Greetings, and welcome to the MRC Global First Quarter 2019 Earnings Call. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Monica Broughton, Investor Relations for MRC Global. Thank you. You may begin..

Thank you, and good morning, everyone. Welcome to the MRC Global First Quarter 2019 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, 2019. The dial-in information is in yesterday's release. We expect to file our quarterly report on Form 10-Q later today, and it will also be available on our website.

Please note that the information reported on this call speaks only as of today, May 3, 2019, and therefore, you are advised that the 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 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 continued interest in MRC Global. Today, I will review the company's first quarter 2019 operational highlights, and then I'll turn over the call to our CFO, Jim Braun, for a more detailed review of the financial results.

As the leading distributor of PVF to the energy industry, we are well-positioned with our customers. We're typically the large players in each of our diversified end-market sectors. This diversification provides us with a certain level of stability, gives us more opportunities to grow and provide some resilience to the inherent market changes.

This quarter was an example of the strength of our customer base and the diversity of our end markets as well as the geographies in which we operate. We continue to execute against our strategy to increase market share, maximize profitability and maintain working capital efficiency as well as optimize our capital structure.

Let me continue with some comments about our customers and what we are seeing from them early in 2019. Our customers started the new year very cautiously in terms of their spending base on the pullback in commodity prices at the end of 2018. However, activity levels increased throughout the first quarter.

We continue to expect the second quarter to be improved over the first quarter. However, we now expect there will be less of an increase than we originally thought as customer spending levels are rising at a slower pace. We also continue to expect the second half of the year to be improved over the first half.

Jim will address the details of our updated guidance, but I want to point out that excluding the nonrecurring projects, our updated guidance implied solid underlying growth in the base business of around 7% in 2019, and we continue to gain market share and expand our growth opportunities.

We continue to drive market share gains by obtaining and expanding multiyear MRO contracts with customers. This quarter, we were awarded a new Enterprise Framework Agreement with EnLink Midstream for their PVF, MRO and committed project needs.

This is expected to be implemented in the coming months, and we expect additional opportunities with this leading midstream company. In addition, we renewed contracts with Phillips 66 for an additional three years and with Peoples Gas, the largest natural gas distribution company in Pennsylvania.

As we mentioned on our last call and consistent with our commitments of higher-margin product and service offerings, we continue our work on expanding our La Porte operations complex to include a 127,000 square-foot valve modification center, which should be finished in mid-2019.

This will give us additional and more extensive capabilities in servicing the growing valve automation market, particularly for midstream customers, and supports our goal of reaching 40% of our sales in the valve product group. In the first quarter of 2019, valve sales were 39% of our total sales.

In the first quarter, we continue to return cash to shareholders as part of our capital allocation strategy. We repurchased $25 million of shares at an average price of $14.24 per share. This April, we repurchased an additional $25 million of shares at an average price of $18.24 per share.

Since 2015 when we began our share repurchase programs, we have repurchased a total 22.5 million shares, returning $350 million to shareholders. We have $25 million remaining under our current authorization to execute, and we plan to continue to buy opportunistically during 2019.

I'll now turn the call over to Jim to cover the financial highlights for the quarter..

Thanks, Andrew, and good morning, everyone. Our total sales for the first quarter of 2019 were $970 million, which were 4% lower than the first quarter of last year with each of our geographic segments reporting a decline in the year-over-year comparison.

Excluding the impact of the three large projects previously mentioned, sales grew 5% in the first quarter. Sequentially, from the fourth quarter of last year, revenue also declined 4%, slightly better than our previous guidance. U.S.

revenue was $779 million in the first quarter of 2019, 3% lower than the first quarter of 2018, with increases in the upstream and the downstream market sectors, offset by an expected decrease in the midstream market sector. U.S.

upstream sales were up 16% in the first quarter of 2019 over the first quarter in 2018, as well completions grew by a comparable 17% over the same period. U.S.

downstream revenue was up slightly in the first quarter as MRO and small-cap project work with new and existing customers more than offset the winding down of the Shell Pennsylvania chemical project. The U.S. midstream sector sales were impacted by the completion of the large TransCanada project in mid-2018 that we previously talked about.

This had a $60 million negative impact on the quarter-over-quarter revenue comparison. Canadian revenue was $68 million in the first quarter of 2019, down 13% from the first quarter of last year, as the upstream sector was adversely affected by government-imposed production limits.

A weaker Canadian dollar also contributed to the decline, unfavorably impacting sales. International revenue was $123 million in the first quarter of 2019, down 2% from the same quarter a year ago, due primary to the impact of weaker foreign currencies and the winding down of the future growth project for TCO in Kazakhstan.

