Dnow Inc. (DNOW) Q4 2019 Earnings Report, Transcript and Summary

Welcome to the DistributionNOW Fourth Quarter 2019 and Year End Earnings Call. My name is John, and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions]. I will now turn the call over to Senior Vice President and Chief Financial Officer, Dave Cherechinsky. Mr. Cherechinsky, you may begin.

Thank you, John. Good morning and welcome to the NOW Inc. fourth quarter and full year 2019 earnings conference call. We appreciate you joining us, and thank you for your interest in NOW Inc. With me today is Dick Alario, Interim Chief Executive Officer. NOW Inc. operates primarily under the DistributionNOW and DNOW brands, and you'll hear us refer to DistributionNOW and DNOW, which is our New York Stock Exchange ticker symbol, during our conversation this morning. Before we begin this discussion on financial results for the fourth quarter and full year 2019, please note that some of the statements we make during this call, including the answers to questions, may contain forecasts, projections and estimates, including, but not limited to, comments about our outlook for the company's business. These are forward-looking statements within the meaning of the U.S. Federal Securities Laws based on limited information as of today, which is subject to change. They are subject to risks and uncertainties, and actual results may differ materially. No one should assume that these forward-looking statements remain valid later in the quarter or later in the year. We do not undertake any obligation to publicly update or revise any forward-looking statements for any reason. In addition, this conference call contains time-sensitive information that reflects management's best judgment at the time of the live call. I refer you to the latest Forms 10-K and 10-Q that NOW Inc. has on file with the U.S. Securities and Exchange Commission, for a more detailed discussion of the major risk factors affecting our business. Further information, as well as supplemental, financial and operating information, may be found within our earnings release, on our website at ir.distributionnow.com, or in our filings with the SEC. In an effort to provide investors with additional information relative to our results as determined by U.S. GAAP, you'll note that we also disclose various non-GAAP financial measures including EBITDA excluding other costs, sometimes referred to as EBITDA; net income excluding other costs and diluted EPS excluding other costs. Each excludes the impact of certain other costs, and therefore has not been calculated in accordance with GAAP. A reconciliation on each of these non-GAAP financial measures to its most comparable GAAP financial measure is included in our earnings release. As of this morning, the Investor Relations section of our website contains a presentation covering our results and key takeaways for the quarter. A replay of today's call will be available on the site for the next 30 days. We plan to file our 2019 Form 10-K today, and it will also be available on our website. Now let me turn the call over to Dick.

