Welcome to third quarter 2020 earnings conference call. My name is Sylvia, and I’ll be 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 Vice President, Marketing and Investor Relations, Brad Wise. Mr. Wise, you may begin.

Good morning, and welcome to NOW Inc.’s Third Quarter 2020 Earnings Conference Call. We appreciate you joining us, and thank you for your interest in NOW Inc. With me today is Dave Cherechinsky, President and Chief Executive Officer; and Mark Johnson, Senior Vice President and Chief Financial Officer. We operate 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. Please note that some of the statements we make during this call, including the responses to your questions, may contain forecasts, projections and estimates including, but not limited to, comments about our outlook of 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 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’ll refer you to our latest 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 a supplemental financial and operating information may be found within our earnings release on our website at ir.dnow.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 earnings per share, excluding other costs. Each excludes the impact of certain other costs and therefore, have not been calculated in accordance with GAAP. A reconciliation of each of these non-GAAP financial measures, to its most comparable GAAP financial measure is included in our 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 third quarter 2020 Form 10-Q today, and it will also be available on our website. Now, let me turn the call over to Dave.

Thanks, Brad. Good morning, everyone, and thank you for joining us. I hope that you and your families are safe and healthy. Businesses worldwide are struggling as this pandemic continues to take its toll and our thoughts are with all those impacted by COVID-19. As a company, we’re committed to working through these challenges to do our part, to improve the circumstances. We continue to execute on our COVID-19 response plan to enhance safety protocols. All locations have remained open operating under WHO and CDC guidelines by providing essential COVID-19 related products to our employees and customers. I am proud of the hard work, resiliency and dedication, our employees demonstrate every day. And I’d like to thank the frontline DNOW women and men for taking care of our customers, being loyal to our key suppliers, supporting our communities and each other during this difficult time. We announced last week that Dick Alario step down as was planned from his short-term role as Executive Vice Chairman of the company. Dick played a strategic role advising me and our leadership team. With his wealth of experience in the oil field services industry, his insight, keen strategic mind, wisdom and wit, Dick has been an invaluable leader and remains an incredible mentor to me and continues as a member of our Board of Directors. In addition to posting our financial results for the third quarter this morning, we also published our first sustainability report, which is now available on our website. Sustainability is not new to DNOW. We take our responsibility seriously to deliver products and solutions safely and reliably around the world that are essential and beneficial to our everyday lives. We also recognize the growing stakeholder interest in transparency around ESG practices and hope you find the report to be informative.…

Thank you, Dave, and good morning, everyone. For the third quarter of 2020, our revenues outperformed our guided revenue percentage decline of low to mid teens with revenue of $326 million or down 12% sequentially. The U.S. segment third quarter 2020 revenue was $228 million, down $32 million or 12% from the second quarter of 2020. One piece of business transformation completed in the period was the combination of our U.S. supply chain services business, including its downstream, industrial and our integrated supply chain solution offering into our U.S. energy business. This combination of similar purpose groups focused primarily on the energy market, improves performance, accountability and combined financial performance as a whole. This decision was made to foster new levels of collaboration and consolidation and will deliver operational efficiencies, spark additional innovation and most importantly, provide increased value and attention to our customers. Our newly combined U.S. energy branch revenue was down 7% sequentially, as many of our customers deferred projects and continued with reduced drilling and completion activity during the quarter. Our U.S. Process Solutions revenue was down 28% sequentially, on lower customer activity. We felt the impact of several months of customer deferrals and elevated new order discipline as customers focused on conserving cash and drawing down their surplus pumps, vessels and fabricated inventory. During the quarter, U.S. Process Solutions shipped existing orders for lax pump packages, measurement units, launchers and receivers to active operators. The increase of completions does provide opportunity for U.S. Process Solutions and specifically our Power Service group to increase our vessel order activity that was relatively quiet during the third quarter. In our Canadian segment, third quarter 2020 revenue was $42 million, up $1 million from the second quarter. As we discussed on the last quarter 2Q call, Canadian revenue included a…

