DNOW Inc (DNOW) 2017 Q4 法說會逐字稿

Welcome to the fourth quarter and full year 2017 earnings conference call. My name is Sylvia, and I'll be your operator for today's call. (Operator Instructions)

I will now turn the call over to Chief Accounting Officer, Dave Cherechinsky. Mr. Cherechinsky, you may begin.

Thank you, Sylvia, and welcome everyone to the NOW Inc. Fourth Quarter and Full Year 2017 Earnings Conference Call. We appreciate you joining us this morning, and thank you for your interest in NOW Inc. With me today are Robert Workman, President and Chief Executive Officer of NOW Inc.; and Dan Molinaro, Senior Vice President and Chief Financial Officer. NOW Inc. operates primarily under the DistributionNOW and Wilson Export brands, and you'll hear us refer to DistributionNOW and DNOW, which is our New York Stock Exchange ticker symbol, during our conversations this morning.

Before we begin this discussion on NOW Inc.'s financial results for the fourth quarter and full year 2017, 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 U.S. Federal Securities Laws based on limited information as of today, which is subject to change. They are subject to risks and uncertainties, and actual results may differ materially. No one should assume that these forward-looking statements remain valid later in the quarter or later in the year.

I refer you to the latest Forms 10-K and 10-Q that NOW Inc. has on file with the U.S. Securities and Exchange Commission for a more detailed discussion of the major risk factors affecting our business. Further information as well as supplemental, financial and operating information may be found within our press release, on our Investor Relations website at ir.distributionnow.com or in our filings with the SEC.

In an effort to provide investors with additional information relative to our results as determined by U.S. GAAP, you'll note that we also disclose various non-GAAP financial measures, including EBITDA, excluding other costs; net income or loss, excluding other costs; and diluted earnings or 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 of these non-GAAP financial measures to its most comparable GAAP financial measure is included in our press release. As of this morning, the Investor Relations section of our website contains a presentation covering our results and key takeaways for the quarter. A replay of today's call will be available on the site for the next 30 days. We plan to file our 2017 Form 10-K today, and it will also be available on our website.

Later on this call, Dan will discuss our financial performance, and we will answer your questions. But first, let me turn the call over to Robert.

Thanks, Dave. Before we get into the business, I want to touch on an announcement we made in November. Effective this Friday, our Chief Financial Officer, Dan Molinaro, will pass the baton to Dave Cherechinsky, our current Chief Accounting Officer. I want to thank Dan for his many contributions during his leadership as CFO. He has been instrumental in all that is DNOW, and without him, we would not be here -- be where we are today. And I'm comforted in the fact that Dan will remain an office away as an Executive Vice President and will continue to be a valuable member of our executive team. Thanks, Dan.

Moving on to the business, we believe the prolonged oilfield market rebalancing is complete. While we expect volatility, we think that the current trajectory is positive and presents great opportunities for DNOW as we enter 2018 a much stronger, more agile organization.

We continue to focus on both growth and efficiency. In 2017, we added over $0.5 billion in revenue while reducing costs. In this uneven recovery, we're operating on shifting tectonic plates in areas where opportunities are abundant and resources and products are scarce and other areas where the inverse is true. Despite projections for growth, we expect to generate cash in 2018 by improving on working capital deployment and generating positive earnings.

I'm excited to highlight a few key takeaways from the year. In 2017, we delivered strong year-over-year growth, a reflection of DNOW's ability to capitalize on the overall energy recovery while reducing costs. Key to our success has been the progress made in executing against our strategy to optimize our operations, drive overall margin expansion, deliver growth and maintain a disciplined approach to our capital allocation. We're optimistic heading into 2018, and are positioned to take advantage of the continued market up-cycle and are confident that our business plan and strategy will allow us to do so.

We remain committed to acquiring the right businesses that made our defined M&A criteria and will deliver significant value for DNOW and our shareholders. At this stage of the cycle, we must also focus our efforts and capital to support organic growth.

Looking at our financial highlights, we're very pleased with our ability to deliver strong year-over-year 4Q growth across all 3 of our operating segments. We grew revenue by $541 million in 2017. Revenue for the quarter was $669 million, up 24% year-over-year.

On a sequential basis, 4Q 2017 revenues were down 4%, even though revenue per billing day was up modestly. This decline was driven by 5% fewer billing days, weather impacts, declining rig counts and customer budget exhaustion in the quarter.

While we're able to generate sequential revenue growth with oil and gas companies despite these factors, this was offset by seasonal declines in midstream and downstream in the U.S. and reduced customer activity in Canada.

For the quarter, we reported a GAAP net loss of $3 million or net income excluding other costs of $1 million. Earnings per share for the quarter was a loss of $0.03 or an earnings per share, excluding other costs, of $0.01. 4Q EBITDA, excluded other -- excluding other costs was $13 million, a year-over-year improvement of $44 million, $10 million of which is attributable to a gain on sale of a property.

Gross margin was 19.1%, up 270 basis points year-over-year, a reflection of our drive to maximize product margins. In 2017, we added $156 million in gross margins, generating a favorable shift to positive earnings. We also added $171 million to EBITDA, excluding other costs, compared to 2016. This represents 32% incrementals for the year in a 19% gross margin environment, which signifies a solid financial recovery for DNOW, positioning us to capitalize on expected further market expansion in 2018.

We maintained a healthy balance sheet ending the year with a net debt to cash position of $64 million. Working capital, excluding cash as a percent of revenue, ended the year at 23.8%, in the range of our expectations.

