DNOW Inc (DNOW) 2016 Q3 法說會逐字稿

Welcome to the Now Inc. third-quarter 2016 earnings conference call. My name is Jason and I will be your operator. At this time all participants are in a 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. Mr. Molinaro, you may begin.

Thank you Jason, and welcome everyone to the NOW Inc. third-quarter 2016 earnings conference call. We appreciate you joining us this morning and thanks 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 Distribution Now and Wilson export brands and you'll hear us refer to Distribution Now and DNOW which is our New York Stock Exchange ticker symbol, throughout our conversations this morning.

Before we begin this discussion on NOW Inc.'s financial results for the third quarter ended September 30, 2016, 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 year.

I refer you to the 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 investor relations website at IR.distributionnow.com or on our filings with the SEC.

In an effort to provide investors with additional information relative to our results as determined by GAAP, you'll note that we disclose various non-GAAP financial measures in our quarterly press release including EBITDA excluding other costs, net loss excluding other costs, and diluted loss per share 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 is included in our press release.

As of this morning the Investor Relations section of our website contains a supplemental presentation covering our Q3 results and key takeaways which should assist you in understanding our third-quarter performance. A replay of today's call will be available on the site for the next 30 days. It also should be noted that we plan to file our third quarter 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.

Thanks Dan.

As you saw on our press release we experienced our largest quarter growth since the third quarter of 2014. I never thought I could get excited about an average global rig count that is lower than peak by more than 55%, but for those of us with a large exposure to the upstream energy industry, the apparent bottoming of energy prices and activity levels were a much welcomed event.

Ignoring the seasonal impact of breakup in Canada each year, the third quarter of 2016 marked the first time in eight quarters that we experienced increased average quarterly global rig counts. Rig count growth in the US and Canada was able to offset revenue declines in other regions internationally. Also in the quarter, WTI stabilized around $45 per barrel, and Henry Hub natural gas prices improved to $2.88 per BTU. But, based on the recent pullback in oil and gas prices, we are still in choppy waters and not ready to characterize the bottom in the past tense as the energy market remains uncertain as to the timing of a durable recovery.

The good news is that we have a great group of employees who are making the right decisions each day to help us navigate the ship in these uncharted waters. In the coming quarters, I know that our employees will continue to seize organic share growth and make adjustments to our business to match the market climate regardless of what comes our way. One of those employees is a 43 year veteran with DNOW and I'd like to take moment to recognize him before discussing results for the quarter. Bill Herrington joined our downstream business unit through the 2000 acquisition of Texas Mill Supply by Wilson Supply at the time. Over the years, Bill has been instrumental securing contracts of many customers such as Bayer, Exxon Mobil, Philips 66, Dow, and others. He is currently responsible for our sales team in our South Texas region. He may not be listening today as he spends considerable time with his customers when he is not with his grandkids and kids. I would like to thank Bill for his many years of dedicated service to DNOW and hope we experience his contributions for many years to come.

Now a review of our results. For the third quarter of 2016, we reported a net loss of $56 million or an adjusted net loss of $36 million which is a modest sequential improvement of $8 million on revenue growth of $19 million. This includes pretax charges of $1 million for severance related expenses and $19 million for an after-tax charge for a valuation allowance recorded against the company's deferred tax assets. Earnings per share for the quarter was a loss of $0.53 or a loss of $0.34 per share after adjusting for severance and the change in the company's deferred tax asset valuation allowance.

Revenue per average global operating rigs for Q3 2016 remained steady sequentially at $1.4 million with acquisitions and $1.3 million excluding acquisitions completed in the last year. Revenue changes were driven by $47 million increase in the US and Canada partially offset by $28 million revenue decline in our international segment. Consistent with previous quarters, pricing pressures experienced early in the downturn persist and competition remains fierce. Gross margin percent for the quarter remain basically flat compared to prior quarter and was up 1.2% year-over-year.

Prices from the manufacturers for welded pipe rose in the quarter, as did resale prices by a similar amount. The opposite can be said for seamless pipe where sourcing costs remained relatively flat but market prices continued to drop indicating destocking continues with pipe distributors. We track dumping suits on steel related products, and are making alternative plans should these cause a disruption or change of supply.

As we mentioned on the last call, Q2 2016 included a fringe benefit credit of $4 million and Q3 2016 included a full quarter of power service expenses with restrained incremental flow through to EBITDA excluding other costs of 11% in the quarter. Due to these items, we expected warehouse selling and administrative, or WSA, expenses to increase sequentially by $5 million. However continued expense reductions enabled us to maintain WSA expenses flat at [$140 million].

