MRC Global Inc (MRC) 2018 Q1 法說會逐字稿

Greetings, and welcome to the MRC Global First Quarter Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Ms. Monica Broughton, Investor Relations. Thank you. You may begin.

Thank you, and good morning, everyone. Welcome to the MRC global first quarter 2018 earnings conference call and webcast. We appreciate you joining us today. On the call, we have Andrew Lane, President and CEO; and Jim Braun, Executive Vice President and CFO. There will be a replay of today's call available by webcast on our website, mrcglobal.com as well as by phone until May 17, 2018. The dial-in information is in yesterday's release. We expect to file our first quarter 2018 report on Form 10-Q later today, which will also be available on our website.

Please note that the information reported on this call speaks only as of today, May 3, 2018, and therefore, you're advised that information may no longer be accurate as of the time of replay.

In our remarks today, we will discuss adjusted gross profit, adjusted gross profit percentage, adjusted EBITDA and adjusted EBITDA margin. You are encouraged to read our earnings release and security filings to learn more about the use of these non-GAAP measures and to see the reconciliation of these measures to the related GAAP items, all of which can be found on our website. In addition, the comments made by the management of MRC Global during this call may contain forward-looking statements within the meaning of the United States federal securities laws. These forward-looking statements reflect the current views of the management of MRC Global. However, MRC Global's actual results could differ materially from those expressed today. You're encouraged to read the company's SEC filings for a more in-depth review of the risk factors concerning these forward-looking statements.

And now, I'd like to turn the call over to our CEO, Mr. Andrew Lane.

Thank you, Monica. Good morning, and thank you for joining us today and for your interest in MRC Global. Today, I will review company performance highlights, and then I'll turn over the call to our CFO, Jim Braun, for a more detailed review of the financial results. I'll then finish with our updated outlook for 2018.

2018 has started strong with first quarter revenue just over $1 billion, the first quarter in the last 10 quarters that we have reported quarterly revenue over $1 billion. Revenue is up 17% over the first quarter of 2017 and up 12% sequentially from the last quarter. Importantly, adjusted gross profit improved to 19.1% in the first quarter.

Adjusted EBITDA came in at $59 million or 5.8% of sales, resulting in strong incremental EBITDA of 16% for the first quarter 2018 over the same quarter a year ago.

Diluted earnings per share were $0.13 in the first quarter compared to breakeven earnings per share a year ago. Contract wins and extensions have benefited the quarter as all our segments and end markets experienced growth. The macro economic conditions for our end markets are all very positive and continue to improve with customer spending higher than last year or concentrated in areas where we operate.

There are several inflationary trends on our products that I'd like to discuss. Recently, Section 232 tariffs targeting steel imports and related quota measures have been put in place. In some cases, steel-producing countries have been granted exemptions from the tariffs. In addition, any (sic) [many] dumping suits in certain product categories have been filed recently. Our costs have also been influenced by various other inflationary pressures, mostly raw material cost increases. Transportation and freight costs have also increased due to higher demand, regulation and limited driver resources. The market continues to adjust to these measures as there are many moving parts in our global supply chain, and many of these elements continue to evolve. In fact, on Monday of this week, the temporary exemptions for certain countries was extended another month.

Nevertheless, product inflation is generally a positive for us as our cost plus contracts allow for price increases to be passed through. Transportation and freight costs are also structured as a passthrough cost in our customer contracts.

While the new pricing could take a quarter or 2 to be realized, we have begun to see margin improvement in the first quarter from higher inflation, and we expect that will continue.

Carbide is typically our product group with the most priced volatility, but given the various inflationary pressures, all our products are experiencing some level of inflation. Some line pipe price -- sizes and types have seen a 25% plus increase. Carbon fittings and flanges, stainless products and valves, all are experiencing price increases. Based on the current market outlook, we expect the trend to continue for certain sizes and types.

In light of these conditions, we have been strategically building inventory, not only for expected increase in demand, but also to get ahead of these price increases and to have product available for our customers when quotes and additional demand extend lead times.

Since April, we completed our $100 million share repurchase program authorized last October. Under this most recent authorization, we repurchased 6.1 million shares at an average price of $16.43 per share. In total, including both of our repurchase authorization, we have repurchased 14.6 million shares at an average price of $15.38 per share. The outstanding share count as of April 27, 2018, is 89.7 million shares. We are pleased with the results of our share repurchase programs, which have returned capital to shareholders on an accretive basis over the past several years.