Now let's take a look at the progress we have made in executing against our strategy. Growing profitability across the organization is a top priority. Globally, we continue to improve our operations cost structure with an eye on tightly managing expenses. We continue to invest in specific shale plays and businesses that are active and to minimize exposure in less active areas.

For 2017, while we closed 29 branches, we added locations and headcount in active areas like the Permian and Rockies. To drive gross margin improvement, we are pushing pricing initiatives in the field through the increased use of technology and are seeing acceptance there. Our omni-channel strategy provides our customers with the ability to acquire thousands of products from any 1 of our 285 locations, our regional distribution centers or by using our e-commerce system.

We are experiencing revenue growth and margin improvement from investments in our e-commerce channel and system. Our PVF and customer-specific apps, punch-out catalog and B2B activity all increased in 2017.

Severance expenses increased in the quarter to $2 million as we extracted costs from underperforming locations and closed 9 branches. We also remain committed to optimizing our operations to deliver high value-add product lines and solutions for our customers. Some of our initiatives, milestones and achievements (inaudible) exploring new supplier partnerships or new ways to work with existing suppliers, as this is an important part of our strategy, and we have made good progress here. We continue to see benefits from our new strategic relationships with key manufacturers, including Forum's Global Tubing and Badger Meter as well as long-term suppliers like Cameron, Kimray and Benteler Steel & Tube, whom we have distributed for years. As an example, our business with select new or expanded lines Global Tubing, Kimray and Badger Meter alone create a much greater rate than the rest of the business in 2017.

As we indicated last quarter, we introduced a beta business model concept for one of our U.S. energy center regions to allow for maximum customer reach at the least possible cost. These footprint changes help with incremental and fee improvement to DNOW. We're encouraged by the results we've seen, where one team received a 4Q bonus for the first time in many quarters because of the changes made, and we are reviewing other areas to replicate this success.

Additionally, DNOW has taken direct steps to further our focus on new customer business development and market share growth within our current customer base. We've invested in technology to support our sales teams, identified new customer target groups and hired many additional sales team members to support and generate future growth. We also inserted resources internationally to maximize our strategic positioning on longer-term global projects, tenders and awards.

Moving onto growth through acquisitions. Effectively integrating the 12 acquisitions we've completed since the downturn began in Australia, Europe and North America remains a top focus for DNOW. It is imperative that we continue to maximize synergies and leverage market opportunities from these businesses.

We've made meaningful progress through the end of 2017, and I'd like to highlight a few examples. In our process solutions business, we have made great strides integrating Odessa Pumps and Power Service. We are leveraging our combined capabilities to deliver on cross-selling opportunities with these businesses. For example, both companies are now stocking NOV multiplex pumps and Schlumberger REDA pumps, which allows us to leverage inventory and offer customers a value-added solution.

As evidence of this benefit in 4Q, we recently received orders from a major E&P customer for our LACT units with NOV multiplex pumps on the discharge. As part of the ongoing integration of MacLean Electrical, we announced the creation of light and energy distribution brand in the United Kingdom, which gives our industrial and street lighting division its own market identity and focus. In addition, the J.T. Day Australia brand is now operating under MacLean Electrical.

In 2017, we integrated the heritage Wilson Supply mill, tool and safety business that targeted manufacturing customers into the acquired machine-tool and supply business in early 2017. This allowed us to combine our sales and operations teams and reduce back-office expenses. We remain intensely focused on stocking levels to ensure working capital as a percent of revenue is meeting expectations in each area and increasing turn rates.

Looking ahead, we will continue to focus on growth and efficiencies as well as further advancing our integrations. Specific to integrations, among the items that we expect to complete in 2018 include, within the U.S. process solutions business, Odessa Pumps and Power Service are further integrating our business development and sales teams to cross train on water injection pump packages, LACT units and ASME vessels, while also combining forces for our midstream initiative.

For MacLean, we still expect additional integration benefits. And under our new regional leadership structure, we will be working as one to utilize business locations and category strengths to increase opportunities. In addition, we will be focused on supporting MacLean's product lines from all DNOW European locations.

Regarding the market, 2017 U.S. rigs peaked at 953 in July. After 4 months of rig counts declining by a total of 42 in the U.S., rigs rebounded somewhat in December, adding 19 rigs, ending the year at 930 rigs and an average of 875 rigs for the year. U.S. rigs were up to 975 at February 9.

Sequentially from 3Q to 4Q, Canada rigs declined for the third time in 10 years with the 2 prior jobs occurring during the severe downturns of 2008 and 2015. Completions have grown for 5 consecutive months through December, although DUC counts continue to climb. And just like rig count, the rebound in crude process and recent activity levels are pointing towards a positive outlook for this year.

4Q '17 completions equaled the highest quarterly count since 1Q '15. In the second half of 2017, completions outnumbered wells drilled in the Appalachia, Bakken, Haynesville and Niobrara plays.

With the acquisitions in our U.S. process solutions group, we anticipate further gains once the service pump companies can deploy sufficient frac horsepower to stop growth in the DUC count and begin working through the inventory of wells waiting in line to be completed. Overall, U.S. 4Q revenues were up 29% year-over-year, though sequentially down 4%, largely in line with U.S. rig count changes and the reduction in billing days.

