MRC Global Inc (MRC) 2013 Q2 法說會逐字稿

Ladies and gentleman, good morning and welcome to the MRC Global second quarter earnings call. During today's presentation all participants will be in a listen-only mode. Following the presentation the conference will be open for your questions.

(Operator Instructions)

Today's conference is being recorded, August 2, 2013. I would now like to turn the conference over to Monica Schafer, Vice President, Investor Relations. Please, go ahead.

Thank you, Alicia. Good morning, everyone. I'm Monica Schafer, the new Vice President of Investor Relations at MRC Global. I would like to welcome you to the MRC Global second quarter 2013 earnings conference call and webcast. We appreciate you joining us. On the call today we have Andrew Lane, Chairman, President and CEO, and Jim Braun, Executive Vice President and CFO.

Before I turn the call over to Andrew, I have a couple of items to cover. There will be a replay of today's call available by webcast on our website, MRCGlobal.com as well as by phone until August 16, 2013. The dial-in information is in yesterday's release. Later today we expect to file the second quarter 10-Q and it will also be available on our website. Please note that information reported on this call speaks only as of today, August 2, 2013, and therefore, you are advised that this information may no longer be accurate as of the time of replay. In addition, the comments made by the Management of MRC 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 Management of MRC. However, various risks, uncertainties and contingencies could cause MRC's actual results to differ materially from those expressed by Management. You are encouraged to read the Company's annual report on Form 10-K, its quarterly reports on Form 10-Q, and current report on Form 8-K to understand those risks, uncertainties and contingencies.

Now, I would like to turn the call over to our CEO, Mr. Andrew Lane.

Thanks, Monica. Good morning and thank you all for joining us today for our second quarter 2013 investor call. I want to welcome you to the call and thank you for your interest in MRC Global. Before turning the call over to our CFO Jim Brown for a detailed review of the second quarter financial results, let me first begin with some of the noteworthy highlights from the quarter. Following Jim's second quarter review I will finish with an updated outlook for the second half of 2013.

Revenues for the second quarter were $1.268 billion and fell within the range we disclosed in late May. Diluted earnings per share and adjusted EBITDA were $0.43 and $99 million, respectively, for the quarter and EBITDA was slightly above the previously disclosed range. While the results were less than what we had planned coming into 2013, there were some bright spots as evidenced by the adjusted gross profit percentage of 19.7% for the quarter and adjusted EBITDA margin of 7.8%. For those of you that a follow this closely you know that 2010 through 2012 were years of strong revenue growth, improved earnings for us as we recovered from the recessionary trough of 2009. Improved spending levels by our major customers, increases in North America shale drilling activity and infrastructure spend, and the early stages of our international expansion all drove our growth and the overall strong financial results.

When we came into 2013, the industry projections for exploration and production capital expenditures in North America had moderated from the previous two years. The industry surveys of the top 300 to 400 customers showed US spending to be flat and Canada was expected to be up slightly. Upstream activity was forecasted to be down in the first half of 2013 with lower rig counts, but was expected to improve in the second half of the year. Midstream CapEx spending was forecasted to be strong based on announced MLP budgets. Downstream activity in petrochemical and refining was expected to improve over 2012 levels. Given this outlook, our original 2013 guidance reflected sales growth of approximately 6%. However, spending levels for the first half of 2013 in the upstream sector and in the transmission segment of our midstream business have been much slower than expected. Spending by some of our largest customers has been off significantly.

There were a number of reasons, including -- lower upstream drilling activity, as reflected in 11% lower average rig count in the United States in the first half of 2013 compared to the same period in 2012; unseasonably cold weather in the first part of the year; lower natural gas liquids prices resulting in lower spending in both natural gas and NGL pipelines; there has been permitting delays and the increased use of rail to transport oil. In addition, several of our larger customers experienced changes in their organization and ownership that impacted their spending. Another contributor has been the deflation of carbon pipe prices.

With the second quarter now complete, and given the preliminary results for July, our outlook at mid year is for a much slower back half of 2013 than previously expected. We provided updated annual guidance in our earnings release last night that has the midpoint of our guidance now 7% below 2012. I will provide more color on the second half of 2013 after Jim's review of the quarter.

While the first half of 2013 has not unfolded as we expected, we continue to implement our long term strategic plan. Our strategic efforts to rebalance our inventory and deemphasize our lowest margin and most volatile product line, oil country tubular goods, or OCTG, was completed last year, resulting in $83 million in OCTG inventory at the end of June 2013. This strategic rebalancing is expected to result in a drop of more than $200 million in sales from OCTG in the year 2013, but it improved overall gross margin. Our adjusted gross profit margin percentage was 19.9% for the first half of 2013, up from 18.8% in the first half of 2012.

In June we were awarded our first a global contract to supply and distribute pipe valves and fittings needs to Celanese Corporation. The Celanese contract is approximately $10 million to $15 million of revenue per year and is the first global PVF contract for us and is yet another example of our strategy to expand our core value proposition through broader global contracts. Expanding our presence in the global chemical market remains a key objective for us.

