DNOW Inc (DNOW) 2015 Q2 法說會逐字稿

Welcome to the second-quarter earnings conference call. My name is Sylvia, and I will 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, Dan Molinaro. You may begin.

Thank you. Welcome, everyone, to the NOW Inc. second-quarter 2015 earnings conference call. We appreciate you joining us this morning and thank you for your interest in NOW Inc. With me this morning is Robert Workman, President and CEO of NOW Inc; and Dave Cherechinsky, Corporate Controller and Chief Accounting Officer. NOW Inc operates primarily under the DistributionNOW and Wilson export brands, and you will hear us refer to DistributionNOW and DNOW, which is our New York Stock Exchange ticker symbol, throughout our conversations this morning.

Before we begin this discussion on NOW Inc financial results for the second quarter ended June 30, 2015, please note that some of the statements we make during this call 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 US 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. I refer you to our latest Forms 10-K and 10-Q that NOW Inc has on file with the US Securities and Exchange Commission for a more detailed discussion of the major risk factors affecting our Business. Further information regarding these, as well as supplemental, financial, and operating information may be found within our press release, on our website at www.distributionNOW.com, or in our filings with the SEC.

A replay of today's call will be available on the site for the next 30 days. It should also be noted that we plan to file our second-quarter 2015 Form 10-Q later today, and it will also be available on our website. Later on this call I will discuss our financial performance, and we will then answer your questions. But first, let me turn the call over to Robert.

Thank you very much, Dan. Welcome to DistributionNOW's Q2 2015 earnings call. Today we reported second-quarter 2015 revenues of $750 million, and excluding other costs for acquisition related expenses and severance, an EBITDA loss of $17 million, or a loss of $0.16 per fully diluted share. Included in our results is a charge of $7 million, impact approximating $0.04 per share, resulting from high steel content inventory adjustments due to falling steel prices. If not for this deflation cost charge EPS would have been a loss of $0.12.

As I'm sure everybody on this call is keenly aware it would be an understatement to describe the last two quarters in the upstream energy space as challenging. After experiencing Q1 2015 sequential rig count declines in the US, Canada, and international segments of 28%, 24% and 4%, in Q2 2015 we realized additional sequential declines of 34%, 68%, and 7%, respectively. In previous downturns, of which none have been as severe as this cycle, revenues for the business have dropped from highs of around $1.3 million to as low as $950,000 for average global operating rig annually. This is a result of operators and drilling contractors destocking their rigs and warehouses and reducing their CapEx and operating expenses in the face of a severely declining market.

We can only credit our employees for growing non acquisition related annualized revenue per global operating rig from $1.1 million in both Q4 2014 and Q1 2015, to $1.2 million in Q2 2015 representing respectable organic market share growth in a business whose revenue is more than 80% levered towards the upstream market. Where some companies have assets such as patents, highly engineered proprietary products, or significant investments in PP&E and service equipment, our largest and most impactful assets are employees. I would like to thank them for the results they have continued to produce in the face of the most severe down cycle that I've experienced in my 24 years at DistributionNOW. In particular today I would like to say a special thank you to [Marilyn Studor], who works in our Wilson export group servicing global oil and gas operators. She joined us through the acquisition of Wilson Supply in 2012, and celebrated her 48th year with DistributionNOW at the end of June. Thanks, Marilyn, for all you do for DNOW.

Moving back to the top line and including acquisitions, annualized revenue for global operating rig grew sequentially by almost 18% to $1.38 million, almost triple the 6% sequential M&A aided growth we delivered in Q1 2015. As expected, revenue adding in Q2 2015 from acquisitions was about $30 million, as compared to the $49 million from acquisitions that was added in the first quarter. The strengthening dollar affected sequential revenue in our Canadian and international segments by approximately $3 million, with only minimal impact on EBITDA. The price erosion impact of $11 million we experienced in the first quarter repeated in the second quarter but did not degrade further sequentially. While towards the end of Q2 2015 we think we likely experienced the full impact of price concessions made earlier in the year, we continue to feel margin pressures from increased project bidding and an over supplied line pipe market, with some analysts predicting an elongated trough in this cycle. Decremental flow through to operating profit was 16.8% sequentially.

Looking more closely at the US. While we had sequential rig count declines of one fourth, and then one third in the last two quarters, a handful of our core areas actually had much more severe declines. Leading the pact with rig count reductions were California, Tuscaloosa Marine Shale, Eaglebine and Permian in the US. Areas that were affected less than average sequential rig count decline were the Utica, Marcellus, Mid-continent, and Rockies.

The revenue decline in the US of 17% was primarily driven by volume reductions of almost one third with our top five oil and gas operator customers and rig counts that maintained their downward progression, destocking of warehouses by operators and drilling rigs by contractors that continued throughout the quarter, wells being drilled but not completed that continued to grow, further outsourcing by customers to fabricators for turnkey projects, continued increases in the number of orders that would formally be placed on the branches at contract pricing being taken out for bid, severe weather in Colorado that slowed activity in April and May and heavy rains in Texas and Oklahoma in June, the winding down of projects and turn around activity with several of our downstream customers, much lower volumes with our supply chain energy manufacturing customers as they cut back on production, and several facility closures in both our upstream and downstream operations, that while improving profitability resulted in partial revenue losses.

