Welcome to the DistributionNOW Fourth Quarter 2019 and Year End Earnings Call. My name is John, 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, John. Good morning and welcome to the NOW Inc. fourth quarter and full year 2019 earnings conference call. We appreciate you joining us, 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 DNOW 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 fourth quarter and full year 2019, please note that some of the statements we make during this call, including the answers to 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 actual results may differ materially. No one should assume that these forward-looking statements remain valid later in the quarter or 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 the 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 website 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 on 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 website 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 2019 Form 10-K today, and it will also be available on our website. Now let me turn the call over to Dick.

Thank you, Dave. Good morning, everyone and thank you for joining us. Over the past three and a half months, I've reaffirmed my confidence in DNOW’s fundamental business strategy, as we continue to rightsize and scale our infrastructure to match market demand, generate cash and deploy capital for inorganic growth, actively manage our portfolio by pruning low margin businesses, and invest in areas that increase employee productivity and enhance customer facing digital solutions. While these efforts have produced material positive results, it's clear that market conditions require that we do more to rationalize our cost structure in order to yield a greater productivity result than the company has historically delivered. To that end, we're taking more steps in response to customer spending plans that continue to decline. Distribution companies like ours generally feel the impacts of a slowdown early, as customers reduce or stop spending and seek to conserve cash. Much of our business is tied to day-to-day MRO purchases with narrow order to cash cycles. Our service to the last mile model, combined with nearby inventory availability necessitates an agile and optimized footprint and sufficient working capital to fulfill our value proposition to our customers. As with many oil fields service cycle leading businesses were vulnerable to sudden drops in customer spending, as we witnessed in the fourth quarter, when activity slowed to a pace much lower than previous season with the clients, particularly in November and December. This was driven by customers' lack of access to capital and increased spending restraint, budget exhaustion, extended holiday impacts and weather conditions in Canada that delayed access to drilling sites. Fortunately for DNOW, we're in a strong cash position with zero debt and we're well positioned to manage this cycle with the fortress balance sheet and access to our undrawn revolving…

Thanks Dick. For the fourth quarter of 2019 we generated $639 million revenue down $125 million or 16%, compared to the same period in 2018. Sequentially revenue declined $112 million or 15%. We attribute the fourth quarter 2019 revenue decline, steeper than expected seasonally to an increasing level of financial discipline demanded by investors and exerted by our customers. Nearly two thirds of the full year revenue drop resulted from reduced pipe sales in 2019. The commodity most negatively impacted by steel price deflation. It is worth noting that US rigs declined every month in 2019. The declines of 2019 we're not remotely as steep as the rig losses in 2015. But we haven't seen this kind of sustained rig stacking like those experienced in 2019 since 1998 nor did we plan for that. In the Canadian segment, 2019 revenues were $319 million, down $39 million or 11% from a year ago, including an $8 million impact from unfavorable foreign exchange rates. Excluding the foreign currency impact, Canada revenue declined $31 million or 9% compared to 2018 in an environment with rig counts declining 29% year over year. In the international segment 2019 revenues were $392 million, down $6 million or 2% from a year ago. Excluding the impact from weaker foreign currencies year over year, the International revenue actually increased $6 million or 2% of 2018. In the U.S. segment, 2019 revenues were $2.24 billion, down $131 million or 6% from 2018 and relatively in line with a rig count declines over the same period. In the U.S. revenues were $468 million, where U.S. energy centers contributed 48% U.S. supply chain services 31% and U.S. process solutions 21% of fourth quarter of 2019 revenue. In the fourth quarter gross margins were 19.6% a 40 basis points declined sequentially. We…