Thank you, Mark. And now I’d like to shift the focus towards our outlook for the fourth quarter. We experienced seasonal revenue declines from the third quarter to fourth quarter each year, due to weather delays on projects, fewer billing days, holidays and seasonal customer budget exhaustion. For example, our third to fourth quarter revenue declined in 2019 was 15%, while global rigs declined 6%, producing a seasonal net revenue to global rig decline or spread of minus 9%. That spread from 3Q to 4Q was a decline of 7% in 2018. Thus, recent history experience, which should suggest a decline in the high single digit percentage range from the third quarter to the fourth. This year we expect these drags on sequential revenue to be negatively impacted by the broad range of customer reactions to macro conditions, where while some will spend more as rigs and completions inch up, others will ease activity due to COVID impact on demand and the potential for additional lockdowns. Moving to M&A. The current market uncertainty has created its share of new challenges, adding unpredictability to the typical M&A process. Notable for us are the expanded processes related to financial due diligence and the stress testing we discussed on our last call around current target earnings performance as we evaluate the requirements critical to trigger closing the transaction. We continue to update and refine our pipeline to confirm each deal is still aligned with our expectations. Though, our balance sheet affords us the ability to be patient and prudent, we are actively engaged in various stages of multiple deal conversations. We continue to remain highly selective and we’ll strike at the right time for the right business for the right value to our shareholders. On the divestment side, as Mark mentioned, in October will be closed on the sale of a business line in the UK, although, it was a small part of the overall business. This move further exemplifies the proactive steps we’re taking to transform our business and prioritize providing long-term value. In closing, I’m excited about the momentum, building in the execution of our strategy. DNOW’s performance reflects our employees’ steadfast dedication to provide superior service and value to our customers. We have produced strong gross margins, despite the deflationary poll by the market and have extracted historic levels of costs from the business with plans for further cost transformation. Our working capital discipline has resulted in a record cash balance and we are deploying disruptive technologies to simplify the customer experience, develop new revenue channels and drive efficiencies. We remain debt-free with more than $0.5 billion in total liquidity to continue our investment in technology, while judiciously pursuing inorganic opportunities that provide the optimal strategic fit. Now, let’s open the call for questions.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] And the first question comes from Sean Meakim from J.P. Morgan.

Thank you. Hey, good morning.

Hi, Sean.

So David to start – good morning. Gross margin was elevated again. So if we exclude the impact of inventory charges, it’d be above 21%. Inventory charges aren’t necessarily new, you can have some each quarter, but you’ve been calling them out, given the magnitude while activity has collapsed. Have we moved past the larger inventory charge periods? Do you see that is ongoing into next year? And how should investors calibrate all the moving pieces to what a, call it, normalized gross margin could look like next year?

Okay. That’s a good questions, Sean. So we talked about over the last few calls, we’ve had kind of two phases of cost reductions. Those are behind us and Mark has kind of spoke to the impact of those. Now we’re moving into another phase, which will take a little longer. So we have 200 locations around the world. We see in the future, repurposing them to be customer focused, but with a narrower range of inventory – less inventory, fewer people, less vehicles, et cetera, to pull costs out of the business. That’ll take a little bit longer. So that’ll – so sizing up, how much inventory is at risk, as we repurpose our branches will take a little longer? We hope to do most of that by year end. So we would expect elevated inventory charges through the end of the year. And then maybe, if we do more dramatic changes in the New Year, we’d see some in the future. But we expect that to normalize at the end of year. Inventory charges are a part of our business, we’re a big distributor. We have a lot of inventory. Over time, we see about 0.5% to 1% of our revenues being the normal level of inventory charges, for example. But as we’ve said, recently, they’ve been elevated. So in terms of what the normalized gross margins would be, we think there’ll be 20%-plus. Now, I say 20% and I say, plus, for a couple of reasons. You have a higher number than that. Part of that’s because we’ve talked exhaustedly about growing our position in midstream. And while the transaction costs to handle large midstream orders is lower, meaning the WSA percentage of revenue would be lower, so goes the gross margin. So that would be an impact to the extent we’re successful in our pursuit of the midstream business. But we’ve talked for a few years now of high grading our customers, our product lines, our locations, our businesses to – for a perpetual track along improved product margin so – and gross margin. So 20% is kind of a baseline.