Offsetting these challenges and what allowed the US to produce revenues that significantly outperformed the 34% sequential rig count decline were increased maintenance projects with two of our largest operator customers in the Eagle Ford, strong activity with midstream customers in the Rockies and Eagle Ford, and actuation and valve shipments to one of the largest midstream companies in the Northeast, growth in sales of artificial lift systems across most areas of the US, increased activity in the southern Utica, and the opening of a few new facilities to support our two largest supply chain operator customers that resulted in nice share gains through reduced leakage in the Permian.

In Canada, revenue declined 23% sequentially, mainly due to significant reductions in the rig count, well completions, fiberglass line pipe projects in the Saskatchewan Bakken, and oil sands related projects, enabling Canada to handily outperform the 68% sequential rig count decline, were customers increasing their discipline by enforcing contracts with DNOW, increases with artificial lift systems, the acquisition of several operators by our largest oil and gas customer in the Canadian Bakken, and the implementation of new contract awards that occurred in Q1 2015 across several areas in Canada.

Internationally, new revenue from our recently completed acquisitions of MacLane, OAASIS, and North Sea Cables, increased artificial lift in multiplex pump package in Australia, and a pickup of PVF and electrical cells in Kazakhstan, were enough to offset considerable declines with the shut-down of the Wafra Field in the middle east, reduced coated line pipe and spools shipments to Kuwait, 9% and 12% sequential rig count declines in Latin America and Europe respectively, and deep-water drillers who have been idling or scrapping rigs and cannibalizing the considerable amount of inventory maintained on those large views vessels.

Looking at market activity moving forward, considering the number of variables currently influencing the price of oil, such as US shale and OPEC production growth, global demand, the Chinese economy, instability in the Middle East, the strength of the US dollar, the possible lifting of sanctions in Iran, the potential to repeal the US oil export ban, progress on US LNG export facilities, and many others, no one can accurately forecast what will happen in the energy market in the coming quarters. Several reports cite industry experts that range from $70 oil by the end of 2015, all the way to $50 oil for the next few years. Currently rig count changes and comparison to trends from prior downturns suggest that a recovery, if it has begun, will be one that is slow going.

The recent pull back in oil prices calls for a weaker demand over the second half of the year and what appears to be an oversupplied oil market in peak-demand season make it difficult to conclusively make any determinations. Regardless of how the market reacts to all of these variables, we'll maintain our strong focus on continuing to deliver organic market-share growth, pursuing M&A opportunities that strengthen or expand our product, geographic, and/or solutions offering to our customers, and positioning the organization to take advantage of the market recovery irrespective of when that happens. Outside of the uneasy state of the market, and in addition to approximately $25 million of revenue that will be added to Q3 2015 from our most recent three acquisitions, our growing participation in an active and stable midstream market should help bolster our revenue stream.

Other bright spots include that for the 15 rigs put back to work in July in the US, we experienced start-up orders to restock them after being idled and cannibalized for months. While there were not enough rigs put back to work to move the needle considerably, it confirmed our expectations that when a recovery happens, drilling contractors will place significant demands on our branches in order to restock cannibalized rig that are currently stacked today.

We have experienced an increase in artificial lift sales in the US and abroad as customers have moved their focus to optimizing production and away from exploration. We have no reason to believe that this trend, as well as increased revenue with well service companies, won't continue while we're in the period of the cycle. While not always a perfect indicator of future activity, drilling permits have increased in several of the shale plays, and some of the largest oil and gas customers have commented that they plan to add a modest number of rigs in the second half of 2015.

Due in part to the impending completion of LNG export terminals being constructed along the Gulf Coast, several customer are acquiring properties in and having exploration discussions for the Haynesville, Fayetteville and Barnett shale plays. Over the last few months, about a dozen operators have notified us we're now their primary supplier in several geographic reasons in the US where we have previously only enjoyed a portion of their purchases due to service-level issues they are having. As well, one of the largest US drilling contractors has recently awarded us preferred-supplier status nationally, which will aid us in growing share with that contractor. As mentioned on our last call, a recent supply change services award with an oil and gas company who is one of the most active operators in the major shale play, has already resulted in over $1 million of project awards and we have yet to conclude contract negotiations.

Several projects in our downstream group that were pushed out in Q2 2015 should bill in Q3 2015 and we expect to see a resumption in turnaround activities. DNOW has contracts with four of the top eight operators that represent 80% of the drilling activity in Canada. Even know the recovery from breakup pales in comparison to prior years, we should still enjoy a pickup in revenues due to increased activity. Also in Q2 2015 in Canada two new contract awards and the execution of a new agreement with a large international oil company for pipe valves and fittings, will begin producing organic growth in Q3 2015. We've also had two of our most significant commercial agreements in Canada extended recently. Resumption of fiberglass line pipe projects in Saskatchewan, as well as a recent award by a fiberglass pipe manufacturer to DNOW as a distributor of spoolable fiberglass pipe, should also bolster revenues in Canada. Our fiberglass team in Saskatchewan has also expanded to the US Bakken in recent months which should begin to yield organic growth soon.

Export project shipments to oil and gas operators in Angola, Oman, and Pakistan should help soften reduced export shipments to offshore drilling contractors. In-country sales of artificial lift systems and multiplex pump packages in Australia, drilling spares in Indonesia, valve projects in Singapore, and pipe valves and fittings in Azerbaijan should help offset declines we're experiencing in Europe, Latin America, and with deep water drillers globally.