Excluding the FX and project impacts, sales grew 17%, reflecting improving conditions internationally. And now let me summarize the sales performance by end market. Upstream sector first quarter 2019 sales increased 3% from the same quarter last year to $312 million, with 16% growth in the U.S.

as described earlier, offsetting Canadian and international declines. Specific to the U.S. our Permian basin revenues grew 19%, and this remains the most active area for us as we continue to grow with the investments being made by IOCs and large independents in this important shale basin. Midstream sector sales, which are primarily U.S.

based, were $361 million in the first quarter of 2019, down 12% from the same quarter the prior year. Our transmission and gathering subsector was down as mentioned earlier with a large project work in 2018. However, our gas utility business, which is now 22% of our overall revenue, continues to show strong growth.

Because of ongoing integrity management programs across the U.S., we saw 11% sales growth in the first quarter over the same quarter a year ago. In the downstream sector, first quarter 2019 revenue was $297 million, comparable to the sales level in the first quarter of last year.

All geographic segments experienced relatively flat year-over-year performance. The U.S. downstream sector saw sales growth of 5%, excluding the impact of the Shell Franklin Project mentioned earlier. Market share gains were important contributor to growth in the downstream sector. Now turning to margins.

Gross profit percent increased 120 basis points to 17.9% in the first quarter of 2019 as compared to 16.7% in the first quarter of 2018. The improvement reflects the benefits of inflation, particularly in carbon pipe; lower project revenue; favorable product mix; and a benefit from no LIFO expense in the current quarter.

LIFO expense of $7 million was recorded in the first quarter of 2018. The gross profit margins in the first quarter were negatively impacted by a couple of unique low-margin midstream orders that we accepted for two strategically important customers. This had a negative impact of 20 basis points on gross profit percentage - percent.

Adjusted gross profit for the first quarter of 2019 was $190 million or 19.6% of revenue as compared to $193 million and 19.1% for the same period in 2018. The items noted above impacting gross profit percent, except for LIFO, also favorably impacted adjusted gross profit percent.

Those low-margin midstream orders had a 30 basis point impact on adjusted gross profit percent in the quarter. And as it relates to the full year, we are reiterating our annual guidance of adjusted gross margin percent to be between 19.7% and 19.9%.

Line pipe prices were higher in the first quarter of 2019 over the same quarter in 2018 due to tariffs and quotas that began to take effect late in the first quarter of last year. Based on the latest pipe logics, all items index average line pipe spot prices in the first quarter of 2019 were 6% higher than the first quarter of 2018.

However, relative to the fourth quarter of 2018, average line pipe prices are 4% lower in the first quarter of 2019.

Line pipe prices are expected to continue to moderate around current levels, and as such, we do not expect to see the same levels of inflation in 2019 as we saw in 2018, barring any significant changes in the trade and tariff negotiations. This has also led to lower-than-expected LIFO expense for the quarter.

And as such, we expect our LIFO expense to be between $20 million and $30 million for the full year 2019. SG&A costs for the first quarter of 2019 were $139 million or 14.3% of sales as compared to $138 million or 13.7% of sales in the same period of 2018.

First quarter SG&A expense was in line with our expectations, and our previous annual guidance - SG&A guidance of $555 million to $575 million remains appropriate. As we've mentioned before, we can experience quarterly fluctuations in SG&A expense during the year.

And I'll note that our annual merit pay increases were effective at the beginning of April. Interest expense totaled $11 million in the first quarter of 2019, which was $3 million more than the first quarter of 2018, due to higher average debt levels and higher interest rates due to increases in LIBOR.

Our effective tax rate for the quarter was 25%, in line with our expectations for the full year. Net income attributable to common shareholders for both the first quarter of 2019 and the first quarter of 2018 was $12 million or $0.14 per diluted share and $0.13 per diluted share, respectively.

The change in the earnings per diluted share is a function of a lower share count as a result of our share repurchase program. Adjusted EBITDA in the first quarter of 2019 was $56 million versus $59 million for the same quarter a year ago.

Adjusted EBITDA margins for the quarter were 5.8%, the same as the first quarter last year, driven by higher product margins despite lower sales volumes, resulting in EBITDA decrementals of only 8%. All three of our segments generated positive adjusted EBITDA this quarter.

Our working capital at the end of the first quarter of 2019 was $923 million, $27 million higher than it was at the end of 2018.

Our working capital, excluding cash as a percentage of sales, was 21.7% at the end of the first quarter of 2019, above our target as we have made strategic valve purchases in preparation for increased customer activity in the balance of the year.

Also of note this quarter was the implementation of a new accounting standard for leases, the adoption of which has no impact to the amount of lease expense we reflect in our income statement or on our cash flows. The impact was to record both right-of-use assets and operating - or operating lease liabilities on our balance sheet.

The impact to - was to add a $190 million asset and a $205 million liability as of March 31, 2019. Our operation has used cash of $40 million in the first quarter of 2019 as accounts receivable and inventory levels increased. We have not changed our cash flow guidance.