Got it. I appreciate all that feedback. I think that’s really helpful. So in somewhat intertwined in all those efforts is – that’s impacting inventory is really about the cost reset. And so we made huge strides in WSA. But even with all the cost out, given where activity is getting back to consistently positive EBITDA number is a little bit challenging until we get more volume. Have you run forward analysis, once you’ve reset the cost base, where you want it to be in terms of how much volume of revenue is required to hit certain hurdle rates around EBITDA margin target? Can you maybe just talk – are you able to give us a framework around, kind of a trough peak versus normalized type of EBITDA margin going forward relative to maybe what you were able to accomplish in the prior cycle?

Yes. So you want me to forecast an EBITDA target? I mean, what I first want to do is get the business to breakeven. And ultimately, we’ve talked – historically, we’ve been in the 5% EBITDA range, we’ve definitely want to get back to that level and higher. But first, when you get to break even. So we’ve seen our North American market declined by 80%, since 2014, we’ve made significant restructures in the business. We’re kind of pursuing a fulfillment central migration, where we’re moving our business to more of a centralized model. So getting to the right level of WSA in the business, forecasting the revenues, all that has to come together to where we – before we start talking about what kind of EBITDA progression. But I would tell you 5% is a minimum starting point and we need to get to break even first, we believe we’ll get to break even in the first half of 2021. And that’s going to require a few things. For example, in the fourth quarter, we talked about a decline, I gave some guidance along those lines. In the meantime, during the fourth quarter, we’re seeing rig counts inch up and completions likely will follow suit as we’re seeing more frac crews going to work. And if that continues into the first quarter and we experienced an expected seasonal increase or reversal from the fourth quarter decline and we continue to make progress in a muted recovery in terms of gross margins, while we’re pulling out costs, we can get to break even in the first half. So that’s kind of phase one after the worst oilfield industry, since the great depression we’ve done heroic work in this company to get to where we’re at right now. So first, we need to get the break even. We have plan to do that and then in the spirit of your question, then we need to get to meaningful EBITDA numbers. And 5% would be a base and above that would be where we need to go as we buy companies, as we divest parts of our business, that aren’t profitable. And as we high-grade, all those things that work and don’t work in our business.

Thanks, Dave. I know that’s not an easy question, but I appreciate the context around your goals. It’s very helpful.

You’re welcome, Sean.

Our following question comes from Jon Hunter from Cowen.

Hey, good morning, Dave and Mark.

Good morning.

So just wanted to dig into the revenue commentary a little bit for the fourth quarter. So your teams are guiding down high single digits. But perhaps, there’s a little bit of offset from the completion side of things that seems to be improving in the fourth quarter. So maybe that helps your Process Solutions business. So can you kind of talk to, if there’s some conservatism baked into that expectation. And then how does that revenue decline look split between your Energy and Process Solutions segments?

Okay. So if you look at just the seasonal – the normal seasonal impact, we would see a revenue decline. In the last several years, the only time we saw increases in 2016, when rig count really took off in the second half of the year. And then we look on a net basis, what happens with our revenues, historically, compared to what happens with rig count, to me, which is the better long-term gauge for revenue opportunities for us. And we just – we simply see that difference of last year, our revenues declined 15%, while rigs declined 6%. So we saw a 9% decline. So we’re kind of expecting that will happen. When you look at October, and of course, we’ve seen our preliminary October revenue numbers, they’re flat with September. And then if you recall, what kind of the contours of the third quarter, September was one of the weaker month – was the weakest month in the third quarter. So our October numbers rivaled September, but September was a soft month in the third quarter. So we kind of start the fourth quarter and October generally is your best month of the fourth quarter. So I expect the seasonal dip in November, December. That’s how we get to that number. There might be some positive offsets. We do have customers that are committing to buy more and we’re seeing in some of the numbers, but I think there’s a heavy pause out there on additional investment, bigger – more impactful than normal given uncertainty. But we’re doing everything we can and we talked exhaustively about focusing on gaining share in the upstream space, while we find revenues in the municipal water business and the mining business and other parts of our customer base, where we can grow. And that’s the best guidance we have right now, Jon.

Thanks. Thanks, Dave. And then I guess following on to that same line of thinking is, you did mention the municipal water and mining and industrial pieces of the business, that could be growth areas for DNOW. Can you talk about what percentage of the business or what kind of revenue contribution you’re getting from those businesses today and a possible market size for those types of end markets?

