DNOW - Q1 2023

Transcript

Operator (participant)

Good morning, afternoon, evening. My name is Bhavesh, and I'll be your conference operator today. At this time, I would like to welcome everyone to the NOW Inc. First Quarter 2023 Earnings Conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. If you would like to ask a question during this time, simply press the star followed by the one on your telephone keypad. If you would like to withdraw your question, please press the star followed by the one again. Thank you. Mr. Brad Wise, Vice President of Digital Strategy and Investor Relations, you may begin your conference.

Brad Wise (VP of Digital Strategy and Investor Relations)

Thank you, Bhavesh, and good morning. Welcome to NOW Inc.'s First Quarter 2023 Earnings Conference call. We appreciate you joining us, and thank you for your interest in NOW Inc. With me today is David Cherechinsky, President and Chief Executive Officer, and Mark Johnson, Senior Vice President and Chief Financial Officer. We operate primarily under the DistributionNOW and DNOW brands, and you'll hear us refer to DistributionNOW and DNOW, which is our New York Stock Exchange ticker symbol, during our conversation this morning. Please note that some of the statements we make during the call, including responses to your questions, may contain forecasts, projections, and estimates, including but not limited to comments during 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 May 4th, 2023, which is subject to change.

They are subject to risks and uncertainties, and actual results may differ materially. No one should assume these forward-looking statements remain valid later in the quarter or later in the year. We do not undertake any obligation to publicly update or revise any forward-looking statements for any reason. In addition, this conference call contains time-sensitive information that reflects management's best judgment at the time of the live call. I refer you to our latest Form 10-K and Form 10-Q that NOW Inc. has on file with the U.S. Securities and Exchange Commission for a more detailed discussion of the major risk factors affecting our business. Further information as well as supplemental financial and operating information may be found within our earnings release on our website at ir.dnow.com or in our filings with the SEC.

In an effort to provide investors with additional information relative to our results as determined by U.S. GAAP, you'll note that we also disclose various non-GAAP financial measures, including EBITDA excluding other costs, sometimes referred to as EBITDA, net income attributable to NOW Inc. excluding other costs, and diluted earnings per share attributable to NOW Inc. excluding other costs. Each excludes the impact of certain other costs and therefore have not been calculated in accordance with GAAP. Please refer to a reconciliation of each of these non-GAAP financial measures to its most comparable GAAP financial measure in the supplemental information available at the end of 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 first quarter of 2023.

A replay of today's call will be available on the site for the next 30 days. We plan to file our 2023 Form 10-Q for the first quarter today, and it will also be available on our website. Now, let me turn the call over to Dave.

David Cherechinsky (President and CEO)

Thanks, Brad, good morning, everyone. I'm proud to see the results of our talented team produced again this quarter as we kick off the year outperforming the sequential revenue guide provided on our last earnings call despite weather-related activity declines, reduced U.S. rig counts and completions, and lower oil and gas prices. The discipline we've maintained as we execute our strategy continues to be constructive to earnings, most recently propelled by our international segment that delivered strong growth in the first quarter with its best quarterly revenue growth percentage sequentially and year-over-year in more than a decade. We had good growth across all three segments, marking the best first quarter EBITDA results since spinning off in May of 2014. Our achievements across the globe are a result of the smart planning, communication, focus, and discipline by our employees.

It's a testament to the hard work and dedication of our team, and I'm grateful for their efforts to deliver success. Regarding capital allocation, we continue to make strategic inorganic investments to fuel growth through acquisitions while opportunistically repurchasing shares. By balancing these two approaches, or even better, pursuing both, we aim to drive sustainable long-term value for our shareholders. In an effort to further bolster our U.S. Process Solutions business, earlier this week, we acquired two U.S. businesses for $33 million, which expand manufacturer territorial exclusivities for key products and provide enhanced revenue opportunities with our existing DNOW customers in those areas. These new territories are adjacent to DNOW's other existing agreements, widening our geographic reach and deepening our products and solution offerings into the downstream refining and industrial markets.

I'm excited to welcome the employees joining the DNOW family and look forward to the growth we can cultivate together. We also continue to return value to shareholders through our $80 million share repurchase program. During the quarter, we were active in the market as we purchased 3.3 million shares amounting to $36 million. Through the end of the first quarter, we have consumed 53% of the authorized $80 million repurchase program. I'll hit some of the financial highlights. First quarter revenue was $584 million, sequentially higher by 7% on better-than-expected international growth of 28%, Canada was up 11%, and the U.S. grew 3%, primarily attributable to the December acquisitions. On a year-over-year basis, revenue is up $111 million or 23%, outpacing the 15% year-over-year increase in global rig count.

