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

Sean C. Meakim - JPMorgan Securities LLC Vaibhav Vaishnav - Cowen and Company, LLC Nathan Hardie Jones - Stifel, Nicolaus & Co., Inc. Ryan Cieslak - Northcoast Research Partners LLC Paul Ryan - Raymond James & Associates, Inc. Walter Scott Liptak - Seaport Global Securities LLC.

Greetings, and welcome to the MRC Global Second Quarter 2018 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, Monica Broughton, Investor Relations.

Thank you. You may begin..

Thank you, and good morning, everyone. Welcome to the MRC Global second 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 August 16, 2018. The dial-in information is in yesterday's release. We expect to file our second quarter 2018 report on Form 10-Q later today, which will also be available on our website.

Please note that the information reported on this call speaks only as of today, August 2, 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 our 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.

We had strong performance in the second quarter across all our key metrics. Revenue was up 17% over the second quarter of 2017 and up 7% sequentially from the last quarter. Second quarter of 2018 adjusted gross profit improved to 19.3% of sales at the high-end of our previous annual outlook.

Adjusted EBITDA was $78 million or 7.2% of sales due to improved gross profit and disciplined cost control, resulting in strong incremental adjusted EBITDA, up 21% for the second quarter 2018 over the same quarter a year ago. The last time quarterly adjusted EBITDA was above 7% was in 2014.

We're simply a more efficient organization and even better positioned from a product mix standpoint and a customer contract position as compared to 2014. Diluted earnings per share was $0.17 in the second quarter 2018, compared to breakeven EPS a year ago. Higher than expected LIFO expense negatively impacted second quarter EPS.

Due to the first half of the year, our revenue has increased 17% from the same period last year with all sectors up double digits. We reported adjusted gross profit of 19.2% of sales for the first six months of the year.

Our aggressive inventory purchases in an inflationary environment and repositioning of our inventory investments to higher margin products has resulted in higher gross margins. We have increased profitability as our adjusted EBITDA for the first six months of the year is $137 million or 6.5% of total revenue.

We've had a very good first half of the year, and I continue to be pleased with our customer contract positions and the progress we've made in improving the profitability of the company. Contract wins and extensions as well as projects have benefited the quarter, as all our end market sectors experienced growth led by the U.S. segment.

While projects have inherent uncertainty as the timing, project work in all our sectors continue to contribute to our leading position. The macroeconomic conditions for our end markets are all very positive and continue to improve with the support of all price, favorable regulatory, and macroeconomic conditions.

According to the Evercore ISI Midyear Survey, U.S. E&P spending is expected to be up 16% in 2018 over 2017. Comparing that growth to our U.S. business growth for the first half of 2018, we are ahead at 22% growth indicating market share gain.

Recent EIA report show a continued increase in well completions in the second quarter over the first quarter as well as a rise in drilled but uncompleted wells, which are at an all-time high.

Some estimates called for a leveling-off of completions in the Permian basin as Permian takeaway capacity constraints have been a topic of much discussion recently. We have yet to see a pullback in activity with our customers and expect our U.S. upstream revenue to be up sequentially in the third quarter, similar to what we saw in the second quarter.

Many of our customers have firm capacity contracts and aren't at risk as smaller operators. To help with things in perspective, our Permian upstream business represents about 6% of our total revenue in the first half of 2018.

We have seen substantial growth and market share gains in this region as our Permian upstream revenue has grown nearly 70% in the first half of 2018 over the same period of 2017. Should customer change course and relocate spending to other basins, we are there to service them as our footprint extends throughout every major shale basins.

Because we are diversified across all energy end market sectors and we have a strong midstream business, we are also actively involved in 10 major transmission projects that are addressing the shortfall in Permian takeaway capacity. We expect these projects to produce between $150 million to $200 million of revenue over the 2018- 2020 time period.