We also announced a new five-year extension to our integrated supply agreement with NiSource for the supply of PVF and related supply chain services to NiSource's pipeline, distribution and midstream businesses. We currently supply NiSource from 25 locations, including a recent new branch opening in the Boston area. Our revenue with NiSource in 2012 was approximately $100 million. NiSource has both an ongoing MRO CapEx program along with an infrastructure modernization program. This award is important as we expect to have over $500 million in revenue over the five-year term based on 2012 activity levels. It also continues our long-standing track record of renewing contracts with our core MRO customers in the US. We are proud to have a renewal rate of over 95% for our MRO contracts since 2000.

Finally, we also continued to implement our strategy of pursuing accretive a bolt-on acquisitions in the US, further strengthening our shale-focused branch operations. On July 1 we closed an acquisition of Flow Control Products, which is a leading provider of pneumatic, electric and electro-hydraulic valve automation packages and related technical valve support in the Permian basin. It's in the most active oil producing region in the US. Concurrent with this transaction we are expanding our regional distribution center in Odessa and Flow Control will operate from this new, expanded facility when it is complete in 2014. This acquisition and expansion attests to our focus on further strengthening our global valve and valve automation capability.

With that let me now turn the call over to Jim Braun to review our second quarter results.

Thanks, Andrew, and good morning, everyone. I'll begin with some general comments on market conditions in the second quarter. The US rig count in the second quarter was down 11% from a year ago. Average WTI oil prices were up less than 1% during the quarter and while natural gas prices were up from last year they still only averaged $4 per MCF during the quarter, making incremental investments in dry gas drilling unattractive.

As previously discussed, the activity of our US customers slowed near the end of the fourth quarter 2012 and their lower-than-expected spending has continued through the first half of 2013. Spending by some of our largest customers in both the upstream and midstream sector was reduced significantly in the quarter. In total, the revenue from six customers who are in our top 25 customer list was off by a combined 39% or $100 million in the second quarter compared to a year ago. The upstream and midstream sectors were impacted the most from this revenue decline.

With that as a backdrop, let's turn to the quarter results. Total revenues for the second quarter work $1.268 billion, which was down 11% from $1.430 billion we reported in the second quarter of last year. The year-over-year decrease was partially offset by the impact of two acquisitions, which added an incremental $41 million of revenue in the quarter. US revenues were $975 million in the quarter, down 13% from the second quarter of last year. Most of this decline was attributable to a 44% reduction in OCTG sales. However, we also saw a 22% reduction from our line pipe sales due to reduced spending by some of our larger midstream and upstream customers. Canadian revenues were $154 million in the quarter, down 4% from the second quarter of last year. Although we are still seeing strong activity in the heavy oil and oil sand regions of Canada, a longer than usual spring break up negatively impacted our results and reduced our second quarter sales by about $10 million.

Internationally, second quarter revenues were down 8% percent from a year ago to $139 million, which was the result of weaker demand, particularly in Australia, where we have seen reduced customer spending in the mining and oil and gas sectors. The integration of our Australian operations into a single business unit is progressing as planned and we expect our nearly $300 million revenue business to be operating on a single ERP system by the end of the year.

Turning to the results based on end market sector. In the upstream sector, second quarter sales decreased 17% to $542 million, which was 43% of total sales. This decrease was driven in part by the planned reduction in OCTG revenues, which was partially offset by the acquisition of Production Specialty Services and Chaparral Supply. Lower well completion and well of hook up activity also contributed to the decline in revenues. Line pipe valves and fittings and flanges are all part of the well hook up package and their revenues were impacted accordingly. Excluding the OCTG reduction and the impact from acquisitions, upstream revenue was down 16% in the second quarter compared to 2012. The midstream sector was down 5% year over year to $376 million, which was 30% of total sales.

As mentioned previously, some of our largest midstream customers have been impacted by the reduced activity in the upstream sector, low NGL prices and then a slow down in crude pipeline permitting. As a result, spending in the distribution part of our midstream sector declined 15%, but was partially offset by an increased spending by some of our larger gas utility customers who have embarked on multi-year pipeline integrity projects. This part of our midstream business grew 12% in the quarter.

In the downstream sector, second quarter 2013 revenues decreased by 7% to $350 million and accounted for 27% of total sales. The decrease is attributable to a reduction in mining and oil and gas activities in Australia. A slight slowdown in Chinese economic growth has negatively impacted the mining industry in Australia. In addition, project cost overruns and budget considerations have limited some of the oil and gas activity in Australia. Poor economic conditions in Europe continue to limit European growth opportunities.

In terms of sales by product class, our energy carbon steel tubular products accounted for $345 million during the second quarter of 2013, with line pipe sales of $231 million and OCTG sales of $114 million. Overall sales from this product class decreased 29% in the quarter from Q2 a year ago, including an $80 million or 41% decline in OCTG sales and a $63 million decrease or 21% in line pipe. The reduction in line pipe revenue was due to reduced spending on pipeline infrastructure and the slower well hook up activity in the upstream part of our business. Line pipe pricing continues to come under pressure in light of the lower activity and excess supply and as a result, deflation impacted sales by about 5%. I should note that approximately 56% of our line pipe sales were within our midstream sector in the second quarter of 2013 while upstream and downstream make up 27% and 17%, respectively.

Sales of valves, fittings, flanges and other products were $923 million in the second quarter. This represents a decrease of 2% from the second quarter 2012. This modest decline in this product group were attributable to slowdown in the upstream and midstream businesses. Revenues from valves were down about 4% during the quarter and carbon steel fittings and flanges were down about 2%, while other products were comparable to the quarter a year ago.