Moving beyond the top line, less acquisitions, we have reduced head count by about 850 out of 5,300. 150 of which were in our corporate office and including just over 60 in the month of July. On the other side of that, through the nine acquisitions we have completed since spin, we have added over 800 new employees. In Q2 2015 we consolidated or closed 11 underperforming branches globally. We continued to evaluate additional underperforming locations. This brings the total consolidations or closures to 26 for the first half of 2015. In the quarter we also added eight new on-site branches in several areas of the US and two branches in the Permian. We have reduced operating expenses by $28 million from the fourth quarter of 2014 to the second quarter of 2015, or by $41 million which is 23% when excluding acquisitions.

Warehouse, selling and administrative expenses have dropped from $179 million and $163 million in Q4 2014 and Q1 2015 respectively, to $151 million in Q2 2015, which includes $13 million added through acquired companies. With continued actions to right-size our businesses to this very low activity level, and will continue doing so while making sure not to sacrifice our future and to position DNOW to prosper during an eventual market recovery.

In taking a look at the balance sheet, we are still working diligently to reduce our working capital as a percent of revenue having reduced about $146 million and $192 million sequentially in Q1 2015 and Q2 2015, respectively, of inventory and receivables, less acquisitions in the period. Unfortunately, with sharp declines revenue that progress does not show up in days of sales outstanding, inventory turns, or working capital as a percent of revenue metrics. We still have a lot to do in these areas but are optimistic based on the considerable progress that was made in July. As we stated on the last call, these balance sheet reductions will only last as long as we remain in a depressed market. We have experienced market recoveries in the past, and understand well the amount of cash needed to fund growth, so we're being mindful of that fact as we make capital allocation decisions.

Sequentially we went from a net debt position of $13 million in Q1 2015 to a net cash position of $34 million in Q2 2015. Due to falling steel prices we he made a $7 million adjustment in reducing inventory costs for steel-intensive products. At the beginning of 2015 we weren't anticipating this event as several US mills were being idled and the processed steel at the time was only slightly higher than the lows of 2009. Resent data suggests that imported steel goods are continuing to deflate and could be reaching up to 20% lower than the bottom we experienced in 2009. We suspect that we have yet to reach the bottom of the steel prices as input costs continue to fall.

Tubular demand, both for OCTG and line pipe is low due to an oversupply, too much global pipe capacity for this type of market, and a strong dollar which makes imports cheaper in the US. As for domestic seamless line pipe, this still remains somewhat steady in price as many of the mills are currently idled or will shut down soon. By the middle of the August likely only two of the six primary domestic mills will be running. We began our US pipe inventory reductions shortly after the acquisition of Wilson Supply, and have reduced those levels by around $70 million since peak. However, many large privately held pipe distributors were building inventory in 2014, and some were buying heavily in the first quarter of 2015. This has led to an over supplied pipe market, sometimes being held by the mills themselves that will put pressure on pipe sales and costing for quarters to come.

Regarding capital allocation, we have consistently communicated our maintenance CapEx should be in the $10 million to $20 million range. At this point it appears as though our maintenance and spin related CapEx combined may be on the low side of that range. As for M&A we recently completed our seventh and eighth acquisition since spin, announced the completion of our ninth deal earlier this week, and just yesterday filed for HSR approval of our tenth and most recent opportunity. Expanding on some of these recent deals, in Q2 2015 we closed the acquisition of an electrical distributor in Norway. Combined with the electrical businesses DNOW has operated in the North Sea for years, along with a strong UK electrical presence of MacLean, Distribution Now has expanded our capabilities to service our customers' cable, [land], and lighting needs across all areas of the North Sea.

The smaller of the three deals we have completed since of end of Q2 was a bolt-on acquisition to our Canadian operations that expands our valve, electrical, and instrumentation business. It's a young company with solid technical knowledge and expertise, and valued customers and suppliers, but still has a lot of room for growth.

On Monday we announced the completions of the acquisition of Odessa Pumps and Equipment. Headquartered in the Permian, Odessa Pumps provides a full line of fluid transfer equipment to the oil and gas and municipal wastewater markets. They have successfully expanded their geographic breadth beyond their home base in the Permian, to the Eagle Ford, Mid-Continent, and New Mexico markets. Through that effort, and with limited access to capital, they have grown revenues by over 50% in a four-year period. We feel confident that by having access to DNOW's considerable infrastructure and balance sheet capabilities, Odessa Pumps will be able to continue their organic-growth performance across the product lines they represent that allow for continued geographic and end-user expansion. Odessa Pumps is also a great win for our supply chain solutions group, where our customers are constantly looking for us to invest in, and expand, the product lines we can provide to support their operations.

Yesterday we filed for regulatory approval to acquire the business of Challenger Industries Incorporated. Headquartered in the heart of the Bakken, and with operations across several areas of the US, Challenger provides pipe, valves and fittings to the downstream, midstream and upstream markets. With the majority of their revenue related to the downstream and midstream markets nationwide, Challenger strengthens our downstream service capabilities, while also expanding our growing participation in the midstream market. Additionally, when considering opportunities to combine the strengths of their upstream operations, mainly located in the Rockies, with that of our energy branches in the same area, it will enhance our ability to service our combined customers in those resource plays.

