DNOW Inc (DNOW) 2019 Q4 法說會逐字稿

Welcome to the DistributionNOW Fourth Quarter 2019 and Year-End Earnings Call. My name is John, and I'll be your operator for today's call. (Operator Instructions)

And I will now turn the call over to Senior Vice President and Chief Financial Officer, Dave Cherechinsky. Mr. Cherechinsky, you may begin.

Thank you, John. Good morning, and welcome to the NOW Inc. Fourth Quarter and Full Year 2019 Earnings Conference Call. We appreciate you joining us, and thank you for your interest in NOW Inc. With me today is Dick Alario, Interim Chief Executive Officer.

NOW Inc. operates primarily under the DistributionNOW and DNOW brands, and you'll hear us refer to DistributionNOW and DNOW, which is our New York Stock Exchange ticker symbol, during our conversation this morning.

Before we begin this discussion on financial results for the fourth quarter and full year 2019, please note that some of the statements we make during this call, including answers to questions, may contain forecasts, projections and estimates, including, but not limited to, comments about our outlook for the company's business. These are forward-looking statements within the meaning of the U.S. federal securities laws based on limited information as of today, which is subject to change. They are subject to risks and uncertainties, and actual results may differ materially. No one should assume that these forward-looking statements remain valid later in the quarter or later in the year. We do not undertake any obligation to publicly update or revise any forward-looking statements for any reason.

In addition, this conference call contains time-sensitive information that reflects management's best judgment at the time of the live call. I refer you to the latest forms 10-K and 10-Q that NOW Inc. has on file with the U.S. Securities and Exchange Commission for a more detailed discussion of the major risk factors affecting our business. Further information as well as supplemental financial and operating information may be found within our earnings release on our website at ir.distributionnow.com or in our filings with the SEC.

In an effort to provide investors with additional information relative to our results as determined by U.S. GAAP, you'll note that we also disclose various non-GAAP financial measures, including EBITDA excluding other costs, sometimes referred to as EBITA, net income excluding other costs and diluted EPS excluding other costs. Each excludes the impact of certain other costs and therefore has not been calculated in accordance with GAAP. A reconciliation on each of these non-GAAP financial measures to its most comparable GAAP financial measure is included in our earnings release. As of this morning, the Investor Relations section of our website contains a presentation covering our results and key takeaways for the quarter. A replay of today's call will be available on the site for the next 30 days. We plan to file our 2019 Form 10-K today, and it will also be available on our website.

Now let me turn the call over to Dick.

Thank you, Dave. Good morning, everyone, and thank you for joining us. Over the past 3.5 months, I've reaffirmed my confidence in DNOW's fundamental business strategy as we continue to rightsize and scale our infrastructure to match market demand, generate cash and deploy capital for inorganic growth, actively manage our portfolio by pruning low-margin businesses and invest in areas that increase employee productivity and enhance customer-facing digital solutions. While these efforts have produced material positive results, it's clear that market conditions require that we do more to rationalize our cost structure in order to yield a greater productivity result than the company has historically delivered.

To that end, we're taking more steps in response to customer spending plans that continue to climb. Distribution companies like ours generally feel the impacts of a slowdown early as customers reduce or stop spending and seek to conserve cash. Much of our business is tied to day-to-day MRO purchases with narrow order to cash cycles. Our Service to the Last Mile model, combined with nearby inventory availability, necessitates an agile and optimized footprint and sufficient working capital to fulfill our value proposition to our customers.

As with many oilfield service cycle leading businesses, we're vulnerable to sudden drops in customer spending, as we witnessed in the fourth quarter when activity slowed to a pace much lower than previous seasonal declines, particularly in November and December. This was driven by customers' lack of access to capital and increased spending restraint, budget exhaustion, extended holiday impacts and weather conditions in Canada that delayed access to drilling sites. Fortunately for DNOW, we're in a strong cash position with 0 debt, and we're well positioned to manage this cycle with a fortressed balance sheet and access to our undrawn revolving credit facility.

In a year that has seen our customers exercise greater capital discipline, we've persisted in optimizing our business by recalibrating our footprint and embracing technology to more efficiently service our customers. We achieved material cost reductions and facility consolidations during the fourth quarter, and we'll continue to do so as the market rebalances, better positioning our company to service our customers more effectively and efficiently.

During the quarter, we closed 10 facilities and reduced head count materially. We redeployed and reduced the level of inventory across our system down to $465 million, a year-over-year decline of $137 million, providing a strong source of cash during this soft market. Operationally, we're reacting more quickly to market dynamics, shedding cost to position the company for future success at all points in the cycle.