Now turning to margins, while sales has been below expectations for the quarter, we have continued to improve gross profit percentage. In the second quarter of 2013 the gross profit percentage grew 230 basis points to 19.2%, up from 16.9% in the second quarter of last year. The increase was the result of planned changes in our product mix as well as a concerted effort to increase gross margins through our profit enhancement initiatives. The use of our LIFO method of accounting resulted in a reduction of cost of sales of $12.5 million in the second quarter of 2013. This compares with an $11.6 million increase in cost of sales for the second quarter of 2012. We expect second half of 2013 will include a further reduction in cost of sales from the use of LIFO in the amount of approximately $15 million. This expected $15 million benefit, if realized, would compare to a total benefit of $43 million that was reflected in the second half of 2012's results.

Our adjusted gross profit percentage, which is gross profit plus depreciation and amortization, the amortization of intangibles plus or minus impact of LIFO inventory costing, increased 80 basis points to 19.7% from 18.9% in the second quarter of 2012. We expect adjusted gross profit percentage to be about 19.5% for the balance of 2013 with the deflationary impact of carbon pipe pricing creating downward pressure on margins.

Second-quarter SG&A costs were $154 million or 12.1% of sales compared to $151 million or 10.6% of sales in the second quarter of 2012. The increase is primarily due to the December 2012 acquisition of Production Specialty Services, which added an incremental $4 million to SG&A in the second quarter. Second-quarter SG&A benefited from a reduction in incentive and variable compensation expense in the amount of $3.6 million. Since the end of the year, we've reduced headcount 2% as a result of reductions from reorganization of our Australian businesses as well as reductions in certain US and Canadian functional areas. We expect SG&A expense to be in a range between $158 million and $160 million in each of the third and fourth quarters of 2013.

Operating income for the second quarter was down slightly at $90 million versus $90.5 million in last year's second quarter, but showed improved profitability at 7.1% of sales versus 6.3%. Our interest expense totaled $15.2 million in the second quarter of 2013, which was a 51% reduction compared with $30.7 million in the second quarter of 2012. This was due to the redemption of our 9.5% senior notes in November 2012 and the resulting lower interest rates on our new term loan. Average debt levels were approximately $317 million lower in the second quarter of this year compared with the second quarter of 2012. At the end of June our weighted average effective interest rate was 4.6%.

During the quarter we had foreign currency exchange losses of $13.6 million, which is considerably larger than what we typically experience. These were due to weaker Australian and Canadian dollars relative to the US dollar. Specifically the Australian dollar moved from an exchange rate at the end of March 2013 of $1.04 to $0.91 at the end of the second quarter, a 12.5% depreciation in the currency. The currency effects negatively impacted our earnings per share by approximately $0.09 in the quarter.

Our effective tax rate for the second quarter of 2013 was 30.5% compared to 34.3% for the same period in the prior year. The lower tax rate is due to a discrete $2.6 million reduction in our deferred tax liabilities, which added about $0.03 to our diluted EPS. Excluding this discrete item, our effective tax rate would have been 34.9%. Our expectation for the full year is that the tax rate will be in the 34% to 35% range.

Despite the soft market conditions, we were able to post improved bottom-line performance. Our net income was $43.9 million for the second quarter, or $0.43 per diluted share, compared to an adjusted net income of $38.8 million, or $0.39 per diluted share, in the second quarter of 2012. This Q2 2012 adjusted net income excludes the $7.5 million after-tax charge, or $0.07 per diluted share, related to the purchase and early retirement of a portion of our senior notes recorded in the second quarter of 2012. Including that charge, net income was $31.3 million, or $0.32 per diluted share, in the second quarter a year ago. Adjusted EBITDA was down 20% year over year to $98.9 million in the second quarter versus $123.6 million a year ago. Adjusted EBITDA margins dipped to 7.8% from 8.6% a year ago. Our outstanding debt at June 30, 2013 was $1.084 billion compared to $1.257 billion at the end of 2012. At the end of the second quarter our leverage ratio, which we define as total debt less cash to the trailing 12 months of adjusted EBITDA, was 2.45 times as compared to 2.6 times at December of 2012.

Our operations generated cash of $7.5 million in the second quarter of 2013. You may recall during last quarter's call we mentioned that the second quarter would include two US estimated tax payments. These two tax payments totaled $49 million in the quarter. Our working capital at the end of the second quarter was $1.126 billion up 5% from the end of March 2013. For the first half of 2013, we've generated cash from operations of $182 million. For the full-year 2013 we expect to generate cash from operations in a range between $250 million and $280 million. Cash used in investing activities totaled $6.2 million in the second quarter and included capital expenditures of $5.8 million. On a year-to-date basis capital expenditures were $10.6 million. Consistent with the slowdown in our revenue expectations for the year, we expect that the 2013 capital expenditures to be below our original 2013 budget of $30 million.

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

Thanks, Jim. Let me conclude with our outlook for the remainder of 2013 and the overall business environment. Natural gas prices have been in the $3.50 to $4 range level in the US, and we expect gas drilling and related gas-focused infrastructure spending to remain relatively flat through the second half of 2013. We also expect weakness in NGL commodity pricing and keep spending in NGL infrastructure at low levels. Crude oil prices have been above $95 a barrel in North America and most recently have moved north of the $100 to $105 barrel range. We expect this to be a positive catalyst for continued oil drilling and infrastructure spending in the second half of 2013.