We are just as optimistic as ever that we'll be able to put capital to work that will not only generate returns for our shareholders but will better position DistributionNOW for an ultimate market recovery. While our M&A pipeline is plentiful, our primary focus is on finding those deals that are the greatest strategic fit, such as product line and geographic expansion, scale, and financial strength; as well as managing our existing acquisitions to deliver on their expected performance in generating value for our shareholders. Even though we have a lot of deals under our belt, from our previous parent company and on our own, we believe in continuously evaluating what has worked, and what can be improved in our deal process, and in our integration efforts to preserve what these companies have built independently and enhance their success as part of DistributionNOW.

We'll continue to be prudent in determining how we allocate capital and thank our shareholders for their confidence and support. I'd like to thank you for your interest in DistributionNOW and I'll now turn the call over to Dan to review the financial highlights.

Thank you very much, Robert. It's been a little over a year since we have spun off from NOV and I'm proud of the efforts throughout our Company as we integrated three large distribution businesses in North America, converted most of our Company to one worldwide ERP system, and created an independent publicly traded company, a Company which is a world-class provider of products and services to the energy industry.

I am thankful for our dedicated, hard working employees who made this happen. They are the true assets here at DistributionNOW. We are facing headwinds from this uncertain market, and this downturn is more severe than most others, but this is nothing new to our seasoned management team who has proven resilient in similar past cycles. We'll continue to concentrate on the needs of our customers, while focusing on producing results for our stakeholders.

Robert discussed our business and I'll touch on our financials. NOW Inc reported a net loss of $19 million, or $0.18 per fully diluted share on a US GAAP basis for the second quarter of 2015 on $750 million in revenues. This compares with a net loss of $10 million, or $0.09 per fully diluted share on $863 million in revenue in the first quarter of 2015. And it compares with net income of $27 million, or $0.25 per fully diluted share on revenue of $952 million for the second quarter of 2014. It should be noted than an earnings comparison with the year-ago quarter is not meaningful as Q2 2014 did not reflect the full costs of running an independent publicly-traded company.

Our second quarter results included $3 million of acquisition and severance-related charges, and when excluded, our net loss was $17 million, or $0.16 per fully diluted share. Gross margin declined $31 million in Q2 to 16.5%, compared with 18.0% in the first quarter of 2015, reflecting reduced volume and continuing price pressure. Our Q2 margins are impacted primarily by a $7 million, $0.04 per share charge related to lower cost of market inventory adjustments for line pipes and other products due to falling steel prices. Operating profit was down $19 million sequentially as the gross margin decline was partially offset by operating expense reductions totaling $12 million. EBITDA for the second quarter of 2015 was a loss of $19 million, $17 million excluding the acquisition of severance-related charges.

Looking at operating results for our three geographic segments, revenue in the US was $496 million in the quarter ended June 30, 2015, down 17% sequentially and down 25% from the year-ago quarter. The second quarter decrease was driven by the continued decline in the US rig count, slightly offset by incremental revenue gain from acquisitions. Excluding the impact of acquisitions, US revenues were down 17% sequentially while the US rig count declined 34% in the second quarter of 2015, as we continued to outperform the domestic rig count. Operating profit in the US for the second quarter 2015 was a loss of $23 million, compared with the loss of $12 million for the first quarter, and a profit of $28 million in Q2 2014, reflecting revenue declines, coupled with the incremental costs of operating as an independent publicly traded company.

In Canada, second quarter revenue decreased 23% sequentially to $89 million, and down 29% from Q2 2014 reflecting the sharp declines in the Canadian rig count, and reduced spending in most regions during seasonal breakup, partially offset by an increase in large project and new contracts revenue. The Canadian dollar continued to decline relative to the US dollar, falling another 2.3% in Q2, with the US dollar strengthening continuing in July, adversely impacting revenue. Canadian operating profit for the three months ended June 30, 2015, was a loss of $5 million, compared with a profit of $3 million in Q1 2015, and with a profit of $2 million in the year-ago quarter. The decrease in OP was essentially due to revenue declines.

International revenue was $165 million in the second quarter, up 13% sequentially and even with the second quarter of last year. Second quarter revenue includes $60 million from companies acquired in 2015, compared with $30 million in the first quarter of this year. Excluding acquisitions, international revenues were down slightly, reflecting reduced market activity and customer spending. International operating profit for the second quarter of 2015 was $1 million, the same as Q1 2015, but down $12 million from the year-ago quarter. We continue to be optimistic about our international opportunities. Revenue channels for the second quarter shows 76% through our energy branches, or stores as many of us know them, with declines across the board geographically, as our upstream business suffers, and 24% through our supply chain locations, which shows the strength in the supply chain group which also benefited by our acquisition activity.

Looking at the income statement I wanted to remind you of a reporting change made earlier this year. We combined operating and warehousing costs with selling, general, and administrative expenses and now report as warehousing, selling and administrative expenses. We believe this change provides a more meaningful measure of our operating expenses and including operating and warehousing costs within SG&A is more meaningful to users of our financial information, plus this will be more consistent with our peers.

Looking at the pieces, operating and warehousing costs were $99 million for the three months end of June 30, 2015. This is down $4 million from Q1 2015 and down $6 million from the year-ago quarter. These costs include branch and distribution center expenses. SG&A expense was $52 million in the recently completed quarter, down $8 million from the previous quarter, but up $7 million over Q2 2014. The increase over the year-ago quarter is related to the net incremental costs in connection with operating as an independent company, spin activities, and ERP conversion implementation, as well as SG&A that came with the acquisitions we completed since the spin. In total we have reduced our quarterly warehousing, selling and administrative expenses by approximately $28 million for the fourth quarter of 2014, or almost 15%, and these costs were down by $41 million when the impact of acquisitions was excluded. The effective tax rate for the second quarter of 2015 was 34%, and we expect the effective tax rate to approximate 32% for the full year.

