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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark one)

FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2015

OR

Commission File Number 001-36325

 

NOW INC.

(Exact name of registrant as specified in its charter)

 

 

7402 North Eldridge Parkway,

Houston, Texas 77041

(Address of principal executive offices)

(281) 823-4700

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  o    No  x

As of October 28, 2015 the registrant had 107,204,061 shares of common stock (excluding 2,152,335 unvested restricted shares), par value $0.01 per share, outstanding.

 

 

 

 

 

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NOW INC.

TABLE OF CONTENTS

 

 

 

 

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PART I—FINANCIAL INFORMATION

 

 

Item 1. Financial Statements

NOW INC.

CONSOLIDATED BALANCE SHEETS

(In millions, except share data)

 

 

See notes to unaudited consolidated financial statements.

 

 

 

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NOW INC.

CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

(In millions, except per share data)

 

 

See notes to unaudited consolidated financial statements.

 

 

 

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NOW INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)

(In millions)

 

 

See notes to unaudited consolidated financial statements.

 

 

 

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NOW INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In millions)

 

 

     See notes to unaudited consolidated financial statements.

 

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NOW INC.

Notes to Unaudited Consolidated Financial Statements

 

 

1. Organization and Basis of Presentation

Nature of Operations

NOW Inc. (“NOW” or the “Company”) is a holding company headquartered in Houston, Texas that was incorporated in Delaware on November 22, 2013. NOW operates primarily under the DistributionNOW and Wilson Export brands. NOW is a global distributor of energy products as well as products for industrial applications through its locations in the U.S., Canada and internationally which are geographically positioned to serve the energy and industrial markets in approximately 90 countries. NOW’s energy product offerings are used in the oil and gas industry including upstream drilling and completion, exploration and production, midstream infrastructure development and downstream petroleum refining – as well as in other industries, such as chemical processing, power generation and industrial manufacturing operations. The industrial distribution portion of NOW’s business targets a diverse range of manufacturing and facilities across numerous industries and end markets. NOW also provides supply chain management to drilling contractors, E&P operators, midstream operators, downstream energy and industrial manufacturing companies. NOW’s supplier network consists of thousands of vendors in approximately 40 countries.

The Separation

On May 1, 2014, the National Oilwell Varco, Inc. (“NOV”) Board of Directors approved the Spin-Off (the “Spin-Off” or “Separation”) of its distribution business into an independent, publicly traded company named NOW Inc. In accordance with a separation and distribution agreement, the two companies were separated by NOV distributing to its stockholders 107,053,031 shares of common stock of the Company after the market closed on May 30, 2014. Each NOV stockholder received one share of NOW common stock for every four shares of NOV common stock held at the close of business on the record date of May 22, 2014 and not sold prior to close of business on May 30, 2014. Fractional shares of NOW common stock were not distributed and any fractional shares of NOW common stock otherwise issuable to a NOV stockholder were sold in the open market on such stockholder’s behalf, and such stockholder received a cash payment with respect to that fractional share. In conjunction with the Spin-Off, NOV received an opinion from its legal counsel to the effect that, based on certain facts, assumptions, representations and undertakings, for U.S. federal income tax purposes, the distribution of NOW common stock and certain related transactions generally was not taxable to NOV or U.S. holders of NOV common stock, except in respect to cash received in lieu of fractional shares, which generally will be taxable to such holders as a capital gain. Following the Spin-Off, NOW became an independent, publicly traded company as NOV had no ownership interest in NOW. Each company has separate public ownership, boards of directors and management. A Registration Statement on Form 10, as amended, relating to the Spin-Off was filed by the Company with the U.S. Securities and Exchange Commission (“SEC”) and was declared effective on May 13, 2014. On June 2, 2014, NOW stock began trading the “regular-way” on the New York Stock Exchange under the ticker symbol “DNOW”.

Basis of Presentation

All financial information presented before the Spin-Off represents the combined results of operations, financial position and cash flows for the Company and all financial information presented after the Spin-Off represents the consolidated results of operations, financial position and cash flows for the Company. Accordingly:

 

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The Company’s historical financial statements prior to May 31, 2014 do not reflect the debt or interest costs it might have incurred if it had been a stand-alone entity. In addition, the Company expects to incur other costs, not reflected in its historical financial statements prior to May 31, 2014, as a result of being a separate publicly traded company. As a result, the Company’s historical financial statements prior to May 31, 2014 do not necessarily reflect what its financial position or results of operations would have been if it had been operated as a stand-alone public entity during the periods covered prior to May 31, 2014, and may not be indicative of the Company’s future results of operations and financial position.

The consolidated financial statements include certain assets and liabilities that were historically held by NOV and were specifically identifiable or otherwise allocable to the Company. The cash and cash equivalents held by NOV were not specifically identifiable to NOW and therefore were not allocated to it for any of the periods presented prior to the Spin-Off. Cash and cash equivalents in the Company’s consolidated balance sheets primarily represent cash held locally by entities included in its consolidated financial statements. Transfers of cash prior to the Spin-Off to and from NOV’s cash management system were reflected as a component of additional paid-in capital on the consolidated balance sheets.

Prior to the Spin-Off, all significant intercompany transactions between NOW and NOV were considered to be effectively settled for cash at the time the transaction was recorded. The total net effect of the settlement of these intercompany transactions is reflected in the consolidated statements of cash flows as a financing activity and in the consolidated balance sheet as additional paid-in capital.

The Company combined operating and warehousing costs with selling, general and administrative expenses in its consolidated statements of operations beginning with its March 31, 2015 Form 10-Q. These costs are now presented within “Warehousing, selling and administrative” expense for all periods presented. Operating and warehousing costs totaled $98 million and $300 million for the three months and nine months ended September 30, 2015, respectively, and $108 million and $315 million for the same periods in 2014, respectively.

The unaudited consolidated financial information included in this report has been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and Article 10 of SEC Regulation S-X. The principles for interim financial information do not require the inclusion of all the information and footnotes required by generally accepted accounting principles for complete financial statements. Therefore, these financial statements should be read in conjunction with the financial statements included in the Company’s most recent Annual Report on Form 10-K. In the opinion of the Company’s management, the consolidated financial statements include all adjustments, all of which are of a normal recurring nature, necessary for a fair presentation of the results for the interim periods. The results of operations for the nine months ended September 30, 2015, are not necessarily indicative of the results to be expected for the full year.

Reclassification

Certain amounts in the prior periods presented have been reclassified to conform to the current period financial statement presentation. These reclassifications have no effect on previously reported operating profit (loss), income (loss) before income taxes or net income (loss).

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect reported and contingent amounts of assets and liabilities as of the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

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Fair Value of Financial Instruments

The carrying amounts of cash and cash equivalents, receivables and payables approximated fair value because of the relatively short maturity of these instruments. Cash equivalents include only those investments having a maturity date of three months or less at the time of purchase. See Note 12 for the fair value of derivative financial instruments.

Recently Issued Accounting Standards

In May 2014, the Financial Accounting Standard Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers: Topic 606. ASU 2014-09 affects any entity using GAAP that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (e.g., insurance contracts or lease contracts). This ASU will supersede the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance. In addition, the existing requirements for the recognition of a gain or loss on the transfer of nonfinancial assets that are not in a contract with a customer (e.g., assets within the scope of Topic 360, Property, Plant, and Equipment, and intangible assets within the scope of Topic 350, Intangibles—Goodwill and Other) are amended to be consistent with the guidance on recognition and measurement (including the constraint on revenue) in this ASU. Early application is not permitted. The ASU provides two transition methods: (i) retrospectively to each prior reporting period presented (ii) retrospectively with the cumulative effect of initially applying this ASU recognized at the date of initial application. The amendments in this ASU were originally set up to be effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. In April 2015, FASB proposed the effective date to be the annual reporting periods beginning after December 15, 2017, and interim periods therein. Early application is permitted as early as the original effective date. The Company is currently assessing the impact of ASU No. 2014-09 on its financial position and results of operations.

