NOW Inc (DNOW) Q4 2018 Earnings Conference Call Transcript

NOW, Inc. (DNOW -0.34%)
Q4 2018 Earnings Conference Call
Feb. 14, 2019, 9:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants
  
  See all our earnings call transcripts.

Prepared Remarks:

Operator

Welcome to the fourth quarter full year 2018 earnings conference call. My name is Sylvia, and I will be your operator for today's call. At this time, all participants are on a listen-only mode. Later, we will conduct a question-and-answer session. If you have a question, please press *1 on your touchtone phone.

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

Dave Cherechinsky -- Senior Vice President, Chief Financial Officer

Welcome to the NOW Inc. Fourth Quarter and Full Year 2018 Earnings Conference Call. We appreciate you joining us this morning, and thank you for your interest in NOW Inc.

With me today is Robert Workman, President and Chief Executive Officer of NOW Inc. We operate primarily under the DistributionNOW and Wilson Export brands. And you'll hear us refer to Distribution NOW and DNOW, which is our New York Stock Exchange ticker symbol, during our conversation this morning.

Before we begin this discussion on NOW Inc.'s financial results for the fourth quarter and full year of 2018, please note that some of the statements we make during this call may contain forecasts, projections, and estimates, including, but not limited to, comments about our outlook for the company's business. These are forward-looking statements within the meaning of the U.S. Federal Securities Laws based on limited information as of today, which is subject to change. They are subject to risks and uncertainties, and actual results may differ materially. No one should assume that these forward-looking statements remain valid later in the quarter, or later in the year.

I refer you to the latest Forms 10-K and 10-Q that NOW Inc. has on file with the U.S. Securities and Exchange Commission for a more detailed discussion of the major risk factors affecting our business. Further information, as well as supplemental, financial and operating information, may be found within our earnings release, on our investor relations website at ir.distributionnow.com or in our filings with the SEC.

In an effort to provide investors with additional information relative to our results as determined by U.S. GAAP, you'll note that we also disclose various non-GAAP financial measures including EBITDA, excluding other costs; net income, excluding other costs; and diluted earnings per share, excluding other costs. Each excludes the impact of certain other costs and therefore has 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 2018 Form 10-K today and it will also be available on our website.

Now let me turn the call over to Robert.

Robert Workman -- President, Chief Executive Officer

Thanks, Dave, and good morning. I want to thank each of you for taking the time to join us today. As we mark the fiscal year end of 2018, we're encouraged that our energy and industrial distributor value is delivering strong topline, bottom line, and free cash flow results in a market that has seen, for the most part, an uneven recovery.

While there's been robust activity in the Permian, Rockies, Bakken and Midcontinent areas, the U.S. midstream market is struggling to keep up with record U.S. oil production levels from the U.S. shale producers, as well as Canadian midstream takeaway issues that persist, and what they still muted offshore deep-water recovery.

DNOW's full scope of products and services, kitted industry applications, and supply chain solutions provide our customers the ability to focus on extracting and delivering oil and gas to the market, as well as processing and distributing refined products in a reliable, safe, and cost-effective manner. We are uniquely positioned to help our customers reduce their total supply chain cost by offering a combination of models suited to each customer's requirements, where we provide application know-how, material availability, and quality products through our multi-channel engagement model. Our energy centers, are strategically located with inventory to meet our customers' demanding drilling and production schedules as well as gathering, and transmission midstream projects by leveraging our global sourcing and replenishment infrastructure that provides high product availability and choice.

Our supply chain services solution delivers value through a one-to-one integrated relationship partnering with the customer to drive efficiency, eliminate waste, and minimize capital. We manage key portions of our customers' supply chain, we often work alongside their personnel, on their premises to source goods and solutions from supplies, manage their warehouses and logistics, minimize product supply chain costs and risk, reduce their SG&A, and eliminate excess capital employed. We see customer value expand with our bundled offerings, where we provided kitted solutions of modular turnkey packages for rotating equipment, valve actuation, and process and production equipment from our process solutions group designed to meet customers' specific applications whether as a package, on a unit-by-unit basis, or for a full turnkey tank battery.

U.S. market leading indicators show some pullback in the fourth quarter, where WTI oil process peaked at $76.00 in early October, and fell to $45.00 by year-end. While, U.S. rig count averaged 1,072, up 2%, sequentially. Our goal of revenue per rig for the annualized fourth quarter was approximately $1.4 million per rig. We finished the fourth quarter of 2018, with a revenue of $764 million, up $95 million, or 14% year-over-year, down $58 million, or 7%, sequentially. U.S. fourth quarter revenue was up 19% year-over-year, surpassing U.S. rig count growth of 16%. Canadian fourth quarter revenue was up 4%, while Canada rigs declined 13%, and our fourth quarter international revenue was up 1% on a year-over-year basis.

Fourth quarter gross margins were up 140 basis points year-over-year, and 10 basis points sequentially, as we continue to experience the effect of Sections 232, 301, and tariffs impacting the price and availability of imports. While we still believe there are gross margin expansion opportunities, when oil prices increase, and market activity strengthens, continued expansion will be more difficult to realize unless we see continued topline growth, noting that realization will put us on a choppy, uneven path.

As a result of gross margin improvement, and strong operational execution, the year-over-year GAAP diluted earnings per share improved to $0.14, and diluted earnings per share, excluding other costs, improved to $0.11. EBITDA, excluding other costs to year-over-year revenue incrementals were 19%. Our execution in a challenging topline environment generated $75 million of cash from operations in the fourth quarter. Solid cash generation. U.S. drilled uncompleted wells or DUCs were 8,594 wells in December, up 31% year-over-year. DUCs, present a future revenue opportunity for DNOW, should the wells be completed, and should drop tank battery construction and gathering systems.

U.S. completions increased 2% sequentially, and 19% year-over-year, to average $1,277 for the fourth quarter. Our 2018 performance was a result of our employees' execution of our strategy to maximize our core operations, drive and retain margin expansion, leverage previous acquisitions, manage expenses, and approach capital allocation with discipline. With the continuing execution of these efforts, we can deliver the gains our shareholders expect, and made excellent progress throughout 2018.

