Greetings, and welcome to MRC Global’s Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Monica Broughton, of Investor Relations..

Thank you, and good morning. Welcome to the MRC Global second quarter 2021 earnings conference call and webcast. We appreciate you joining us. On the call today, we have Rob Saltiel, President and CEO; and Kelly Youngblood, 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 13, 2021. 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, July 30, 2021, 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 various non-GAAP measures, including net debt, adjusted gross profit, adjusted gross profit percentage, adjusted SG&A, adjusted EBITDA and adjusted EBITDA margin and adjusted net income.

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 team 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. Rob Saltiel..

Thank you, Monica. Good morning, and welcome to everyone joining today’s call. I will begin with second quarter highlights and cover some of the key drivers influencing our business today. I will then turn over the call to Kelly for a detailed review of the financial results, before wrapping up with a discussion of our outlook for future quarters.

Second quarter revenue increased 13% sequentially, exceeding our previous expectations led by extremely strong revenue growth in our gas utilities business. This is our largest sector and it has continued to expand as our customers undertake safety and integrity projects and upgrade residential meters.

Our upstream production and midstream pipeline businesses were also up by 13% and 6% respectably, as energy market conditions improved and oil field activity levels increased. Bucking the trend, our downstream and industrial sector declined modestly in the second quarter, following a strong 12% improvement in the first quarter.

Our adjusted EBITDA for the second quarter came in at $36 million or 5.2% of total sales. Both of these results are the best we have achieved since the third quarter of 2019. We remain focused on balance sheet strength and financial flexibility. Our long-term debt at the end of the second quarter stood at $297 million, while net debt was $234 million.

These are the lowest long-term debt and net debt balances since our company went public in 2012. Our leverage ratio is at 2.2x, well within our preferred operating range. We generated $23 million in cash from operations in the second quarter for a total of $47 million in the first half of this year.

This cash flow result for the second quarter exceeds our previous guidance due in part to extended lead times on some of our inventory purchases. However, we still plan to increase our inventory levels modestly in the second half of the year in order to match anticipated higher activity levels.

Now I’ll turn to some of the key drivers affecting our business. The first is inflation.

We are experiencing inflation across all product groups to varying degrees depending on product category, where we see the most inflation impact is our carbon steel products, particularly line pipe as those prices have increased in the 50% range over the last six months.

As we have discussed on previous calls, inflation is generally good for our business as many of our contracts are structured as cost-plus a percentage markup. The next topic I would like to address is the supply chain.

With the rapid increase in economic activity, we are seeing issues with the availability of certain products and experiencing numerous freight delays. Operationally, we are navigating this environment with isolated disruptions, which at this point have not been material.

We have seen some product orders delayed due to raw material shortages and plant outages. Freight costs have moved up significantly along with delays, but we are generally able to pass on higher inbound freight costs to our customers.

However, certain outbound freight costs may not be fully reimbursable by contract customers and have introduced some modest pressure on margins. Supply chain issues are expected to continue for the near future as economic growth has outpaced manufacturing capacity in certain circumstances.

The third driver for our business is the rise in commodity prices. Increased oil and gas prices typically translate into increased activity in the U.S. and international oil fields, which has a positive impact on our upstream production business.

The IOCs and larger independence who comprise the largest share of our upstream customers had generally exercised capital restraint in the first half of this year. However, with growing conviction and the strength of the oil price recovery, we expect these customers to increase their completions activity over the next few quarters.

Our midstream pipeline business, which includes natural gas gathering systems around new production, also benefits as completion activity picks up. On our last earnings call, I discussed some of the ways that MRC Global is participating in the global energy transition.

To reflect the growing importance of this sub sector to our overall business, beginning in the third quarter, our downstream and industrial sector is being renamed, the downstream industrial and energy transition sector.

While the energy transition portion of our sector revenue is relatively small at this point, it is an area of high focus and growth potential similar to where we were with our gas utilities business a decade ago. We remain committed to helping our customers achieve their green energy and decarbonisation initiatives as a valued distribution partner.

Given this backdrop, I would like to highlight some of the energy transition projects we have already been awarded or are tracking for future participation. We currently supply PVF products to biofuel, carbon capture, geothermal, hydroelectric power and wind projects in various parts of the world.