Now we'll have more to say on our cost structure transformation later, but I want to address another tenet of our strategy, customer focus. Our sales teams are more synergistically aligning, organizationally and otherwise, to focus on capturing profitable market share. We're doing this surgically and with more spring in our step as we cross-sell and upsell more effectively. We expect that our efforts here will grow market share and better position DNOW as we work beside key customers on streamlining functions so that we can afford to help them lower their cost of operations, which is the key priority for E&P companies in this capital-constrained environment.

Of course, the other component of our customer focus is enhancing and expanding our e-commerce capabilities. Over the last couple of years, the company has moved a substantial measure of its sales transactions into 1 or more of several digital platforms designed to make DNOW easy to order from, pay invoices to and otherwise, complement our superior bricks-and-mortar last-mile sales and delivery channel with the technology-driven ways customers want to do business today. We're investing in technology in several areas to evolve the way DNOW conducts business for internal and external stakeholders alike. Internally, we're focused on increased employee productivity and system efficiencies. One of the ongoing projects is improving our order management system, with the benefits scheduled to be realized during 2020 that will provide improved response time to customer inquiries, faster order-to-cash processing, better customer service and lower transaction error rates, resulting in increased productivity per employee.

We've also been building on our digital strategy to allow customers to leverage the power of mobility and the ease of Internet-based technologies. DigitalNOW is what we are now calling our e-commerce platform, a means to simplify the way our current customers order and interact with us and how new customers will embrace us. Our goal is to provide a B2C-like experience in the energy and industrial markets, supported by a global network of proven top-tier suppliers and reputable manufacturers who stand behind the DNOW brand and quality program.

Today, we're leveraging technology to aid in employee productivity, processing more transactions with less labor, using mobile apps installed on our customers' smartphones to order and replenish workover trailers and consigned inventory, evaluating and using sensors to provide data from fabricated process, production and pump packages to help our customers manage their installed assets.

These are just a few of the supply chain solutions we're developing, piloting and deploying to propel DNOW into the clear leadership position in supply chain solutions technology. With all that in mind, I'd like to address a few additional areas of focus.

Free cash flow generation in the quarter was $69 million, $212 million for the full year. A result of continued working capital discipline by the seasoned leadership team and our dedicated employees across the globe. This performance was further exemplified by robust collections and inventory reductions in the period, maintaining our working capital, excluding cash as a percent of revenue, beating our 20% target for the second consecutive quarter. Hitting this metric in the fourth quarter, as fast as revenue declined during that period, is a testament to our team's ability to quickly reduce our working capital and generate cash in a rapidly contracting market. This is sound leadership, and I'm proud of the result.

We continue to be a growth-minded company and are positioned to take advantage of an increasingly more attractive acquisition landscape in the North American market. Our opportunity in a contracting market lends itself to acquisitions, while our tendency shifts to organic opportunities during market expansion. We ended the year with nearly $600 million of total liquidity, providing ample ability to deploy capital and seize market opportunities.

I'll reiterate from last quarter, we are focused on M&A. And as market uncertainty persists, we are seeing our prospect pipeline continue to grow. As one might imagine, elongated periods of low activity by E&Ps, such as the one we're seeing, tend to bring the bid-ask range for M&A down. So we're being patient given the current outlook. Our strategy is to be selective and to further differentiate DNOW by acquiring value-added, higher barrier entry businesses with accretive margins that will generate better returns. We're seriously engaged in multiple opportunities of this type at this time.

Another part of our strategy is to increase EBITDA margins, requiring the routine reevaluation of our current portfolio of businesses and their contribution to overall financial performance. In the fourth quarter, for the first time since spin-off, we decided to divest an underperforming business that was primarily selling cutting tools to the aerospace and automotive markets in North America. Today, I'm happy to report we recently closed that transaction, generating $28 million in cash. Removing this business from our portfolio will help improve our revenue per employee efficiencies, our overall margins and free up cash for growth.

For the fourth quarter, we delivered $639 million in revenue, a sequential decline of $112 million. EBITDA, excluding other costs, was $5 million. For the year, our revenue was $2.95 billion, and EBITDA was $87 million.

Looking at our reporting segments. In the U.S., revenue was down 17% sequentially. This rate of decline was surprising given that our daily revenue tracking was as expected in October and early November. We experienced an accelerated decline of U.S. land activity during the quarter, with October to December completions monthly average declining 20%. We witnessed a higher normal seasonality effect as activity dropped off at the end of November and throughout December, resulting from customer budget exhaustion, timing of holidays and continued customer capital discipline. Our energy center saw the most impact from reduced activity, while our process solutions and supply chain services customers also reduced drilling and completion expenditures and delayed projects.