This does not include the various gathering and processing facility feed, feeding these transmission pipelines, nor the various tie-ins and laterals that inevitably develop as part of these transmission line projects. Last quarter, we spoke about inflation and the impact it has on our business.

We discussed several inflationary trends on our products, including Section 232 tariffs, targeting steel and aluminum imports and related quota measures on countries such as South Korea. Since we last reported, Canada, Mexico and EU are no longer exempt from Section 232 tariffs on steel and aluminum.

Also, a final decision on carbon steel plants anti-dumping was rendered, increasing cost and lead times. Recently, Section 301 tariffs have been put into place which impact certain valves, valve parts and gaskets made in China. The Section 301 tariffs impacts are less clear as the global supply chain adapts to some of its nuances.

For example, a domestic ball valve manufacturer who imports Chinese parts may choose to have their valve assembled in China to avoid the tariff, as only certain types of Chinese valves are affected by this tariff.

This complicates matters, but we are experts in managing a complex, global supply chain and have been building the inventory as needed to help ensure supply of our customers during this period of tremendous change and volatility in supply.

Regarding the general impact of inflation on our business as a distributor operating under a cost plus contract structure, inflation is generally positive for us. And we have been working aggressively to push contract pricing increases through to reflect the current market environment.

We've begun to see margin improvement in the second quarter from higher inflation. All of our major product categories have experienced some level of inflation, but carbon pipe has experienced the most price volatility which we expected. Some line pipe sizes and types have seen much as a 35% increase since the end of last year.

Carbon fittings and flanges, stainless products and valves are all experiencing price increases. Based on the current market outlook for line pipe, we expect pricing to level off in the back half of the year as the tariffs and quotas have taken effect.

As we discussed last quarter, given these conditions, we have been strategically building the inventory to get ahead of these price increases and have product available for customers. While we spoke about this in our last earnings report, it bears repeating.

In the second quarter, we completed our $100 million share repurchase program, authorized last October with a $20 million purchase at an average price of $17.39 a share. In total, including both of our repurchase authorizations, we've repurchased 14.6 million shares at an average price of $15.38 per share.

We're pleased with the results of our share repurchase programs, which have returned capital to shareholders on an accretive basis over the past several years. We believe this investment in our company has been a prudent use of capital that has created value for shareholders.

Our capital allocation strategy has balanced return of capital with an ease of operating the business. Today, in the growth stage of our traditionally cyclical business, we are focused on providing the capital to support that growth as evident by the increase in our working capital levels.

This quarter, we've had a couple of market share wins and updates I'd like to share with you. We renewed our Enterprise Framework Agreement with BP for the U.S. downstream operations for two more years.

We also renewed our Enterprise Framework Agreement for an additional three years with Marathon Petroleum, who will be the largest independent refiner in the United States when their acquisition of Andeavor closes. We expect to grow our share with them as a combined company.

Finally, we also signed a new Enterprise Framework Agreement with one of the largest independent oil producers in the Permian Basin. This is a new upstream market share gain, and we are now one of two PVF suppliers. With that, I'll now turn the call over to Jim..

Thanks, Andrew, and good morning, everyone. Our total sales for the second quarter of 2018 were $1.082 billion, 17% higher than the second quarter of last year as all end market sectors produced double-digit growth led by downstream and closely followed by midstream.

Sequentially, revenue increased 7% from the first quarter with all sectors experiencing growth. Beginning with our largest segment, U.S. revenue was $878 million in the quarter, up 22% from the second quarter of last year as U.S. midstream activity increased the most at $75 million or 20% growth. The increase in the U.S.

midstream sector was driven primarily by gas utility revenue, which was up $38 million or 21%. Spending from several gas utility customers on integrity and growth projects, maintenance and outages contribute to the increase.

