Monica Schafer Broughton - MRC Global, Inc. Andrew R. Lane - MRC Global, Inc. James E. Braun - MRC Global, Inc..

Sean C. Meakim - JPMorgan Securities LLC Matt Duncan - Stephens, Inc. Vaibhav Vaishnav - Cowen & Co. LLC Nathan Hardie Jones - Stifel, Nicolaus & Co., Inc. Walter Scott Liptak - Seaport Global Securities LLC David J. Manthey - Robert W. Baird & Co., Inc..

Greetings and welcome to the MRC Global First Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Monica Broughton, Investor Relations.

Thank you. You may begin..

Thank you and good morning, everyone. Welcome to the MRC Global first quarter 2018 earnings conference call and webcast. We appreciate you joining us today. On the call, we have Andrew Lane, President and CEO; and Jim Braun, Executive Vice President and CFO.

There will be a replay of today's call available by webcast on our website, mrcglobal.com, as well as by phone until May 17, 2018. The dial-in information is in yesterday's release. We expect to file our first quarter 2018 report on Form 10-K later today, which will also be available on our website.

Please note that the information reported on this call speaks only as of today, May 3, 2018, and therefore, you are advised that information may no longer be accurate as of the time of replay. In our remarks today, we will discuss adjusted gross profit, adjusted gross profit percentage, adjusted EBITDA, and adjusted EBITDA margin.

You are encouraged to read our earnings release and securities filings to learn more about the use of these non-GAAP measures and to see a reconciliation of these measures to the related GAAP items, all of which can be found on our website.

In addition, the comments made by the management of MRC Global during this call may contain forward-looking statements within the meaning of the United States federal securities laws. These forward-looking statements reflect the current views of the management of MRC Global.

However, MRC Global's actual results could differ materially from those expressed today. You are encouraged to read the company's SEC filings for a more in-depth review of the risk factors concerning these forward-looking statements. And now, I'd like to turn the call over to our CEO, Mr. Andrew Lane..

Thank you, Monica. Good morning and thank you for joining us today and for your interest in MRC Global. Today, I will review company performance highlights and then I'll turn over the call to our CFO, Jim Braun, for a more detailed review of the financial results. I'll then finish with our updated outlook for 2018.

2018 has started strong with first quarter revenue just over $1 billion; it's the first quarter in the last 10 quarters that we have reported quarterly revenue over $1 billion. Revenue was up 17% over the first quarter of 2017 and up 12% sequentially from the last quarter. Importantly, adjusted gross profit improved to 19.1% in the first quarter.

Adjusted EBITDA came in at $59 million or 5.8% of sales, resulting in strong incremental EBITDA of 16% for the first quarter 2018 over the same quarter a year ago. Diluted earnings per share were $0.13 in the first quarter compared to breakeven earnings per share a year ago.

Contract wins and extensions have benefited the quarter, as all our segments and end-markets experienced growth. The macroeconomic conditions for our end-markets are all very positive and continue to improve with customers spending higher than last year were concentrated in areas where we operate.

There are several inflationary trends on our products that I'd like to discuss. Recently, Section 232 tariffs targeting steel imports and related quota measures have been put in place. In some cases, steel producing countries have been granted exemptions from the tariffs.

In addition anti-dumping suits in certain product categories have been filed recently. Our costs have also been influenced by various other inflationary pressures, mostly raw material cost increases. Transportation and freight costs have also increased due to higher demand, regulation, and limited driver resources.

The market continues to adjust to these measures as there are many moving parts in our global supply chain and many of these elements continue to evolve. In fact on Monday of this week the temporary exemptions for certain countries was extended another month.

Nevertheless, product inflation is generally a positive for us as our cost plus contracts allow for price increases to be passed through. Transportation and freight costs are also structured as a pass-through cost in our customer contracts.

While the new pricing can take a quarter or two to be realized, we've begun to see margin improvement in the first quarter from higher inflation and we expect that will continue.

Carbon pipe is typically our product group with the most price volatility, but given the various inflationary pressures, all our products are experiencing some level of inflation. Some line pipe sizes and types have seen a 25% plus increase. Carbon fittings and flanges, stainless products and valves, all are experiencing price increases.

Based on the current market outlook, we expect the trend to continue for certain sizes and types.

In light of these conditions, we have been strategically building the inventory not only for expected increase in demand, but also to get ahead of these price increases and to have product available for our customers when quotes and additional demand extend lead times.

This April, we completed our $100 million share repurchase program authorized last October. Under this most recent authorization, we repurchased 6.1 million shares at an average price of $16.43 per share. In total, including both of our repurchase authorizations, we have repurchased 14.6 million shares at an average price of $15.38 per share.