Turning to the balance sheet, NOW Inc had working capital of $1.28 billion of June 30, 2015. Accounts receivable was $665 million at the end of Q2, a reduction of $132 million during the quarter. For the first half of this year we reduced AR approximately $240 million, or some 29%, before the additions from acquisitions. Inventory was $892 million, or $53 million lower than the end of the first quarter. We have slowed the inventory replenishment process and should show significant reductions in the second half. Cash totalled $114 million at June 30, 2015, which was down $8 million during the quarter, almost 80% of our cash is located outside the US, as our US cash is used to repay bank debt. Capital expenditures during Q2 were $3 million. Our maintenance CapEx normally runs $10 million to $20 million annually, but as Robert mentioned should be on the low side of this range of this year.

Our current day sales outstanding are slightly improved to the low 80s but impacted by the low revenues, and we continue to work on improving these results to closer to the 60-day range. Inventory turns were 2.8 times, but we believe we will return to at least 4 turns. On a trailing 12-month basis our working capital was 35% of sales, 32% when cash is excluded, but higher if you annualize the quarters with our objective of getting to a 25% rate. We ended the second quarter with $80 million of bank debt, having paid off $55 million of debt during the quarter, and considering our cash position, we were net cash. Our borrowing costs approximated 1.7%, and we continue to have plenty of dry powder as we consider growth opportunities for DNOW.

The third quarter 2015 will continue to be challenging as we deal with this downturn, but our focus remains on our customers. We'll continue integrating our recent acquisitions, identifying synergies to reduce costs. We have confidence in our strategy, in our employees, and in our future as we position NOW Inc to continue to serve the energy and industrial markets with quality products and solutions. We are an organization with an experienced management team, a strong balance sheet, and we believe this current downturn creates new opportunities for us and our shareholders. With that, Sylvia, let's open it up to questions.

Thank you. We'll now begin the question-and-answer session.

(Operator instructions)

Our first question comes from Matt Duncan, Stephens Inc.

Good morning, guys.

Good morning, Matt.

First question, Robert, just on all the M & A that you guys have done recently. I can certainly appreciate you may not want to size up each deal individually, but can you give us some idea how much you've added to annual sales with Odessa Pumps and Challenger combined, which appear to be the two bigger ones you have done since the last call.

We're not going comment on Challenger yet because we have not acquired them, and there's knows guarantee it will pass HSR, so we're going to leave that one out of the commentary. We've had $5 million added in Q4 last year, and we had $49 million added in Q1, and we had $30 million added in Q2, and we expect $25 million added in this quarter.

Okay. Roughly how big is the Odessa Pumps business, if you go back to pre-down downturn, how big is that business? In terms of their product line, are you guys going to be able to take most of what they sell and spread it across your footprint, or some of their pumps lines especially going to have geographic restrictions to them?

We'll continue to give you our acquisition revenues added in the quarter, but I'm not going to separate out each acquisition, but it was big enough that we had to file HSR. Odessa Pumps has a wide range of products that they represent. One of which overlaps with ours, which is national Barko multiplex pumps, which are those large tri-flex pumps we fabricate skids for and build buildings and ship to the oil place to move fluids through pipelines. So, that's a complementary product line for us, and we have three facilities in distribution that do that alone.

The other product lines they represent are a variety of styles of pumps that have specific applications, and these are tightly managed channels to market. One pump of their product line the manufacturer may say, hey, it's nation-wide, get after it and do everything you can to grow revenue. One of their other product lines may say we want you to stay in your current geographic area and don't go outside the bounds, so there's a mix of both of those.

So, we plan to start from the position of living within those constraints by each manufacturer, and hopefully gain their confidence in how we grow their revenue streams in whatever geographic region we're allowed to participate. And then our goal would be, you guys have done really good. Try this area, or take it to this area, we're not doing so well.

So it's a mixed bag. Some immediately, we can sell everywhere. Some, we're going to have to stick within their geography.

Okay. A couple quick numbers. Dan, what was free cash flow in the quarter? I missed the numbers you gave on the breakdown of revenues between energy branches and supply chain, if you could give me that again, I would appreciate it.

The energy branch was 76%, and supply chain was 24%, which is real close to what the first quarter was, too, Matt, obviously, with revenue down and the upstream piece is down further. Free cash flow, probably a minus 20.

Thanks. I'll get back in queue.

Our next question is from Walter Liptak - Global Hunter.

Just a follow-on to the last one on acquisitions. With the revenue compressing on some of the acquisitions, how are you going about with evaluation and how should we think about accretion in 2016?

Most of the acquisitions we have completed so far are affected by the energy market, whether they are overseas or in the states. And so, we have looked at valuations based on the current P & L, and we're living within the same multiples. We've always talked about in that four to six range based on the current P&L.

So, and immediately deals for us as we acquire them at really reasonably prices, and then obviously when the market recovers the multiple that we paid will have looked a lot better than the four to six range. We're living in a world where we wouldn't be doing acquisitions if we felt like the energy market would never rebound, and we don't want to wait until the market starts strengthening to start doing acquisitions, because at that point you will pay more than you do now. So we're trying to take advantage of the down market.