For the full year 2019, we expect cash flow from operations to be approximately $150 million to $200 million. Working capital growth is expected to moderate, and we plan to achieve our 20% working capital sales ratio by the end of the year. Capital expenditures were $2 million in the first quarter of 2019.

We expect this to increase as construction continues on our new valve modification center. Nevertheless, we've lowered our expectations somewhat and are now expecting total capital expenditures of $20 million to $25 million in 2019. Our debt outstanding at the end of the first quarter was $746 million compared to $684 million at the end of 2018.

And our leverage ratio, based on net debt of $719 million, was 2.6x, up from 2.3x at the end of 2018, but well within our stated target range. The availability on our asset-based lending facility was $382 million, and we had $27 million in cash at the end of the first quarter.

We have no financial maintenance covenants in our debt structure, and our nearest maturity is September 2022. Regarding our updated 2019 guidance. As Andrew mentioned and from our previous comments, we are making a couple of changes since we last reported in February. Spending by our customers in the U.S.

was low in December and continued into January and February, but picked up in March as we expected, resulting in a first quarter about where we thought.

However, customer activity levels are rising at a slower pace than originally thought, and we now expect that the year will have less growth than we had originally anticipated, primarily in the second quarter. We continue to expect growth in the base business.

While there remains some uncertainty and spending levels, we have exposure to diversified end markets. Our customer base is also more weighted to some of the larger IOCs, pipeline operators, natural gas utilities and large refinery and chemical companies, all of which are either not subject to commodity price changes or less impacted.

Their operating and capital plans are typically more stable and their spending is increasing or being focused in areas where we operate. Given this, the midpoint of our revenue range is now $4.17 billion as we've narrowed the range to between $4.07 billion and $4.27 billion.

We expect that the second quarter of 2019 will be up about 6% to 9% from the first quarter of 2019 as activity levels with our customer base pick up. From a sector point of view, we expect the upstream business to drive the growth in 2019.

At the midpoint, we expect each of the midstream and downstream sectors to be slightly down due to the nonrecurring projects. By geography, we expect the U.S. to grow, while Canada and international decline. The U.S. business is being driven by upstream growth in 2019 with the midstream and downstream showing little growth due to projects rolling over.

Midstream Permian basin activity will be strong, offset by a slowdown in the Northeast U.S. gas transmission infrastructure spend. Our Canadian business is over 70% upstream as being negatively impacted by crude differentials and government-imposed production restrictions.

Our International segment is being impacted by an approximately $80 million decline from the ramping up of the TCO future growth project. Our backlog at the end of the first quarter of 2019 was $636 million, nearly unchanged from the end of 2018 as projects have delivered.

However, excluding these projects, the backlog is up 5% in the first quarter of 2019 over the end of 2018 across all segments but primarily the U.S. upstream and gas utility businesses. Our adjusted EBITDA guidance has changed, and we now expect it to be between $260 million and $290 million.

Given the lower EBITDA and lower LIFO expense, we now expect diluted earnings per share between - to be between $0.70 and $1 in 2019.

So in summary, our first quarter 2019 was basically in line with expectations, and we've changed our full year expectations to reflect a somewhat slower start to the second quarter and more tempered expectations for the remainder of the year while still reflecting growth in our underlying business. And with that, we'll now take your questions.

Operator?.

[Operator Instructions]. Our first question comes from the line of Sean Meakim with JPMorgan..

So Andy, to start, I mean it seems like there's, if anything, increased confidence in the cash from operations or effectively the free cash flow guide from the year considering it didn't shift alongside EBITDA and then maybe it gets easier to hit the cash flow target if you're not contemplating the upper end of that sales target.

So your front-loaded inventory in valves, Jim highlighted that. I'm curious, how is working capital normalized through the year? So I guess, the two parts to the question is, one, maybe just give us a little more feedback on your confidence level in the free cash guide or the implicit free cash guide.

And then the second part would be, does the working capital of sales target of 20%? Is that still a goal for all of '19? Or is that really more of an exit rate type of target?.

Yes. Sean, let me start, and Jim, I'm sure, will add some comments. We feel very comfortable for several reasons. We started the year.

I think we've briefly mentioned it on the last call that some long lead time valves that orders placed in 2018, our intent was to make sure we have those in, in early 2019 for both the upstream and midstream activity levels that strengthen in the second and third quarters.

So we're - at the end of the first quarter, we're high in valves over kind of normal run rate. We also ordered a lot of line pipe last year ahead of inflation. So we're high in line pipe, but the second and third quarter are big construction quarters for us.

And we also increased our gas products because we had a very slow gas utility business in the first quarter because of the winter impact in the Northeast. So second and third quarters are the strong quarters for gas utility construction. So all three of those will play out. I'm confident we'll fulfill all our revenue projections.