Mid-2013 industry exploration and production CapEx forecasts show stronger spending in international markets than originally forecasted, which tend to be more oil focused, and also increased in deepwater. The outlook for North American land spending remains subdued compared to the last two years. This subdued outlook is reflected in our backlog of $639 million at the end of June, which is down from $664 million at the end of 2012. From an end-market perspective, we expect upstream drilling activity and related production facility infrastructure spend to be flat in the second half of 2013. We expect drilling to remain focused on oil opportunities. In midstream, we do not see a pickup in line pipe and valves in the second half as infrastructure spend remains focused on oil development with continued restrain in spending by our customers on infrastructure for natural gas and NGL production. However, our gas utility customer activity and spending levels in the second half are positive for us. We also expect to see continued good activity levels in downstream petrochemicals and refining in the second half of 2013.

From a product-line perspective, we expect our OCTG revenues for 2013 to be in the $460 million to $490 million range and we expect our line pipe sales to be in the $915 million to $965 million range. Geographically, we expect our US business to be flat in the second half of 2013 over the first half of the year and we expect both Canada and international to show growth in the second half over the first half. Overall, we now expect, based on the midpoint of our annual revenue guidance, 2013 second half sales to be up approximately 2% over the first half. While this is an improvement, it is much lower than we originally thought the back half of 2013 would be.

Given the results from the first half of the year, the subdued billings in July, and our outlook for the remainder of the year, we have updated our 2013 annual guidance as shown in our earnings release. For the full-year 2013 we expect revenues to be in the range of $5.1 billion to $5.3 billion, adjusted EBITDA to be in the range of $385 million to $415 million, and fully diluted earnings per share to be $1.65 to $1.85. For the remainder of 2013 we will continue to focus on implementing our long-term strategic plan. In North America we are investing and expanding our regional distribution centers, or RDCs, to more efficiently supply our branch network. In June we opened a new regional distribution center in Tulsa to support our active Oklahoma branches. In Odessa we are expanding our RDC after the acquisitions of Production Specialty Services and Flow Control Products. In Canada we are expanding our Edmonton RDC due to activity levels in heavy oil end projects. All three RDCs will have expanded valve and valve automation capabilities. All of these 2013 North American investments are positioning us for future growth in North America when spending by our customers increases.

In addition, in order to bring more focus to the sales growth opportunities within the customers below our top 25, we have implemented a targeted account program for those accounts in 25 to 100 ranking. This is expected to bring a focus similar to that of our largest customers to those next largest 75 customers. To complement this program we have also implemented operational realignment of our US subregions to support enhancements to both our sales and operation capabilities. Within our subregions, regional sales manager and operation manager positions have been added to lead the local sales effort and in support of our customer needs, respectively.

Over the next 12 to 18 months, in mergers and acquisitions, we will be focusing on expanding our international platform in our key targeted growth markets outside of North America. We remain focused on international expansion opportunities that broaden our ability to service our major customers where they have significant E&P spend. The third part of our strategic plan is to be successful with broader, multi-region contracts with our top US MRO customers, like we did with ConocoPhillips in 2008, Shell in 2012, and Celanese so far in 2013.

While these contracts take time to negotiate, I am confident that we will be successful in these efforts. We are currently working on several large contract opportunities and still expect that at least one to be signed in the second half of 2013. While we are disappointed in the US spending levels in 2013 and the resulting year-on-year revenue drop, we expect our investments in our North America hub-and-spoke delivery platform and our efforts in M&A and our global contracting in the second half of 2013 will all set us up for growth in 2014 with successful implementation of our global one-stop shop strategy. We'll have a better outlook on that and will provide an update on the next earnings call.

With that, we will now take your questions.

(Operator Instructions)

We ask that you please ask one question, one follow-up question, then requeue for any additional questions. Matt Duncan, Stephens Inc.

The first thing I have got, I want to look at the guidance a little bit more. I apologize, Andy, you gave a lot of detail there, I just want to make sure I heard it all. What rig count assumption is baked into the new guidance? What was in the old guidance? Then, also on steel pricing, what are you guys assuming there versus what was in the old guidance?

The way we were looking at the back half in the original guidance was a flat to down rig count in the first quarter, a slight improvement in the second quarter and a net 200 rig in the US increase in the back half of '13. That was our original projection and as you know the rig count didn't pick up at all, actually went down during the second quarter. What we are seeing is a flat to maybe up 50 rig outlook for the back half. It will be late in the back half to more in the fourth quarter and definitely oil focused. On the steel pricing, as you know, you look at the spot pricing both carbon pipe and line pipe and OCTG spot prices have declined over the last year, 10% to 12%. The decrease in pricing has slowed and moderated a little bit in the last couple of months, but still declining, so we see flat to continue slightly down, not as much as of the past year, but still pressure on carbon pipe, both line pipe and OCTG for the back half.

On the OCTG trade case, are guys assuming anything, any impact from that on either price or volume later this year?

Yes, Matt, it is important case. It follows the successful case 2009 and '10 with the Chinese pipe. It is nine companies and a case against nine countries on focused on OCTG volumes and pricing. We do not expect any uplift from that in 2013. As you saw with the Chinese pipe, it tends to stabilize the low end of the market and stabilize pricing, if they are successful in the trade case. You have that as a positive going into 2014, if successful I think it puts a floor on pricing declines and maybe strengthens that lower end of market, primarily the spot market with the imports. We also think you have a lot of volume in the US capacity coming on stream in 2013 and 2014 that offset that volume that potentially could be taken out of the market from the trade suit. We think that is a moderating factor going into next year on pricing.

Allison Poliniak, Wells Fargo.

Australia, obviously mining being weak, could you specifically just bring that out? I think you said it is $300 million of revenue, and I may have missed this. How far down was that in terms of revenues this quarter? What your view is over, say the medium term, in Australia?

I will let Jim talk to the quarter, but let me give you a broader view. We are still very pleased with the Australia position, we are clear number one in that marketplace. Two things are impacting us here in the short term, the mining pullback in the industry, and that is a smaller percent of our business. It was an important aspect of the Australian market. Then, the cost overruns, it's really just an overheated market right now, and many of our customers have pushed their projects out and slowed their projects, so we are seeing it in the stainless steel sales we have down there. We still feel good about the market. Long term it's a very strong market for us. It also serves as a hub into more activity that is project related into all of Southeast Asia. As Australia slows on us, we will also use our strength there as an Australian Southeast Asian hub to serve a broader market.

Allison, the Australian revenues were $68 million in the quarter. They were down about $12 million quarter over quarter.

Great. Andy, you made a comment about focusing your acquisition activity internationally. I think just given the EMP spend it certainly makes sense over there. Can you talk about the multiples difference here versus internationally? Is there a noted difference there?

Yes, Allison, it is on the higher end of our multiples that we pay for a couple of reasons. One for the companies we are targeting and the ones we've done so far, have the been in the most attractive areas for us. Also, they've been heavily weighted towards valve automation and also stainless products, so those are premier distributor's we've targeted. There is less competition in those markets. There is a few bigger players, so like with Australia, with three acquisitions there we became the number one in the market. We can move quicker to have a major position in some of those regions, but the multiples tend to be a higher in the range more in the five to seven range trailing 12 month EBITDA, Jim and I have talked about previously, higher than our US bolt on. A lot more potential for us. The areas we were still, been a very strategic for us are Southeast Asia, the Middle East and the North Sea and those three primarily are where we continue to want to build out the full PVF platform. Those are where we see the biggest opportunity and the most positive response from our customers as far as our ability to add the broader contracts if we have a bigger presence in those three areas.

Jeff Hammond, KeyBanc Capital Markets.

Just to go back a bit, the guidance, it seems like your first guidance cut of $300 millions was focused on line pipe. Can you just give us a better -- it seems pretty broad based here, but can you give us, maybe, a better sense by stream or buckets of products where the incremental $400 million cut is coming?

Jeff, Jim will talk you through that, but let me -- I want to make a couple comments about the guidance overall, and I know how disappointing it is with the size of the changes. When you look back at the start of the year, and we tried to cover that in the script. But really what we saw in November, December initially of 2012 was a capital pullback in the last two months after 10 very strong months. We still had a lot of indications that 2013 was going to be a strong marketplace for us. We did not feel at that time that it was in a broader general slowdown in spending, which it did turn out to be. The first quarter we had a lot of whether activity and that caused us some pause, that pulled the original guidance down slightly. We felt that we still had very strong second, third quarter and also a stronger second half of '13. As we got into May and we saw weak billings in May, which should have been the first strong month of billings for us, and the backlog going into June, we pulled it down, as you said, further and that was mostly tied to where we saw the weakness was the line pipe.

Of course, we had planned on the to $200 million pull down in OCTG. The strategy was that when we made that decision in the third-quarter 2012 we had a robust line pipe marketplace in front of us, and we fully expected to replace that $200 million in OCTG with additional line pipe sales. Just the opposite occurred. The weakness came in the midstream, some of it is isolated to three of are very largest midstream customers, so instead of replacing the OCTG outlook, we actually had a $200 million decline in line pipe in our latest thinking. I know these are big numbers, but that is the dramatic switch in outlook for the Business.

The other thing that we didn't see coming as dramatically, is the gas pullback and NGL pricing collapse of mid 2012 finely impacted and really at the end of 2012. All through the first, if you include July, all through the first seven months of 2013, we've seen a very subdued spending in upstream infrastructure in both gas and NGL. I think the rig count on gas is down another 35% year on year. What it's come to us is a much lower spend, while the oil market is good, a much lower spend in both gas, infrastructure and NGL infrastructure, which impacts primarily our upstream production business. Jim, can give you more color now on the latest change in guidance.

Jeff, the big adjustment was in the upstream business. If you look back to our original full-year guidance at the beginning of the year, we were planning for a back half of '13 that would be up 11% from the first half. As you know, the first half came in a bit weaker. Where a lot of the growth was expected and planned was in the upstream the business and we've pulled that down. As Andy mentioned, we see that consistent with the rig count expectations. The midstream is holding up pretty well from our previous guidance. We're doing a little bit better in line pipe than what we thought earlier this year. Then, the downstream should do well; we should see some growth there. Not a whole lot of change in the downstream piece of the business.

Back on midstream, as you read the headlines and listen to others, it just seems like a market that is continuing to grow and people are talking about still a robust spend environment, or at least stability at high levels. I'm just going to understand the disconnect. Is it customer specificity? Is there some inventory draw down? Is there share shift? Help me understand the disconnect between the magnitude of your cut versus what maybe more broadly people are saying?

