MRC Global Inc (MRC) 2012 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the MRC Global second quarter earnings conference call. During today's presentation all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions.

(Operator Instructions)

This conference is being recording today, Wednesday, August 8, 2012. I would now like to turn the conference over to Ken Dennard of DRG&L. Please go ahead.

Thanks, Michaela and good morning, everyone. We appreciate you joining us for MRC Global's conference call today to review 2012 second-quarter results. We would also like to welcome the Internet participants listening to the call as it is being simulcast live over the web.

Before I turn the call to Management, I have the normal housekeeping details to run through. For those of you who do not receive an email of the earnings release yesterday afternoon and would like to be added to the distribution list, please call our offices at DRG&L. That number is 713-529-6600 and provide us your contact information, or you can email me at my email address on the contact section of the press release.

There will be a replay of today's call. It will be available by webcast on the Company's website and that's www.mrcpvf.com. There will also be a recorded replay available by phone, which will be available until August 15, 2012. That information for access is in yesterday's press release.

Please note that the information reported on this call speaks only as of today, August 8, 2012; and therefore, you are advised that time-sensitive information may no longer be accurate as of the time of any replay listening. In addition, the comments made by Management of MRC today, during this conference 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 Management of MRC. However, various risks, uncertainties, and contingencies could cause MRC's actual results, performance, or achievements to differ materially from those expressed in the statements made by management. The listener is encouraged to read the Company's annual report on Form 10-K, its quarterly reports on Form 10-Q, and current reports on Form 8-K to understand certain of those risks, uncertainties, and contingencies.

Now, with that behind me, I would like to turn the call over to MRC Global's CEO, Mr. Andrew Lane. Andrew?

Thanks, Ken.

Good morning, and thank you all for joining us today for our second quarter 2012 investor call. We would like to welcome you all, and thank you for your interest in MRC Global. I would like to begin by highlighting our second-quarter accomplishments before turning the call over to our CFO, Jim Braun, who will go through our financial results more detail.

Turning to our second-quarter performance. It was another record quarter despite a great deal of volatility in the energy commodity market. We managed to achieve our highest ever second-quarter revenue of $1.43 billion, which was a 22% increase over the same quarter a year ago. And, it is the third-highest revenue for any quarter in the Company's history.

Once again, the revenue increase was broad based. As each of our upstream, midstream, and downstream sectors continued to perform well. And, all three sectors exhibited year-over-year growth in excess of 20%.

Activity in the liquid plays in the US remains robust, despite the slide in crude prices during the quarter. Although we are continuing to see a slowdown in the dry gas areas, particularly upstream activity in the Marcellus and Haynesville shales, our diversity in terms of end markets and within our customer base has succeeded in mitigating this fall off.

Adjusted EBITDA for the second quarter came in at $124 million, or 8.6% of revenues. This represents an increase of 36% over the second quarter of 2011 adjusted EBITDA of $91 million, or 7.8% of revenues. This 80 basis point improvement was driven by an improved sales mix and the upside leveraging of the fixed-cost component of our expenses.

I would like to note that we are continuing to re-balance our inventories toward higher-margin products. Thus reducing our more volatile, lower-margin Oil Country Tubular Goods, or OCTG business, which will become a smaller component of our inventory and revenues. We anticipate OCTG to be approximately 10% of our total inventory and contribute a similar percentage to our total revenues going into 2013, as compared to its traditional higher-weight.

For example, in 2008, OCTG represented 26% of the inventory, and 25% of the Company's revenues. We are making good progress in implementing our strategic shift as OCTG inventories were 12% of the total at the end of the second quarter, and made up less than 14% of our consolidated revenues in the second quarter, and less than 15% of our year-to-date revenues.

Turning back to the quarter now, the robust performance was mainly the result of several key items. An increase in activity in the oil and gas liquid plays, such as the Permian, the Bakken, the Eagle Ford, the Mississippian Lime, and the Niobrara Shale; strong growth in the midstream sector, with the continuing build out of the infrastructure required to get new production to market. And the strong contribution from an international acquisition of SPF and Piping Systems, Australia, which made up nearly two-thirds of the downstream sector's growth.

There were also several additional noteworthy events during the quarter. In late May, we signed a five-year global valve Enterprise Framework Agreement with Shell. This first-of-its-kind, global contract covers Shell's upstream, midstream, and downstream project and MRO requirements in North America, Europe, Asia, Australia, the Middle East, and Africa. It makes MRC the single-source distributor for valve and automation services, and the primary distributor for a multitude of other products for Shell's business units, worldwide. And, this represents the largest distribution contract that we have ever entered into with a global customer.