In the quarter, we reduced headcount by 143 and our branch footprint by 12. Simultaneously we opened one artificial lift center and four on-site service centers for our supply chain services customers. We reduced non-acquisition headcount by 1,964 or just over 36% during the last two years and have closed or consolidated about 110 branches and on-site locations. These non-acquisition expense reductions have produced over $270 million of WSA expense reductions or a 38% reduction since the peak of Q4 2014.

With expenses and gross margins relatively flat sequentially we believe break-even EBITDA remains at revenues of $700 million. We will continue our efforts to reduce produce break-even revenues further by maximizing product margins and minimizing expenses where possible as we have more facility closures already completed and plans for Q4 2016.

Diving deeper into the quarter, organic revenues in the US with upstream and midstream customers grew sequentially by about $16 million. We saw large customer account wins some of whom increased their purchases sequentially by as much as 35%. Additionally, an increase in revenue was attributed to wins from continued construction of a customer's new facilities in the Northern Rockies and another customer's enhanced oil recovery pipeline. We also experienced an increase in valve sales due to market share gains and a slight increase in project sales. All US upstream areas showed growth with the exception of the Gulf of Mexico with the largest improvements coming from the Marcellus, Utica, Mid-Continent, and Permian areas.

Along with the declines in the offshore Gulf of Mexico and with our [ETC dapple] midstream project winding down, a more than 20% reduction of completions in Texas as reported by the Texas Railroad Commission were a major driver limiting revenue growth in the US that lagged rig count increases. Although rig counts began to improve in the quarter, facilities or tank batteries which are significant to upstream revenues do not materialize until after the completion job ends. In US supply chain services, modest activity increases with Occi and Devon along with the continued implementation with Hess allowed for modest growth while our downstream and industrial manufacturing businesses declined slightly.

A full quarter of our recent Power Service acquisition added a total of about $20 million of sequential incremental revenue in Q3 2016 in the US process solutions group. Considering these acquired sales, revenues in process solutions were relatively flat sequentially as growth in municipal projects and service work helped offset large delayed projects with Crestwood in the Permian and Paradigm in the Bakken as well as general softness in the DJ Basin and the Bakken.

In Canada, revenue growth of about $12 million was driven by a recovery from seasonal breakup, the addition of our exclusive distributorship of the NOV fiberspar spooled fiberglass product line, a general increase with midstream customers, and sales growth to drilling contractors in this Q. Excluding acquisitions, revenues in our international segment are down approximately 75% since its peak, as non-acquisition operations in that segment are heavily oriented to the offshore drilling industry.

Our US export sales, which is a large business within our international segment, is off almost 90% since peak as their largest customers are offshore drillers. The continued stacking and scrapping of jackups, floaters, semisubmersibles, and drill ships in the offshore arena, creating surplus inventories that are being cannibalized at shore bases to support the working fleets continues to negatively impact our offshore market in the Gulf Coast, North Sea, Latin America, West Africa, and Asia-Pacific regions.

Looking at market activity moving forward in the US, continued production declines in oil inventory draws, which are translating into increased rig counts and stabilizing energy prices, are increasing the appetite for some customers to complete a portion of their DUC inventory. We're also experiencing modest activity increases in the major gas shale plays in Texas that have not occurred for more than a half decade. These increases might be sufficient to offset continued softness in the Gulf of Mexico, the normal seasonal declines we experience due to holidays, fewer billing days, and the winding down of budgets.

Anticipated increases with turnarounds downstream and slight activity improvements with operators should produce modest growth in our US supply chain services group, while softness in the overall industrial sector may put a governor on that. This group should also begin delivering water alternating gas kits to Occi, as well as a recent order from Devon for several three-phase separators, all of which are being sourced from our process solutions group.

We expect US process solutions to experience the bottom in this revenue stream in the next couple of quarters as the modular units they provide are relatively long lead time items, so the recovery in that business tends to lag that of our MRO business. However, this group experienced an increase in purchase orders that should start materializing in the first half 2017 and beyond. New orders include five large mainline pipeline stations for DCP in the Eagle Ford which are scheduled to begin delivering mid Q1 2017 and a large H2S scavenger package for Conoco Phillips in Alaska.

In addition to these projects, we also have received orders and encouraging feedback from customers outside their core areas of the DJ Basin and the Bakken shale plays. We're also in the early stages of implementing an on-site materials management solution for process solutions in Casper that should be completed in the first half of 2017. This initiative will increase profitability on modular packages, improve supply chain processes, lower overall costs, and increase competitiveness.

In Canada, we are expecting continued revenue growth as many of our contract customers are planning increases in wells drilled through Q4 2016 and into 2017. In addition to an increased drilling program, we are working with a contract customer to prepare for a large oil sands turnaround project that will begin this quarter and continue into next year. While we plan to support another contract customer in the Saskatchewan Bakken with their planned growth and wells drilled, we've also been given feedback from them that some of our first quotes for modularized tank battery solutions looks promising.

