Greetings, and welcome to the MRC Global's Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the conference over to your host Monica Broughton, Investor Relations. Please go ahead..

Thank you, and good morning. Welcome to the MRC Global second quarter 2022 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 23, 2022. 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, August 9, 2022, and therefore, you are advised that the information may no longer be accurate as of the time of replay.

In our call today, we will discuss various non-GAAP measures, including net debt, adjusted gross profit, adjusted gross profit percentage, adjusted SG&A, adjusted EBITDA, adjusted EBITDA margin and adjusted net income. Unless we specifically state otherwise, references in this call to EBITDA refer to adjusted EBITDA.

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

In addition, the comments made by the management of MRC Global during this call may contain forward-looking statements within the meaning of the United States federal securities laws. These forward-looking statements reflect the current views of the management of MRC Global. However, 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 would like to turn the call over to our CEO, Rob Saltiel..

Thank you, Monica. Good morning, and welcome to everyone joining today's call. I will begin with a high-level review of our second quarter results, then to discuss growth opportunities and our positive outlook for our business.

I will then turn over the call to Kelly for a detailed review of the quarter and our 2022 guidance before providing a brief recap. In a nutshell, our second quarter results were outstanding as we increased revenue significantly over the prior quarter while driving more of that revenue to the bottom line.

And we did all this while increasing our backlog by double digits. Our strong second quarter was punctuated by a 14% sequential revenue increase, exceeding our previous expectations.

All four business sectors experienced double-digit sequential growth led by our gas utilities and downstream industrial and energy transition or DIET businesses, followed by our upstream production and midstream pipeline sectors.

Gas utilities drove more than 40% of this quarter's sequential growth and hit a new milestone with $314 million of revenue in the second quarter, its highest quarterly revenue to-date.

Our gas utilities business continues to benefit from an increasing number of integrity management and meter upgrade projects and to a much lesser extent, housing starts. Our DIET sector generated nearly a third of the second quarter's sequential improvement and is on track to approach $1 billion in revenue this year.

This business has benefited from increased maintenance and turnaround activity and is rapidly returning to pre-pandemic revenue levels. Our two traditional energy sectors, upstream production and midstream pipeline also experienced strong revenue improvements in the quarter. In particular, our U.S.

upstream business grew 16% sequentially as our traditional customers ramped up investment in response to persistently strong oil and gas prices, and we expanded our share with new customers. New oil and gas production and geographic expansion of the U.S.

oilfield both require new gathering and processing assets, which in turn has benefited our midstream business in the quarter. Our international business grew sequentially by 12% despite the unfavorable impact of weaker foreign currencies that shaped 500 basis points of this increase for the quarter.

Historically, our international business has lagged the U.S. business recovery due to a higher concentration of longer lead time projects. The good news is that our underlying international business is strengthening as we've increased our international backlog by $31 million since year-end, implying stronger international revenues in 2023 and beyond.

Our Canada revenue was down 7% due to the spring break-up there. However, the backlog has grown significantly and is up 54% since year-end, supporting our expectations of strong growth in the back half of this year.

We continue to emphasize profitability and efficiency at MRC Global, and I'm very proud of our team for delivering adjusted EBITDA margins of 7.7% in the second quarter. This is the highest margin achieved by the company since 2014 when our quarterly revenue was nearly double what it is today.

We are a much leaner and more focused organization than we've ever been, and this is greatly aided our improved results. In addition to the strong revenue and EBITDA performance in the first half of 2022, our backlog has continued to increase as well, supporting our positive outlook and the growing momentum in our businesses.

In the second quarter, our backlog grew across all four business sectors and all three geographic segments and ended at $746 million, a 12% increase over the first quarter. As of July 31, our backlog is a further 7% higher than our June 30 figure, adding to our confidence for the second half of 2022.

Our full year guidance remains at $3.3 billion of revenue and $230 million in EBITDA. This represents about $30 million more EBITDA than we generated in 2019, but on approximately $360 million of lower revenue. Our 2022 guidance also yields a 7% EBITDA margin, which is a 150 basis point improvement over 2021.