Thank you, Dave. Looking ahead, industry experts are calling for a 10% to 15% reduction in U.S. lower 48 drilling and completion CapEx spend in 2020 that will continue to impact the top line of our U.S. business. According to the EIA U.S. oil production was still increasing in October and November of 2019 despite the rig count peaking in December of 2018. We witnessed a Permian month over month oil production per rig decline in January 2020. While month to month production levels for the last three months have been flat. With respect to guidance, we're guiding full year 2020 revenues to be down in the high-single digits to the mid-teens percentage range. This guidance considers the resulting loss of revenue of approximately 3% related to the sale of the business discussed earlier. Accordingly, we're guiding first quarter 2020 revenues to be flat to down in the low-single digits range. This sequential quarter guidance also considers the resulting loss of revenue approximately 3% related to the sale of the business discussed earlier. Before I move on to recognize one of our dedicated employees, I'd like to summarize the progress the team here at DNOW made in the execution of our strategy in the fourth quarter. We continue to act aggressively in response to a lower for longer North American market, while optimizing and reducing our footprint through facility consolidations in the U.S. and Canada, focusing on margin discipline in the challenging U.S. land market, investing in technology to increase our employee efficiencies, and rolling out a growth platform for digital solutions that will provide additional employee productivity and capture the shift to e-commerce. We divested a low performing business which will improve our margins and financial performance. On the supply chain side, we're leveraging our distribution centers infrastructure and…

[Operator Instructions] And our first question is from Blake Hirschman from Stephens Inc.

Oh yeah. Good morning guys.

Good morning, Blake.

First off, can you give us a better sense as to how much things fell off into November, December, after the first month of the quarter. And then any color on how things might have trended since then into January and February that would be good as well.

Okay. So October, you know, on our call, the last call we said that, our revenues normally trend 5% to 10% decline and we would be at the high end of that range, possibly higher. In October we were tracking in the 8% to 10%, decline range, which we felt pretty good about. Just started tracking, consistent with our plan. In fact, we were a little bit above plan. And things were going okay in the first half of November and things really fell off at that point. So the first half of the quarter was tracking with our expectations. But there was a notable decline certainly during the holiday weeks. We expected that. But in the second half of November, things really just dropped precipitously and continued even more so into the final month of the year. We didn't expect that to be, to happen like that. And it was pretty dramatic. In terms of January and February. January turned out to be better than November, December. That wasn't a big feat because those were such low months, but gives us some comfort that the seasonal reversal, would happen in the first quarter, at least to some degree. So we grew in January versus those two prior months and February is kind of tracking along those lines. So Dick talked about the first quarter or revenues would be flat to down low single digits. That feels about right to us.

Got it. And then as a follow-up to that how do you expect that to trend by geography and also by the US, the different pieces there as far as the sequential trends?

Well, I think what we feel pretty good about is the third quarter will be our best quarter of the year, simply due to weather, simply due to seasonality. That's our read right now. But we're starting from the low point if you consider where we're at 4Q '19. That's why we guided to a decline in 2020. But the contours of the year in the U.S. probably follow the standard pattern except from the second quarter. Actually yes, we'll see some growth in the second quarter in the U.S. from the first the second in the U.S. Same with Canada. Canada is going to have a pretty good second quarter of this year we're thinking. So the downturn due to weather would be less impacted. And then International, we're pretty project oriented there. So the trend in that we're not real sure a lot right now.

Alright, thanks, guys. I'll hop back in queue.

Our next question is from Walter Liptak from Seaport.

Good morning Walt.

Hey, good morning guys. Wanted to ask about the overhead expenses. And what I thought I heard is $40 million that's coming out next year, which is a big number. But it sounds like there's going to be some offsets to that. So I wonder if you can maybe provide a little bit more detail, maybe even quarterly about how that warehouse expenses is coming down in 2020.