Under the terms of the contract, there is an option to extend the contract's initial five-year term for an additional five years. This standardized, one-stop distribution platform affirms our belief that many energy companies will migrate towards our model as a means to optimize their global supply chain needs for PVF purchases. We do expect to see some incremental revenue from the contract over the balance of 2012, but the benefits of the global arrangement will be evident in 2013 and beyond, where we expect Shell will become our largest customer in terms of revenue.

In June, we signed an agreement to acquire the majority of the operating assets of Chaparral Supply, a provider of PVF products and oil field supplies to its former parent organization, SandRidge Energy. Their operations have been merged into our Alva, Oklahoma branch, which was opened relatively recently to serve the Mississippian Lime play. As a part of the acquisition, we have agreed to a supply agreement with SandRidge, whereby MRC will serve as the primary PVF product, and oil field supply distributor to their operations, in both Oklahoma and Kansas.

Finally, we were honored to debut in Fortune magazine's Fortune 500 list. As many of you know, the Fortune 500 ranks the top 500 US companies by total revenues for their respective fiscal years. It was especially gratifying to be recognized in this prestigious list so soon after our April IPO.

With that, let me now turn the call over to Jim Braun to review our second-quarter results in more detail.

Thanks, Andrew; and good morning, everyone.

I'm going to speak to a number of items impacting our results, and then Andrew will return with some concluding remarks. First, let me begin with some comments on the second quarter market conditions.

The North American rig count was 7% above year-ago levels, averaging 2,147 rigs in Q2. In the US, the rig count averaged 1,970 in the second quarter, up 8% from a year ago, with oil rigs accounting for 70% of the total number of rigs. This increase in activity took place against the backdrop of weakening crude oil and natural gas prices during the quarter; although, the average WTI price for the quarter remained over $90 per barrel.

In the second quarter of 2012, our sales reached $1.43 billion, an increase of 22.4% versus the $1.168 billion we earned in the second quarter of last year. This marks our ninth-consecutive increase in quarter-over-quarter revenues. Of the $262 million increase quarterly revenues, 76% came from organic growth, with a remainder of about $64 million from our acquisitions of SPF in June 2011 and OneSteel Piping Systems in March of 2012.

Our North American segment had revenues of $1.279 billion in the second quarter, an increase of 17% from Q2 of 2011. This increase was substantially all organic.

Internationally, revenues doubled to $151 million, from $75 million a year ago, as a result of the two Australian acquisitions. Organic revenue growth in our International segment was 16.9% during the quarter, due to higher activity levels in the UK, the Netherlands, and Australia.

In the upstream sector, sales increased 21.7% in second quarter of 2012 to $657 million, or 46% of our quarterly revenues. We continue to see strong activity in the oily and wet gas areas in the various US shale plays as well as the Canadian heavy oil and tar sands region. North American MRO sales in this sector grew 32%, even as we started to reduce our OCTG business.

The midstream sector continued to be strong, as the drivers we saw during the first quarter persisted. Second-quarter sales to the midstream sector increased 23.3% to $397 million in the second quarter of 2012 and represented 28% of sales. Revenues from our natural gas utility customers increased 32%, while revenues from our gathering and transmission customers increased 19%. Key drivers of the growth include the continued build out of the oil and gas gathering infrastructure and transmission pipelines as well as increased pipeline integrity work and expenditures by natural gas utilities.

In the downstream sector, second quarter 2012 revenues increased 22.8% to $377 million and accounted for 26% of total sales. Nearly two-thirds of this growth was attributable to our international acquisitions of SPF and PSA, which are more heavily weighted towards our downstream sector than our business as a whole. Our North American downstream sales for the quarter were up 6% year-over-year. Anticipated increases in turnaround activity have been slow to develop, but we continue to believe they will pick up in the back half of the year.

In terms of sales by product class, our energy carbon steel tubular products accounted for $488 million, or 34% of our sales during the second quarter of 2012, with line pipe sales of $294 million and OCTG sales of $194 million. Overall sales from this product class increased 6% in the quarter from Q2 a year ago.

Sales of valves, fittings, flanges, and other products reached $943 million in the second quarter, or 66% of sales. This represents an increase of 33% over the second quarter 2011 results. Carbon steel fitting and flanges and alloy pipe had a particularly strong quarter, growing 50% over last year's second quarter to $300 million, driven in large part by Australian acquisitions.