Although we are not changing our guidance, we believe there is a bias to the upside for our full year performance. As we look to the future, each of our end market sectors has a strong growth story, both in the near term and longer term. I want to highlight four specific growth areas for us. First, the energy transition.

This is a subsector where we have seen tremendous growth this year, especially with the reconfiguration of petroleum refineries to process organic and waste feedstocks to produce renewable fuels. Our energy transition backlog includes a wide variety of projects, including the previously announced offshore wind farm in New York.

Multiple carbon capture and hydrogen projects in both the U.S. and Europe are visible within the three year horizon. Most importantly, we are developing relationships, project experience and technology expertise that provides us a first-mover advantage in PVF supplies for the energy transition space.

This year, we expect to generate approximately $100 million of energy transition revenue, and we expect this figure to be exceeded significantly in 2023. MRC Global is playing a major role in the energy transition, and we expect this to be a growth driver for many years.

The second area I'd like to highlight is our chemical strategy, which is gaining meaningful traction. About a year ago, we assembled a team with unrivaled chemicals expertise tasked with identifying opportunities and growing our market share.

We have won recent contract awards with major customers, and we are expanding our product mix to serve new U.S. and international markets. Our chemical subsector grew 10% sequentially in the second quarter and is up 28% versus the second quarter of 2021.

The outlook is very positive as North American chemical industry capital spending is expected to grow 18% through 2024. There is significant opportunity for MRC Global to deliver strong growth in the chemical space as this market expands and as we gain market share. The third growth area I would like to highlight is the upstream production sector.

We are the largest PVF distributor to the energy sector, and we are committed to retaining our leadership position. We've enhanced our product offerings to serve private and smaller public operators, and we are expanding our footprint in the critical Permian Basin by opening a new facility in Midland, Texas to better serve our customers there.

Our international upstream business has picked up as well, in part due to the increased focus on energy security in Europe.

Among our four business sectors, upstream production is expected to achieve the highest percentage growth this year at approximately 30%.We believe that we are in a multiyear growth cycle for the traditional oilfield after years of underinvestment, driven by increases in worldwide energy demand and an expanded role for U.S. energy production.

And finally, I'd like to highlight the global LNG market as an area of growth for MRC Global. Natural gas is a logical transition fuel to a lower carbon future, and the U.S. in particular, is blessed with abundant supplies that can be exported economically and safely to world markets as LNG.

We expect that the increased focus of energy security will help facilitate growth of LNG production infrastructure in the U.S. in parallel regasification and transmission facilities in consuming markets.

Here in the U.S., we are already active in supplying large quantities of PVF to approved LNG projects, and we expect a good number of additional LNG projects to gain approval in the next three to five years.

Lastly, I want to commend our operations, supply chain, sales and marketing teams who continue to deliver essential PVF products to our customers safely and timely, while providing superior service in addressing our customers' evolving needs.

Our support functions continue to provide capable systems and personnel for our business to thrive and grow amid challenging market conditions. It has been a total team effort in MRC Global, and I'm very proud of our people for stepping up. With that, I'll now turn the call over to Kelly..

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 2022 to the first quarter of 2022.

Total sales for the second quarter were $848 million, a 14% sequential increase, outperforming our previous expectations of an upper single-digit improvement and returning our quarterly revenue rate to late 2019 pre-pandemic levels. All sectors grew double-digits, led by gas utilities and DIET followed by the upstream and midstream sectors.

Gas utilities second quarter sales were $314 million, an increase of $43 million or 16%. We continue to experience strong growth with our customers in this market, which is expected to accelerate even further in the third quarter with the construction season well underway.

While there is the potential for the new home market to decline with interest rate increases, we do not anticipate this having a significant impact on our gas utilities business as 85% or more of customer budgets in this sector are generally dedicated to maintaining and upgrading existing infrastructure.