1Q 2023 gross margins were 23.5%, lower sequentially as expected, primarily due to dilutive project margins. For example, project margins in 4Q 2022 were better than in 1Q 2023 given the product mix and reduced vendor consideration was lower in the first quarter following a strong 4Q 2022 close. For the first quarter, EBITDA was $47 million or 8% of revenue, solid performance yielding excellent results. On a year-over-year basis, EBITDA is up $19 million or 68%, resulting from a robust 17% year-over-year EBITDA to revenue flow throughs. Free cash flow consumption was $11 million in the first quarter as we invested in working capital to support growth and deployed $5 million in capital investments to round out infrastructure and rental asset enhancements. That said, we expect to produce positive free cash flow in 2023. Some regional comments.

In the U.S., revenue was $427 million, an increase of $13 million or 3% sequentially, driven by growth from newly acquired businesses and demand for our U.S. Process Solutions offerings for process, production, and pump packaged equipment. U.S. energy revenues were relatively flat sequentially as U.S. rig count softened by 2% and was negatively impacted by poor weather in the Northwest. Many job sites were inaccessible due to record snowfalls in the winter. Rig counts in dry gas areas receded in the first quarter as operators sought to balance supply with demand for natural gas as Henry Hub spot gas prices hovered around $2.65 per million BTUs. Across the oily basins, drilling and completion activity drove demand for our seamless and ERW steel pipe, as well as our spool mounted coil line pipe.

Our Williston Megacenter is now fully operational. We're excited about the growth opportunities and revenue synergies the new center enables. Key successes in the quarter include agreement renewals for IOCs and gas utility and refinery customers to provide PVF and MRO products for their maintenance CapEx spend. During the quarter, we grew market share as we implemented a new PVF commitment with an IOC in the Permian. We expect the increase in market share to contribute to future revenue growth. Activity improved sequentially with our Integrated Supply Chain Services customers as we work to lower their lease operating expenses by managing the demand for products and improving availability of inventory to meet construction and project time frames. In the downstream market, spending by refining and chemical processing customers remained strong as they ordered products for projects for turnarounds.

We are providing PVF products for biodiesel conversion projects at refineries as customers increase their throughput of renewable diesel products. Our U.S. Process Solutions business grew to 26% of our U.S. segment due to revenue additions from the December acquired companies, while demand increased for our LACT units and pump booster packages as the midstream activity was up for us in the quarter. Our vessel fabrication business also remains strong as operators seek to increase their separation capacity for newly completed wells. We are seeing growth in pump packages, air compressors, and aftermarket service capabilities in non-oil and gas markets, where we are targeting industrial manufacturing and food and beverage producers. We are providing vertical turbine pumps for mining projects and industrial air compressor dryer package to a cereal manufacturer in the food and beverage market. Last quarter, we announced our acquisition of Stealth Pump and Supply.

Looking collectively at the service organizations of Odessa Pumps and Stealth in the Permian, the combined service offering positions DNOW as one of the largest pump service organizations in the oil and gas place. This strength has led to successfully securing a win for a preventative maintenance contract with a large IOC to service over 800 installed pump package units. Outside of oil and gas, we won an additional service contract for a preventative maintenance program for pumps and municipal water districts, further unlocking revenue opportunities in the water, wastewater markets. Our FlexFlow business saw increases in demand for water transfer applications as operators sought to expand their use of water recycling as opposed to water disposal to offsite permitted disposal sites. During the quarter, we deployed several of our mobile horizontal pumping units to Canada to support pipeline pressure testing for a new LNG pipeline under construction.

We saw a demand increase for products that mitigate emissions as onshore production operators find solutions to mute their overall environmental footprint. Increased regulation and industry standards around flaring and emissions drive greater demand for many of the natural gas emission reduction products DNOW provides to our customers. Furthermore, we see demand improving for our recently acquired EcoVapor oxygen removal systems applied to oil and gas tank batteries. During the quarter, our EcoVapor business expanded their ZerO2 lease fleet as contracted units grew despite a challenged sub $3 per MMBtu gas environment. The growth during the period speaks to the value proposition of the ZerO2's ability to reduce customers' routine gas flaring at tank battery installations by removing oxygen from the collected gas venting from the oil and produced water storage tanks.

While EcoVapor has traditionally supplied oxygen removal equipment to oil and gas operators, we are seeing an increase in demand for our products in the renewable natural gas industry. Similar to oil and gas, RNG operators must address oxygen contamination within the collected waste gas from landfills and biowaste gas sources in order to sell the gas to the midstream market. This challenge is solved using our EcoVapor ZerO2 units and opens up the growing market as we see RNG demand increasing. We achieved a notable success and winning a large project for EcoVapor ZerO2 units with water separation equipment to swine farm operators who collect and process the biogas to sell to the midstream gas market. Since March 31, we were successful in securing the largest EcoVapor RNG order from a large landfill gas customer.

The ordered units will ensure the project meets the customer's stringent pipeline specifications for their RNG streams. In Canada, revenue was $83 million for the quarter and increased 11% sequentially. Our Canadian team continues to perform well as we supply and service a diverse mix of oil and gas operators, midstream companies, projects through a number of EPC customers, and land-based drilling contractors. Highlights include strong demand for our valve and actuation solutions for a number of capital projects, as well as daily MRO demand. Outside of oil or gas, we saw revenue improve from an agribusiness customer with demand for pipe fittings and flanges for a processing plant project. For international, revenue was $74 million, a sequential increase of $16 million or 28%. For the past few quarters, quote volume has increased in our international segment as long cycle projects were being budgeted.

We are now seeing DNOW win those competitive inquiries, converting those to orders and driving higher revenue in the first quarter. In the U.K., MRO activity increased with electrical distribution products, industrial and safety equipment, and valve products to our MacLean business. We are seeing growing activity tied to increased customer investment in the North Sea as reinvestment in existing fields and new investment in greenfields and FPSOs expand. Revenue expanded with the major IOC as we provided a variety of products to them in the U.K., Middle East, West Africa, and Asia Pacific. During the quarter, we renewed a five-year frame agreement for electrical products with a customer based out of the Middle East, and an additional agreement for PPE products with a major IOC, with downstream refining and petrochemical assets.

In Norway, activity increased as customers seek to expand their natural gas exports to Europe to replace a portion of the previously imported Russian gas. On several projects, we supplied low voltage electrical cable and instrumentation to an EPC to support a subsea tieback project for an offshore production platform. In Australia, inquiries are improving for both MRO and Greenfield activity as we secured a sizable project for electrical cable in the carbon capture space and secured orders for pumps for an FPSO development with a major IOC. Moving to our DigitalNOW initiatives, our digital revenue as a percent of total SAP revenue for the quarter was 43%, lower sequentially due to customer and project billing mix on the top line growth.

During the quarter in Canada, we began receiving purchase orders digitally with a new round trip PunchOut customer, enabling procurement simplicity and driving efficiencies for both parties. This preferred order method delivers incremental revenue efficiently, alleviating costs linked to non-digital ordering. Within our U.S. Process Solutions organization, we began rolling out our new field service app that allows our pump mechanics to document and perform service work through an all digital interface. We will continue to expand the training and the use of this technology to help drive efficiencies and improve customer service. Last quarter, we talked about our FlexFlow OptiWatch solution as a digital real-time asset monitoring tool used to measure the performance and health of a horizontal pump working asset.

We are happy to see that our OptiWatch software solution is gaining popularity with customers as we actively monitor over 100 customer owned horizontal pump units in the field. This provides additional revenue opportunities for field service, maintenance, and asset replacement. With that, let me hand it over to Mark.

Mark Johnson (SVP and CFO)

Thank you, Dave. Good morning, everyone. Total first quarter 2023 revenue was $584 million, up $37 million or 7% from the fourth quarter of 2022 and reaching the highest revenue quarter since the pandemic. On a year-over-year basis, first quarter revenue was up $111 million or 23%. EBITDA excluding other costs or EBITDA for the first quarter was $47 million or 8% of revenue. The U.S. revenue for the first quarter 2023 totaled $427 million, a $13 million increase or 3% higher than the fourth quarter of 2022. Year-over-year, U.S. revenue increased $93 million or 28% from the first quarter of 2022.

Our U.S. energy centers contributed approximately 74% of total U.S. revenue in the first quarter. Our U.S. Process Solutions contributed 26%. In Canada, for the first quarter, revenue totaled $83 million, an increase of $8 million or 11% from the fourth quarter of 2022. Year-over-year, Canada first quarter revenue was relatively flat, increasing $1 million or 1%, limited by a 7% negative foreign currency revenue impact of approximately $6 million. International revenue for the first quarter of 2023 was $74 million, up $16 million or 28% sequentially. Year-over-year, international first quarter revenue was up $17 million or 30%, despite a 9% negative foreign currency revenue impact of approximately $5 million.

As anticipated, our first quarter gross margins were down from their recent highs to 23.5%, but remain above the 2021 and 2022 combined gross margin of 22.9%. Warehousing, selling and administrative, or WSA, for the quarter was $109 million, up $5 million sequentially, primarily from a full quarter of operating expenses from our fourth quarter acquisitions and the resetting of limit-based payroll tax expense in the new year. We continue to make progress on reducing WSA as a percent of revenue, with our first quarter WSA as a percent of revenue improving sequentially and when compared to the first quarter of 2022. In the second quarter, we expect WSA to approximate the first quarter level. Moving to operating profit by our geographic segments.

In the first quarter, the U.S. delivered $23 million in operating profit or 5.4% of revenue. Canada delivered $8 million in operating profit or 9.6% of revenue. The international segment reported $4 million in operating profit or 5.4% of revenue in the first quarter of 2023. Moving to income taxes on a GAAP basis, the effective tax rate for the three months ended March 31, 2023, was 8.6%. I remind you, this is the effective tax rate as calculated from the face of the income statement and is below the typically expected tax rate at these earnings levels. Our income tax expense provision on the income statement includes a favorable tax benefit from the changes in the tax valuation allowance on our deferred tax assets.

As such, this is why when imputing our non-GAAP tax rate, we exclude such income tax benefits. For modeling purposes, the non-GAAP effective tax rate was approximately 26% for 1Q 2023. For estimating an effective tax rate for the go-forward quarter and year for modeling net income excluding other costs, a 26%-28% tax rate is a good estimate and excludes the favorable impact from changes in the valuation allowance. Net income attributable to NOW Inc. for the first quarter was $31 million or $0.28 per fully diluted share. On a non-GAAP basis, Q1 2023 net income attributable to NOW Inc. excluding other costs, was $28 million or $0.25 per fully diluted share.

Moving to the balance sheet, at the end of the quarter, we had zero debt and a cash position of $168 million. Cash decreased by $44 million in the first quarter as we invested in growth of our business with strategic inventory purchases and capital investments, and we repurchased common stock in the quarter to return value to shareholders. In the first quarter, we reported $6 million of depreciation and amortization expense in line with our expectations following our fourth quarter 2022 acquisitions. In the second quarter of 2023, we expect quarterly depreciation and amortization expense to be between $6 million-$7 million. We ended the quarter with total liquidity of $555 million, which comprises our net cash position and $387 million in additional credit facility availability.

Our existing half a billion dollars revolving credit facility extends into December 2026, providing DNOW with ample access to capital for more than the next three and a half years. Accounts receivable was $422 million, an increase of $24 million or 6% from the fourth quarter. Inventory was $406 million at the end of the first quarter as we invested $25 million in additional inventory while turn rates remained flat sequentially at 4.4x. A portion of this inventory investment was specifically procured to support several of our Process Solutions customers with forecasted project growth. Accounts payable was $323 million at the end of the first quarter, an increase of $19 million from the fourth quarter.

For the first quarter of 2023, working capital, excluding cash as a percentage of our first quarter annualized revenue, was approximately 17.6%. In the first quarter, net cash used in operating activities was $6 million, as we invested more than $50 million in working capital to support growth. First quarter free cash flow consumption was $11 million, with capital expenditures for the first quarter of $5 million as we invested in operating equipment and facilities to enhance efficiencies and increase service levels to our customers. In 2023, we are actively investing in upgrading the utility of key facilities, expanding our rental fleet for the FlexFlow and EcoVapor businesses. With these commitments, we estimate our capital expenditures for full year 2023 to be in the $20 million range.

We are looking to generate $100 million in cash from operations in 2023. When looking back at the trailing twelve months through 1Q 2023, we are free cash flow positive, having generated $16 million in cash from operations and invested $14 million in the business. This free cash flow generation was achieved on approximately $500 million in annual revenue growth when comparing the trailing twelve months ended 1Q 2023 to the corresponding period ended 1Q 2022. This shows how our focus on the fundamentals and discipline managing the business has positioned DNOW to generate cash through the cycles, which bodes well for future growth and capital allocation plans.

We continue to execute on our share repurchase program that is authorized through December 31, 2024, with additional repurchases of $36 million in the quarter or 3.3 million shares of common stock. As of March 31, 2023, we have repurchased $43 million under our $80 million authorized share repurchase program. Our commitment to growing the company through organic growth and acquisitions remains a key priority, while also having the ability to repurchase shares opportunistically as we use the tools in our broadened capital allocation framework to generate attractive shareholder returns without deviating from our disciplined approach to balance sheet management. We continue to be debt-free, have no interest payments on debt while we keep cash flow generation a priority. With that, let me turn the call back to Dave.

David Cherechinsky (President and CEO)

Thank you, Mark. Switching to our outlook for the second quarter of 2023. In the U.S., we expect market share gains, revenue from acquisitions, and the beginning of revenue synergies derived from those acquisitions to drive mid-single digit sequential quarter growth in the second quarter in the U.S. Internationally, we expect approximately $4 million in projects not to recur in the second quarter, driving a sequential decline in that segment. In Canada, the expected seasonality will drive sequential revenue lower. Canada's revenue historically declines approximately 20% sequentially from the first quarter to the second quarter due to the second quarter freeze, thaw, muddy breakup period, where heavy equipment access to production areas is restricted.

Taken altogether, we expect DNOW's second quarter sequential revenues to increase in the low single digit percentage range from 1Q 2023, in spite of the expected Canadian seasonal decline, approximating year-over-year second quarter growth to 10% for DNOW. We expect second quarter EBITDA to approximate our 1Q 2023 EBITDA dollar level. For the full year of 2023, we reaffirm our view that revenue will increase 8%-12% compared to the full year of 2022 revenue, and our 2023 full year EBITDA is targeted at 8% of revenue. We anticipate free cash flow will gather momentum as the year progresses, and we expect to deliver cash flow from operations of approximately $100 million for the full year of 2023. Before we open it up for questions, I'm gonna close with some comments about the business.

Our year is off to a nice start, including strong top and bottom line performance in the first quarter, with revenue growing 7% sequentially, driving 8% first quarter EBITDA as percent of revenue. Again, solid results. We achieved these better than expected results despite headwinds related to inclement weather, lower U.S. rig counts and completions, and weaker oil and gas prices in the first quarter. We are excited about our international segment posting strong sequential revenue growth of 28% at operating profit levels not seen since 2014. In the first quarter, we returned cash to shareholders by repurchasing $36 million of shares, with the cumulative purchase levels exceeding $43 million through March 31. Earlier this week, we completed two additional acquisitions, further strengthening our U.S. Process Solutions business.

We are in a great place as a company on solid financial footing with incredible talent singularly focused on our customers. We remain debt-free with ample liquidity and possess an advantageous variety of tools to further advance DNOW's position in the market. With that, let's open the call for questions.

Operator (participant)

At this time, I would like to remind everyone, in order to ask a question, press the star, then the number one on your telephone keypad. Your first question comes from the line of Tommy Moll from Stephens Inc. Your line is open.

Tommy Moll (Managing Director and Equity Research Analyst)

Morning, and thank you for taking my questions.

David Cherechinsky (President and CEO)

Good morning.

Tommy Moll (Managing Director and Equity Research Analyst)

Dave, I wanted to start on the second quarter outlook you provided. If I heard and read correctly, on a sequential basis, revenue up, WSA dollars flattish, EBITDA dollars flattish. I presume that means you're giving back a little bit on the gross margin rate. If I'm correct on that, any drivers there you could point us to would be helpful. Thank you.

David Cherechinsky (President and CEO)

Yeah. Good question, Tommy. Yeah, that's, that's a good read. That's, that's, kind of how we're modeling the second quarter. We're gonna see a full quarter of now four recent acquisitions in the last four months. We're starting to see some of the gross margin erosion I've been speaking about the last several quarters, which finally hit in the first quarter. You know, I've been talking about gross margins and really pricing as a priority, 'cause we're always working on high grading our businesses and focusing on the higher margin products, et cetera. There was a layer of premium pipe margins which we enjoyed for a number of quarters because we had product availability where our competition didn't. We were able to command higher margins.

We've been guiding to that layer of premium margins dissipating, and it's begun to do so. We do expect a little margin compression in the second quarter, primarily due to Canada. Canada's gonna, you know, move into a breakup period. Canada tends to be our highest gross margin segment. As we see that, you know, kind of geographic mix kick in the second quarter, we'll see a little slippage there. We, you know, we still expect very strong margins this year. We talked last quarter about a 30 basis points full year decline from 2022 to 2023. We saw about 20 basis points decline from a full year of 2022 to the first quarter of 2023.

We do expect a little more, you know, taming of the overall margins, but we're doing everything we can to high grade, you know, like we talked about. In terms of the second quarter, that's how we get there. Like you said, the three big inputs, WSA largely being flat and gross margins eroding a little bit as expected and really seasonally impacted from Canada.

Tommy Moll (Managing Director and Equity Research Analyst)

Thank you. That's helpful. As a follow-up, I wanted to ask about the two acquisitions you closed in May. It sounds like they're in the pump and seal distribution space. If you could just talk generally about your appetite for additional deals in that space, why you like it, what the pipeline looks like. Are there any sizable deals you're chasing? Anything along those lines would be helpful.

David Cherechinsky (President and CEO)

Yeah. I'll start it off. I'm gonna hand it to Brad. I think the two deals we closed Tuesday this week, I think it was Tuesday, represents the tenth consecutive Process Solutions acquisition we've made. We're really focused on growing that business, growing primarily our pump business, and the seal business as well that came from these two acquisitions. That's a big part of our focus. We will do more deals like that this year. In terms of larger deals, we are talking to companies to try to affect larger ones.

We think that the multiples on these deals could get a little better as interest rates rise and, you know, some of the uncertainty, you know, kind of happens in the market. We are looking, and, you know, that's a big part of our focus. Like I said in my opening comments, we're in a position to really pull all the levers. We are focused primarily on growing organically. The market itself isn't growing at the rate as it was last year. Secondarily, we're focused on M&A, and we've done four deals in four months. Thirdly, we're focused on share repurchase and the way our balance sheet, the way we manage our balance sheet, we could do all three.

In terms of details on the acquisitions, Brad, you wanna give some color?

Brad Wise (VP of Digital Strategy and Investor Relations)

Yes, Dave. Tommy, good morning. Yeah, just some additional color. You know, back in 2019, DNOW acquired a company called PSI out of Wyoming. It really was kind of a really good relationship with a top-tier pump manufacturer that, you know, we sell a lot of pumps in the market as far as new pump packages. That acquisition in 2019 took us into the mechanical seal area and really expanded our service capability with that manufacturer, in addition to some other benefits that that acquisition provided.

The two acquisitions we closed really earlier this week, kinda build upon that strategy of securing, broadening our geographic footprint in Wyoming, Montana, Colorado, with that same, you know, very large pump manufacturer, broadens our capability on the mechanical seal line, significantly expands our aftermarket service capability. They're really kind of, you know, the leader in the pump service and repair business. Very, you know, high gross margins, high EBITDA margins. Accretive to, you know, our current kinda core base business, and that's been part of our acquisition strategy going forward. We're real excited about, you know, these two businesses. They are, you know, bolt-ons that Dave mentioned in his prepared remarks.

We're gonna extract synergies out of that as the year progresses, and really excited about expanding our footprint there in that area.

David Cherechinsky (President and CEO)

Just one comment on the synergies. We're gonna focus on revenue synergies.

Brad Wise (VP of Digital Strategy and Investor Relations)

Correct.

David Cherechinsky (President and CEO)

You know, we wanna grow that business. We are not looking at, you know, really, cost savings from those deals. We're looking at leveraging the sales talent, the competencies of some of the services they provide their customers. We wanna grow that business for the rest of Process Solutions and DNOW, from a revenue synergy perspective. Anyway, thanks.

Brad Wise (VP of Digital Strategy and Investor Relations)

Yep. Thank you for the insight. I'll turn it back.

David Cherechinsky (President and CEO)

Thanks, Tommy.

Operator (participant)

The next question comes from the line of Doug Becker from Capital One. Your line is open.

David Cherechinsky (President and CEO)

Morning, Doug.

Doug Becker (Managing Director and Senior Equity Research Analyst)

Good morning. Following along the same lines of questioning, Dave, you highlighted that market share gains, the acquisitions, some synergies should drive revenue growth in 2Q, even as the North America rig count is gonna be down. Just wanted to get your thoughts on organic growth for the quarter and the full year, just given the very fluid nature of what's happening in the U.S.

David Cherechinsky (President and CEO)

I think, I think most of the organic growth we're gonna see in the second quarter is gonna happen in the U.S. Of course, we're gonna see, like I said, in Canada, a seasonal decline. In international, we had a really strong quarter. We do expect, you know, a number of projects totaling about $4 million not to repeat in the second quarter. That'll kind of moderate the level of activity there. In the U.S., where we're gonna see most of our organic growth is with really new customers or having penetrated customers in different regions of their, of the North American footprint.

We're gonna see, you know, continued growth in South Texas, in the Permian, and in the Bakken, where we just stood up our Megacenter there, really to leverage multiple DNOW businesses from our FlexFlow business, to EcoVapor, to our fiberglass enterprise, et cetera. We see those as the three main areas of growth, and it's mostly market share derived. You know, we've seen kind of rig counts decline. Same thing with completions. We've seen some of the market fundamentals kind of slow down a little bit. As it turns out, you know, we have, you know, simply a better mousetrap with how we service our customers, and then a sales team that conveys the value with our customers.

We believe market share gains are gonna be the primary fuel for us in the second quarter.

Doug Becker (Managing Director and Senior Equity Research Analyst)

No, that's really encouraging. How would you characterize DNOW's current exposure to end markets outside North America upstream, just given some of the recent acquisitions and initiatives? Just your commentary, it sounds like the end market exposure really has broadened, and I guess at the same time, international and offshore activity seems to be increasing, as well. Really just exposure outside North America upstream.

Brad Wise (VP of Digital Strategy and Investor Relations)

Yeah, Doug, this is Brad. I'll take a shot at that and maybe Dave or Mark might layer on top. You know, going back, you know, since we spun off from NOV in 2014, you know, our international business was highly levered to the upstream, really drilling segment, having to be a, you know, kind of a core distributor for NOV and OEM equipment. You know, since the, you know, the downturn in international offshore, we've done a good job diversifying our international business. We're more land-based in key areas in the Middle East and the U.K. and Asia and Australia. You know, we're more project-centric, executing projects through EPCs, but also, you know, large capital projects associated with NOCs and IOCs in different areas.

Of course, our MacLean Electrical group, which is a previous acquisition we did, has a very good top management team, is driving the business as we expand our electrical distribution capabilities, not only in the UK and Australia, but also exporting that to IOC relationship, global relationships we have in West Africa. We're seeing that export side of the business pick up. You know, from a diversification, it's a lot healthier business. You know, we're starting to see, you know, the offshore business, you know, day rates increase. You know, that's a small part of our business now. I would say probably 5% of our international revenue, where at one time it was, you know, much higher than that.

It's a healthier, more, you know, end market diverse, geographically diverse business. Like we pointed out this quarter, really excited about the growth. We've been waiting for this, you know, segment to grow. I think, you know, we're seeing that. The backlog's picking up. The activity's picking up. It's, you know, finally hitting on all cylinders and excited about the future. As we think, you know, we're seeing more investment in CapEx, you know, in the Middle East, certainly with, you know, Saudi Arabia and Kuwait and Abu Dhabi and UAE, as well as Norway, all around energy security, they're really kind of driving investment in those areas that, you know, we have a pretty good foothold. We're obviously looking to expand.

Certainly would be open to M&A activity internationally as well. That kind of sums it up.

Doug Becker (Managing Director and Senior Equity Research Analyst)

Just any commentary on, say, downstream, exposure or kind of new energy exposure, really hit on the international thought there, but maybe some of the other.

Mark Johnson (SVP and CFO)

Sure, yeah. Downstream internationally, if that was the question specifically, I, you know, Brad.

Doug Becker (Managing Director and Senior Equity Research Analyst)

Oh, not just internationally, just broadly.

Mark Johnson (SVP and CFO)

Sure. Yeah. I think, you know, really across all geographies, we're seeing expansion in the downstream sector, which has been great. You know, Brad kind of alluded to, you know, kind of the offshore, you know, over-reliance, you know, in prior cycles, you know, of our business. Now, for the international segment, we're seeing the downstream sector play a predominantly larger part of that market. Where before, you know, if you look back nine years ago, you know, it was, you know, single-digit percentages probably. Being able to grow that into double-digit, 20%+ of international, is a bright spot for us.

I do think some of the large projects Dave talked about on the call, you know, give us a lot of optimism, you know, for this space, for energy evolution, and to be able to provide those products that our customers are needing in that arena.

Doug Becker (Managing Director and Senior Equity Research Analyst)

Thank you.

David Cherechinsky (President and CEO)

Thanks, Don.

Operator (participant)

Thank you. Our next question comes from the line of Nathan Jones from Stifel. Your line is open.

Adam Farley (AVP and Equity Research Analyst)

Good morning. This is Adam Farley on for Nathan. I wanted to follow up on the gross margin line of questioning. Are you still seeing inflation in any of your product categories? I understand that line pipe prices are coming down, have you seen moderation in line pipe given some of the recent moves in other steel prices?

David Cherechinsky (President and CEO)

Well, on the first part about inflation. You know, I think we're seeing kind of a return to the norm on general inflation. We're not seeing the kind of. We're seeing long lead times for certain types of valves and certain product lines. We're seeing a normalization otherwise. We're starting to see kind of normal pricing with our manufacturers. Manufacturers are trying to push some price increases through. Some of them stick, some of them don't, which is kind of a normal tenor for a less, you know, stretched supply chain.

I think we're starting to see more balance in terms of product availability for most products, especially MRO products and fittings and flanges and routine kind of type of valve sales, et cetera. Kind of a reversion to the norm there. I would say that inflation is kind of normalized now, and it's back to a normal behavior for most product lines. We are seeing some product availability issues internationally, and that is slowing some projects down. We're seeing less of that in North America. In terms of pipe pricing, what we're seeing primarily in pipe is kind of margin compression as pipe pricing has stabilized. Some pipe prices, you know, might have come down, but that margin is squeezing a little bit.

That's due to simply improved product ability for products that, you know, the only the biggest suppliers could acquire a year ago. Today, it's, you know, much more liquid supply chain there. We're seeing higher costs at inventory, you know, creating that margin squeeze. Inflation is more normal, you know, back to kind of the normal range, I would say, despite some product lines having long lead times. That's something we experience on a, kind of a regional basis.

Adam Farley (AVP and Equity Research Analyst)

Okay. Thank you for that. I did want to call out. You called out weather in the press release impacting the quarter. Was it meaningful enough to quantify the impact from weather? If it was, would you expect to make up any of that revenue in the near term?

David Cherechinsky (President and CEO)

I think we estimate about $7 million in revenues lost or deferred. How much of that gets deferred into the second quarter, I don't know. Probably some of it would. It's probably a number along those lines which, you know, would amount to, you know, 1.5% or so. That, that was one of the drags in the first quarter. Some of that could, you know, could slip into the second quarter or slipped into April already. That, that wasn't the primary, but that was kind of the third reason for, or the third kind of headwind in addition to oil and gas prices, completions, et cetera.

Adam Farley (AVP and Equity Research Analyst)

Okay. Thank you for taking my questions.