For the U.S. segment, 4Q operating margins experienced strong sequential decrementals as WS&A costs declined while revenues improved. Our U.S. energy center business outperformed the U.S. overall with a 4Q year-over-year improvement of 37%, but had a steeper 9% sequential decline, 4Q versus 3Q, on the back of seasonality, negative weather impacts in the Permian and Rockies, delayed pipe shipments due to congestion at the Port of Houston and choppy midstream projects that didn't recur in the Mid-Continent and Northeast.

Softness from these challenges was partially offset in the Northeast by the implementation of a recently awarded midstream launcher and receiver contract and continued strong pipe shipments to gas utility customers. Looking forward, we expect continued growth for Forum, Global Tubing and several midstream and gas utility projects across many U.S. basins that were delayed from 4Q that will help offset slow activity rebound with customers who have yet to finalize the budgets.

We've seen an increasing number of midstream projects that should materialize in 2018 and beyond and expect more projects to be announced in the coming quarters. With trade suits and potential sanctions in the mix, the supply chain is less certain. With inventory on hand and strong supplier relationships, this could play as a near-term benefit for DNOW.

In 4Q, the U.S. supply chain business grew 15% year-over-year and 3% sequentially. The sequential increase was due to growth with our energy customers, partially offset by downstream and industrial customers, which saw expected turnarounds pushed from 4Q into early 2018. Supply chain energy customers grew sequentially, overcoming reduced billable days, weather and holidays and a transition of a customer's assets with pipeline projects executed in the Eagle Ford.

This growth was driven by strong upstream facilities and midstream project work with Marathon, OXY and Devon that offset seasonal softness with Hess. Despite turnaround delays that were pushed to the first half of 2018, downstream and industrial activity experienced a large amount of bid activity in 4Q, and we secured 2 new customers which should bode well for future quarters.

For the machine-tool supply business, their sales increased in line with increased aircraft deliveries and increased customer manufacturing activity related to an improving oil and gas industry. With oil prices steady or improving, an increase in the number of billing days, normalized manufacturing schedules and a strong turnaround season, we should see an improved 1Q for U.S. supply chain services business overall.

The oil and gas customers in supply chain services are projecting increased drilling, completions and capital projects in 2018, so that should be a nice tailwind. We've also had some success in transitioning some of these customers to source from U.S. process solutions for pumps, process equipment, oil and gas measurement systems and controls. 4Q U.S. process solutions grew 35% year-over-year with the Permian being the largest contributor to growth. The Permian remains by far the busiest region for the solution, but we are seeing increased bid requests in the Rockies, Eagle Ford and DJ basin.

Going forward, based on customer activity we received in 4Q, we expect large water injection pump packages, ASME vessels and LACT unit sales in the Permian and Bakken, an increase in midstream actuated valve projects in the DJ basin and large fluid transfer pump projects in the Bakken for one of our supply chain customers. These orders received late last year are promising for the [20th] performance of our U.S. process solutions group.

As the demand for our U.S. process solutions products continues to increase, we will continue pushing into new areas, including increasing our total valve solutions presence in the Permian Basin. While Canada's top line grew year-over-year by 16%, revenues declined 11% sequentially in 4Q. Total 4Q well spud were down 18% sequentially. Big projects related to the shutdown of tie-ins with our largest customers, stalled turnarounds with our largest oil sands customer, reduced pipe activity and long lead time back-ordered inventory drove the decline.

We had several customers cease operations for the holidays earlier than normal, and we saw a decrease in well spud that began in mid-December. For the quarter, gross margin gains drove strong sequential flow-throughs. The Canadian freeze and related activity should boost revenue in 1Q sequentially as increases will likely occur in the north, most likely in the Montney and Duvernay plays. Shipments with multiple customers that slipped from 4Q, a growing customer base for our NOV Fiberspar spoolable pipe team, recently received midstream project purchase orders and a growing activity in our valve actuation and artificial lift groups all point to a strong 1Q for Canada.

Similar to the U.S., pipe manufacturers are expected to allocate capacity to OCTG. This, along with the Chinese OCTG, ERW and seamless line pipe excluded from the Canadian market, may cause pricing to be more volatile, which would be favorable to us.

International 4Q revenues were up 12% year-over-year, 4Q operating margins were similar year-over-year. Sequentially, international top line was relatively flat as increased revenue in the CIS in both Azerbaijan and with Kazakhstan's future growth project, electrical cable sales in China and work with Woodside, Chevron and Shale in Australia were offset by softness in Europe, Latin America and project completions in the Middle East.

Sequentially, margins compressed as high-margin projects came to a close and severance costs accelerated due to the amplified cost-cutting measures across the segment. Drilling outside the U.S. is forecast to increase 5% led by improvement in Russia, China, Western Europe, Australia and parts of Africa. Growth in capital project's backlog in the UAE, Kazakhstan, Azerbaijan and Egypt should boost our Middle East and CIS operations.

As well, recent wins in Trinidad, Brazil, Colombia and Mexico show promising signs for our Latin American operations. New artificial lift projects with several customers and a recent MRO award with Chevron for Gorgon and Wheatstone should provide a nice tailwind for the -- for Australia throughout 2018.

Global offshore drilling is believed to have hit an inflection point and is expected to begin a recovery. We're in discussions with many of our drilling customers and believe we are well positioned to benefit from these gains given our presence in this market and regions. Finally, DNOW is a large global enterprise. There is a lot working well across the organization, and word is those managers have more than enough flexibility to prosper further.

From our perspective, the downturn is over. Our managers know that growth at high incrementals, given our existing sufficient infrastructure to support growth is paramount. We are ready to invest further in high-return locations and businesses. Low-return locations or businesses are under significant oversight and their managers understand that we will operate as if this market is the new normal and will continue sizing the business to reflect that.