In July 2015, the FASB issued ASU No. 2015-11, Simplifying the Measurement of Inventory. Under ASU 2015-11, inventory will be measured at the “lower of cost and net realizable value.” ASU 2015-11 defines net realizable value as the “estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation.” ASU 2015-11 is effective for interim and annual periods beginning after December 15, 2016. Early application is permitted and should be applied prospectively. The Company is currently assessing the impact of ASU 2015-11 on its financial position and results of operations.

In September 2015, the FASB issued ASU No. 2015-16, Simplifying the Accounting for Measurement-Period Adjustments.  Under ASU 2015-16, the adjustments to provisional amounts identified during the measurement period will be recognized in the reporting period in which the adjustment amounts are determined.  The effect on earnings of changes calculated as if the accounting had been completed as of the acquisition date must be recorded in the reporting period in which the adjustment amounts are determined rather than retrospectively. For public entities, ASU 2015-16 is effective for interim and annual periods beginning after December 15, 2015. Early application is permitted and should be applied prospectively. The Company adopted ASU No. 2015-16 in the quarter ended September 30, 2015. The impact of the adoption was immaterial to the Company’s consolidated financial statements. Refer to Note 13 Acquisitions.

 

 

2. Property, Plant and Equipment

Property, plant and equipment consist of (in millions):

 

 

 

 

 

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3. Accrued Liabilities

Accrued liabilities consist of (in millions):

 

 

 

4. Debt

On April 18, 2014, the Company entered into a five-year senior unsecured revolving credit facility with a syndicate of lenders, including Wells Fargo Bank, National Association, as administrative agent. The credit facility became available to the Company on June 2, 2014 as a result of the satisfaction of customary conditions, including the consummation of the Separation. The credit facility is for an aggregate principal amount of up to $750 million with sub-facilities for standby letters of credit and swingline loans, each with a sublimit of $150 million and $50 million, respectively. The Company has the right, subject to certain conditions, to increase the aggregate principal amount of commitments under the credit facility by $250 million. Borrowings under the credit facility will bear interest at a base rate (as defined in the credit agreement) plus an applicable interest margin based on the Company’s capitalization ratio. The base rate is calculated as the highest of (a) the Federal Funds Rate, as published by the Federal Reserve Bank of New York, plus 1/2 of 1%, (b) the prime commercial lending rate of the administrative agent, as established from time to time at its principal U.S. office, and (c) the Daily One-Month LIBOR (as defined in the credit agreement) plus 1%. The Company also has the option for its borrowings under the credit facility to bear interest based on LIBOR (as defined in the credit agreement). The credit facility is unsecured and guaranteed by the Company’s domestic subsidiaries. The credit agreement also provides for customary fees, including administrative agent fees, commitment fees, fees in respect of letters of credit and other fees. The annual commitment fee ranges from 25 to 35 basis points of the unused portion of the credit facility. The line of credit expires in April 2019, unless extended.

The credit facility contains usual and customary affirmative and negative covenants for credit facilities of this type including financial covenants consisting of (a) a maximum capitalization ratio (as defined in the credit agreement) of 50% and (b) a minimum interest coverage ratio (as defined in the credit agreement) of no less than 3:1. As of September 30, 2015, the Company was in compliance with all covenants. The Company continuously monitors compliance with debt covenants. A default, if not waived or amended, would prevent the Company from taking certain actions, such as incurring additional debt.

At September 30, 2015, the Company had borrowed $120 million against its senior unsecured revolving credit facility. The Company is not obligated to pay back the borrowing against the senior unsecured revolving credit facility until the expiration date of April 18, 2019. In addition, the Company has a $4 million letter of credit outstanding as of September 30, 2015. This letter of credit was issued under a discretionary agreement with a member of the Company’s bank group.

 

 

5. Accumulated Other Comprehensive Income (Loss)

The components of accumulated other comprehensive income (loss) are as follows (in millions):

 

 

The Company’s reporting currency is the U.S. dollar. A majority of the Company’s international entities, in which there is a substantial investment, have the local currency as their functional currency. As a result, currency translation adjustments resulting from the process of translating the entities’ financial statements into the reporting currency are reported in Other Comprehensive Income or Loss in accordance with ASC Topic 830 “Foreign Currency Matters.”

 

 

 

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6. Business Segments

Operating results by reportable segment are as follows (in millions):

 

 

 

7. Income Taxes

In connection with the Separation, the Company and NOV entered into a Tax Matters Agreement, dated as of May 29, 2014 (the “Tax Matters Agreement”).  The Tax Matters Agreement sets forth the Company and NOV’s rights and obligations related to the allocation of federal, state, local and foreign taxes for periods before and after the Spin-Off, as well as taxes attributable to the Spin-Off, and related matters such as the filing of tax returns and the conduct of IRS and other audits.  Pursuant to the Tax Matters Agreement, NOV will prepare and file the consolidated federal income tax return, and any other tax returns that include both NOV and the Company for all the liability periods ending on or prior to May 30, 2014. The income tax provision (benefit) for periods prior to the Separation has been computed as if NOW were a stand-alone company. NOV will indemnify and hold harmless the Company for any income tax liability for periods before the Separation date.  The Company will prepare and file all tax returns that include solely the Company for all taxable periods ending after that date.  Settlements of tax payments between NOV and the Company were generally treated as contributions from or distributions to NOV in periods prior to the Separation date.

The effective tax rate for the Company was 22.8% and 23.7% for the three and nine months ended September 30, 2015, respectively, and 34.7% and 35.3% for the same periods in 2014, respectively. Compared to the U.S. statutory rate, the effective tax rate was impacted in the period by non-deductible expenses in the U.S. and foreign jurisdictions, including estimated goodwill impairment, and other discrete items principally related to recording a valuation allowance on certain foreign net operating loss carryforwards.

To the extent penalties and interest would be assessed on any underpayment of income tax, such accrued amounts have been classified as a component of income tax provision (benefit) in the financial statements consistent with the Company’s policy.

The Company is subject to taxation in the United States, various states and foreign jurisdictions. The Company has significant operations in the United States and Canada and to a lesser extent in various other international jurisdictions. Tax years that remain subject to examination by major tax jurisdictions vary by legal entity, but are generally open in the U.S. for the tax years ending after 2009 and outside the U.S. for the tax years ending after 2008. The Company is indemnified by NOV for any income tax exposures related to the periods prior to the Separation.

 

 

8. Earnings (loss) Per Share (“EPS”)

For the three and nine months ended September 30, 2015 and 2014, 6,509,775 and 6,540,227, 1,233,385 and 2,083,908, respectively, of stock options, restricted stock awards (“RSAs”), restricted stock units (“RSUs”), and performance share awards (“PSAs”) were excluded from the computation of diluted earnings (loss) per share due to their antidilutive effect. 

 

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Basic and diluted earnings (loss) per share follows (in millions, except share data):

 

 

 

 

9. Stock-based Compensation and Outstanding Awards

The Company established the NOW Inc. Long-Term Incentive Plan (the “Plan”). The Plan was adopted by the Company’s board of directors on May 1, 2014. Under the Plan, the Company’s employees are eligible to be granted stock options, RSAs, RSUs and PSAs.