Yes, I noted in my commentary, those are small parts of the business. A lot of that activity is happening in Odessa pumps, and Odessa pumps is less than 10% of our business and that might be – and we’re seeing growth in the water disposal business and that represents about 10% of Odessa pumps. So we’re in the less than 3% range in terms of where we are today. What we do see, though, is more customer acceptance of the offerings we have in that area. So we see it as a potential to grow, especially, after one of our most successful businesses in Odessa pumps to use our fixed cost, branch network for Odessa pumps and add business to the existing revenue stream there.

Understood. And then I guess, kind of a bigger picture question is looking into 2021 and your activity progression as things improve here. How do you think about working capital for the full year? Is there still some efficiency to be gained there, such that, your working capital consumption as activity improves could be limited or is there any kind of range or way to think about that in 2021? Thank you.

Okay. So in terms of working capital next year, I think Mark mentioned that our working capital as a percent of revenue was 22% for the quarter, and for the tail end of the 2019 period, we had working capital as a percent of revenue 80% range. So I say, I mean first answer that there’s room for improvement in terms of turning our inventory a little faster, improving collections. So there’s room for improvement there. If we see some modest growth next year, and again, we’re not forecasting 2021, but to the extent, we do we would begin to consume capital somewhat to add inventory, certainly for accounts receivable. So how much cash flow we’d have is going to be a function of revenues. But I think in the spirit of your question, while our – I think Mark said our inventory turns are 3.3, that’s kind of low. But in a market like this, we see that as a pretty strong performance, given how illiquid most inventories are out there. But generally room for improvement, but if – to the extent there is growth, we may see muted free cash flow in the New Year.

Thanks, Dave. I’ll turn it back.

Okay. Take care, Jon.

Our following question comes from Doug Becker from Northland Capital.

Thanks. Wanted to get a little more color on the margin improvement in the quarter? I think in the prepared commentary, you mentioned pricing improvements as well as mix. Just wanted to get – to make sure I heard that correctly, but also any color on where the strength was?

Yes. So mix was – so there’s really three components to major impacts on gross margin. Sean asked about one of them, and that was inventory charges. They were a little bit lower in the quarter. That wasn’t the primary driver for gross margin improvement, though it was price and the two components there would be mix, which we benefited from. So in the international space and in the U.S. as well, we saw lower projects – lower levels of projects. Projects tend to be larger orders at lower margins. So that helps. So there is a mix component. And we’re continuing the process of picking the right manufacturers, who support our customers, to maximize margin. So we have a better margin gain from saddling up at the right suppliers, and we are discontinuing lines that are less profitable. So that’s kind of a – that’s a mix effect too, but it also is – we’re picking the higher margin products, or with some customers pricing products better. So we’re in the throes of a downturn. There is a lot of competitive activity. Some of that is behind us with certain customers, and now we’re re-pricing at a higher level.

Now that all makes sense. Is it fair to say that we’ve probably seen the trough in gross margins, maybe in the second quarter? Then given those – some of those things are more structural than transitory in nature?

So my sense is, yes. But let me qualify that. So it feels like we have. I mean if you look at pipe prices, they’ve turned the corner. It’s a very, very slight turn, but we’ve seen pipe prices begin to improve maybe for one month. But my caveat would be, we’re going into the fourth quarter, almost all of our competitors are going to decline in terms of revenues, and I think we’ll see real scrappy – the competitive response in the fourth quarter, just due to the seasonal decline in revenues. And so we already guided to a revenue decline. We said we’re in a period of elevated inventory charges. We expect a competitive response from – especially the regional competitors, trying to make payroll to price, even their inventory below costs in the fourth quarter. So all those are kind of negative effects on gross margins in the fourth quarter, largely driven due to the evaporation of projects and volume opportunities in the fourth quarter. So on balance, we could see just a little bit of a slip in the fourth quarter. Inventory charges will impact that quite a bit. But I do believe from a pricing perspective, Doug, we have dropped.

That’s good. And then you mentioned, you expect to gain share as a result of the E&P consolidation. Where did those share gains typically come from? Presumably because, your larger competitor is talking about share gains from consolidation as well. It’s the smaller players. But just want to get a little more context around that?