We are supplying in 12 unique biofuel projects that are underway four of which are in our International segment. We are supplying stainless and carbon steel pipe valves and fittings to a large scale carbon capture facility in Canada.

As a result of our performance on the first phase of an offshore wind farm in Europe, we were recently awarded the second phase, where we were providing pipe valves, fittings and flanges, some of which are high alloy metals. In Australia, we are supplying PVF to a large renewable energy project for hydroelectric power stations.

We were also the MRO and project supplier to several geothermal locations around the globe. Looking to the future, we are currently tracking 30 new biofuel projects, 21 carbon capture and storage projects and 12 hydrogen projects.

Given our existing relationships with many of these project sponsors and our extensive international presence, especially in Continental Europe, which has been leading the global energy transition, we believe MRC Global is well-positioned to capture a disproportionate share of this business going forward.

And with that, I’ll turn the call over to Kelly to cover the financial highlights for the second quarter..

Thanks, Rob and good morning, everyone. My comments today will be focused on sequential comparisons. So unless stated otherwise, we are comparing the second quarter of 2021 to the first quarter of 2021. Total sales for the second quarter were $686 million, a 13% increase in the U.S. gas utilities business driving the improvement followed by the U.S.

upstream and midstream pipeline sectors. Gas utility sales, which are primarily U.S.-based were $269 million in the second quarter, 28% higher rebounding from seasonal spending declines in the first quarter, as customers continued to execute on their integrity upgrade plans. Compared to the second quarter of 2020 revenue was up $64 million or 31%.

This quarter, the gas utility sector represented 39% of our total revenue and we now believe the sector is well on track to reach $1 billion in revenue next year. Downstream and industrial sales were $191 million in the second quarter of 2021 modestly lower by 2% driven by the U.S. segment.

As a reminder, this sector increased 12% in the first quarter due to increased repair and turnaround activity related to the February freeze that impacted the Gulf Coast region. This sector now represents 28% of our total revenue.

Upstream production sales for the second quarter of 2021 were $143 million, 13% higher driven by strong sequential improvement in the U.S. and International segments. This sector is now 21% of total revenue. Midstream pipeline sales, which were primarily U.S.-based were $83 million in the second quarter of 2021, a 6% increase.

This sector now represents 12% of total revenue. Now, I will summarize the sales performance by geographic segment. U.S. revenue was $558 million for the second quarter, up 15% with increases in all sectors except the downstream and industrial sector as activity levels improved. The U.S.

downstream and industrial sector revenue declined modestly by $2 million or 1% due to less turn around and maintenance activity compared to the first quarter where we benefited from winter freeze related repair work. U.S.

upstream production sales were up $13 million or 19% due to higher customer completion activity and related build out a facility infrastructure. This improvement is in line with U.S. well completions, which also increased 19% over the same period. The U.S.

midstream pipeline sector revenues increased $5 million or 7% from improved market conditions and small project activity. Canada revenue was $30 million in the second quarter of 2021, down 6% as a result of spring breakup related declines in the upstream production sector and the timing of project activity that impacted the midstream pipeline sector.

International revenue was $98 million in the second quarter of 2021, an increase of 5% primarily related to the upstream production sector due to an increase in MRO and project activity in Australia, Singapore and Norway. Now turning to margins. Our gross profit percent was 16.3% in the second quarter as compared to 16.9% in the first quarter of 2021.

LIFO expanse came in at $11 million in the second quarter as compared to $4 million in the first quarter impacting margins. Adjusted gross profit for the second quarter was $134 million or 19.5% of revenue, modestly higher compared to the first quarter 19.4% margin.

And as mentioned by Rob, line pipe, which was 15% of total second quarter revenue is experiencing hyperinflation. Based on the latest Pipe Logix index average line pipe spot prices in the second quarter of 2021 were 46% higher than the second quarter of 2020. This increase has resulted in higher LIFO costs than previously expected.

Prices are expected to continue increasing throughout the year, which will likely result in further LIFO expanse in 2021. Well, it is a difficult number to predict, we’re currently modeling an additional $20 million of LIFO expanse in the second half of the year.

SG&A costs for the second quarter were $102 million or 14.9% of sales as compared to $126 million or 20.9% of sales in the same period of 2020. The $24 million year-over-year decrease in SG&A is a result of the significant cost reduction actions taken last year that are now fully embedded in our run rate.