On a positive note, I'm happy to say that in the quarter, we moved 2 more existing energy branch E&P customers into our supply chain service model. As we emerge from the piloting phase to full deployment, this model will help these 2 customers reduce their procurement, inventory and warehouse expenses using our integrated supply chain solution.

In our U.S. Process Solutions business, activity continues to build in our recently acquired Houston facility as we begin to take market share for process and production equipment in the Permian, Eagle Ford and Gulf Coast areas. We continue to be well positioned in the major oil plays to provide modular fabricated tech battery process and production equipment from the Bakken and Northern Rockies to South Texas and the Gulf Coast from our Casper, Wyoming and Houston, Texas facilities.

In Canada, revenue was down 8% sequentially. Historically, Canada had delivered a very active fourth quarter, but low capital investment, warmer weather resulting in a later freeze, coupled with a longer-than-usual December holiday season, impacted sequential revenue growth. As a result, we've scaled our footprint to match the reduced activity. We closed 5 Canadian branches during the quarter, redeployed and reduced inventory and personnel, lowering our operating expenses. We continue to outperform, win business and gain market share in a depressed market. We continue to be more innovative in servicing our customers as we've grown our e-commerce catalog sales in Canada to its higher -- highest level ever.

In the International segment, revenue was down 6% sequentially. Project cycles impacting our electrical distribution business and seasonality drove the sequential decline. We witnessed sequential gains in Asia and the Middle East, offset by declines in West Africa, and an improving but muted offshore recovery. We remain optimistic about the long-term prospects in the international arena, with offshore rate utilization and day rates trending up during the quarter.

As offshore rigs are contracted, they require an initial load out of inventory that's potentially a large revenue stream for DNOW. As the rigs are deployed and are working and consuming that inventory, they need to replenish these items, and DNOW is well positioned with locations to help support our customers around the world where offshore drilling takes place.

Before moving on to discuss our outlook for 2020, I'll turn the call back over to Dave to review our financials.

Thanks, Dick. For the fourth quarter of 2019, we generated $639 million in revenue, down $125 million or 16% compared to the same period in 2018. Sequentially, revenue declined $112 million or 15%. We attribute the fourth quarter 2019 revenue decline steeper than expected seasonally to an increasing level of financial discipline demanded by investors and exerted by our customers.

Nearly 2/3 of the full year revenue drop resulted from reduced pipe sales in 2019, the commodity most negatively impacted by steel price deflation. It is worth noting that U.S. rigs declined every month in 2019. The declines in 2019 were not remotely as steep as the rig losses in 2015, but we haven't seen this kind of sustained rig stacking, like those experienced in 2019, since 1998. Nor do we plan for that.

In the Canadian segment, 2019 revenues were $319 million, down $39 million or 11% from 1 year ago, including an $8 million impact from unfavorable foreign exchange rates. Excluding the foreign currency impact, Canada revenue declined $31 million or 9% compared to 2018 in an environment with rig counts declining 29% year-over-year. In the International segment, 2019 revenues were $392 million, down $6 million or 2% from 1 year ago. Excluding the impact from weaker foreign currencies year-over-year, the international revenue actually increased $6 million or 2% for 2018.

In the U.S. segment, 2019 revenues were $2.24 billion, down $131 million or 6% from 2018 and relatively in line with the rig count declines over the same period. In the U.S., revenues were $468 million, where U.S. Energy Centers contributed 48%, U.S. Supply Chain Services, 31% and U.S. Process Solutions, 21% of fourth quarter 2019 revenue. In the fourth quarter, gross margins were 19.6%, a 40 basis points decline sequentially. We cited this as a possibility on our last call. The decline was due primarily to pricing pressures on steel pipe products and as competitors clamored for the next incremental revenue dollar as a means to liquidate inventory in a low activity period and to reduce year-end inventory property taxes. Similarly, margin erosion year-over-year was most pronounced in our pipe category then, to a much lesser degree, fittings and flanges, both high steel content and commoditized product lines.

Gross margins were 19.9% for the full year 2019 versus 20.1% in 2018. Our emphasis on higher-margin product lines, intentional avoidance of lower-margin orders and products, the deployment of technology to maximize both order win rates and margins and finally, mix, driven by lower pipe sales as a percent of total sales in 2019, muted the impact of deflation. We achieved price levitation, solid 2019 gross margins in a deflationary period at levels just barely below 2018, an inflationary period. There will be gross margin variability each quarter, with the trends in steel pipe pricing leading the direction in overall product margins.