The outstanding share count as of April 27, 2018 is 89.7 million shares. We are pleased with the results of our share repurchase programs, which have returned capital to shareholders on an accretive basis over the past several years.

Our capital allocation strategy has balanced the needs of our operating business, which is impacted by the energy markets, with our balance sheet, and taking advantage of the cyclicality of our end markets. We believe this investment in our company has been a prudent use of capital that has created value for shareholders.

This quarter we have also renewed and expanded our Enterprise Framework Agreement with TransCanada for three more years. TransCanada purchased our longtime customer, Columbia Pipeline Group in 2016. This was an important renewal of the legacy Colombia Pipeline Group business and an expansion to include TransCanada's U.S. legacy assets.

The combined company was one of our largest customers in 2017, driven by their active pipeline expansion program. This is another example of maintaining customer contracts and expanding contract scope to capture additional market share.

We continue to gain market share through our account management process and our framework agreements and expect to have more contract renewals and expansions in the second quarter to share with you. I am pleased to report that all three of our segments reported positive operating income for the quarter.

I've noticed the positive result for our International segment. As you know international customer spending has remained depressed. However, the restructuring steps we took late last year in this business have paid off with a return to profitability. Equally encouraging are the positive signs we are starting to see in customer activity levels.

First quarter was a great start to the year. We are encouraged by the positive macro trends and looking forward to continued growth. In years of improving macro conditions like this one, historically we have seen that our first quarter is our lowest revenue quarter of the year as our customers' ramp up their new budgets.

So with that, I'll now turn the call over to Jim..

Thanks, Andrew and good morning everyone. Total sales for the first quarter of 2018 were $1.10 billion or 17% higher than the first quarter of last year as all end-market sectors produced double-digit percentage growth led by upstream and closely followed by downstream.

Sequentially, revenue increased 12% from the fourth quarter with all segments and sectors experiencing growth. Now, starting with revenue by segment. U.S. revenue was $806 million in the quarter, up 21% from the first quarter of last year, as downstream activity increased the most at 31% or $55 million.

The increase in downstream is primarily due to project deliveries for Shell's Pennsylvania Chemicals Project, increased turnaround activity for both refining and chemical customers and share gains. The U.S.

midstream sector increased $47 million or 14% from the first quarter last year due to growth in spending as oil, gas and liquids productions in the United States has increased, which has in turn driven more gathering systems as well as various pipeline projects by transmission customers.

Midstream growth was also driven by gas utility customer integrity work. Typically, we see less construction for transmission and gas utility integrity work in the winter months, so we expect that this work will increase throughout the year. The U.S.

upstream business increased $38 million or 27% from the first quarter last year, as well completion activity increased. Our U.S. upstream growth trailed the overall increase in well completions due to our customer mix. Sequentially, U.S.

segment sales were up from the fourth quarter by 13%; gains were across all sectors but primarily due to an increase in downstream sales due to our large project deliveries, followed by midstream related to increased gathering activity and finally, upstream, from increased completions.

Canadian revenue was $78 million in the first quarter, up 1% from the first quarter of last year. Canada's revenues were nearly flat as gains in midstream and downstream revenue were offset by reduced upstream revenue.

Canadian rig count declined 9% in the first quarter of 2018 over the same quarter a year ago, driving the decline in our Canadian upstream business. The Canadian segment also benefited $3 million from the strength in the Canadian dollar against the U.S. dollar in the quarter.

Sequentially, the Canadian segment was up 10% from the fourth quarter due to an increase in midstream line pipe sales for various small cap projects and upstream, as completion activity increased. In the International segment, first quarter revenues were $126 million, up 6% from a year ago.

Sales were up due to higher upstream activity from valve sales for the future growth project in Kazakhstan, partially offset by a decline in the midstream sector from a non-recurring pipeline project in Australia. The International segment benefited $11 million from foreign currency strength against the U.S. dollar in the quarter.

Sequentially, the International segment was up 8% from the fourth quarter from increases in all sectors. Now turning to our results based on end market sector. Compared to the same quarter a year ago, all sectors grew double digits.

In the upstream sector, first quarter sales increased 23% from the same quarter last year to $302 million, driven primarily by higher well completions in the United States followed by oil and gas production facility project deliveries in the International segment.

Downstream sector sales grew 21% from the same quarter last year to $298 million, driven by the project deliveries for petrochemical customers including Shell's ethylene cracker in Pennsylvania, a stronger turnaround season for both refiners and chemical producers, and market share gain from new contract customers.