Our teams are operating with an understanding that substandard profit and cash remittances are obsolete concepts. Consistent performance measured by cash generation, frugality, efficiency and yield, while deepening our importance to and winning over more customers will continue to be our mantra.

Now let me turn it over to Dan to review the financials in more detail.

Thanks, Robert. We look back on many successes of 2017, including an impressive year-over-year 26% revenue growth, while continuing to reduce warehousing, selling and administrative costs and increasing margins from 16% to 19%.

I remain impressed with our dedicated workforce, and I am convinced we have the top people in the industry. I'm grateful for the hard work, integrity and perseverance of the DNOW family. Thanks for all you do.

In 2018, we will continue to concentrate on the needs of our customers, while maximizing the long-term value for our stakeholders. Robert discussed our business, and I'll say more about our financials.

NOW Inc. reported a net loss of $3 million or $0.03 per fully diluted share on a U.S. GAAP basis for the fourth quarter of 2017 on $669 million in revenue. This compares with a net loss of $9 million or $0.08 per fully diluted share on $697 million of revenue in the third quarter of 2017. When looking at the year ago quarter, we had a net loss of $71 million or $0.66 per fully diluted share on revenue of $538 million for the fourth quarter of 2016.

The fourth quarter 2017 results included $3 million of after-tax charges for valuation allowances recorded against our deferred tax assets and $1 million of severance charges. After adjusting for these other costs, our fourth quarter net income was $1 million or $0.01 per fully diluted share, both non-GAAP measures.

Fourth quarter 2017 gross margin was 19.1% compared with 19.4% in 3Q 2017, and compared with 16.4% in the year ago quarter. Operating profit was breakeven in the fourth quarter of this year, a $6 million improvement from the previous quarter and an improvement of $47 million from the year ago quarter.

Fourth quarter EBITDA, excluding other costs, a non-GAAP measure, was $13 million, improving by $8 million sequentially. While revenue declined due to seasonal factors, EBITDA, excluding other costs, improved, a counterintuitive and notable achievement.

Looking at operating results for the 3 reportable geographic segments, revenue in the United States was $488 million in the quarter ended December 31, 2017, down 3% sequentially and up 29% over the year ago quarter. Year-over-year improvement in the U.S. rig count, coupled with the full year benefits of the mid-2016 acquisition contributed to these revenue improvements.

Revenue channels in the U.S. for 4Q were 52% U.S. energy, 32% U.S. supply chain services and 16% U.S. process solutions. Fourth quarter operating loss in the U.S. was $1 million, an improvement of $9 million from the third quarter of 2017 and a $42 million improvement over the year ago quarter. The year-over-year narrowing of the U.S. operating loss was primarily driven by increased volume, improved pricing and reduced warehousing, selling and administrative expenses.

In Canada, fourth quarter revenue declined 11% sequentially to $85 million and was up 16% over 4Q 2016, due essentially to Canadian rig activity coupled with the impact of the weakening U.S. dollar. Revenue in Canada was up almost $100 million in 2017 to end the year with $356 million, even with the rare seasonal decline in the fourth quarter.

For the 3 months ended December 31, 2017, Canada's operating profit was $4 million, same as 3Q '17 and improved $6 million over the year ago quarter, reflecting growth in the period at higher margins during the year. Canada posted an operating profit in each of the four quarters of 2017, and delivered 32% operating profit flow-through from 2016 to 2017.

International operations generated fourth quarter revenue of $96 million, which was up 1% over the third quarter of 2017, and up 12% over the year ago quarter. International's operating loss was $3 million for the fourth quarter of 2017, due primarily to severance costs and lower gross margins as higher-margin projects declined as a percent of sales. This compares with breakeven in the third quarter of 2017, and an operating loss of $2 million in the year ago quarter.

Continuing on to the income statement, warehousing, selling and administrative expenses was $128 million in the fourth quarter, a $13 million reduction sequentially, partially attributed to a $10 million gain on the sale of a facility. There is much being written about tax reform in the U.S. and the impact going forward. The Tax Cuts and Jobs Act provided for a reduction in the U.S. corporate income tax rate, requiring that we remeasure our deferred tax balances based on the reduced tax rate. While we are in a net deferred tax asset position in the U.S., we also have a full valuation allowance. As a result, we had to write-down both the deferred tax balances and our valuation allowance, resulting in a 0 net P&L impact. These write-downs of our deferred tax assets and valuation allowance amounted to $69 million in the fourth quarter.

We also recorded a onetime $33 million charge relative to the transition tax resulting from the mandatory deemed repatriation of our unremitted foreign earnings, which was fully offset by foreign tax credits and net operating losses, again resulting in 0 P&L impact. Our effective tax rate, as calculated for GAAP purposes, was essentially 0% for 2017. When we are no longer subject to a valuation allowance in the U.S., we expect our effective tax rate to be in the mid-20% range.

Turning to the balance sheet. NOW Inc. had $637 million of working capital, excluding cash, at December 31, 2017, which was 23.8% of sales, remaining below our 25% target, and we will continue to optimize our capital employed.

Accounts receivable decreased $43 million sequentially to $423 million. The pace of bankruptcies in our energy space is easing, but we must continue to be diligent as we extend credit. Our current days sales outstanding was 58 days, our lowest level since the spinoff, but there is more we can do.