Revenue from gathering and transmission was also up due to increased oil, gas and liquids production in the United States driving the need for more pipeline capacity. The U.S.

downstream sector benefited from project deliveries for Shell's Pennsylvania polymers project, a large export order; increased maintenance and repairs from outages; as well as market share gain. In total, the U.S. downstream was up 29%. U.S.

upstream business increased $30 million or 19% from the second 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 first quarter by 9%.

Gains were across all sectors, but primarily in midstream sales due to large project deliveries followed by upstream related to increased completions. Canadian revenue was $80 million in the second quarter, up 16% from the second quarter of last year.

Canada's revenue was higher primarily from increased upstream activity for a heavy oil thermal facility work which drove the outperformance of the Canadian rig count, which declined 8% in the second quarter of 2018 from the same quarter a year ago. The Canadian segment also benefited $3 million from strength in the Canadian dollar against the U.S.

dollar in the quarter. Sequentially, the negative impact of breakup was offset by facility work mentioned above resulting in sales growth of 3%. In the International segment, second quarter revenue was $124 million, down 7% from a year ago.

Sales were lower due to a decline in the midstream sector from a nonrecurring pipeline project in Australia partially offset by higher upstream activity in Kazakhstan. The International segment benefited $6 million from foreign currency strength against the U.S. dollar in the quarter. Turning to our results based on end market sector.

Compared to the same quarter a year ago, all sectors grew double-digits. Downstream sector sales were 24% from the same quarter last year to $303 million, driven primarily by U.S. downstream as described earlier.

In the upstream sector, second quarter sales increased 19% from the same quarter last year to $307 million, driven primarily by higher well completions in the United States and heavy oil project deliveries in the Canadian segment. Midstream sector sales increased 12% from the same quarter last year to $472 million.

Our midstream business is typically about 95% U.S. based with the exception of 2017 when we had a significant project in Australia. Both midstream subsectors experienced growth. Sales to our gas utility customers increased by 22% and sales to our transmission and gathering customers increased 5%. Turning to margins.

Gross profit percent increased 20 basis points to 16.4% in the second quarter of 2018 from 16.2% in the second quarter of 2017. LIFO was a headwind for the quarter as we recorded LIFO expense of $15 million and $5 million in the second quarter of 2018 and 2017 respectively.

Given the inflationary environment, we now expect our LIFO expense to be $50 million for the full year. The adjusted gross profit percentage was 19.3% in the second quarter of 2018, up from 18.5% in the second 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 second quarter of 2018 were 32% higher than the second quarter of 2017, and 12% higher sequentially. We expect pipe inflation to level off as tariffs and quotas take effect.

SG&A cost for the second quarter of 2018 were $136 million, an increase of $4 million or 3% from $132 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 12.6% from 14.3% as revenue growth exceeded increases in operating expenses. Sequentially, compared to the first quarter of 2018, SG&A expense was down $2 million. Consistent with our previous outlook, we expect SG&A expense for 2018 to be between $545 million and $555 million.

Interest expense totaled $10 million in the second quarter of 2018, which was $2 million higher than the second quarter of last year, primarily due to higher average debt balances. This quarter, we repriced our term loan lowering the interest by 50 basis points and saving approximately $2 million per year.

We recorded a one-time expense of $1 million to write off the related debt issuance cost. Our tax rate for the second quarter was 27%, resulting in a tax expense of $8 million. Our tax rate is higher than the U.S. statutory rate of 21%, primarily due to pre-tax losses in certain foreign jurisdictions without a corresponding tax benefit.

We have not changed our estimate of 28% to 29% for the 2018 annual effective tax rate. Our second quarter 2018 net income attributable to common shareholders was $16 million or $0.17 per diluted share as compared to breakeven last year.

Adjusted EBITDA in the second quarter was $78 million versus $44 million a year ago, and adjusted EBITDA margins for the quarter were 7.2%, up from 4.8% a year ago.

Incremental EBITDA was 21% for the second quarter 2018, over the same quarter a year ago, well above historical levels as adjusted gross profit margin improved and operating expenses were aggressively controlled.

All three of our operating – or all three of our segments generated positive EBITDA this quarter, including international, which continues to benefit from cost reduction and restructuring actions taken at the end of 2017.

We used $65 million of cash in the second quarter of 2018 as we continue to build working capital due to higher activity levels and strategic positioning as well as an effort to invest ahead of inflationary environment.

Our working capital net of cash at the end of the second quarter of 2018 was $920 million, $269 million more than a year ago, and $212 million more than at the end of 2017. As a result, at the end of the second quarter 2018, our working capital, excluding cash, as a percentage of trailing 12-month sales was 23%, above our 20% target.

However, we expect to return to the 20% range by the end of the years. Our inventory levels will begin to decline during the third quarter. As such, we expect that we will generate cash in the back half of 2018 and end the year with breakeven to negative $25 million in cash from operations.

Our debt outstanding at the end of the second quarter was $708 million compared to $526 million at the end of 2017. Our leverage ratio based on net debt of $677 million increased to 2.9 times from 2.7 times at the end of last year, commensurate with the increase in debt.

The availability on our ABL facility was $414 million at the end of the second quarter, and we had $31 million in cash. Finally, capital expenditures were $4 million in the second quarter and $9 million for the first half of the year.

And given our spend rate is somewhat lower than we initially anticipated, we've lowered our annual capital expenditure guidance estimate to $20 million. And now, I'll turn it back to Andrew for closing comments.

Thanks, Jim. I'll end with our current outlook. Based on strong first half results, project delivery timing and our outlook for the back half of 2018, we are maintaining the midpoint of our annual revenue guidance at $4.25 billion.

However, we're increasing our adjusted gross profit percentage guidance for the full year 2018 to 19.2% to 19.4% based on our performance to-date and our expectations for the last half of the year. Our expectations for 2018 are largely unchanged.

We have some shifting among our end market sectors based on project timing, but generally, the market conditions are all still positive for us. More specifically, as compared to 2017, we expect upstream to be 22% to 27% higher, midstream at 5% to 10% higher, and downstream at 20% to 25% higher. By geographic segment, our expectations for the U.S.

segment are unchanged at 15% to 20% growth this year compared to last year. Our International segment is also unchanged at 10% to 15%, and our expectations for Canada are slightly lower at 5% to 10% due to lower than expected customer spending in 2018.

Sequentially, we expect third quarter 2018 to be up low single-digit percentages from the second quarter 2018. Our backlog was $828 million at the end of the second quarter, flat with a year ago, as many project deliveries had taken place.

Spending survey updates indicate more spending than originally anticipated at the beginning of the year, which we have seen. Crude prices are relatively stable lately and supportive of investment.

The inventory of drilled but uncompleted wells or DUCs remains high and continue to grow in the second quarter, which we believe will be worked down over time resulting in future upstream revenue.

Projects and market share gains continue to support our downstream business, keeping in mind that project delivery timing can always fluctuate from quarter-to-quarter.

As production continues to increase in the U.S., the need for additional takeaway capacity grows as well as the need for gathering systems which has got a lot of attention lately in the Permian. A more constructive regulatory environment for energy infrastructure project and inflation in line pipe pricing, all continue to benefit our business.

This supports our midstream business as we continue to serve customers with projects across the U.S. These are all positive market dynamics, and we have a strong base of customer contracts with great relationships. With that, we'll now take your questions.

Operator?.

Thank you. We will now be conducting a question-and-answer session. Our first question comes from the line of Sean Meakim with JPMorgan. Please proceed with your question..

Thanks. Hey, good morning..

Good morning, Sean..

Good morning, Sean..

Andy, with the revenue range for 2018 mostly unchanged, nuances to the mix, could you maybe just walk us the flex points to hit the upper end of the range, steel inflation, some project timing? Maybe just help us see kind of – given that unchanged despite continued solid performance in the first half of the year, what are those flex points to hit the upper end of the full year range that you've laid out?.