Our spring turnaround revenue was about $25 million in the first quarter. Midstream sector sales increased 11% from the same quarter last year to $410 million. Both subsectors experienced growth. Sales to our gas utility customers increased by 14% and sales to our transmission and gathering customers increased 7%.

Gas utility sales increased primarily due to line pipe and valve orders for integrity projects. The increase in sales to transmission and gathering customers was due to gathering systems as production increased, as well as transmission projects for takeaway capacity.

The mix between our transmission and gathering customers and our gas utility customers was weighted 52% for transmission and gathering, and 48% for gas utilities in the first quarter.

All end-market sectors showed sequential growth as well, with the strongest performance in our downstream sector experiencing growth of 19% driven by the deliveries for the ethylene cracker in Pennsylvania and the spring turnaround season. Now turning to margins.

Gross profit percent increased 50 basis points to 16.7% in the first quarter of 2018 from 16.2% in the first quarter of 2017. LIFO was a headwind for the quarter as we recorded LIFO expense of $7 million and $1 million in the first quarter of 2018 and 2017 respectively.

The adjusted gross profit percentage was 19.1% in the first quarter of 2018, up from 18.2% in the first quarter of 2017. The increase in adjusted gross profit percentage reflects the positive impact of the inflationary conditions mentioned earlier and a favorable product mix.

As noted, we've seen inflation in line pipe prices, which have increased considerably in 2018. Based on the latest Pipe Logix, all items index, average line pipe spot prices in the first quarter of 2018 were 28% higher than the first quarter of 2017 and 12% higher sequentially.

We expect and continue to experience type inflation, as uncertainty around tariffs and quotas remain. Domestic suppliers have, where possible, moved up pricing to match increases from foreign-sourced products.

SG&A costs for the first quarter of 2018 were a $138 million, an increase of $12 million or 10% from $126 million a year ago, due primarily to wage and incentive increases, volume-related increases from higher activity levels, and unfavorable foreign currency movements.

As a percentage of revenue, SG&A fell to 13.7% from 14.6% as revenue growth exceeded increases in operating expenses. As compared to our previous outlook, first quarter SG&A expense was higher than expected due to volume-related increases and foreign exchange mentioned above.

With a strong performance this quarter and higher expected revenues in 2018, we are updating our outlook and estimate for our annual SG&A expense will be $545 million to $555 million or a run rate of about $136 million to $139 million per quarter for the remaining three quarters of the year.

Salary and wage inflation remain a factor in certain operating areas. Interest expense totaled $8 million in the first quarter of 2018, which was $1 million higher than the first quarter last year, primarily due to higher average debt balances.

This quarter we entered into a five-year interest rate swap to fix a portion of the interest expense on our term loan. Under the terms of the swap, we receive a one month LIBOR rate on a notional amount of $250 million and pay a fixed rate of 2.71%.

This effectively fixes the interest rate on $250 million of the term loan at 6.21% when considering the 3.5% margin provision of the term loan. Our tax rate for the first quarter was 28%, resulting in a tax expense of $7 million. Our tax rate is higher than the U.S.

statutory rate of 21%, primarily due to state taxes and pre-tax losses in certain foreign jurisdictions without a corresponding tax benefit. Based on our current projections of earnings by jurisdiction and the other provisions of the new U.S.

tax law, we're estimating an effective tax rate of 28% to 29% for 2018, not significantly different from our previous tax guidance. Our first quarter 2018 net income attributable to common shareholders was $12 million or $0.13 per diluted share as compared to breakeven last year.

Adjusted EBITDA in the first quarter was $59 million versus $36 million a year ago and adjusted EBITDA margins for the quarter were 5.8%, up from 4.2% a year ago as revenue increases outpaced costs. Incremental EBITDA was a healthy 16% for the first quarter of 2018 over the same quarter a year ago.

All three of our segments generated positive EBITDA this quarter, including International, which benefited from the cost reductions and restructuring actions taken at the end of 2017.

We used $74 million of cash in the first quarter of 2018 as we built working capital faster than initially expected due to higher activity levels, as well as an effort to invest ahead in the inflationary environment.

Our working capital net of cash at the end of the first quarter 2018 was $818 million, $237 million more than a year ago and $110 million more than at the end of 2017. As a result, at the end of the first quarter of 2018 our working capital, excluding cash as a percentage of trailing 12-month sales was 21.6%, slightly above our 20% target.

However, we expect to return to the 20% range by the end of the year. With higher than expected sales for the year and opportunistic inventory buys we expect that cash flow from operations for 2018 will be about breakeven. Our debt outstanding at the end of the first quarter was $639 million, compared to $526 million at the end of 2017.