Mark Johnson (SVP and CFO)

Thanks, Adam.

Operator (participant)

Thank you. Our last question comes from Jeffrey Robertson from Water Tower Research. Please go ahead with your question.

Jeffrey Robertson (Managing Director)

Thank you. Good morning.

David Cherechinsky (President and CEO)

Good morning.

Jeffrey Robertson (Managing Director)

Good morning. You mentioned Process Solutions represents or represented 26%, I think it was, of U.S. revenue in the first quarter.

David Cherechinsky (President and CEO)

That's right.

Jeffrey Robertson (Managing Director)

Can you talk about where you see that segment revenue going over the next several quarters? I believe if I'm correct, that's generally tends to be a higher margin mix of business for you.

David Cherechinsky (President and CEO)

Yeah. I get that question from time to time, and it's hard for me to pinpoint a kind of a target number. I think when we first put together Process Solutions, it accounted for about 18% of our U.S. revenues. Now it's up to 26%. That was several years back. Like I said earlier, the last 10 businesses we purchased have been in that space. We think there are revenue synergies for each deal we're doing. Every deal we're doing has better gross and operating margins. Overall, that reporting unit, I guess, or that business line has better net margins. That's a big focus for us.

What that percentage can get to, you know, we joke about that around here because, you know, we have two, you know, pretty strong leaders of those businesses who wanna both grow their business. You know, I'd like to see that business get to, get to be 1/3 of the U.S. business and grow beyond that. I also wanna grow our energy business as well. You know, that's a big target for us. It's, it's an area where we're moving more into, really high margin, kind of rental assets, business lines, which we really like. The bottom line really becomes, you know, really more attractive to me than the top line, but we wanna grow that business for sure.

Jeffrey Robertson (Managing Director)

In terms of the rental businesses, so those are stickier businesses than or maybe not stickier, but a longer duration revenue stream than what you might see on the energy centers?

David Cherechinsky (President and CEO)

It's just primarily better gross margins, and it allows for pull-through sales of our other businesses. It's complementary to the product lines we already service those customers for. It just simply gives us a bigger share of the wallet, makes us more important to the customer, and it provides better margins as well. I think that's the primary motivation for growing that rental business. There's a repair business that we focus on as well that simply provides better margins and complementary suite of solutions for the customer.

Jeffrey Robertson (Managing Director)

In your comments, you mentioned some a biodiesel project and some landfill gas projects, and I think even a project on a swine farm. Can you just talk about the opportunity in renewable natural gas and landfill gas and biodiesel? Is that something that could become increasingly material for DNOW?

David Cherechinsky (President and CEO)

I'm gonna let Brad. Brad has his hands up, so he wants to grab this one. Brad?

Brad Wise (VP of Digital Strategy and Investor Relations)

Good morning, Jeff. You know, we're obviously, we're, you know, fairly levered to upstream oil and gas, but we're looking to diversify and we really like the RNG market for a number of reasons. You know, we've sold historically, you know, some pipe valves and fittings into the RNG market, but you know, with and also into the biodiesel as some of these refineries in certain states take advantage of opportunities to, you know, convert their refining capacity to process biodiesel. You know, where we have agreements and relationships, we're able to provide products for those, you know, biodiesel projects at refineries.

On the RNG side, you know, the EcoVapor acquisition we did in the fourth quarter, you know, really kinda cements a really good, you know, product solution that fits a lot of the demand that we see on the horizon, as we, you know, we see the RNG end market growing at a higher rate than certainly than oil and gas in the immediate future. We're excited about, you know, what EcoVapor can bring to that, whether it's dairy farms, swine farms, as they're capturing RNG and having to meet the same stringent requirements that oil and gas operators have to put gas free of oxygen into the midstream takeaway section, as well as landfill gas.

You know, traditionally, we haven't done a whole lot in the landfill gas applications, but, you know, we see again that opportunity kinda unlocked for DNOW with what EcoVapor can provide from a leading project. We think that might open up additional products across Process Solutions for us with other fabricated pieces of equipment or pump packages, as well as, you know, fiberglass pipe, as well as just our regular PVF business. You know, we're pretty bullish on RNG. We're not ready to name a number yet on that, but we're excited about the growth and the growth potential that DNOW has in that end market.

Jeffrey Robertson (Managing Director)

Thank you very much.

Operator (participant)

There are no further questions at this time. Mr. Brad Wise, I turn the call back over to you.

Brad Wise (VP of Digital Strategy and Investor Relations)

Okay. Thank you, Bhavesh, and thank you everyone for joining, for your questions today and your interest in NOW Inc. We look forward to talking with everyone on the second quarter 2023 earnings conference call in August. Have a nice day, and I'll turn it back to the operator to conclude our call.

Operator (participant)

Thank you. This concludes today's conference call. You may now disconnect.