Let me start and Jim may have some color to add. We're very strong believers in midstream infrastructure spend over a longer-term cycle here. We are also in a very strong position in that segment, both from line pipe and valves and the fittings and our track record there. We talked about it in the script, the gas utility side, like NiSource in the East and PG&E on the West Coast, very strong for us. In the script we talked about the gas utility segment being up 12%, so that is a real bright spot and that matches probably exactly what you are hearing from utilities that have both a new investment program and a modernization program going. We are doing well in that segment of the business.

What's really slowed on year on year for us is the transmission side. There's a couple of unique things going on there. One, and Jim mentioned it in the script, six of our largest customers, and this may be more specific to MRC, but six of our largest customers in our top 25, which as you know make up roughly half of our revenue, pulled back in their spending this year. Many of them are well documented. Chesapeake's reduction in upstream spending as tied to Access Midstream, which spun out as used to be Chesapeake Midstream now Access Midstream, are closely tied today to the current activity levels with Chesapeake. That spending has come down considerably for us and that is a top 10 customer for us. Tied to that is another one, Williams. Williams and Access have looked at different business opportunities there. I think that is well publicized. When we look at that whole sector and our top midstream customers, and the third one in midstream that I want to reference just briefly is DCP Midstream. Very active, hugely active for us in 2012 and still active in '13 but at a lesser degree than they were in '12.

When I look at DCP and what is going on with Williams and Access Midstream and two of them tied to what is going on with Chesapeake, that is a big part of our pullback. It doesn't necessarily represent a big pullback in the smaller MLP budget but in our core midstream customer base. Another one that we need to mention is Shell, while we had won the global contract, we have overestimated the pace, the ramp up, our inventories and the ramp down, the current holders inventories. In an expectation of more growth coming from Shell in 2013, we're just not seeing it. We are very confident that 2014 and beyond will be really good years for that contract, but it has taken, as it always does, longer than we expect in the transition phase of ramping up that new contract. The other one that has impacted both our midstream and upstream is the lower spending at Hess, which is also a top 25 customer.

Those things are important. They are six of our top 25 customers that are important to us and that we have not been able to replace the drop in their activities with pickup in the smaller MLP marketplace. What we talked about into script was some changes we made both structurally and personnel and sales-focused on that the group. We think that will yield us some better returns. Then, we haven't loss share. We haven't lost contracts. We just cannot control the spending levels on some of our major customers at this point.

Ryan Merkel, William Blair.

I think the biggest question of today is, is the guidance conservative enough? You gave a lot of detail, but I am wondering how you have thought about it? Does the midpoint represent what you think you can do or does the midpoint represent a 20% or 10% cut of what you think you can do? Just trying to get a sense of how you have thought about it and is this conservative enough?

Ryan, it is conservative enough. When Jim, as you know, we've spend a lot of time trying to make sure that we got this guidance exactly right for you because of all of the volatility in the marketplace this year. The way we look at, we have July, which just finished July, so we have preliminary results there. When I look at the marketplace, June was the best month of the second quarter but much below what we expected in both May and June. July is flat to slightly up from June. As Jim said, the marketplace is not near as robust in upstream and midstream as we thought. We felt we had double-digit growth on the previous guidance from the back half. When we look at the first seven months, including preliminary July, and we look at our activity levels and we gave a lot of guidance on OCTG and line pipe in the marketplace and both in our outlook on the three end markets, we feel the most likely scenario, because that is the midpoint of our guidance is a $5.2 billion, which shows a 2% increase, not double-digit, but a 2% increase in the back half.

We were conservative in our estimate of the US market. I think a downside scenario would be the $100 million drop in revenue and that would come not in the third quarter, but if there was a slow down in the end of spending in late November, December like there was last year I think that would be the downside scenario. The upside scenario of $100 million higher for us would be that we are underestimating the US and there are some signs but not a great deal of sign that it will pick up more than we expect. That is basically a 6% growth in the back half over the first half. It is not an exact science. We are doing our best to give you everything the way we are looking at the marketplace. Of course, our confidence level is the highest, with seven months already behind us basically, with the outlook for the next five months ahead of us, we feel the $5.2 billion is the right target.

Okay, very helpful. Same question, you had a long list of headwinds, some seemed temporary, some might persist, but the one I want to key on is this idea that truck and rail to transport oil has been headwind. What does that mean to your business going forward? Any sense of when that might change?

It is unique to the Bakken, although there is some in Texas happening. Ryan, part of it is related to the delay in permitting. We have got a lot of wells that we hear about from our customers that are WOLP, waiting on line pipe and waiting on the pipeline. The permitting is a big part of that process. The have not been as fast to permit the lines, so the stopgap measure has been the use of rail primarily for shipping oil, primarily from Bakken moving it east and west, and also some repositioning of oil on the Gulf Coast. I think it is going to be a part of the marketplace now for a while, because some companies have made the investments in the rail and the leases. I certainly believe as the industry I think knows that the most efficient and the best way to transport a lot of production is through pipeline. The pipeline infrastructure will get put in place both in the Bakken and in the Gulf Coast and the Permian to the Gulf coast, so we see that coming. I don't believe there is this dramatic shift away from pipeline storage to rail. Rail is not without risk as everyone knows.