And essentially, we have a little over $100 million of inventory that we'll work out between now and the end of the year. So that's the driver. And you're exactly right, because a little less growth on the top side makes that very achievable for us, and we feel good about that.

And we also moderated our CapEx spend given that it's going to be a little bit slower year, so we decreased that a little bit. So all of those factors together, we feel good about both the cash flow from ops and our free cash flow estimates..

And so then just on the working capital piece - working capital to sales ratio, would you call 20% basically I expect to exit the year versus maybe an average for the year?.

Sean, I think that's an exit rate. I think working capital will kind of peak here sometime in the second quarter and then start to come down over the balance of the year. But as we get to the end of the year, we should think back to that 20% rate..

Got it. Okay. That makes sense. And then so with that cash flow guidance in place, we're looking at a double-digit free cash flow yield on the current market cap.

So is it fair to say that the Board's let me to authorize another buyback after you exhaust the last $25 million on the current one?.

Yes, Sean, what we'll do and what we've typically done is we get to that point in time. We'll look at it and evaluate the various capital allocation opportunities and make a determination at that time..

Our next question comes from the line of Sam Darkatsh with Raymond James Financial..

A few questions, if I could. You took the high end of the sales guidance down for the year, but you kept the high end of the SG&A intact. And I thought that was interesting, especially since it's early and up in the year, you would suspect to be able to manage SG&A to whatever the sales volumes would dictate.

So Andy, I'm trying to figure out what sorts of nondiscretionary investments are taking place this year that might cause those spending levels to remain static..

Yes, Sam, and it's a very good point. I think it's more likely to not be at the high end and it will be closer to the low end or midpoint. But yes, a little weaker in international, weaker in Canada. Canada is a very difficult market this year.

So those will both have, given our current outlook, decreases in SG&A, and those are ongoing right now and somehow even occurred in the first quarter, those will continue. So we're streamlining costs there because of a slower revenue environment. In the U.S., of course, we'll pick up in the back half. So we don't have that phenomena going.

And we have some incremental investment going to staff up for our midstream modification shop. It's a very big market. We see it as an excellent growth opportunity for us to do the complete kit in midstream automated valve. So we are having some staff up on that, but there will be a lot of revenue and margin contribution.

We're only going to have the impact of half of that this year as we opened in July, but then a real good run rate going into next year from that. So I think you're exactly right. It's unlikely given the moderation in the top line that we'll be at the top of that guidance..

Second question. I know you mentioned customer orders may be tailing off a little bit. Another real good leading indicator I would think for you would be supplier lead times.

What are you seeing with those lead times? And what does it suggest for pricing in market share if lead times are contracting? Maybe it's little harder to use your balance sheet as a weapon..

Yes, that is a dynamic going on. Of course, last year, extended lead times, lots of inflation. We accelerated orders last year because of that environment. This year, lead times have definitely come in contracted. We're still in a very good - especially in carbon pipe, much lower lead times.

Valves don't move that much and so we still have some extended lead times, although even some of those in the U.S. valve manufacturers have shortened, but we're in a very good position from an inventory position and our cost position, still taking advantage of this market. But there is that dynamic.

As that - as you know, as that dynamic changes, then puts some marginally pressure on pricing. I think the only area we've really seen it is in line pipe. You see it in the spot market information we talked about in our prepared remarks.

Primarily smaller sizes and ERW type line pipe are seeing the biggest price pressures at this point, but we're in very good position from an inventory standpoint and what the markets we do serve mostly with seamless and DSAW in larger diameter for pipelines..

If I can sneak one more in, Andy, and I'll try and frame this delicately. But with the Anadarko situation, I understand that you had a renewal of the contract recently, but Chevron and OXY are obviously very different sized customers for you.

So how would you frame the risk/reward of that situation developing going forward?.

Yes. So all three of the players involved here are good customers of ours. Chevron, of course, is our largest customer. We just went through a review with them on all the North America. We have the new global seven year contract with the new North America, review of what we stock for and pricing in the whole gamut.

So of course, the most positive would be, for us, Chevron acquiring Anadarko. Anadarko is a good customer of ours. We renewed our contract with them, but they tended to split the work more between the major two players in the industry and some regional players. So of course, that's part of the Chevron world. That would improve nicely for us.

Occidental is also a good customer, but I'd say we're more in the number two position with them. They also split their work between the two largest players and even some regional players in the Permian. So it would be combining two good customers, but of course, we would favor the Chevron outcome if it to go that way..

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

Just starting here on the gross margin, adjusted gross margin line, you guys called out a couple of headwinds that you had during the first quarter. One, I would assume was already in - you've baked into the guidance of the gross margins from the year in terms of those lower-margin midstream projects.

But you are seeing some additional deflation on pipe prices, which should impact your gross margins a little bit.

Can you maybe talk about what the offsets are there that are overcoming those kind of headwinds to the gross margin percentage for you guys to be able to take that guidance for the year the same?.