The DIET sector, second quarter revenue was $259 million, an increase of $33 million or 15%. This sector continues to surprise to the upside driven by growing energy transition work, primarily renewable biofuel projects in the U.S. as well as increased refinery and chemical turnaround projects and maintenance activity.

Also as mentioned by Rob, this business is approaching the $1 billion mark for this year, making it our second largest sector behind gas utilities. The upstream production sector revenue for the second quarter was $178 million, an increase of $20 million or 13%, led by the U.S. as well completion activity increased for our primary customer base.

International also experienced increased upstream activity in Norway and Australia as energy demand and client spending continues to rise post pandemic. Midstream pipeline sales were $97 million in the second quarter, up $10 million or 11%.

We are seeing consistent improvement in this market as production levels gradually increase, driving the need for additional gathering and processing infrastructure. Now I will cover sales performance by geographic segment. U.S.

revenue was $717 million in the second quarter, a $99 million or 16% increase, also led by the gas utilities and DIET sectors with all sectors of mid-teen percentages. The U.S. backlog increased double digits this quarter with all sectors up sequentially, supporting our outlook for the back half of the year.

Canada revenue was $40 million in the second quarter, a 7% decline compared to the first quarter, primarily as a result of the spring break-up seasonal impact in the upstream production sector. However, the backlog in Canada increased 38% sequentially, positioning this market for an improved second half of the year.

International revenue was $91 million in the second quarter, a 12% increase with all sectors up despite a $4 million foreign currency headwind. The upstream production sector experienced higher activity from customers responding to post-pandemic energy demand and supportive commodity prices.

The DIET sector increased in New Zealand from project work on a geothermal power facility as well as in the Netherlands from additional project work, including biofuels. Now turning to margins.

Adjusted gross profit for the second quarter was $181 million, 21.3% of revenue, an 80 basis point improvement over the first quarter and the second time in our public company history, it has been over 21%.Compared to a year ago, it is 180 basis points higher as we continue to experience the benefit of higher sales volume, the positive impact of inflation, our preferred supplier position and proactive supply chain management.

As a reminder, most of our public company peers use an average cost inventory methodology. Therefore, when benchmarking MRC's Global results, it is more appropriate to use the adjusted gross profit numbers to correct for the impact of LIFO expense, placing our inventory on an average cost basis.

Before adjustments, our gross profit percentage was 17.8% in the second quarter, down 50 basis points from the first quarter, primarily due to increased LIFO expense, which was $20 million in the second quarter and $6 million in the first quarter.

SG&A costs for the second quarter were $120 million or 14.2% of sales as compared to $107 million or 14.4% of sales in the first quarter. As a percentage of revenue, SG&A improved by 20 basis points sequentially and 70 basis points year-on-year.

Absolute SG&A costs increased $13 million sequentially, driven by increased head count requirements to support our improved growth outlook and wage and benefit enhancements required to remain competitive in the marketplace for talent.

In addition, we experienced increases in discrete areas such as medical cost, air travel and in transportation fuel costs that are expected to moderate going forward. Therefore, we expect overall SG&A expense levels to stabilize with only modest growth anticipated for the remainder of the year.

And for the full year, we expect SG&A as a percentage of sales to be in the low 14% range, similar to this quarter. However, it may fluctuate the next two quarters based on sales volumes. EBITDA for the quarter was $65 million or 7.7% compared to the previous quarter, which was $48 million or 6.5%.

As Rob mentioned, this is the highest quarterly EBITDA margin percentage we've generated since 2014 or nearly half of the revenue base, demonstrating how we have streamlined our cost structure and are running the company much more efficiently.

Tax expense in the second quarter was $6 million compared to $7 million of expense in the first quarter, resulting in an effective tax rate of 30% due to unbenefited foreign losses. For the quarter, we had net income attributable to common stockholders of $8 million or $0.09 per diluted share.