Year-end inventory was $590 million, up $28 million over 3Q as we respond to increased activity. Inventory turns were 3.7x, a bit below our targeted 4.0x. We must continue to carefully manage the inventory replenishment process as activity levels improve and supplier lead times fluctuate. Days payable outstanding were 49 days in fourth quarter '17. Cash totaled $98 million at December 31, 2017, with $81 million located outside the U.S., more than 1/3 of that being in Canada.

As I mentioned in my comments on taxes, the Tax Cuts and Jobs Act required we accrue a mandatory one-time transition tax on the deemed repatriation of our unremitted foreign earnings. Despite the result in reduction of the tax cost of an actual repatriation following the act, we have no plans for an actual repatriation at this time.

We ended the quarter with $152 million borrowed under our revolving credit facility, and we remain in a net debt position of $64 million when considering total company cash. Our debt to cap remained at 12% at year-end, and we had $429 million in availability. Our borrowing cost on the debt approximates 4%, and we expect the Fed to continue to push short-term rates incrementally higher during 2018 as we attempt to fend off inflation.

Our credit facility matures in April of 2019, and we have begun refinancing negotiations. Capital expenditures were $1 million in the fourth quarter of this year, giving us $4 million for the full year 2017, the same as the full year 2016.

Showing the effects of improving business conditions and the need to support improving activity, free cash flow used in the fourth quarter was $9 million. Our worldwide market continues to be challenging as we remain closely tied to global rig count and drilling and completions expenditures.

We will continue to focus on serving our customers as we rationalize expenses, concentrate on integration gains from our acquisitions, and seek to maximize new opportunities. We have confidence in our strategy, in our employees and in our future as we position NOW Inc. through the energy and industrial markets with quality products and solutions. We are an organization with exceptional leaders, outstanding employees, solid financial resources, and we'll continue to respond to the needs of our customers.

This is my final earnings call as DNOW's CFO, and I have been honored to serve this wonderful organization since our spin from NOV. The finance department will be in the capable hands of Dave Cherechinsky and most of you already know him well. I'll continue to serve Robert and our board as Executive Vice President, and look forward to seeing you at investor conferences, shareholder meetings and elsewhere.

With that, I'll turn it back to Robert for some concluding comments.

Thanks, Dan. At the foundation of DNOW's success is the deep bench of dedicated employees. This quarter, I'd like to highlight [Hank Babylon] right here in Houston. Hank is a Sourcing Specialist and has been part of our DNOW family for 44 years. I first met Hank in the early '90s when I transferred from the Bryan, Texas branch to the Houston export group off Clinton as an expeditor. We spent many days dodging bullets and worrying about whether or not our cars would still be in the parking lot at the end of the day. Hank and I have a lot in common in that we don't give up easily.

The first time Hank interviewed with National Supply, he didn't get an offer. He couldn't understand why, and he came back and asked for another interview. The second time around, he got the job and he's been with us ever since. Thank goodness we didn't make the same mistake of letting him get away a second time. Since then, Hank has worked for us at 9 different locations and in 6 different functions. He knows our industry, organization and products inside and out. Thank you for everything you do for DNOW, Hank, and thanks for giving us a second opportunity to do the right thing.

Before opening up for questions, I'd like to reiterate that we're proud of the year-over-year growth that we drove as well as optimistic about the 2018 macro backdrop and our ability to continue to leverage that to the benefit of our shareholders and employees. Based on customer budgets previously announced, growth with our North America shale-focused customers, offset slightly with only modest improvements in the international and offshore markets, revenues could improve low double digits with the topside being mid-teens in 2018.

Due to current market activities, the continued growth in our revenue per billing day and an increase in the number of billing days, we would expect sequential revenues to grow mid- to high single digits in 1Q. For these sequential and year-over-year periods, incremental EBITDA generation on improved revenues should be in the 10% to 15% range.

We're excited about our progress against our strategy and the related initiatives in each of the businesses. And looking ahead, our focus on improving operations while capitalizing on the ramp-up of completions and delivering on operational and working capital efficiencies will drive continued positive earnings momentum.

And with that, let me turn it over for questions, Sylvia.

(Operator Instructions) And our first question comes from Matt Duncan from Stephens Inc.

So Robert, first question. You talked about this a little bit, but just on Canada, it's obviously abnormal to see a sequential decline in revenues there in the fourth quarter. I think the only time that's happened before since you spun out was during the downturn in 2015. So is it really just sort of an abnormal market setup that drove that this year? Is there anything else going on that we need to be thinking about? And do you expect to see Canada bounce back pretty nicely here in the first quarter?

Yes. So Canada definitely was a surprise, because they usually grow in Q4. And rig counts usually grow in Q4. And neither 1 of those 2 things happened this particular Q4. It was very odd to see how much basically the industry shut down in December. It was surprising. It usually doesn't happen, because that's their winter season so they're usually active. So budgets were exhausted, people put out projects, rigs were laid down and everybody took Christmas, a really long Christmas. So the good news is, if you keep up with the Baker Hughes report, that it's coming back strong in 1Q. So this might just be one of those weird abnormalities, the third time in 10 years that that's happened.

Okay, makes sense. On the profit side of things, this is the second straight quarter where you guys have had positive EBITDA, but your profit levels are probably still a little bit lower than where I think your shareholders would like them to be. Certainly, I know they're lower than where you want them to be. So talk a little bit more about your plan to improve profit. I know you've had the beta test going on. With revenue growth in low double digits, you're obviously going to get some nice operating leverage, but what else are you guys doing to drive profits higher? Are you going to take the beta test? You've been running, I believe, in the Haynesville and maybe that out more broadly. What are the plans there?