Warehousing, selling and administrative expenses, or WS&A, was $134 million or down $2 million sequentially and down $1 million from the fourth quarter of 2018 as we made expense adjustments in the period to reflect market trends. Note that inclusion in this figure was $5 million in severance, suggesting the significant actions taken to date are evident in our WS&A numbers. WS&A was down $16 million in 2019 versus 2018. The decline would be $21 million if you add back the $5 million more in severance in 2019 compared to 2018.

We expect WS&A to decline in the first quarter of 2020, but we expect a seasonal increase in WS&A expenses driven primarily by the resetting of limit-based payroll taxes, health care cost inflation, offset by reduced severance and the expense reductions we've implemented so far. As such, we expect WS&A to be in the high $120 million in the first quarter and down approximately $40 million in 2020 versus 2019, with more of the expense savings being realized in the second half of 2020.

When considering the locations closed or consolidated in 2018 and 2019, the revenue generated in those locations is approximately $12 million more in 4Q '18 than in 4Q '19 or $66 million more on a year-to-date basis. While we did retain some of the revenue by supporting customers from other locations, most of the decline in sales was the result of reductions in customer spend, which necessitated the closures. These footprint changes allowed us to move resources elsewhere and improved returns on working capital as evidenced by reducing the inventory of $15 million in these locations then redeploying back into our branch network. This remains key at DNOW, grow the business while demanding improved productivity and working capital velocity. This is the tactical side of scaling the business efficiently to meet market demand.

We performed our annual goodwill impairment test during the fourth quarter of 2019 and determined the fair value of the International and Canada operating segments was below their carrying value. As a result, we recorded a noncash goodwill impairment, $81 million, $54 million in international and $27 million in Canada. The impact of a prolonged activity curtailment, our results in market deterioration added uncertainty to the timing and pace of an expected recovery.

During the fourth quarter of 2019, we discontinued the use of certain trade names in order to minimize brand dilution and aligning the company's marketing around select DNOW brands. As of December 31, 2019, we abandoned these trade names and recognized a noncash impairment charge of $38 million, $34 million in the U.S. and $4 million in international. This will result in approximately $3 million lower amortization in 2020 for DNOW. After ongoing review of our strategy, the company decided to sell a business that was primarily in North America and in the U.K., selling cutting tools to the aerospace and automotive markets. We classified the business' assets and liabilities as held-for-sale at December 31, 2019, and recorded a $9 million noncash impairment charge for the quarter.

Subsequent to year-end, on January 31, 2020, we sold the business for $28 million, subject to customary post-closing working capital and other transaction price adjustments as defined in the transaction agreement. The disproportionate amount of resources DNOW is dedicating to this business, underperformance and the associated distraction costs made the sale attractive. The $28 million in cash received in January simply adds dry powder for other opportunities in the future, all while fortifying our commitment to become more efficient and profitable in every dimension of business.

Operating loss was $137 million. Net loss for the fourth quarter was $139 million or $1.27 per diluted share. Other costs in 4Q '19 totaled $133 million pretax, when totaling noncash goodwill impairments, $81 million; noncash trade name abandonment, $38 million; loss on assets held for sale, $9 million; and severance of $5 million. On a non-GAAP basis, EBITDA excluding other costs was $5 million for the fourth quarter of 2019. Net loss, excluding other costs, was $6 million or a loss of $0.05 per diluted share.

Moving on to operating profit. The U.S. generated operating losses of $50 million or 11% of revenue, a decline of $67 million when compared to the corresponding period of 2018, primarily due to the $43 million impairment charges, a decline in revenue and greater severance expenses, partially offset by reduced operating expenses.

Canada operating loss was $26 million or down $30 million when compared to the corresponding period of 2018 as a result of a $27 million impairment charges, greater severance expenses and the revenue decline mentioned earlier.

International operating loss was $61 million or down $62 million when compared to 4Q '18, primarily due to the $58 million in impairment charges.

Turning to the balance sheet. Cash totaled $183 million at the end of the fourth quarter, with approximately half located outside the U.S. We exited the year with no outstanding borrowings under our revolving credit facility. December 31, 2019, our total liquidity from our credit facility availability plus cash on hand was $596 million. Accounts receivable were at $370 million at the end of the fourth quarter, down $96 million sequentially, improving DSO of 53 days. But after adding back accounts receivable for the assets held for sale, DSO would have been 56 days.