You mentioned artificial lift a couple of times, and I wonder if there's a way that we can get some more color on it. When an artificial lift goes in, how much revenue is there attributed to it, and what kind of penetration rates are we looking at as producers try and increase production?

It's hard to quantify artificial lift per well, because there's not like it's one system, and in some cases like in Australia we're selling the big bean unit, the pump jack plus the sucker rides, plus the new ride pump, which is a lot more expensive than a customer that is pulling pumps out of the ground that we repair and bring back to them to run back down in a hole. Artificial lift is a broad range of different levels of revenue depending on what kind of project it is.

We also do plunger lift systems, we do progressing cavity pump systems, we do hydraulic pumping units. It depends on the customer's field and which kind of artificial lift they are employing, and it's hard to quantify that across any of our geographies, because there are different products involved that are sold actually through the branches. There's not a separate unit that does artificial lift, it's part of our branch business.

It sounds like this is kind of a bright spot to look forward to in the back half of the year. I wondered about the trends. Did you see artificial lift pick up during the quarter, or is its something you expect in the back half to get better?

No. It's been increasing I would say starting a little bit in Q1 and much heavier in Q2, and we expect it to continue to climb in Q3. The degree is almost impossible to forecast, because you never know what customers are going to do with respect to working over their wells. But it is a bright spot in our revenue stream.

Got it. Thank you.

Our next question is from Jeff Hammond, KeyBanc Capital Markets.

This is James filling in for Jeff. Just starting with the international segment, first half, running at a 35% core decline. And of course you guys did talk about the puts and takes there in the quarter. How are you thinking about the back half here for that segment, for that business?

Well the international segment for us is by far the lumpiest piece of our business, because it's project oriented in that we ship large amounts of goods to like an Iraq field, or into Asia or, you know, a rig gets pulled into Singapore and they have to do a big refurbishment job, which could be large orders. So it's never consistent based on rig count like Canada and the US. Canada and the US are much more closely correlated to rig count shift.

So we had projects in Q2 that were pushed to Q3, but they were not enough that you will see a massive pop in our international revenues. It's a pretty depressed market. It's very volatile right now, for all of the reasons I mentioned earlier with the things going on in the middle east and the Chinese economy and the rest. The North Sea and the off shore drillers, so we don't have big hopes you will see a big pop in revenue in the international segment, especially with as depressed as the offshore market is now.

You provided a lot of great color regarding the pricing environment for line pipe and tubulars. Does the pricing erosion sustain at this $11 million level or is there further downside to go?

There's two areas of the market that are depressed and those margins, further deterioration in pot pricing, and an over supply that continues to cause issues in the line pipe market, as well. We didn't experience any sequential decline in Q2 from Q1, we just repeated what we experienced in Q1.

I think if we have any margin decline it won't be from any kind of pricing concessions. It's going to be from further project building and people trying to dump inventory where they've go an over supply. We could see more pricing pressure in Q3 and Q4, just simply due to that.

Thanks. I'll get back in the queue.

Our next question is from Sam Darkatsh, Raymond James.

Good morning. How are you?

A couple of quick questions. One of them is piggybacking on a prior question. You mentioned not just the artificial lifts, but there's a myriad of factors that are allowing you to outgrow or outperform the rig declines in the US and Canada. Be it with maintenance projects, be it southern Utica, midstream Rockies, new awards, what have you.

How sustainable, or what's the trend of that over the next couple of quarters in terms of what your expected performance might be versus rig count in 3Q and 4Q in the US and Canada?

We have grown the organic piece, less M&A over the last three quarters, only slightly in Q1 and more significantly in Q2. I don't know where that could go from here. It depends on what happens to the competitors in this depressed market.

A lot of that is market share gains because they either don't have the balance sheet to fund their businesses, or they are closing locations, or winning contracts. And it's hard to forecast how those are going to turn out. So, I would simply for modeling purposes, assume we'll repeat our current global annual revenue per rig going forward, based on whatever you think the market is going to do from a rig count perspective, and then just add in any acquisition revenues we give you.

The second question, I believe last quarter you were pegging a combination of receivables and inventories by year end, about $300 million to $350 million below Q1 levels. Is that still where you stand? I know there's been a bunch of moving parts with working capital between now and then. Where do you think receivables and inventories in the aggregate will look by the year end.

We are thinking the second half of this year, less anything we add through acquisitions, basically our original receivables and inventory balances for distribution now, that we should be able to pulled another $250 million to $300 million off the balance sheet. We have done a good job so far. We have closed seven acquisitions through Q2 and we still have a net cash position. So we've been pulling enough cash off the balance sheet to fund these acquisitions.

The last question, Rob, and this is probably more qualitative, because you have to be a bit mindful of talking about individual acquisitions, I understand, but the folks that are interested or increasingly interested in selling at this point, folks that you are looking to acquire, could you qualitatively talk about the quality of those businesses? Are these distressed operators? What do the margins look like versus the company average right now, or is there another reason, impetus, why they might be selling now as opposed to when the market turns?

There's lots of reasons why the companies sell, but I'll preface this by saying, we're not in the turn around business. There's several acquisitions out there I was pretty excited about, but once I got the financials and saw how poorly they're performing in this market, we decided to pass even though they had a nice top line. They just had bottom line numbers that would have not been accretive to our targets, or where we are headed.