Matt, this is Dave. So we're -- we -- first of all, we expect growth in the year, as Robert guided to. We expect, depending on the rate of growth, some further price appreciation during the year. But as you saw from our full year results and our year-over-year results, while we're adding hundreds of people or new customers and opportunities in the shale plays, we're shuttering locations, canceling leases and reducing personnel as well. So we're continuing to rightsize our business for the parts of the world that haven't benefited from the recovery. And we're pushing price. We saw a seasonal dip in the fourth quarter. I think that put some downward pressure on price, but we expect some recovery there as well. So our focus is growth, better pricing and making sure the organization produces on a location and business basis.

All right. So -- and then last thing from me then on price and sort of how to translate this all to incremental margins. What are you guys expecting from price this year? I mean, the lead times have really stretched out on certain things. You talked about some of the trade issues that have been going on. How much price do you expect to get this year? What does that mean for gross margin? And then at the end of the day, Robert, if we're talking low-double-digit to mid-teen revenue growth, what type of year-over-year incremental operating margin should you get on that, based on sort of everything you guys are planning for the year?

Well, Robert talked about incrementals in the 10% to 15% range. As you know, for the last several quarters, we've seen premium follow-throughs for several quarters in a row. We believe 10% to 15% is kind of our average normal operating arena. But there is some upside on the gross margin side. We could move towards 20% depending on the rate of growth in the year. And like I said, we're still pulling out cost. So while we believe 10% to 15% is the right guidance range, we're going to be pushing hard to pierce that top level and getting to the higher percentages.

So David, if gross margin is up you're going to be above 15% is kind of what I'm hearing.

If we see meaningful gross margin appreciation, yes.

Our following question comes from David Manthey from Baird.

Yes. First off, could you just tell us how you feel about your revenue per U.S. or global rig in 2017? And then when you look at 2018, that 10% to 15% growth, do you think the revenue per rig metrics go up, stay the same and why?

Well, so it stayed roughly flat, again, at that $1.3 million level. If the world turns out the way customers are saying it's going to turn out, right? I mean, that's a big if, because it usually never does. But let's say -- let's just play like it's one of those weird years where they go down the path they say they're going to go down, which would be very, very modest rig adds in the U.S., but a ramp-up of completions, then it could skew that measurement to the positive.

Okay. And then second question is on the process solutions business. If you could talk about how much traction you're gaining in selling a complete package. I understand that's everything, except the tanks. Or are you having more success with, say, selling the pump, skids or valve solutions or LACT units than you are selling a complete turnkey package. And I don't know if there's any metrics you can wrap around that, Robert, in terms of the number of turnkey tank batteries you sold in 2017 relative to kind of the partial year in 2016? Anything to help us understand the traction you're gaining there in the PS segment?

Yes. So you know we do sell complete tank batteries in the Rocky Mountains, because that's where that business has been forever and our goal was to expand that to other plays. What we've seen is, in the beginning, customers only ordering water injection pump packages, or only ordering ASME vessels, or only ordering LACT units to kind of gauge out their comfort with our quality, our ability to deliver, and so forth and so on. As we've gone through 1.5 years of selling like 12 pieces a kit, like all the exact same pieces a kit, now we're seeing that customers order may be 2 or 3 of the pieces. So it's gaining traction, and we're getting more and more kit, but we've only really done probably a total turnkey outside of our core market twice so far, but that's twice more than we did before. And at least customers are ordering multiple units now as opposed to only giving us 1 component of this -- of the tank battery.

Our following question comes from Nathan Jones from Stifel.

I wonder if we could go back a little bit to the incremental margins and look at the WS&A side of that. If you're looking at 20% -- 19%, 20-odd gross margins and 10% to 15% EBITDA margins with upside, that tends to imply that you are going to be adding net warehousing, selling and administrative costs. Can you talk about what the plans are for the net costs on that side? Where costs are coming out? Where they're going in? And how that shakes out for your outlook for WS&A in '18?

Okay. Yes, Nathan. Nathan, this is Dave. We closed 29 locations in 2017. We added about 10. Almost all of those were for new customers, Marathon, OXY, a growing customer. And we've got initiative in the Permian, which I believe we talked about in the last couple of quarters about adding a lot of salespeople and operations to support growth in the Permian. So that was -- that's where we're seeing the growth. And where we're seeing the reductions are in the international arena and in slower activity locations in United States and Canada, that's where we're pulling the cost out. I see those WSA numbers staying fairly flattish for the year despite growth. The percentage will come down each quarter, the absolute value should not grow, it should be in the 140 range. So our focus is on, like Robert said, efficiency. Efficiency, growing the business, so WSA should be fairly flat.

If you're forecasting or looking at WSA being fairly flat, gross margins in the 19%, 20% range with potential upside from pricing pushing gross margins higher, aren't you being really conservative with this 10% to 15% incremental margin guidance?

Well, yes. I mean, 20% gross margin would be an achievement for us this year. It's possible. And I said it, if the right things happen, if we see a good growth rate, that will happen. Yes, there should -- could be some conservative in those numbers. But we don't know what's going to happen in the market in these coming quarters. A month ago, we had $66 oil, and now we're seeing $59. So there's still some uncertainty there.

And if you were on the -- our call 4 quarters ago, the Q4 of '16 call, had said, do you think there's any chance you can get over 30% flow-through in 2017, you would have not gotten a single yes from many of us.