Turning to our international segment, the end of Wheatstone and Gladstone projects in Australia were major contributor to revenue declines. However, what should provide a partial recovery outside of North America in Q4 2016 are recent awards with Chevron TCO in Kazakhstan, wins in Latin America with Ocean Rig, [Oderberg, and Dolphin], a seasonal spike in Russia and the CIS, and valving and electrical product shipments to Kuwait for the onshore Jurassic gas project.

We're currently finalizing an agreement with Schlumberger to extend our exclusive distribution rights for the REDA HPS pumps and certain related parts to 15 states to include key new regions such as Louisiana, the Permian, and Eagle Ford. This, along with our previously executed global enterprise distributor program with Schlumberger for its camera and engineered and distributed valve product lines, further strengthens our relationship with this world renowned brand. We believe the expansion of our REDA agreement, combined with our current distribution agreements with National Oilwell Varco and Flowserve for their pumplines will enable Distribution Now to provide unparalleled pump product coverage, saltwater disposals, and water flood projects, in all of the major shale plays throughout the central US, especially in the Permian where activity has increased the most.

Internally, we continue to invest in technology that will enable organic growth within all of our geographies and product lines. In addition to the millions of electronic transactions and associated revenues that we currently enjoy with our customers and suppliers both through B2B and our online catalog, we have recently developed and rolled out apps that not only allow customers to place orders on their smartphones from their customized product baskets but also enables them to use their personal devices to scan materials from our production workover trailers and consigned rig packs. We've also implemented vending with upstream customers complete with RFID portals to automate the deployment of goods and electronically communicate usage data.

We're currently in the development stages for technology that will allow customers to snap pictures of pipe inventory and it will immediately tally the inventory count. We're always looking for innovative ways to make it easier for customers to do business with us and bring efficiency to the supply chain as we have many more projects currently on the drawing board.

Moving to capital allocation. In the quarter we were able to generate cash flow from operations of $31 million bringing the total to $186 million year to date and $588 million since the downturn began in Q4 2014. Continued cash generation enabled us to move sequentially from a net debt position of $44 million to a net debt position of only $14 million in the quarter. We generated cash sequentially by reducing net inventory and receivables by $57 million and $15 million, respectively, by bringing inventory terms to 3.3 from 2.8 and DSOs to 59 from 64. We also continued to have minimal capital expenditure needs of $1 million in the quarter.

These improvements to our balance sheet have reduced working capital as a percent of revenue, excluding cash, from 33% to 29%, sequentially. Our goal is to continue making improvements to our working capital as a percent of revenue with the ultimate goal of reaching at least 25%. Additionally we're making strides on integrating acquisitions into process solutions and leveraging the DNOW organization to aid the team in growing organic share at a greater pace than they could achieve as stand-alone entities.

That said, we continue to have a healthy balance sheet and will use that asset to grow organically or inorganically to increase our competitive advantages. Considering our cash balance, line of credit, recent ability to use our equity due to lapsing of restrictions previously imposed by our tax matters agreement, and the future cash benefit we will receive from the use of our deferred tax assets including net operating losses, our balance sheet is available to support all forms of growth we're pursuing.

We're excited about what we have achieved in this market downturn, the opportunities our organization and financial position afford us and the future we will create for the Distribution Now family. Now it will turn the call over to Dan to review the financials.

Thanks Robert.

When we were spun off into a separate publicly traded company I had great confidence in this company, its seasoned management team, and our future Despite these two years and a challenging market, I am as confident as ever in DNOW. I continue to be proud of the efforts of our dedicated workforce as we created a standalone world class provider of products and solutions to energy and industrial markets. I am grateful for the hard work and perseverance of the DNOW family. They make me proud. We will continue to concentrate on the needs of our customers while focusing on producing long-term value for our stakeholders.

Robert discussed our business and I will say more about our financials. NOW Inc. reported a net loss of $56 million or $0.53 per fully diluted share on a US GAAP basis for the third quarter of 2016 on $520 million in revenues. This compares with the net loss of $44 million or $0.40 per fully diluted share on $501 million of revenue in the second quarter of 2016.

When looking at the year ago quarter we had a net loss of $224 million or $2.09 per fully diluted share on revenue of $753 million for the third quarter of 2015. It should be remembered that the third quarter of 2015 included $255 million of non-cash charges associated with goodwill impairment. The third quarter of 2016 results included $1 million in pretax severance charges and $19 million for after-tax charges for a valuation allowance recorded against our deferred tax assets. After adjusting for these items, our third-quarter loss was $36 million or $0.34 per share, both non-GAAP measures.

Gross margin was 16.7% in Q3, up slightly over the 16.6% in Q2 and improved over the year ago margin which was 15.5% but included inventory cost adjustments. The company generated an operating loss of $53 million in Q3 compared with a loss of $57 million in Q2. Third quarter EBITDA excluding other costs, a non-GAAP measure, was a loss of $40 million.