Yeah, Sean, I think – let me go through by sector, it is maybe the best way rather than geography, because the U.S. is going to be strong in the second half. So upstream I think is an acceleration of some more of the drilled uncompleted wells. When you look at our U.S.

upstream revenues year-to-date, we're tracking 23% and the completions are up 32% year-to-date. And as we stated on previous call, our customer base was slower to pick up in the first quarter as some of the smaller operators were on new budgets earlier.

So I think to hit the upper end of the range, we'll see our major customers stay active in the back half, maybe some more completion activity than we forecast. But I think we're really solid on upstream.

I mean we mentioned in our prepared remarks, our Permian Basin revenues, while only 6% of our total revenues are growing at the fastest pace close to 70%, 68% year-to-date. So it's a bright spot. Our customers are very busy there. Some of the smaller operators that are running into takeaway capacity limitations are not our core customer group.

We feel good about that. Midstream is really about projects and timing. We've spent a lot of time in the second quarter quoting projects related to the tariffs and the cost of new projects, and what we had is a carryover in the first half of the large gas infrastructure with our TransCanada business in the East. So that tails off year-on-year.

Back half has roughly $80 million less revenue than the first half and so that creates the lower percentage growth year-on-year. That was our number one customer last year, but we're very busy in midstream. It's just smaller projects and timing in 2018, back half of 2018 and into 2019.

But that's a real positive once we get past everyone understanding our contracts, what the new carbon pipe pricing is. And then downstream is a real positive to hit the high end there, just continue to ramp up on our new contract, the ExxonMobil LyondellBassell. Lots of growth there still to come. We feel very good about (29:46).

It's not so much new projects being sanctioned. We ought to have a good turnaround season in the third quarter. But it's really about those projects ramping up and spending increasing at midyear. So I think those three together would all hit towards the upside of our guidance..

And just the follow-up on that, is it fair to say that some of the perhaps lost opportunities in midstream this year that there is – that can give you a little bit more of a tailwind and confidence into what 2019 look like eventually?.

Sean, I'm very optimistic about our midstream business. We did have the year-on-year change with the big gap (30:26) we've been through that several times, many times. (30:30) One year with Williams and Access Midstream was very busy. We did over $300 million revenue. I'm talking about 2010 through 2014. DCP one year was over (30:42) million.

Last year, TransCanada was (30:46). So we go through these cycles of big buildouts in infrastructure with one major customer, and then (30:53) tail – those investments tail off, but we have more projects going in midstream. As I said, smaller but higher margin projects going than we've had in a long time.

So I'm still very optimistic about midstream being good into 2019. In the second quarter, just more, I would say, stalling of new investments as people understood the impact of – the full impact of the tariffs..

Thank you for that. And just on the gross margin, could you maybe give us a little bit of how you see the inflationary impact of steel prices making its way through the inventory and ultimately onto the income statement? Line pipe seems like a little bit faster, some are slower. Inventory turn products maybe take a bit longer.

Just how you see that kind of flowing through the income statement through the year?.

Sean, this is Jim. So you're exactly right. We see the biggest impact in our carbon line pipe business. We saw that in the second quarter. We should continue to see that into the third and fourth quarter, as we realize sales from the investments we've made.

Behind line pipe, I'd say, our carbon fittings and flanges is another piece of the business where we see similarly high rates of inflation, either due to some of the quotes that have been put in place, or some of the duties that have been put in place on some of those products. So those should continue to flow through the back half of the year..

Okay. Fair enough. Thanks for the detail..

Thanks, Sean..

Our next question comes from the line of Vebs Vaishnav with Cowen. Please proceed with your question..

Hey. Thank you for taking my questions.

I guess Sean touched on this, just the growth lowered, is that just what you are referring to people taking a pause and is that what's driving or is there anything we need to consider?.