That's fair. I understand. And then maybe on capital allocation, balance sheet is in pretty good shape here. You guys could probably use some more scale given the downturn has probably taken the peak energy center revenue down this cycle. What kind of assets are you looking at? And what kind of expectations do you have for capital to be deployed in 2018?

Well, I mean, we've made good progress in both DSOs and turns, which are the big driver, but we're not to our stated goals yet. And so even though we're happy that we're headed in the right direction, we still need to improve inventory turns and DSOs still need to come down. So we should get more efficient in working capital as a percent of the revenue that we grow. Some things are happening in Q3 and Q4. And partially in Q1, where these lead times have 30 weeks or 35 weeks on all sorts of products by the way, we're happy to try to get ahead of that. And so some of the stuff is showing up that's being planned for future deliveries, and so it kind of bulked up our inventory in Q4.

I was talking a little more specifically around potential M&A.

Well, we never forecast how many deals we're going to do or how much money we're going to spend because that gets you into trouble eventually, because you might make some bad choices just trying to meet a number that you laid out there. We're not at all nervous about taking on more leverage if the right deal comes along. It just gets a little more difficult in this environment when you have a recovery going on to close the bid as spread.

Our following question comes from Sean Meakim from JPMorgan.

Congrats to Dan and Dave. By the way, both moves are well deserved, so congrats to both of you. So just a little bit of a clarification, I guess, in the first quarter, we've heard pretty consistently from a lot of the completions-levered companies that weather delays in West Texas and North Dakota made for a slower start to the year, particularly in January. I guess, I would have thought that would negatively impact DNOW, given you'd lose some days of sales activity pushed to the right a bit. Is that not the case? Or was it just on a relative basis, more seasonality in the first quarter? I was just curious if you could give a little bit more kind of how January unfolded for you?

Yes. I mean, so we've got a month and a week under our belt into this quarter. And so that drove our answer or our forecast of what we think sequential is going to happen in the business. So if we were experiencing significant delays in the business, I wouldn't have thrown out there that we could grow high single digits.

Right. So -- but you're saying basically that weather was not a significant factor for you in those areas in the first quarter.

Yes. The -- exactly, the weather definitely did affect us in Q4, whether it was rain in West Texas or freezing up in -- on several places, and you combine that with less billing days and customer budget exhaustion and the holidays and all that stuff, that's what happened generally in Q4. But so far, we're pretty excited about where Q1 is headed.

Okay. That's helpful. And then I guess, maybe you could just give us a little more specificity around the lead times that you're seeing, extend? Where are you seeing -- which product lines would you highlight and how the -- give us a sense of the rail activity versus a year ago?

Yes. So when we -- when the market started beginning to recover, and what was that? 3, 4 quarters ago, lead times for our engineered valves, for NOV multiplex pumps, for Schlumberger REDA pumps, that stuff was all in the 15-week range, 18-week range or whatever. We're seeing 30 and 40 weeks on stuff -- on several product lines, it affects all of our businesses, all of our 3 segments in the U.S. and then our global and international segments. We have a congestion in the Port of Houston that they have to figure how to solve. It's holding up big pipe orders that we have sitting there waiting to be delivered and shipped to customers. So we got all sorts of clogs going on in the supply chain that we're trying to get ahead of.

And then I guess just one last follow-on to that. Could you help us understand the economics of how you're contracts work such that are you able -- how are you, as a distributor, able to capture some of that value as things get really tight, lead times push up relative to what your suppliers would benefit from?

So it's really a two-pronged approach, and we're working both. So we have contracts with customers where we have agreed on a price for everything that they buy from us. And so if they just place an order on us and don't ask us to bid it, the system prices it based on our contract. And so to move those margins up, we have to go renegotiate. Sometimes we do it on a specific product line, sometimes we do it in a specific geography with the customers to get them to accept a contract amendment that we can put in the system, which we are doing. The other part is, lot of our customers don't just place big orders on us. So an oil and gas company that buys stuff from us every day may not ask us to bid it, because it's just $100 orders, $1,000 orders, $5,000 orders. But when you get into larger orders like for the midstream market or the tank battery market, they don't just order that material based on a pricing contract, they send that out for bid. And that's why our branches are starting to really surgically push price, because they're trying to grow their margins, because the higher they grow their gross margins, the higher their EBITDA margins are, which just makes their quarterly bonus bigger. So we're pushing on both fronts.

Our following question comes from Steve Barger from KeyBanc Capital Markets.

Just want to make sure I'm thinking right about your message on 1Q. If these improving trends lead you to that sequential revenue increase, will that be enough to generate positive EPS on an operating basis and a sequential increase in EBITDA?

Yes. And yes.

Yes, and yes.

That's perfect. Back to the comment on skewing revenue per rig to the positive. If I look at Slide 7, obviously that's already been happening over the last couple of years. Is there any specific thing that you can call out on what's driving most of that change right now? And is that accompanied by a sustainably better mix?

Well, our revenue per rig is growing simply because we believe we're growing our market share, okay. So that's just going to drive that number up. The unfair thing about that measurement is that 1 land rig in this measurement is the same as 1 drillship. And a drillship buys a lot more than a land rig. So with the offshore market still severely depressed, I'm actually quite happy that, that number keeps growing. Because it should really grow in some far distant future, far, far away when the offshore market comes back and then we get to add 1 rig and the spin with 1 rig and that's going to be a big impact to that number. But when it comes to the offshore market, I'm not holding my breath.