Looking at operating results for our three geographic segments. Revenue in the United States was $372 million in the quarter ended September 30, 2016, up 10% over Q2. Third-quarter revenue in the US was down 25% from the year ago quarter, with the decline being less than the 45% fall in the year ago US rig count, as acquisition revenue improved our position. Reduced customer spending certainly contributed to these year-over-year revenue declines.

Third-quarter operating loss in the US was $46 million compared with the $44 million loss in the second quarter of 2016. In Canada, third quarter revenue increased 22% sequentially to $67 million but down 29% from Q3 2015 which is less than the 37% decline the year ago rig count in Canada. Declines in the Canadian rig count and low completions as well as the strengthening of the US dollar contributed to lower year to date revenue in 2016. For the three months ended September 30, 2016, Canada's operating loss was $2 million compared with a loss of $8 million in Q2 and compared with operating profit of $2 million in the year ago quarter. Market activity in Canada remains sluggish.

International operations generated third-quarter revenue of $81 million, which was down 26% from the second quarter of 2016 and down 50% from the year ago quarter. Additional revenue provided by acquisitions was offset by decreased international rig activity, reduced customer spending as they used their own inventory, and the completion of certain major projects. International operating loss for the third quarter 2016 was $5 million, similar to Q2, and compares with an operating profit of $1 million in the year ago quarter.

You'll recall that last quarter we moved from two to three revenue channels in the US, adding process solutions to our existing energy centers and supply chain services. For Q3 revenue channels in the US show energy centers at 52%, US supply chain at 33% and US process solutions at 15%. For your modeling I will give you Q1 and Q2. In Q1 we had 54% US energy centers 37% US supply chain services and 9% US process solutions. That was 54%, 37%, and 9%. In Q2, US energy centers were 53% US supply chain services were 36% with US process solutions at 11%. Again, that's 53%, 36%, and 11% for Q2.

Continuing on our income statement, warehousing, selling and administrative expenses were $140 million in Q3, unchanged from Q2 and down $13 million from Q3 2015. We continue to show progress with our cost-cutting initiatives. It should be remembered that we've acquired 12 companies, adding to these costs. These costs include branch distribution center expenses as well as corporate costs.

The effective tax rate for Q3 2016 was essentially 0% as we're not allowed to record a tax benefit on our losses in the US due to our deferred tax asset valuation allowance position. There was a mix of tax benefits and tax expense in our jurisdictions outside the US, which largely offset each other. I expect Q4 to also be close to 0%.

Turning to the balance sheet, NOW Inc. had $601 million of working capital excluding cash at September 30, 2016 which was 29% of Q3 annualized sales. We still strive to get at least 25% again. Accounts receivable improved another $15 million in Q3 ending the quarter at $339 million. We reduced AR more than [$550 million] in the past two years despite adding AR from our acquisitions. We continue to be challenged by bankruptcies in our energy space with some 180 North American oil companies and service providers filing for bankruptcy since early 2015. Access to capital remains a problem for many in our industry with energy companies defaulting on billions of dollars of debt. Fortunately it's not a problem for us.

Our current day sales outstanding were 59 days down from 64 days in Q2 and an improvement over the 80-plus days last year. I am pleased with this progress as we continue to work on improving these results.

Inventory was $532 million at the end of Q3, a reduction of $57 million in Q3. We have slowed the inventory replenishment process and have reduced inventory more than $400 million since the start of last year, despite increased inventory from acquisitions. Inventory turns were at 3.3 times which is an improvement over the last few quarters as we move toward four turns again. Days payable outstanding 41 days.

Cash totaled $131 million at September 30, 2016 with $109 million located outside the US, almost half of this being in Canada. We ended the quarter with $145 million borrowed on our credit facility, down $35 million in Q3. Our borrowing cost on this debt averages less than 3%. At September 30, 2016 we had a net debt position of only $14 million. Capital expenditures during Q3 was approximately $1 million which we have averaged each quarter this year. Free cash flow for the third quarter was $30 million and totaled $183 million for the nine months of this year.

Our worldwide market continues to be challenging in 2016, but there are signs that better times may be ahead. In the meantime, we will continue to focus on serving our customers as we manage costs and concentrate on synergy gains from our acquisitions. We have confidence in our strategy, in our employees and in our future as we position Now Inc. to strengthen our value proposition as we continue to serve the energy and industrial markets with quality products and solutions. We are an organization with an experienced management team, strong financial resources, and we are prepared for whatever the future brings.

With that Jason, let's open it up to questions.

Thank you.

(Operator Instructions)

Matt Duncan, Stephen think.

Hey, good morning guys. This is Will, I'm filling in for Matt.