On a normalized basis, SG&A was $101 million for the second quarter adjusting for facility closure costs in Korea. Sequentially, our adjusted SG&A increased approximately $3 million due to the timing of certain professional service fees recorded during the quarter.

However, as a percent percentage of revenue, our SG&A improved by 150 basis points down to 14.9%. Adjusted EBITDA in the second quarter of 2021 was $36 million versus $24 million in the first quarter. Adjusted EBITDA margins for the quarter were 5.2% versus 3.9% in the first quarter driven by higher revenue and our continued focus on cost controls.

Our incremental EBITDA margin was 23% comparing the second quarter of 2021 to the second quarter of 2020, well above historical levels, which typically averaged in the mid teens. Our effective tax rate was 20% due to the mix of global earnings for the quarter. However, our normalized effective tax rate remains unchanged in the 26% to 28% range.

For the quarter, we had a net loss attributable to common stockholders of $2 million or $0.02 loss per share. However, normalizing for LIFO expanse recorded in the quarter, we had adjusted net income attributable to common stockholders of $6 million or $0.08 per share.

At the end of the second quarter of 2021, our percentage of net working capital to sales was 17.6% much better than our historical averages and an improvement compared to our normalized value of 18.5% in the first quarter.

We generated $23 million of cash from operations in the second quarter of 2021 longer than expected inventory lead times related to supply chain and logistics issues impacted our anticipated increase in inventory balances. We also experienced stronger sales during the quarter, which resulted in additional cash generation.

However, for the second half of the year, we expect to increase inventory levels in response to higher anticipated sales activity, as supply chain disruptions hopefully begin to stabilize. Our long-term debt outstanding at the end of the second quarter of 2021 was $297 million and net debt was $234 million.

This is the lowest level of debt in MRC’s public company history. We reduced total debt by $85 million compared to the first quarter of 2021 due to an excess cash flow payment related to our credit agreement. The lower debt level will also result in interest savings of approximately $5 million on an annualized basis going forward.

Our leverage ratio has now reduced to 2.2x significantly better than our peak last year of 3.8x. In the last 18 months, we have reduced our net debt position by 55% and we expect to continue to make progress when our leverage ratio, as the market continues to improve.

At the end of the second quarter, the availability on our ABL facility was $444 million, we had $63 million of cash and our liquidity was $507 million. We also anticipate completing an extension to our ABL facility during the third quarter with similar terms as our current ABL. Now turning to our 2021 outlook.

We are optimistic about the future as the economy continues to strengthen and confidence grows that oil demand will return to 2019 levels in the near future.

While there are moderating forces such as customer capital discipline, customer mix and reinstatement of pandemic restrictions, our solid first half performance, improving backlog and encouraging customer conversations, all contribute to our positive outlook.

For the full year, we expect total company revenue will grow in the mid single digit percentage range as compared to 2020 versus our previous guidance of low single digit percentages. From a sector perspective, we expect a high double digit increase in sales for gas utilities and flattish revenue for downstream and industrials.

Partially offsetting these improvements, we expect a mid single digit percentage decline in upstream production revenue and a low single digit percentage of decline in the midstream pipeline sector. However, when comparing the second half of 2021 to the first half, we expect growth in all our sectors also averaging in the mid single digit range.

From a geographic view, we expect the U.S. and Canada to increase mid single digits and international to the decline mid single digits for the full year of 2021 versus 2020.

Although our international business is expected to decline slightly this year, the anticipated ramp up in international activity should be supportive for growth in 2022, as we typically experience a lag between an improvement in drilling and completion activity and our business, which is longer lead time and project oriented.

Sequentially, we expect the third quarter company revenue to be up low single digits compared to the second quarter.

The upstream and midstream sectors are expected to have the most improvement with single digit growth and downstream and industrials is expected to increase low single digits, while the gas utility sector is expected to be flat to modestly higher coming off its highest quarterly revenue in company history.

We still expect the fourth quarter revenue to decline seasonally, but at the low end of the historical range of 5% to 10%. We also expect our adjusted gross profit margins to remain in the 19.5% range as inflation improvements are moderated by mix shifts.