Yeah. Vebs, I would just say, it really is not lowered too much. I would say it's the years playing out almost exactly as we expected at the midpoint as our focus on the guidance. Upstream a little stronger, and downstream a little stronger, and then midstream, I would say there was the pause in the second quarter.

And also, we have a heavy weighting, as you know, over 50% of our revenues, 54% year-to-date come through our major multiyear contracts.

So as we push through price changes in inflationary environment, it takes us a quarter or so to get those prices through it and a little slower to respond than the transactional businesses they respond much quicker to price increases. So there's a little bit of that, but no, we still feel very good about the overall growth..

Okay. I'm not trying to have any guidance or just like if you think about 2019, what end markets do you think would grow the fastest if you can rank? Help us rank them..

Yeah. If you just think about it in terms of our midpoint of our guidance for 2018 as the starting point, I think you're still going to see very strong upstream. Downstream would be second and then midstream will be third..

Okay. Yeah. That's helpful.

And can you talk about the larger downstream and petrochemical that could be beyond 2019? Just what are you seeing out there and what's the typical time when those customers actually start speaking, which are those projects?.

Yeah. There is several projects being discussed in either Corpus Christi or Houston Ship Channel area or Louisiana that were actively involved in. So we do a lot of pre-feed and feed quoting, a lot of pricing upfront. So we are already involved in a lot of those. And then it's really the sanctioning.

But as you said, I think that tends for us to be late 2019 and then 2020, 2021 as the bigger chemical projects in the Gulf Coast get a sanction. But we feel very good about the downstream outlook both refining and chemical for the Gulf Coast U.S. specifically..

Got it. And one last question if I could squeeze in.

Just gross margins should improve in 3Q is my understanding or it is my thinking, and then when you budget for the year, do you normally consider fourth quarter margins? How do you consider fourth quarter gross margins versus third quarter?.

Yeah, Vebs, as you know, the line we typically see fourth quarter down 8% sequentially off the third. We don't typically see large margin degradation with that. They tend to hold up very well and sometimes actually increase based on the mix of products..

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

Thanks, Vebs..

Our next question comes from the line of Nathan Jones with Stifel. Please proceed with your question..

Good morning, everyone..

Nathan..

Good morning, Nathan..

I'd like to talk a little bit about the expense line, the SG&A line here. You guys have already just done a very good job controlling costs over the last couple of years as we've seen volumes coming back. It looks like you're going to run about 13% of sales in SG&A this year.

If I look back historically, that probably bottomed out in low double digits, kind of 11% to 12% range.

How much further leverage do you think you can get on that line before you (36:58) start adding back meaningful costs to support the growth?.

Yeah. Nathan, we've done exactly what you said. We've really tried to watch the line on cost, not only discretionary spending but head count. We've been (37:14) U.S. to support the market and we've been (37:17) in Canada. It is a soft market. Internationally, we've done a nice job to remove some of the cost that we don't need.

In terms of where we think we can get to, we certainly think that 12% range is certainly achievable. I would say (37:38) another nine months or so before we'd have to start adding some cost (37:44). We'll factor that in when we put our budgets and plans together for 2019..

Okay. And then you guys talked about planning on or thinking that you're going to have a pretty strong turnaround season downstream in the second half of 2018.

Can you give us a little more color on what you're expecting from that market in terms of revenue growth?.

Yeah, Nathan, I would just say that's always a little bit of a (38:12) on a pure revenue base for us.

I would just say because there is a lot of announced plans and then what they actually spend is always a variable we deal with, but if you look at the announced plans, the third quarter turnaround season will be very similar to the first quarter of 2017 and the first quarter of 2018 as far as magnitude..

Then you guys just mentioned that you have 54% of revenues that come through these major multiyear contracts. Specifically, on the transactional business, the other 46% there, you've got high demand. You've got stressed supply chains. You probably got some of the smaller competitors starting to run out of inventory.

Do you guys see the opportunity to push real price increases there rather than just cost plus to actually increase the margins on that part of the business given the supply demand balance at the moment?.

Yeah, Nathan, we do and we've in fact been doing that. And I would just clarify – we'll talk about our contracts positions. It goes beyond just top 25 and 54% of our revenue. We've probably got under contract 75% to 80% of our business. So the transactional piece making up the remaining.

But you're exactly right that's where we have the opportunity and we've been using that to leverage this price in this inflationary environment..

Do you think that there is opportunities to push more price through that channel in particular?.

Well, we continue to do that. I mean it's still competitive, and you got other people out there, they're bidding on this work as well. So that continues to be the objective..

Okay. Thanks very much..

Our next question comes from the line of Ryan Cieslak with Northcoast Research. Please proceed with your question..

Hey. Good morning, guys..

Good morning, Ryan..

My first question, I wanted to go back to the outlook for the year and what that implies for the back half as it relates to your incremental margins. I think that implies sort of some deceleration in the incremental versus what you guys put up here in the second quarter which was really good to see.

What would be maybe some of the puts and takes to be able to sustain that type of low 20% type of incremental margin in the back half of the year? Is there a path to get there? What are some of the offsets just seems like with maybe some additional pricing opportunity, maybe some better mix on the midstream side that you would – there would be a path there.

I just want to make sure I understand it..

No, Ryan, you're exactly right. I mean the path is the 20%-plus incremental is really driven first and foremost by what we can do on the gross margin line. And just by the way of comparison, the back half of this year has some tougher comps versus 2017. Where in the third and fourth quarters we were already around that 19% adjusted gross profit.

So it gets a little tougher. As you know, if you work through our guidance, you get incrementals of about 17.5% for the year which is what we had thought.

So our ability [Technical Difficulty] (41:35) incremental margins of 20% are going to be a function [Technical Difficulty] (41:39) can we get that price, can we drive our adjusted gross margin [Technical Difficulty] (41:43) up even higher towards the high end of our range in our guidance..

Okay. Great. And then for my follow-up, going back to the updated midstream outlook, just wanted to maybe pull that a threat a little bit more as it relates to what's going on.

Is this a function of more of the market just stalling as they sort of cycle through what's going on with the tariffs or is this more of an internal strategic decision for you guys to be for a lack of a better way of saying it walking away from some business you were quoting earlier because of the issue on tariffs and ultimately what customers' expectations are? Thanks..

Yeah, Ryan, it's really both of those aspects. Part of it is new project sanctioning and trying to understand the impact of the inflation and the tariffs. But I would say, we're looking at over 40 projects overall in midstream that are very active. And then we have the 10 active projects in the Permian. So there is still a lot of activity.

The other part of it is your other point which is very true. In this environment where it's difficult to get – suppliers are getting more limited, imports are definitely more limited especially from South Korea.

We have our inventory in place because we made an early commitment, we're not going to take low margin midstream work at this point in the cycle. We did some of that in 2017 as the market was starting to recover and the volumes were picking up.

But where we sit in 2018 with the commitment we've made to inventory and the position we've made with buying inventory ahead of inflation, we're certainly being more selective going after higher margin projects in midstream. So it is both of those aspects, but that ought to have a good impact on overall margins once those go forward..

That's good to hear. Thanks guys, best of luck..

Thank you..

Our next question comes from the line of Paul Ryan with Raymond James. Please proceed with your question..

Hi, guys. Thanks for taking my question. First question I have is a multipart I suppose. Circling back to the midstream projects in the Permian that are expected in 2019 and 2020, a few of those are from your midstream customers such as Energy Transfer Partners and Phillips 66.

Just generally speaking, can you help us understand when those ultimately get determined for those midstream projects? Secondly, how much volume typically goes through distribution versus direct? And then of the business MRC would get in that case, is it accretive or dilutive to your company-wide margins?.