Yeah, hey Walt, this is Dick. Let me start here. You did hear correctly. We anticipate year on year $40 million coming out of WSA. And we do expect that the back half of the year will show a higher run rate of reduction or a lower run rate of actual cost in the first half. I'll give you some general comments and Dave may have some specifics to fill in. We have three distinct buckets of processes going on in this cost transformation. What is the typical one? The one that's activity driven to essentially variable costs, headcount reductions, spending, constraints, facility closures and consolidation. Another one is kind of an internal and external benchmarking process where we look at our best performing branches and try to mimic them from a cost structure standpoint. That's internal benchmarking. Externally you would look at things like layers, management layers and things in the organization that you would compare to other companies. That's a second bucket. And then the third is this whole efficiency and productivity topic where the application of technology, figuring out what the least valuable 10% or 15% of the things that you do as a company are and determine if you can eliminate it. So that's the -- $40 million is what we anticipate. We anticipate it to be to be a greater impact in the back half of the year and it kind of flows through those three general process buckets. I hope that that's helpful with your question.

Okay, yeah, that's great. So you expect to get the full $40 million minus some inflationary things around healthcare and other things.

Right. I think when I was speaking into going into the first quarter was kind of the effects of things would happen in the first quarter. But now we expect to get the full $40 million out the way the numbers should shake out as the first quarter would be the highest and the fourth quarter be the lowest in terms of WSA. But we got them processed. We talked about facility closures. We sold the business, which is something we've not done before. We're making those kinds of decisions. Their -- pockets of our companies that really strongly want to build on those, investing those and they're parts on the other end of the spectrum, and we're addressing it.

Okay, great. And I wonder about your receivables and bad debt expense. Considering the budget constraints, it seems like you're able to collect the accounts receivable. Can you give us some color on any bad debts?

Well, we had the benefit in the fourth quarter. As we said earlier, October was the best, strongest billing month and things fell from there. So we have the benefit of the lower billings in December which aided in the collections for the quarter. We still had 56 day DSOs, which -- we haven't seen for a long time. And I said 56 because you have to add back the effects of the assets held for sale. But we're still making good progress on collections. Now in a market like this, we are going to see more customers and more bankruptcy -- going bankrupt and having difficulty pain. So we simply have to thread the needle on who we give credit to, how much credit we give, that kind of thing as we try to grow the top line in this market.

Okay, great. Thank you, guys.

Thanks, Walt.

Our next question is from Sean Meakim from JPMorgan.

Thank you. Good morning.

Good morning, Sean.

So, the $40 million reduction in WS&A to clarify that leaves WS&A as a percentage of sales still in the high teens. So it sounds kind of flattish year-on-year given the top line expectation. I'm guessing the exit to exit looks like maybe a low teens reduction year-on-year, so maybe more in line with the top line guidance. Dick touched on the three buckets that you're using to approach cost reductions. But if we put another way, I'm curious how much of the cost savings that you've initiated would be characterized as tactical versus structural. It is not like it's mostly tactical with some efforts that structural, I'm just looking at your closest peer has comparable gross margins, but higher EBITDA margins to recycle because it generates significantly more volume on a comparable G&A base. So given how the cycle's playing out, are there more structural changes that you can adopt in order to get that margin more aligned with the current environment?

Yeah, Sean, this is Dick. Again I'll give you kind of a general response. I think the approach that we're taking is we must transform the cost structure of this company. And certainly, some of it will be structural in nature as you describe it as opposed to tactical. Let me start here, we have a statement, in our prepared materials. It talks about, delivering a productivity result that is better than the company's historical performance in that area. I think what you would have seen in the past, the way things were done, is the percentage of WSA sales would have increased if you had sales coming down. Step one here is to keep it flat, or get it down a little bit and that's what I meant by the differential. And then, look, we will -- I've said the attitude is we must align for this market. That's been embraced by the management team, it's been planned for and it's ongoing. Look you look back at the headcount reduction, facility closures and the steps we took in the back half of the year, you can see the traction. And so we understand the relative cost structure differences, we also understand the relative differences in the nature of the businesses of the public companies. And so I can tell you, the team here is working extremely hard to get the most efficient cost structure that we can to prepare us for whatever the rest of this downside throws at us.