Sam Darkatsh, Raymond James.

Two questions if I might. First, and you referenced it I believe in your earlier -- line pipe industry pricing, at least from what we are looking at, is down about 16 months in a row sequentially. The line pipe industry tonnage though is only down about five for six months in a row, which suggest that pricing lead on the way down. In your experience, Andy, which turns first on the way back up? Would it be pricing or tonnage? And why?

We've been through several cycles, Sam and tonnage will start to move first as demand picks up and then pricing will pick up after that. That has been the way it is and tonnage falls the fastest and then prices cut in a more dramatic shift. Prices fall dramatically behind that if there is a big adjustment. What we're seeing is a gradual slowness in demand, and as you said, the 16 months in a row of a softening in the spot pricing. Now, it has slowed some, but what we've done there is also we are very tied through major customers and that is great when things are growing, but it also impacts us when they slow some of their spending. We are in a very strong position both in line pipe and in OCTG, in our months of supply and our inventory management.

We will be very quick to take advantage when we see that pricing has dropped and we see an upturn in spot pricing, we will use that opportunity to buy smart at that point. We have done some of that as we have gotten in these recent pricing declines. We have, as we stated, only $83 million in inventory, which is basically two to three months supply in OCTG, so we are managing that tighter than we ever have. We feel good there from an inventory and costing standpoint. Also, we feel good about our seamless and our desalt line pipe positions with the most pressure being on ERW carbon pipe. It is something that has to be managed every week and we pay very close attention to both the tons and its pricing and when is the right time to buy and when is the right time to pull our inventories lower.

Second question on the income statement, Jim. You mentioned SG&A in the third and fourth quarter to be around $158 million to $160 million. I think your gross profit dollar guidance suggests that gross profit sequentially in the back half really don't -- aren't all that materially different than where it was really in the second quarter, but your $158 million to $160 million in SG&A suggests that you will be actually spending more in OpEx then you would be given your run rate on adjusted basis in Q2. Why would that be? Why the deleverage in OpEx spending, particularly based on that you now know what the slope of demand is compared to before where it did surprise you a bit?

You are exactly right, Sam, and again that is the high end of our expectation. We should see some opportunities to improve on that. That is how we built the operating expense in there. We do have the uptick from the second quarter to the third quarter on the change as a result of the adjustment to the variable comp plans. There is potentially some upside on the operating expense as you described.

Sam, I will just add a comment. We are big believers in our position in the marketplace and while we are very disappointed in the last couple quarters of activity levels, we know the spending is going to turn. We know we have an excellent position in the marketplace. We also know we need to capture more market share in some of the key oil basins while we wait for the gas and NGL markets to come back. We are investing in additional sales and sales focus and outside sales reps and inside sales reps in our major oil basins in the US. We know it's tough right now, at this point, to add SG&A expense, but we strongly believe that that is the right thing to do because we want to be even stronger with the position from a customer facing standpoint in those markets that we think are going to be strong for sure in the years to come as oil-based markets.

Luke Junk, Robert W Baird.

Andy, first question for me would be really a bigger picture question. I know as we have gone through 2013 here we continue to hear more and more about pad drilling in the upstream sector. I'm just wondering if you could talk a little bit about what the dynamics would be for MRC as we see more pad drilling, either opportunities for you guys or some challenges that come along with that as well?

Luke, the pad drilling is very growing segment you see, but it really impacts the drilling contractors and the oilfield service equipment companies a lot more than it does us. It allows them to stage their capital equipment in a very efficient manner and then like pressure pumping very efficient to perform pressure pumping on multiple wells off of a pad, very efficient from a drilling rig operation that moves small amounts and drill effectively on the wells on a pad. All of that is good for drilling contractors' efficiency and oilfield service companies, has very little impact on us because we really come in after that. Except for the tubing and casing that goes with the shale wells, that is a positive for us. We really come after that and tie in both the well tie in, the flow lines into the production facilities, so it doesn't change the dynamic much for us to tie in multiple wells from a pad versus discrete wells.

Okay, helpful. Follow-up question for me would be on the gross profit enhancement initiatives, just the gross margin, you did come in nicely above what we were looking for this quarter. I realize some of that is obviously due to product mix. Just curious, Jim, if you could talk about some of the biggest levers that you've been able to pull on that side of things?

One of the things that has been the most successful is our discretionary pricing programs with some of our smaller transactional customers. Where we really try to maximize margin opportunities with those customers, where we do not necessarily have the cost plus type arrangement. We're applying a different mindset to approach that sector of the market than we do with our larger customers. That is certainly been one of the bigger things. You mentioned the product mix. We have seen the benefit of that in the oil country tubular goods. Then again, an ongoing activity for us and one that you can't emphasize enough is just continuing to buy smart on the procurement side. Our supply chain organization is constantly looking for the best opportunities out there in the market price with our suppliers.

Luke, Jim covered all the key items there, but I would just add the product mix is a fundamental long-term shift for us. Now it has caused a lot of pain to go through the reduction in revenue with the OCTG in the last couple quarters and communicating that. We targeted 8% to 10% when we announced this in the end of 2012 of our revenue would be OCTG. We are at 9% at the end of the second quarter. That is our long-term position in mix, so that will have positive gross margin improvement going forward. The other thing we're focused on both with our acquisitions that you saw with Flow Control Products. We continue to look for acquisitions that are valves and valve automation, which is our highest margin business. Both from an acquisitions standpoint, internationally where the gross margins are higher, from a valve position, so we are targeting additional companies to join that will bring enhanced margins. Then, the mix change that has been a dramatic shift for us. Despite the turmoil we are in the best position we are on our waiting of carbon by both OCTG and line pipe for the remainder of our products than we have been in for five years. It was hard to get to this point, but this is the platform to grow from.