Thank you, Dave. Good morning, everyone and thank you for joining us. Over the past three and a half months, I've reaffirmed my confidence in DNOW’s fundamental business strategy, as we continue to rightsize and scale our infrastructure to match market demand, generate cash and deploy capital for inorganic growth, actively manage our portfolio by pruning low margin businesses, and invest in areas that increase employee productivity and enhance customer facing digital solutions. While these efforts have produced material positive results, it's clear that market conditions require that we do more to rationalize our cost structure in order to yield a greater productivity result than the company has historically delivered. To that end, we're taking more steps in response to customer spending plans that continue to decline. Distribution companies like ours generally feel the impacts of a slowdown early, as customers reduce or stop spending and seek to conserve cash. Much of our business is tied to day-to-day MRO purchases with narrow order to cash cycles. Our service to the last mile model, combined with nearby inventory availability necessitates an agile and optimized footprint and sufficient working capital to fulfill our value proposition to our customers. As with many oil fields service cycle leading businesses were vulnerable to sudden drops in customer spending, as we witnessed in the fourth quarter, when activity slowed to a pace much lower than previous season with the clients, particularly in November and December. This was driven by customers' lack of access to capital and increased spending restraint, budget exhaustion, extended holiday impacts and weather conditions in Canada that delayed access to drilling sites. Fortunately for DNOW, we're in a strong cash position with zero debt and we're well positioned to manage this cycle with the fortress balance sheet and access to our undrawn revolving 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 headcount 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 self-market. Operationally, we're reacting quickly to market dynamics, shedding costs to position the company for future success at all points in the cycle. And we'll have more to say on our cost structure transformation later. But I want to address another tenant 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 the market share and better position DNOW, as we work besides 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 one 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 involve the way DNOW conducts business for internal and external stakeholders alike. Internally, we're focused increased employee productivity and system efficiencies. One of the ongoing projects is improving our order management system, with a benefit 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. Digital NOW is what we're now calling our e commerce platform. A means to simplify the way our current customers order and interact with us and our 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 work over trailers and consigned inventory. Evaluating and using sensors to provide data from fabricated process production, and punk packages 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 disciplined 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 decline 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 in our position 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 four we are focused on M&A. As market uncertainty persists we're 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 and entry businesses with accretive margins that will generate better returns. We're seriously engaged in multiple opportunities at this time. Another part of our strategy is to increase EBITDA margins, acquiring 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 US 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 US land activity during the quarter with October to December completions monthly average declining 20%. We witnessed a higher than 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 processed 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 two more existing energy brands E&P customers into our supply chain service model. As we emerged from the piloting phase to full deployment, this model will help these two customers reduce their procurement, inventory and warehouse expenses using our integrated supply chain solution. In our US process solutions business activity continues to build in our recently acquired Houston facility as we began to take market share 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 five Canadian branches during the quarter, redeployed 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 highest level ever. In 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 in 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 regulation and day rates trending up during the quarter. As offshore rigs are contracted, they require an additional load out of inventory. That's potentially a large revenue stream for DNOW. As the ratio deployed and 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 revenue down $125 million or 16%, compared to the same period in 2018. Sequentially revenue declined $112 million or 15%. We attribute the fourth quarter 2019 revenue decline, steeper than expected seasonally to an increasing level of financial discipline demanded by investors and exerted by our customers. Nearly two thirds of the full year revenue drop resulted from reduced pipe sales in 2019. The commodity most negatively impacted by steel price deflation. It is worth noting that US rigs declined every month in 2019. The declines of 2019 we're not remotely as steep as the rig losses in 2015. But we haven't seen this kind of sustained rig stacking like those experienced in 2019 since 1998 nor did we plan for that. In the Canadian segment, 2019 revenues were $319 million, down $39 million or 11% from a year ago, including an $8 million impact from unfavorable foreign exchange rates. Excluding the foreign currency impact, Canada revenue declined $31 million or 9% compared to 2018 in an environment with rig counts declining 29% year over year. In the international segment 2019 revenues were $392 million, down $6 million or 2% from a year ago. Excluding the impact from weaker foreign currencies year over year, the International revenue actually increased $6 million or 2% of 2018. In the U.S. segment, 2019 revenues were $2.24 billion, down $131 million or 6% from 2018 and relatively in line with a rig count declines over the same period. In the U.S. revenues were $468 million, where U.S. energy centers contributed 48% U.S. supply chain services 31% and U.S. process solutions 21% of fourth quarter of 2019 revenue. In the fourth quarter gross margins were 19.6% a 40 basis points declined sequentially. We 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 was most pronounced in our pipes category, then to a much lesser degree fittings and plants both high steel content and commoditized product lines. Gross margins were 19.9% for the full year of 2019 versus 20.1% in 2018. Our emphasis in higher margin, 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 and a deflationary period at levels just barely below 2018 in inflationary period. There will be gross margin variability each quarter with the trends and steel pipe pricing leading the direction in overall product margins Warehousing selling and administrative expenses or WSA was $134 million or down $2 million sequentially and down $1 million in the fourth quarter of 2018 as we made expense adjustments in the period to reflect market trends. Note that inclusion of this figure was $5 million severance suggesting the significant actions taken today are evident in our WSA numbers. WSA 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 WSA to decline in the first quarter of 2020. But we expect a seasonal increase in WSA expenses driven primarily by the resetting of limit based payroll taxes, health care costs, inflation, offset or reduced