Thanks, Dick. I appreciate that feedback. That makes sense. Maybe we're going to switch over to the M&A commentary. Going after higher value add businesses with accretive margins obviously makes sense. But I'm curious how that looks at the EBITDA line. So, can you layer on these types of businesses without materially adding to that WS&A. I guess I'm just trying to better understand as these types of opportunities allow you to leverage the existing footprint as you're rationalizing costs, or do you need gross margins high enough to offset incremental G&A? I mean, obviously, there's a range of the types of businesses you're looking at. But maybe you can help us frame how the M&A strategy layers into the cost strategy, I think that would be helpful.

Sure, look, I will call your attention to the fact that, the company has made a dozen or more acquisitions and added WSA every time we've done that since the spin. Yeah, you look back historically and compared to today and what we're forecasting for this year, and we're taking meaningful percentages out of WSA. So the team here is extremely good at that when the bolt on is such that we can absorb the overhead and not increase WSA may happen for the first few quarters. But once the transition is done, that's kind of the goal here. With regard to -- we've taken the same approach on acquisitions as we did or as we began with this divestiture we made. We know that that divesting of that business is going to improve EBITDA percentages. And we're looking for that result with the M&A targets that we're dealing with as well. We will move expeditiously, but as I said, we will be patient to make sure that that's the result that we get.

Understood. Great. Thank you.

Our next question is from Steve Barger from Keybanc Capital Markets.

Good morning. I'm just going to go back to the M&A question. Can you just maybe talk through some of the specific margin and free cash flow characteristics of some of the deals you're in process with or maybe some that looked promising and didn't get done? Just trying to see relative to the base business, what you could be looking at to add to the portfolio.

Well, we're not going in the service business. We're not going to move into areas with low revenue per head or anything like that. We're looking for incremental accretive financial results, but with businesses that fit what we do, that's got to be the sort of the first priority. So some of them might be small companies that just have better EBITDA performance that will bolt on, some might be a little bit larger. But you don't have to worry about us moving into some of the businesses that require heavy head counts and things like that. We bet that's just not the nature of DNOW's business profile. So we're not ready to kind of devote a whole lot at this point. But you should kind of look back at the last few acquisitions and see these things, particularly the ones in the process solutions business. They generate higher margins and don't have a significant difference in the cost of operations.

So it should mix you positively as you go through this M&A process.

Yeah, that's the goal, absolutely.

And you talked about how the lower cost of operations is a key focus for customers. But are they willing to make decisions about doing things differently in this environment or are they more locked down and not willing to take chances with a new way of doing things?

I would not say that. I think we have many opportunities to engage customers across the entire spectrum. Major, large independents, mid-sized public companies who absolutely are open to anything that the service industry can bring them technically, operationally or whatever to get their costs down. We have not seen -- look, there are companies, don't get me wrong, there are companies who have procurement systems that they rely upon to get good pricing terms and conditions and all that. But generally we get an open ear when we move the discussion over to value as opposed to price. And I think that's going to just get better as this commodity prices stay where they are. I would not classify things as, you know, being so stressed that customers aren't willing to move things around. We've seen good evidence of that. And one thing I would point to is, again, we picked up two customers this quarter, but we move into our supply chain solutions model, which tells you, we are having success every quarter at propagating that business style.

Got it. And so as you think about pruning the underperforming businesses and adding on via acquisition to mix up the portfolio, can you just talk about the attributes you're looking for as you go through the CEO search? Are you looking for relationships or a sales focused or more of an operating guy, to with an eye toward cost control? And maybe just how far along you are in the process?