Fourth quarter inventory levels were $465 million, resulting in inventory term rates of 4.4x. Adding back inventory held-for-sale, churn rates would have been $4.2 million. Accounts payable were $255 million at the end of the fourth quarter, with days payable outstanding at 45 days or 46 days, ignoring accounts payable held for sale. Net cash provided by operating activities was $74 million in the fourth quarter and $224 million during the year, with capital expenditures of approximately $5 million in the fourth quarter and $12 million for the full year, resulting in $69 million in free cash flow in the quarter and $212 million in free cash flow for the year.

Working capital, excluding cash as a percent of revenue from the fourth quarter of 2019, was 19%, beating our target, targeting 20% for a second consecutive quarter.

With that, I'd like to comment on our success to date on the balance sheet. While not yet optimal, we are achieving leanness on the balance sheet. We are turning working capital more than 5x a year, a clear measure of financial fitness. Being selective about the good reorder and in what quantities, how fast we sell our inventory and how quickly we collect accounts receivable provide us choices for how we drive growth, how agile we are, how attractive we can be to our customers using cash derived from the balance sheet to invest in technology.

A liquid balance sheet gives us flexibility. The same kind of discipline and passion we've demonstrated in managing working capital now needs to become routine and predictable. We've begun to apply that thinking to drive efficiencies in warehousing, selling and administrative expenses, now pursuing leanness in the business.

As a recap, we closed or sold 20 locations so far in 2020, most attributable to the sale of the business. We consolidated or closed 20 locations in 2019, with 10 of those completed in 4Q '19 alone. We closed 20 locations in 2018, in a year where we added nearly $0.5 billion in sales. All combined, we had 285 locations at the end of 2017 and 225 locations today, 60% or 21% fewer locations. Since June 2019, after we completed 2 acquisitions, we've since made 600 head count reductions through today, approximately 240 resulting from the sale of the business. With our current head count just under 4,000 for the first time since we purchased Wilson supply in the U.S. and CE Franklin in Canada in 2012, we're driving a leaner and more efficient DNOW. We're lean on the balance sheet and now, we've committed to accelerate further efficiencies in the business, pulling out costs in underperforming locations, areas, businesses and functions and do more as activity modulates.

With that, I'll turn the call back to Dick.

Thank you, Dave. Looking ahead, industry experts are calling for a 10% to 15% reduction in U.S. lower 48 drilling and completion CapEx spend in 2020 that will continue to impact the top line of our U.S. business. According to the EIA, U.S. oil production was still increasing in October and November of 2019 despite the rig count peaking in December of 2018. We witnessed a Permian month-over-month oil production per rig decline in January 2020, while month-to-month production levels for the last 3 months have been flat.

With respect to guidance, we're guiding full year 2020 revenues to be down in the high-single-digits to the mid-teens percentage range. This guidance considers the resulting loss of revenue of approximately 3% related to the sale of the business discussed earlier. Accordingly, we're guiding first quarter 2020 revenues to be flat to down in the low single-digits range. This sequential quarter guidance also considers the resulting loss of revenue of approximately 3% related to the sale of the business discussed earlier.

Before I move on to recognize one of our dedicated employees, I'd like to summarize the progress the team here at DNOW made in the execution of our strategy in the fourth quarter. We continue to act aggressively in response to a lower for longer North American market by optimizing and reducing our footprint through facility consolidations in the U.S. and Canada, focusing on margin discipline in a challenging U.S. land market, investing in technology to increase our employee efficiencies and rolling out a growth platform for digital solutions that will provide additional employee productivity and capture the shift to e-commerce. We divested a low-performing business, which will improve our margins and financial performance.

On the supply chain side, we're leveraging our distribution centers infrastructure and optimizing our logistics, which is resulting in reduced inventory, higher fill rates and increased turns. Our sourcing strategy is structured to respond to changes in import tariffs, reducing working capital as a percent of revenue and leveraging our acquisitions through cost -- sorry, cross-selling offerings. The success of these is evidenced by generating $69 million in free cash flow in the fourth quarter and $212 million for the year.

On the technology front, I'm motivated by the progress we're making to improve the usability, speed and performance of our order management system and our ERP platform. This will deliver productivity gains. I'm excited about the future, a digital NOW future, where our customers embrace a model that delivers on our vision of being the leader in supply chain management for the energy and industrial markets.

Now it's my pleasure to continue a DNOW tradition and recognize one of the employees whose daily hard work and dedication enable us to deliver on our promises. Born and raised in Hattiesburg, Mississippi, Harry Joe Thornhill has a love for the energy and industrial business and for Mississippi catfish. He attended Southern Miss and has remained a loyal football and baseball fan to this day, supporting his Alma Mater.