Our adjusted net income attributable to common stockholders on an average cost basis, normalizing for LIFO expense was $23 million or $0.27 per diluted share. We consumed $50 million of cash from operations in the second quarter as we increased our inventory position corresponding with our revised projected increase in activity levels.

We expect to continue building inventory levels into the third quarter and to be relatively flat in our use of cash from operations for this quarter.

However, we do expect to generate significant cash in the fourth quarter that should result in a net positive cash flow from operations for the full year, which is unusual for the company as we have historically consumed cash in years of strong revenue growth.

Our total debt outstanding at the end of the quarter was $356 million, a $53 million increase from the first quarter due to increased inventory purchases and to a lesser extent, growth in accounts receivable.

Our leverage ratio, based on net debt of $335 million, was 1.7 times, which is an improvement over the last 12 months when our average leverage ratio was 2.2 times. We expect to make further progress on our leverage ratio as our EBITDA continues to grow, and we lower our net debt position with expected cash generation during the fourth quarter.

We ended the quarter with availability under our ABL facility of $529 million and $21 million of cash for a total liquidity position of $550 million. Our backlog position continues to demonstrate solid growth momentum. This is the fourth quarter where our backlog has been up double digits returning to 2018 levels.

In one month, the backlog has grown another 7% in July at $795 million, a 19% increase compared to March 31. This strong backlog position is an indication of the health of the business and future growth potential. Now turning to our 2022 outlook.

As we announced a month ago, we are projecting our revenue to come in at approximately $3.3 billion or a 24% growth with EBITDA at $230 million or 7% of sales, a 150 basis point improvement compared to last year.

From a total company perspective, this translates to a double-digit improvement in all sectors ranging from about 30% for upstream production followed by DIET and gas utilities with expected growth exceeding 20% and about 14% for midstream pipeline. From a geographic view, we expect the U.S.

and Canada to increase very strong double digits and international increasing mid-single digits. Sequentially, we expect the third quarter company revenue to be up mid-single digits compared to the second quarter and the fourth quarter to decline seasonally in the range of about 5%.

Our normalized effective tax rate for the year is projected to be between 27% to 30% but could fluctuate from quarter-to-quarter due to discrete items. Now I'll turn it back over to Rob for closing comments..

Thanks, Kelly. I will summarize a few highlights before opening for Q&A. Our impressive first half performance, combined with a rapidly growing backlog and strong business fundamentals in each of our end markets has increased our confidence in our 2022 outlook.

Each of our four business sectors is expected to grow revenue by strong double-digit percentages in 2022 versus 2021. Our U.S. and Canada segments are expected to grow by strong double-digit percentages and our international business is expected to grow mid-single digits. We are a more efficient company with an unwavering focus on our bottom line.

We are earning peak EBITDA margins on much lower revenues and our EBITDA margins are expected to increase further as we grow revenue.

We reaffirm our guidance that MRC Global will achieve $3.3 billion in revenue and $230 million in EBITDA or 7% EBITDA margin this year, which would be our best EBITDA margin percentage since 2014.And finally, we believe we are in the early innings of multiyear growth for our business with many drivers of durable growth across all four sectors, particularly in gas utilities, chemicals, energy transition and traditional energy.

And with that, we will now take your questions.

Operator?.

At this time, we will be conducting a question-and-answer session. [Operator Instructions] Tommy Moll with Stephens has our first question. Please proceed..

Good morning, and thanks for taking my questions..

Good morning, Tommy..

Rob I wanted to start off on gas utilities. I think you mentioned this was a record quarter on a revenue basis. And I'm curious, as you look forward, can you talk to the pipeline both in terms of potential for new customer adds or big incremental deals with existing customers? Thank you..

Yeah. We're happy to do that, Tommy. Look, the gas utilities business continues to really be a fantastic business for MRC Global, something that we have grown organically over the last 15 years to now becoming our largest sector and one that continues, as you say, to set records. We did have a record quarter for gas utilities.