Yes. And I would add, Steve, that if you look at rig counts, the rate of growth has obviously declined, but completions are growing. So we could see a bias towards higher revenue per rig even if rigs stay flat because of the growth in completions.

To the offshore comment, I did see in there. I think, you said the drilling would be up 10% in 2018. Does that start to translate immediately into a benefit for you in 2018? And does that say good things about what could happen in international?

Most of everything I've read about growth outside of the U.S. and Canada on CapEx growth, a lot of that is not offshore. There's some that is, you've seen the reports out from the drillers last week, getting new contracts and things of that nature. But don't forget, I don't know how many rigs it's been, 140, 150 up, floating rigs have been scrapped or maybe even more so far, all that inventory went to a shore base somewhere. And so they have a lot of inventory that they can use to support any rig additions for quite a while. I mean, these rigs carry a lot of inventory. So it's going to take a while to burn through that material before they start ordering stuff from us.

Got it. And I'll just squeeze one last one in. Good to hear your expectations on cash generation in 2018. Do have a range around what you're thinking about? And is that coming more from -- is that just the positive swing in earnings? Or can you get some benefit from working cap?

Yes. The positive swing in earnings will, of course, generate cash for us in the year. The opportunity, like Robert said, is to -- for us to improve our DSOs, which we've made nice progress on, but they're not where they need to be. And to sell a lot of that pent-up inventory we bought for projects that are beginning to materialize in the first half of the year. So there should be cash generated on that side of the equation as well. How much that will be? That could be -- it'll be positive. It'll be in the 0 to $25 million range during the year, it depends. Depends on what happens with those critical assets.

Our following question comes from Walter Liptak from Seaport Global.

I want to ask about the pricing question that you were discussing previously. Are you seeing any differential in pricing by basin? You mentioned the Permian and the Rockies are doing a little bit better. Is it easier to get price pass-through there? And why is it lagging in some of the other ones, if that's true?

Yes. So it's always easier to push price when activity is very busy, because customers become less concerned with price and more concerned with how fast you respond to their project bid request, do you have the material available quickly and can you get it out to locations. So that always happens in any cycle that we're in and when the market falls apart, then they really get price focused. So having said that, that means anywhere that we're not experiencing growth, which is most of the gas plays, except for the Northeast, so Haynesville, Fayetteville, all that stuff is still depressed. So we're not getting much traction there. California, Alaska, those places haven't had the same spurring growth. So I would say that we're getting most traction in the Eagle Ford, in the Permian, and in the Niobrara, in the Bakken, and the Marcellus.

Okay. Yes, it sounds good. If that's the case with branch closings, you've mentioned 29 in '17, and I think that was held back by some leases and things. Can you give us some idea of the kind of cost activity you'll be doing in 2018?

You mean cost reduction activity?

Yes. I guess, how many -- are there some leases that are rolling off, whether you are able to end, are you expecting the same number of branch closings or does that slow?

I would not expect the same number of branch closings. We're seeing the market grow. We will be continuing to close branches, but the markets -- although it's an uneven recovery, we are seeing the market expand and that should limit the number of locations closed. We want to be in more places. We want to be close to our customers. What we're working on is transitioning our locations to smaller locations with less inventory, with more of a sales presence so we could be close to the customers without that invested capital and personnel level.

Our -- we have -- I don't know how many jobs we have posted, but there's a ton of them out there for areas where we're experiencing growth and need more help. Our goal is to continue to focus on the places where that's not the case to try to maintain expenses at a reasonably flat level, which will be quite a feat if we can continue to pull costs out enough to do that while we're hiring and opening in other places.

Right. Okay, it sounds good. And then Robert, I think you mentioned in your commentary that you paid a fourth quarter bonus for the first time, which I guess would be a great accomplishment. So the questions are around, what were the metrics pay down, is it revenue growth? I think you mentioned profitability is one of the metrics. And then what are you thinking about for the bonus accrual for 2018? Because if that keeps up, there'll be a -- I guess a delta in your profitability from bonus payments.

Yes. So the comment I made about a bonus is our branch bonus program, which affects the vast majority of all the DNOW employees. The -- our corporate plan only affects the office here in Houston plus a few others -- locations. But -- so the branches have to generate enough EBITDA margins to pay a bonus and there's all sorts of metrics involved in that. And it involves running your balance sheet well. Because if you don't run your balance sheet well, all of the mistakes you make there end up in EBITDA, which reduces your profitability and so forth and so on. So my comment about that was is the area where we implemented that beta program where we're having substandard generation of income statement results and they did this program where they reduced expenses on the outlying branches and supported it from D.C. and increased sales presence, and so forth and so on, one of those branches that hasn't had a bonus in forever because they've never met the criteria to get a bonus at their branch actually got into the pay zone. So which then -- basically reinforces that switching gears to this model of reducing expenses while managing the top line is actually working.

Okay, got it. Okay. And I guess, Dave, in -- just in 2018, are you thinking about corporate bonus accruals? When will we start to see that flow into the income statement?

Yes. Well, yes, they -- we expect to pay some bonuses, that's in the guidance we gave. Like Robert said, we paid based on working capital turnover and EBITDA performance. If we get to certain levels, we'll payout. But the projections we gave will reflect it.

And it's self-funding.

We have no further questions at this time. I will now turn the call over to Robert Workman, CEO and President, for closing statements.

Thank you. Thanks, everybody, for your interest in our quarter and in the interest in our company. And we look forward to speaking to you in May about our Q1 results.

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