In October of 1975, Harry Joe began his career as a storeman for Jones & Laughlin Supply. Over his 44-year career, he held numerous roles as a store and regional manager in operations and purchasing from various locations within Texas, Louisiana, Mississippi and Colorado. In 1999, Jones & Laughlin was acquired by Wilson Supply. Harry Joe continued with Wilson in management roles in operations and business development. In 2012, Wilson Supply was acquired by NOV, and in 2014, joined the DNOW family with the spin-off.

Harry currently works as our Director of Business Development in our U.S. Supply Chain Services business. A father, grandfather and devoted husband, Harry Joe recently celebrated his 45th wedding anniversary. People who know Harry Joe comments that he's almost always smiling, takes an active interest in people and will likely know at least 1 person in any given public place. Consequently, in those public places, he has more than once been asked to take a photo with a stranger to be mistaken for Dr. Philip McGraw or more famously known as Dr. Phil, the popular daytime talk show television personality and best-selling author. Harry Joe, we thank you for your continued dedication and your years of service to DNOW.

Now I'll turn the call back to John, and we'll start taking questions.

(Operator Instructions) And our first question is from Blake Hirschman from Stephens Inc.

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

Okay. So October, on our call, the last call we said that our revenues normally trend 5% to 10% decline. And we'd be at the high end of that range, possibly higher. In October, we were tracking in the 8% to 10% decline range, which we felt pretty good about. It started kind of tracking consistent with our plan. In fact, we were a little bit above plan, and things were going okay in the first half of November. And things really fell off at that point.

So the first half of the quarter was tracking with our expectations. There was a notable decline, certainly during the holiday, we expected that. But in the second half of November, things really just dropped precipitously and continued even more so into the final month of the year. We didn't expect that to be -- to happen like that, it was pretty dramatic.

In terms of January and February, January turned out to be better than November, December. That wasn't a big feat because those are such low months, but it gives us some comfort that the seasonal reversal would happen in the first quarter, at least to some degree. So we grew in January versus those 2 prior months, and February was kind of tracking along those lines.

So Dick talked about the first quarter where revenues will be flat to down low single digits, that feels about right to us.

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

Well, I think what we feel pretty good about is the third quarter will be our best quarter of the year simply due to weather, simple due to seasonality. That's our read right now. But we're starting from the low point, if you consider where we're at 4Q '19, that's why we guided to a decline in 2020. But the contours of the year in the U.S. probably follow the standard pattern, except for the second quarter.

Actually, yes, we'll see some growth in the second quarter in the U.S. -- from the first to second in the U.S., same with Canada. Canada is going to have a pretty good second quarter of this year, we're thinking. So the downturn due to weather would be less impacted. And then international, we're pretty project-oriented there. So the trending on that, we're not real sure about it right now.

Our next question is from Walter Liptak from Seaport.

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

Hey, Walt, it's Dick. Let me start here. You did hear correctly. We anticipate year-on-year $40 million coming out of WS&A, and we do expect that the back half of the year will show a higher run rate of reduction or a lower run rate of actual cost than the first half.

We -- I'll give you some general comments, and Dave may have some specifics to fill in. We have 3 distinct buckets of processes going on in this cost transformation. One is the typical one, the one that's activity-driven, essentially variable costs, head count reductions, spending constraints, facility closures and consolidation. Another one is kind of the internal and external benchmarking process where we look at our best-performing branches and try to mimic them from a cost structure standpoint. That's internal benchmarking.

Externally, you would look at things like layers, management layers and things in the organization that you would compare to other companies, that's the second bucket. And then the third is this whole efficiency and productivity topic where the application of technology, figuring out what the least valuable 10% or 15% of the things that you do as a company are and determine if you can eliminate.

So that's the -- $40 million is what we anticipate. We anticipate it to be a greater impact in the back half of the year, and it kind of flows through those 3 general process buckets. I hope that's helpful with your question.

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

Right. I think when I was speaking to going into the first quarter, it was kind of the effects of things that would happen going into the first quarter. But no, we expect to get the full $40 million out. That the way the numbers should shake out is the first quarter would be the highest and the fourth quarter will be the lowest in terms of WS&A. But we've begun a process, and we talked about facility closures. We sold the business, which is something we've not done before. We're making those kinds of decisions. There are pockets from our company that are really strong, we want to build on those, invest in those. And there are parts that are on the other end of the spectrum, and we're addressing that.

