Unprecedented Declines in Drilling Activity Hammer NOW Inc.'s Earnings

The extended weakening of oil prices put even more pressure on oil and gas drilling activity during the fourth quarter, significantly reducing the need for oil-field equipment. That hit oil-field equipment distributor NOW Inc. (DNOW -1.88%) very hard, with its revenue and earnings continuing to be clobbered. Unfortunately, 2016 isn't shaping up to be any better, with the company putting its focus on four things: the long-term outlook, generating cash, aligning its cost structure to sales, and winning market share.

Drilling down into the numbers
NOW reported revenue of $644 million, which was 14% less than last quarter and down 36% from the year-ago quarter. Meanwhile, it posted an adjusted loss of $27 million, or $0.25 per share, which is a steeper adjusted loss than last quarter, when it lost $18 million, or $0.17 per share. CEO Robert Workman summed up the company's troubles during the quarter by noting in the earnings release that:

During the fourth quarter we continued to see unprecedented declines in drilling activity in North America and abroad. As long as rig count declines and drilled but uncompleted wells accumulate, our performance will be negatively affected.

That negative performance was felt across revenue for all three segments of the company's business:

Data source: NOW.

Revenue in the U.S. slumped 13% over last quarter, though that would have been even worse had it not been for the contribution of three recent acquisitions, which boosted sales by $17 million. That said, if there was a silver lining, it was that the year-over-year sales decline after stripping out the positive impact from acquisitions was 45%, which actually outperformed the 60% decline in the U.S. rig count over the past year. Given that the rig count is a barometer for activity levels, it implies that NOW has outperformed its competitors during the downturn, likely by winning market share. 

NOW's Canadian segment was also significantly affected by the decline in that country's rig count. Overall, sales were down 16% from just last quarter and down 56% year over year. That segment was affected by early project shutdowns, a 57% decline in the rig count, and a 14% foreign exchange impact due to the stronger dollar.

International revenue, likewise, dropped steeply last quarter, falling 19% from just the third quarter, though, thanks to acquisitions, revenue was only down 10% year over year. That said, slumping global rig activity, especially in offshore drilling where NOW has a heavy customer concentration, more than overcame the boost the company received from acquisitions.

Despite the declining sales and the adjusted loss, NOW is still generating cash flow, bringing in $80 million in cash during the quarter and $324 million for the full year. That solid cash flow enabled the company to maintain a virtually debt-free balance sheet because it's primarily paying for acquisitions with cash flow.

A look at the outlook
Workman didn't have a whole lot to say about NOW's outlook for 2016, except to say, "[D]espite a depressed environment, our mission is simple: focus on the long term, generate cash, align our cost structure with sales and gain market share." That said, what he didn't say speaks volumes. First, the company really doesn't seem to have much, if any, visibility right now in terms of what its sales will look like in 2016. Furthermore, unlike past quarters, there wasn't any mention of acquisition opportunities, suggesting it's just too tough to value acquisition targets right now. Instead, its near-term focus is on generating cash by continuing to push costs down to align with the current sales environment. That ability to generate cash will position the company to take advantage of opportunities when they arise, but also to pounce when the recovery comes by being able to quickly restock equipment inventories in order to fully serve its customers.

Investor takeaway
The oil market certainly hasn't shown any signs of improvement, and there's no near-term visibility that conditions will improve in 2016. That's forcing NOW to focus on what it can control, which are its costs and ability to generate cash so that it can be in a strong position to capture opportunities in the eventual upturn.