Well, let me talk about timing first, and Jim can talk about the margins. It is our core base you mentioned. [Technical difficulty] (44:49) and Kinder, DCP and Enterprise. So a lot of [Technical difficulty] (44:55) for us.

We did say in our prepared remarks you see $150 million, we have clear visibility of $150 million to $200 that will go through distribution through us on those projects. There still is a large amount on the big trunk line projects that goes direct to the steel mills. But that's always the case.

And then our estimate of those contributions on those new installations [Technical difficulty] (45:25) later in those projects, so we do a lot more in gathering and tie-ins that all comes to distribution on the shorter lead time.

So the dynamics really the same as far as the big trunk lines, Jim, on margin?.

Yeah, the margin question is really a function of whether we can sell the pipe from stock and it's something we have which again is positive to the overall company margins. If it's a order delivery that we have to go out and source [on a buyout or direct basis, it'll certainly be below.

And as Andy mentioned earlier, we're trying to tighten up a little bit on some of the really low stuff in this environment to try to keep pushing up the margins even on those buyout and direct orders..

Got it. And then my second question, you lowered your cash from operations guidance for the year but sales was essentially the same.

If I understand you correctly from your prepared remarks, this is due more to inventory investment in the second half as opposed to current inventory not turning as quickly as you previously thought?.

No, we certainly expect some inventory to turn that we've got. I mentioned in the comments that we were going to be lowering overall inventory levels.

It's really just a function [Technical difficulty] (46:37) preparing or being able to go [Technical difficulty] (46:41) strategic points depending where we are [indiscernible] (46:43) inflation [Technical difficulty] (46:44). So as you mentioned, we went from breakeven to a negative $12 million or $13 million.

So it's a tweak to our overall cash flow guidance..

Okay. Thanks..

Thank you. Our final question comes from the line of Walter Liptak with Seaport Global. Please proceed with your question..

Hi. Thanks. Good morning, guys. So most of my questions have been asked but I'll ask about the Permian. And it seems pretty clear that the customers there are not kind of diversifying or start spreading to other basins because of the capacity constraints as quick as people thought.

I wonder if you could provide a little bit more color about any conversations that you've had with your customers and especially if you're serving the larger customers, I guess their timing on production, the amount that they can continue to increase and when this new midstream capacity comes online..

Yeah, Walt. I see very little impact to us specifically because as you said, we are with the major customers there in the Permian and they really have taken care of capacity issues on the takeaway. It's a lot more general activity of the small operators that's being impacted the most and their ability to access the pipeline.

So we see very – we actually see as we said earlier, our Permian business is up 68% year-on-year. It's our fastest growing area. And our major customers will stay busy through the second half even more so than they were in the first quarter.

So we don't see that impact for us although there will be an impact overall to the smaller customer base but that's not our core group. And then as that goes on we see the midstream sales picking up because of our involvement in the [Technical difficulty] (48:48) projects out of the Permian.

So net-net, we still expect in the second half, Permian will be our fastest growing area in our U.S. upstream business..

Okay. And as you think about the other basins, I think you made a comment that you're positioned for some of the other basins to pick up. Are you building inventory, adding people? I wonder if you can comment on if you're expecting other basins to pick up in the second half..

Well, we will see other basins pick up, the Eagle Ford for sure. I mean we've stayed very busy [Technical difficulty] (49:27) and the West Coast. We stayed very busy in the Marcellus. And I would say it's a [Technical difficulty] (49:34) inventory in our regional distribution centers that [Technical difficulty] (49:38) look for those businesses.

But the bigger ramp-up in spending was both line pipe, carbon fittings and carbon steel across the board and then also the Permian and the Gulf Coast were where you saw the biggest change in our inventory position. And all of that's related to the outlook we see for the second half of the year..

Okay. Got it. Thank you..

Thank you. We have reached the end of the question-and-answer session. I would now like to turn the floor back over to management for closing comments..

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

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