One was in Canada, and one was in the U.S. That short-term impacted our margin that we don't - is not sustainable. We're not going to continue with that as activity picks up, and it has in March and it has continued in April. So I think we get back to more normal margins.

And you're right on the other impact, some deflation in line pipe, but I think that's more impact that we're going to have to deal with for the rest of the year. We're still up slightly from a year ago, but marginally in the spot market, but we do a lot with our customers out of stock because we have the pipe they need on short lead time.

So those margins tend to hold up better than the spot market when you have a lot of pipe only companies bidding. So I think that's the dynamic that will come. The one thing offsetting that we might have mentioned that in the last call, Korea, South Korea is a good supplier for us. They run a quota system.

So we're able to buy some lower-cost import pipe to offset some of that pricing pressure on the top in 2019. So we still feel very good about our line pipe pricing year-on-year. So I think it's going to play out by the end of the year, exactly in the range we forecasted, which will be a new high point for us above the 19.6% we did last year..

That's great color, very helpful. Second question. You guys took some revenue out of the full year guidance. You talked about a slow start at the start of the year, and the second quarter possibly not ramping up to the level you'd previously expected.

Is what's built into your guidance in the second half of '19 changed from where it was three months ago? Or are you still expecting the same level of revenue and the same ramp up into the second half that you were previously?.

Yes, Nathan. Two dynamics really impacting this. And the one and the biggest one is what we've been talking about for a couple of quarters. We had a unique alignment of three major projects last year that really drove a lot of revenue, $260 million, that were nonrecurring into this year.

So when you think about our performance this year when we put it in our comments, if you look - if you take out the $260 million of the three projects, I want to give a little color on each of those, we're actually growing the base business 7% with the new guidance. And I think that's an important thing.

If you look at the first quarter compared to the first quarter a year ago without the projects, our growth in the base business was actually 5%. So we are growing. We knew we had that challenge. When you think about the upstream, we had $80 million that was in Kazakhstan. The completion rate in the U.S. is up, and we're doing very well in the U.S.

completions. As we said, completion growth is 17%, and our U.S. upstream business grew 16%. We have a very tight correlation of our U.S. upstream revenues with the U.S. completion data. And the other big one was our Permian basin revenue base, which is primarily upstream and midstream, but the upstream part was 19%.

So those - on the upstream, we're doing very good. So we will not only replace that $80 million, but have an up year slightly and upstream globally. In midstream, we talked about the big TC energy or TransCanada previously, $100 million of gas infrastructure. So we have to replace that.

We're forecasting to be slightly down in midstream, but actually growing in the Permian projects that we've talked about to replace that $100 million. We still feel very good about the Permian basin. So a completely different part of our business, but all in NGL pipelines and gas pipelines.

Just to give you an update on that, as we said on the last call, we project $200 million of revenue from the Permian build-out. We had $15 million in 2018. We did only $10 million in the first quarter, and we're forecasting an additional $70 million to $90 million in 2019.

So in the back half, to answer your question, we'll be ramping up in the Permian midstream and the U.S. upstream, both we - and the U.S. primarily in Permian, those will be performing. Then we'll have the second half higher than first half built into our guidance.

And then the Permian build-out will continue on into 2020 with another $80 million to $100 million for us. And the final piece is downstream. We have the Shell polymer, $80 million in 2018 that didn't repeat. And really, we'll be basically flat.

In our downstream, we'll be growing $80 million to replace that project with the contract wins we've had in downstream. So that's the biggest impact is we've - we're looking at our comparisons year-on-year. We have nice growth in all three areas, but that offsets the big nonrecurring projects.

The other thing that really hit us, we knew January and February were slow. We had a really nice pickup in March. April was good but not great. We originally thought we'd have more than double-digit growth in the second quarter as customers ramp up spending faster.

We're still going to have growth in the 6% to 9% range in the second quarter but not double digit as we thought. So that's the primary thing that caused us when we look at the four months already in the books, what we needed to ramp-up in spending in the next eight months to get to the high end of our guidance, so we don't see that right now.

And that's basically why we lowered the top end of the guidance $200 million and a midpoint $100 million. It's certainly - when you look at today's WTI, you look at today's Brent pricing, customers should be increasing spending given the higher cash flows in midyear.

We don't have a lot of evidence of that right now, besides what we know already from our own customer contracts. So we think it was appropriate to pull it down some given the first four months' results..

Our next question comes from the line of Veb Vaishnav with Howard Weil..

I guess, just if I think about the 6% to 9% revenue growth for the second quarter, can you help us is that the Permian midstream that's driving that you guys alluded to? And how does that play out in context of are all the project headwinds that you guys talked about are already behind us?.

Yes. So that growth we ought to see concentrated in our upstream and in our midstream business. On a year-over-year comparison, the big projects, the big one you're still going to have is the TransCanada. That finished in June of 2018, so that will still impact the year-over-year comparisons.