And keep in mind, a lot of what we're doing in this space is we are taking business that is currently in-sourced by utilities, and they're outsourcing its MRC Global. And we've continued to penetrate many of the large gas utilities in the U.S.

And at the same time, with existing customers, we've expanded our product offerings, and you're seeing those two effects manifested in our numbers. Going forward, we still have a number of large gas utilities that we either don't serve at all or we serve in a very small way in terms of the products and/or the geographies that we cover.

And our team is very active in developing those customers and those product offerings so that we can continue to expand our business there.

I've been on a number of these meetings myself, where we're doing a little bit of work, but we can certainly do a lot more, and again, in a lot of cases, we're competing against what is currently in-sourced activity. So we're very excited about continued growth in this business.

Kelly talked a lot about the growth in the backlog, both in the quarter and even from June to July. Gas Utilities continues to grow in backlog for us, and this really reflects this growing pipeline of work that you referred to in your question..

Thanks, Rob. I appreciate it. Shifting gears to SG&A. If you look at the guidance for 2022, it implies notable leverage on that expense line versus the prior year. At the same time, I would assume you've probably seen some inflationary pressures there.

So I wonder if you could talk to any of those? And then as you look forward into '23 on the assumption that your revenue is up, which I recognized you're not guiding to today, but just for the sake of conversation, let's just assume that.

Can you continue to show leverage on that line or are there some inflationary pressures that have just started to creep a bit and it's going to be more challenging? Thanks..

Yeah. Let me give you a context on that, and then I'll let Kelly add some color. But look, we've said many times before that in the distribution business, inflation is our friend. And we have certainly seen increases in our margins and revenues due to inflation.

But of course, this increasing activity that we've had in 2022 does require that we have adequate personnel to service that increased activity. So we've had to go out and hire personnel, and we'll continue to do so to serve the growing level of activity, which we expect to continue based on the growth in our backlog.

At the same time, I think we all know we're in inflationary times in terms of wages, and we want to make sure that we are paying our people a fair wage, and we've had to really be market responsive in that respect. So we've introduced some wage increases as well with the improving performance of the company.

There's going to be some more discretionary pay that will be coming in as part of the improved performance of the company.

So this SG&A number has gone up from quarter-to-quarter, probably more than we had anticipated, but we certainly expect that to moderate going forward because a lot of the things that occurred in the second quarter versus the first, really were onetime things and/or we've caught up in terms of our wage levels given where the market is.

Going forward, we continue to see SG&A as a percentage of revenue coming down, okay? So this year, we're modeling around 14% as we increase revenue going forward into '23 and beyond, we certainly expect the scale effects to allow us to be more efficient in terms of our SG&A spend.

So I do think the second quarter was somewhat anomalous in terms of the increase over the first quarter. We think our costs are going to moderate from here, and we think we'll continue to see a reduced SG&A as a percentage of revenue as we go forward.

Kelly, you want to add some color on that?.

You covered it very well, Rob, but maybe just a couple of things. I mean I do want to point out that even with the higher SG&A costs that we have this quarter, as a percent of revenue, our company is best-in-class when you look at that percentage, especially compared to our primary peers.

We've always been, I think, much more efficient on SG&A, and we expect to continue to be so. Some of that sequential change. Just to point out, as a reminder, in Q1, we did have a couple of million dollars of benefit or credit recorded in the first quarter related to the CARES Act.

And so that had artificially brought that SG&A number down somewhat in the first quarter. But then as Rob mentioned, here in the second quarter, with the new trajectory of the business or the new forecast, our revenue forecast went up $200 million. Our expected EBITDA went up $30 million.

And as a result of that, we had headcount increases, overtime increases, some location premiums that were introduced in certain markets to remain competitive. And then Rob kind of hinted to it because of the increased EBITDA projections, that causes a change in our accrual requirements for incentive bonuses.

So there was a year-to-date kind of retroactive catch-up in the quarter that, that will not -- you won't see that continue in the future quarters. And then just across the board, benefit claims have went up.