During the nine months ended September 30, 2015, the Company granted 534,929 stock options with a fair value of $8.06 per share and 157,538 shares of RSAs and RSUs with a weighted average fair value of $22.59 per share. In addition, the Company granted PSAs to senior management employees with potential payouts varying from zero to 146,486 shares. The stock options were granted February 24, 2015 with an exercise price of $22.44. These options generally vest over a three-year period from the grant date on a straight-line basis over the requisite service period for each separately vesting portion of the award as if the award was, in-substance, multiple awards. The RSAs and RSUs were granted February 24, 2015 and May 27, 2015 and vest on the third anniversary of the date of grant. The PSAs were granted on February 24, 2015 and can be earned based on performance against established metrics over a three-year performance period. The PSAs are divided into three equal, independent parts that are subject to three separate performance metrics: (i) one-third of the PSAs have a Total Shareholder Return (TSR) metric, (ii) one-third of the PSAs have an EBITDA metric, and (iii) one-third of the PSAs have a Working Capital (WC) metric.

Performance against the TSR metric is determined by comparing the performance of the Company’s TSR with the TSR performance of designated peer companies for the three year performance period. Performance against the EBITDA metric is determined by comparing the performance of the Company’s actual EBITDA average for each of the three-years of the performance period against the EBITDA metrics set by the Company’s Compensation Committee of the Board of Directors. Performance against the WC metric is determined by comparing the performance of the Company’s actual WC average for each of the three-years of the performance period against the WC metrics set by the Company’s Compensation Committee of the Board of Directors.

Stock-based compensation expense totaled $7 million and $20 million for the three months and nine months ended September 30, 2015, respectively, and $5 million and $10 million for the same periods in 2014, respectively.

 

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A summary of stock option activity under the Plan as of September 30, 2015, and changes from December 31, 2014 through September 30, 2015 are presented below:

 

 

The weighted-average remaining contractual terms of outstanding options and exercisable options at September 30, 2015, were 6.8 years and 6.4 years, respectively. The total intrinsic value of options exercised for the period from December 31, 2014 through September 30, 2015 was $0. As of September 30, 2015, unrecognized compensation cost related to stock option awards was $10 million, which is expected to be recognized over a weighted average period of 1.6 years.

A summary of the status of the Company’s nonvested shares as of September 30, 2015, and changes for the period from December 31, 2014 through September 30, 2015 are presented below:

 

 

As of September 30, 2015, unrecognized compensation cost related to RSUs, RSAs and PSAs was $49 million, which is expected to be recognized over a weighted average period of 4.0 years.

 

 

10. Commitments and Contingencies

The Company is involved in various claims, regulatory agency audits and pending or threatened legal actions involving a variety of matters. At September 30, 2015, the Company recorded an immaterial amount for contingent liabilities representing all contingencies believed to be probable. The Company has also assessed the potential for additional losses above the amounts accrued as well as potential losses for matters that are not probable, but are reasonably possible. The total potential loss on these matters cannot be determined; however, in the Company’s opinion, any ultimate liability, to the extent not otherwise recorded or accrued for, will not materially affect the Company’s financial position, cash flow or results of operations. These estimated liabilities are based on the Company’s assessment of the nature of these matters, their progress toward resolution, the advice of legal counsel and outside experts as well as management’s intention and experience.

The Company’s business is affected both directly and indirectly by governmental laws and regulations relating to the oilfield service industry in general, as well as by environmental and safety regulations that specifically apply to the Company’s business. Although the Company has not incurred material costs in connection with its compliance with such laws, there can be no assurance that other developments, such as new environmental laws, regulations and enforcement policies hereunder may not result in additional, presently unquantifiable, costs or liabilities to the Company.

 

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The Company does not accrue for contingent losses that, in its judgment, are considered to be reasonably possible, but not probable. Estimating reasonably possible losses also requires the analysis of multiple possible outcomes that often depend on judgments about potential actions by third parties. NOW’s management currently estimates a range of loss for reasonably possible losses for which an estimate can be made is between zero and $25 million in the international segment primarily attributable to accounts receivable with one customer. The Company has accrued its best estimate for loss at September 30, 2015. Factors underlying this estimated range of loss may change from time to time, and actual results may vary significantly from this estimate.

In connection with one of the Company’s acquisitions, the Company agreed to make contingent consideration payments of up to $6 million upon the attainment of certain profitability milestones through February 2018. As of September 30, 2015, the estimated fair value of the contingent consideration of $3 million was recorded in other long-term liabilities.

 

 

11. Related Party Transactions

In connection with the Spin-Off, the Company and NOV entered into a Separation and Distribution Agreement, Tax Matters Agreement, Employee Matters Agreement, and Transition Service Agreement each dated May 29, 2014.

The Separation and Distribution Agreement contains the key provisions related to the separation from NOV and the distribution of the Company’s common stock to NOV shareholders. The Separation and Distribution Agreement separated the assets related to the Company’s business from NOV, along with liabilities related to such assets, which now reside with the Company. In general, the Company agrees to indemnify NOV from liabilities arising from the Company’s business and assets, and NOV agrees to indemnify the Company from liabilities arising from NOV’s business and assets (that remained with NOV), except as otherwise provided in such agreement.

The Tax Matters Agreement governs the respective rights, responsibilities and obligations of each party with respect to taxes and tax benefits, the filing of tax returns, the control of audits, restrictions to preserve the tax-free status of the Spin-Off and other tax matters.

The Employee Matters Agreement governs the Company and NOV’s compensation and employee benefit obligations with respect to current and former employees of each company, and generally allocates liabilities and responsibilities relating to employee compensation and benefit plans and programs. Such agreement also provides the adjustment mechanisms to be applied as a result of the Spin-Off to convert outstanding NOV equity awards held by Company employees to Company awards.

The Transition Service Agreement provides for transitional services in the areas of information technology, tax, accounting, finance and employee benefits and are initially short-term in nature. The charges under these transition service agreements will be at cost-based rates.

Allocation of General Corporate Expenses

For the periods prior to the Separation, the consolidated financial statements include expense allocations for certain functions provided by NOV as well as other NOV employees not solely dedicated to NOW, including, but not limited to, general corporate expenses related to finance, legal, information technology, human resources, communications, ethics and compliance, shared services, employee benefits and incentives, and stock-based compensation. These expenses were allocated to NOW on the basis of direct usage when identifiable, with the remainder allocated on the basis of operating profit, headcount or other measures. Actual costs that may have been incurred if the Company had been a stand-alone public company would depend on a number of factors, including the chosen organizational structure, what functions were outsourced or performed by employees and strategic decisions made in areas such as information technology and infrastructure.

During the three and nine months ended September 30, 2014, NOW was allocated $0 million and $6 million, respectively, which was included within warehousing, selling and administrative expenses in the accompanying consolidated statements of operations. Allocations from NOV discontinued as of May 30, 2014.

 

 

12. Derivative Financial Instruments

The Company is exposed to certain risks relating to its ongoing business operations. The primary risk managed by using derivative instruments is foreign currency exchange rate risk. The Company has entered into certain financial derivative instruments to manage this risk.

 

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The derivative financial instruments the Company has entered into are forward exchange contracts which have terms of less than a year to economically hedge foreign currency exchange rate risk on recognized nonfunctional currency monetary accounts. The purpose of the Company’s foreign currency economic hedging activities is to economically hedge the Company’s risk from changes in the fair value of non-functional currency denominated monetary accounts.