The ones we have gotten so far, there's all sorts of reasons why. Odessa Pumps has its own story and the owner of Odessa Pumps is staying with us. He's a great guy and passionate about the part of company, but he has his own personal reason why he wanted to go ahead and sell on.

There's others, that have really invested, they were privately held companies in the 2014 growth, that assumed 2015 was going to look a lot like 2014, that got themselves in a position of having almost no cash, a tremendous amount of debt, and were getting beat up by their bankers and by their suppliers, but still had mid to high single-digit EBITDA margins. But their revenues had fallen to the point they couldn't fund their balance sheet.

I could give you 12 others reasons why companies are selling, but generally we don't get into the position of buying a distressed firm thinking we can go in and fix it and turn it around. We have other things to do and there's plenty of opportunities out there that wouldn't involve that kind of consumption of our resources to turn their companies around.

Final housekeeping question. The four to six times the current EBITDA, the current P&L you referred to, is that expected 2015? Is that trailing? What is current P&L mean?

Our forecast for the future 12 months.

Very helpful. Thank you, Rob. I appreciate it.

Our next question comes from Chuck Minervino, Susquehanna.

Good morning.

I wanted to touch on margins a little bit more here. I think you mentioned in your prepared remarks that you reduced head count another 80 employees or something in July. I'm assuming you are kind of prepping for a little bit of a slower for longer kind of rig count period. Can you talk about, assuming your revenues are roughly flat in 3Q, kind of how you see margins transpiring for some of these other business lines, kind of in Q3, Q4.

This is Dave, Chuck. We see our current expense level being in that 151, maybe south by $5 million in the third and fourth quarter. We, like Robert said earlier, we pulled $41 million expense out of the business on a quarterly basis, so we're real sensitive to, you know, cutting too much before what ultimately will be a recovery.

So we think, you know, 150, maybe $5 million less in the third and fourth quarters, that would be a target number. In terms of gross margins, like we alluded to earlier, there's still over-costed pipe in the market, and a big influx of goods coming in from overseas, which are further pressuring costs and replacement costs for inventory.

So, we'll see some pressures on that. So, we'll try to offset that as much as possible with cost reductions, recognizing we're getting close to going too far if the recovery is eminent, but our real kind of, you know, offset to that would be product cost and deflationary impacts.

Let me expand on that. Dave quoted the 151 number, that's with acquisitions. If you look at our expense base that we had starting in Q4, it was $179 million a quarter. We dropped that without acquisitions in Q2 to $138 million. That's a huge reduction in our business, and we're getting to the point now where we have to really think about each step we take going forward.

I wouldn't expect that $138 million without acquisitions to drop any much further than the $135 million number, but the $151 million number could actually go up. We already closed Odessa Pumps, that will add expenses. And if we close Challenger, that will close more expenses.

So, you'll see revenue come with those as well. But $151 million could actually grow depending on our success rate closing acquisitions. But our core business will continue to reduce expenses.

Got it. You mentioned Challenger there. I think you also mentioned in your prepared remarks an incremental $25 million of revenues in 3Q from acquisitions, is that excluding Challenger or assuming that closes?

We never assume we're going to close a deal and include numbers. That only includes all acquisitions through Odessa Pumps. We're hitting what is historically in August a slow period in the government.

So, while we got early termination on Odessa Pumps, we don't expect the same thing to happen for Challenger, simply because they are on vacation and on the beaches and all that neat stuff. So, we didn't include any expense, forecast, or any revenue improvements related to Challenger in our numbers.

That's more likely a 4Q kind of impact, assuming it does close?

If the government gives us early termination, which we're not expecting, but say they do, it will close in the quarter. But if things go the way we think they will, it might be a closed the first day of the fourth quarter.

One last one for me, just more I guess a little bit more theoretical. This de-stocking process, you guys seem like you are willing to take your inventories down, let them kind of run lower and I'm sure your customer are doing the same, cannibalizing what they have, too. In your experience in this space going back to your time at NOV, as well, how long--say you stay in like this kind of a flat rig count environment for a while, is there a point when customers have to stop de-stocking and when that kind of opportunity runs out and they're forced to start buying equipment again?

Yes. Our rule of thumb is, as a rig, as one rig gets stacked, it has enough inventory on it to support an operating rig anywhere from six to eight weeks. So the big deal here is, there's probably two and three and four rigs stacked, so that's quite a bit of inventory to support these rigs. But it was a very nice uptick with respect to seeing the amount of inventory that the 15 or so rigs in July, that got put back to work, had to acquire in order to operate.

This game is always -- this [grungiest] business is always about being able to forecast the future, which is hard, whether you are in the pipe market, or the drilling market, or the valve market. So our challenge will be to see the rig count improving fast enough to get our inventories up, so that we can meet demand from the customers. And that will be something we have to do as touch and go as we go forward.

One last one. Those incremental revenues that you got from those rigs going back to work, were those--I don't know if you could break it out that way, but would you say that was accretive to margins?

If you think about a branch that had to get those orders out to those rigs, they didn't add any expense to do that. Unless it was freight or fuel, but we didn't add head count to do that. So, most of the margin flows straight to the bottom line.

Got it. Thank you very much.

Our next question is from Flavio Campos, Credit Suisse.

Just from a more high-level perspective, on the acquisitions we have seen so far, we have seen a little bit of everything. Pumps distribution, which is a little bit on the higher margin, good for mix. We have seen PVF on the down stream and midstream. And we're seeing international targets, as well.