Now, turning to margins, the gross profit percentage in the second quarter of 2012 grew 210 basis points to 16.9%, from 14.8% in last year's second quarter. The increase was driven by improved product mix and the leveraging of our fixed-cost component of cost of sales. Included in our cost of sales was a LIFO charge of $11.6 million in second quarter of 2012, compared with a $17.6 million in the second quarter of 2011.

Our adjusted gross profit percentage, which is gross profit plus depreciation and amortization and amortization intangibles, plus or minus the impact of LIFO inventory costing, increased to 18.9% from 17.7% in the second quarter of 2011.

Moving on to SG&A. Although the absolute dollar level was up, expenses were flat on a percentage of sale basis. In this year's second quarter, SG&A costs were $151 million, or 10.6% of sales, compared $124 million, or 10.6% of sales, in the second quarter of 2011. The increase in expense year-over-year is primarily due to additional personnel costs, other costs directly related to the increase in business activity, and our acquisitions of SPF and OneSteel Piping Systems.

Operating income for the second quarter improved to $90.5 million, or 6.3% of sales, from $48.6 million, or 4.2% of sales, in last year's second quarter. Both higher gross profits and increased leverage of our fixed G&A costs contributed to the operating income increase.

Our interest expense totaled $30.7 million in the second quarter of 2012, which was an 11% reduction compared with $34.5 million in the second quarter of 2011. This was primarily due to lower interest rates on our asset-based lending facility, as our average outstanding debt levels were comparable between the two quarterly periods.

During the second quarter, we purchased in the open market, $102 million of our senior secured notes, for $110.4 million. Consistent with our strategy following the IPO to reduce our long-term debt, reduce interest expense, and improve cash flow. The purchases were funded from drawings against our Global ABL Facility and were made at an average price of $108.28 per $100 of face value. In connection with these purchases, we incurred a pretax charge of $11.4 million, or $7.5 million after tax, consisting of the purchase premium and the write-off of the deferred financing costs and original-issue discount.

Our effective tax rate for the second quarter of 2012 was 34.3%, compared to 34.6% for the same period in the prior year. During the quarter, we lowered slightly the expected rate for the full-year 2012 to 35.3% from 36%, which drove the lower rate in the second quarter. Our expectation for the full year is the tax rate will be in the 35% to 36% range.

Net income was $31.3 million for the second quarter, or $0.32 per share on a fully diluted basis, as compared to $4.7 million or $0.06 per share in the second quarter of 2011. Included in our second-quarter net income is $7.5 million after-tax charge, or $0.07 per diluted share, that's related to the purchase of a portion of our senior secured notes. Excluding the impact of this charge, net income was $38.8 million, or $0.39 per diluted share.

As a reminder, our outstanding share count was 101.5 million shares at the end of the second quarter. With the April 2012 IPO, the weighted average diluted share count during the second quarter was 98.7 million shares, compared with 84.6 million shares during the second quarter of 2011.

Consistent with our strong revenue and profit performance, adjusted EBITDA improved significantly over the prior period. Adjusted EBITDA was $123.6 million in the second quarter of 2012, compared to $90.6 million for the same period in 2011. As a percentage of sales, adjusted EBITDA grew to 8.6% in the second quarter from 7.8% a year ago. On an incremental basis, the $33 million year-over-year improvement in adjusted EBITDA is 12.6% of the $262 million revenue growth.

Our outstanding debt was $1.355 billion as of June 30, 2012, decreasing from the $1.612 billion at the end of the first quarter. In April, we completed our IPO, where we sold 17 million shares of newly issued common stock, resulting in net proceeds of $333 million, which was used to pay down amounts owed on our Global ABL Facility. A selling shareholder also sold 5.7 million shares as part of the IPO.

At the end of the second quarter, our leverage ratio, defined as net debt to trailing 12 months of adjusted EBITDA, was 2.9 times, as compared to 4.1 times at the 2011 year end. Our operations used cash of $65 million in the second quarter of 2012, which was due to working capital build during the quarter, particularly on the inventory line.

Inventory terms declined slightly, while DSOs improved modestly. Additionally, our semi-annual interest payment on our senior secured notes of $50 million was made during the quarter. The inventory build was responsive to the increasing activity levels in the first half of the year; and with the necessary investments in inventory now in place, we have made targeted inventory reductions a priority in our operations for the second half of 2012. Our working capital at the end of the first quarter was $1.283 billion, compared to $1.175 billion at the end of March; and our total liquidity, including cash on hand at the end of the quarter, was $653 million.

Cash used in investing activities totaled $26 million, including $15 million for working capital adjustments related to the PSA acquisition and capital expenditures of $10.4 million. Our expectation for full-year CapEx is between $26 million and $27 million. We are accelerating IT spend for the integration of our Australian acquisitions, the development of productivity tools for our US business, and a small portion of the increase in our expectation will be in the fulfillment for our new contract with Shell. In addition, we are going to spend capital to expand our Nisku facility to support the growing business in Canada.

Now, I will turn the call back to Andrew for his closing comments.

Thank you, Jim.

Let me conclude with some thoughts on the current business environment. Our backlog at June 30 was $857 million, including $695 million in North America and $162 million in our International segment. The backlog at the end of the first quarter was $948 million. The decrease in Q2 is reflective of our inventory rebalancing efforts and our repositioning of our OCTG business, as discussed previously.

After a short-term drop in oil prices to $78 per barrel during the second quarter, prices rebounded to just under $90 a barrel at the end of the quarter. And natural gas prices have returned to the $3 per mcf level at the end of the quarter. Commodity prices at these levels should continue to good activity levels for our upstream business.

Demand for midstream infrastructure to transport oil and natural gas liquids to market remains robust, and we should continue to benefit from that. For the downstream sector, we should see some additional benefit in the form of a more active turnaround season for domestic refineries in the second half of the year.

We believe the key drivers for our business and our primary end markets remain strong; and with our first-half performance, we are increasing our previous annual guidance. We now expect full-year 2012 revenues to be between $5.5 billion and $5.65 billion. We expect our adjusted gross profit percentage to be 18.3% to 19%, and we also expect our adjusted EBITDA percentage to be between 8.2% and 8.6% for 2012.

I am pleased with our sales growth, the performance of our newly acquired businesses, and our industry-leading new Shell contract. As I emphasized earlier, we will continue to focus on our higher-margin product lines and downsize our OCTG business. We should benefit our earnings stability and yield some further margin improvement.

We will also work to expand the footprint of the higher-margin valves, fittings, and flanges business. Our goal is to reduce earnings volatility and improve overall profitability.

With that, we will now take your questions. Operator?

Thank you, sir. We will now begin the question-and-answer session.

(Operator Instructions)

Terry Darling, Goldman Sachs.

Andy, I wonder if you talk a little bit about how you're thinking about upstream, midstream, downstream in the second half, relative to the first half? If you look at the implied guidance for the back half, I think it's revenue growth in the second half, relative to the first half for the total Company of up 1 to minus 3. Maybe give us some color around that range for the three segments?

Yes, Terry. We feel good about the second half. A lot of dynamics going on as we go into 2013.

If we look at the year as a whole, I do want to start there. At the midpoint of our guidance, this will be another 15% annual growth, which really -- above our 10% to 12% target we had as a company, during the IPO. So, we are right on plan for annual growth. We had a very strong first half of the year.

We see, with the upstream activity, things moderating in the second half. So, we are planning for either flat to slightly down rig count activity in the upstream sector. What we're absorbing right now is the shift from downsizing our OCTG business. As we said before, that is our lowest-margin business; it is our most volatile business; and while we have a good position in that sector, we just want it to be a lower percentage of our overall mix.

We really want to concentrate on those customers that buy broadly from us -- a broad PVF offering, and where it is important part of that mix. We will have no customers at the end of the year where they only buy OCTG from us because of the margins there.

At the same time we see good investment in infrastructure spend, which we are concentrating on for the long term, we will have decreasing OCTG revenues in the second half. But, the balance of that is a pretty flat picture for upstream, from where we were in the second quarter.

Midstream is, as we have said, our fastest growing end market, remains very active, both from a line pipe and from a valve standpoint. So, we feel very good about midstream through the rest of the year. Then downstream, we had a good first quarter in turnaround. Second quarter was flat activity wise, not as robust as we thought it would be. The utilization was extremely high, 92% in the quarter. A lot of activity on the refining side; but we see historically, the August through October timeframe is good turnaround activity for us. So, we feel cautiously optimistic about improving turnaround in the second half.

There are the two major events going on -- the Port Arthur Shell / Saudi Aramco refinery that went through a start-up issue, and then the recent fire the last couple days in the Richmond, California Chevron facility. Now, we do have the MRO contracts on both facilities, and we will work closely with the customers on providing product to try to get both of those refineries back up. So, there's two big unplanned events going on; it is hard to estimate at this point. We feel a little bit better about the downstream turnaround in the fall than we saw in the second quarter.

I do want to emphasize, we feel very good about the midstream activity.

Just a couple of follow-ups there. Andy, on that midstream outlook I interpreted from your comments, second half flattish to up slightly versus the first half. Do you have enough visibility on 2013 within midstream at this point to say whether you think, clearly that business grows? Or, clearly it is flat, or clearly it is down? Or, is to too short cycle at this point to really get a read on that?

Terry, it is probably too soon to make a good read on 2013.

We feel really good about -- the budgets, major customer budgets were increased here midyear; and we feel, even with the commodity pricing variations that went through the second quarter, we feel good about the spend on midstream through the end of the year. Lots of committed projects, but it's too early for 2013.

We have a very good tons-shipped in the second quarter, kind of flat with the first quarter, which was a very good quarter for us. We still feel real good about the line pipe and associated valves and fittings. Remember now, we are the tie ins to the midstream and not those major trunk lines that get a lot of publicity, but those usually go direct to the mills both from a line pipe standpoint and to manufacturers from a valve standpoint.

Luke Junk, Robert W. Baird.

First question, Andy, would be as we think about the volatility that we saw both in oil prices and natural gas through the quarter, would be fair to say that you saw some unevenness from month to month through the quarter, or were your trends pretty consistent throughout?

Yes, our model adapts very well to the shifts, as we have talked about. It's more of a shifting of inventory for us from the hub to the active branch areas, but it does cause some fluctuations in activity on a monthly basis.

If you look at the year, for the first half of the year, we dropped a little over 300 rigs on the gas side and picked up about 220 rigs on the oil side. And, the net was down 4%. There was a lot of change in activities, but from an infrastructure spend, it is very consistent.

The oily areas of the Marcellus, the wetter gas areas were very active for us, the dry gas areas of Marcellus, Haynesville, Barnett had very slow activity. Then, our two bright spots remain through the first half, and also we see for the second half, is the Eagle Ford in south Texas and the Bakken in North Dakota, really robust activities in both of those oil areas. The Permian Basin, and both the San Juan Basin, all very active.

Okay, that's helpful. Second, just wondering if you would care to comment at all on what you've seen in July so far?

Third quarter, historically, has been a very good quarter for us. We have no seasonal impact -- second quarter we absorbed approximately $50 million in revenues sequentially decrease because of the spring break up in Canada. So, we have that every second quarter as everyone [supplies] products and services up there, so we offset that with a good US. Normally, the third quarter is our best quarter of the year, and we certainly see activity in July was good.

Matt Duncan, Stephens.

Congrats on a great quarter.

The first question I have got, Jim, kind of getting back, or Andy, either one, to the underlying conservatism in the guidance. If I'm doing my math correctly, if I look at just OneSteel and Chaparral Supply, and look at those as the acquired sales, I'm getting at high end of your guidance the growth, the organic growth, in the back half of the year pretty low, around 3%. A, am I doing my math right? And b, if you could talk about how much conservatism is in the guidance?

Yes, I think Matt, you touched on a one of the key drivers on that. I think the other one that we have a little less visibility to is the downsizing -- the re-shifting in the OCTG business, coupled with a little bit of a flattening of rig count, that's going to have some impact. So, that may be a piece of the variable that you are missing. As you know, coming in this quarter with half of the year behind us, we tightened up the reins of guidance, on the revenue in particular, and feel like it is a good fairway to be in.

Okay, fair enough.

Jim, on the debt, you said it ticked up mostly on inventory. How much do you think you can manage that inventory down by the end of the year? And, do you have a viewpoint on what your free cash flow should be for this year, and then a targeted leverage ratio as you exit the year?

Yes. With the -- we used $47 million of cash in the first half of the year. We still feel confident that we can generate close to $150 million for the full year, so that means we are going to generate about $200 million of cash in the back. And, a lot of that is going to come from that inventory reduction. That will be the single largest source from the balance sheet. Using that midpoint in the guidance, we end up with a leverage ratio right around 2.5.

Sam Darkatsh, Raymond James.

Question, I guess if my math holds, it looks like that, sequentially, your adjusted gross margin is expected potentially to decline in the second half. I'm guessing there is a little bit of contribution from the Shell deal in there. And, I guess you are working down inventory also. But, could you talk about that what the primary drivers of that, if my math holds?

Yes, Sam, the margins, the adjusted gross margins, for the first half of the year are somewhere between 18.8% and 18.9%, and that is the high end of our range. We are expecting to hold it at that level for the balance of the year. I don't know that we are expecting that to decline over the back half.

But, you had the low end of the range is in the low-18%s. So, suggesting that the midpoint would be below where you are at now, so that would suggest that there might be a little bit of pressure on gross margins? Or, am I reading too fine a point on that?

Well, Sam, the only thing I would say, we left a little room on that range. You have seen spot pricing on both line pipe and OCTG in the last couple of months come down to 2% to 3%. So, a little bit of pressure with a flat rig count. And, a little pressure on imports on line pipe, so we factored some of that in. We feel very good about the third quarter. The fourth quarter is little more uncertain for us. So, we have a little conservativeness in our range there. We don't feel like any significant impact on the margins.

Which leads me to my second question perfectly. Could you talk about pricing in each of the streams? We see with the line pipe and OCTG, but it is hard to see what your overall pricing looks like by stream. And, if also you could give expectations for LIFO, Jim, that would be great.

Jim, why don't you do LIFO first, and I'll do pricing.

Yes, I think on the LIFO, as you know, we have got about $28 million in there the first half. We have seen some moderation in the steel prices, a little bit of deflation. With that as a backdrop, we would expect the second half to be fairly comparable to the first half, probably $25 million to $28 million in the last of the year.

Yes, Sam, and on pricing, it is a little bit of a mixture for us. As you know, with the spot pricing in line pipe, OCTG slight downturn there, 2% to 3%. We actually have price increase in valves as lead times are getting extended with a strong demand globally for valves, and that's broad based, up, mid, and down. So, that's a positive, slightly flat to -- although, slightly up on fittings, flanges, and our general products, so that's our general guidance.

Doug Becker, Merrill Lynch Bank of America.

Andy, just wanted to get a better sense for what the optimal mix of OCTG is? How much would you ideally like to have? And, how quickly do you think you can actually get there? Is it year end, or does that spill into 2013 before you get there?

Yes, Doug, this is -- just to recap this. This is a multi-year strategy that we have been implementing. If you go back 2007 and 2008, two very strong years for us in that product line; historically, very high margins over and with the steel inflation we saw. 2009 and '10, we spent two years adjusting and downsizing that business from the high-cost inventory we had from '07 and '08. And then, 2011 and '12 have been -- 2011 and the first half of 2012 have been times where we have decided to re-balance and optimal for us, our peak was the 26% of inventory and 25% of sales in 2008.

And, we see a good level for us that fits with our customer base is 10%, roughly 10% of inventory and 10% of sales being tied to OCTG, we have a -- that remains a significant position for us. But, it is of a scale that we think dampens the volatility and also fits who we are. We're making bigger investments in our valve lines, bigger investments in seamless line pipe, bigger investments in both stainless and carbon fittings and flanges.

So, we are offsetting the inventory gains that we -- investments we want to make on those higher-margin product lines, we'll do reductions on our lowest-margin OCTG. I think we will get to 10% by the end of the year. And going into 2013, that's really our target. We'll see how activity levels go. If activity levels in drilling side deteriorate, we might move that down slightly. I do not see us moving it up more than 10% as we go forward because it doesn't fit our strategy.

Yes, makes sense. Then, a quick one for Jim. Your thought process on purchasing additional debt going forward? What type of interest rate can you refinance debt at this point? It seems like there's is a significant opportunity to reduce interest expense going forward.

Yes, we are continuing to evaluate and look at what our options are in terms of reducing our overall interest expense and improving profitability. Certainly, one of the options is refinancing. Those rates today would be somewhere in the 7% to 7.5% range.

Allison Poliniak, Wells Fargo.

Going back to the OCTG. As you deemphasize that product line, have you talked about, or could you talk about, the impact to gross margin that you would expect?

Yes. We haven't -- if you look historically, and you look at our mix, and you look at the other players out there, you look at the B&L portion of Edgen Murray, you look at Sooner in Oil States, and if you look long term over a 20 year period, this is a business that, historically, has had mid-single digit profitability gross margins. That's really after a spike in 2007, '08, that's where it has [returned]. We fit very closely that industry range of profitability.