William Bremer, Maxim Group.

Can you touch upon, a little bit, subsequent to the quarter, you mentioned July as flat, a little bit up from June? My second question there afterwards is, what actually sold well during the quarter that surprised you or what continues to sell well in your mix?

Bill, in the mix, let me do the second part first. In the mix, despite the slowdown in some of our midstream and both in line pipe in the midstream valves that go with that, valves, on a more global perspective, still doing very well. Our fittings and flange business is still doing very well. Probably one of the best performers was our gas products, our poly pipe and that is tied to the uptick in our gas utility business that we talked about. Those are all positives. Stainless steel was a mixed bag. Some positives in the US in chemical, but also slow down in Australia that offset that. From a product line, I think that is a good general review. When you look at July, July is better than -- April was the low point for us, May was a little better, June was the best month of the quarter, and then July is just as a little bit better than June. Not near the pickup at we expected. It is in the positive direction, which ties to our 2% guidance increase for the back half. Nothing dramatically shifted in July, except a few more looks at some increases in line pipe activity that would be fourth quarter deliveries that we'd like to see.

I think that is important to note because two of these specialty contractors reported the last couple of days, both very, very strong backlog figures quarter to quarter. More importantly, both of them called out midstream products as well as continued downstream almost running at full capacity, and that is being echoed here. Is that in sync to what you're seeing and what we really need to see is the upstream turn?

Yes, Bill, that is exactly in sync. The upstream has to turn, but we are being very cautious that it will. We don't really see the catalyst both in the gas upstream or the NGL upstream, but we do see a big catalyst with this current pricing on oil. If that materializes into increased spending at the end of third quarter into the fourth quarter, that would be a positive for upstream. We do like, and that is part of our thinking when we look at our higher side of our guidance, that would be a 6% increase over the first half. That is predicated on a pickup in midstream and we are seeing some signs that it won't be in the third quarter, a big pickup, but in the fourth quarter we do see some signs that oil pricing specifically might have a positive for us. We are muted a little bit on that but we see that as the potential upside. In downstream we didn't talk too much about it, but we will have a better second half in both refining with the turnaround activity and chemical. We will have a good second half in Canada because the fourth quarter will be very strong for us this year again. Then, international, we expect that we hit the low point in Australia activity. We expect that pickup. I think from the high level that we are very much aligned with what you're seeing from the others.

Matt Duncan, Stephens Inc.

Andy, I just wanted to follow up on the prepared comments you had on global supply contracts. I think you said you expect to close one in the back half of this year. I think last quarter you had expected that may be in the third quarter. Has the timing on that contract slipped some, and if so what is causing that?

Matt, that is a good point. I probably should have expanded a little bit more on that. I did say in the third quarter on the last two calls. They are tough to time exactly. It is not in our control. It is really in our customer's control on final negotiations, and then contract amendments and their rollouts of their own organizations. What I will tell you it is getting even better, and I'm even more confident that we will have a large one in the second half, we said now, because it might not be in August or September, it might be a little bit later than that. When I talked about having one big new contract on top, Celanese was a smaller one but a nice one. When I talked about that, we were talking on two contracts. We are now in discussions on four contracts.

The timing is not an exact prediction. It will happen, but what I like more than anything is, we have a broader group than we had a quarter or even -- and definitely more than two quarters ago, talking about a much broader contracts with us. I am optimistic that we are in the best position in the marketplace to capture that right now. It is 100% in alignment with our strategy. The fours customers we are talking to are all major players in the industry. That trend continues the trend that we said. If we build our international platform, they would contract on a broader basis from us, and that will create long-term value. We just have to get those in-house.

Andy, on those contracts, are they all looking like they could be exclusive? That are some that you might be one of one or two or a handful of providers on those? On the one that you had thought might be in the third quarter, that now sounds like it could end up being the fourth, is that slipping partially because it sounds like maybe it is getting bigger and there's more going into it? I'm just trying to understand a little better?

Without giving too much detail, some of those we've already captured some additional scope through contract amendments, but we are waiting for a broader scope contract. That is why it is a sliding, but we've already picked up some areas that will talk about in the third quarter on those contracts. At least one of them is not exclusive. Some will want to do broader contracts but want to keep two players out there. Some are talking much more exclusive for the main core product lines that we do. They will take different forms. Most important thing to me, because we don't mind, we love the exclusive. If it is not exclusive and we have to compete day to day to take the flexible share, we usually do very well in that environment. The bigger thing for me is it is picking up momentum with our large customer based at a broader-scope platform is the right way to go.

At this time I would like to turn the conference back to Management for any final remarks.

I want to thank all of you for joining us today. We look forward to talking to you on our next call.

Ladies and gentlemen, this concludes our conference for today. If you would like to listen to a replay of today's conference, please dial 1-800-406-7325 or 303-590-3030 and enter the access code of 4624702 followed by the pound sign. Thank you for your participation. You may now disconnect.