Regarding SG&A, as we pivoted to a growth phase, SG&A as a percentage of total revenue is the more relevant metric that we’re focused on. So while absolute SG&A costs may modestly increase going forward due to increased activity levels and the reinstatement of certain discretionary costs, the percentage of revenue trend will continue to improve.

SG&A as percentage of revenue this year is expected to average in the low 15% range, but is expected to gradually decline in the 13% to 14% range over the coming years. We expect our normalized effective tax rate to remain in the 26% to 28% range.

However, our quarterly tax rates may fluctuate as certain discrete items can give rise to large swings in the rate. And finally, as mentioned earlier, we expect to increase our inventory in the second half of this year, due to improved market conditions we are already seeing and for the growth expected in 2022.

The cash impacts could continue to fluctuate by quarter given the uncertainty of delivery dates, but our current forecast is to be cash flow neutral in the second half of this year. We also plan to continue to prioritize excess cash towards debt reduction and lowering our leverage ratio. Now I’ll turn it back over to Rob for closing comments..

Thanks, Kelly. I want to add a few thoughts on our business outlook and corporate goals before opening for Q&A. Regarding our outlook for the second half of 2021 as Kelly said, we continue to see positive momentum.

Our backlog of business has continued to increase as we have moved through the first half of this year and we expect revenues across all sectors of our business to increase in the second half of this year versus the first half. We were also increasingly optimistic about our opportunities for growth next year.

Strong commodity prices should benefit the upstream production and midstream pipeline sectors, while increased turnaround and project activity benefits the downstream.

Continued mid to upper single digit spending increases by our gas utility customers should allow us to hit our target of $1 billion of revenue in 2022, a year earlier than we had previously expected. While we enjoyed a solid second quarter, we retain important financial imperatives that we must achieve at MRC Global over the coming quarters.

We must transition to a consistently positive net income. We must increase our returns on invested capital beyond compensatory rates. We must increase our EBITDA margin percentages into the upper single digits as our revenues increase and we achieve higher flow-through rates to the bottom line.

And we must achieve a share price that reflects our improving business outlook, exciting growth prospects and greater consistency in our financial results. I will close by highlighting that we recently issued our fourth annual ESG report earlier this month. In doing so, we’ve made considerable progress in expanding our disclosures in key areas.

Just as we are committed to assisting our customers in achieving their ESG goals, we must ensure that our own ESG initiatives are well aligned with society’s rising expectations. We encourage you to read our latest report on the company website. And with that, we will now take your questions.

Operator?.

Thank you. [Operator Instructions] Our first question is from Nathan Jones with Stifel. Please proceed..

Good morning. This is Adam Farley on for Nathan. Bigger distributors with more purchasing power should have better access to products.

Is MRC seeing any market share gain opportunities in this environment? And how is it going about taking advantage of them?.

Yes. We – with our customers, I think MRC Global has benefited in a market where there have definitely been supply chain issues and challenges. I think we benefited from the fact that when you look at our supplier base, in a lot of cases, we are one of the top customers of our main suppliers, one and two, number one or number two in a lot of cases.

And your point is well taken that we’ve got an opportunity here where there is limited access, in some cases, to product, where we have established relationships, where we have a deep customer relationship with our suppliers that we get preferential access to these materials. So I do think it has given us an opportunity to gain some share here.

And certainly, in our gas utilities space, we’re gaining share there. And you see that in our financials. Now going forward, we do continue to see some challenges in the supply chain. We don’t think that the supply chain issues are over.

However, we are looking for these issues to moderate, both in terms of inflation and product pricing and availability and timing of deliveries. But we certainly have seen an opportunity to gain share as we’ve had preferential access to material.

And looking forward, we would certainly look for that to either continue or for the entire supply chain issues to abate to the point where we’re certainly in a as good or a preferential basis..

Okay. And then shifting gears to the energy transition projects.

Is there a sweet spot where MRC plays for energy transition projects? Is it maybe biofuels? And then are there certain areas that you can accelerate maybe through acquisitions to maybe accelerate that?.

Yes. I think you hit on it well. There obviously are various opportunities in the energy transition space that span the gamut. And probably one of the more natural places for pipe valves and fittings distribution is the biofuel space. In a lot of cases, as you know, this is – these are conversions of existing refineries.

So a lot of the equipment that we would typically provide in more of a petroleum fed refinery or in a petrochemical complex, these are replaced by different feedstocks. But the products that are required are very similar, maybe with some metallurgy differences.

So I think biofuels has certainly been a big part of the energy transition space for MRC Global to date. Probably 60% of what we’ve done has been in the biofuel space. But going forward, as we talked about in our prepared comments, we definitely see applications outside of that space.

Even currently, as I mentioned, we’re in carbon capture, hydroelectric wind, and we certainly are looking for opportunities in hydrogen. I mentioned, we’re tracking a lot of projects there. So there’s going to be an evolution into this space developing really from our – I would say, first foray and strength in biofuel to other areas.

Now as we think about the energy transition more broadly and how it impacts our strategy, we certainly feel that this is going to be a bigger part of our business. It’s going to be a bigger part of our world economy. We’ve got to figure out as a leading distributor how we can play in that space.

And so we’re going to continue to keep our eyes open for how we can both grow this business organically and potentially grow it inorganically as the opportunities present themselves. Obviously, our balance sheet is in really good position now. We talked about the fact that this is in the best shape on a debt and net debt basis since the IPO in 2021.

So we have financial flexibility and strategic flexibility we haven’t had before. So we’ll certainly keep our eyes open for opportunities to expand in the energy transition space..

Thanks for taking my question..

Our next question is from Tommy Moll with Stephens. Please proceed..

Good morning. Thanks for taking my question. You’ll mention on your upstream business, you ought to see a tailwind in the coming months and quarters from increased completions activity, which I think is commentary consistent with others in the industry.

I’m just curious how much visibility you have there? Any insight you have into how far forward customers are making decisions? Is it really more just managing to the remainder of this calendar year, maybe where there’s some budget left? Or do you have any sense of early 2022 at this point?.

Yes. We certainly are talking to our customers about their spend going forward. And as we mentioned in our prepared comments, because we tend to serve IOCs and larger independents – and as we know, a lot of these customers have taken a pledge to be more capital restrained.

A lot of the recovery in the upstream space has been muted as it relates to oil business. Although it’s up, it’s certainly not up to the level that you’ve seen in increased oilfield activity. So a lot of what we have is anecdotal through discussions with our customers.

But clearly, there’s going to be a need for replacement of lost production due to the high decline rates, coupled with a growing conviction that both the recovery in world economic activity and the maintenance of healthy commodity prices is more secure as we look to 2022. This is really what gives us confidence in the growth of this space.

Kelly, you have anything you want to add to that?.

No, Rob, I think you covered it well..

Thanks, Rob. That’s helpful. Following up, I just wanted to ask about SG&A. And I heard the commentary, lot and clear that as we go through an up cycle here. The dollar amount may be up, but you’re more looking at the percent of revenue.

Is there any more wood to chop on the fixed cost side there? Or going forward, should we more just think about this as managing the variable piece through the up cycle?.

Yes.

I’ve mentioned on our previous call that when you have a network of locations like we do both here in North America and worldwide, where we’ve got over 120 locations, we are constantly looking at that network to make sure that it’s optimized in terms of our location relative to our customer base and then the entire hub-and-spoke system that we’ve got set up between our regions, and our branches is optimized.

So we’re always taking a look at fixed costs. I think we took a lot of those fixed costs out last year as part of our rationalization, but we certainly take a look at that all the time.

And certainly, on the edges, you’ll see us pruning and adding where it makes sense because, as you know, our customer base does move around, whether that’s oilfield movement or our balance of business with our other sectors.

I think the other – the other thing it’s important to note is that last year was really a year of austerity in terms of discretionary pay and benefits as it related to our employee base. Obviously, a big part of our SG&A is related to personnel costs.

And clearly, as the market recovers, we expect that some of these discretionary costs and benefits will return to our cost base, but not in any disproportion to the growth that we’re going to have in terms of our revenue and our profitability.

So as Kelly said in his comments, if you look at the percentage of SG&A relative to revenue, even in a inflationary environment as it relates to wage pressures and potential augmentation of our workforce, our SG&A will be a lower percentage of our revenue, and we’ll still be able to increase margins going forward..

Thanks, Rob. Go ahead, Kelly..

Yes, I was just going to add on to that. I mean, we covered some of this in the prepared remarks. But even with the slightly elevated SG&A cost we had this quarter on a basis point comparison to last quarter, we were down 150 bps. So I think we’re going to kind of move away from providing like an absolute dollar amount as guidance.

Just switch more to as a percentage of revenue. And the way – just to give a little bit of color there, if you look historically, when we’ve been in a down market, the percentage of SG&A as a percent of revenue, we’ll get up, call it, 16%, 17% range. I think we hit a little over 17% in one quarter last year.

But in a more improved market, we used to get down into a 13% to 15% range. And so for 2021, I think a full year average, be thinking of that low 15% range between, call it, 15.2% 15.3% type range.

But over the next couple of years, as revenues continue to improve, I think you’re going to see that step lower, again, very much from comparison to what we’ve seen historically, where you get down into that 13% to 14% range, which is a good place to be..

Thank you for the context there and hopefully not overstaying my welcome by asking one other related up cycle question here. Just on the working cap side, you mentioned that we ought to see inventory build as we go into Q3, which makes good sense given the circumstances.

But looking more into the future next year, if you want to pick a year, how should we think about how you’ll manage that just in terms of percent of revenue? Or what’s a good way to frame what we should expect to see there?.

Yes. Tommy, I think if you think back in previous years, we would quote working capital as a percent of revenue and roughly a 19% to 20% range. We’re doing much better than that. We were much lower than that this quarter, I think, less than 18%.

And so that’s the way we’re kind of tracking it going forward when we model working capital and our future projections is more kind of sub 18% range. We’ll continue to work on that as much as we can. And we’re looking at centralizing inventory more, minimizing the amount of stock we keep in the customer service centers that we have out in the field.

And so over time, I think that could improve even more. But for the next, call it, the next year or two, I would target more in the 17% to 18% range..

Yes, and if I could just add to that. We’re very focused on capital efficiency as it relates to our investment in inventory. I think we are moving out a lot of the slow-moving stuff that was in inventory before we went into the pandemic and a bit of the downturn last year.

And going forward, as Kelly mentioned, we’re really centralizing our approach to inventory to ensure that we’re very prudent in that and that we focus on the high turn items. So I think you’ll continue to see capital efficiency improve as we go forward..

Thank you, Rob, I will turn it back..

Our next question is from Jon Hunter with Cowen & Company. Please proceed..

Good morning. So I wanted to ask on the margins. I appreciate the margin commentary. And it seems like you’re looking for kind of flattish in the mid-19.5% level. I guess I’m curious, you noted some of the inflationary impacts and then some supply chain issues.

So is there a way you can quantify what margins perhaps would have been excluding some of the supply chain disruptions?.

Yes. So Jon, that one is a difficult one. And let me kind of explain why. There’s a lot of puts and takes into our margins every month, every quarter, as I’m sure you can imagine. The positive side are some of the things that are influencing margins positively is obviously inflation.

And I think more so on the line pipe part of the business, where we had a lower average cost and with the spike in prices, we’re able to sell line pipe at a much better margin. And that’s one of the reasons it went from line pipe, 12% of our revenue in Q1, up to 15% of our revenue in Q2. The mix is obviously very important.

Just overall, the higher valve concentration and the more downstream type work we get is accretive to our margins. But then on the negative side, our international revenues are slightly down this year, and international margins overall are accretive to the company average. So that works against us.

We – with price adjustments, we’ve got price adjustments here in the first half of the year, but there’s always a lag effect. And that can have some pressure on margins until you get all of those price adjustments fully baked in.

And we mentioned in the – I think in Rob’s prepared remarks, there’s some of the higher logistics costs that we’re seeing right now, freight, cost of containers, things like that, that if it’s inbound freight, we can typically pass that through. Outbound freight, it’s not always a guarantee that you can pass that through.

So that can weigh against margins. And then just the gas utility, and we wanted to make this point that I think it’s pretty common knowledge that gas utilities can work against us from a gross margin perspective.

But when you look at the SG&A requirements for that business and look at the EBITDA or operating income effect of gas utilities, it’s actually accretive to our overall margins. So we don’t try to get too hung up.

Especially now with gas utilities, almost 40% of our revenue, it’s really more to be think – it’s more appropriate, I think, to be thinking about our margins from an EBITDA perspective more so than a gross margin perspective..

Yes. If I could jump in there, Kelly. Thanks for bringing it up, Jon. I mentioned this on the last call. Obviously, we are – we take a close look at gross margins because they’re important in terms of determining how much can flow through to the bottom line.

But more important for us, and we think our shareholders is our bottom line margins, our EBITDA margins. And for this quarter, we crossed over the 5% threshold. We talked about a longer-term goal of higher single digit margins. And perhaps this point was lost at least until Kelly just made it, and I’ll make it again.

And that is that even though our gas utility business may have a lower gross margin in aggregate and be somewhat dilutive to the gross margin, looking at what the cost to serve and the variability of SG&A with incremental sales, we think it’s accretive.

So as you see our gas utility business grows, you see our downstream and industrial business grow, we think those are accretive to our bottom line margins. One interesting fact is that our gas utilities are probably – are definitely the most integrated with us digitally of any of our customer base.

And so we get lots of efficiencies in terms of the size of orders, repeatability, cost to serve, those sorts of things. So hopefully, that gives you a little bit of color on how we think about that and the focus on bottom line margins and the impact of the growth of our different sectors on those margins..

Thanks. That’s helpful. And then kind of an unrelated follow-up related to your energy transition. You’re tracking the 30 biofuel projects, carbon capture and hydrogen.

I’m curious if you’ve identified an addressable market or if you’re able to discuss the kind of content that MRC would get in terms of revenues on any one of these given projects going forward?.

Well, look, the total addressable market, I think we all know it’s huge and growing, I think, each day. But let me give you a little bit of color of the projects that we’re currently involved in. And these are projects that may not come to fruition in terms of billing for a few quarters out. This number is approximately about $40 million to MRC Global.

And this is obviously very early days in this space for us. But it just gives you a flavor for where it is relative to the overall picture. Still small overall, but growing fast. And as we said in previous comments, we really need to figure out how we can get a bigger piece of this pie.

We do think we’re advantaged in terms of our global footprint and our existing customer relationships. Many of these customers are leading the charge into the energy transition as they diversify. But looking even beyond that, we want to be a big player in the energy transition.

We’ve got a nice foothold already, and we see great growth opportunities going forward..

Thanks for that Rob. And then I guess just last one for me is in terms of the revenue progression in the third quarter, you guided it up, I think, low single digits. So curious where you are currently at the end of July here in relation to the low single-digit increase.

And then what kind of seasonal drop off you’re expecting in the fourth quarter?.

Yes, Jon, we’re tracking well. I mean, there’s obviously no changes to what we would say, but we’re tracking very well there. And I think maybe I talked about it more from a backlog perspective. I think in Q1, our backlog was up something like 13%. We went up a few more percent here in Q2.

But just quarter-to-date here, July 30 compared to June 30, our backlog is up about 7% at this point. So that – yes, that gives us confidence in the numbers we’re providing..

Great. Thanks, Kelly. I will turn it back..

[Operator Instructions] Our next question is from Ken Newman with KeyBanc Capital Markets. Please proceed..

Good morning, guys. I was – I understand the moving pieces in gross margins and the lower cost to serve going forward. I’m curious if you could just clarify if there’s any change to how you’re thinking about run rate EBITDA margin exiting the year? I think you mentioned that 5% to 6% type of range last quarter..

Yes. We – I’ll start and let Kelly add in here. But for the quarter, as you know, we crossed 5% in terms of our EBITDA margin. And we think the rest of the year is probably going to be in that range. I think that the growth prospects for the second half of the year are certainly less extreme than what we saw quarter-to-quarter from Q1 to Q2.

But as we move into next year with anticipated continued growth in certain of the sectors that have already moved up, but bigger growth potentially in midstream and upstream and our downstream business, we can see those EBITDA margins move up even further as we get greater operating leverage.

But I think you ought to be thinking about this year really being around the 5% range on EBITDA margins moving into the higher single digits as we move through 2022.

Kelly, you want to add to that?.

Maybe just a couple of other points, Rob. I think you covered it well. But just to reiterate, we were 3.9% in Q1, jumped up to the 5.2% number here in Q2. That’s the highest absolute EBITDA number and margin number that we’ve had since Q3 of 2019. We had 23% incremental margins over that time frame.

So very happy with the cost we took out and the improvement that we’re seeing in margins.

And we – just as the revenues continue to go up, and just the mix of work that we talked about earlier as well, we think it’s very achievable, like Rob said, that when we get into 2022 and 2023, that we’ll start to step up closer to that 6% and then ultimately up to that kind of 7% mark. But it’s baby steps, right? It’s gradual as revenue improves.

It doesn’t happen overnight, but we feel like we’re certainly on track to get there..

Yes. Switching gears here. The leverage you said is at the lowest point since you’ve IPOd.

I’m just curious if you could talk about the capital deployment and how you’re kind of balancing that between what is obviously some pretty strong growth focus over the longer term? And where you see the best returns of capital at this point? And I guess, longer term, where do you see the leverage target going?.

Yes. I’ll jump in and I’ll let Kelly add to that, Ken. Look, for the near term, we definitely want to continue to focus on our balance sheet, continue to strengthen the balance sheet, pay down debt to even lower levels. Let’s keep in mind here, we’re still very early into a recovery.

And despite our optimism, I think we all know that there is always uncertainty in space related to energy services. So we really are thinking about capital allocation in the near term as being further improvement of the balance sheet.

This also gives us financial flexibility and strategic maneuverability as we look further afield, potentially get back and look at some inorganic growth opportunities. As I mentioned on the last call, it’s been quite a few years since we’ve done a significant acquisition.

Obviously, to transform the company, that may be something that we look at and having a strong balance sheet would put us in that position. So near term, our focus is really on the balance sheet and debt pay downs..

And maybe just to add on, I mean, we talked about some of this in the prepared remarks, but our net debt went down to the $234 million mark this quarter. That was largely driven by the excess cash flow suite payment that we made, the $86 million payment we made back in April.

So that brought our gross debt down to the $297 million, but the net debt down to $234 million. I think we’ve guided earlier in the year and consistently that we would get down to a 2.0 range or maybe better by the end of this year.

And as the EBITDA continues to improve going into 2022, which is the feeling right now, we haven’t guided anything specifically at this point. But it certainly feels like the business is going to be better in 2022 and even on into 2023. And that gets you down just without any just kind of status quo, just fairly conservative growth rates.

It gets the leverage ratio down into the low 1 range or even lower than 1 when you get into the 2023 time frame. But we’ll – it’s a long time between here and now, but it feels like it’s certainly headed in the right direction..

Yes. And just to remind here too, we also said we’re going to be roughly cash flow neutral between now and the end of this year. So it isn’t as if the net debt will continue to reduce at the level that it has in the last couple of quarters. So we’ll be taking a pause there as we restock inventory moving through the second half of this year.

But to Kelly’s point, to the extent that our outlook on 2022 and 2023 comes to fruition, our balance sheet is going to be in a much better shape than it’s ever been really as we look to the future..

Last one, if I could, and I’ll jump back in you. And I know – I clearly understand that it’s a little difficult to kind of quantify the puts and takes into the impact on margins in the quarter.

But since you did highlight some of these challenges around supply chain, particularly on the higher freight costs, can you just kind of give us any sense of what’s embedded into the guidance from higher costs related to whether it’s higher outbound freight costs or any other kind of supply chain challenges?.

Yes. I would say in terms of the freight cost going forward and the outlook there, Ken, we’re really looking for a lot of this – these supply chain issues to moderate. They certainly are not going to go away overnight.

But we do believe the worst is behind us in terms of what you’ve seen in terms of steel inflation, in terms of ships being stacked up at ports, the lack of containers and the cost of those. So we do believe that the worst of this is likely to be behind us.

Obviously, this delayed our ability to restock our inventory by really a couple of quarters because we tried to lean into the inventory growth early seeing the recovery coming. But as we talked about, we continue to push out a lot of these delivery dates.

But going forward, we do see some – as part of the guidance, we do see some modest inflationary pressures, but certainly subsiding a bit from the extreme inflation we saw over the last couple of quarters..

Understood. Thanks for the color..

Thank you. Ladies and gentlemen, we have reached the end of the question-and-answer session. I would like to turn the call back to Monica Broughton for closing remarks..

Thank you, everyone, for joining our call today and for your interest in MRC Global. We look forward to having you join us for our third quarter conference call on October. Have a good day..

This concludes today’s conference. You may disconnect your lines at this time. Thank you very much for your participation, and have a great day..