Our leverage ratio based on net debt of $594 million increased to 2.9 times from 2.7 times at the end of last year, as debt increased in the first quarter. The availability on our ABL facility was $409 million at the end of the first quarter and we had $45 million in cash. As part of the changes related to the new U.S.

tax law, we repatriated $30 million of cash from our Canadian operations during the quarter.

Capital expenditures were $5 million in the first quarter and while we're running somewhat under the previous guidance, we have no change to our annual guidance estimate of $25 million as additional costs to build-out the La Porte RDC office facility are expected. And now, I'll turn it back over to Andrew for closing comments..

Thanks, Jim. I'll end with our current outlook. This quarter's strong performance resulted in all sectors outpacing our initial estimates. As a result of the solid quarter and our expectations for the remainder of the year, we are raising our guidance for 2018. Market conditions are trending positive across all of our business.

Commodity prices are higher than they were at the beginning of the year and higher than the levels at which most spending surveys indicate our customers budgeted. Global crude oil inventory levels are supportive of a rebalancing of supply and demand. The WTI oil price was over $68 per barrel recently, the highest it has been since 2014.

Well completions continue to increase and our customers are more active in most all the areas we operate, all supporting our upstream business. The inventory of drilled but uncompleted wells, or DUCs, remains high and continued to grow in the first quarter. They represent future revenue opportunities as they are eventually worked down.

Downstream projects fuelled by stable, low cost feed stock prices are progressing and will be positive in 2018 and beyond. We have also seen the benefit of our market share gains as our new contracts are showing growth, supporting all our business, but particularly the downstream.

As production continues to increase in the U.S., the need for additional takeaway capacity grows as well as the need for gathering systems. A more constructive regulatory environment for energy infrastructure projects and inflation in line pipe pricing all benefit our business.

Gas utilities continue to execute long-term plans to repair, replace, and upgrade their distribution network. These market dynamics support our midstream business. Our backlog was $888 million at the end of the first quarter, up $55 million or 7% from a year ago, primarily due to increases in downstream and upstream project spend in the U.S.

The backlog has continued to increase in April, indicative of growing activity levels going into the summer construction cycle, which is typically the busiest time of the year. Given the improving macroeconomic market factors and our strong first quarter performance, we have raised our guidance expectations.

We expect total revenue to be between $4.1 billion and $4.4 billion, which is $200 million higher at the midpoint than we previously estimated. By sector, as compared to 2017, we now expect upstream and downstream each to be 15% to 25% higher and midstream to be 10% to 20% higher.

For comparison, we previously expected upstream to increase by 10% to 20% and midstream and downstream to each grow by 5% to 15%. The increase in downstream guidance is driven by strong first quarter performance, expected project deliveries, and market share gains.

Similarly, for upstream and midstream, strong first quarter results, higher commodity prices and improved outlook for customer spending is bolstering our expectations. We have increased our expectations for the U.S. segment, raising growth to 15% to 20% this year. Canada and International are expected to be up 10% to 15%.

Sequentially, we expect second quarter 2018 to be up mid-single digit percentages from the first quarter 2018. We also have updated our expectation of adjusted gross margins in 2018 to a range from 19.0% to 19.3% for the year.

Margin tailwinds include continued inflation in our product categories, favorable product mix changes to higher margin valves, instrumentation and stainless products. We have not changed our expectations regarding tempo and we still expect the second half to be stronger than the first half with our third quarter our highest revenue quarter.

So with that we will now take your questions. Operator..

Thank you. Ladies and gentlemen, we will now be conducting the question-and-answer session. Our first question is coming from the line of Sean Meakim with JPMorgan. Please proceed with your question..

Thank you. Good morning..

Good morning, Sean..

Andy, maybe just starting with the updated guidance, I'm wondering how much pricing reflation is embedded relative to expectation of higher volumes? And then maybe you could just talk a little bit about the incremental margin impact at the EBITDA line at the low end versus the high end of the range?.

Yeah, Sean. So let me talk – the pricing and what we've put in there. Jim can talk about the incremental EBITDA margin. The tariffs the big swing factor for us; it's a really big deal this year. Inflationary environment is good for us.

When you look back at our company, 2012 to the first half of 2014 was inflationary and that's spurred a lot of growth on the top-line but also margin improvement. Then, 2015 and 2016 were two years of difficult deflation. So we're back in – it started in 2017, but in a much higher inflationary environment in 2018.

So we have, for what we know today, factored in two things; one is just stronger demand. CapEx budgets are up, and so we're taking advantage of that. The overall market spend is up and our market share gains and contracts is up.