Are we agnostic throughout these three strategies, do we have any preference to any specific area for acquisitions? Or is the Company going to remain opportunistic.

We'll definitely going to remain opportunistic, but we do have the core areas that we have stated, you know, in every meeting we have had with shareholders about where we are going to invest. It's also in our IR presentation, as well. But we're going to stick within our focus with respect to growing our presence in the downstream or midstream market, or strengthening our upstream presence, or expanding geographically internationally.

Growing our core product lines, like valve actuation, electrical and the rest. That's been our tragedy since day one and all of our acquisitions so far have been within that frame of mind?

That's helpful. When you look at your footprint right now, we've had the 26 branch closures, and now that ERP is behind you, I know originally the strategy with Wilson was to focus on the branch strategy and not on the D.C. model that Wilson had and that has been changing a little bit. Are we switching this strategy towards a little bit more centralized distribution or are we still focused on branches and how does that impact your warehousing costs going forward?

As soon as we acquired -- we were not a distribution center style model at National Oil Well and Wilson very much was. The first thing we did, even prior to closing Wilson, was to analyze the cost of having the D.C. model and looking at returns and the amount of capital employed involved, and the affect on margins and rebates and all that stuff. And we determined that it was a good model, it was better than having each branch carry all that inventory on their own.

So, we adopted their model day one, we invested in some systems enhancements to help that process along, we have a half a million square foot D.C. here in Houston. We have got them on both coasts in the US. In California and New Jersey. We've got two up in Ebbeden, one in Canada, Singapore, Dubai, and all over the place.

So, we adopted that model since we acquired Wilson and invested in enhancing and bringing efficiencies to it. So, we plan to keep that model.

Perfect. Perfect. That's helpful. If I can sneak in a last one on the gross margin.

Still seeing some pressure coming down Q3, Q4, since we don't have a lot of history here, can you put the current like under 17% gross margin we saw in the quarter in perspective a little bit? I know it's difficult because of the merger, but can you put it a little bit in perspective, how close this is to the depths of the prior cycle?

Well, this is Dave, Flavio. Our gross margins are lower than they were in the depths of the last cycle. In part because today we're seeing $46 oil where August 2009, the last big downturn, we had $71 oil prices. So, manufacturers, distributors, customers, everyone is scrambling to generate cash, and there's additional influx of products coming into the market where this was not happening six years ago.

So we have more product coming in and everybody is trying to off as load inventory, especially the smaller players trying to generate cash. So we're seeing an anomalous impact that didn't persist as long as it is persisting now in the last down turn.

What we need is some resumption in rig activity, and we're seeing a little bit of that percolate, but that will be delayed as oil prices are so low. This is lower that we saw last time.

Flavio, just to give you a couple of data points, for one particular grade of pipe, which was a ERW import X42, in December '08, price per ton was 1550, and at the bottom of the drop in the '08-09 cycle, 720. We started out in October 14 at 820, higher than the 720 bottom in the last cycle. And the late data show it's below 600, so it's more severe this cycle than last.

That makes sense. Very helpful. Thank you for taking my questions.

Our last question will come from Sean Meakim, JP Morgan.

Good morning. I wanted to touch on working capital. You noted that a lot of the changes underway inside the Company aren't showing up in the metrics given the downturn. Can you give us a sense of how much the changes are structural versus cyclical, meaning in a recovery could you see a faster closing of the GAAP towards some of your targets given the progress you made?

What kind of targets are you referring to?

Working capital relative to revenue.

Okay. Got it. We're clearly not where we want to be. So we started this process thinking we'd see some recovery. We saw 2009 as a proxy for what will happen this year and that has not happened. So we have more inventory than we'd normally have.

We're burning that down and seeing nice progress in our accounts receivable reductions. It's going to take a little longer to get to those working capital targets but it's-- except for market share, growth in how we take care of our customers, cleaning up that balance sheet is priority number one around here. You will see improvements in the third quarter and graduated improvements in the coming quarters, as well, so that's a top priority, and absolute dollar terms, like Dan has said, we've made progress and in ratio terms we have not, but that's the number one focus here.

One last thing on the shifts in the rig count, last cycle versus this cycle. In the current environment, the fleet shifted even more towards the highest [back] rigs as the ones that kept working. In a recovery I think we're likely to see the highest beck rigs that are available go back to work first. Given that shift in mix compared to last cycle coming out of the downturn, how does that impact your business?

Outside of the one-time pops we're going to get because some rigs will have to buy a lot of material to get back to work, on a regular maintenance perspective, month to month, they're very similar in how much goods they consume. It's a different mix and they consume less goods, but they are a lot more expensive because they have more high-tech equipment on there.

We did that through last year actually in 2014, we started measuring revenue per rig and comparing some of the SCR and the mechanical rigs to the AC rigs, and it was almost negligible, the difference amount of revenue it took to maintain those rigs on an operating basis.

Margins any different or margins are also fairly similar?

Very similar. Almost every contractor we sell to, we have a contract with. And so, it's not like we can price these orders as they order them. It's automatically system priced and we know the margins.

That makes sense. Thanks, Robert.

We have no further questions. I would like to turn the call back over to Mr. Molinaro.

Actually, Robert will wrap it up.

Thank you very much for your interested in DistributionNOW Inc. and we look forward to talking to you next quarter about our results in Q3. Thank you.

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating.