Logo of jester cap with thought bubble.

Image source: The Motley Fool.

NOW Inc  (NYSE:DNOW)
Q2 2019 Earnings Call
Aug. 02, 2019, 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome to the Second Quarter 2019 Earnings Conference Call. My name is Sylvia, and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions].

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

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

Welcome to the NOW Inc. second quarter 2019 earnings conference call. We appreciate you joining us this morning, and thank you for your interest and NOW Inc. With me today, is Robert Workman, President and Chief Executive Officer. NOW Inc. operates primarily under the DistributionNOW and Wilson Export 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.

Before we begin this discussion on NOW Inc.'s financial results for the second quarter of 2019. please note, that some of the statements we make during this call, including the answers to your questions, 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 US 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. 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 only as of the date of the live call.

I refer you to the latest Forms 10-K and 10-Q that NOW Inc. has on file with the US 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 maybe 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 will note that we also disclose various non-GAP financial measures, including EBITDA, excluding other costs; Sometimes referred to as EBITDA, net income excluding other costs, and diluted earnings per share excluding other cost. 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, in 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 second quarter 2019 Form 10-Q today, and it will also be available on our website.

Now, let me turn the call over to Rob.

Robert R. Workman -- President and Chief Executive Officer

Thanks, Dave and good morning. I want to thank to be protecting the time to join us today. We are encouraged by our consistent year-over-year top line 2Q, '19 results, even though U.S. and Canadian rig counts declined and one of our largest customers activity pulled back considerably due to their large pending acquisition. Specifically, our U.S. Process Solutions team was able to exceed pre-acquisition second quarter 2014 revenue levels, back when rig count levels were nearly double the level we're seeing today, by leveraging our full suite of products, broad support infrastructure throughout the major shale plays, and by bundling opportunities with U.S. Energy Centers and U.S. Supply Chain Services.

Our cross-selling our products and solutions continues to add value to our customers across a wide variety of energy and industrial products. One area strong focus for us has been collaboration between our U.S. Energy Centers, U.S. Supply Chain Services and U.S. Process Solutions teams resulting in pull through sales, new customer introductions, increased market opportunities and further market penetration.

To further these efforts, we have made some recent adjustments to our sales organizations to drive top line growth, gain market share and lead our DNOW strategically into the future. For the second quarter, we generated revenue of $776 million, a $9 million sequential decline and a $1 million year-over-year decline or essentially flat in line with our guidance.

Global rig count averaged 2,181 rigs in the second quarter, a sequential decline of 4%. Our annualized revenue per rig was $1.4 million for the second quarter of 2019. Completions were up 6% sequentially. U.S. drilled, but uncompleted wells or DUCs averaged 8,277 for 2Q, down 2% sequentially. DUCs present future revenue opportunity for DNOW, should the wells be completed, which should drive tank battery construction and midstream gathering systems. An increase in completions and a decrease in DUCs provides us with opportunity for our [Indecipherable] PVF solutions, midstream gathering products and our U.S. Process Solutions businesses production packages.

WTI averaged $60 per barrel for the second quarter, gaining upward momentum from the first quarter average of $55 per barrel. We did see WTI process experience in upward price trend throughout the first and into the second quarter with a pull back in May and June trading in the $50 to $60 per barrel range. In the area of operations, we continue to optimize our footprint and inventory to capitalize our market opportunities as we scale to meet market demand. We've closed three locations year-to-date and expanded our facility footprint by adding two locations this quarter, which I will touch on later.

We're starting to see working capital benefits from our newest regional distribution center or RDC in the Permian that was recently added to our network. The Permian RDC investment solidifies our long-term commitment to customers in the Permian region, while providing operations with more flexibility on inventory planning, order fulfillment strategies for staging and bundling, as well as logistic solutions for our customers. The Permian RDC and others within our system allow us to better leverage and utilize our capital invested in inventory. These benefits combined with our employees continued focus on optimizing inventory efficiencies, assisted with our sequential inventory reduction. We will continue to create opportunities to better tune our inventory across our network to improve customer service, our inventory turns and our return on invested capital.

Since the formation of U.S. Process Solutions in 2016, which was the result of combining the acquisitions of the Odessa Pumps and Power Service, we have expanded our product offerings while delivering more value to our customers for process production, measurement and fluid movement, fabricate package such as tank battery hookups, upgrades on existing batteries, pumping solutions for midstream crude, water, NGL pipelines and produced water disposal, gas measurement, LACTs, vapor recovery units, and ASME test and multiphase separators.

I have mentioned before, that we are exploring ways to expand capacity where we have production and logistic choke points, both organically and inorganically to grow in these areas. Therefore, I am pleased to announce the acquisition of a small business at the end of the second quarter with 140,000 square feet of fabrication capacity in the Houston area for our U.S. Process Solutions business. This strategic location positions the DNOW closer to our Eagle Ford Permian, Scoop Stack and Gulf Coast customers. While this business historically focused on downstream ASME vessels, fractionating towers and upstream production equipment, we intend to expand its capabilities to include more packages such as LACT units, instrument air packages, produced water injection skids and pipeline fluid transfer pump packages.

Furthermore, with our proximity to the Gulf Coast, we believe this facility opens additional cross-selling and bundling opportunities with our downstream and industrial business to target midstream infrastructure, LNG export terminals, chemical plants, refineries and other industrial facilities.

Also during the quarter, we acquired a territorial bolt-on business for our U.S. Process Solutions that provides an expansion to our exclusive territory for a key supplier, which is our pump and mechanical steel partner in certain regions. I'm excited to welcome these employees from both acquisitions to the DNOW family. We are deploying technology to enhance our quote turn around time, customer order process, fulfillment delivery mechanisms and pricing intelligence. To that end, we have started two significant global IT projects. One being moving our current SAP ERP to SAP Suite on HANA platform, while also moving to Google's Cloud Platform. These moves will allow us to gain processing speed and enable future scalability when we need more processing power. These moves have minimal processing impact to DNOW users, so the learning curve has been virtually eliminated and it creates the ability for users to process transactions quicker for customers and suppliers. This along with continued upgrades to our branches network bandwidth allows, for reduce transaction times and greater customer experience. The expected completion for these projects are scheduled for 1Q, 2020.

We've also started to migrate to a robust e-commerce solution that provides a rich customer experience by moving to SAP's Commerce Cloud solution. This online e-commerce catalog solution will [Technical Issues] self-service options. As our market continues to grow in the e-commerce world, our scalability will be in place to be able to stay abreast of our market needs and respond quickly. Completion on this project is expected to be late 2020.

Additionally, we continue to proactively address demand for integrated digital services and have adopted several strategic platforms to provide cost effective, scalable and innovative solutions. Examples of this include RFID and GPS applications with follow on document management and maintenance capabilities that complement our core business. We are investing in the development of an order management system, that will improve speed and reduced the learning curve associated with processing sales orders and purchase orders. This system will complement the power of our system, while allowing users to focused on customer service. We are currently piloting the system and expect to scale to an enterprisewide order management system.

We're also reviewing internal processes and looking for areas in which we can apply artificial intelligence to more accurately forecast and automate manual processes. These initiatives will further drive the expanding customer service side of our business across all units and allow our customers access to new avenues of value, cost reduction opportunities and release of trapped value.

Turning to market activity, our U.S. Energy Center -- Center channel saw activity increase in the Southeast, Northeast and Rockies with declines in the Permian Mid Continent, South Texas in the Western region. We were successful during the quarter in expanding our product and service reach by securing a valves and MRO consumables agreement with Shell in the Permian and Gulf of Mexico and a notable large long-term agreement with Lucid Energy a key Permian-based midstream company. The Delaware Basin continues to be active with a number of our customers as we supply core MRO and pipe, valve and fittings or PVF products to drilling contractors, oil and gas operators and midstream customers. In South Texas, we were successful in providing PVF for midstream customers, for gathering and pipeline projects as well as processing facilities that have been under construction to help absorb increased takeaway capacity from the Permian to the Gulf Coast downstream market.

In the Northeast ,our midstream launcher and receiver program for major midstream customer continues to bear fruit, as we provide prepackaged staged in delivery of customer PVF kits, which increases our customer supply chain efficiency and streamlines their order process. Our employees collaborate with multiple parties including fabricators, to ensure the material is forecasted, kitted, quality documents are validated, and order fill rates meet agreed-upon predetermined targets.

Our line pipe business increased sequentially during the quarter due to a $9 million project, which we don't expect to recur in 3Q, '19 . As for U.S. Supply Chain Services or SCS, revenue was down sequentially. The decrease in revenue is attributed to one of our top customers reduction in spinning as they focused on completing a large acquisitions. In the short-term, this will be a headwind on U.S. SCS revenue with this customer, but we're optimistic, this may offer an opportunity to grow market share once the acquisition is closed. Activity continued with other SCS energy customers in the Delaware Basin, Powder River, Eagle Ford and Bakken place. We are witnessing some SCS operators that previously constructed large, multi-well pad designs who are now reassessing their designs and configuring fewer wells per pad to minimize parent-child well interference.

U.S. SCS operator customers orders related to steel line pipe, valves, flowback kits, packaged production equipment and electrical products. We were successful in expanding product line sales of polypipe with one of our key SCS E&P operators. We've also experienced increased activity from work overs along with schedule projects on new gas compressor station construction .

Regarding downstream and industrial activity, we executed on project and turnaround business involving PVF, mill tool, and safety products for major refineries and chemical plants. For U.S. Process Solutions, we delivered significant sequential revenue improvement due to an increase in completions providing a second quarter tailwind for our U.S. Process Solutions business in the areas with the Permian, Bakken Rockies and Eagle Ford. In the quarter, our strategy to grow market share for our fabricated process and production equipment business continues, as we received orders for the full suite of our packaged equipment that were shipped to North Dakota, Wyoming, Montana, Texas, New Mexico and Colorado areas. Customers range from small to large independent E&P operators and midstream companies which represented our largest growth market sequentially for U.S. Process Solutions. Our inventory stocking program targeted for the water disposal and water management industry continues to bear fruit. For water applications, customers not only include oil and gas operators in midstream firms, but are also expanding to the growing number of stand-alone water management companies.

We are working with manufacturers to plan and provide kitted pump solutions, which offers unique value proposition to our midstream water management customers from pump packages, process and production equipment, as well as actuated valves from our U.S. Process Solutions group. We continue to make inroads as an engineer pump distributor, winning jobs and higher pressure applications in the midstream pipeline booster market for crude, natural gas liquids and lot in fluids movement for gathering lines. Our customers are relying more and more on our engineering, technical and application expertise and rotating and process equipment.

As noted on previous calls, Canada remains a challenging market with egress constraints related to pipeline approvals. Limits on oil tanker traffic and water from Vancouver Island to the border of Alaska. Production curtailments, volatile oil and gas commodity pricing and infrastructure approval uncertainty. Despite the challenges in Canada, our Canadian team delivered solid revenue year-over-year with well spuds decreasing by 186 from 1,026 to 840. Activity related to plant expansions in Sarnia tied to EPC projects, help gains as well as product line wins in PVF related sales to our MRO customers.

Additional increases in activity were in fabrication and midstream project work, offsetting cyclical reductions in the drilling and well completions activity. International rig count averaged 1,109 in the second quarter, up 8% sequentially. We believe international growth should start to materialize as more rigs are activated, service companies mobilized and hence EPCs tender more upstream oil and gas projects for facilities that are nearing award stage. Growth in international rig count is encouraging as we are well positioned to participate in rig consumable replenishment orders with newly activated rigs deplete their international stock after deployment.

International revenue contribution was led by offshore activity in the U.K. and Latin America. Jackup rig load-outs for newbuilds continued during the quarter in Asia and new rig activations occurred in Mexico. DNOW provides many of the OEM and MRO consumables used during the drilling operations of an offshore rig, where we also provide an inventory replenishment model in virtual warehouses from a nearby shore based branch in close proximity to where the rig has been deployed. Middle East land activity softened resulting from the cyclical nature of projects that have been pushed to the second half of the year. Our U.K. MacLean Electrical Group has been successful in securing orders and shipping electrical products, tied to oil and gas project activity in the Middle East and former Soviet Union.

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

Thanks, Robert. For the second quarter of 2019, we generated $776 million in revenue, down $1 million or essentially flat compared to the same period in 2018. Sequentially, revenue declined $9 million or 1% landing well within the range we guided to in our first quarter earnings call. U.S. rigs declined 5% in the second quarter sequentially, and when compared to the same quarter in 2018. U.S. rigs declined an additional 4% through July 26 from the second quarter of 2019 average.

In the second quarter, gross margins were 19.7%, down from the 20.1% level in the first quarter and down 50 basis points from 20.2% a year ago. First half 2019, gross margins were up marginally to 19.9% or 9.8% in the first half of 2018. As we have noted, a key contributor to margin decline is hot roll coil pricing whose decline affects our welded pipe business and negatively impacts our inventory replacement costs. On the seamless side, the OCTG market continues to weaken, leaving more mill capacity on the market to produce seamless line pipe. The result is a downward pressure on prices, the market looks to turn higher cost inventory into cash at lower gross margins.

The sequential decline was primarily driven by product margin pressure on steel pipe, while the year-over-year -- year-over-year quarter product margin decline related to high content steel products, pipe primarily and fitting in plant to secondarily. We expect gross margins to be choppy in the near-term, as the market reacts to reduce activity levels, oil and gas, commodity prices and more directly to observed steel price declines. Over the last few years, we experienced meaningful product price appreciation, the primary driver for our gross margin gains. For example, our gross margin 16.4% in 4Q, '16 and grew steadily over seven of eight successive quarters by a total of more than 400 basis points to a record high of 20.5% in 4Q, '18. For a few quarters in that time frame, we enjoyed a period of premium product margins, which were driven primarily by pricing gains from pipe. A portion of which is the result of a favorable spread between lower inventory costs and higher replacement costs which fueled premium product margins and provided a boost to gross margins in those periods. Now the converse is happening, instead of a boost, we are experiencing a gross margin squeeze, as the point spread between existing inventory costs, replacement cost and selling prices narrow for steel related products. As replacement cost stabilize, current inventory is exhausted and replaced with the now lower lower market costed items. This gross margin squeeze [Indecipherable] and gross margins could grow all other things being equal.

As we have discussed, we generally expect gross margin gains in the growth environment and contrary trends in a market softening. Warehousing, selling and administrative expenses or WSA was $136 million, down $3 million from the second quarter of 2018 and below our forecasted levels as we maintained our diligence around fine-tuning our model to improve the financial performance of the business.

As such, when considering the locations consolidated or closed, in 2018 and through the second quarter of 2019, the revenue generated in those locations approximated $6 million more in 2Q, '18, than in 2Q, '19 or $18 million more in the first half of 2018 versus the first half of 2019. While we did retain some of the revenue by servicing activity from other locations, we were able to move resources to fund growth elsewhere and improve earnings and returns on working capital. This remains a mantra for DNOW, grow the business, while demand in improved operating efficiencies and working capital velocity. In the third quarter, we expect WSA to approximate a $139 million per quarter, as our operating expenses will expand marginally, as we include the cost structure from the two new acquisitions.

Operating profit was $17 million or 2.2% of revenue, a decline of $1 million year-over-year. Net income for the second quarter was $14 million or $0.12 per diluted share, equally the corresponding period of 2018. On a non-GAAP basis, EBITDA excluding other costs was $27 million or 3.5% of revenue for the second quarter of 2019, a decline of $2 million versus the second quarter of 2018. Net income excluding other cost was $10 million or $0.09 per diluted share. Other costs, after-tax for the quarter included the benefit of approximately $5 million from changes in the valuation allowance, recorded against the Company's deferred tax assets, offset by approximately $1 million in other cost after-tax in the period. Our effective tax rate for the three months ended June 30, as calculated for U.S. GAAP purposes was 5.1%.

Moving to our segments, U.S. revenues were $605 million, a $5 million improvement in the second quarter of last year. A major decline in U.S. rig activity. Looking at the distribution channels, our U.S. Energy Centers contributed 53%; U.S. Supply Chain Services 28%; and U.S. Process Solutions 19% of second quarter 2019 revenue.

Canadian revenues were $74 million, down $1 million year-over-year. Pulling out the negative impact of foreign exchange in Canada, the revenue would have increased $2 million, against a 22% decline in Canadian rig count, and internationally revenues were $97 million in the second quarter 2019, down $5 million from a year ago, primarily driven by unfavorable foreign exchange rate impacts.

Moving on to operating profit. The U.S. generated operating profit of $60 million, or 2.6% of revenue, flat compared to the corresponding period of 2018, primarily due to a decline in gross margins, offset by reduced operating expenses. Canada operating profit was $1 million or flat when compared to the corresponding period of 2018, as a result of the revenue decline mentioned earlier. International operating profit was nil or down $1 million when compared to 2Q, '18, driven by the revenue decline discussed above.

Turning to the balance sheet. Cash totaled $80 million at June 30, with $74 million located outside the U.S. During the second quarter of 2019, we repatriated $13 million from our Canadian operations, to repay amounts under borrowed under our credit facility. In the quarter, we reduced our amounts borrow under revolving credit facility by half, as we ended the quarter with $62 million borrow, and move to a net cash position of $80 million when considering total company cash.