In the area of operations, we continued to optimize our footprint and inventory, to capitalize on market opportunities as we scaled to meet market demand. We opened two new locations, and closed one location in the fourth quarter. During 2018, we optimized our distribution network by opening two strategically located regional distribution centers in the Bakken and Rockies. These new RDCs will help DNOW execute a more efficient inventory strategy, while improving our delivery capabilities to customers in the region. In the fourth quarter, we began converting an existing location in the heart of the Permian play, into a regional inventory location, with the goal of becoming a regional distribution center later this quarter, which will support numerous energy center and supply chain customer on site locations.

This investment further solidifies our long-term commitment to customers in the Permian, while providing our operations with more flexibility on inventory planning, or fulfillment strategies for staging and bundling, as well as logistics solutions for our customers. We continue to execute our human capital strategy in the Permian, and other high activity, low unemployment areas to strengthen our position, and gain market share by prioritizing, recruiting and training, relocating key personnel, and providing a safe, positive work environment based on our core values of accountability, doing what it takes, and caring about our coworkers, our customers, and our communities. Our strategy is paying off as we provide commodities, and focus on tank battery hook-ups, upgrades on existing batteries, pumping solutions for water transfer, produced water disposal, gas measurement, LACT, and vapor recovery units, and modular fabricated process and production equipment.

We are meeting a strong demand for gathering systems and midstream projects comprised of pipe high-yield fittings and flanges, large-diameter valves, and actuation, closures, pump packages, and fabricated equipment, such as pig launchers and receiver modules. We continue to manage product cost changes, and inventory mix related to Section 232, impacting steel products, Section 301, impacting Chinese manufactured goods, and components. And dumping cases related to certain imported pipe fittings and flanges through our strong relationships with suppliers. Cost changes are integrated into our pricing and quoting process when applicable. As evidence to our bottom line improvement, we're deploying technology to enhance our quote turnaround time, customer order process, fulfillment and delivery mechanisms.

Our cross-selling of products from acquired companies continues to bear fruit. The strong collaboration between U.S. energy centers, U.S. supply chain services, and U.S. process solutions is resulting a pull through sales, new customer introductions, increased market opportunities, and further market penetration.

Turning to our segments, U.S. revenues were $579 million, up $91 million, or 19% year-over-year, outpacing U.S. rig count growth of 16%, down sequentially $51 million, or 8%. Consistent with our guide for the fourth quarter, during our last call, seasonal realities, take-away capacity issues, commodity price declines, fewer business days, customer budget exhaustion, and extended holiday shutdowns, resulted in sequential topline decline beyond the normal seasonal adjustment. U.S. energy centers contributed 53 %. U.S. supply chain services, 32%. And U.S. process solutions, 15% of fourth quarter 2018, U.S. revenue.

The Permian continues to be the most active in areas of the Delaware and Midland basins, along with modest growth in the Midcontinent, Bakken, and the Rockies. U.S. energy centers was $307 million, up 20% year-over-year, while down $27 million, or 8% sequentially. Late, in the fourth quarter, we were able to secure our contract with one of the largest operators in the Permian that began bearing fruit almost immediately. Our sales and operations teams have been working tirelessly for years to win this account by out-servicing the competition when given the opportunity, targeting them with products they need that are exclusively distributed by DNOW, making joint sales calls with companies we have acquired, that have long-established commercial relationships with them, and by bundling solution offerings that our competitors can't provide from Odessa Pumps and Power Service. with the pipe valve fittings, and other products that are distributed by our U.S. energy centers. I can't express how proud I am of our teams that have been trying to win over this account. And I'm sure they're also happy that I can no longer bring this up during our sales strategy meetings.

As for U.S. supply chain, revenue was up 19% year-over-year, down sequentially, $13 million, or 7%. 2018 revenue, was primarily driven from central tank battery projects related to Greenfield, and enhanced oil recovery activity with our integrated customers. Where, DNOW is positioned as an integral part within their supply chain, by managing key aspects, and project management, procurement, sourcing, and inventory and warehouse management. Active areas include the Delaware Basin, and the Permian, The Bakken, the SCOOP, and STACK places in the Midcontinent, and the Gulf Coast. U.S. Supply chain customers saw year-over-year growth in 2018, with steel line pipe, vessel fabrication, kitted pipe valve, and fitting solutions, and electrical sales.

For U.S. process solutions, we saw 14% year-over-year revenue growth, down, sequentially, $11 million, or 11%. Our Process Solutions continues to gain momentum and market opportunities. During the quarter, we shipped a turnkey tank battery to the Delaware Basin. This order generated more than $3 million in revenue, and comprised of 5 ASME production vessels, 11 tanks, a water transfer pump unit, and pipe racks. Our strategy to grow market share for a fabricated process and production equipment business in the Permian is paying dividends as we receive orders from large and small, E&P independence, leveraging our Odessa pumps, supply chain services, and energy center relationships. We continue to plan with our mainstream customers, which enables us to invest in specific inventory in crude oil pump packages to meet customer demand for gathering and midstream projects.

As produced water becomes more of a target market for us, we are stocking saltwater disposal pump packages designed for water disposal and reuse application in shale plays along water companies or E&P operators, the ability to keep production targets by moving produced water to more distant disposal areas. The Permian, remained the most active region for U.S. Process Solutions, with the Bakken, Rockies, and Midcontinent area experiencing increased activity over the quarter.

Moving to pricing impacts, as reported, flats. Decreasing hot roll coal prices fell $100 per ton, or 12% by the end of the fourth quarter, and $172 per ton, or 19%, off its June 2018 peak, putting downward pressure on domestic welded pipe. As a response for our U.S. businesses, we continued to manage our domestic welded pipe replenishment strategy, and our on-hand inventory, by increasing our tariffs in order to minimize our exposure in a market with price deflation.

We have witnessed inflationary pricing on import valves due to Section 301, and are watching developments in this area. We are well-positioned through our domestic and international sourcing relationships to provide for the current demand.