Hello Will.

I want to start with the midstream piece of the business and what you're seeing and hearing from customers there. How would you characterize the tone of those conversations regarding the outlook into 2017 and what would you say the pick up in the 3Q from the 2Q was largely driven by in the midstream market?

Those midstream projects are very lumpy because they are project oriented. For example, we've been working on ETC's dapple project now for many, many quarters. I was actually with a large midstream customer probably three weeks ago and they have several projects in the queue that they plan to start in Q1. I think you will find a mixed bag. I think you'll find some midstream firms that will slow down and others will pick up. That we actually a pick up in midstream in Canada in the quarter.

Okay. That helps. And Robert you touched on the pricing environment in the remarks. I wonder if you are seeing or felling a bottom or firming in the pricing environment while activity was picking up and how you are thinking about price now looking forward versus what you saw on the 3Q?

Our margins are driven really in two major buckets. One is our contract customers and so the branches can affect those margins. So when we negotiate and constantly look to remove either concessions were made in the past or push pricing there. We have not had much traction yet because we're in the lull at the bottom. And then the other big piece of our business is really margins that are managed by the branches.

So we may have a contract customer that buys from us every day and they may send us a spreadsheet full of materials to bid. So the branches at that point do not have to live out the contracts they basically price it at what they think the market will accept. So they are going to continue to push margins naturally at all of the branches because that would only improve their incentive program which is driven by EBITDA margins. So far we have not seen any that stick, but I would expect if activity continues to improve that eventually that would start gaining tractions as project availability and service levels take precedent over price differences.

Okay. And last thing from me. I'm wondering how you guys are thinking about M&A and what your appetite right now is there as we've seen a pick up in the upstream activity. Trying to get an idea of the working capital reinvestment you'll need if trends continue to work higher or even potentially improve, how that working capital investment might offset your acquisition activities through the recovery?

So we have plenty of room just in our line of credit and cash not to mention other forms to fund both the recovery and do acquisitions. I mean whatever you are modeling for rig count recovery which could get you quickly to our revenue line we will continue to work our way down to 25% of revenue for working capital. So that will give you an idea of how much additional cash we would need to fund inventory and receivables, but it won't be nearly the amount of cash and credit line we have available right now currently. We're still interested in M&A, we're still working like we always have. We just currently have a tremendous amount of our resources focused on the organic opportunities that exist by getting the synergies out of the acquisitions that are now in the process team.

Great. Thanks a lot Robert.

Thank you. Ryan Cieslak, KeyBanc Capital Markets.

Good morning, guys.

Hello, Ryan.

I guess first off Robert, I just would be curious to know when you look at the quarter and how it played out maybe relative to your expectations. Was there one particular month that was weaker or better than the others and just maybe some directional sense of how the quarter ended relative to maybe how it started.

In a flattish market, which we have not been in a long time, in a flattish market Q3 is usually our strongest quarter. Q2 is usually our weakest due the break up in Canada. Q4 and Q1 look generally similar to each other. As normal, the third month of the quarter was our strongest month. So that was not unexpected. That generally happens in our business that the revenue grows per month through the quarter. It was stronger than we expected it to be because most of the offset that was a surprise for us was simply the winding down of projects internationally.

Okay. It seems like there's puts and takes going into the fourth quarter, still a choppy market and certainly international, the upside of things have been weak. Is there maybe just go directionally what we should think about the type of sequential pattern in sales going into the fourth quarter for you guys. Is it going to be what you generally see or is there a better way of thinking about the trend on the topline going from the third quarter to the fourth quarter?

In the three geographic segments, we expect international to recover, maybe not to the Q2 levels but definitely a strong recovery in international. Canada will continue to grow based on what we're hearing from our customers on their drilling program. And in the US with rig counts continuing to increase, my hope would be and we won't know but my hope would be that, that could offset fewer billing days holiday impact, Thanksgiving and Christmas; and our customers always start winding down budgets later in Q 4. I think if we ended up with a flat US revenue stream that would be pretty exciting.

Okay. Great. I'm sorry if I missed this. Did you guys provide some direction of where we should think about operating expenses or WSA into the fourth quarter? I know you guys of given the guidance about that in the past. I'm sorry if I missed it, but just any color around that would be great.

We are not going to sit on our hands and wait on the market come back. We're going to continue the same expense cutting in Q4, that we did in Q3, that we did in Q2. Based on our past the performance I would expect we could reduce expenses further in the $3 million to $5 million range for WSA. That being said if you see rig counts start going up 30 per week, for the rest of the quarter that would - those increases would probably offset those targeted reductions. But based on modest activity improvement like we've experienced so far, I would expect we could reduce expenses again by $3 million to $5 million.

Okay. This is my last question. Dovetailing off of that is you've done some significant cost-cutting here since the peak, certainly a market that remains very uncertain and choppy. Robert, how are you thinking about the business going into next year in terms of maybe some additional cost opportunities or what you need to see to really feel comfortable that you guys have caught enough from a cost perspective.

I'm excited every quarter because we manage -- that cost cutting actually happens in our operations. These are the branch managers at are doing the best they can to try to improve their profitability. They have already gone above and beyond with respect to what I thought they could accomplish in the expense reduction effort. So if the market stays consistent going forward as it has been the last few months then I would expect costs to continue to come down. If we have some type of robust recovery then that would be a whole other scenario.

Andrew Buscaglia, Credit Suisse.

Hello, Andrew.

Hello, how are you?

We're good, how are you?

Good, can you give us an update just after you had that great analyst day on power service. I think I missed what it contributed in the quarter. And then if you could comment into Q4 just for modeling purposes what you expect. I know seasonally there's typically a slowdown but could you give us some color there?

So, we acquired power service in Q2 and that contributed $7 million in revenue in the quarter. Then they contributed an additional $20 million in Q3 and that would be $27 million of revenue that they had in Q3. Now that business is longer lead time so these orders that we're receiving lately that are quite exciting, you know some of these pumps have 12, 18, and 24 week deliveries and things of that nature. So it will take a while for that one to materialize unlike our energy center business which is pretty close to the tip of the spear. I would think that our process team revenues will continue to soften into Q4 and possibly Q1 until those long lead time items start materializing into our revenue stream.

Okay, so then after Q1 we should model somewhat of a material pick up for that specific?

I guess it depends how you define the word material. But you would definitely model a pickup in that business beyond there.

Could you give us an update on DUC inventory, anything change in the quarter over the last three months?

Well there's all sorts of people that have that data out there that conflicts with each other, but we did notice a nice little pick up mainly in the Northeast and in the Bakken with respect to customers completing DUC inventory. Now it's a far cry from the number that's actually out there. You get anywhere from 4,000 to 5,000 DUC out there on people that try to keep up with it. So we did not have at kind of recovery, but we did the dozens and dozens of wells that have been capped get completed. So that was an exciting little turn around, finally.

That's it for me. Thanks, guys.

Thank you.

Sean Meakim, JPMorgan.

Hello, Sean.

Good morning. So you referenced rig count as a good proxy for your business and we have a natural lag between drilling and completions [and that makes sense we saw some of that] in the quarter, but we did lag the rig count by a good bit. Now if I've understood correctly, we're talking about a flattish top line in the US for 4Q, US land rig count of about 13% quarter to date. Seasonality toward year-end is understood. How do we think about the business eventually catching up to what we have seen in terms of rig count off the bottom here?

The only reason we use rig count as an indicator for our revenue stream is simply because it is the least inaccurate data point we can find. If there was solid completions data out there that did not vary widely between firms, we would switch to measuring our revenue on a completion basis, because the vast majority of our upstream revenue is with the actual completion of the tank battery, not necessarily the consumables that the drilling rig consumes while they're drilling. Really it's the only thing we have to measure against unless you have a data source is accurate and reliable. So, generally you are going to spend, I don't know how many days you are going to spend drilling a 6 or 8 well pad, and we're going to be selling to the drilling contractor while that's going on, and then we're going to sell very little to the frack crew, maybe some safety gear and tools but not anything worth measuring and that takes a month or two. Then they do the tank batteries. So there's definitely a lag between our revenue stream and rig count movements. It's probably one of the more closely tied businesses to rig count movements but there is still definitely a lag there.

And so, that's all well and understood. If we think about -- can you give us a little more detail just on this quarter how your drilling business, drilling related business, did perhaps relative to the overall?

It definitely improved as a percent of total revenue starting about mid- last quarter. It is up several percentage points of total revenue.

Okay. And then just thinking about the relationship between revenue and working capital as you kind of make your way through the turn. Is your expectation that the working capital build will lag the revenue ramp and that's how you get to your efficiency targets? Or is there some risk as go another quarter here where we have generated more cash, we liquidated more inventory, we actually have to build more working capital early in order to catch up? Just curious about that interplay.

I would expect Sean, that the progression that you have seen from the point of spend all the way to now where we've been working on working capital down that you will see that ratio continue to improve. Now, will we have to buy some A items that are high turn items to replenish those in the branches? Sure, we will but I would think DSOs and inventory turns will continue to improve.

Okay. Fair enough. Thanks.

Thank you.

James West, Evercore ISI.

Hello, James.

Good morning guys. Robert, so kind of following up on Sean's question there about rig count growth and understanding the lags. How good is rig count now as a proxy for your drilling related or completions related businesses? It seems to me like it would be more tied to the completion side or the number of completions done per quarter because there was a pretty significant disconnect between the rig count in both the US and Canada and your growth in both those regions in this quarter. I understand we may see a pickup later on but given your guidance it sounds like the lag is much longer than I would have expected.