The Company records all derivative financial instruments at their fair value in its Consolidated Balance Sheets. None of the derivative financial instruments that the Company holds are designated as either a fair value hedge or cash flow hedge and the gain or loss on the derivative instrument is recorded in earnings. The Company has determined that the fair value of its derivative financial instruments are determined using level 2 inputs (inputs other than quoted prices in active markets for identical assets and liabilities that are observable either directly or indirectly for substantially the full term of the asset or liability) in the fair value hierarchy as the fair value is based on publicly available foreign exchange rates at each financial reporting date. At September 30, 2015, the net fair value of the Company’s foreign currency forward contracts totaled a net asset of less than $1 million and is included in other current assets in the accompanying Consolidated Balance Sheets; and the gain of less than $1 million is included in other income (expense) in the accompanying Consolidated Statements of Operations. The notional principal associated with those contracts was $119 million as of September 30, 2015.

At September 30, 2015, the Company’s financial instruments do not contain any credit-risk-related or other contingent features that could cause accelerated payments when the Company’s financial instruments are in net liability positions. The Company does not use derivative financial instruments for trading or speculative purposes.

 

 

13. Acquisitions

For the nine months ended September 30, 2015, the Company completed six acquisitions for an aggregate purchase price consideration of approximately $431 million. These acquisitions primarily expand NOW’s market in the United States, the United Kingdom, Australia and Norway. The Company has included the financial results of the acquisitions in its consolidated financial statements from the date of acquisition. In connection with one of the acquisitions, the Company agreed to make contingent consideration payments of up to $6 million upon the attainment of certain profitability milestones. At the acquisition date, the Company estimated the fair value for contingent consideration to be approximately $4 million by using a Monte Carlo simulation. Changes in fair value of the contingent consideration liability subsequent to the acquisition date, such as changes in the probability assessment, are recognized in the period when the change in estimated fair value occurs.

The Company completed its preliminary valuations as of the applicable acquisition date of the acquired net assets and recognized goodwill of $221 million and intangible assets of $84 million which is subject to change. If additional information is obtained about these assets and liabilities within the measurement period (not to exceed one year from the date of acquisition), including through asset appraisals and learning more about the newly acquired businesses, the Company will refine its estimates of fair value to allocate the purchase price more accurately; any such revisions are not expected to be significant.

The Company has not presented supplemental pro forma information because the acquired operations would not have materially impacted the Company’s consolidated operating results.

In July 2015, the Company entered into an agreement to purchase the business of Challenger Industries, Inc. The completion of this acquisition is subject to customary closing conditions. Challenger Industries, Inc. is a pipe, valves and fittings supplier for the downstream, midstream and upstream energy markets.

 

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Following is the purchase price allocation detail (in millions):

 

 

14. Goodwill Impairment

Generally accepted accounting principles require the Company to test goodwill for impairment at least annually or more frequently whenever events or circumstances occur indicating that goodwill might be impaired. Events or circumstances which could indicate a probable impairment include, but are not limited to, a significant reduction in worldwide oil and gas prices or drilling; a significant reduction in profitability or cash flow of oil and gas companies or drilling contractors; a significant reduction in worldwide well remediation activity; a significant reduction in capital investment by other oilfield service companies; or a significant increase in worldwide inventories of oil or gas.

The Company considered the sustained decline in worldwide oil and gas prices and rig counts, which has impacted the Company’s current results and future outlook as well as the decline in the market value of the Company’s stock, as indicators that the fair value of the Company’s reporting units’ goodwill could have fallen below their carrying values. As a result, the Company performed an impairment analysis of its goodwill during the third quarter of 2015.

The inputs used in the interim impairment test in the second quarter of 2015 were updated for current market conditions and forecasts and the valuation techniques used in the analysis were consistent with those used during previous testing. The Company has not completed the Step 2 measurement of the Company’s reporting units’ goodwill impairment due to the complexities involved in determining the implied fair values of the Company’s reporting units’ goodwill and in light of finalizing purchase accounting related to recent acquisitions. Significant estimates that are subject to change in the Step 2 analysis include, but are not limited to, the valuation of amortizable customer relationships and trade names, preliminary purchase price accounting related to recent acquisitions, estimated fair values of inventory and property, plant and equipment, among others. Any adjustments to the estimated impairment charge in the fourth quarter may be material to our consolidated results. The Company expects to complete the measurement of its reporting units’ goodwill impairment in the three months ended December 31, 2015.  The third quarter 2015 goodwill impairment test indicated that two of the Company’s four reporting units’ goodwill were impaired (U.S. Energy and International). In the three and nine months ended September 30, 2015, the Company recognized an estimated impairment of $255 million ($202 million after tax) associated with the fair value of goodwill.

The impairment charges were primarily the result of the substantial and sustained decline in oil prices during 2015, actual and forecasted declines in rig activity and the effects of those events and forecasts on the Company’s results of operations. Further, continued adverse market conditions could result in the recognition of additional impairment if the Company determines that the fair values of its reporting units have again fallen below their carrying values.

 

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15. Subsequent Event

Subsequent to September 30, 2015, market conditions continue to deteriorate, and we identified additional adverse trends such as declines in rig count, oil and natural gas prices and increasingly unfavorable changes to anticipated capital spending budgets of operators. On that basis, in the three months ended December 31, 2015, we expect to reevaluate whether the fair value of our reporting units has fallen below its carrying amount, which could result in the Company recognizing additional impairment of goodwill.

 

 

 

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements

Some of the information in this document contains, or has incorporated by reference, forward-looking statements within the meaning of section 27A of the securities act of 1933, as amended, and section 21E of the securities exchange act of 1934, as amended. Statements that are not historical facts, including statements about our beliefs and expectations, are forward-looking statements. Forward-looking statements typically are identified by use of terms such as “may,” “believe,” “anticipate,” “expect,” “plan,” “predict,” “estimate,” “will be” or other similar words and phrases, although some forward-looking statements are expressed differently. You should be aware that our actual results could differ materially from results anticipated in the forward-looking statements due to a number of factors, including, but not limited to, changes in oil and gas prices, changes in the energy markets, customer demand for our products, significant changes in the size of our customers, difficulties encountered in integrating mergers and acquisitions, general volatility in the capital markets, changes in applicable government regulations, the inability to realize the benefits of the Spin-Off, increased borrowing costs, competition between us and our former parent company, NOV, unfavorable reactions from our employees, the triggering of rights and obligations by the transaction or any litigation arising out of or related to the separation, impairments in goodwill or other intangible assets and worldwide economic activity. You should also consider carefully the statements under “risk factors,” as disclosed in our Form 10-K, which address additional factors that could cause our actual results to differ from those set forth in the forward-looking statements. Given these uncertainties, current or prospective investors are cautioned not to place undue reliance on any such forward-looking statements. We undertake no obligation to update any such factors or forward-looking statements to reflect future events or developments.

Company Overview

We are a global distributor to the oil and gas industry and other industries with a legacy of over one-hundred and fifty years. We operate primarily under the DistributionNOW and Wilson Export brands. Through our network of more than 300 locations and approximately 5,000 employees worldwide, we stock and sell a comprehensive offering of energy products as well as an extensive selection of products for industrial applications. Our energy product offering is required throughout all sectors of the oil and gas industry – from upstream drilling and completion, exploration and production (“E&P”), midstream infrastructure development to downstream petroleum refining – as well as in other industries, such as chemical processing, industrial manufacturing operations, power generation and utilities. The industrial distribution portion of our business targets a diverse range of manufacturing and other facilities across numerous industries and end markets. We also provide supply chain management to drilling contractors, E&P operators, midstream operators, downstream energy and industrial manufacturing companies around the world.