So, as we are decreasing that from our mix, you will see a margin improvement that results from the inventory investment in the valves and the stainless product lines and seamless line pipe, which are all at or above our Company average. So, we are -- you are basically switching 6% or 7% profit business for the average 18%, 19% profit business. And, that's our goal.

Okay, great. Can you just touch on the acquisition environment, what you guys are seeing out there right now?

Yes, it is still very active. The big deals in the quarter, of course, were National Oilwell Varco buying Wilson; and also, just after the quarter closed, the CE Franklin portion of business in Canada. Those were the big deals.

There's others out there that we have looked at, but we are sticking to our strategy of geographic expansion. International -- approximately 10% of our revenues now come from our International which is, per our plan, to continue to grow that segment. So, we have several we are looking at in that arena.

We did the Chaparral bolt on, which is consistent with the ones we have done. A very good multiple, new MRO five-year multiple of MRO contract that we like very much. There's still plenty of opportunities and a several, couple that we are looking at here in the shorter term in the US bolt on. Then, we still like valves and valve automation, but it has to be at the right multiple for us.

Perfect, thank you.

David Mandell, William Blair.

On the Shell agreement, can you guys provide a little more detail on the size of the opportunity? And, also the margin profile that you would expect there?

Yes, David, let me -- with the Shell agreement, they don't let us disclose too much. Let me just frame it from what I think is all public information. What we have said through the IPO is Shell and Chevron are our top two customers. We have said that no customer is larger than 6% our revenues in 2011. So, if you think about those super majors in the 4% to 5% range just to talk about it of our $4.8 billion, you get to a $200 million to $250 million size annual revenue from our top customers. So, that's the starting baseline.

For Shell, we had their MRO work, PFF and valves in the US, and we had their MRO valve work international. So, that makes up the baseline of really the range of the $200 million, $250 million. What this is, if you look at their CapEx spend, and let's just use -- I use the Barclays capital spending survey as my reference. If you use Shell, which is always in one the top five capital budgets, and their annual CapEx this year was roughly $25 billion, and a good estimate for PVF uses on the capital project is 5%, some are 3% to 4%, and some are 6% to 8%, but 5% is a good number when you look at a capital budget on what is actually PVF.

So, if you use the $25 billion, they spend roughly $1.2 billion a year on buying PVF for those capital projects, of which we have not had a significant amount at all. If you look at our revenue split, and roughly 25% of our PVF is valve, of our total mix, and that's pretty comparable to a project spend. You can easily look at their annual valve spend is roughly -- on their capital projects is roughly $300 million. So, these projects all have a life over a couple years, they are major projects.

So, we will be in a period of ramping up on some new projects for valves and as other projects wind down for them that we have not participated on. But, it is a significant contract for us. We clearly see Shell being our number one customer in 2013 and beyond with the contract.

And, this is really a culmination of our strategy to build an international presence to go with our strong North America platform so that we could compete and win contracts like this. This combining of a North America PFF contract, where we picked up both stainless and alloy PFF in Canada. We also pick up the valves, of course, in Canada, to go with our US presence.

Then, to pick up the projects work that went with our MRO platform internationally is a really big contract for us. And, it is the first of its kind where you combined a PFF North America business with a global valve business. So, we like being a first mover on that. There's other customers we are targeting now for the same type of contract.

And, over the next couple years, our strategy still is to build out our international capabilities so that we can have broad PVF contracts because that is the future. And, we think that significantly separates us from our competitors. It is a good first step for us. It is a great contract.

On a margin basis, for the valves, the Shell approach was to lock in cost with each of the valve manufacturers with their own separate agreements, so we have a distribution margin agreement on top of that. So, we have no cost risks on this contract. So, the margins will not be at the Company average we have had for valves where we take on a lot of cost risk for our purchases. It is a very good contract, and it's an industry-first mover contract that we think others will follow.

We did not pickup Australia PFF, which it was already under contract. We see that as another addition to the contract we already signed as we go forward. So, there's a lot of things to be very happy about with the contract, and it really puts a stamp on our global strategy.

All right, sounds good. Then, second question, for the backlog, how do you guys define it? Then, how far out do those sales usually come?

Yes, the backlog is -- it usually goes out a couple quarters. It is not like an EPC backlog that is multiple year, usually goes out two to three quarters for us. It is the fabrication and the engineering procurement construction projects that go in our backlog. Also, our OCTG program drilling projects go in that.