Turning to our Canadian operations, revenue was up 4% year-over-year, at $88 million. Sequentially, revenue was down $5 million, or 5%, as the market continues to suffer due to a lack of takeaway capacity, and mandatory production cuts instituted by the Alberta government to offset rising crude inventory levels. Canadian rig count averaged 177, Down 15% sequentially, and down 13% year-over-year. Well spreads in the fourth quarter did decrease 27%, sequentially. The Canadian market outlook remains challenging. On January 29th, the Petroleum Services Association of Canada revised the forecasted number of 2019 wells to be drilled lower by 1,000 wells, or 15%, to 5,600 wells, a downward revision to their November 2018 forecast. Finding deteriorating investor confidence due to lack of access to markets beyond the U.S., delays in midstream takeaways projects, widening differentials, and political uncertainty.

Finally, the international segment reported 4Q revenues of $97 million, up 1% year-over-year, or up 4% year-over-year, when considering the $3 million of foreign exchange headwind, and down $2 million, or 2% sequentially -- or down 1%, when considering a $1 million foreign exchange headwind. As average international rig count of 1,011 was up 1% sequentially, and up 7% year-over-year. Total year international revenue was up 5%, versus 2017, and still up 5% when excluding the $2 million favorable foreign exchange against an average rig count increase of 4%.

Gains, were led by increased offshore activity in Europe, Asia, and Latin-America. We are receiving orders for jack-up rig load outs, as well as we experience a heightened level of jack-up rig readiness activity in Asia and Europe. The Middle East land activity remains steady.

Looking ahead, we're excited to see more jack-up and floater tenders materializing, continued increase in offshore activity in Europe, Asia, and Latin-America. Particularly, Norway, U.K, Mexico, Singapore, and Brazil, and what appears to be long-term plans for the continued buildup of LNG infrastructure, which would benefit DNOW due to the acquisition of MacLean. Our experienced U.K. management team is currently navigating the supply chain challenges related to Brexit, as the U.K. works toward an exit agreement with the E.U.

We are pleased with the results of 2018, given the volatile operating environment during the fourth quarter, and sharp pullback in commodity process by delivering solid bottom line fourth quarter results. Our employees continue to produce in what has been a unique, challenging, and uneven recovery that has required ramp-up in investments to support growth in certain areas along with further expense in working rationalization and others. We will continue down the path of aligning our business around the market dynamics and generating improved returns for our shareholders.

Before moving on to discuss the outlook for 2019, I'll turn the call over to Dave to review the financials.

Dave Cherechinsky -- Senior Vice President, Chief Financial Officer

Thanks, Robert. For the fourth quarter of 2018, we generated $764 million in revenue, up $95 million, or 14% from the same period in 2017. Full year 2018 revenue exceeded 2017, by $479 million, or 18% year-over-year. Sequentially, revenue declined $58 million, or 7%. Last quarter, we guided that seasonal third to fourth quarter revenue declines would be more pronounced than usual, due to our strong performance in 3Q, softening oil prices, and takeaway capacity issues occurring in Canada, and the Permian. However, oil prices fell further than expected, where WTI peaked early in the quarter, but plunged by year-end, spoiling the mood in the second half of the quarter. In the fourth quarter, gross margins reached 20.5%, our highest-level post-spin. We have experienced gross margin expansion for four quarters in a row, with gross margins up 140 basis points from the fourth quarter 2017, and up, sequentially, 10 basis points. This slight uptick in gross margin percent in the period can be attributed to lower inventory obsolescence charges, and increased better consideration contribution in the period, slightly more favorable than the unfavorable effects of price pressure in the fourth quarter.

As anticipated, product margins declined sequentially in 4Q18, in key product categories, as the spread narrowed on replacement costs, as replenished inventory arrived at costs closer to market price. Competitive pressure contributed to these declines as distributors were clinging to sales in the slow holiday months, in a period with sharp declines in oil prices. As we discussed, we believe there's room for gross margin gains over time, expanding generally in inflationary conditions, when oil and steel pipe inflation occurs, and our market expands further.

We expect gross margin turbulence in the near term as the market reacts to reduced activity levels in commodity price volatility. Warehousing selling and administrative expenses, or WSA was $135 million. In 2017 and 2018, we closed and consolidated approximately 45 locations. In 2018, foregone revenues from most closures amounted to approximately $90 million, when comparing residual 2018 revenues to 2017 for these closed locations. Closing those sites dampened the topline revenue growth, but enabled a healthier net debt position, free cash flow generation, and EBITDA flow-throughs for DNOW. These moves were intentional and reflective of the nomadic realities of our business: rigs move, completions are deferred, opportunities shift.

So, while we've always been great at scaling up in the growth market, we're now proactively mobilizing and following our existing, or finding new customers elsewhere when activity drives up. While we maintained some of those revenues from coverage by nearby locations, these measures allowed redeployment of $16 million in inventory, and reinvestment of $19 million of warehousing selling, and administrative resources into more lucrative areas. From this, we more than paid for nearly a dozen locations added in 2017, and 2018, while generating $42 million more in 2018 revenues from these new opened locations.

These actions are reflected in DNOW results. In 2017, while global rig count increased 27%, our revenues increased $541 million, or 26% with 32% EBITDA or revenue flow-throughs. In 2017, while global rig count increased 9%, our revenue growth doubled that at $479 million, or 18% with 21% flow-throughs. Two consecutive half-a-billion-dollar growth years. We are maintaining our guidance and expect WSA to be in the low-140s in the first quarter, driven primarily by the resetting of limit-based payroll taxes, coupled with favorable state, and local tax assessments, and bad debt recoveries from 4Q18 that are not forecast to recur.

Operating profit was $22 million, or 2.9% of revenue compared to break-even in 4Q17. Net income for the fourth quarter was $16 million, or $0.14 per diluted share, an improvement of $0.17 when compared to the corresponding period of 2017. On a non-GAAP basis, EBITDA, excluding other costs was $31 million, or 4.1% of revenue for the fourth quarter of 2018. Net income, excluding other costs was $11 million, or $0.11 cents per diluted share. Other costs after tax for the quarter, included the benefit of approximately $5 million from changes in evaluation allowance recorded against the company's deferred tax assets, offset by less than $1 million in severance expenses after tax, in the period. Our effective tax rate as reported for GAAP purposes was 10.7% for 2018. In 4Q18, we continued to evaluate the provisions of a tax cuts and JOBS Act, as well as all interpreted guidance issued to-date. We completed our accounting for the enactment date effects of the law.

Cash, totaled $116 million at December 31, with $95 million located outside the U.S., nearly half of which is in Canada. Historically, it's been our practice and intention to reinvest earnings of our foreign subsidiaries. In light of the significant changes made by the tax cuts and JOBS Act, as of year-end 2018, we are no longer permanently reinvested with regards to our pre-2018 Canadian and U.K. earnings. We intend to repay, create excess cash from both Canada and the U.K., to the U.S., in the future, providing additional treasury flexibility including repayment of amounts borrowed under our credit facility.

Moving to our segments. U.S. revenues were $579 million, a 19% improvement from the fourth quarter of last year. On the continued billed and U.S. rig activity. Canadian revenues, were $88 million, up 4% year-over-year, despite declines in Canadian rig count, and increased customer participation in the Canadian oil sands. Internationally, revenues were $97 million in the fourth quarter of 2018, up $1 million from a year ago, driven by increased customer projects, offset from unfavorable foreign exchange.

Moving on to operating profit. The U.S. generated operating profit of $17 million, or 2.9% of revenue, an improvement of $18 million when compared to the corresponding period of 2017. Primarily, due to significant revenue increases, and improved pricing assisted by commodity inflation. Canada operating profit was $4 million, or flat, when compared to the corresponding period of 2017. International operating profit was $1 million, or up $4 million when compared to 4Q17, driven by improved pricing.

Turning to the balance sheet, cash totaled $116 million, December 31, and we ended the quarter with $132 million borrowed under our revolving credit facility, and a net debt position of $16 million, when considering total company cash. At December 31, 2018, our total liquidity from our credit facility availability, plus cash on-hand was $501 million. Our debt-to-cap was 10% at December 31, or 1% when considered on a net debt basis. The fourth quarter 2018 marked the lowest net debt position for DNOW in seven quarters. Working capital, excluding cash as a percent of revenue remained steady, sequentially, at 21.7%.

Accounts receivable were $482 million at the end of the fourth quarter, down $77 million sequentially. And our DSOs improved to 58 days. Fourth quarter inventory levels were $602 million, and term rates declined sequentially to 4, in the fourth quarter. Accounts payable were $329 million at the end of the fourth quarter, with days payables, outstanding, and 49 days. Net cash provided by operating activities was $79 million for the fourth quarter, with capital expenditures, primarily in the U.S. Permian of approximately $6 million, resulting in $69 million pre-cash flow in the quarter.

Given the volatility in the market, the significant lack of clarity in terms of how budgets ultimately get set in how this year plays out, we will stay alert and responsive. There is an inherent headwind after marching forward all year with gross margin gains as price inflation eases to more normalized levels. We will move steadfast to improve working capital in operational efficiencies in the periods ahead.

And now, I will turn the call back to Robert.

Robert Workman -- President, Chief Executive Officer

Thanks, Dave. Let's wrap up with outlook for 2019. Looking forward, in the U.S., as customers take a more cautious approach to CapEx budgets and spending levels in response to continued volatility in crude oil prices, drilling activity levels are expected to decline. However, if budget shifts from drilling wells toward completing DUCs, the investments we made in Power Service and Odessa Pumps, from modular rotating production and process equipment may continue to bear fruit and be able to offset declines in other areas of our U.S. business.

In Canada, where political turmoil and takeaway issues for which there aren't any solutions in sight, 2019, will be challenging, and we expect declines there. Outside of these segments, we have some bright spots [audio skip] with an offshore drilling contractor in Asia, the LNG market, and other projects in the Middle East that should enable our international business to grow, year-over-year when compared to 2018. In these scenarios, these could result this could result in flat year-over-year revenues to a decline in the low single digits. We expect 1Q19 revenue to increase sequentially in the low to mid-single-digit range, with gross margins being flat-to-down modestly, and WSA returning to the low-140s. The challenges will be to combat gross margin pressure. This will be difficult due to the competitive pressures that come with a flat market environment.

Before I move on to recognize one of our dedicated employees, I'd like to summarize the progress we've made in the execution of our strategy. We continue to focus on margin discipline, identify opportunities for enhancement in areas related to our quotation process, as well as pricing. Improving our operating efficiencies, optimizing our inventory and our sourcing strategy in response to Sections 232, 301, and import tariffs on steel products, and leveraging our previous acquisitions through enhanced cross-selling of products, and bundled product, and service offerings. We are adjusting our footprint and our supply chain in line with customer demand, and optimizing our human capital, replenishment strategy, and supply relationships. We approached capital allocation with discipline, by leveraging our inventory investment, maintaining our working capital as a percent of sales with a sequential decline in revenue, generating cash, paying down debt, and maintaining a pristine balance sheet that would give us optionality in the event that one of the many companies we'd like to add to our differentiated product and service offering becomes viable. With the further successful execution of our strategy, we expect continued improvement toward generating free cash flow, and greater shareholder value.

With that, let me recognize one of the employees whose daily hard work and dedication enable us to deliver on our promises. After 44 years of service, Wayne Alloman, has spent most of his tenure with DNOW, increasing the productive life of Texas Oil Wells, by applying the use of artificial lift technology, and solving customer problems. Today, Wayne works as an artificial lift coordinator, managing our artificial lift pump shop, in Sundown, Texas. In February, 1975, Wayne started his career with Continental Emsco Company, as a storeman, in McCamey, Texas, not far from my hometown of Crane. Longing for the Piney Woods of East Texas, Wayne notified his regional manager that he'd be interested in working in East Texas. But a year later, he was promoted to pump shop specialist, and moved to the less piney, Sundown, Texas, and eventually became pump shop foreman. In 1999, Continental Emsco was acquired by Wilson supply, which was acquired in 2012, in part of the successful spinoff of DNOW, in 2014, from NOV.

For the past 11 years, Wayne has relished the role of artificial lift coordinator, as he states the best part of his job over the years is helping as many customers resolve problems in the field. Wayne, has called Sundown home for many years, where he and his wife, Patty, raised two daughters, and are now enjoying the privileges and pleasures of being grandparents. Wayne, has no plans of retiring any time soon, as he loves his job, and enjoys working with customers. However, he is still open to considering a transfer to East Texas. Wayne, thanks for your loyalty, dedication, and service to DNOW over 44 years. Like many of our hardworking employees, we, too, enjoy solving our customers' problems, one well at a time.

To our employees around the world, we thank you for your passion and talent, helping DNOW deliver an impressive $1 billion in revenue growth over the past two years, where operating expenses actually declined.

...

Now, let me turn the call over to Sylvia, to start taking your questions.

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. If you have a question, please press *1 on your touchtone phone. If you wish to be removed from the queue, please, press the #. If using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, if you have a question, please press *1 on your touchtone phone.

Our first question comes from Steve Barger, from KeyBanc.

Steve Barger -- KeyBanc Capital Markets -- Analyst

Hi. Good morning, guys. I'll start with the outlook commentary on the flat-to-slightly down revenue. Can you give some more detail around any macro factors that'll drive results higher or lower? What's in your forecast for price versus volume, and where you see your biggest commercial opportunities to outgrow?

Robert Workman -- President, Chief Executive Officer

We're just basically planning our business around what's been announced already by customers, and drilling contractors, and the rest. We're not planning any pricing to drive revenue improvement. It's all about outperforming in markets where there's opportunity to offset areas where we're going to have some softness, simply because of activity level.

Canada, is going to be down. International, is going to up. And we hope, the U.S., is up slightly, which if that all happens that way, we'll have a flattish year, year-over-year. Now it won't be flat quarter-over-quarter, or year-over-year, we're going to have some differences there. But on a year-over-year basis. That's what we're expecting based on: customer budget announcements, what the current rig counts are doing, what customers are saying they're going to do in 2Q, and beyond. So, we're just planning around their announcements.

Steve Barger -- KeyBanc Capital Markets -- Analyst

And in terms of change of the sentiment, in terms of what might happen, is it strictly just oil prices in the U.S.? Or what would cause your forecast to end up looking conservative?

Robert Workman -- President, Chief Executive Officer

It's really the whole process. I mean, customers set their budgets based on their own oil price forecast. They're all trying to live within their cash flow right now, so they estimate their cash flow based on the barrels they're going to produce, and the price of oil they're assuming. If the price of oil changes, then obviously, they can be more active, and produce more volume and still live within their cash flow. So, really, they would know more than we do what their plans would be if it's not consistent with what they stated publicly already.

Steve Barger -- KeyBanc Capital Markets -- Analyst

And really impressive free cash flow for the year. In a growth environment, if revenue is down low single digit next year, what happens to working cap and free cash flow? Can that improve from 2018 with what you expect for mix?

Dave Cherechinsky -- Senior Vice President, Chief Financial Officer

Yeah. I think, if we saw a flattish year, or a little bit of a decline as we said was possible then, I think we'd see free cash flow similar to 2018, maybe better. Our focus is going to be on strengthening our position in markets where we're very strong, like the Permian, gaining market share, defying gravity on price. In a market, where things kind of slow down, it's hard to grow product margins and thus gross margins. So, we're really going to be focused on the highest possible price, the highest margin customers, highest margin product lines, while getting more efficient in the business, which we've done a fabulous job doing. So, that free cash flow number could be similar to 2018, maybe better, depending on gross margins, and inventory turn rates and receivables, which we're getting better at. So, I feel pretty good about that.

Steve Barger -- KeyBanc Capital Markets -- Analyst

Yeah. And obviously, the balance sheet is in terrific shape, so tons of flexibility there. Thinking about that, can either of you expand on the statement that was in the prepared comments, or the press release about allocating capital, differentiate from competitors? What are you thinking about there? What should we look for?

Robert Workman -- President, Chief Executive Officer

Well, we made several acquisitions in the depth of this downturn, 15 and 16-ish timeframe that are bearing fruit right now. And the reason we made those acquisitions during that period of the market was because that's the only place where we can actually make sense out of the bid-ask spread. So, the reason you haven't seen them as of late, is everybody's got a lot of optimism around where the market was heading, and kind of wanted to wait it out to see if their businesses wouldn't be worth a lot more. Companies like Odessa Pumps, and Power Service, and MacLean, I mean, if we could find more of those that would fit geographies where we currently don't have those solutions at valuations, that make sense to our shareholders, we would do those. So far, they haven't because, we've been in, kind of, in a positive environment, which is typically not our sweet spot in getting valuations that generate good returns.

Steve Barger -- KeyBanc Capital Markets -- Analyst

Got it. Thanks. I'll jump back in line.

Operator

Our next question comes from David Manthey, from Baird.

David Manthey -- Baird -- Analyst

Hey guys. First off, WS&A, came in lower than your expectations. Could you talk about the components of that outperformance? You mentioned bad debt recoveries. But were there other components that made up that better-than-expected outcome?

Dave Cherechinsky -- Senior Vice President, Chief Financial Officer

Bad debt was one of those things. We resolved some long, outstanding state and provincial products, and those ended up being favorable to us in the period because, revenues dropped, our commissions were down, considerably. And then, we had the non-recurring lease exit costs from closures in prior quarters, which kind of drove that difference. So, very, very nice decline, sequentially. And in the first quarter, we'll see payroll taxes in the early part of the year increase. We won't see the recurrent in some of those favorable events I talked about.

David Manthey -- Baird -- Analyst

Right, thank you, for that. Second, with all the talk about takeaway capacity in the Permian, and this Kinder Morgan Gulf Coast Express, expected to come online in October, is it your expectation that you'll see an uptick in completion after that happens? Or is there some lead time there? Any indication that you're getting from your customers in terms of when the completions might start to happen in the Permian, relative to that increased capacity?

Robert Workman -- President, Chief Executive Officer

Several of our largest customers aren't having takeaway issues, specifically, the ones that are in our supply chain services group because, they did a really good job of hedging. It's the other customers, mainly in our energy center business, where they were more hesitant to hedge, that are now having trouble getting their product to market. And there's no doubt that their plans currently at mid-$50-oil is what they're saying.

Now, mind you, they say the same thing to me that they say to the rest of the world, but if they follow through with what they're saying publicly, that even though their budgets are going to be down, 19 versus 18, they plan to shift a heavier portion of their total budget toward starting working through their DUCs. If they do that, that's good. That's good for DNOW. So, that's what they're saying at this point. We'll see where it goes from here. I, typically am surprised every quarter. I don't know why, but when a customer says they're going to do one thing and do something different. But that's currently what they're out there saying to the market.

David Manthey -- Baird -- Analyst

Got it. Thanks, very much.

Operator

Our following question is from Ryan Cieslak, from Northcoast Research.

Ryan Cieslak -- Northcoast Research -- Analyst

Hey, good morning, guys. I wanted to go back, and ask a fast question about gross margins, if there's a way maybe to quantify or directionally provide some color on how much of a benefit stronger pricing was to gross margins for you guys in 2018. It sounds like certainly, there's some emerging pressure there, or competition. So, if we assume maybe a flat-to-down year for pricing in 2019, what's the potential headwind we should be thinking about with regards to product margins in 2019 for you guys?

Dave Cherechinsky -- Senior Vice President, Chief Financial Officer

In terms of the 2018 benefit from product margins, easily, was 100 basis points, maybe even higher than that. I think we ended last year, 4Q18, for example, we had 19.4% gross margin -- 2017, I'm sorry. So, maybe it was in the 100 basis points, or maybe even a little lower because, we had some other favorable lower inventory charges for the full year, and that kind of thing. In terms of 2019, in a flat-to-slightly down environment, keeping that number where it's at today, 20.5, it's going to be harder to do because, in the quarter of 4Q18, we had a few favorable events, lower inventory charges, higher supplier rebates. So, that won't recur. So, it's a matter again, of a focus by our teams, of favoring higher margin transactions, and keeping on that track. But I expect gross margins to be flat-to-down in line with revenues. How much that'll be, we won't know.

Robert Workman -- President, Chief Executive Officer

Ryan, we've been saying that now, I think, 3 quarters in a row, and it's never happened, yet. The main reason is because, generally, when we give expectations for gross margins, we generally huddle around what we think base margins, product margins are going to do. So, if we think the product margins are going to come down in a really competitive environment, then we generally say we expect gross margins to come down with it. We've had product margin declines several quarters in a row, now. It's just that all the other items in our gross margin bucket more than made up for it.

Ryan Cieslak -- Northcoast Research -- Analyst

That's fair. Just sort of coming off that question, then, sales just are potentially down year-over-year, in 2019, slight, low, single digits. What are the other opportunities you might have outside of product margins, with gross margins, and any cost levers that you have that can support EBITDA levels? Or it may be the right starting point to be thinking about EBITDA is actually declining something similar to the guide you gave the topline? How do we think about year-over-year EBITDA this year, considering the topline guidance?

Robert Workman -- President, Chief Executive Officer

Based on a softening market in the U.S., and a definitely softening market in Canada, our internal goal that we're trying to hold ourselves to is to not have it negatively affect our income statement next year. So, we're internally holding ourselves to the challenge of revenue and EBITDA not declining in a declining market. In a market, when Canada is going to really not go the right direction, unless somebody pulls off a miracle up there. So, if that means that gross margins get pulled back some, and we have to get more efficient to get the same EBITDA value, then that's what we're going to do.

That's generally where we're headed. Again, competitors get pretty scrappy struggling for market share, when there's no more market growth going on. So, we'll win our fair share of those battles. I feel confident that our team will produce results that don't miss people's expectations. But it will be a more difficult year in 2019, than 2018 to maintain the gross margin percent, and expense levels we have simply because, in that kind of environment, the competitors get pretty heightened around going after things they didn't before.

Dave Cherechinsky -- Senior Vice President, Chief Financial Officer

We see revenues stabilize or decline slightly; we're going to focus on free cash flow, and in turning our balance sheet appropriately, and be more efficient in the business. Given the guidance we've given today, we see the contours of 19 being similar to 18. Things could change. Oil prices are up 20% from where they land at the end of the year. We could see oil prices come back, and sentiment improve. We haven't built that in our numbers. But we're focused on free cash flow to the extent growth becomes flat.

Ryan Cieslak -- Northcoast Research -- Analyst

My last question, and I'll get back in the queue. What are you assuming for orders for the full turnkey package and process solutions in 19 versus 18? It seems like you had some incremental momentum there, the last couple of quarters, which is great to see. Any metrics you can provide that highlight maybe the oil momentum going in to 19? Is this how we should be thinking about the traction with that business over the next couple quarters? Thanks.

Robert Workman -- President, Chief Executive Officer

In a scenario where we provide the whole kit to attain battery, I suppose it is different, individuals components, we clearly have a bigger revenue stream on that particular tank battery. It's nice to see that we're able to secure one in the Permian; recently. And that particular customer, once they went through the experience with us on that full turnkey package, has already placed orders for more. So, we expect certain areas of our business to decline, and I would imagine, just general activity declines will affect our energy center business the most because, they're out there fighting day-in and day-out, to win every order. There's really no differentiator between them and the competition, other than our service levels, and our relationships. That's where we're going to feel the pinch in a declining market. Our expectation is that the midstream market, and the process solutions kitted packages will be the revenue growth that would help offset those declines and let us grow in a down market.

Ryan Cieslak -- Northcoast Research -- Analyst

Thanks, guys.

Operator

Our following question comes from Sean Meakim, from JP Morgan.

Sean Meakim -- JP Morgan -- Analyst

Good morning. You noted that you expect, or that you hope the U.S. will be flattish, more or less, in 19. Can you talk a little bit about your customer mix in the U.S. across the majors, public independence, and maybe smaller private ones? And how you expect those budgets to look year-on-year, and how that kind of builds up to maybe a flattish result, overall?

Dave Cherechinsky -- Senior Vice President, Chief Financial Officer

So, I don't think customer budgets will deliver the flattish results. I think, it's growth in our production group -- our process solutions group, and in our midstream group, is going to help offset declines across all those customers you just mentioned. However, we have several majors that are at our Top 5 accounts. Some of those majors, have announced CapEx improvements or increases for this year. But then, we have a whole bunch of independence, say, smaller than -- the Anadarkos and down, they're announcing CapEx budgets that are way lower. So net-net of that, we expect, we'll translate into rig count and completion activity, and current forecast across the industry for rig count and completion activity is to be down, year-over-year.

Now, we hear a lot of people talking about second half improvements in those areas, but net-net on a year-over-year basis, it's going to be down according to everybody's forecasting. We have some big accounts. I think you know OXY, is one of our biggest accounts. They're going to be busy, but we have a bunch of other great accounts that are not going to be as busy, and they've already started laying down rigs. They've already announced it. I think, net-net, on the whole, our daily revenue with those operators is going to be down slightly. And the hope is, offset by increased midstream work that we've already got under way, and more success in our Process Solutions group in penetrating those markets, where we were selling this kit into the Rockies, almost 90%-something of all the kits went to the Rockies. I'll bet that went to 10% outside the Rockies, the year before last. It probably went up to a little over 20%, outside of the Rockies in 2018. I'm expecting the same kind of trend for 2019 as we're more successful in penetrating these accounts with a solution that our competitors don't provide.

Sean Meakim -- JP Morgan -- Analyst

Right. That's helpful. One piece of that, if you would mind. Looking across Process Solutions, energy branches, the U.S. business, what would you say your customer mix looks like across those three buckets of customers?

Dave Cherechinsky -- Senior Vice President, Chief Financial Officer

Well, we report that out as upstream, midstream. Then, our supply chain services, has got our downstream business in it, and our upstream. I don't know the exact number because, the issue is, like, I was just walking through our warehouse a few minutes ago -- not few minutes ago, but earlier this morning. And we had some huge valve and valve actuation packages that are sitting there, that are being build to an operator. Well, they are clearly not going to go to the operator's upstream business; they're going to go to the operator's downstream business. So, if you run that query in a SAP, to figure out what revenue is going upstream versus midstream, that's going to show up in the upstream bucket, even though it's going to a downstream project because, that particular customer code is designated as upstream.

So, that's why we report upstream, midstream as a collective unit. Then, if you think about other people consider down-midstream to be like the gas utilities and things of that nature. We don't pull that up in our upstream-midstream bucket; that's in our downstream business. So, I can't give you an exact number of what's exactly upstream, and what's exactly midstream. I can tell you, if I only measure revenue, we're the only people like Williams, and Enlink, and Energy Transfer, and Howard Energy, and all those pure midstream players, it's mid-teens-percent of our entire U.S. business. But when you add in all the midstream work that goes into OXY, or Devon, or something like that, it's up, well over 20. But I don't have an exact number.

Sean Meakim -- JP Morgan -- Analyst

Fair enough. So, on WS&A, you talked about it a good bit, but the $135-number has some seasonality; some one-time benefits. Low-40s for 1Q, has some transitory seasonal impacts there. It seems like topline is going to be down, quarter-over-quarter. What's the normalized level to think about for 2019, if revenue ends up, let's say, flattish-to-slightly down, like you expect? Then, what are the flex points around that normalized? So, if sales underwhelm, can you flex at low-30s just on lower commissions? How do we think about what's normalized, and how can you flex around that?

Robert Workman -- President, Chief Executive Officer

I'll speak to the first quarter. We expect WSA to be in the low-140s. Now, if things were to slow down, then we would work toward bringing that number toward the high-130s. We would make adjustments to get there. Now, if it's down, low, single digits, it could still end up being a 140-quarter, low-140s. Because, we want to seize the recovery, or the resumption in growth, when it happens. Yes, we could bring it below 140, if we have to, if we see a decline worse than what we're guiding to.

Dave Cherechinsky -- Senior Vice President, Chief Financial Officer

And Sean, the folks that make the biggest impact on gross margin percent and expenses, are clearly the people out, on operations that are running the branches, and all of our operations. They're heavily incented, based on the where the revenue goes to maximize gross margin percent, and reduce expense, of percent of revenue because, that improves their bonus. So, this is a pretty self-adjusting model where, if they don't focus on those things, they're hurting their own pocket.

Sean Meakim -- JP Morgan -- Analyst

Got it. If I could, just one more thing on working capital, 22% of sales again, this quarter. Obviously, very good, targeting the same, in 19. If you had to say 22% in 19, revenues down, slightly, just to verify, that means you'd expect it on net working capital would be a source of cash this year? Can you get that number below 20%? Is there anything else that you guys -- Dave, you, kind of have up your sleeve, in terms of how you can drive further capital efficiency with that part of your balance sheet?

Dave Cherechinsky -- Senior Vice President, Chief Financial Officer

Your point is a good one, Sean. If we did see revenues decline, we would generate more cash from working capital. I do think there's room for improvement there. We have a build-in inventory at the end of the year, and things are kind of softening at the early part of 2019. So, I think we can trim some inventory there, and the same with receivables. So, we're striving to get to a five-turn on working capital. You know, we want to get to 20%. Whether we'll do that or not, remains to be seen. But I think, if things were to go below flat growth, then we would see improved free cash flow in 2019.

Sean Meakim -- JP Morgan -- Analyst

Very helpful. Thanks a lot.

Operator

Our next question is from Nathan Jones, from Stifel.

Nathan Jones -- Stifel Nicolaus -- Analyst

Beautiful, as usual. Maybe, back to the WSA line, here, a little bit. I know we spoke before, Robert, and you said that that number should be under 15% of revenue. I know revenue is tough to predict for full year, so let's just say it's flat for 19. You're going to still be sitting fairly significantly above that. If revenue kind of stayed around this level, you'd need to be down around 120. It doesn't sound like you've got any intentions of cutting that kind of cost out of the business at the moment. Which, makes me think you're a bit more confident in the long-term and maybe 2019 is a bit more of a pause. If it became evident, let's say that, revenue wasn't going to pick back up in 2020, what kind of actions could you take to drive that WS&A number down to get that kind of 15% of sales on this kind of revenue level? Or do you need volume in order to get that down further?

Robert Workman -- President, Chief Executive Officer

If you look at businesses... on how many profit centers and facilities we have -- but if you look at those businesses in areas where activity is, I would call, mid-cycle. Not peak. Not bottom. Not valley. Just mid-cycle. We're managing expense-to-revenue in that range. It's the areas where that hasn't recovered yet. For example, 22 countries that aren't in the Canada, or the U.S., they're still waiting for the offshore to come back. We all know that's coming back because, if I get the FID started, there's already been awards going to drillships, and semisubmersibles, and jack-ups.

