NOW Inc. (NYSE:DNOW) Q1 2023 Earnings Call Transcript May 6, 2023

Operator: 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 Incorporated First Quarter 2023 Earnings Conference Call. All lines have been placed on me to prevent any background noise. [Operator Instructions] Mr. Brad Wise, Vice President of Digital Strategy and Investor Relations, you may begin your conference.

Brad Wise : Thank you, Bhavesh, and good morning, and 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 4, 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 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 website at ir.dnow.com or in our filings with the SEC. 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 will also be available on our website. Now let me turn the call over to Dave.

David Cherechinsky : Thanks, Brad, and 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 3 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 2 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 2 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. Now 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 was up $111 million or 23%, outpacing the 15% year-over-year increase in global rig count. 1Q 23 gross margins were 23.5%, lower sequentially as expected, primarily due to dilutive project margins. For example, project margins in 4Q ’22 were better than in 1Q ’23, given the product mix and reduced vendor consideration was lower in the first quarter following a strong 4Q ’22 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. Now 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 and 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 mega center is now fully operational, and 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 PBF commitment with an IOC in the Permian, and 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 remain strong as they ordered product for projects for turnarounds. We are providing PBF products for biodiesel conversion projects at refineries as customers increased 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 lapped 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 serial 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 plays. 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. And 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 Flex Flow 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 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 DNO 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 million Btu 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 in the oil and produced water storage sinks. 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 gas industry, 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.And since March 31, we were successful in securing the largest EcoVapor/RNG order from a large landfill gas customer. The order units will ensure the project meets the customers’ 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 and 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, 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 McLean 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 for them in the U.K., Middle East, West Africa and Asia Pacific. During the quarter, we renewed a 5-year frame agreement for electrical products with the customer base 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. In On several projects, we supply 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 nondigital 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 Flex Flow OptiWatch solution as a digital real-time asset monitoring tool used to measure the performance and health of the horizontal pump working asset. We are happy to see that our Optowatch 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 : Thank you, Dave, and 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 and 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. And 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. And 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, and 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 3 months ended March 31, 2023, was 8.6%. I remind you, this is the effective tax rate is calculated from the face of the income statement and is below the typically expected tax rate at these earnings levels.

As 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. And for estimating an effective tax rate for the go-forward quarter and year for modeling net income, excluding other costs, a 26% to 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. And 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 0 debt and a cash position of $168 million. Cash decreased by $44 million in the first quarter as we invested in the 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 to $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 $0.5 billion revolving credit facility extends into December 2026, providing DNOW with ample access to capital for more than the next 3.5 years. Accounts receivable was $422 million, an increase of $24 million or 6% from the fourth quarter. And inventory was $406 million at the end of the first quarter as we invested $25 million in additional inventory, while churn 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. And 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.

In the 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 and upgrading the utility of key facilities, expanding our rental fleet for the Flex Flow and EcoVapor businesses. And 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. And when looking back at the trailing 12 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 12 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 of priority. And with that, let me turn the call back to Dave.

David Cherechinsky : Thank you, Mark. Now 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. And in Canada, the expected seasonality will drive sequential revenue lower. Canada’s revenue historically declined approximately 20% sequentially from the first quarter to the second quarter due to the second quarter freeze thaw, muddy breakup period where heavy equipment and access to production areas is restricted.

Taken all together, we expect DNOW’s second quarter sequential revenues to increase in the low single-digit percentage range from 1Q ’23 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 23 EBITDA dollar level. And for the full year 2023, we reaffirm our view that revenue will increase 8% to 12% compared to the full year 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 2023. Before we open it up for questions, I’m going to 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 a 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% and 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. And earlier this week, we completed 2 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.

Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of Tommy Moll from Stephens Inc.

Operator: The next question comes from the line of Doug Becker from Capital One.

Operator: Our next question comes from the line of Nathan Jones from Stifel.

Operator: Our last question comes from Jeffrey Robertson from Water Tower Research.

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

Brad Wise : 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: Thank you. This concludes today’s conference call. You may now disconnect.