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

Well, we had the benefit in the fourth quarter. As we said earlier, October was the best -- strongest billing month, and things fell from there. So we have the benefit of a lower billings in December, which aided in the collections for the quarter. We still have 56-day DSOs, which we haven't seen for a long time. And I say 56 because you have to add back the effects of the assets held for sale. But we're still making good progress on collections.

Now in a market like this, we are going to see more customers and more bankrupts -- that are going bankrupt and having difficulty paying, so we simply have to thread the needle on who we get credit to, how much credit we give, that kind of thing, as we try to grow the top line in this market.

Our next question is from Sean Meakim from JPMorgan.

So the $40 million reduction in WS&A. To clarify, that leaves WS&A as a percentage of sales still in the high-teens. So it sounds kind of flattish year-on-year given the top line expectation. I'm guessing the exit-to-exit looks like maybe a low-teens reduction year-on-year, so maybe more in line with the top line guidance?

Like Dick touched on the 3 buckets that you're using to approach cost reductions. But if we put another way, I'm curious how much of the cost savings that you've initiated would be characterized as tactical versus structural? Sounds like it's mostly tactical with some efforts that's structural. I'm just looking at your closest peer has comparable gross margins, but higher EBITDA margins through cycle because it generates significantly more volume on a comparable G&A base. So given how the cycle is playing out, are there more structural changes that you can adopt in order to get that margin more aligned with the current environment?

Yes, Sean, this is Dick. I'll -- again, I'll give you kind of a general response. The -- I think the approach that we're taking is we must transform the cost structure of this company. And certainly, some of it will be structural in nature, as you described it, as opposed to tactical.

Let me start here. We have a statement in our prepared materials. It talks about delivering a productivity result that is better than the company's historical performance in that area. I think what you would have seen in the past, the way things were done, is the percentage of WS&A to sales would have increased if you had sales coming down.

Step 1 here is to keep it flat or get it down a little bit, and that's what I meant by the differential. And then look, we'll -- as I said, the attitude is we must align for this market. That's been embraced by the management team. It's been planned for, and it's ongoing.

Look, you look back at the head count reduction, the facility closures and the steps we took in the back half of the year, you can see the traction. And so we understand the relative cost structure differences. We also understand the relative differences in the nature of the businesses of the public companies. And so I can tell you, the team here is working extremely hard to get the most efficient cost structure that we can to prepare us for whatever the rest of this down cycle throws at us.

I appreciate that feedback, that makes sense. So maybe we could switch over to the M&A commentary. Going after higher value-add businesses with accretive margins, obviously makes sense, but I'm curious how that looks at the EBITDA line. So can you layer on these types of businesses without materially adding to that WS&A?

I guess I'm just trying to better understand, if these types of opportunities allow you to leverage the existing footprint as you're rationalizing costs, or do you need gross margins high enough to offset incremental G&A? I mean obviously, there's a range of the types of businesses you're looking at, so maybe if you could help us frame how the M&A strategy layers into the cost strategy, I think that would be helpful.

Sure. Look, I will call your attention to the fact that the company's made a dozen or more acquisitions and added WS&A every time we've done that since the spin. Yet, you look back historically and compare it to today and what we're forecasting for this year, and we're taking meaningful percentages out of WS&A. So the team here is extremely good at that when the bolt-on is such that we can absorb the overhead and not increase WS&A. It may happen for the first few quarters, but once the transition is done, that's kind of the goal here.

With regard to -- we've taken the same approach on acquisitions as we did at -- with this divestiture we made. We know that divesting of that business is going to improve EBITDA percentages, and we're looking for that result, with the M&A targets that we're dealing with as well. We will move expediously. But as I said, we will be patient to make sure that, that's the result that we get.

Our next question is from Steve Barger from Quebec Capital Markets (sic) [Keybanc Capital Markets].

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

Well, look, we're not going into service business. We're not going to move into areas with low revenue per head or anything like that. We're looking for incremental accretive financial results. But with businesses that fit what we do, that's got to be the sort of the first priority.

So some of them might be small companies that just have better EBITDA performance that we'll bolt-on, some might be a little bit larger, but you don't have to worry about us moving into some of the businesses that require heavy head counts and things like that. We -- that's just not the nature of DNOW's business profile.

So we're not ready to kind of divulge a whole lot at this point, but you should kind of look back at the last few acquisitions and see these things, particularly the ones in the process solutions business, they generate higher margins. They don't have a significant difference in the cost of operations.

Yes. So it should make you -- positively as you go through this M&A process?

Yes, that's the goal. Absolutely.