Yes. Our revenue per rig for global operating rigs for the quarter it was pretty much flat with Q2, but I do agree there's definitely a lag between rig count increases and our revenue stream. If you think about it, it has been a month drilling the wells on the pad, and then they're going to spend one to two months doing the completion job and then the biggest revenue stream for us upstream, by far as it relates to activity, is the tank battery. So the biggest part of our revenue related to the rig count increases we've had over the last two, three months has yet to materialize.

But aren't you involved as the rigs are staffed and stood back up, aren't you involved in getting all the ancillary equipment and supply chain going again so you would see a concurrent improvement? I understood this is smaller revenue piece but there would be some concurrent improvement as well.

There's no doubt that we experience revenue growth with the drilling contractors even before they start drilling. They have to replenish inventory on these rigs before they even move them out to the well site. But as a percent of the total upstream revenue we have, it's not going to move the needle. It's great revenue, we love our drilling Contractor customers, but at the end of the day our operator customers by far carry the weight when it comes to our revenue stream.

James, I want to add something. If you look at our rig count, like Robert said, it is still our best but inaccurate proxy for what revenue should do. If you look at our revenues from the first quarter or breakout from the first quarter in Canada which I think is a better comparative period given the breakup, our revenues are up versus a much smaller rig market, down 26% in Canada versus the first quarter and our sales are up if you look at the same in US, rig count from the first quarter is down 14% but our revenues are up or flat even after pulling out power service. There is not a perfect quarter to quarter correlation but over time, I think it still is a good barometer.

Okay, that's helpful. Another follow-up from me on the balance sheet. The balance sheet obviously in good shape right now. But you are going to have to rebuild your inventories probably significantly as the recovery takes hold. So if we envision a scenario where activity, maybe not rig count given the efficiency on the rig side, but activity, completion activity, gets back to a 2013, maybe early 2014 type level, how much incremental inventory are you going to add to the balance sheet to be able to service your customer base in North America?

As a general rule of thumb you should expect our inventory turns to work their way to four. You should expect our DSOs to be in the mid-50s and you should expect our working capital spend of revenue to be around 25[%]. So if we had $1 billion in revenue, we need $250 million of cash to fund our balance sheet, and we could do that several times over.

Okay. Thanks, guys.

Thank you.

Vebs Vaishnav, Cowen and Company.

Hey, how are we doing? Thanks for taking my question. I guess it has been asked in various forms, I'm going to time from a different angle. How would you characterize your drilling versus completion revenue share within the US?

Our revenue share?

Yes, how much comes from drilling versus completions?

I don't have that number in front of me, Vebs. Our drilling revenues must, of our upstream business they have to be 10%, 8%. I could go pull it out and publish it, but it's definitely insignificant compared to the operators. Operators might be half of it.

Okay. Let's say if we were to say US DMC spending is up 15% to 20% in the fourth quarter, you are implying that it is by spending being up 15% to 20%, you still have lag revenues in the fourth quarter.

Well, so were talking about the US as a whole right now, and so we're going have some declines in the process team group, for the reasons I mentioned earlier about some bigger lags along lead time, and we're going to have an impact of fewer billing days, billing days are a big deal in this business. And we're going to have holiday impact. And we're going to have winding down of budgets. A lot of customers -- if you get Pete aside and he'll talk about in his H&P days they send the crews home at Thanksgiving and Christmas unless there is a really strong reason not to. All of that stuff combined hopefully will be offset by the activity improvements we have in the non-holiday season periods of the quarter.

Okay. Could you help me just think about how much of the US business comes from the Gulf of Mexico?

Back in 2014 before the slowdown? I think it was maybe 11% or 12%. I remember running the numbers a long time ago. It somewhere in the range. Now it has to be 5% or less.

Okay. There was a comment that you made basically saying considering your credit facilities and the lapsing of restrictions previously enforced by tax payer on issuing more equity. You would use all forms of growth. Was that a comment related to a preemptive thing or was it in consideration for a deal?

No, no, no. There are several forms of currency that we have to do M&A. I was just highlighting some of the ones that folks don't always know about, which obviously our DTA will be cash avoidance in the future. And most folks don't know that we have been under a tax matters agreement for two years where we had no access for our equity if the right deal came up that where equity would make sense. I'm just kind of updating the callers or listeners on -- we have more than one form. We have cash, a line of credit that's barely tapped into. We have plenty of powder in many forms to not only fund a recovery, we could fund a recovery of couple billion more dollars of revenue and still have room. Just making sure everyone knows that it's not an either or for us. It's an all the above. We're just currently focused on getting the synergy and organic benefit out of some acquisitions of recent and making sure we don't divert those resources on to other areas of our business and miss out on basically free revenue growth.