We've fuel, travel expenses, insurance premiums, there's been across -- increases across all of those different cost categories that we think will normalize at this point. And so as Rob mentioned, do not expect that kind of change going forward.

We think we'll have a modest type increases in the coming quarters and kind of remain at that low 14% level. Although, I think Q3, it will go lower than that as a percent of revenue because of the higher revenue that we're projecting with high -- sorry, mid-single digit revenue increases.

And then in the fourth quarter, it could go a little bit above that just because of the lower revenue but would average out to a similar number that we had this quarter..

I appreciate all the context, and I'll turn it back..

Perfect..

Our next question comes from Doug Becker with Benchmark Research. Please proceed with your question. .

Thanks. So it looks like net leverage is still on track to be around 1 times at year-end, likely trend lower next year. Last quarter, you mentioned that this increases flexibility for inorganic growth.

What are your thoughts on a share repurchase as those leverage statistics come down?.

Well, thanks for your question, Doug. Look, we are committed to maintaining a strong balance sheet in MRC Global. And we believe that, that is valued by our investors and it certainly gives us more strategic flexibility to look at inorganic opportunities.

I do want to remind, as we have said in our prepared comments that we did consume cash in the second quarter as we did in the first quarter. The third quarter is going to be relatively flat, and we do plan to generate good cash levels in the fourth quarter, so that for the year, operating cash flow will be positive.

But as we currently stand, we do have a balance on our ABL that we'd like to pay down, and we'd certainly like to continue to improve our leverage levels as we move through the rest of this year and probably early into next year.

I think it's a bit premature to talk about any kind of share buybacks at this time, but we certainly will continue to revisit capital allocation as the balance sheet strengthens and as we look outside for inorganic opportunities..

That makes sense. And then you highlighted a number of growth drivers.

How do margins compare in, say, the chemical, energy transition in LNG end markets compared to the company average?.

Yeah. Those businesses tend to be accretive to margins for us. When you talk about the energy transition, a lot of what we're doing is in renewable fuels, and there tends to be a lot of valves and also a good amount of stainless and alloys involved in that. Those tend to be accretive for us. I could say the same thing about the chemical space as well.

So a lot of those growth areas for the company are accretive in margins. I think you've seen our gross margins come in at pretty healthy levels, and that certainly is supportive of that..

I think you alluded to this, but accretive to gross margins as well as EBITDA margins..

Yes. I'm talking about gross margins, absolutely..

Perfect. And then so you alluded to this in the prepared remarks, but two of the last three quarters, adjusted gross margins have been above 21%.

Is it too early to say that adjusted gross margins of 21% are realistic for next year, given some of the product shift you just were answering about earlier?.

Yeah. We said at the beginning of the year that we'd be north of 20%. I think we've been pleased with the gross margins being where they are right now. I think it's probably too early to make predictions for '23, but we certainly see holding north of 20% gross margins to persist through the end of this year..

Thank you, Rob..

Thank you. .

Our next question is from Nathan Jones with Stifel. Please proceed with your question..

Good morning, everyone..

Good morning..

Good morning..

Another question on gross margins. The business does tend to benefit a little bit from inflation, and we have started to see some of the commodity costs roll over.

Do you think that we're kind of looking at peak gross margins for the year in 2Q and some of that deflation start to be a bit of an impact on gross margins going forward or any color you can give us from that perspective on gross margins?.

Yeah. It's a great question because I think if you look over the history of this business, we've seen periods of rapid inflation and around the time of the financial crisis, we saw significant deflation. And so this is certainly something that we watch very carefully and manage closely in terms of our inventory levels.

I would tell you currently that we still see inflationary impacts in our VAMI and our gas products and probably a little bit more of a flattening in the carbon and in the stainless product groups. So the kind of rapid inflation that we saw maybe earlier in the year, especially around the early days of the Ukraine war has subsided somewhat.

But we still see a bias toward general inflation across our product groups at least as we move through this year. I think as we look to 2023, this is something that we'll continue to have to watch and manage.

But we certainly -- when we see flattening in terms of pricing as we are in the carbon products, we manage our inventory carefully to make sure that we don't hold too much of that at any period of time.

But as we've said, the gross margins that we're seeing north of 20%, we think those are certainly very much intact through the remainder of this year, and then we'll just see what 2023 holds for us..

And you guys raised guidance when you preannounced the quarter a month ago. And I think, Rob, you made a brief comment that you're probably biased to the upside even a month later.

Maybe just talk about where that upside might come from or what trends you've seen in the last month since you raised that guidance, that give you confidence that maybe there's some upside to the numbers from here..

Yes. Look, it's a great question. I think it really just comes right down to the backlog. We continue to grow our backlog across all segments and all sectors. And we continue to see a very strong demand for the products and services that we provide our customers. And there's been a lot of talk obviously about recession impacts.

We're not seeing any of that in any of our geographies or in any of our business sectors. So that gives us confidence in the remainder of this year, and we certainly feel good about our guidance. And again, I think if there's any bias to the upside, we're not going to change the guidance, but we certainly would hope to do better..

And just one more on the international side of the business. Obviously, it's a longer cycle, it's later cycle and tends to move a lot later than the other businesses do.

Can you talk about what you've seen in terms of increased project activity that might manifest itself for you as revenue in 2023, 2024, just to give a longer-term outlook for that side of the business?.

Sure. I'll talk about two elements there. The upstream and the downstream or DIET businesses. But on the upstream side, I think we all understand that the international markets, particularly Europe, are much more keen to develop more of their own energy given what's happened with the importation or lack thereof of Russian energy supplies.

So we've seen projects go through in the North Sea. We've seen end of -- or we see life extensions on existing platforms in the Norwegian Sea. And So I think there's a lot of optimism, if you will, on the upstream side as it relates to Europe that wasn't there, let's say, even six months ago, and we're seeing some project benefits there.

On the DIET side, in energy transition, in particular, we're seeing a lot of demand for renewable diesel projects in Central Europe and some of the -- most of those are actually in our backlog as opposed to have been recognized so far. And going forward, we continue to see lots of opportunities for energy transition.

A number of carbon capture and hydrogen projects that are being planned for the U.K. and Central Europe. So we're very excited about the growth in that international business. It is delayed. Its very project focused, but we certainly have expectations of double-digit growth in that business in 2023 over 2022..

Thank you very much for taking my questions..

You're welcome..

Our next question comes from Ken Newman with KeyBanc Capital Markets. Please proceed with your question..

Hey. Good morning, guys..

Good morning..

Good morning..

I know it's still early days, but I'm curious if you have a view on just how large an opportunity the tax bill is working through Congress can be to both your traditional energy and your renewables portfolio going forward?.

Well, it's kind of hot off the press, Ken. I mean, there's the minimum tax thing, 15%, but you have to have $1 billion of income or higher, so that doesn't affect us..

Yes..

Yeah. Good point, Rob. And then I think some of the other areas, there's a semiconductor space that I think we're pretty excited about that that's something that could be a good opportunity for us to participate in as that infrastructure gets built out.

And then just energy transition projects in general that benefit from that, especially the ones that are already kind of driven by our primary customer base, that's going to be very positive for us as well. So go ahead, Rob..

Yeah. Any of these stimulus measures really are positive for our business. And what it does is it creates additional investment, especially in some of these new energy areas or areas that need additional incentives to create business activity. And as that activity comes to the U.S.

and in the markets which is our most dominant market, we think it can only benefit MRC Global. I think as Kelly said, it's early to identify specifics on how it impacts us, but it's a net positive for our business, no question..

Right. And then just going back to an earlier comment, Rob, you talked about a significantly higher opportunity for energy transition sales in '23 versus I think you said $100 million in revenue for 2022. Any way you can help us kind of size about how to think about what significantly higher means in that context.

And as a follow-on to that, just remind us about the operating leverage profile in that space relative to the opportunity on higher volumes..

Yes. What I would say about 2023 on the energy transition is if we just look at our backlog, we think '23 will be stronger than '22. I think it's a bit early to give any kind of sense of how much bigger that will be. But we continue to field enquiries around projects in the energy transition space.

Again, currently, we're really focused on -- and have been focused primarily on renewable diesel projects, but we're seeing a lot more developments around hydrogen and carbon capture that are really a bit further out. So we continue to be very bullish on the energy transition space.

And look, we think this business is very, very accretive for us in terms of the opportunities. We tend to get very large order sizes around these projects. Keep in mind, energy transition today is largely a project business. We're really not doing much in the way of MRO.

But to the extent that we get in on the project side, it certainly puts us in a great position to leverage that business going forward with ongoing MRO activity. So it's a business that we continue to be very excited about.

We're very focused on and we think, as I said in my comments, we think we're developing a first-mover advantage with a lot of these projects that we've been involved in or work with EPCs and end users. It's really been an excellent development for us and one that we think will pay dividends for years to come..

Yeah. One more for me. Just wanted to talk about the guide increase for the year. I think someone else earlier in the call kind of hinted that, but maybe I'll ask it in a different way. Obviously, 2Q came in stronger than you originally anticipated on the flow-through. I think it was high teens here in the quarter.

I think maybe originally, the implied guidance is maybe low double digits.

When I look at the back half, the implied guidance is maybe closer to like high single digits versus the prior year on year-over-year basis to 2H '22 versus the prior year, right? Any color on what's driving the expectation for lower operating leverage in the second half? Is that primarily all SG&A lumpiness that you talked about earlier or just any sense on what's the [Technical Difficulty] kind of baked into this outlook?.

Yeah. Ken, this is Kelly. I'll take that one. Yes, I think probably what you're seeing there, if you look at it by quarter, I think Q3 would be more what you would be expecting in kind of fall-through type numbers. But we have built in, which hopefully ends up being conservatism in the fourth quarter with a 5% fall off.

As a reminder, historically, that Q4 seasonality is kind of a 5% to 10% drop off. We're not seeing anything at this point that's going to -- that we don't think is going to have it -- be at the higher end, it's probably going to be more at that lower end around 5%. I think we said that in the prepared remarks.

But just that lower revenue base and probably a little bit of more conservatism in the margin projection that we put out there just in case of some of the deflationary things that Rob talked about that will hit at some point. Could be upside to that, but just trying to have some conservatism mainly around the fourth quarter seasonality..

There's no expectation that price cost falls off versus the first half projections that you….

No, no, absolutely not..

Maybe just one more if I could squeeze it in, and I'm sorry if I missed this. But Kelly, did you mention your expectation for LIFO reserves into the third quarter? And if I look at line pipe pricing, they still seem pretty elevated here.

Would you expect that to kind of be flat or up sequentially just given the lag in the index?.

Yes. yes, that's a great question. We didn't cover it in the prepared remarks, but I'll give you some context around that. Q1 was $6 million in LIFO expense. Q2 was $20 million and what we're modeling right now, Ken, it's a great question.

We're modeling $90 million for the full year, so that does show a fairly significant increase there in the second half. That was one of the reasons we pointed out in the prepared remarks.

That when everyone is comparing our numbers to our peer group, you should really look at our adjusted numbers, whether that's at the gross margin level, EBITDA level, net income level.

That's really the more apples-to-apples comparison because that LIFO expense or that LIFO impact, even in years when you have a deflationary environment and we have LIFO income, that can distort our GAAP results that you see on just the pure GAAP financial statements.

And So the average numbers are really a much better indicator of how we're benchmarking against our peers..

All right. That's helpful. Thank you very much..

You bet..

You're welcome..

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

Thank you for joining us today and for your interest in MRC Global. We look forward to having you join us for our third quarter conference call in November. Have a great day. Thank you..

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