And then you layer on inflation on top of that and that's really embedded in our – in our growth (00:28:11) estimate that we've put out there.

And the tariffs are both a combination of the anti-dumping countervailing duties, which aren't getting as much press but are a big factor with both carbon steel, flanges, forged steel fittings, large diameter carbon steel pipe and stainless steel flanges.

So all of those are outside the Section 232 impact and all are having a inflationary impact on our products. Our costs – our contracts are all cost-plus. So we've done this many years and we'll move those higher costs on to our customers as the pricing increases.

So, certainly, what we know today as far as the tariff impact – and we've seen a lot of impact both U.S. mills and foreign mills – what we know for sure is already embedded in our updated guidance, but there's still some uncertainty with Canada and Mexico, the EU still undetermined. So, we don't maybe have all of that baked in yet..

Yeah, Sean on – as to your question on incrementals, at the midpoint of the guidance we expect to see the strong incrementals of the 16%, 17%. And if you move it up to the high end, I think you'd see something a little bit stronger than that, that we wouldn't have to add as much cost.

Likewise, if for some reason we were at the low end of the guidance, you might see a little bit of softening in those. But we should be in the 16%, 17% range..

Okay. Great. Thank you for that. And then, you moved your guidance the most in the downstream on a percentage basis. Obviously, spring turnaround, the ethylene cracker and the – you get some help in the first quarter.

But just how much of the increase is more visibility from some of the share gains you've had in that stream with specific customer, the projects, and thinking about how those opportunities are influencing your guidance versus your (00:30:20)? Just how that – and then when you expect that mix to unfold?.

Yeah, Sean that's the big positive; it's the contract wins and the ramping up of the higher budgets for those customers that we won the contracts for. So that's the largest impact on the revised incremental revenues going up. The Shell Franklin, as we spoke before is kind of a $7,500 million project for us with around $25 million in the first quarter.

We had $25 million in turnaround; it was a good first quarter in the U.S. for us. We'll see some more in April, but we also – for the year, we see $70 million to $90 million in turnaround revenues with a good third quarter also projected. So, turnaround is trending nicely for us.

The one big downstream project we will ramp up the rest of the year, and then the rest of the increase in revenue forecast is coming from the contract gains, and they are spending year-over-year.

Part of it is because we didn't have those contracts for the full year last year, and part of it is, now we have a full year run rate but they're also spending more. So we feel good about downstream projections..

Great. Thank you..

Thanks, Sean..

Thank you. Our next question is coming from the line of Matt Duncan with Stephens. Please proceed with your question..

Hey. Good morning, guys. Great start to the year..

Thanks, Matt. Good morning..

So, Andy, you guys are obviously outgrowing rig count on the upstream side of things pretty handily right now. I'm curious if maybe you could separate out the price impact that you're seeing from the volume impact.

And on the volume side, is this something you think you can continue with? What's driving it? Is it really just the growth in completions coming back and you guys taking share on top of that? Just how should we think about your upstream business relative to what's happening on rig count, understanding you're more of a completions driven business than rig count?.

Yeah. Matt. Let me just make a couple comments about that. So I would say first that – which shouldn't be a surprise that 50% of the rigs in the U.S. are in the Permian. So that's been the big activity increase for everyone in the industry. We have 10 core branches in the Permian that we service customers from.

So our Q1 revenue year-on-year increase was 70%. So far out growing the rig count we've taken market shares in the Permian, get market share gains. We feel very good about our position there from both contracts and customers. And the activity levels are much higher, so that by far has fueled the U.S. upstream growth.

And the other thing you'll see as the year plays out, our customers are not the – our primary customers are not the one rig and two rig operators, it's the majors. So when you look at our top 10 North America upstream customers, eight of them are in the U.S. and then we have CNRL and Husky in Canada.

But it's the Chevron, Shell, Anadarkos, Apaches, ExxonMobil, all the big players, they tend to start relatively slow on new budgets in January/February. So the Permian activity, we expect to be strong for the full year. We like our gains there.

And then our major customers are actually getting very active, both – Chevron, you see their overall CapEx is down for the year because of the less CapEx spend in Australia and some of the LNG projects, but a big increase in spending in Permian Basin, which we benefit from as they are our largest customer.

And then also ExxonMobil picking up with XTO there. So, a lot of things to be positive about for our upstream business and in the completion phase. If you look at the drilled uncompleted, it's 7,600 for the U.S. It's actually increased during the quarter, but completions have also – number of completions also increasing.

So, we look at the DUC account as a backlog of future wells to be completed and the current activity is fueling our growth. So we feel good about that upstream, primarily more so from activity and demand and in pricing..

Okay. And then second question is just on the competitive environment and the opportunities that you may be seeing as a result of lengthening lead times, tariffs and those sorts of things. I would think that supply is becoming tighter. You guys obviously have pretty strong relationships with the bigger suppliers in the industry.

Is that helping you take share with your customers? Is that something that you expect to continue going forward?.

Yes. And it's a very large positive for us from a couple aspects. One, we have strong balance sheet and our ability to carry at larger inventories and buy in bulk is something the small competitors just can't do. A lot of small competitors competed in this marketplace on low cost import pipe; that's going to change, and has already changed.

So, where they might have competed on a low cost offering, definitely they're at a disadvantage when these tariffs and quotas get put in place. So, I think for those reasons, we're very strong. We have the capability as things change like this in global supply chain to maneuver and reset our global buys for our customers.

And so, small players can't do that. And if you look at just the impact of these tariffs in our carbon pipe inventory, 70% is domestic, 30% is import. So as these tariffs or quotas get put in place internationally, we have the ability to ship more volume to our domestic mills and suppliers, which serves us very well, We do it very easily.

We already have both sets of part numbers cross-referenced with our customers on Approved Manufacturer List. And when you look at stainless, it's 40% domestic and 60% import. And smaller number of players in that field, but we have the same flexibility to shift our buys. So, those are big advantages in the marketplace. Our customers realize that.

And the big thing that we did, we were planning for an inflationary environment coming into this year, with kind of mid to – mid-single-digits to 10% inflation. Of course with the tariffs and antidumping countervailing dutying suits, the inflation is going to be more like 20%.

So, during December, January, February timeframe, we accelerated our purchases ahead of the inflation. So you saw our inventory come up $110 million and it had two big drivers. One was just the increase in demand that we're seeing for our valve product line.

So, roughly $40 million of that increase is demand-driven as people are spending a lot more this year and we are realizing that in increased valve sales.

And then the other $70 million was split $60 million for line pipe and $10 million for carbon fitting flange and stainless and that was all done to accelerate our purchases to have lower cost inventory ahead of this rapidly increasing inflation environment.

Lead times are going to get extended when the quotas impact is felt and we are already seeing that from South Korea. They are already bumping up against some restrictions on the new quota, which is 70% of the last three years. So we'll be very well-positioned to have that inventory in place for our customers as we shift to some alternative sources.

So, I feel good about our flexibility and we have plenty of liberty to keep doing that. And I feel very good about our inventory position and our cost position, especially in this inflationary year..

Okay, great. Thanks for all the color, Andy. Appreciate it..

Thanks, Matt..

Thank you. The next question is coming from the line of Vebs Vaishnav with Cowen & Company. Please proceed with your question..

Hey. Good morning and thank you for taking my questions..

Yeah. Good morning, Vebs..

Good morning.

First, can we talk about the first quarter revenues, what drove the revenues above expectation? How much was tariff if – help if any? And any one-time items that occurred in first quarter that could not recur in 2Q?.

Yeah. Vebs, let me start and Jim may add some color to it. But no one-time items, nonrecurring items that I would classify in the first quarter at all. So, just activity picked up more than we expected.

A lot of our bigger customers' new budgets kicked up, but I would say – and that's why we're still guiding up for mid-single-digit growth in the second quarter. Some of that was a little slow even in January. So just – the rig count is over 1,000 now; a big positive there.

The midstream business we're still tracking – currently booking revenue on over 20 projects and another 30 projects. We think we'll see revenues starting at least in the later part of this year. So the midstream is really strong.

And so, everything was a positive activity wise, even with the late winter that we had in the Northeast that really just impacted our midstream pipeline business, our gas utility business. The first quarter is usually our slowest quarter anyways in that area. So those projects kick-in in the second quarter and third quarter.

So, I would just say, predictable and a little bit higher activity spending drove the increase over what we originally guided to, but it was a positives on that and also on the downstream. The ramp-up of the customers' year-on-year of the new contracts was – what we've previously talked about was a positive in the quarter. So I think U.S.

drove the big increase in the first quarter higher than we thought. And then all three end markets really kicked in a little bit stronger than we thought in first quarter. Jim, do you....

Vebs, I would just add, as you know that we noted in the quarter, we had some nice deliveries both on the TCO project in Kazakhstan in the upstream side and Shell Franklin in the U.S. on the downstream side. And looking at the delivery schedules, the expectations are, we'll have another strong quarter of those in the second quarter.

So, to reiterate Andy's point, we're not expecting a big fall-off on any one-time things in Q2..

That's helpful.

And if I think of the 5% or mid-single digits 2Q revenue guide, how are you thinking about the impact on completions that we have seen in 1Q and that could potentially impact you in 2Q?.

Yeah. We don't see a drop-off in completion activity in Q2 from the upstream side, we see – the only thing we're dealing with, as everyone does in Q2, is spring break-up in Canada from an upstream perspective. But, no, I think the – so that will be a negative headwind, but the tailwinds in the U.S.

are still very strong for us and primarily for the reasons that it's our customer group that's going to be very active in completions during the second quarter, maybe even more or so than the first quarter. So, I think that offsets the spring break-up in Canada. So, I think that's a solid guide for us..

Okay. And last one for me. I think you mentioned because of the – because of Section 232 and other inflationary activities going on, you expect margins to expand from here on.

Did I get that correctly? And then, if that is the case then if you can help me reconcile the guidance of gross margins, which is essentially flat from first quarter?.

Yeah. Let me start – and just with a little high level and then Jim can talk to this better. But yeah, Vebs, we've definitely seen inflation. We're definitely going to see improving margins and we have predicted even at the start of the year, we'd have improving margins during the year.

So, solid first quarter at 19 point – adjusted gross margins I'm talking to, 19.1% in the first quarter. And then we increased our guidance from 19% to 19.93% just to reflect the – at the high end of that guidance, some improving margins towards the second half of the year with the first quarter that we've already realized.

Jim?.

That right. Again the inflationary impacts, we're building some of that into our margin expectations which is why we've raised it. The midpoint has moved up slightly, but as you noted, we've taken the high end of the guidance up to $19.3 million..

Okay. So fair to think gross margins should improve at least in 2Q and 3Q and then seasonally down in 4Q.

Is that fair way of thinking about it?.

It's – that's the normal for us, Vebs, yes..

Okay. Thank you for taking my questions..

You bet..

Thank you. The next question is coming from the line of Nathan Jones with Stifel. Please proceed with your question..

Good morning, everyone..

Good morning, Nathan..

A question on Canada here; the organic revenue was down in the first quarter. I'm sure you listened to your competitor's call yesterday. They were calling not only the spring breakup but also delays in the Trans Mountain pipeline, potentially causing some lower activity up there.

Are you guys seeing a similar thing there? You haven't said anything about lower activity outside of just the normal seasonal breakup there..

Yeah, Nathan. Well, I don't listen to anybody else's call, but I will tell you what I think about Canada. It's a – there's a lot of dynamics going on in Canada for sure; well, the recount was down year-on-year, that's one point.

Definitely there is some takeaway capacity limitations, so you are seeing more old shipment on rail which slows everything down. So those aspects – you are seeing a very large – price differential on the heavy crude between Western Canada and the U.S., which also is slowing some of the economics down.

And I think the biggest thing of all that though is, if you look back at – Nathan, at 2016-2017, so many properties changed hands from what was large U.S. independent, and even IOC ownership to now a Canadian company ownership. I think they're still getting their hands around the new assets and developing their development plans.

So I think that's probably stalled some of the activity. So, the price differential on the crude definitely slowed activity and also the change in ownership of the assets.

So I think we had a good quarter there and we'll have just the normal seasonal breakup in the second quarter, but it is definitely a difficult market to get your hands fully around this year because of all that change..

Okay. And then another one on pricing. It would seem that – outside of passing through inflation here, given relatively high demand, long lead times in the supply chain, tightness in the supply chain, did the market – should be right for you to actually raise real pricing and push real net pricing through.

It doesn't necessarily look like there's a lot of that happening yet.

Do you see opportunities to increase the gross margin on certain products, many products, or any products?.

Yeah.

Nathan, you're right, and I certainly believe the pricing is going to be much higher by the end of the year than it is in the first quarter, primarily carbon steel line pipe, carbon steel flanges and fittings, stainless steel pipe and stainless steel fittings and flanges, all will be impacted by either this – impact of tariffs or quotas, because it just is a much more inflationary environment that we're going to go through.

We're going to have the ability with our time, with our inventory position to leverage our buys. We did a lot of that already as I spoke to her earlier, so that will help us. But pricing will definitely increase through the year and be much higher at the end of this year than the start.

So I think all those dynamics are happening even valve pricing, some of the changes going on in the manufacturing environment, in the regulatory environment in China are impacting the valve prices and valve lead times.

So it's just as we've been through like I referenced in 2012, 2013 our revenues grew nicely, our margins improved nicely and it was a inflationary environment which is the best environment for us as we are buying and selling every day..

And do you have a very healthy demand environment here. Obviously over the last few years, the drillers have really taken down the breakeven costs in some of these wells.

Does the rising costs of products that are going in here in your opinion have the potential to tamp down demand at any point or are these guys making so much money that this really doesn't put much of a dent in their profits?.

Well, I just have some couple of points. One, we don't sell any products to downhole for the downhole completions anymore and we don't provide a product to the region by the rigs directly. We have never done that. So we don't impact those directly. You know what you'll see is the impact of higher costs in production.

But at today's prices as you mentioned they're not going to not complete wells or tie-in wells because of the additional costs of tie-ins or production facility expansions. So I don't see that.

In midstream, you might see some impact on pipelines or some renegotiation on pricing agreements there if it's on a new pipeline with the higher cost line pipe that's going to be in the market. And we don't – so maybe there, but we haven't seen it yet.

And even pipeline operators can apply for an exclusion to the higher price import pipe if they've already had a project sanctioned. So we've seen some of that. And we don't really see any impact on our increases in costs on the downstream.

You look in refining and chemicals on those big plants, our pipe valves and fittings revenues or the cost for them is roughly 5% of a big project. So even a nice increase for us in terms of the overall pricing. It wouldn't change any of the downstream economics.

So we – sum it all up, we don't see an impact with our customers on the higher inflationary part, because of our size to their business..

That's helpful. Thanks for taking my questions..

Thank you, Nathan..

Thank you. Our next question is coming from the line of Walter Liptak with Seaport Global Securities. Please proceed with your question..

Hi. Thanks. Good morning. Good quarter..

Thanks, Walt. Good morning..

Wanted to just ask a follow-up on the downstream. And you referenced the turnaround activity for this year at $70 million to $90 million. I wonder if we could get a little bit more detail maybe how much is that up for you guys year-on-year, how much is the market versus any new wins. And turnarounds I think have been kind of elusive for a few years.

You think we're finally at a point where there's more work to be done? What are you finding out as you get into these claims?.

Yeah, Walt, we certainly think that – in the first quarter, we saw a return to a good turnaround season from a last couple of years where people have continued to defer or delay something. So incrementally – and we've said before the difference between a good turnaround and a okay turnaround is usually $10 million to $15 million.

We're optimistic about the fall turnaround season. And again, the contract wins, when we get a new contract, new customer, with that comes their turnaround. So we are able to participate in higher level of turnaround because of those contract positions.

But we do think that we've seen a bit of a shift to where some of this work now is getting done, where previously it hadn't been..

Yeah, Walt, I would add to Jim's comment. So we – is at $25 million in the first quarter; we see the third quarter, the fall turnaround being around $30 million. And the balance of the $70 million, $90 million will in the second and fourth..

Okay. That sounds great. Thank you..

Thank you..

Thank you. Our final question is coming from the line of David Manthey with Baird. Please proceed with your question..

Hey. Good morning, guys..

Hi, David..

Hi, David..

So first off, I'm wondering if you could break down or give us any color on the 90 basis point year-to-year improvement in adjusted gross margin? If you can talk about whether it's product, customer, geographic mix, inflation? What drove that primarily?.

Yeah. I would say, of that basis improvement you're probably about a – a third of it is going to be some price across most of the product lines with a big heavy emphasis on line pipe. And then I think another third is going to be product mix between more valves. Line pipe relatively speaking was – and didn't increase that much.

And then you asked about geography; most of that is coming – most of that improvement is coming out of the U.S. business..

Yeah. Dave, I'd just add to Jim's comments. So our highest margins are downstream and then valves and stainless. So the pickup in downstream revenues helped us; the pickup in the U.S. helped us; and then as Jim said, what tends to be our lowest margin business, our carbon line pipe is actually doing very well this year with the inflationary aspects.

And so that raises the blend. And of course our multiyear shift to much higher valves is really important and trailing 12 months now, 36% of our revenue. So that also has an impact..

Thanks, Andy. That was – my next question was the percentage of sales from valves, automation and instrumentation et cetera. And you said, 36%p; that's a trailing number.

Could you talk about what the growth was in the first quarter?.

It was 38% of the revenue in the first quarter, 36% on a trailing 12 months, and Jim, do you have the growth quarter-on-quarter?.

Yeah, in terms of valves, Dave, it was about $57 million year-over-year..

Okay. Perfect. Thank you very much..

Thank you, Dave..

Thanks, Dave..

Thank you. Ms. Broughton, it appears there are no further questions at this time. So, I'd like to pass the floor over to you for any additional concluding comments..

Thank you for joining our call today and for your interest in MRC Global..

Ladies and gentlemen, we thank you for your participation. This does conclude today's teleconference. You may disconnect your lines at this time and have a wonderful day..