At June 30, 2019, our total liquidity from our credit facility availability plus cash on hand was $586 million. Our debt-to-capital ratio was 5% at June 30. Working capital, excluding cash as a percent of revenue for the second quarter of 2019 was just under 21%. Accounts receivable were at $496 million at the end of the second quarter, down $17 million sequentially improving DSOs to 58 days. Second quarter inventory levels were $598 million, resulting an improved inventory turn rates at 4.2. Accounts payable were $336 million at the end of the second quarter with days payable outstanding unchanged sequentially at 49 days. Net cash provided by operating activities was $69 million for the second quarter with capital expenditures of approximately $3 million, resulting in $66 million free cash flow in the quarter.

We are working capital intensive business. Our employees are focused on providing value-added products and supply chain solutions, by out outdelivering and outsourcing the competition, while finding ways to meaningfully speed up collections, reduce purchase quantities and safety stock values and aspiration enabled in the static atmosphere and to optimize our operational footprint we continue to generate free cash flow in this environment.

And now, I'll turn the call back to Robert.

Robert R. Workman -- President and Chief Executive Officer

Thanks, Dave. Let's wrap up with the outlook for the third quarter and the rest of 2019. Looking ahead, the most recent report from the EIA showed a trend of a lower number of wells drilled an increasing trend and completions and a slight draw down of DUC inventory during the last quarter. With WTI trading in the mid-50s, we expect our customers to continue to exercise capital discipline and focus on operating within free cash flow generation. If completions activity grows, we could see continued benefit from our U.S. Process Solutions business for modular rotating, production, measurement and process equipment. This would also benefit our U.S. Supply Chain Services and U.S. Energy Centers for demand for PVF, especially as it applies to midstream-gathering projects that would be required to get oil, gas and water to their final destination.

However, general industry expectations are for softening in the second half of 2019. And as I said earlier, one of our largest U.S. Supply Chain Services operator customers announced they'll be closing a major acquisition in 3Q, 2019. This will put downward pressure on our U.S. Supply Chain Services revenue for the remainder of the year as our customer continues exercising capital allocation austerity and preparation for the pending combination. In Canada, our political controversies and takeaway issues persist, the rest of 2019 will remain a challenge. As we exit a seasonal breakup period, we do expect a modest top line Canada in [Phonetic]. We remain cautious, however, about our Canadian operations due to the continued rig declines and political uncertainty.

Looking ahead internationally, we're seeing more rig activations, more Jack-up and floater tenders materializing, continue to increase in offshore activity in Europe and Mexico, an uptick in land-based activity in Australia and more production facilities quoting activity tied to capital projects. Recent and planned FID approvals in offshore rig contract announcements indicate that the worldwide offshore markets are poised for a long-term recovery and that should produce top line improvements for our International segment in 2020 and beyond, as customers work through inventories and move from exploratory to development activities.

Given these scenarios and recognizing opaque view we have into our customers' second half 2019 budgetary plans, we reaffirm our original guidance for the full year to be flat revenues to low-single digit percentage decline. We will continue to focus on maximizing gross margin percentage and a choppy price environment, work to improve our working capital turns and generate positive free cash flow.

Before I move on to recognize, one of our dedicated employees. I'd like to summarize the progress we made in the execution of our strategy. We continue to optimize our footprint, focus on margin discipline in a challenging U.S. land market, identify opportunities for enhancement in areas related to our quotation process as well as pricing, improving our operating efficiencies, further investing in technology, optimizing our inventory and sourcing strategy in response to import tariffs on steel products. Reducing working capital as a percentage of revenue and leveraging our acquisitions through enhanced cross-selling our products in bundled product and service offering, as evidenced by generating $66 million in free cash flow in the quarter.

We made progress on these objectives, all while simultaneously moving DNOW to a net cash position, which provides additional optionality in the event that one of the many companies, we'd like to add to our differentiated product and service offering becomes viable like the two small acquisitions we closed this quarter. With successful execution of our strategy. We expect continued improvement toward free cash flow generation and creating greater shareholder value through continued expansion and consolidation.

With that, let me recognize one of the employees whose daily hard work and dedication enables us to deliver on our promises. This month [Indecipherable] Phil will celebrate 44 years with DNOW. She is the cash manager in our treasury department residing in our corporate office in Houston. Debbie [Phonetic] is a [Indecipherable] of Estonian and upon graduation began her career with National Supply, one of the many companies that makes up the DNOW we know today as a final clerks accounts in accounts payable.

Debbie has contributed through various positions within the finance department through her tenure from AP, credit, payroll and in 0.1 moving into the Treasury Department. Debbie is always one of the first in our corporate office each morning. She looks forward to going home to her husband Frank and her three dogs as well as watching their daughters Heather and Macalus, and dogs too. Weekends often find Debbie visiting family in Chapel Hill and Brenham Texas home of [Indecipherable]. Thanks, Debbie for your continued dedication service to DNOW.

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

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. [Operator instruction] And our first question comes from Steve Barger from KeyBanc Capital Markets.

Steve Barger -- KeyBanc Capital Markets -- Analyst

Hey, good morning guys.

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

Good morning.

Steve Barger -- KeyBanc Capital Markets -- Analyst

Just first, Robert, on the customer slowdown way for the acquisition to close any way to quantify what that took away from the quarter and what do you expect for 3Q there?

Robert R. Workman -- President and Chief Executive Officer

I expect more of the same. There's just -- it's just a lot going on there. So, we had a pretty significant pull back and I'll say significant. I mean, it's in the millions in new, in that quarter. And I expect it again and again, but it's going to be $5 to $10 million a quarter.

Steve Barger -- KeyBanc Capital Markets -- Analyst

Okay. So, a pretty big gap. And, I just want to start with the two acquisitions, really good to see you back in the market. Any more detail on how long it will take to bring that capacity on to support process organic growth and maybe what those acquisitions look like in terms of revenue and margin?

Robert R. Workman -- President and Chief Executive Officer

Well. They both have a different story. The story with the one we acquired in Wyoming is that they are -- they have a particular territory that's outside of ours, but adjacent to it, where they distribute exclusively for Flowserve and that's our partner in up and almost all of our regions on [Indecipherable] pumps and mechanical sales. So, being able to pull out their -- some of their products into hours for example mechanical sales. We didn't have the mechanical sale on and now we get it. It should help grow, but if you take a quarter or two to kind of get traction on that. The other acquisition was -- in Casper where we do all this construction or this fabrication. Many of the facilities are assembly shops, but several of the facilities are feed shops. And so, we have a facility that has not the biscuits and it feeds the final assembly shops and we have two facilities that build spools both carbon and stainless and they feed the similar shops. But the big feed stock shop we have is the ASME vessel Shop, and it also feeds other shops.

And right now, we had some a choke point there, because of demand. And so our delivery times we're getting extended to the point that it was costing us potential future revenue, because customers couldn't wait that long. And so we had to come up with a solution for it, and fortunately for us, this one presented itself and it was a lot more economical for us than doing a greenfield expansion. And, the customer is -- the owner of that facility had already declared that business non-core and they had spent several months winding that business down. So we have just -- we're going to take us a couple of quarters to wind that business up. So I don't expect anything material from those two acquisitions in three and four, but we're really excited about what 2020 could hold once we get these things integrated.

Steve Barger -- KeyBanc Capital Markets -- Analyst

That sounds great. So this just further is the kind of thought process about being able to take more share with process as those ramp up?

Robert R. Workman -- President and Chief Executive Officer

Absolutely, and plus, most of our current U.S. Process Solutions business is all upstream and midstream. There is a little bit of downstream, but not much. This business has a great reputation, with a lot of the downstream customers with fractionating towers and other things that go into chemical plants and refineries. So, being able to build on that and tied in with our downstream Industrial business to try to generate the same success in that area that we have on the upstream piece with the energy centers is pretty exciting as well. But, at the end of the day, it also makes us more competitive, because now logistics will costs us less to compete in the Delaware or the Midland or the Eagle Ford because we're inproximity.

Steve Barger -- KeyBanc Capital Markets -- Analyst

Yeah. That's good. And the balance sheet is in obviously great share, but what's hopefully closer to a cycle bottom than not. As your team is looking at acquisitions, is the focus more on deals that plug holes in a geography or more about finding or adding to the niche product lines that you have that provide the differentiation?

Robert R. Workman -- President and Chief Executive Officer

Yeah. Our strategy has changed over the many years. We're really looking for expansion of products and services that we can provide our customers, because that benefits the rest of our business. So for example, in supply chain, we have several operators who have outsourced their procurement, the inventory management to us, and the more we can expand into the products that they consume regularly and add value by reducing their costs as opposed to just marking up purchases from another supplier, the more valuable we've come to them and the longer and stickier those relationships can be. So, we're really looking at a high barrier to entry stuff, it's not hard to go open a branch somewhere if you're selling pipe, valve fittings or MRO supplies, and all you needed a little bit of inventory and some good employees and you can start competing. To get involved -- we do in the Process Solutions business is not an overnight thing and it would require a lot of capital. So we're really looking to expand our product breadth and to acquire higher varied entry businesses that have accretive EBITDA margins.

Steve Barger -- KeyBanc Capital Markets -- Analyst

Got you. And then just one last one is does integrating these two small acquisitions kind of slow down the M&A or do you have enough bandwidth to continue looking for those things well, while you go around your daily business?

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

No. There has been no slow and we didn't put anything on hold or slow down our team that does M&A. So, I see that these having almost no impact on opportunity -- on opportunities to be present themselves to allocate capital for M&A.

Steve Barger -- KeyBanc Capital Markets -- Analyst

Okay. And I'll just one more, what's your comfort zone in terms of size for potential deals?

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

We're really not shy about size. In fact, we prefer large over small honestly, because it takes resources, in corporate and beyond and like IT and HR and Legal, it takes almost the same amount of work to complete a small deals it has as a big deal and big deals move the needle. Just, we haven't found one yet that we wanted to acquire where we could come to terms with what they expected for the business.

Steve Barger -- KeyBanc Capital Markets -- Analyst

Got it, thanks. Nice job.

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

Thank you.

Operator

Our next question comes from Walter Liptak from Seaport Global.

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

Hey, Walt

Walter Liptak -- Seaport Global -- Analyst

All right, thanks. Hey, good morning, Dave. Good morning, Robert.

Robert R. Workman -- President and Chief Executive Officer

Good morning.

Walter Liptak -- Seaport Global -- Analyst

I wanted to ask about the sales outlook for the back half and I guess the question is, we've seen the volatility unless today and I guess during the quarter around the oil prices and the customers same both type on their budgets, cash flow. Are we underestimating with the second half the book price is you've got the $5 million to $10 million order customer rolling off was pluses weakness. What are the offsets to get the growth, we're seeing Process Solutions grow, it sounds like international could grow, but I wonder if you could help us bucket, those [Indecipherable] so understand for the second half that reflects only down low-single digit?

Robert R. Workman -- President and Chief Executive Officer

Well, there is no down -- let's put away if you, if you listen to the earnings calls of all the drillers and if you've listened to the earnings calls of all the frac companies that do the completions and you take them out their word activity is going to be soft. The rigs are getting stacked out and frac fleets for the most part are getting put and yard somewhere. So for us to deliver on our commitment for the year, we're going to have to outperform the market. Now so far we've been outperforming the market I'm pretty excited about it, but I expect some shifting in our revenue in 3Q and 4Q between the groups and -- I'll let Dave give you some thoughts but, but like Process Solutions had a huge growth period a huge growth quarter. I expect them to still performed well, but if they may have some pull back, because we have lot of projects go through in 2Q. But maybe I guess somewhat -- your thoughts on it.

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

Yeah, I'll give some kind of a segment view. First of all, in terms of the outlook, I think there is -- we usually have a pretty good feel for the forward quarter. But at this time, I think there is more unknowns the knowns, while we're pretty confident. Canada is going to emerge from break up and we will grow in Canada. We may not see the kind of growth we normally see in Canada. And given the timing of projects in international, we think will grow sequentially in international, but that's like Robert says that's one of the -- our lumpiest most project oriented segment.

And then in the U.S., U.S. Energy is probably going to be flattish and Process Solutions had its best quarter since we acquired those two main acquisitions. That's one of the things we're really proudest about in the quarter is how Process Solutions just shined in the quarter, we expect some correction to that in the third quarter. We don't expect them to grow sequentially. And they finally with supply chain, while we have some puts and takes there, we do expect some growth there. So some, -- the U.S. market is going to be flattish for us and Canada in international plus up a little bit, but they're -- like I said, there are more unknowns that knows.

So that's kind of where we're at. We generally see the third quarter as our best our best quarter of the year. The third quarter of this year, we expect will be better, but and may be more in the first quarter range or maybe a little higher. So, and then the fourth quarter, we for the last several years have seen a sequential decline and we expect that a similar decline.

Robert R. Workman -- President and Chief Executive Officer

[Speech Overlap]

Walter Liptak -- Seaport Global -- Analyst

I'm sorry about that. Yeah. I just had one, one more for you. And on the pipe costs -- how are you guys doing on inventory and with pipe prices coming down, what's the revenue impact from that in the back half of the year?

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

So, that's a very good point because, we've seen pipe prices come down quite a bit this year and that has a double effect it brings down revenue levels. Obviously, even if you sell the same tonnage of pipe and that puts margin pressure on us and our competitors. So we don't know pricing has stabilized for pipe, it doesn't seem like it has. The general market declines and the pipe prices continue, we could see downward pressure on gross margins. We're trying to manage our inventories very tightly to mitigate or to get the negative impact of commodity deflation. We're trying to price aggressively. While we continue to take market share and we believe we are, but our customers are smart and those -- if is this kind of product abundance right now. so there we're going to be really looking for better cost and better price material. So, gross margins could come under continued pressure, but we're going to try to hold it like it is right now, but there are a lot of market forces that may may be impact that.

So that's an issue given revenues being down in the fourth quarter and flattish to up a little bit in the third quarter combined with gross margins could pick -- could bring our -- bottom line was down a little bit in the second half.

Walter Liptak -- Seaport Global -- Analyst

Thanks, Rob.

Operator

Your next question comes from Chuck Minervino from Susquehanna.

Charles Minervino -- Susquehanna -- Analyst

Hi. Good morning, guys. Just I was hoping to touch a little bit more on that gross margin path, a little bit as well. I think you touched on it in the prior question a little bit. I mean it sounds like you're kind of anticipating some further deterioration there. As you mentioned in the opening remarks that you've seen as low on the gross margin side kind of back in '16 and that 16% range kind of peaked up last year, around 20.5%. Is that what you think the general range is? And I mean do you think we could be heading back to '16 or do you think we're more likely heading more like 2018 number. Just kind of the scenarios that kind of get you around that range as we kind of think about forecasting that for the next couple of quarters or even the next couple of years here?

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

Yeah. The floor is much higher than '16. We could be at the floor. I'm just saying that there are forces. If you think about it, the sentiment has kind of eroded during the year and in the last 24 hours, it may have eroded twice what it did during the whole rest of the year. So that's just a reality we have to deal with. If things get tighter in the quarter and customers are buying less and this inventory are -- everyone is trying to offload, there'll be some downward pressure, but that's not necessarily the case. If the market grows in the third quarter or our sales grows in the third quarter, we could see flatness in gross margins.

So to answer your first question, we're not anywhere close to 16%. We're going to be in the 18% and higher and 19% probably for the year 19% plus. But we really don't know what kind of gross margin erosion is our models have pretty flat for the rest of the year flat at the 2Q level, but of course like that subject to change.

Robert R. Workman -- President and Chief Executive Officer

And don't forget some of the pressure is competitive which it is what it is. But some of it's just to do to still -- falling steel prices. So we turn our inventory four times a year plus, so you can -- we can work through that inventory pretty quick. And then the replenishment inventory is going to be a lower cost inventory. So, if we ever have a gross margin percent this year that starts with an 18 handle, I'm going to be super surprised.

Charles Minervino -- Susquehanna -- Analyst

Got it. That's helpful. And then just a separate question, Canada in the quarter was quite a bit better than we thought. And I think Dave in your remarks. Just a little bit earlier, you kind of talked about how there might be some pressure in the U.S. but being brought up a little bit by Canada, that sounds to me like a little bit different. I mean -- I guess, we were under the impression that Canada was going to be fairly weak this year. So it sound and down quite a bit. Am I mistaken in that or have things changed for you a little bit in Canada and if so, kind of what was that just the 2Q numbers are pretty good and it sounds like at least for the year is going to be maybe better than you maybe we're originally expecting?

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

Yeah. The Canada has shrunk two years in a row, but we're very much holding our own there. Rig count declined in Canada in the second quarter 22% and our revenues are essentially flat. We believe we're gaining market share there, and I talked -- Mark -- Robert and I talked a lot about prices and solutions being one of the stars in our quarterly results. Canada is certainly up there. So, we feel confident about Canada. We almost all we see a third quarter emergence from break up recovery. We expect to grow and so that's why we expect to grow in the third quarter. We don't expect to grow at the same kind of rates we normally would into the third quarter, but will grow there. So while the market is shrinking, I think we're taking share and it's showing in our numbers.

Robert R. Workman -- President and Chief Executive Officer

No doubt about it.

Charles Minervino -- Susquehanna -- Analyst

That's great. And is the Canada business, I mean is the rig count still the best proxy for you guys there or are you selling into some other markets there that are may be on as rig exposed and maybe tracking the rig count isn't quite the best way to do that?

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

That market has got. There are several pieces of market in that market. So, obviously from the upstream piece, we really track closer to well completions, and well completions, spuds and the wells drilled. Then you get into the oil sands, which is a whole another animal and then we are really, really big into the midstream market in Canada. So, there is a lot of things that affect our Canadian revenue.

Robert R. Workman -- President and Chief Executive Officer

Yeah, I mean rig counts isn't correlated like it would be in the U.S. but it's a barometer and -- so we look at it as one and one of our kind of bellwethers for what we should be earning in terms of revenues up there.

Charles Minervino -- Susquehanna -- Analyst

Thanks a lot guys.

Operator

Thank you. Our next question comes from Nathan Jones from Stifel.

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

Hi, Nathan.

Adam Farley -- Stifel -- Analyst

Hey, good morning. This is Adam -- hey, this is Adam Farley on for Nathan.

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

Okay.

Adam Farley -- Stifel -- Analyst

I just wanted to turn back to U.S. Process Solutions. Obviously, a real good quarter, outperforming the market and you guys are likely taking share. I was wondering, if you could give an update on the turnkey solution for tank batteries, how is it being an accepted in particularly in the Permian and then maybe some of your growth expectations there?

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

So, we're gaining traction, and what I mean by that is, we first started out attacking these other shale plays that they have never operated in before by using the Odessa Pumps infrastructure. Like we would get tested somebody order 20 lacks units or somebody order 20 oil and gas water separators or whatever, which would go to 20 different pads instead of buying the full kit for pad. And then it grew and then we had a cup -- we have one customer that actually what the full into lot of [Phonetic] in order to everything on the well side, love to so much ordered for more that particular customer is having some issues right now just with production and living within cash flow. So they've not reordered any more than the five.

But what we have seen is some other customers that are ordering instead of if there's 12 piece of kit on a tank battery, they went from order in 1, to order in 2, to order in 3, to order in 4 and so we're making traction there not as fast our warrant, but the order intake volume from those customers are still really high because they're ordering certain pieces of our kit to go to like 5,10,15,20 well pads as opposed to just a single well, all the kit on the one well pad. So from a revenue perspective, it's not disappointing, just from the check the box perspective, more customers are adopting, it's on its way there and it's head in that direction and they're adding more and more kit. But we're still looking for a full adoption and we're not quite there yet.

Adam Farley -- Stifel -- Analyst

Okay, that's helpful. And then, I find your comments around midstream water per your interesting produced water is likely to increase in the shale plays and investments, probably going to be needed there to address that. Could you just talk about how that midstream water market is developing and then how DNOW directly benefits from it? Thanks.

Robert R. Workman -- President and Chief Executive Officer

Well, it's, as you can imagine, if you're going to be in the water business, whether you're an oil company or midstream company or a pure water management company, you've got to have pumps. And we have -- especially in the Delaware and well, pretty much all the way from the, from the Eagle Ford to the Bakken, we're the largest pump distributor in those spaces. So there's a lot of benefit there because we have high quality brands that customers want, and then the real benefit is those pumps have to be connected with pop valves and fittings in valves and actuation. And so by bringing our process group in with our energy group and bringing in the entire package, it becomes easier for that particular target customer to work with us, because they have less vendors to deal with and we have the brands of the products are really most interested in, which is which multiplex pumps are we going to do they want? Which H pumps do they want? Which [Indecipherable] and typical pumps do they want? And when you can meet that demand, the pipe valves and fittings become a secondary conversation. Whereas if you didn't have that, then just we bidding you on pipe valves and fittings just everybody else they has pipe valves and fitting. So, it's a nice growth market for us and I expect a lot from it.

Adam Farley -- Stifel -- Analyst

All right. Thanks for taking my questions.

Robert R. Workman -- President and Chief Executive Officer

You're welcome.

Operator

Our next question comes from Marc Bianchi from Cowen.

Marc Bianchi -- Cowen -- Analyst

Hey. Thanks. If I'm hearing you guys right. It sounds like you're expecting U.S. to kind of be flat in the third quarter, and I was hoping you could go through the details a little bit more. It sounded like, if I kind of take what, we've heard from some of the OFS companies that you talked about HP Patterson talking about rig counts to be down high single-digits. I think Patterson's completion activity is down 10% in the third quarter. So, is that the kind of market outlook that's underlying your expectation for flat? And then also, I think there was a supply chain customer that you mentioned that slow down. So if you could just help us kind of bridge all that, it would be great?

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

Well, we talked about U.S. Energy being flattish. It could be up, are you -- the U.S. could be up and the U.S. Energy is looking flattish to us, because as Robert mentioned in his opening comments, we had a $9 million order -- pipe order that won't recur. So that's something we have to overcome for U.S. Energy Group to grow. We think supply chain will be up, like we said and process solutions down. So that's going to be the major drivers for the quarter. Again, that's going to be -- we talked about winning some new customers. Depending on the time when those revenues materialize there could be some uplift in the third quarter as well.

Robert R. Workman -- President and Chief Executive Officer

Now, basically in a declining market, which is pretty much what the drillers in the completion companies have put -- stated on their earnings call the last three weeks, we're hoping to be flat or up slightly to overcome the market, but that's going to require share -- taking share like we have been.

Marc Bianchi -- Cowen -- Analyst

Got it, got it. Okay. That's really helpful, guys. Thanks. And my second question is on just the working capital, you've done a great job [Technical Issues] get the ratio to sales down to below 21% this quarter. I would suspect that you get some more working cap released throughout the back half of the year, if kind of the overall is flat to down. So how do you think of it in the context of that 20% that you delivered this quarter as we roll through the back half?

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

I think we'll see similar or better working capital to revenue ratios. Rev -- we do think revenues will be down a bit in the second half. So we'll see receivable the opportunity to generate more cash from reduced receivables, because the market is flat to down and it's really a little bit easier to to gauge inventory skew quantity requirements will be able to pull up more inventory. So, we're living in this space that the second half free cash flow is as good or better than the first half free cash flow. And we always want to get our working capital as a percent of revenue closer to 20, we're making nice progress there. So we've got all hands on deck to really accelerate the movement in working capital and liquid as as much as we can and enable us to to gain market share. So that's kind of where we're at right now.

Marc Bianchi -- Cowen -- Analyst

Great. Thanks very much. I'll turn it back.

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

Your Welcome.

Operator

Our next question comes from Vebs Vaishnav from Howard Weil.

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

Hey, Vebs.

Vaibhav Vaishnav -- Scotia Howard Weil -- Analyst

Hey, good -- hey good morning.

Robert R. Workman -- President and Chief Executive Officer

Good morning.

Vaibhav Vaishnav -- Scotia Howard Weil -- Analyst

I guess the process -- of the supply chain, understand what you're talking about on the existing one customer, but if I'm not mistaken, you were working on getting one other large customers into supply chain. Any progress on that or either for that one customer or how you are progress -- how you think about adding more customers to your supply chain?

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

Yeah, that's, as we -- I think as we've discussed before, that is our longest cycle sale, because it requires a huge culture shift and the particular customer that you're targeting, and not all customers meet that model. So, if you've got a smaller pool of customers that actually have all of them, of the indications that their size, with their facilities, their concentration, in certain place all the stuff, it limits the customers and we have -- we always have two or three customers that we feel like are just right around the corner but they always undertake three months, six months, nine months, 12 months. So we have several conversations going on. I hope that we're surprised soon with another win, but really it's it's just so hard to forecast that because it takes the CEOs, and the CFOs and the EVPs of ops and the VPs of procurement, all to finally take the big plan. So, but that's, then again, the other four over the same way and we got them across the finish line. So it's not impossible, it's just a really hard to sell.

Vaibhav Vaishnav -- Scotia Howard Weil -- Analyst

Got it, OK. On M&A, you guys did two M&A, can you just talk about how you are thinking going forward. Is it mostly going to be in Permian or are there more that other product lines that you can make -- you are thinking about from an M&A perspective?

Robert R. Workman -- President and Chief Executive Officer

Yes. So I, as it -- the U.S. Process Solutions which is typically where we will be doing M&A, it's about expanding product lines or expanding to geographies where we don't currently service. So or don't -- we don't have a big presence in that particular group. So, I would love to go out and do some large M&A actions with companies that would expand our product lines in that particular group, but they are hard to come by. So these little bolt-on deals that we're doing, that carry low risk that are don't consume a lot of cash, that really we can plug them into the network and grow them rapidly, because they don't have our network. That's kind of where we've been headed. But the minute that -- a larger one becomes viable and the stars aligned and we are bid-ask spread shrinks to zero as far as what they expect and what we're willing to pay. I couldn't get -- Dave to write the check quick enough.

Vaibhav Vaishnav -- Scotia Howard Weil -- Analyst

Got it. Okay. And maybe one modeling question. So, gross margins have come down like 40 bps each of last two quarters. You guys talked about how we are seeing a softening market and more pressure on gross margins. Anyhow you can say gave around like well should we use, should we assumed a similar decline in gross margins or how could we think about for the, -- for the next couple of quarters?

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

Yeah. I would assume a similar decline of all that could happen they could be flat. I mean, it's going to matter on many things, who the customers are? What the product mix is? Do steel prices continue to decline? Are we able to quickly liquidate our over cost of inventory? I talk to my opening comments about how we've got kind of a squeeze on margins right now, because steel related products, those product costs are coming down. So our margins are squeezed there and as we turn our inventory, we will be able to eliminate that squeeze and bring margins up for that element of gross margin. So that's a very hard thing for us to gauge. There are some headwinds like steel price declines. And in a market that's, kind of soft. So those are not favorable to gross margin gains, but we're doing all we can to mitigate any further erosion in gross margins and will just have to see how that plays out.

Robert R. Workman -- President and Chief Executive Officer

Yeah, that's probably one of the single hardest items for us to forecast, because you have thousands of employees out there, process and millions of transactions. When we try to get all the tools we can to help them push price like we have a system and helps them recommend price based on the market there in and the replacement cost of material and all that other stuff. So, it's really difficult like, there several quarters in the last 12 that if you'd ask, can you grow margins 700 or 70 basis points? I'd say no, and we went over that. And then we had another quarter where went up 170 basis points, I'd never would have forecast that. I didn't think we'd be at 19.7 right now personally.

So it's just a really hard number to forecast, but if you believe some of the pipe manufacturers that have already reported. I haven't found it -- I have not found any evidence of his, but these are people who do this for a living, they expect a hot roll coil to increase throughout the rest of the year. If that does, that will completely change our perspective on gross margin percent. So, we'll see how that goes. But definitely inflation is great, but inflation -- I'm sorry, deflation and a competitive slowing market is what puts the biggest squeeze on margins.

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

Vai;

That's very helpful. Thank you for taking my questions.

Thanks.

Robert R. Workman -- President and Chief Executive Officer

Thanks, Vebs.

Operator

Ladies and gentlemen, we have reached the end of our time for the Q&A. I will now turn the call over to Robert Workman, CEO and President for closing statements.

Robert R. Workman -- President and Chief Executive Officer

Thanks everyone for dialing in to our call today, and thank you to all our employees who helped us, put up some amazing results. And we look forward to talking to you in about three months, regarding our 3Q results. Thanks.

Operator

[Operator Closing Remarks]

Duration: 61 minutes

Call participants:

David A. Cherechinsky -- Senior Vice President and Chief Financial Officer

Robert R. Workman -- President and Chief Executive Officer

Steve Barger -- KeyBanc Capital Markets -- Analyst

Walter Liptak -- Seaport Global -- Analyst

Charles Minervino -- Susquehanna -- Analyst

Adam Farley -- Stifel -- Analyst

Marc Bianchi -- Cowen -- Analyst

Vaibhav Vaishnav -- Scotia Howard Weil -- Analyst

More DNOW analysis

Transcript powered by AlphaStreet

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.