So, it's not a question of that market coming back. It's question of when, not if. I think it would be insane for us to say we've got to get revenue to 14% of revenue -- expenses, 14% of revenue and then go shut down 21 countries. So, I'm going to wait that out. They're not losing money. They're prepared to take share when the market comes back. We'll be the only ones there because our competitors couldn't survive it because, they didn't have the balance sheet to support it. Our expense-to-revenue ratio should be in that number you just described. But that's when all of our businesses are performing in a mid-cycle market. A bunch of them have recovered from the depths of the downturn, to almost mid-cycle kind of areas, and we're still waiting on another couple of customer segments to recover. It's not a big roll of the dice; it's clear that it's coming back.

Dave Cherechinsky -- Senior Vice President, Chief Financial Officer

Hey, Nate, this is Dave. I would add that, 19 could be seen as a pause in your example. If you look at 2017, we grew our revenues by $541 million; didn't add any expenses to the business. If you look at 2018, we grew our business by almost another half a billion; didn't add any expenses. So, if things slow down, or stabilize like this, we would do some more retooling. We don't expect that on a long-term basis. Our current guide is as of today, and things could change. I see this more of a pause than the new normal.

Nathan Jones -- Stifel Nicolaus -- Analyst

That's helpful. The comments on offshore are helpful, too. I know you've been carrying costs there that will leverage extremely well when that market comes back. I know when we were talking about this last year, Robert, your idea was that maybe it was late-2019, but more likely, it was going to be sometime early 2020, when you start to really see that recovery kick back in. Price dropped $20 a barrel from a peak of $85. How does that change your outlook for a recovery in offshore? Does it push it to the right a little bit? Do you still think that that recovery occurs with the same veracity at $65, than it would've at $85? Any color you can give us there?

Robert Workman -- President, Chief Executive Officer

The offshore market for DNOW is the longest cycle business we have. If you remember, back in 12, 13, and 14, when offshore was really busy, and the market went down hell in a handbasket, in a heartbeat, you didn't see that same kind of reaction immediately in the offshore market because, you don't just pull a drillship out to offshore, in Nigeria. And then, the oil prices go to $45 and then, you just stop drilling the well. You can do that in the Bakken; you can lay the rig down. But you're not going to do that when you have a contract on a drillship. So, it was really slow for customers to cut back in that area. That's why production took so long to start declining offshore because, they had to finish the projects they were already on.

Once you start a project, you finish that project. The good news is, people are starting projects, right now. They're awarding contracts to drillships, and semis, and jack-ups, right now. So, I don't think volatility in oil price is going to affect what we know is coming at least from the contracts that have been led already. We have some pretty cool stuff going on in Singapore right now, with a relationship we have with the drilling contractor, we're loading out all of their onboard stores. Which, will take quarters, and quarters to get completed. So, we've got some good, positive news coming from offshore, finally. I think it will only get better, from our international segment.

Nathan Jones -- Stifel Nicolaus -- Analyst

That's good news. Thanks, I'll pass it on.

Operator

Our next question is from Marc Bianchi, from Cowen.

Marc Bianchi -- Cowen & Co. -- Analyst

Thanks. Good morning, guys. Just one left, for me. On the guide here, for first quarter, in terms of the revenue progression, just curious what you've seen on the ground thus far, in the first quarter, and how that kind of shapes up relative to the guide you're providing for the whole quarter?

Dave Cherechinsky -- Senior Vice President, Chief Financial Officer

I think, so far, what we're guiding to the first quarter relates to what we're hearing from customers. I don't really want to speak to what's transpired so far. But we went into the fourth quarter, and came out of the fourth quarter with kind of a depressed mood, in terms of opportunity. But oil prices are coming back; sentiment could change. Really, what we're hearing is what customers are announcing in their budgets, and their actual results, and that's how we're kind of shaping 2019, and the first quarter, in particular. It's a matter of what's going to happen out in the marketplace. But we don't really want to get too much --.

Robert Workman -- President, Chief Executive Officer

Just to be blunt, Marc, clearly, we're looking at the numbers. We wouldn't guide to something in 1Q if the numbers didn't suggest that's where we're headed.

Marc Bianchi -- Cowen & Co. -- Analyst

No, certainly not. I think the question's really coming from, there was a big fall-off in completion activity toward year-end. We've heard that from a number of the pressure pumpers, and there's kind of a variety of what people are seeing thus far, in the quarter. Some, have said things have bounced back pretty hard. Some, have said it stayed pretty flat with the exit rate. I'm just kind of wondering, from your vantage point, what you've seen on that end, and kind of how that's expected to progress throughout the rest of the quarter.

Robert Workman -- President, Chief Executive Officer

We're seeing what you just heard. We're seeing completion activities softer, right now. Not dramatically softer, but definitely, softer than it was 60-90 days ago. But our business is, although, completions are extremely important, and rig counts are extremely important to this business, as evidenced, by plotting our revenue against either one of those 2 indices, we have a lot of other stuff going on in the business outside of those 2 items that give us confidence in the guide we just gave on the call, regarding what we expect sequentially to happen on the topline 4Q to 1Q.

Marc Bianchi -- Cowen & Co. -- Analyst

That makes sense. Thanks a lot, Robert, I'll turn it back.

Operator

I will now turn the call over to Mr. Robert Workman, CEO, and President, for closing statements.

Robert Workman -- President, Chief Executive Officer

Thanks, Sylvia. Thanks, everyone on the call: employees, and shareholders, and our analysts, for taking the time to listen to us today. We look forward to the call 90 days from now.

...

Operator

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

Duration: 62 minutes

Call participants:

Dave Cherechinsky -- Senior Vice President, Chief Financial Officer

Robert Workman -- President, Chief Executive Officer

Steve Barger -- KeyBanc Capital Markets -- Analyst

David Manthey -- Baird -- Analyst

Ryan Cieslak -- Northcoast Research -- Analyst

Sean Meakim -- JP Morgan -- Analyst

Nathan Jones -- Stifel Nicolaus -- Analyst

Marc Bianchi -- Cowen & Co. -- Analyst

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