So, the drop in the second quarter was as we pulled back on OCTG inventories, we pulled back on our future programs on OCTG, and that was the drop. We are slightly ahead of the backlog we had at the end of year 2011, and it is in the areas we want it to be on projects.

We have very little added in the second quarter due to the Shell contract because it was so new, just late May. So, that will be added as we build project backlog going forward, even over the next year.

Terry Darling, Goldman Sachs.

Andy, I wonder if you might provide a little more color on how the acquisition pipeline is looking, and how you are measuring your firepower right now?

Yes, Terry, it is strong. There's lots of candidates that we are looking at. We try to keep a couple in international on the burner with us and a couple bolt ons in the US. We have got over $600 million availability now in our ABL, even with our long-term debt purchase buyback.

So, we feel very good about -- our priorities are the working capital in North America where we will be pulling some inventory down the second half, and Jim already mentioned the $200 million cash flow. So, we feel very good about our working capital needs are covered. Then, the next priority for our ABL and our use of money is acquisitions. So, that takes the spotlight here in the second half.

Then, we still have -- our third priority is the debt, further debt buy down. I see some areas, regionally, in US primarily, where the oil activity remains robust, and there are some regional players. That is going to be a priority for us; US oil-based regional distributors.

Then, I also still like the UK and Norway as a good market for us that we are not in, in the PFF. We are there in UK in valves today. We have looked at things in Continental Europe, but that is kind of on hold for us. And, we like Southeast Asia, Singapore, as another good spot.

We have US oil plays, small both-on acquisitions at the size we have been doing, maybe slightly larger. We continue to look at valves and valve automation, but those are relatively small, all US based. Then, North Sea and Southeast Asia would be the other two areas that we are focusing on right now.

That sounds like you have got a pretty good line of sight to some additional acquisition growth as you look into '13.

Yes.

Then, just to understand how you're thinking about your upstream performance relative to the rig count, you have continued to grow revenues faster than the rig count. And, obviously, you've got the mix benefit that's coming from the shift to the oil, shale activity. It kind of looks like that mix effect will continue to a degree in the third quarter, and then maybe flatten out in the fourth if we were to pretend that the rig count goes sideways from here as you indicated your baseline assumption.

Any additional color you want put around that whole question of your upstream growth, relative to the rig count for us?

Yes, Terry, really our strategy is to decouple from the rig count. And, I think you have it exactly right. The third quarter will still have a pretty good weighting to OCTG and in the infrastructure in upstream.

Our growth has come from production facilities and tie-in the wells and tie-ins of production facilities to the midstream infrastructure, and we see a long growth vehicle there that is not directly related to the rig count. So, we'll position ourselves that OCTG will be smaller, as you described, in the fourth quarter, even if the rig count turns down at the end of this year or starts out low in '13. It will have a much smaller impact on our business.

While we believe to continue grow in the upstream because we are focused on the infrastructure spend on tying-in either the wells that have already been drilled, or just building out the infrastructure to expand for the higher production, like you are seeing in Eagle Ford and Bakken. There's -- a lot of investment still has to occur just to take care of the ramp up in overall production.

Super. Thanks, Andy.

Matt Duncan, Stephens.

Jim, just real quick first, a clarification on LIFO. I think you said it was $28 million in the first half, the press release says $18.5 million?

No, if I said that, I misspoke. It is $18 million and it's what we see something comparable in the back.

Okay, good. Just wanted to be clear on that. In terms of quarterly interest expense going forward, after you bought back those notes and flip that out, it looks like that's about a $2 million per quarter benefit in terms of quarterly interest expense --?

That is correct.

Okay. Then, the debt level is up little bit, but I assume you're still going have roughly that $2 million per quarter benefit from the 2Q level.

That's right because it happened there towards the end of the second quarter.

Okay. Then, last thing, were there any IPO-related costs that flowed through the SG&A line at all this quarter?

No, there were not.

Okay. So, that's a pretty clean number, and that expense level is what we should base our forecast off of?

Yes. That second quarter G&A has got a full quarter of the Australian acquisition, so that would be a good run rate.

Okay, thanks.

Thank you for joining us today on the call and your interest in MRC Global. We look forward to talking to you again after the conclusion of third quarter.

Ladies and gentlemen, this does conclude our conference for today.

If you would like to listen to a replay of today's conference, you may do so by dialing 303-590-3030 and entering the access code of 4549971.

We thank you for your participation; and at this time, you may now disconnect.