Our global product offering includes consumable maintenance, repair and operating (“MRO”) supplies, pipe, valves, fittings, flanges, electrical, artificial lift solutions, mill tools, safety supplies and spare parts to support customers’ operations. We provide a one-stop shop value proposition within the oil and gas market and particularly in targeted areas of artificial lift, measurement and controls and valve actuation. We also offer warehouse and inventory management solutions as part of a comprehensive supply chain and materials management offering. Through focused effort, we have built expertise in providing application systems and parts integration, optimization solutions and after-sales support.

Our supply chain solutions include outsourcing the functions of procurement, inventory and warehouse management, logistics, business process and performance metrics reporting. These solutions allow us to leverage the infrastructure of our SAP™ Enterprise Resource Planning (“ERP”) system to streamline our customers’ purchasing process, from requisition to procurement to payment, by digitally managing workflow, improving approval routing and providing robust reporting functionality.

We support major land and offshore operations for all the major oil and gas producing regions around the world through our comprehensive network of Energy Branch locations. Our key markets beyond North America include Latin America, the North Sea, the Middle East, Asia Pacific and the Commonwealth of Independent States. Products sold through our Energy Branch locations support greenfield and expansion plant capital projects, electrical projects, midstream infrastructure, MRO and manufacturing consumables used in day-to-day production. We provide downstream energy and industrial products for petroleum refining, chemical processing, industrial manufacturing operations, power generation and utilities through Supply Chain and customer on-site locations.

We stock or sell more than 300,000 stock keeping units (“SKUs”) through our branch network. Our supplier network consists of thousands of vendors in approximately 40 countries. From our operations in over 20 countries we sell to customers operating in approximately 90 countries. The supplies and equipment stocked by each of our branches is customized to meet varied and changing local customer demands. The breadth and scale of our offering enhances our value proposition to vendors, customers and shareholders.

 

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We employ advanced information technologies, including a common ERP platform across most of our business, to provide complete procurement, materials management and logistics coordination to our customers around the globe. Having a common ERP platform allows immediate visibility into the financials and operations of most branches worldwide, enhancing decision making and efficiency. Over the past two years, we have devoted significant resources to the ERP initiative and we have moved most of our locations on to one ERP platform.

Demand for our products is driven primarily by the level of oil and gas drilling, servicing and production, transmission, refining and petrochemical activities. It is also influenced by the global economy in general and by government policies. Several factors have driven the long-term growth in spending including investment in energy infrastructure, the North American shale plays and market expectations of future developments in the oil, natural gas, liquids, refined products, petrochemical, plant maintenance and other industrial and energy sectors.  These arrangements are generally repetitive activities that address recurring maintenance, repair, operational work, well completion, production, oil and gas transmission and drilling activities.

Project activities, including facility and plant maintenance (turnarounds), expansions, exploration and new construction projects, are usually associated with customers’ capital expenditure budgets, sometimes in association with their construction partners. We mitigate our exposure to price volatility by limiting the length of price protection on such projects which allows us to adjust pricing depending on factors that influence our supply chain.

Summary of Reportable Segments

We operate through three reportable segments: United States (“U.S.”), Canada and International. The segment data included in our Management’s Discussion and Analysis (“MD&A”) are presented on a basis consistent with our internal management reporting. Segment information appearing in Note 6 – Business Segments of the Notes to Unaudited Consolidated Financial Statements (Part I, Item 1 of this Form 10-Q) is also presented on this basis.

United States

We have more than 200 locations in the U.S., which are geographically positioned to best serve the upstream, midstream and downstream energy and industrial markets. Our U.S. branch network enables us to broaden our customer base, leverage our inventory and purchasing power and enhance our position in the energy and industrial markets.

We also have extensive one-stop shop specialty operations in the U.S. that provide our customers a unique way to purchase artificial lift, valves and valve actuation, electrical, measurement and controls, and fluid transfer which enables them to better focus on their core business. In these businesses, we provide additional value to our customers through the design, assembly, fabrication and optimization of products and equipment essential to the safe and efficient production of oil and gas.

Canada

We have a network of approximately 60 locations in the Canadian oilfield, predominantly in the oil rich provinces of Alberta and Saskatchewan in Western Canada. Our Canada segment primarily serves the energy exploration, production and drilling business, offering customers the same products and value-added solutions that we perform in the U.S. In Canada, we also provide training for and supervise the installation of fiberglass pipe, supported by substantial inventory and product expertise on the ground to serve our customers.

International

We operate in over 20 countries and serve the needs of our international customers from more than 30 locations outside of the U.S. and Canada, most of which are strategically located in major oil and gas development areas. Our approach in these markets is similar to our approach in the U.S., as our customers look to us to provide inventory and support closer to their drilling and exploration activities or industrial operations. Our long legacy of operating in many international regions, combined with significant expansion into several new key markets, provides a competitive advantage as few of our competitors have a presence in the U.S., Canada and International markets.

 

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The Separation

On May 1, 2014, the NOV Board of Directors approved the Spin-Off of its distribution business into an independent, publicly traded company named NOW Inc. In accordance with a separation and distribution agreement, the two companies were separated by NOV distributing to its stockholders all 107,053,031 shares of common stock of NOW Inc. after the market closed on May 30, 2014. Each NOV stockholder received one share of NOW common stock for every four shares of NOV common stock held at the close of business on the record date of May 22, 2014 and not sold prior to close of business May 30, 2014. Fractional shares of NOW common stock were not distributed and any fractional shares of NOW common stock otherwise issuable to a NOV stockholder were sold in the open market on such stockholder’s behalf, and such stockholder received a cash payment with respect to that fractional share. In conjunction with the separation, NOV received an opinion from its legal counsel to the effect that, based on certain facts, assumptions, representations and undertakings, for U.S. federal income tax purposes, the distribution of NOW common stock and certain related transactions generally was not taxable to NOV or U.S. holders of NOV common stock, except in respect to cash received in lieu of fractional shares, which generally will be taxable to such holders as capital gain. Following the separation, NOW is an independent, publicly traded company, and NOV has no ownership interest in NOW. Each company now has separate public ownership, boards of directors and management. A Registration Statement on Form 10, as amended, relating to the Spin-Off was filed by the Company with the SEC and was declared effective on May 13, 2014. On June 2, 2014, NOW Inc. stock began trading the “regular-way” on the New York Stock Exchange under the symbol “DNOW”.

Basis of Presentation

The financial statements are presented as if the Company’s businesses had been consolidated for all periods presented. The Company’s historical financial statements prior to May 31, 2014 were derived from the consolidated financial statements and accounting records of NOV and include assets, liabilities, revenues and expenses directly attributable to the Company’s operations. The assets and liabilities in the combined financial statements have been reflected on a historical cost basis, as immediately prior to the separation all of the assets and liabilities presented were wholly owned by NOV and were transferred within NOV. All intercompany transactions and accounts were eliminated. The Company’s historical financial statements prior to May 31, 2014 reflect allocations of certain corporate costs from NOV for certain corporate functions historically performed by NOV, including allocations of general corporate costs related to executive oversight, accounting, treasury, tax, legal, procurement and information technology. These costs have been allocated to the Company on a basis that it considers to reflect fairly and reasonably the utilization of the services provided to or the benefit obtained by the Company’s businesses. Actual costs that would have been incurred if we had been a stand-alone public company would depend on multiple factors, including organizational structure and strategic decisions made in various areas, including information technology and infrastructure. The Company’s historical financial statements prior to May 31, 2014 do not reflect the debt and interest costs it might have incurred if it had been a stand-alone entity. In addition, the Company expects to incur other charges, not reflected in its historical financial statements prior to May 31, 2014, as a result of being a separate publicly traded company. As a result, the Company’s historical financial statements prior to May 31, 2014 do not necessarily reflect what its financial position or results of operations would have been if it had been operated as a stand-alone public entity during the periods covered prior to May 31, 2014, and may not be indicative of the Company’s future results of operations and financial position.

