level because you've been working hard on cost discipline for a number of years now. How much more costs can come out in 2020 and what kind of costs are coming, are last, like is there more facility costs and as you optimize logistics, what do you think is a target run rate for that?

We've been focused on being more efficient as we approach the market. And while we were growing during the, if you can call them, the up years of 2017, 2018, we grew and really became a lot more productive. Now, we're in a different scenario where really all year along, the U.S. market has shrunk. So we've been pulling out costs. And in the last call, we said we'd have a $138 million to WSA in the third quarter and it was $136 million because we've begun to make cost adjustments and those include facility closures, reduced rent and lease costs resulting from that. On personnel reductions, we've been doing those globally and kind of more stridently given the North American activity direction. So, that's where you're going to see most of the cost savings are in personnel, rent, and the peripheral cost that come with that. That's a big focus for us. So we're not really ready to talk about what the level is going to be for 2020. We will be more elaborative about that on the February call.

If I could ask one. Do you have a look at into customer budgets for 2020? What do you think the, what's your outlook for rigs or what customers are telling you about spending for next year?

I think the early reads are 2020, there is going to be some contraction, some further contraction. There are some prelim numbers being put out there. I don't think the budgets are formalized and certainly not to a position where we're ready to comment and what our outlook looks like. But it looks like in North America anyway, the market will shrink, then it could be -- so I don't want to really say much more than that. But that's kind of how we're viewing things. So, we've got to position our business to shine in 2020, like we have in 2019.

Our following question comes from Blake Hirschman from Stephens, Inc. Please go ahead.

On the 4Q commentary, I was curious if you could give a little bit more by way of geographic trends and that kind of at the upper end of sequential historical declines, kind of that 10% or so. How does that break out by different geographic markets?

I'll start with international, because that's one area where there is ultimately some optimism there. And so we expect, for the fourth quarter, at least, our international business to be flat with some project revenue moving up or down, which might make it down a few million or up a few million, but flattish internationally. In Canada, where as you know, historically, the fourth quarter used to be better than the third, that has not been the case for the last couple of years, so we do expect revenues to slow down there. I don’t have a good feel for it in Canada, but we do expect a decline in revenues overall. In the U.S., if you look at last year, for DNOW, we had a stellar 3Q '18. We had $822 million in revenues. Just a perfect storm of great revenues in that period and then things really slowed down in US. And I think our revenues overall went down 7%. And that was throughout 4Q '18, rig counts were going up throughout the quarter and peaked at December 28th, but the opposite's true here. So we're going into the fourth quarter with rig counts probably going to drop at least 10% from the third quarter level. And the sentiment is sour. Customer budgets are exhausted. And people are waiting until the 2020 budgets are refreshed. So we talked about where we normally see 5% to 10% decline. We think it will be the high end of that range or possibly higher. So that's kind of the flavor. The U.S. being 75% of our revenues, that's the one I think we have the most color on and how the revenues are going to trend.

And then on the gross margins, nice sequential pick up there. You called out mix, it sounded like it was probably the key driver. I think the slide also talk about better pricing. Could you kind of frame-up the drivers behind that sequential gain?

So interestingly, we saw pretty stable margins across most product lines except pipe. I mean, in some product lines, we actually saw some product margin gains. So, you could argue, we're seeing price stability where the market is right now, except for pipe. What impacted our second quarter, the third quarter gains in gross margins was, we simply sold less pipe in the third quarter. So, as percent of sales, what is a lower-margin product was reduced in the third quarter. And in Canada right now we have better than average margins on a segment level and Canada revenues increased and U.S. revenues declined. So that it was kind of geographic and product mix, which drove overall improvement in gross margins. But otherwise, we're seeing some margin stability, except for steel-related products.

And then just lastly on debt. It looks like you've paid down all of it. How should we be thinking about that? You guys are going to stay debt free into the 4Q and maybe into the next year, or are you just going to tack on a little mainly for M&A opportunities to come?

Blake, this is Dick. Look, as you heard, it's enviable to be in our position with the state of the oilfield service business as it is today. So, we're going to continue to exercise discipline. But I mean, this is prime time or the sweet spot what we see coming for the DNOW strategy. We have been acquisitive. The acquisitions have been accretive. Everybody here is focused on what we can do with the balance sheet. But I think the great thing here is that we are able and have demonstrated, this management team has, they are able to use the balance sheet as its bank account and then quickly pay it back and get ready for the next round. So, I think the message here is we stay the course. We continue to do what we've done successfully, and we just wait for this pipeline to build some more and take advantage of our strengths.

Our following question comes from Vebs Vaishnav from Howard Weil. Please go ahead.

I guess I just want to address the elephant in the room. Want to speak about, if you can provide some color around the recent management changes that would be helpful.

Vebs, this is Dick. Look, let me start here. After very careful consideration, the DNOW Board determined that a change at the CEO position was best for the company. And if you go back and look at our press release and the Form 8-K that we filed, I want to emphasize. The Board terminated Robert's employment without cause. There is no change in our strategy and his resignation from the Board was not due to a disagreement. Look, it often in casing business, there are times when the Board determines that it's necessary to make a change in leadership when there is not a for-cause termination. Let me be clear, when there is not a for-cause termination event and there is no financial irregularities for business disagreements, which is the case here. So look I would wrap it up by saying, the Board and I recognize there's ample runway for DNOW to advance its market position and generate incremental value. And I've given you something incremental there. So I hope that we can put that matter to bed and move on.

I guess going back to some of the financial guidance that you guys talked about for the fourth quarter. Maybe Dave, if we think about -- first of all, when you guys talk about 5% to 10% decline and maybe even higher end, you are talking about overall revenues, not US specifically, I want to make sure of that.

That's right. And really that 5% to 10% is where we tend to land historically. And we were saying that, that's normally a good benchmark. But given the decline or the erosion of activity in the fourth quarter and customer discipline, we haven't seen before, discipline and focus on free cash flow, we expect to potentially go beyond that range. But that's global, that's not just the U.S. view.

And if you could provide some color around like, is it more energy center or is it more supply chain that's driving that?

So I think it would be more energy center, more E&P related. In that supply chain is going to be part of that. So if our top big supply chain customers reduce their spending with some of them have notably, then that impacts us directly similar to how it would at branch level. Now where we have some offsets and where we've been making gains recently is in the midstream arena, most of that's project related, but a bunch of it's related to increasing activity in our Power Service business. We talk a lot about Odessa Pumps and Power Service as a unit that makes up our process solutions, U.S. Process Solutions. They've just been making great headway. So they might fall at a lesser rate in the fourth quarter than we'll see in supply chain or in the energy centers. But even there, we expect some revenue declines in U.S. Process Solutions, perhaps with stability in the Power Service area.

And last question if I may squeeze in. I think you touched upon this, but I was very surprised to see U.S. revenues down and margins up. And I couldn't really see a whole lot of change in the business mix. So could you just address it one more time for me, please?

I think primarily in the US, what happened is we had some U.S. -- we had lower pipe sales. Most of our pipe sales actually happened in the U.S. And those margins have been declining, where they peaked in 2018, they have been declining in 2019. But because pipe sales themselves declined absolutely, as a percent of U.S. sales and a percent of global sales, that improved U.S. margins and global gross margins. But on a DNOW basis also, Canada right now has higher product margins than we are experiencing in U.S., in part because we do more midstream work down here and we sell more pipe down here. And Canada sales went up in the period. So those are the main drivers for the 30 basis points improvement in the third quarter.

Our following question comes from Sean Meakim from JPMorgan. Please go ahead.

So maybe just to touch on the midstream a bit more. You even highlighted some wins there. At the same time, transmission companies are feeling the pressure from investors to become more capital discipline. As you've noted, line pipe pricing has been very weak, so a lot of cross currents there. Can you maybe just talk a bit about the progress you've made in midstream in the context of what seems like a more challenging environment you are spending in that stream?

Generally, we're going to see fourth quarter declines across all of those down and midstream markets. And midstream in particular is going to be a function of demand by our customers. But we recently won new business. And if you look at on a year-over-year basis and the progress that we've had with our Power Service business, that's why we're limiting the decline in revenues because we're gaining some market share there. So we expect even midstream to decline in the fourth quarter but at a lesser rate from the other revenue streams. We don't have a great feel for that, and customer budgets are still being formulated or exhausted in the fourth quarter. But we have seen resilience in new contracts, largely led by our solutions offering in process solutions.

And I'm glad that the elephant in the room has been acknowledged. But I was hoping to take a bit more of a forward outlook on that topic. So, as Dick's leading the search for the full-time CEO, could you maybe just give us some broad strokes of what you and the Board are looking for in terms of internal versus presumably external candidate. What type of characteristics that you think are needed in the next CEO?

Well, first of all, we're going to select the candidate under a very broad search program. So, we're going to take our time. And I think it's fair to say that given the very, very strong culture here, we're not going to be seeking to change agent. I think that we are going to seek someone that can facilitate the success of this existing very, very strong management team and prosecute the strategy that has been a winner for us so far. And then I guess the last thing I would say is we're not going to go fast. We're going to be very patient and select the best candidate that accomplishes those things for the company.

Our following question comes from Nathan Jones from Stifel. Please go ahead.

My first question is regarding the Canadian market. Clearly, the macro environment there is weak. But it sounds like you guys are making solid progress and maybe gaining share. So, I was wondering if you can provide any color on what that market share gain is coming from?

We talked a little bit about it on the opening comments, the Cardium and Viking Plays and kind of the oil sands. So, we're picking up revenue stream that other competitors are kind of walking away from. We've got established presence in Canada, good coverage, although we made closures in the quarter. We are able to scoop up some of the revenues that others are walking away from. And we talk a lot about our management team in Canada. There are scrappy customer-focused group of folks and we've been repeatedly able to gain ground up there, while maintaining margins in a really kind of miserable environment. So, I think it's kind of related to those areas I talked about, but it's also just the attitude of our people and the scrapping nature of how they do business. I'm real excited about not just the revenues, but the earnings of that business as well.

And then just switching over to international, it sounds like there was a couple of bright spots, project work. Maybe just from a high level as we move into 2020, how do you look at that business? Are you seeing any increased activity in maybe offshore? Any color there would be helpful.

Yeah, I think we're seeing some positive movement in Latin America. In Mexico and Brazil, we're seeing revenues increase there. We're starting to see some interest in our export group, most notably to West Africa. So, things are starting to percolate a little bit. Still a project business. Still in the early goings of what you probably can't even characterize as a recovery internationally yet. But we see optimism there where we're kind of preparing for other possibilities in North America.

Ladies and gentlemen, we have reached the end of our time for question-and-answer session. I will now turn the call over to Mr. Dick Alario, Interim CEO for closing statements.

Okay. Thank you for calling in today. And we will see everyone in the next call. Have a good quarter.

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.