Sure. Let me tell you where we are in the process, first of all. Shortly after the last transition, the board formed a special committee to head up the search. I'm not on that committee. The search committee immediately began interviewing search firms, they got one under contract there, quickly to evaluate both internal and external candidates. The next thing to do, which has been done is to form, what I call a candidate profile, which addresses those competencies that you brought up, and I'll get to in a second, that's been done. By the way, one interesting aspect of this one is in addition to that, there was a cultural assessment done where all of our board members, all of our leadership team and some other people in the company, shared the views that they have about the culture of the company, so that when we look at various candidates internally and externally, we can compare their skills and experience with the cultural aspects of DNOW and see how they fit. So that's all been done and the search firm has provided it’s sort of initial list of candidates, and the interview process has begun. Can't tell you when it will end. I can say that the community still engaged. It's focused on getting the best CEO that we can get. We will update you as things fall into place. I said on the last call that this management team is extremely skilled and very experienced. And you just look at the balance sheet the way things have been done. And you've got a management team here that can be relied upon to protect the capital and the business, in the shareholder interest. So again, we're not looking for a change agent. And the notion of this cost transformation that we're doing right now, we're going to be able to hand the next CEO, a business whose cost structure is size for this market. And so I would tell you that generally, the focus will be to see a CEO that fits culturally, that understands the distribution business and how to tweak the various levers to improve the performance of the company. And that might constitute a number of different characteristics and skills. But that's what I mean when I say that the committee is very focused on seeding the best CEO that we can to lead the company.

That sounds positive. And last one for me. Dave, it sounds like from the revenue guidance, the 2020 is going to look like 2017 plus or minus from the top line perspective. Maybe can you talk about how you expect gross margin and EPS to compare this year versus that year or what kind of detrimental margin should we be thinking about as we go through the model?

Well, I think the main thing to watch there is what happens with steel prices, steel prices more broadly and then steel price prices particularly. Our margins in 2019 were actually pretty good except for pipe and fittings and plans. It's a pretty flat, pretty resilient. And if we find that seamless pipe has bottomed, that's possible. And that ERW puts dropping the net debt would mean that if there were a decline in gross margin next year would be muted. But to me, that's the kind of thing to watch. I think 4Q was kind of a low point except for a further downward movements in pipe. So we're kind of thinking gross margins will be pretty strong next year, maybe down a little bit, but it's going to be type dependent, that's going to drive that difference.

Understood. Thanks.

And our next question is from Jon Hunter from Cowen.

Good morning and thanks for taking my questions. So, specific to the U.S. some of the completion levered companies have indicated activity up mid-single digits to high single digits in the first quarter. Your U.S. supply chain and process solutions declined more or less in line with the dropping completions, but U.S. energy center was down quite a bit more. So I'm wondering how we should be thinking about the underlying growth in the U.S. in 1Q. And if we should be thinking about energy center perhaps outperforming the overall growth in the U.S.?

Well, we guided the first quarter flat to down low-single digits. And if you look geographically, we may grow in Canada but we don't expect to grow in the U.S. In part because we sold the business. And I think the sales impact for the loss of revenues gone from 4Q to 1Q was $19 million. So that's why we got into that range. So that one's going to be a big headwind in terms of what's going to happen to U.S. U.S. energy centers, it's going to be dependent on rig counts and completions. And except for our seasonal rebound we won't see much growth in U.S. energy.

Got it? And then as it relates to margins for the year, I know we touched on it a bit on steel pricing being a factor there. But is there anything on the mix side that could change what your margins would be in 2020 from the 19.6% you achieved in the fourth quarter?

Well, if our pipe sales -- if the supply of pipe drops, and we sell more pipe, those margins will be lower, and that would be a negative mix change to gross margins. I don't expect that to happen. I don't expect pipe sales about next year, but I don't know that yet. That would be mix change that would make a difference. The business we just sold had lower gross margins than 19.6. So that will get a little bit of lift there. We talked about the amortization expense going down next year, we'll get a little bit of pop from there. But the pipes going to be the big one. If pipe sales go down and that would be -- that would help us. Otherwise we see pretty broad stability in pricing. Just a matter of what's going to happen in the market. Sales were to fall more than we expect, that would be in a negative impact too.

Great, thank you. I'll turn it back.

Okay.

And ladies and gentlemen we have reached the end of our time for the question and answer session. I will now turn the call over to Dick Alario interim CEO for closing statements.

Well, thank you everyone for joining us. We appreciate the interest in DNOW. And we look forward to speaking to you next quarter.

Thank you.

Thank you ladies and gentlemen. That concludes today's conference. Thank you for participating. You may now disconnect.