severance and expense reductions and influence so far. As such we except WSA 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 revenue generated in those locations approximated $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 inventory $15 million in these locations then redeploying back into our branch network. This remains key at DNOW, grow the business while demand improve 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 non-cash goodwill impairment of $81 million; $54 million in the International and $27 million in Canada. The impact of a prolonged activity curtailment our results and 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 the 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, company decided to sell a business that was primarily in North America and in the UK, selling cutting tools to the aerospace and automotive markets. We classified the business's assets and liabilities as held for sale at December 31 2019, and recorded a $9 million non-cash 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 and price adjustments as defined in the transaction agreement. The disproportionate amount of resources DNOW was dedicated to this business. Underperformance and the associated distraction costs made this 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 in the 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 2019 totaled $133 million pretax, with totally non-cash goodwill impairments of $81 million, non-cash trade name abandonment $38 million, loss on assets held for sale $9 million and severance of $5 million. On a non-GAAP 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. U.S. generated operating losses of $50 million or 11% of revenue. A decline of $67 million when compared to the correspondent 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 losses $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. Tuning 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 to 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 turn rates of 4.4 times. Adding back inventory held for sale turn rates would have been 4.2. 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 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 2019 was 19%, beating our targeted 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 five times a year, a clear measure of financial fitness. Being selective about the goods we order and in what quantities, how fast we sell our inventory and how quickly we collect accounts receivables provide us choices for how we drive growth, how agile we are, how attractive we can meet our customers using cash drive, from the balance sheet to invest in technology. And 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 and warehousing selling 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 two acquisitions, we've since made 600 headcount reductions through today, approximately 240 resulting from the sale of the business. With our current headcount just under 4000 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 at the balance sheet. And now we've committed to accelerate further efficiencies in the business, pulling up costs in underperforming locations areas businesses and functions and do more as activity modulation. 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 three months have been flat. With respect to guidance, we're guiding full year 2020 revenues to be down in the high-single digits to the mid-teens percentage range. This guidance considers the resulting loss of revenue of approximately 3% related to the sale of the business discussed earlier. Accordingly, we're guiding first quarter 2020 revenues to be flat to down in the low-single digits range. This sequential quarter guidance also considers the resulting loss of revenue approximately 3% related to the sale of the business discussed earlier. Before I move on to recognize one of our dedicated employees, I'd like to summarize the progress the team here at DNOW made in the execution of our strategy in the fourth quarter. We continue to act aggressively in response to a lower for longer North American market, while optimizing and reducing our footprint through facility consolidations in the U.S. and Canada, focusing on margin discipline in the challenging U.S. land market, investing in technology to increase our employee efficiencies, and rolling out a growth platform for digital solutions that will provide additional employee productivity and capture the shift to e-commerce. We divested a low performing business which will improve our margins and financial performance. On the supply chain side, we're leveraging our distribution centers infrastructure and optimizing our logistics, which is resulting in reduced inventory, higher fill rates and increased turns. Our sourcing strategy structured to respond to changes in import tariffs, reducing working capital as a percent of revenue and leveraging our acquisitions through costs -- 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 am motivated by the progress we're making to improve the usability, speed and performance of our order management system in our ERP platform. This will deliver productivity gains. I'm excited about the feature a Digital NOW feature 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 at DNOW tradition and recognize one of the employees whose daily hard work and dedication enabled 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 store man for Jones and Loughlin 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 and 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 one 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. Phillip McGraw or more famously known as Dr. Phil the popular daytime talk show, television personality and bestselling 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.

Oh yeah. Good morning guys.

Good morning, Blake.

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

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

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

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

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

Our next question is from Walter Liptak from Seaport.

Good morning Walt.

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

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

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

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

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

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

Okay, great. Thank you, guys.

Thanks, Walt.

Our next question is from Sean Meakim from JPMorgan.

Thank you. Good morning.

Good morning, Sean.

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

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

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

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

Understood. Great. Thank you.

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

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

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

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

Yeah, that's the goal, absolutely.

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

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

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

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

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

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

Understood. Thanks.

And our next question is from Jon Hunter from Cowen.

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

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

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

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

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

Okay.

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

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

Thank you.

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