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

Oh, I would not say that. I think we have many opportunities to engage customers across the entire spectrum. Majors, large independents, midsized, public companies who absolutely are open to anything that the service industry can bring them technically, operationally or whatever to get their cost down. We've not seen -- look, there are companies, don't get me wrong. There are companies who have procurement systems that they rely upon to get good pricing in terms of conditions and all that. But generally, we get an open ear when we move the discussion over to value as opposed to price, and we -- I think that's going to just get better as these commodity prices stay where they are.

I would not classify things as being so stressed that customers aren't willing to move things around. We've seen good evidence of that. And one thing I would point to is, again, we picked up 2 customers this quarter that we moved into our supply chain solutions model, which tells you we're having success every quarter at propagating that business style.

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

Sure. Let me tell you where we are in the process, first of all. Shortly after the last transition, the Board formed a special committee to head up the search. I'm not on that committee. The search committee immediately began interviewing search firms. They got one under contract fairly quickly to evaluate both internal and external candidates.

The next thing to do, which has been done, is to form what I call a candidate profile, which addresses those competencies that you brought up, and I'll get to in a second. That's been done. By the way, one interesting aspect of this one is, in addition to that, there was a cultural assessment done where all of our board members, all of our leadership team and some other people in the company shared the views that they have about the culture of the company so that when we look at various candidates, internally and externally, we can compare their skills and experience with the cultural aspects of DNOW and see how they fit. So that's all been done, and the search firm has provided its sort of initial list of candidates and the interview process has begun.

Can't tell you when it will land. I can say that the committee is fully engaged. It's focused on getting the best CEO that we could get. We will update you as things fall into place. I said on the last call that this management team is extremely skilled and very experienced. And you just look at the balance sheet and the way things have been done, and you've got a management team here that can be relied upon to protect the capital in the business and the shareholder interest. So again, we're not looking for a change agent.

And the notion of this cost transformation that we're doing right now, we're going to be able to hand the next CEO a business whose cost structure is sized for this market. And so I would tell you that generally, the focus will be to seek a CEO that fits culturally, that is -- that understands the distribution business and how to tweak the various levers to improve the performance of the company. And that might constitute a number of different characteristics and skills, but that's what I mean when I say that the committee is very focused on seating the best CEO that we can to lead the company.

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

Well, I think the main thing to watch there is what happens with steel prices. Steel prices, more broadly, and then steel prices particularly. Our margins in 2019, were actually pretty good, except for pipe and fittings and flanges, we're pretty flat, pretty resilient. And if we find that seamless pipe has bottomed, and that's possible, and the ERW puts dropping, that would mean that if there were a decline in gross margins, next year would be muted. But that's, to me, that's kind of the thing to watch.

I think 4Q was kind of a low point, except for a further downward movements in pipe. So we're kind of thinking gross margins to be pretty strong next year, maybe down a little bit, but it's going to be type-dependent. That's going to drive that difference.

And our next question is from Jon Hunter from Cowen.

So specific to the U.S., some of the completion levered companies have indicated activity up mid-single digits to high single digits in the first quarter. Your U.S. Supply Chain and Process Solutions declined more or less in line with the drop in completions, but U.S. Energy Center was down quite a bit more. So I'm wondering how we should be thinking about the underlying growth in the U.S. in 1Q and if we should be thinking about energy center perhaps outperforming the overall growth in the U.S.

Well, we guided the first quarter flat to down low single digits. And if you look geographically, we may grow in Canada. But we don't expect to grow in the U.S., in part because we sold the business, and I think the sales impact to the loss of revenues going from 4Q to 1Q is $19 million. So that's why we guided in that range. So that alone is going to be a big headwind in terms of what's going to happen in the U.S.

U.S. Energy Centers, it's going to be dependent on rig counts and completions. And except for a seasonal rebound, we won't see much growth in U.S. energy.

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

Well, if our pipe sales, if the supply of pipe drops and we sell more pipe, those margins will be lower, and that will be a negative mix change to gross margins. I don't expect that, and I don't expect pipe sales about next year, but I don't know that yet. That would be a mix change that will make a difference.

The business we just sold had lower gross margins, the 19.6%, so that will get a little bit of lift there. We talked about amortization, the expense going down next year. We'll get a little bit of a pop from there. But the pipe is going to be the big one. If pipe sales go down, then that would be -- that would help us. Otherwise, we see pretty broad stability in pricing. It's just a matter of what's going to happen on the market. If sales were to fall more than we expected, that would be a negative impact, too.

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

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

Thank you.

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