The key thing Robert, is the equity side with the tax matters agreement too, because now that opens up currency as you said all forms of currency so we can kind of run the business as we need to.

Okay. Last question, if I may. If you could just update us on the power services M&A acquisition. How is the progress on that piece of the business on just putting it on a broader US scale?

Putting on a what scale?

A much broader US. (Inaudible).

Believe or not, their peak obviously was late 2014 early 2015 because their lead times are longer so they didn't fill the downturn at the beginning of it. Their quote log right now for that business for this modular solutions is greater now than it was back then. So there is a lot of exciting things happening. They are constantly sending me emails about projects they win up in the Marcellus and Utica or down in the Eagle Ford or up in Alaska that they would never have even known about if they had not been part of the DNOW organization. And on top of that, you now combine it with the Odessa Pumps teams, you've got the entire Odessa Pumps army out there trained and generating these opportunities as well. So I'm excited about it, I'm extremely excited about it.

Chuck Minervino, Susquehanna.

Hello, good morning.

Hi Chuck, how are you?

Just a couple questions. I guess first in the international business, I think you said that's going to recover in 4Q. Do you think that we have now seen the bottom in 3Q with that international business, or is that more of a -- I know you have some cross currents there with offshore still kind of in decline, and you have some new projects starting. But you think that we've seeing the bottom now in 3Q as we look out into 2017?

You know, if you separate our business internationally into offshore centric and not offshore centric. Onshore work, both coming from a claim which the acquisition we made who are knocking it out of the park. I don't want to detract from their success. They had a lull because of the winding down of two LNG projects. But compared to their past performance they are killing it. Groups like that and our teams in the Middle East that are focused on projects in Kuwait and some shipments into Iraq and some other areas, they've been making up for some of the offshore decline. So that particular segment is going to continue to do well.

The part I don't know and I don't know anybody out there that does know, is what is Q4, Q1, and Q2 and Q3 look like for the floater fleet? Are they going to stack another 30 rigs, are they going to stack another 10 rigs, are they going to get busy again? You hear a mixed bag of what's going to go on with offshore projects. I've hear positive things from [Slumberjay] and others this quarter about FID projects and I've heard negatives from others. The offshore is the wildcard for me for international segment, because if it's a big enough decline, the great things happening elsewhere might not be able to mask it.

Are you able to help us with how big offshore now is as piece of the international business?

I think when I looked at it last, which was a few quarters ago, it was about half of our international segment. I'm sure that's moving every quarter less and less and less, because obviously as revenues decline in that segment, they grow elsewhere, the ratio is going to switch.

Okay. You might have touched on it earlier, but kind of looking at the US business. I think in the past couple quarters you guys have talked the little bit about maybe 15% or 20% incremental margins in that business as the revenue grows. And it looks like the incrementals are actually negative, this quarter. Can you just help us understand what is going on there? I know there's some acquisitions that have worked in there as well. How to maybe think about maybe incrementals as US begins to recover more materially?

The incrementals in the quarter were clearly affected by nonrecurring benefit and then the full quarter loaded full of power service expenses. But if you saw a nice ramp revenue in the US and we did not have any one-off scenarios like the ones that I have just described, then you would expect at least the first few quarters of a recovery, a robust recovery, you would expect high teens or low 20s in flow through.

So is this just more of a matter of timing before we start seeing that?

Yes. I think Q3 would've looked a lot different without those two things that I just mentioned. So those kinds of events mask the operational flow-throughs that we experience in the quarter. So if that stuff stays kind of stays constant and we have considerable revenue growth in the US segment in the coming quarters, you will see flow-throughs that are clearly in the mid to high teens or low 20s.

Got it. Thank you.

You are welcome.

Thank you. Our next question comes from Joe Gibney, Capital One.

Hello, Joe.

Covered most of the ground really well, I just wanted to touch on a small piece of your business and perspective on downstream perhaps, maybe tone of conversation with customers regarding outlook for possible increase in turnaround work, I know it can lumpy on the project side too. But just some perspective there, I would appreciate it.

Well, Joe, I've been hearing that turnarounds are one quarter away now for it feels like two years. I've gotten to the point now that when they come to my office to talk about turn around activity in the coming quarter, I stick my fingers in my ears, because I'm just tired of hearing one thing and it materializing differently. They are pretty excited. They're telling me right now that they think Q4 is going to be a good turn around quarter. We'll see if it ends up being true. But they are pretty upbeat on turnarounds this quarter and to Q1.

Into Q1, yes.

Thank you. That will end our question-and-answer session. I will now turn the call back to President & CEO, Robert Workman for closing statements.

I would like to thank everyone for your interest in Distribution Now. We look forward to talking to you in February.

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