Yes. So I talked very topically about that, and I’ll elaborate. So we’re looking at six North American purchases or acquisitions or combinations and three of those six are top echelon ranking customers, big customers of ours, with whom we have strong relationships and the company those – that are better being acquired, are not in our top echelon. So to the extent that the acquirers pursue a sole source or a singular procurement strategy, we should pick up share from the acquired companies, not so much from the acquirers, because we already have a strong position. I mean, generally the national distribution companies benefit from these kinds of mergers. The regional players find themselves kind of flat-footed, they can’t manage a nationwide or North American wide relationship, so we have an advantage there. And we see the opportunity there, is to leverage our Process Solutions business. So in each of these relationships and by the way all of 12 of these companies are customers of ours. But our Process Solutions is becoming more and more important to our big customers. So we see that as an opportunity to parlay that product offering set to the acquired company as well. So I see the pickup potential really being with the acquired company, and that’s kind of our target. We said on the call that, while we are optimistic, this will be a hard scrabble fight, but we think we’re well-positioned.

Thank you very much.

Welcome.

Our next question comes from Walter Liptak from Seaport.

Hey, good morning guys.

Hi Walter, good morning.

Congratulations on controlling the costs. I wanted to ask about WS&A, and if I heard you right, you said we are tracking toward $400 million of WS&A for the full year, is that right?

Mark?

Yes, $395 million – about $395 million is the guide.

Okay, all right. And within there, there is probably some transitory costs, both pluses and minus, and I wonder if we could talk – if you can give us a little bit of color on those, like you called out government subsidies, at some point those are going to go away. You are spending on this digital. I mentioned that there might be some expenses going through. I wonder if you could just help us understand, maybe what – like a normal level of WS&A might be as we pull out some of those pluses and minuses?

Right. Yes, I think as we mentioned, we’re still pulling levers. So I think normalized, I don’t think we’re talking about that. We can call out, you’re right. Some of the government subsidies, albeit limited and cap based on some of them, those – as we see it, those peaked in the third quarter. And we see those trailing off in the fourth quarter, and then that’s in our expectation as well, that – those also offset, so would other initiatives that were underway to reduce costs. So I think right now, we’re in the process of planning – annual planning and visiting with customers and planning, as much as we can into the next year. And so a lot of those initiatives underway, and so I think next time we are on this call, we will have a little better line of sight, let’s hope about the industry and activity levels to talk more about normalized levels of WSA.

Yes, I think Walt, we – I mentioned a little bit in the Q&A earlier on the call, that we’ve made significant reductions. Now we’re – and those were the – those were less – those were easier to make, in terms of – now we’re moving towards a system, where we want to stay close to our customers. We want to maintain as much as possible, our fleet of locations, which is 200 today. Tomorrow, we’re going to be pursuing branches half their size and with less inventory and fewer trucks like Mark said, and that takes a little bit long to affect that kind of physical move of those branches. So it’s harder for us to say what our normalized level of WSA is. We have said historically, that a normalized WSA should be closer to 15% of revenues. So that’s where we have to end up, and that’s where we’re going to get. But that will be more of an evolution, than what we’ve experienced so far, which is in terms of cost reduction, more revolutionary.

Okay, got it. Yes, there’ll be some evolution to that – the WS&A line. I wondered about the DigitalNOW, if there is any data points that you can give us like what – how many orders were processed as a percentage or the number of users that were added? Any data for us to kind of help us understand where you are in that process?

Yes. So similar to last quarter, our revenues – about a third of our global revenues happen through various digital channels, and that’s growing. If you look at our top 30 or three dozen customers, about 56% of our revenue is through digital channels. So usually, our larger customers, is where we do the bulk of our digital activity today. The opportunity is to fold in more smaller customers, and to add product offerings, like we talked about earlier in the prepared remarks about making it easier for customers to make large purchases from us, to really accelerate that process. And to kind of cut out the quoting and the price degradation process, and the high cost of quote process and make it simple for the customer to produce wells, et cetera. So that’s kind of where we’re at. Our midstream – or our upstream customers, where we see the most digital integration, we think the opportunity there is with our midstream, which is where we have the least, and that’s largely because that’s a high quoting business and we’re still working on making that process more seamless.

Okay, got it. Thank you.

Welcome.

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 Dave Cherechinsky, CEO and President, for closing statements.

Okay. Well, thank you, everyone for attending the call. We appreciate your interest in NOW Inc., and we’ll talk to you soon. Stay safe.

Thank you, ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may now disconnect.