But in terms of that growth, it's going to led by upstream and midstream, and then we'll continue to have some growth in downstream as well..

Yes. Vebs, I'll just add to Jim's comments. Flat and international sequentially, flat in Canada sequentially and then, of course, we've got spring breakup in the second quarter, but it will be basically flat.

So as Jim said, the growth that we see already coming, it will be mostly driven by up and mid, and primarily those two driving the business in the U.S..

That's helpful color. And I think, Andy, you mentioned like for - you expect second half improved over first half.

Is that a function of all the project headwinds would be done essentially by first half and then second half takes a step up? Or can you help us just think about what drives - what's driving second half confidence over the first half?.

Yes. We feel good about - or at least with the visibility we have of the second half. It's primarily gas utilities will get busy especially in the third. We'll have our best quarter in the third quarter as we historically have. That's just our big construction and the sales quarter.

So I think the Permian definitely will be ramping up in the third quarter so we feel confident of that. Gas utilities will be business - busy. The completions on the upstream and the Permian are very good driver for us, and we think that will be busy. And downstream will be just solid.

We'll be continuing to ramp-up on the new contracts that offset the projects. And of course, our core strategy is the growth in the valve business. And that's really why our working capital and inventory is high in the first half. We see a lot of - and when I talk midstream, I used to talk line pipe mostly.

Now midstream to us is a combination of both line pipe and fittings and flanges, but also a big component is our midstream valve. And as I said, we opened up our new valve shop, and we see a nice incremental on valve - midstream valve sales in the second half that we won't have in the first half. So that's part of it.

And then we mentioned the new EnLink contract. We'll have a nice ramp in midstream revenues due to that new contract, both line pipe and MRO and projects there.

So midstream valves from the new facility, a new contract and then just overall the Permian projects actually getting to the stage where we play a bigger part towards the end and along the upstream completion. Those we feel good about. And downstream will just be solid in the second half. So we feel good about that..

Okay. And just, if I may, just thinking about the gross margins for the second quarter and maybe just in terms of one of your peers was talking about choppy markets.

So can help us as to how you are thinking about gross margins from 1Q to 2Q?.

Yes, Vebs, we should see some improvement.

Certainly, there's very little softening in pipe prices, which is having an impact, but when we look at our balance of our portfolio and as Andy mentioned, the valve activity we see and some of the things we talked about having in the first quarter, we should see improvement in the second quarter in that area..

And definitely stronger margins than the second half of the year, Vebs..

Our next question comes from the line of Marc Bianchi with Cowen and Company..

I guess following up on the last line of questions from Vebs there. If we're going to get kind of the midpoint of revenue for the year and the midpoint of gross margin for the year that you guys are guiding to, it kind of seems like you need to be at that 19.9% rate here in the second quarter and in the back half of the year.

But Andy, it sounded like you just sort of implied there's a bit more of a ramp there.

So I guess if you could maybe clarify how you're thinking about the progression, if it's any different? And then what that exit rate, which seems to be a really healthy level, kind of implies for 2020? I mean, it sounds like you have maybe advantaged inventory position, perhaps some of that goes away, but just kind of how you think the exit rate implies into '20 as well would be helpful..

Yes, Mark, let me start. One way to look at us. If you look at the last two years, the first quarter of profitability, I'm talking adjusted gross margin percentage. It was 18.2% in the first quarter '17.

It was 19.1% in the first quarter '18 and 19.6% now in the first quarter '19, with the caveat that we had a couple of projects that pulled it down from what would have been 19.9% in the quarter. And if you look at the last two years, as our volume goes up through the year, second, third quarter, especially in the third quarter, our margins go up.

And last year, of course, we had added positive of the inflation impact with all the tariffs, and so we had a really strong 20% plus in the back half. But essentially, the first quarter tends to be our low-margin quarter. So we still feel good about averaging on the high end for the remainder of the year.

And so which will bring that average up into our guidance. And for your point about 2020, as we discussed, we're definitely targeting to be 20% margin for 2020, and that's within our control. It's mostly driven by the product mix. I mean, we will have - if you look at the first quarter, our valve sales were 39% of our total.

We expect to get to our 40% total. We expect the margin impact to be very positive from the midstream valve expansion. So that - while line pipe - we're not predicting line pipe pricing into '20 yet, but what may or may not happen in any kind of tariffs there, but in the rest of our four business we feel very good.

We've been targeting this strategy for a long period of time. We continue to try to take out the lower-margin project work and the low-margin product sales that we used to have. So I think everything's aligning that at least if we were giving guidance that we're definitely targeting a run rate at the end of '19 and our target for '20 - 2020 is 20%..

That's really helpful, Andy. And maybe just near-term question on second quarter. As it relates to the G&A, I think in earlier conversations, you said could be maybe towards the midpoint or low end for the year.

Just as we roll into second quarter, would you anticipate it's most likely flat with what you delivered in the first?.

Yes. Mark, I think it'd be flat to up a little bit. I made the comment earlier about some pay increases. And to want to the earlier questions in terms of SG&A investment or expense, we do have plans to continue to invest in technology as part of our build-out of our MRC Global platform.

So I would say you're going to be at similar levels or maybe a little higher..

Marc, I would just add, but then pulled down in the third and fourth quarter due to the reductions in SG&A and international in Canada that I talked about earlier. So I think those play out. And then by the end of the year, we'd end at the lower midpoint..

Our next question comes from the line of Walter Liptak with Seaport Global Securities..

I appreciate all the color. So most of my questions have been asked. So I've got a couple of follow-ups, and I guess one of them is along the lines of the G&A that you just mentioned in international and Canada.

For example, when do the international project, the $80 million start to roll off? Was that - do that roll off in the first quarter? Or did it roll off last year? And the timing of cost, how difficult is it to take the overhead costs out of the international markets?.

Yes. Well, so the project that we've talked about in Kazakhstan was $80 million. We had roughly a $10 million - a little over $10 million carry over into this year. So it's kind of rolling off. And it's part - just this whole discussion on SG&A in Canada and international. The U.S., of course, is performing very well.

And from an EBITDA percentage standpoint, so we mentioned that it's 5.8% overall globally. We're six in the first quarter, EBITDA percent, and U.S. was 6.5%, which we feel very good about. And when we look at Canada, it's around 1%, and it's 4% in the International.

So we have room to get both our Canada and international business streamlining SG&A to get our EBITDA percent closer to the U.S. and where we want to be. So we're going through that process now. It's easier, of course, in the Canada market because there's a general market decline.

But also, in International, some softness in the Europe, Norway area, some softness in Australia, two big markets for us that we're streamlining costs as we speak and have started in the first quarter try to adjust those. This are, of course, a little longer and little harder in Europe in Norway and then of course in Canada, but we'll get it done.

And really, that's the set up with higher EBITDA performance, especially in international going into next year. In Canada, we're just really sizing our costs to the lower spending level by our customers there.

Jim, do you have anything to add?.

Okay, great. And then just switching gears over to the new valve modification facility. How much spending has to come through? And was it? A machinery? Now it sounds like you're pretty close to the end on that project.

Is it just machineries that come in? And then the important question for me on that is when does it start to contribute? Can you get some revenue and margin benefit in the back half of the year from that?.

Yes. Well, so it is machinery. So it's some mills and lays, some assembly, welding and paint, and we've been in this business. What we've done historically, we are a very big supplier of valves, both the manual valves and the automation part. What we've been needing to do is outsource all.

When you have this full assembly, the format of the way that getting to install it in these days, it comes as a complete assembly. So we would have our part. We would outsource the machining and the full assembly and then pull it in for the full assembly. And so what the shop does. So we're in the game today, and we're a big player.

What this new investment in shop, it allows us to do everything in-house and deliver a complete assembly to our customers. So it has both the revenue growth and the margin positive impact, lots of demand, huge demand when you think about all the pipeline work that's getting done, lots of midstream, automated shutdown valves is ongoing.

And we also have the demand from the replacement lines of the older lines in the United States. So it'll ramp very quickly. We'll have - our target is to be fully operational by July 1. And it will be a continuation of what we did, but we'll have the incremental revenues and margin impact from the full assembly.

We think also that just ability where we can bring our customers. They can see our 400 million-plus valve inventory, our actuation capabilities and then now ability to put the whole assembly together, form in one shop. We have at least one competitor in the U.S. that does that today, and it's a big market.

So we feel very good that, that will ramp nicely once we open..

Our next question comes from the line of David Manthey with Baird..

First off, you're saying that the U.S. downstream business in 2019 is expected to be flattish. I think there was an $80 million of projects in there as well, so I guess a little bit better than that.

But can you discuss your general expectations for the fall turnaround season specifically?.

Yes, Dave. Yes, so I think it's flattish to down 1% or in that range for the whole year. But given that, we're going to replace $80 million of revenue with new contract growth. The turnaround season was good in the first quarter.

A lot of that work didn't get completed, and that carries into the second quarter so we'll see some more turnaround even in the early part of the second quarter. And we think we'll have a nice turnaround season in the fall. We've got already visibility on projects there.

So you think about our downstream business of around $1.2 billion - $1.2 billion business, our turnaround revenues tend to be around 10% of that in good year is when they've we're not deferring projects. So I think we'll be right there, around an active fall turnaround to go with the first quarter and part of the second quarter.

And there certainly is a lot of projects being done. As - when refining margins come down, the crack spreads retract. They tend to do more maintenance on projects, so it's a mixed bag there. Results aren't as good, but their willingness to do more projects at this time goes up.