 

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Operating Environment Overview

The Company’s results are dependent on, among other things, the level of worldwide oil and gas drilling, well remediation activity, price of crude oil and natural gas, capital spending by oilfield service companies and drilling contractors, and worldwide oil and gas inventory levels. Key industry indicators for the third quarter of 2015 and 2014 and the second quarter of 2015 include the following:

 

 

The following table details the U.S., Canadian and international rig activity and West Texas Intermediate Oil prices for the past nine quarters ended September 30, 2015, on a quarterly basis:

 

 

 

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Sources: Rig count: Baker Hughes, Inc. (www.bakerhughes.com); West Texas Intermediate Crude and Natural Gas Prices: Department of Energy, Energy Information Administration (www.eia.doe.gov); Hot-Rolled Coil Prices: American Metal Market (www.amm.com).

The worldwide quarterly average rig count increased 0.5% (from 2,178 rigs to 2,189 rigs) and the U.S. declined 4.7% (from 909 rigs to 866 rigs) in the third quarter of 2015 compared to the second quarter of 2015. The average price per barrel of West Texas Intermediate Crude declined 19.8% (from $57.85 per barrel to $46.42 per barrel) and natural gas prices increased 0.4% (from $2.75 per MMBtu to $2.76 per MMBtu) in the third quarter of 2015 compared to the second quarter of 2015. The average price per short ton of Hot-Rolled Coil increased 0.2% (from $461.43 per short ton to $462.55 per short ton) in the third quarter of 2015 compared to the second quarter of 2015.

U.S. rig count at October 16, 2015 was 787 rigs, down 79 rigs compared to the third quarter average of 866 rigs. The price for West Texas Intermediate Crude was $45.91 per barrel at October 19, 2015, down 1.1% from the third quarter average. The price for natural gas was $2.43 per MMBtu at October 19, 2015, down 12.0% from the third quarter average. The price for Hot-Rolled Coil was $433.64 per short ton at October 27, 2015, down 6.2% from the third quarter average.

Executive Summary

For the three and nine months ended September 30, 2015, the Company generated a net loss of $224 million and a net loss of $253 million, respectively, on $753 million and $2,366 million in revenue, respectively. Revenue decreased $317 million or 29.6% and decreased $733 million or 23.7% for the three and nine months ended September 30, 2015, respectively, when compared to the corresponding periods of 2014. For the three and nine months ended September 30, 2015, net income decreased $256 million and decreased $353 million, respectively, when compared to the corresponding periods of 2014.

For the three and nine months ended September 30, 2015, the Company generated an operating loss of $291 million or negative 38.6% of revenue and an operating loss of $326 million or negative 13.8% of revenue, respectively, compared to an operating profit of $50 million or 4.7% of revenue and an operating profit of $155 million or 5.0% of revenue, respectively, for the corresponding periods of 2014. In the three and nine months ended September 30, 2015, the Company recognized an estimated impairment of $255 million associated with the fair value of goodwill. The impairment charges were primarily the result of the substantial and sustained decline in oil prices during 2015, forecasted declines in rig activity and the effects of those forecasts on the Company’s results of operations.

Outlook

Our outlook for the Company remains tied to worldwide rig count, particularly in North America. The significant declines in rig count contribute to an unpredictable environment and several factors could alter activity significantly. Projections for oil and gas prices and resulting rig counts fluctuate considerably and energy-related companies are taking varied approaches during these uncertain times. Sustained lower oil prices may heighten the risk of political disturbances in oil-export-dependent economies, but can also offer an incentive to maximize output and stimulate growth.

Given the lack of visibility into when this market will recover, our approach during this time is to focus on what we can control. We take a quarter-to-quarter approach to managing the Company based on market conditions, while also continuing to advance our long-term strategic goals. We believe recent and current market conditions present a unique opportunity to execute strategic acquisitions that will help position the Company to emerge as a stronger global distribution business as the market recovers. We also believe that our long history of managing through these cycles will enable us to capitalize on new opportunities.

 

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Operating results by reportable segment are as follows (in millions):

 

 

United States

For the three and nine months ended September 30, 2015, revenue was $497 million and $1,594 million, respectively, a decline of $251 million or 33.6% and a decline of $520 million or 24.6%, respectively, when compared to the corresponding periods of 2014. These decreases were driven by a sharp decline in U.S. rig count, slightly offset by incremental revenue gains of approximately $40 million and $90 million from acquisitions in the respective periods.

For the three and nine months ended September 30, 2015, the United States generated an operating loss of $294 million or negative 59.2% of revenue and an operating loss of $329 million or negative 20.6% of revenue, respectively, a decline of $322 million and a decline of $415 million, respectively, when compared to the corresponding periods of 2014. For the three and nine months ended September 30, 2015, excluding $252 million in charges related to an estimated goodwill impairment, U.S. operating profit decreased due to lower volumes, pricing pressures and inventory charges.

Canada

For the three and nine months ended September 30, 2015, revenue was $94 million and $299 million, respectively, a decline of $79 million or 45.7% and a decline of $190 million or 38.9%, respectively, when compared to the corresponding periods of 2014. These decreases were attributable to the sharp decline in Canadian rig count, coupled with the impact of the strengthening of the U.S. dollar.

For the three and nine months ended September 30, 2015, Canada generated an operating profit of $2 million or 2.1% of revenue and an operating profit of nil or 0.0% of revenue, respectively, a decline of $12 million and a decline of $33 million, respectively, when compared to the corresponding periods of 2014. Operating profit decreased in the periods primarily due to the declines in revenue discussed above, offset by expense reductions realized in the periods.

International

For the three and nine months ended September 30, 2015, revenue was $162 million and $473 million, respectively, an increase of $13 million or 8.7% from the same quarter in the prior year, and a decline of $23 million or 4.6% when compared to the nine months ended September 30, 2014. These levels were impacted by an overall decline in international drilling activity and customer spend, both periods offset by incremental revenue gains from acquisitions of approximately $70 million and $160 million in the respective periods of 2015.

 

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For the three and nine months ended September 30, 2015, the international segment generated an operating profit of $1 million or 0.6% of revenue and an operating profit of $3 million or 0.6% of revenue, respectively, a decline of $7 million and a decline of $33 million, respectively, when compared to the corresponding periods of 2014. Excluding acquisitions and $3 million estimated goodwill impairment, the decreases were primarily attributable to volume declines at lower margins and additional bad debt charges booked in the respective periods.

Cost of products

For the three and nine months ended September 30, 2015, cost of products was $636 million and $1,970 million, respectively. This is in comparison to $857 million and $2,485 million for the corresponding periods in 2014, respectively, a decrease of $221 million and a decrease of $515 million, respectively, primarily due to declines in revenue, coupled with inventory cost adjustments made in the periods. Cost of products includes the cost of inventory sold and related items, such as vendor consideration, inventory allowances, amortization of intangibles and inbound and outbound freight.

Warehousing, selling and administrative

For the three and nine months ended September 30, 2015, warehousing, selling and administrative costs were $153 million and $467 million, respectively, compared to $163 million and $459 million, respectively, for the corresponding periods of 2014. For the three months ended September 30, 2015, the decrease is related to cost-cutting initiatives taken as a result of the decline in market activity, offset by additional costs associated with acquisitions. For the nine months ended September 30, 2015, the increase was primarily related to additional costs associated with acquisitions and incremental bad debt expense, offset by the cost-cutting measures mentioned above. Warehousing, selling and administrative costs include branch location, distribution center and regional expenses (including costs such as compensation, benefits and rent) as well as corporate general selling and administrative expenses.

Impairment of goodwill

In the three and nine months ended September 30, 2015 the Company recognized an estimated impairment of $255 million associated with the fair value of goodwill. The Company has not completed the Step 2 measurement of the Company’s reporting units’ goodwill impairment due to the complexities involved in determining the implied fair values of the Company’s reporting units’ goodwill and in light of finalizing purchase accounting related to recent acquisitions. Significant estimates that are subject to change in the Step 2 analysis include, but are not limited to, the valuation of amortizable customer relationships and trade names, preliminary purchase price accounting related to recent acquisitions, estimated fair values of inventory and property, plant and equipment, among others. Any adjustments to the estimated impairment charge in the fourth quarter may be material to our consolidated results. The Company expects to complete the measurement of its reporting units’ goodwill impairment in the three months ended December 31, 2015.  The third quarter 2015 goodwill impairment test indicated that two of the Company’s four reporting units’ goodwill were impaired (U.S. Energy and International).

Other income (expense)

For the three and nine months ended September 30, 2015, other income (expense) was nil and expense of $6 million, respectively, compared to expense of $1 million and expense of $1 million, respectively, for the corresponding periods of 2014. These charges were mainly attributable to exchange rate changes and bank charges associated with utilizing the credit facility.

Income tax provision (benefit)

The effective tax rate for the three and nine months ended September 30, 2015 was 22.8% and 23.7%, respectively, compared to 34.7% and 35.3%, respectively, for the same periods in 2014. Compared to the U.S. statutory rate, the effective tax rate was impacted in the period by non-deductible expenses in the U.S. and foreign jurisdictions and other discrete items principally related to recording a valuation allowance on certain foreign net operating loss carryforwards and estimated goodwill impairment charges in 2015.

Non-GAAP Financial Measure and Reconciliation

In an effort to provide investors with additional information regarding our results as determined by GAAP, we disclose a non-GAAP financial measure in our quarterly earnings press releases and other public disclosures. The primary non-GAAP financial measure we focus on is earnings before interest, taxes, depreciation and amortization, excluding other costs (“EBITDA excluding other costs.”) This financial measure excludes the impact of certain amounts as further identified below and has not been calculated in accordance with GAAP. A reconciliation of this non-GAAP financial measure to its most comparable GAAP financial measure is included below.

 

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We use this non-GAAP financial measure internally to evaluate and manage the Company’s operations because we believe it provides useful supplemental information regarding the Company’s on-going economic performance. We have chosen to provide this information to investors to enable them to perform more meaningful comparisons of operating results, and as a means to emphasize the results of on-going operations.

The following table sets forth the reconciliation of EBITDA excluding other costs to its most comparable GAAP financial measure (in millions):

EBITDA excluding other costs

 

 

Liquidity and Capital Resources

We assess liquidity in terms of our ability to generate cash to fund operating, investing and financing activities. We expect to remain in a strong financial position, with resources expected to be available to reinvest in existing businesses, strategic acquisitions and capital expenditures to meet short- and long-term objectives. We believe that cash on hand, cash generated from expected results of operations and amounts available under our revolving credit facility will be sufficient to fund operations, anticipated working capital needs and other cash requirements, including capital expenditures.

As of September 30, 2015 and December 31, 2014, we had cash and cash equivalents of $126 million and $195 million, respectively. As of September 30, 2015, approximately $96 million of our cash and cash equivalents was maintained in the accounts of our various foreign subsidiaries and, if such amounts were transferred among countries or repatriated to the U.S., such amounts may be subject to additional tax liabilities, which would be recognized in our financial statements in the period during which such decisions were made. We currently have the intent and ability to permanently reinvest the cash held by our foreign subsidiaries and there are currently no plans for the repatriation of such amounts.

At September 30, 2015, the Company had $120 million of borrowings against its revolving credit facility. The credit facility contains usual and customary affirmative and negative covenants for credit facilities of this type including financial covenants. As of September 30, 2015, the Company was in compliance with all covenants. The Company continuously monitors compliance with debt covenants. A default, if not waived or amended, would prevent the Company from taking certain actions, such as incurring additional debt. In addition, the Company has a $4 million letter of credit outstanding as of September 30, 2015. This letter of credit was issued under a discretionary agreement with a member of the Company’s bank group.

 

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The following table summarizes our net cash flows provided by operating activities, net cash used in investing activities and net cash provided by financing activities for the periods presented (in millions):

 

 

Operating Activities

For the nine months ended September 30, 2015, net cash provided by operating activities was $244 million, compared to net cash provided by operating activities of $30 million in the corresponding period of 2014. For the nine months ended September 30, 2015, net cash provided by operating activities was negatively impacted by a decrease in accounts payable and accrued liabilities of $281 million and a net decrease in other liabilities of $5 million, offset by a decrease in receivables and inventories of $316 million and $183 million, respectively.  The decreases in accounts payable and accrued liabilities are a result of paying down outstanding liabilities as well as limiting new purchases in 2015 due to the volatile market.  For similar reasons, accounts receivable and inventories had a positive impact on cash flow in the period.

Investing Activities

For the nine months ended September 30, 2015, net cash used in investing activities was $402 million compared to net cash used in investing activities of $24 million in the corresponding period of 2014. For the nine months ended September 30, 2015, the Company used $397 million in cash to fund acquisitions during the period (net of cash acquired), in addition to lower capital expenditures than the corresponding period in the prior year when the Company was consolidating facilities and ERP systems following the Wilson and CE Franklin acquisitions. The Company also had $3 million in proceeds from disposal of property, plant and equipment in 2015.

Financing Activities

For the nine months ended September 30, 2015, net cash provided by financing activities was $118 million compared to net cash provided by financing activities of $74 million for the corresponding period of 2014. The 2015 activity was primarily attributed to the Company borrowing against its credit facility during the nine months ended September 30, 2015.

Effect of Exchange Rates

For the nine months ended September 30, 2015, the effect of the change in exchange rates on cash and cash equivalents was a decrease of $29 million compared to a decrease of $15 million for the corresponding period of 2014. The primary reason for the change in 2015 compared to 2014 was a decline in the foreign exchange rate for the Australian dollar, British pound, Canadian dollar and Mexican peso compared to the U.S. dollar.

We intend to pursue additional acquisition candidates, but the timing, size or success of any acquisition effort and the related potential capital commitments cannot be determined with certainty. We continue to expect to fund future acquisitions primarily with cash flows from operations and borrowings, including the undrawn portion of the credit facility or new debt issuances, but may also issue additional equity either directly or in connection with acquisitions. There can be no assurance that additional financing for acquisitions will be available at terms acceptable to us.

Critical Accounting Policies and Estimates

For a discussion of the critical accounting policies and estimates that we use in the preparation of our consolidated financial statements, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K.  In preparing the financial statements, we make assumptions, estimates and judgments that affect the amounts reported. We periodically evaluate our estimates and judgments that are most critical in nature which are related to allowance for doubtful accounts; inventory reserves; goodwill; purchase price allocation of acquisitions; vendor consideration; and income taxes. Our estimates are based on historical experience and on our future expectations that we believe are reasonable. The combination of these factors forms the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from our current estimates and those differences may be material.

 

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Generally accepted accounting principles require the Company to test goodwill and other indefinite-lived intangible assets for impairment at least annually or more frequently whenever events or circumstances occur indicating that goodwill or other indefinite-lived intangible assets might be impaired. Events or circumstances which could indicate a potential impairment include (but are not limited to) a significant reduction in worldwide oil and gas prices or drilling; a significant reduction in profitability or cash flow of oil and gas companies or drilling contractors; a significant reduction in worldwide well remediation activity; a significant reduction in capital investment by other oilfield service companies; or a significant increase in worldwide inventories of oil or gas.

Based on the decline in oil and gas pricing and rig count which have impacted the Company’s current results and future outlook, the Company chose to complete a goodwill impairment analysis during the third quarter in 2015. The inputs used in the interim impairment test in the second quarter of 2015 were updated for current market conditions and forecasts and the valuation techniques used in the analysis were consistent with those used during previous testing. The Company has not completed the measurement of the Company’s reporting units’ goodwill impairment due to the complexities involved in determining the implied fair values of the Company’s reporting units’ goodwill and in light of finalizing purchase accounting related to recent acquisitions. Significant estimates that are subject to change in the Step 2 analysis include, but are not limited to, the valuation of amortizable customer relationships and trade names, preliminary purchase price accounting related to recent acquisitions, estimated fair values of inventory and property, plant and equipment, among others. Any adjustments to the estimated impairment charge in the fourth quarter may be material to our consolidated results. The Company expects to complete the measurement of its reporting units’ goodwill impairment in the three months ended December 31, 2015.  The third quarter 2015 goodwill impairment test, indicated that two of the Company’s reporting units’ goodwill were impaired (U.S. Energy and International). In the three and nine months ended September 30, 2015, the Company recognized an impairment of $255 million ($202 million after tax) associated with the fair value of goodwill.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to certain market risks that are inherent in our financial instruments and arise from changes in interest rates and foreign currency exchange rates. We may enter into derivative financial instrument transactions to manage or reduce market risk but do not enter into derivative financial instrument transactions for speculative purposes. We do not currently have any material outstanding derivative instruments. See Note 12 (Derivative Financial Instruments) to the Consolidated Financial Statements.

A discussion of our primary market risk exposure in financial instruments is presented below.

Foreign Currency Exchange Rate Risk

We have operations in foreign countries and transact business globally in multiple currencies. Our net assets as well as our revenue and costs and expenses denominated in foreign currencies, expose us to the risk of fluctuations in foreign currency exchange rates against the U.S. dollar. Because we operate globally and approximately one-third of our year-to-date 2015 revenue was generated outside the United States, foreign currency exchange rates can impact our financial position, results of operations and competitive position. We are a net receiver of foreign currencies and therefore benefit from a weakening of the U.S. dollar and are adversely affected by a strengthening of the U.S. dollar relative to the foreign currency. As of September 30, 2015, our most significant foreign currency exposure was to the Canadian dollar with less significant foreign currency exposures to the Australian dollar, British pound and Mexican peso.

The financial statements of foreign subsidiaries are translated into their U.S. dollar equivalents at end-of-period exchange rates for assets and liabilities, while revenue and costs and expenses are translated at average monthly exchange rates. Translation gains and losses are components of other comprehensive income (loss) as reported in the consolidated statements of comprehensive income (loss). For year-to-date 2015, we experienced a net foreign currency translation loss totaling $72 million, which was included in other comprehensive income (loss).

Foreign currency exchange rate fluctuations generally do not materially affect our earnings since the functional currency is typically the local currency; however, our operations also have net assets not denominated in their functional currency, which exposes us to changes in foreign currency exchange rates that impact our earnings as foreign currency transaction gains and losses. Foreign currency transaction gains and losses arising from fluctuations in currency exchange rates on transactions denominated in currencies other than the functional currency are recognized in the consolidated statements of operations as a component of other income (expense). For year-to-date 2015 and 2014, we reported foreign currency transaction losses of $2 million and less than $1 million, respectively. Gains and losses are primarily due to exchange rate fluctuations related to monetary asset balances denominated in currencies other than the functional currency and fair value adjustments to economically hedged positions as a result of changes in foreign currency exchange rates.

 

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Some of our revenue for our foreign operations are denominated in U.S. dollars, and therefore, changes in foreign currency exchange rates impact earnings to the extent that costs associated with those U.S. dollar revenues are denominated in the local currency. Similarly some of our revenue for our foreign operations are denominated in foreign currencies, but have associated U.S. dollar costs, which also give rise to foreign currency exchange rate exposure. In order to mitigate those risks, we may utilize foreign currency forward contracts to better match the currency of the revenues and the associated costs. Although we may utilize foreign currency forward contracts to economically hedge certain foreign currency denominated balances or transactions, we do not currently hedge the net investments in our foreign operations. The counterparties to our forward contracts are major financial institutions. The credit ratings and concentration of risk of these financial institutions are monitored by us on a continuing basis. In the event that the counterparties fail to meet the terms of a foreign currency contract, our exposure is limited to the foreign currency rate differential.

The average foreign exchange rate for year-to-date 2015 compared to the average for the same period in 2014 decreased by 11.8% compared to the U.S. dollar based on the aggregated weighted average revenue of our foreign-currency denominated foreign operations. The average foreign exchange rate for year-to-date 2015 compared to the average for the same period in 2014 of the Australian dollar, British pound, Canadian dollar and Mexican peso compared to the U.S. dollar decreased by 16.5%, 8.0%, 12.9% and 15.7%, respectively, compared to the U.S. dollar.

We utilized a sensitivity analysis to measure the potential impact on earnings based on a hypothetical 10% change in foreign currency rates. A 10% strengthening from the levels experienced during year-to-date 2015 of the U.S. dollar relative to foreign currencies that affected the Company would have resulted in an approximate $1 million increase in net loss for the same period. A 10% weakening from the levels experienced during year-to-date 2015 of the U.S. dollar relative to foreign currencies that affected the Company would have resulted in an approximate $1 million decrease in net loss for the same period.

Commodity Steel Pricing

Our business is sensitive to steel prices, which can impact our product pricing, with steel tubular prices generally having the highest degree of sensitivity. While we cannot predict steel prices, we manage this risk by managing our inventory levels, including maintaining sufficient quantity on hand to meet demand, while reducing the risk of overstocking.

Interest Rates

We are subject to interest rate risk with our credit facility. The credit facility requires us to pay interest on outstanding borrowings at variable rates. Each one percentage point change in interest rates associated with the facility would result in a less than one million dollars change in our quarterly cash interest expense based on the balance at September 30, 2015.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. The Company’s disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed by the Company in the reports it files under the Exchange Act is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosures and is recorded, processed, summarized and reported within the time period specified in the rules and forms of the Securities and Exchange Commission. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective as of the end of the period covered by this report at a reasonable assurance level.

 

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Changes in Internal Control Over Financial Reporting

The Securities and Exchange Commission has adopted rules that generally require every company that files reports with the Commission to evaluate its effectiveness of internal controls over financial reporting. Our management, with the participation of our principal executive and principal financial officers, will not be required to evaluate the effectiveness of our internal controls over financial reporting until the filing of our 2015 Annual Report on Form 10-K, due to a transition period established by Commission rules applicable to new public companies.

There were no changes in internal control over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II—OTHER INFORMATION

Item 6. Exhibits

Reference is hereby made to the Index to Exhibits commencing on page 32.

 

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: November 3, 2015

 

 

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INDEX TO EXHIBITS

(a) Exhibits

 

 

We hereby undertake, pursuant to Regulation S-K, Item 601(b), paragraph (4) (iii), to furnish to the U.S. Securities and Exchange Commission, upon request, all constituent instruments defining the rights of holders of our long-term debt not filed herewith.

 

 

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