Our capital allocation strategy has balanced the needs of our operating business, which is impacted by the energy markets, with our balance sheet and taking advantage of the cyclicality of our end markets. We believe this investment in our company has been a prudent use of capital that has created value for shareholders.

This quarter, we have also renewed and expanded our enterprise framework agreement with TransCanada for 3 more years. TransCanada purchased our longtime customer Columbia Pipeline Group in 2016. This was an important renewal of the legacy Columbia Pipeline Group business and an expansion to include TransCanada's U.S. legacy assets. The combined company was one of our largest customers in 2017 driven by their active pipeline and expansion program. This is another example of maintaining customer contracts and expanding contract scope to capture additional market share. We continue to gain market share through our account management process and our framework agreements and expect to have more contract renewals and expansions in the second quarter to share with you.

I am pleased to report that all 3 of our segments reported positive operating income for the quarter. Of note is the positive result for our International segment. As you know, international customer spending has remained depressed; however, the restructuring steps we took late last year in this business have paid off with a return to profitability. Equally encouraging are the positive signs we're starting to see in customer activity levels.

The first quarter was a great start to the year. We are encouraged by the positive macro trends and looking forward to continued growth. In years of improving macro conditions like this one, historically, we have seen that our first quarter is our lowest revenue quarter of the year as our customers ramp up their new budgets.

So with that, I'll now turn the call over to Jim.

Thanks, Andrew, and good morning, everyone. Our total sales for the first quarter of 2018 were $1,010,000,000 or 17% higher than the first quarter of last year as all end market sectors produced double-digit percentage growth led by upstream and closely followed by downstream. Sequentially, revenue increased 12% from the fourth quarter with all segments and sectors experiencing growth,

Now starting with revenue by segment. U.S. revenue was $806 million in the quarter, up 21% from the first quarter of last year as downstream activity increased the most at 31% or $55 million. The increase in downstream is primarily due to project deliveries for Shell's Pennsylvania chemicals project, increased turnaround activity for both refining and chemical customers and share gains.

The U.S. midstream sector increased $47 million or 14% from the first quarter last year due to growth in spending as oil, gas and liquids productions in the United States has increased, which has in turn driven more gathering systems as well as various pipeline projects by transmission customers. Midstream growth was also driven by gas utility customer integrity work. Typically, we see less construction for transmission and gas utility integrity work in the winter months, so we expect that this work will increase throughout the year.

The U.S. upstream business increased $38 million or 27% from the first quarter last year as well completion activity increased. Our U.S. upstream growth trailed the overall increase in well completions due to our customer mix. Sequentially, U.S. segment sales were out from the fourth quarter by 13%. Gains were across all sectors, but primarily due to an increase in downstream sales due to our large project deliveries followed by midstream related to increased gathering activity, and finally, upstream from increased completions.

Canadian revenue was $78 million in the first quarter, up 1% from the first quarter of last year. Canada's revenues were nearly flat as gains in midstream and downstream revenue were offset by reduced upstream revenue. Canadian rig count declined 9% in the first quarter of 2018 over the same quarter a year ago, driving the decline in our Canadian upstream business. The Canadian segment also benefited $3 million from the strength in the Canadian dollar against the U.S. dollar in the quarter. Sequentially, the Canadian segment was up 10% from the fourth quarter due to an increase in midstream line pipe sales for various small cap projects and upstream as completion activity increased.

In the International segment, first quarter revenues were $126 million, up 6% from a year ago. Sales were up due to higher upstream activity from valve sales for the future growth project in Kazakhstan, partially offset by a decline in the midstream sector from a nonrecurring pipeline project in Australia. The International segment benefited $11 million from foreign currency strength against the U.S. dollar in the quarter. Sequentially, the International segment was up 8% from the fourth quarter from increases in all sectors.

Now turning to our results based on end market sector. Compared to the same quarter a year ago, all sectors grew double digits. In the upstream sector, first quarter sales increased 23% from the same quarter last year to $302 million, driven primarily by higher well completions in the United States, followed by oil and gas production facility project deliveries in the International segment. Downstream sector sales grew 21% from the same quarter last year to $298 million driven by the project deliveries for petrochemical customers including shells, ethylene cracker in Pennsylvania, a stronger turnaround season for both refiners and chemical producers and market share gain from new contract customers. Our spring turnaround revenue was about $25 million in the first quarter.

Midstream sector sales increased 11% from the same quarter last year to $410 million. Both subsectors experience growth. Sales to our gas utility customers increased by 14% and sales to our transmission and gathering customers increased 7%. Gas utility sales increase primarily due to line pipe and valve orders for integrity projects. The increase in sales to transmission and gathering customers was due to gathering systems as production increased as well as transmission projects for takeaway capacity. The mix between our transmission and gathering customers and our gas utility customers was weighted 52% for transmission and gathering and 48% for gas utilities in the first quarter.

All end markets sectors showed sequential growth as well, with the strongest performance in our downstream sector, experiencing growth of 19% driven by the deliveries for the ethylene cracker in Pennsylvania and the spring turnaround season.

Now turning to margins. Gross profit percent increased 50 basis points to 16.7% in the first quarter of 2018 from 16.2% in the first quarter of 2017. LIFO was a headwind for the quarter as we recorded LIFO expense of $7 million and $1 million in the first quarter of 2018 and 2017, respectively.

The adjusted gross profit percentage was 19.1% in the first quarter of 2018, up from 18.2% in the first quarter of 2017. The increase in adjusted gross profit percentage reflects the positive impact of the inflationary conditions mentioned earlier and a favorable product mix.

As noted, we've seen inflation in line pipe prices, which has increased considerably in 2018. Based on the latest Pipe Logix all items index, average line pipe spot prices in the first quarter of 2018 were 28% higher than the first quarter of 2017 and 12% higher sequentially. We expect to continue to experience pipe inflation as uncertainty around tariffs and quotas remain. Domestic suppliers have, where possible, moved up pricing to match increases from foreign source products.

SG&A cost for the first quarter of 2018 were $138 million, an increase of $12 million or 10% from $126 million a year ago due primarily to wage and incentive increases, volume-related increases from higher activity levels and unfavorable foreign currency movements. As a percentage of revenue, SG&A fell to 13.7% from 14.6% as revenue growth exceeded increases in operating expenses. As compared to our previous outlook, first quarter SG&A expense was higher than expected due to volume-related increases and foreign exchange mentioned above.

With a strong performance this quarter and higher expected revenues in 2018, we are updating our outlook and estimate for our annual SG&A expense will be $545 million to $555 million or a run rate of about $136 million to $139 million per quarter to the remaining 3 quarters of the year. Salary and wage inflation remain a factor in certain operating areas.

Interest expense totaled $8 million in the first quarter of 2018, which was $1 million higher than the first quarter last year primarily due to higher average debt balances. This quarter, we entered into a 5-year interest rate swap to fix a portion of the interest expense on our term loan. Under the terms of the swap, we receive a 1-month LIBOR rate on a notional amount of $250 million and pay a fixed rate of 2.71%. This effectively fixes the interest rate on $250 million of the term loan at 6.21% when considering the 3.5% margin provision of the term loan.

Our tax rate for the first quarter was 28%, resulting in a tax expense of $7 million. Our tax rate is higher than the U.S. statutory rate of 21%, primarily due to state taxes and pretax losses in certain foreign jurisdictions without a corresponding tax benefit. Based on our current projections of earnings by jurisdiction and the other provisions of the new U.S. tax law, we are estimating effective tax rate of 28% to 29% for 2018, not significantly different from our previous tax guidance.

Our first quarter 2018 net income attributable to common shareholders was $12 million or $0.13 per diluted share as compared to breakeven last year.

Adjusted EBITDA on the first quarter was 59 million versus $36 million a year ago, and adjusted EBITDA margins for the quarter were 5.8%, up from 4.2% a year ago as revenue increases outpace cost. Incremental EBITDA was a healthy 16% for the first quarter of 2018 over the same quarter a year ago. All 3 of our segments generated positive EBITDA this quarter, including International, which benefited from the cost reductions and restructuring actions taken at the end of 2017.

We used $74 million of cash in the first quarter of 2018 as we built working capital faster than initially expected due to higher activity levels as well as an effort to invest ahead in the inflationary environment. Our working capital net of cash at the end of the first quarter 2018 was $818 million, $237 million more than a year ago and $110 million more than at the end of 2017. As a result, at the end of the first quarter of 2018, our working capital, excluding cash as a percentage of trailing 12-month sales, was 21.6%, slightly above our 20% target. However, we expect to return to the 20% range by the end of the year.

With higher-than-expected sales for the year and opportunistic inventory buys, we expect that cash flow from operations for 2018 will be about breakeven. Our debt outstanding at the end of the first quarter was $639 million compared to $526 million at the end of 2017. Our leverage ratio based on net debt of $594 million increased to 2.9x from 2.7x at the end of last year as debt increased in the first quarter. The availability on our ABL facility was $409 million at the end of the first quarter and we had $45 million in cash. As part of the changes related to the new U.S. tax law, we repatriated $30 million of cash from our Canadian operations during the quarter.

Capital expenditures were $5 million in the first quarter. And while we're running somewhat under the previous guidance, we have no change to our annual guidance estimate of $25 million as additional cost to build out the La Porte RDC office facility are expected.

And now I'll turn it back over to Andrew for closing comments.

Thanks, Jim. I'll end with our current outlook. This quarter's strong performance resulted in all sectors outpacing our initial estimates. As a result of the solid quarter and our expectations for the remainder of the year, we are raising our guidance for 2018.

Market conditions are trending positive across all of our business. Commodity prices are higher than they were at the beginning of the year and higher than the levels at which most spending surveys indicate our customers budgeted. Global crude oil inventory levels are supportive of a rebalancing of supply and demand. The WTI oil price was over $68 per barrel recently, the highest it has been since 2014. Well completions continue to increase and our customers are more active in most all the areas we operate, all supporting our upstream business. The inventory of drilled but uncompleted wells or DUCs remains high and continue to grow in the first quarter. They represent future revenue opportunities as they're eventually worked down.

Downstream projects fueled by stable low cost feed stock prices are progressing and will be positive in 2018 and beyond. They have also seen the benefit of our market share gains as our new contracts are showing growth, supporting all our business, but particularly the downstream.

As production continues to increase in the U.S., the need for additional takeaway capacity grows as well as the need for gathering systems. A more constructive regulatory environment for energy infrastructure projects and inflation in line pipe pricing all benefit our business. Gas utilities continue to execute long-term plans to repair, replace and upgrade their distribution network. These market dynamics support our midstream business.

Our backlog was $888 million at the end of the first quarter, up $55 million or 7% from a year ago, primarily due to increases in downstream and upstream project spend in the U.S. The backlog has continued to increase in April, indicative of growing activity levels going into the summer construction cycle, which is typically the busiest time of the year.

Given the improving macroeconomic market factors and our strong first quarter performance, we have raised our guidance expectations. We expect total revenue to be between $4.1 billion and $4.4 billion, which is $200 million higher at the midpoint than we previously estimated. By sector, as compared to 2017, we now expect upstream and downstream each to be 15% to 25% higher and midstream to be 10% to 20% higher. For comparison, we previously expected upstream to increase by 10% to 20% and midstream and downstream to each grow by 5% to 15%. The increase in downstream guidance is driven by strong first quarter performance, expected project deliveries and market share gains. Similarly for upstream and midstream, strong first quarter results, higher commodity prices and improved outlook for customer spending is bolstering our expectations.

We have increased our expectations for the U.S. segment, raising growth to 15% to 20% this year. Canada and International are expected to be up 10% to 15%. Sequentially, we expect second quarter 2018 to be up mid-single-digit percentages from the first quarter 2018.

We also have updated our expectation of adjusted gross margins in 2018 to a range from 19.0% to 19.3% for the year. Margin tailwinds include continued inflation in our product categories, favorable product mix changes to higher margin valves, instrumentation and stainless products. We have not changed our expectations regarding tempo and we still expect the second half to be stronger than the first half with the third quarter our highest revenues quarter.

So with that, we'll now take your questions. Operator?

(Operator Instructions) Our first question is coming from the line of Sean Meakim with JPMorgan.

Andy, maybe just starting with the updated guidance. I'm wondering how much pricing reflation is embedded relative to expectation of higher volumes. And then maybe, can you just talk a little bit about the incremental margin impact at the EBITDA line at the low end versus the high end of the range?

Yes, Sean, so let me talk the pricing and what we've employed there. Jim can talk about the incrementals, EBITDA margin. The tariffs, the big swing factor for us, it's a really big deal this year. Inflationary environment is good for us. When you look back at our company, 2012 through the first half of 2014 was inflationary, and that spurred a lot of growth on the top line, but also margin improvement. Then '15 and '16 were 2 years of difficult deflation. And so we're back in -- it started in '17, but in a much higher inflationary environment in '18. So we have from what we know today factored in 2 things. It's -- one is just stronger demand. CapEx budgets are up, and so we're taking advantage of that. The overall market spend is up, and our market share gains and contracts is up. And then you layer on inflation on top of that, and that's really embedded in our growth period estimate that we've put out there. And the tariffs are both a combination of the anti-dumping countervailing duties, which aren't getting as much press, but are a big factor with both carbon steel flanges, forge steel fittings, large-diameter carbon steel pipe and stainless steel flanges. So all of those are outside the Section 232 impact, and all are having a inflationary impact on our products. Our costs -- our contracts are all cost plus, so we've done this many years and we'll move those higher costs on to our customers as the pricing increases.

So certainly, a good -- what we know today as far as the tariff impact, and we've seen a lot of impact, both U.S. mills and foreign mills. What we know for sure is already embedded in our updated guidance, but there are still some uncertainty with Canada, Mexico, the EU's still undetermined. So we don't have -- maybe have all of that baked in yet.

Sean, as to your question on incrementals. At the midpoint of the guidance, we expect to see the strong incrementals of the 16%, 17%. And if you moved up to the high end, I think you'd see something a little bit stronger than that. We wouldn't have to add as much cost. Likewise, if for some reason we were at the low end of the guidance, you might see a little bit of softening in those. But we should be in the 16%, 17% range.

Okay, great. And then you moved your guidance the most in the downstream on a percentage basis. Obviously, spring turnaround, the ethylene cracker, you had some help in the first quarter. But just, how much of the increase is more visibility from some of the share gains you had in that stream with specific customers and projects and thinking about how those opportunities are influencing your guidance versus your expectation for fall turnaround? Just how that -- how then we should expect that mix to unfold.

Yes, Sean. That's the big positive, it's the contract wins and they ramping up of the higher budgets for those costumers that we won the contracts for. So that's the largest impact on the revised incremental revenues going up. The Shell Franklin, as we spoke before, is kind of a $75 million, $100 million project for us with around $25 million in the first quarter. We had $25 million in turnaround. It was a good first quarter in the U.S. for us. We'll see some more in April. But we also -- for the year, we see $70 million to $90 million in turnaround revenues with a good third quarter also projected. So turnaround's trending nicely for us. The prop -- the one big downstream project will ramp up the rest of the year, and then the rest of the increase in revenue forecast is coming from the contract gains and their spending year-over-year. Part of it is because we didn't have those contacts for the full year last year, and part of it is now we have a full year run rate, but they're also spending more. So we feel good about downstream projections.

Our next question is coming from the line of Matt Duncan with Stephens.

So Andy, you guys are obviously outgrowing rig count on the upstream side of things pretty handily right now. I'm curious if maybe you could separate out the price impact that you're seeing from the volume impact. And on the volume side, is this something you think you can continue with what's driving it? Is it really just the growth in completions coming back and you guys taking share on top of that? Just how should we think about your upstream business relative to what's happening at rig count, understanding you're more of a completions-driven business than rig count?

Yes, Matt. Let me just make a couple comments about that. So I would say first, which shouldn't be a surprise, that 50% of the rigs in the U.S. are in the Permian, so that's been the big activity increase for everyone in the industry. We have 10 core branches in the Permian that we service customers from. So our Q1 revenue year-on-year increase was 70%. So far outgrowing the rig count, we've taken market shares in the Permian. We had market share gains. We feel very good about our position there from both contracts and customers, and the activity levels are much higher. So that by far has fueled the U.S. upstream growth. And the other thing you'll see as the year plays out, our customers are not -- our primary customers are not the 1- and 2-rig operators. It's the majors. So when you look at our top 10 North America upstream customers, 8 of them are in the U.S. and then we have CNRL and Husky in Canada. But it's the Chevron, Shell, Anadarko, Apaches, ExxonMobil, all the big players, they tend to start relatively slow on new budgets in January, February. So the Permian activity, we expect to be strong for the full year. We like our gains there. And then our major customers are actually getting very active. Both Chevron, you see their overall CapEx is down for the year because of the less CapEx spend in Australia and some of the LNG projects, but a big increase in spending in the Permian basin, which we benefit from as they are our largest customer. And then also ExxonMobil picking up with XTO there. So a lot of things to be positive about for our upstream business. And in the completion phase, if you look at the drilldown completed, it's 7,600 for the U.S. It's actually increased during the quarter. But completions have also -- the number of completions are also increasing. So we look at the DUC town as a backlog of future wells to be completed and the current activities we want to grow. So we feel good about that upstream, primarily more so from activity in demand than in pricing.

Okay. And then second question is just on the competitive environment and the opportunities that you may be seeing as a result of lengthening lead times, tariffs and those sorts of things. I would think that supply is becoming tighter. You guys obviously have pretty strong relationships with the bigger suppliers in the industry. Is that helping you take share with your customers? Is that something that you expect to continue going forward?

Yes. And Matt, it's a very large positive for us from a couple aspects. One, we have a very strong balance sheet and our ability to carry larger inventories and buy in bulk is something the small competitors just can't do. A lot of small competitors competed in this market place on low-cost import pipe. That's going to change and has already changed. So where they might have competed on a low-cost offering, definitely they're at a disadvantage when these tariffs and quotas get put in place. So I think, for those reasons, we're very strong. We have the capability as things change like this from global supply chain to maneuver and reset our global buys for our customers. And so small players can't do that. And if you look at just the impact of these tariffs in our carbon pipe inventory, 70% is domestic and 30% is import. So as these tariffs or porters get put in place internationally, we have the ability to shift more buy-in to our domestic mills and suppliers, which serves us very well, and we do it very easily. We already have both sets of part numbers cross-referenced with our customers on approved manufacturer list. And when you look at stainless, it's 40% domestic and 60% import. And a smaller number of players in that field, but we have the same flexibility to shift our buys. So those are big advantages in the marketplace. Our customers realize that. And the big thing that we did, we were planning for an inflationary environment coming into this year but kind of mid- to -- mid-single digits to 10% inflation. Of course, with the tariffs and anti-dumping, countervailing duty suits, the inflation is going to be more like 20%. So during December, January, February timeframe, we accelerated our purchases ahead of the inflation. So you saw our inventory come up $110 million, and it had 2 big drivers. One was just the increase in demand that we're seeing for our valve product line. So roughly $40 million of that increase is demand driven as people are spending a lot more this year and we're realizing that in increased valve sales. And then the other $70 million was split $60 million for line pipe and $10 million for carbon fitting flange and stainless. And that was all done to accelerate our purchases, to have lower cost inventory ahead of this rapidly increasing inflation environment. And lead times are going to get extended when the quota's impact is felt, and we're already seeing that from South Korea. They're already bumping up against some restrictions on the new quota, which is 70% of the last 3 years. So we'll be very well positioned to have that inventory in place for our customers as we shift through some alternative sources. So I feel good about our flexibility and we have plenty of liberty to keep doing that, and I feel very good about our inventory position and our cost position, especially in this inflationary year.

The next question is coming from the line of Vebs Vaishnav with Cowen and Company.

First, can we talk about the first quarter revenues? What drove the revenues above expectation? How much was tariff helped, if any? And any onetime items that occurred in fourth quarter that could not recur in 2Q?

Yes, Vebs, let me start and Jim might add some color to it. But no onetime items, nonrecurring items that I would classify in the first quarter at all. So just activity picked up more than we expected. A lot of our bigger customers, new budgets kicked up. But I would say -- and that's why we're still guiding up for mid-single-digit growth in the second quarter. Some of that was a little slow, even in January. So just the rig count's over 1,000 now, a big positive there. The midstream business we're still tracking, currently booking revenue on over 20 projects and another 30 projects we think we'll see revenue starting at least in the later part of this year. So the midstream's really strong. And so everything was a positive activity-wise, even with the late winter that we had in the northeast that really just impacted our midstream pipeline business and our gas utility business. But the first quarter is usually our slowest quarter anyways in that area. So those projects kick in, in the second and third quarter. So I would just say, predictable and a little bit higher activity spending drove our -- the increase over what we originally guided to. But there's positives on that and also on the downstream. The ramp-up of the customer's year-on-year of the new contracts was -- what we previously talked about was a positive in the quarter. So I think U.S. drove the big increase in the first quarter higher than we thought, and then all 3 end markets really kicked in a little bit stronger than we thought in first quarter. Jim, do you...

So Vebs, I would just add, as you know -- we noted in the quarter we had some nice deliveries, both on the TCO project in Kazakhstan in the upstream side and Shell Franklin in the U.S. on the downstream side. And looking at the delivery schedules, the expectations are we'll have another strong quarter of those in the second quarter. So to reiterate Andy's point, we're not expecting a big falloff on any onetime things in Q2.

That's helpful. And if I think about the 5% of mid-single digits 2Q revenue guide, how are you thinking about the impact on completions that we have seen in 1Q and that could potentially impact you in 2Q?

Yes, we don't see a dropoff in completion activity in Q2 from the upstream side. We see -- the only thing we're dealing with as everyone does in Q2 is spring breakup in Canada from an upstream perspective. But no, I think the -- so that will be a negative headwind. But the tailwinds in the U.S. are still very strong for us. And primarily for the reasons that it's our customer group that's going to be very active in completions during the second quarter, maybe even more so than the first quarter. So I think that, that offsets the spring breakup in Canada. So I think that's a solid guide for us.

Okay. And last one for me. I think you mentioned because of Section 232 and other inflationary activities going on, do you expect margins to expand from here on? Did I get that correctly? And then if that is the case, then if you can help me reconcile the guidance of gross margins, which is essentially flat from first quarter?

Yes. Let me start in just with a little high level, and then Jim can talk to this better. But yes, Vebs, we're definitely seeing inflation. We're definitely going to see improving margins. And we have predicted, even at the start of the year, we'd have improving margins during the year. So solid first quarter at 19 -- on adjusted gross margins, I'm talking to 19.1 in the first quarter. And then we increased our guidance to 19 to 19.3 just to reflect at the high end of that guidance some improving margins towards the second half of the year with the first quarter that we've already realized. Jim?

So that's right, Vebs. Again, the inflationary impacts, we're building some of that into our margin expectations, which is why we've raised it. The midpoint's moved up slightly, but as you noted, we've taken the high end of the guidance up to 19.3.

Okay. So fair to think gross margin should improve at least in 2Q and 3Q and then seasonally down in 4Q? Is that a fair way of thinking about it?

That's the normal for us, Vebs. Yes.

The next question is coming from the line of Nathan Jones with Stifel.

A question on Canada here. The organic revenue is down in the first quarter. I'm sure you listened to your competitor's call yesterday. And they were calling not only the spring breakup, but also delays in the trans mountain pipeline potentially causing some lower activity up there. Are you guys seeing a similar thing there? You haven't said anything about lower activity outside of just the normal seasonal breakup there.

Yes, Nathan. Well, I don't listen to anybody else's call, but I will tell you what I think about Canada. It's -- there's a lot of dynamics going on in Canada, for sure. Well, the rate count was down year-on-year. That's one point. Definitely there's some takeaway capacity limitations. So you're seeing more oil shipment on rail, which slows everything down. So those aspects. You're seeing a very large, call it price differential on the heavy crude between Canada, Western Canada and the U.S., which also is slowing some of the economics down. And I think the biggest thing of all that, though, is if you look back at, Nathan, at 2016, '17, so many properties changed hands from what was large U.S. independent and even IOC ownership to now Canadian company ownership. I think they're still getting their hands around the new assets and developing their development plans, so I think that's probably stalled some of the activity. So the price difference around the crude has definitely slowed activity and also the change in ownership of the assets. So I think we had a good quarter there, and we'll have just a normal seasonal breakup in the second quarter. But it is definitely a difficult market to get your hands fully around this year because of all that change.

Okay. And then another one on pricing. It would seem that outside of passing through inflation here given relatively high demand, long lead times in the supply chain, tightness in the supply chain, the market -- it should be ripe for you to actually raise real pricing and push real net pricing through. It doesn't necessarily look like there's a lot of that happening yet. Do you see opportunities to increase the gross margin on certain products, many products, any products?

Yes, Nathan. You're right, and I certainly believe the pricing is going to be much higher by the end of the year than it is in the first quarter, primarily in carbon steel line pipe, carbon steel flanges and fittings, stainless steel pipe and stainless steel fittings and flanges. All will be impacted by either the impact of tariffs or quotas because you -- it just is a much more inflationary environment that we're going to go through. We're going to have the ability with our inventory position to leverage our buys. We did a lot of that already as I spoke to earlier, so that will help us. But pricing will definitely increase through the year and be much higher at the end of this year than the start. So I think all those dynamics are happening. Even valve pricing, some of the changes going on in the manufacturing environment and the regulatory environment in China are impacting the valve prices and valve lead times. So it's just as we've been through, like I referenced 2012, '13, our revenues grew nicely. Our margins improved nicely, and it was an inflationary environment, which is the best environment for us as we are buying and selling every day.

And you have a very healthy demand environment here. Obviously over the last few years, the jewelers have really taken down the breakeven costs on these wells. Does the rising costs of products that are going in here, in your opinion, have the potential to tamp down demand at any point? Or are these guys making so much money that, that this really doesn't put much of a dent in their profits?

Well, I did -- I'd address that from a couple of points. One, we don't sell any product down hole, for the down hole completions anymore. And we don't provide any products to the rigs directly, and we have never done that. So we don't impact those directly. What you'll see is the impact of higher costs in production. But at today's prices, as you mentioned, they're not going to not complete wells or tie in wells because of the additional costs of tie-ins or production facility expansions. So I don't see that. In midstream, you might see some impact on pipelines or some renegotiations on pricing agreements there, if it's on a new pipeline with the higher cost line pipe that's going to be in the market. And we don't -- so maybe there, but we haven't seen it yet. And even pipeline operators can apply for an exclusion to the higher price import pipe if they've already had a project sanction, so we've seen some of that. And we don't really see any impact on our increases in costs on the downstream. You look in refining and chemicals on those big plants, our pipe valve and fittings revenues or the cost for them is roughly 5% of a big project. So even a nice increase for us in terms of the overall project, it wouldn't change any of the downstream economics. So we can -- summing it all up, we don't see an impact with our customers on the higher inflationary part because of our size to their business.

(Operator Instructions) Our next question is coming from the line of Walter Liptak with Seaport Global Securities.

Wanted to just ask a follow up on the downstream, and you referenced the turnaround activity for this year at $70 million to $90 million. Yes, I wonder if we could get a little bit more detail, maybe how much is set up for you guys year-on-year? How much is the market versus any new wins? And turnarounds, I think, have been kind of elusive for a few years. Do you think we're finally at a point where there's more work to be done? What are you finding out as you get into these plans?

Yes, well, we certainly think that here in the first quarter, we saw return to a good turnaround season from last couple of years where people have continued to defer or delay some things. So, incrementally, we said before that the difference between a good turnaround and an okay turnaround season is usually $10 million to $15 million. We're optimistic about the fall turnaround season. And again, the contract wins that when we get a new contract, new customer, with that comes their turnaround. So we're able to participate in higher level of turnaround because of those contract positions. But we do think that we've seen a bit of a shift to where some of this [work now] is getting done where previously it hadn't been.

Yes, Walt, I would just add to Jim's comment. So he said $25 million in the first quarter, we see the third quarter, the fall turnaround being around $30 million. And then the balance of the $70 million, $90 million will be in the second -- in fourth.

Our final question is coming from the line of David Manthey with Baird.

First off, I'm wondering if you could break down or give us any color on the 90 basis point year-to-year improvement in adjusted gross margin, if you can talk about whether it's product, customer, geographic mix, inflation. What drove that primarily?

Yes, I would say of that basis improvement, you're probably about 1/3 of it is going to be some price across most of the product lines with a big heavy emphasis on line pipe. And then I think another 1/3 is going to be product mix between more valves. Line pipe relatively speaking was -- it didn't increase that much. And then you asked about geography. Most of that's coming -- most of that improvement's coming out of the U.S. business.

Yes, Dave, I'll just add to Jim's comment. So our highest margins are downstream and then valves and stainless. So the pick-up in downstream revenues helped us, the pick-up in the U.S. helped us. And then as Jim said, our -- what tends to be our lowest margin business, carbon line pipe, is actually doing very well this year with the inflationary aspects. And so that raises the blend. And of course, our multiyear shift to much higher valves is really important and trailing 12 months now, 36% of our revenue. So that also has an impact.

That was my next question was the percentage of sales from valves, automation and instrumentation, et cetera. And you said 36%, that's a trailing number. Could you talk about what the growth was in the first quarter?

Yes. It was 38% of the revenue in the first quarter, 36% on a trailing 12 months. And Jim, do you have the growth quarter-on-quarter?

Yes. In terms of valves, Dave, it was about $57 million year-over-year.

Thank you. Ms. Broughton, it appears there are no further questions at this time, so I'd like to pass the floor over to you for any additional concluding comments.

Thank you for joining our call today and for your interest in MRC Global.

Ladies and gentlemen, we thank you for your participation. This does conclude today's teleconference. You may disconnect your lines at this time, and have a wonderful day.