So I think we'll have no problem replacing that $80 million with the contracts plus the turnaround activity for the full year..

Great.

And then at a high level, thinking about tariff negotiations, I know it's a very theoretical, but when you think about the potential outcomes here, what would you look at and think that this was positive versus negative for you, depending on what the tweet looks like?.

Yes. I think, it's - yes, as you said, we're just a tweet away from a change, but I think you've seen in the moderation in the line pipe price in the U.S., the tariffs got put in place and most of the import pipe and the all the U.S.

mills raised pricing in parallel, even though they weren't subject to any of the tariffs because the whole market pricing was going up. And I think you're seeing with some moderation of activity and some pushback from customers that some of that ran up in pricing in the U.S. steel mills is coming back out. I think that's the biggest impact.

We're not envisioning a lot of new tariffs being put in place on the carbon side. And the biggest one would be the China impact. As they put in 10% tariffs, and that has a big impact on all the valves and valve components there that we import from China.

Passing those under our customers and raising the cost of valves, it's the negotiations break down and it goes to 25% tariffs, that will have a negative impact and our valve business just from the standpoint of higher cost, and we're going to have to pass that on to the customers.

On the positive side, the negotiations go well, and they drop to 10% tariff on the valves and valve components. That certainly would benefit us to be more aggressive with our valve sales. So I think it's uncertain which way that goes, but that'd be the biggest impact for us..

Our next question comes from the line of Steve Barger with KeyBanc Capital Markets..

On the wins and renewal list on Slide 11, any other commentary on what tipped the customers in MRC's direction? And what do the economics look like on some of those new contracts versus ongoing projects?.

Yes, Steve. I mean, we do very good in the major contracts with a strong sense of procurement or supply chain group. We've targeted many of these. The profitability is very good at our company average. The Peoples Gas, we mentioned, was a two year renewal. The Phillips 66, we added three years to the contract.

EnLink Midstream was a new market share gain for us contract and then some other renewals. But - so it's partially renewals. It's the Marathon Petroleum has started the integration with Endeavor. That's the largest now independent refiner in the United States. We had some work with Endeavor.

We had the bulk of the work with Marathon Petroleum, so we're picking up there. So we're very pleased. We tend to have a 95%, 98% renewal rate. We work very closely with our customers. We're working closely with them now to switch some of our stock sales over the catalog and e-commerce sales with them. And the top 25 still make up 55%.

So we feel good about that. We feel good. Our fabrication business is growing. We're right at $400 million of PBF sales to local regional fabricators. And our integrated supply business across all three streams is now $1.1 billion. So we feel good, really good about that. I mean I feel great about our contract customer position.

The only thing not holding us back from leaving a better year is the customer spending levels given the pressure on them to spend within their cash flows and the discipline there. With today's commodity prices, you'd expect the cash flows and spending to be up.

And with our contract position, of course, we would have been at the high end of our range previously, but we just don't see that. With all the E&P spending discipline, we don't see the ramp-up in the spending right now. But I certainly feel great about our contract position as we go into 2020..

Yes.

And with customers being a little more disciplined, any thoughts on how you're evolving to the environment beyond what you've talked about? Any new initiatives in terms of service offerings or other strategic pivots in response to market conditions?.

I think the biggest one, Steve, is we're kind of moved into a mode of full-service MRC Global model account management, strong customer touch, very strong customer service for those top 25 or even the top 35 customers when we look at them.

And then a kind of account management mini light version, still strong customer service for the next 100 customers.

And then we're really looking at a lower service level, if you will, or an e-commerce push over for the long tail of very small customers looking for a more efficient model to service them, given that the technology that Jim mentioned we are investing in.

We just see a more efficient way to service them with their smaller annual buys through an online version and save our full-service branch touch points for our major customers. So strategically, you're going to see that play out some this year, but a lot in '20 and '21..

Very good. And just one quick one.

How are you paraphrasing debt reduction or just thinking about the balance sheet versus the balance adjustment, any broader balance sheet comments as you think about the market?.

No. We're comfortable where we are in our range on a leverage between 2 and 3. As you know, it's a little high at 2.6, but with the cash flow guidance that we've provided, we would generate some cash and be able to pull that leverage down below 2.5 as we work towards the end of the year..

Our final question today comes from the line of Blake Hirschman with Stephens..

Just a quick follow-up on the drivers behind the 2019 sales guidance. The new range, I could have missed it, but I don't think I heard anything about FX.

Does the new range capture greater-than-expected headwind from FX at least compared to what you were thinking a few months ago?.

No. It remains relatively the same in terms of from an FX perspective..

Thank you. This concludes our question-and-answer session. I'll turn the floor back to Ms. Broughton for any final comments..

Thank you for joining us today and for your interest in MRC Global. We look forward to having you join us for our second quarter conference call in August. Have a good day. Goodbye..

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation..