Aug 2, 2013
Executives
Andrew R. Lane - Chairman, Chief Executive Officer, President, Member of Risk Management Committee, Chief Executive Officer of McJunkin Red Man Corp and President of McJunkin Red Man Corp James E.
Braun - Chief Financial Officer, Executive Vice President and Member of Risk Management Committee
Analysts
Matt Duncan - Stephens Inc., Research Division Allison Poliniak-Cusic - Wells Fargo Securities, LLC, Research Division Jeffrey D. Hammond - KeyBanc Capital Markets Inc., Research Division Ryan Merkel - William Blair & Company L.L.C., Research Division Sam Darkatsh - Raymond James & Associates, Inc., Research Division Luke L.
Junk - Robert W. Baird & Co.
Incorporated, Research Division William D. Bremer - Maxim Group LLC, Research Division
Operator
Ladies and gentlemen, thank you for standing by, and welcome to the MRC Global Second Quarter Earnings Conference Call. [Operator Instructions] Today's conference is being recorded, August 2, 2013.
I would now like to turn the conference over to Monica Schaeffer, Vice President, Investor Relations. Please go ahead.
Unknown Executive
Thank you, Alicia, and good morning, everyone. I'm Monica Schaeffer, the new Vice President of Investor Relations at MRC Global.
And I'd like to welcome you to MRC Global's 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.
That 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 the 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 the 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 reports on Form 8-K to understand those risks, uncertainties and contingencies.
And now, I'd like to turn the call over to our CEO, Mr. Andrew Lane.
Andrew R. 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 Braun, for a detailed review of our second quarter financial results, let me first begin with some of our noteworthy highlights from the quarter.
Following Jim's second quarter review, I will finish with an update and 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 have 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 who have followed us 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 in 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 2 years. The industry surveys of the top 300 to 400 customers showed U.S.
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 the 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 resulted in lower spending in both natural gas and NGL pipelines; there's 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 lower back half of 2013 than previously expected. We provided update and annual guidance at our earnings release last night that has the midpoint of our revenue 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 late 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 an 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 global contract to supply and distribute pipe, valves and fittings to Celanese corporation.
The Celanese contract is approximately $10 million to $15 million of revenue per year and it's 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 5-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 in 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 5-year term, based on 2012 activity levels. But it also continues our long-standing track record of renewing contracts with our core MRO customers in the U.S.
We are proud to have a renewal rate of over 95% for our MRO contracts since 2000. Finally, we also continue to implement our strategy of pursuing accretive bolt-on acquisitions in the U.S., further strengthening our shale-focused branch operations.
On July 1, we closed on the acquisition of Flow Control Products, which is a leading provider of pneumatic, electric and electrohydraulic valve automation packages and related technical valves support in the Permian Basin. It's the most active oil-producing region in the U.S.
Concurrent with this transaction, we are expanding our regional distributor center in Odessa, and Flow Control will operate from this new expanded facility when it's 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.
James E. Braun
Thanks, Andrew, and good morning, everyone. I'll begin with some general comments on market conditions in the second quarter.
The U.S. 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 average $4 per MCF during the quarter, making incremental investments in dry gas drilling unattractive. As previously discussed, the activity of our U.S.
customers slowed near the end of the fourth quarter of 2012 and their lower-than-expected spending has continued to 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 6 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.
And with that as a backdrop, let's turn to the quarter results. Total revenues for the second quarter were $1,268,000,000, which was down 11% from $1,430,000,000 we reported in the second quarter of last year.
The year-over-year decrease was partially offset by the impact of 2 acquisitions, which added an incremental $41 million of revenue in the quarter. U.S.
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 breakup negatively impacted our results and reduced our second quarter sales by about $10 million. Internationally, second quarter revenues were down 8% 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 hook-up activity also contribute to decline in the 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 a slowdown 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 multiyear 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 in 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 the $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 of 2012. This modest decline in this product group was attributable to the 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. And now, turning to margins.
While sales have been below expectations for the quarter, we've 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 on 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 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 the intangibles and plus or minus the 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 U.S. and Canadian functional areas.
We expect SG&A expense to be in the 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, which 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 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 U.S.
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 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 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 net 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 $1,084,000,000 compared to $1,257,000,000 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 2.45x as compared to 2.6x at December of 2012. Our operations generated cash of $7.5 million in the second quarter of 2013 and, you may recall, during last quarter's call, we mentioned that the second quarter would include 2 U.S.
estimated tax payments. These 2 tax payments total $49 million in the quarter.
Our working capital at the end of the second quarter was $1,126,000,000, up 5% from the end of March 2013. And for the first half of 2013, we've generated cash from operations of $182 million, and 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 and 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.
And now, I'll turn the call back to Andrew for his closing comments.
Andrew R. Lane
Thanks, Jim. Let me conclude with our outlook for the remainder of 2013 and the overall business environment.
Natural gas prices is up and in the $3.50 to $4 range level in the U.S. 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 price 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 forecast shows 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 last 2 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 restraint in spending by our customers in 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 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 U.S. 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's 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 that's 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'll continue to focus on implementing our long-term strategic plan. In North America, we are reinvesting in 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 our activity levels and heavy oil projects. All 3 RDCs will have expanded valve and valve automation capabilities.
All of these 2013 North America 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 the 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 U.S.
sub-regions to support enhancements of both our sales and operation capabilities. Within our sub-regions, regional sales manager and operation manager positions have been added, to lead the local sales effort and the support of our customer needs, respectively.
Over the next 12 to 18 months, in mergers and acquisitions, we will be focused 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 U.S. MRO customers, like we did with Conoco Phillips in 2008, Shell in 2012 and Fellaini, so far, in 2013.
While these contracts take time to negotiate, I'm confident that we will be successful in these efforts. We are currently working on several large contract opportunities and still expect at least one to be signed in the second half of 2013.
While we're disappointed in the U.S. 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 the successful implementation of our global one-stop shop strategy.
We'll have a better outlook on that and we'll provide an update on the next earnings call. With that, we will now take your questions.
Operator
[Operator Instructions] And our first question comes from line of Matt Duncan with Stephens Inc.
Matt Duncan - Stephens Inc., Research Division
First thing I've got, I want to look at the guidance a little bit more, and I apologize, Andy, you gave a lot of detail there. I just want to make sure I've heard it all.
What rig count assumption is baked into the new guidance? What was in the old guidance?
And also on steel pricing, what are you guys assuming there versus what was in the old guidance?
Andrew R. Lane
Yes, Matt. The way that we are 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 U.S.
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, it actually went down during the second quarter.
So what we're seeing is a flat to maybe up 50-rig outlook for the back half. And it'll be late in the back half to more in the fourth quarter and definitely oil-focused.
On steel pricing, as you know, if 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%, it's 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 the past year, but still pressure on carbon pipe, both line pipe and OCTG for the back half.
Matt Duncan - Stephens Inc., Research Division
Okay. And on the OCTG trade case.
Are you guys assuming anything? Any impact from that on either price or volume later this year?
Andrew R. Lane
Yes, Matt. It's an important case.
It follows the successful case in 2009 and '10 with the Chinese Pipe. It's 9 companies and a case against 9 countries that are 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 at the low end of the market and stabilize pricing if they're successful in the trade case.
So you have that as a positive going into 2014. If successful, I think it puts the floor on pricing declines and maybe strengthens that lower end of the market, primarily the spot market with the imports.
But we also think you have a lot of volume in the U.S. capacity coming onstream in 2013 and 2014.
That offset that volume that potentially could be taken out of the market from the trade suit. So we think that's a moderating factor going into next year on pricing.
Operator
Our next question comes from the line of Allison Poliniak with Wells Fargo.
Allison Poliniak-Cusic - Wells Fargo Securities, LLC, Research Division
So Australia, obviously mining being weak, could you specifically just bring that out? I think you said it's $300 million in revenue, and I may have missed this.
How far down was that in terms of revenue this quarter? And just sort of what your view is over, say, the medium term in Australia?
Andrew R. Lane
Yes, I'll let Jim talk to the quarter. But let me give you a broader view.
We're still very pleased our Australian position. We're a clear #1 in that marketplace.
Two things are impacting us here in the short term: the mining pullback in the industry, and that's a smaller percent of our business, but it was an important aspect of the Australia market; and 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're seeing it in the stainless steel sales we have down there. But we still feel good about the market.
It's long-term, it's a very strong market for us. It also serves as a hub into more activity that's project-related in all of Southeast Asia.
So as Australia slows on us, we will also use our strength there as an Australian Southeast Asia hub to serve a broader market.
James E. Braun
Yes. Allison, the Australian revenues were $68 million in the quarter and they were down about $12 million, quarter-over-quarter.
Allison Poliniak-Cusic - Wells Fargo Securities, LLC, Research Division
Great. And then, Andy, you made a comment about focusing your acquisition activity internationally.
And I think just given the E&P spend, it certainly makes sense over there. Can you talk about sort of the multiples difference here versus internationally?
I mean, is there a noted difference there?
Andrew R. Lane
Yes, Allison. It's on the higher end of our multiples that we pay for a couple of reasons.
One, for the companies we're targeting, and the ones we've done so far, have been in the most attractive areas for us. And also, they've been heavily weighted towards valves, valve automation and also stainless products, so those are kind of premier distributors we've targeted.
But there's less competition in those markets. There's a few bigger players.
So like with Australia, with 3 acquisitions there, we became the #1 in the market. So we can move quicker to have a major position in some of those regions but the multiples tend to be higher in the range, more in the 5 to 7 range, trailing 12-month EBITDA, Jim and I have talked about previously, higher than our U.S.
bolt-on, but a lot more potential for us. And the areas are still very strategic for us, there's Southeast Asia, the Middle East and the North Sea.
And those 3, primarily, are where we continue to want to build out the full PVF platform and 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 3 areas.
Operator
Our next question comes from line of Jeff Hammond with KeyBanc Capital Markets.
Jeffrey D. Hammond - KeyBanc Capital Markets Inc., Research Division
Just to kind of go back to the guidance. It seems like your first guidance, because of the $300 million was focused on line pipe, and can you just give us about -- I mean, 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?
Andrew R. Lane
Yes, Jeff. Jim will talk you through that.
But I want to make a couple of comments about the guidance, overall, and I know how disappointing it is with the size of the changes. And I want to -- when you look back at the start of the year, 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 2 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 a broader general slowdown in spending, which it did turn out to be.
The first quarter, we had a lot of weather activity and that caused us some pause that pulled the original guidance down slightly. But 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've 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 in line pipe.
Of course, we had planned on the $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 expect to replace that $200 million in OCTG with additional line pipe sales. And just the opposite occurred, the weakness came in the midstream, some of it is isolated to 3 of our very largest midstream customers.
And so instead of replacing the OCTG outlook, we actually had a $200 million decline in line pipe, in our latest thinking. So that was -- I know these are big numbers, but that's 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, finally impacted and, really, at the end of 2012, and all through the first -- if you include July, all through the first 7 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.
And what'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. And Jim can give you more color now on the latest change in guidance.
James E. Braun
Yes, Jeff. The big adjustment was in the upstream business.
And 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. And as you know, the first half came in a bit weaker.
And where a lot of that growth was expected and planned, it was in the upstream business and we pulled that down. And as Andy mentioned, we see that consistent with the rig count expectations.
The midstream's 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. And on the downstream, downstream should do well.
We should see some growth there, not a whole lot of change in the downstream piece of the business.
Jeffrey D. Hammond - KeyBanc Capital Markets Inc., Research Division
Okay. And then just back on midstream.
As you kind of read the headlines and listen to others, it just seems like a market that's continuing to grow and people are talking about still a robust kind of spending environment or, at least, of stability at high levels. So I'm just trying to understand the disconnect.
Is it customer specificity? Is there some inventory drawdown?
Is there some share shift? I mean, help me understand kind of the disconnect between the magnitude of your cut versus what maybe, more broadly, people are saying.
James E. Braun
Yes, Jeff. Let me start, Jim may have some color to add.
We're very strong believers in midstream infrastructure spend over a longer-term cycle here. And we're also in a very, very strong position in that segment both from line pipe and valves and the fittings and our track record there.
We talked about in the script, the gas utility side, like NiSource in the east and PG&E in the West Coast, very strong for us. In the script, we talked about the gas utility segment being up to 12%.
So that's a real bright spot and that matches probably exactly what you're hearing from utilities that have both a new investment program and a modernization program going. So we're 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, 6 of our largest customers, and this may be more specific to MRC, but 6 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. And many of them are well-documented.
Chesapeake's reduction in upstream spending, as tied to Access midstream, which spun out, has used to be Chesapeake Midstream, now Access Midstream, but closely tied today through the current activity levels with Chesapeake. That spending has come down conservatively for us and that's a top 10 customer for us.
And then tied to that is another one, Williams. And Williams and Access have -- I've looked at different business opportunities there.
I think that's well-publicized. So when we look at that whole sector and our top midstream customers, and the third one in midstream that I want to reference is, briefly, is DCP Midstream.
Very active, hugely active for us in 2012, and still very active in '13, but at a lesser degree than they were in '12. So when I look DCP and what's going on with Williams and Access Midstream, and 2 of them tied to what's going on with Chesapeake, that's a big part of our pullback.
So it doesn't necessarily represent a big pullback in the smaller MLP budget, but in our core midstream customer base. And another one that we need to mention is Shell.
While we have won the global contract, we've overestimated the pace, the ramp up, our inventories and the ramp down, the current holders' inventories. So in an expectation of more growth coming from Shell in 2013, we're just not seeing it.
And we're 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.
And then the other one that's impacted both our midstream and upstream is the lower spending at Hess, which is also a top 25 customer. So those things are important.
There's 6 of our top 25 customers that are important to us and we have not been able to replace the drop in their activities with pickup in the smaller MLP marketplace. But what we talked about in the script was some changes we made, both structurally and personnel in sales focus on that group.
And we think that'll yield us some better returns. And then we haven't lost share.
We haven't lost contracts. We just can't control the spending levels on some of our major customers at this point.
Operator
Our next question comes from the line of Ryan Merkel with William Blair.
Ryan Merkel - William Blair & Company L.L.C., Research Division
So, I mean, I think the biggest question of today is, is the guidance conservative enough? And you gave a lot of detail, but I'm just wondering how you thought about it.
So 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 to how you thought about it and is this conservative enough?
Andrew R. Lane
Yes, Ryan. And it is conservative enough.
And when Jim, as you know, we've spent a lot of time trying to make sure that we got this guidance exactly right for you, and that's because of all the volatility in the marketplace this year. And the way we look at it, we have July, we just finished July, so we have preliminary results there.
And when I look at the marketplace, June was the best month of the second quarter but much below than what we expected in both May and June. July is kind of flat to slightly up from June.
So as Jim said, the marketplace is not near as robust in upstream and midstream as we thought. We thought we had double-digit growth on the previous guidance from the back half.
So when you look at the first 7 months, including preliminary July, and we look at our activity levels, and we gave a lot of guidance on OCTG and line pipe and in the marketplace and our outlook on the 3 end markets, we feel the most likely scenario, because that's the midpoint of our guidance, is $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 U.S.
market. And 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 slowdown in the end of spending in late November or 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're underestimated in the U.S.
than there are some signs, but not a great deal of signs, that it will pick up more than we expect. And that's basically a 6% growth in the back half, over the first half.
So it's not an exact science, but where doing our best to give you everything the way we're looking at the marketplace. But of course,, our comfort level is the highest that we're 7 months, already behind us.
Basically with the outlook for the next 5 months ahead of us, we feel the $5.2 billion is the right target.
Ryan Merkel - William Blair & Company L.L.C., Research Division
Okay, very helpful. And then, second question, you had kind of a long list of headwinds, some seem temporary, some might persist.
But the one I want to key on was this, it's the idea that truck and rail to transport oil has kind of been a headwind. What does that mean to your business going forward?
And any sense of when that might change?
Andrew R. Lane
Yes. It's unique to the Bakken, although there is some in Texas happening.
Part of it is -- Ryan, part of it is related to the delay in permitting. We've got a lot of wells and we hear about from our customers that are WOLP, waiting on line pipe.
They're waiting on the pipeline. And so the permitting is a big part of that process.
They haven't been as fast to permit the lines. So the stopgap measure has been the use of rail, primarily for shipping oil, and primarily from Bakken moving it East and West, then also some repositioning of oil on the Gulf Coast.
I think it's 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. But 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.
And the pipeline infrastructure will get put in place both in the Bakken and the Gulf Coast, and the Permian to the Gulf Coast. And so we see that coming.
I don't believe there's this dramatic shift away from pipeline, storage, rail. And rail is not without risk, as everyone knows.
Operator
Our next question comes from the line of Sam Darkatsh with Raymond James.
Sam Darkatsh - Raymond James & Associates, Inc., Research Division
Two questions, if I might. First, and you referenced that, I believe, in your earlier -- line pipe industry pricing, at least from what we're looking at is, down, I guess, about 16 months in a row, sequentially.
The line pipe industry tonnage, though, was only down about 5 or 6 months in a row, which suggests that pricing led on the way down. In your experience, Andy, which turns first on the way back up?
Would it be pricing or tonnage? And why?
Andrew R. Lane
Yes. And 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. And that's been the way it is and tonnage falls the fastest.
And then prices, in a more dramatic shift, prices fall dramatically behind that. If there's a big adjustment.
But what we're seeing is a gradual slowness in demand and, as you said, the 16 months in a row of softening in the spot pricing, now it has slowed some, but what we've done there is also, we are very tied to the major customers and that's great when things are growing, but it also impacts us when they slow some of their spending. But we're in a very strong position, both in line pipe and in OCTG and our months of supply and our inventory management.
And we'll be very quick to take advantage when we see that pricing has troughed and we see an upturn in spot pricing, we will use that opportunity to buy smart at that point. And we've done some of that as we've gotten in this recent pricing decline.
So we have, as we stated, only $83 million in inventory, which is basically 2 to 3 months supply in OCTG, so we're managing that tighter than we ever have. We feel good there from an inventory and costing standpoint.
And also, we feel good about our stainless and our DSO line pipe positions, with the most pressure being on TRW carbon pipe. But it's something that has to the managed every week and we pay very close attention to both the tons and the pricing and when's the right time to buy and when's the right time to pull our inventories lower.
Sam Darkatsh - Raymond James & Associates, Inc., Research Division
Second question on the income statement, Jim, you mentioned SG&A in the third and fourth quarter could be around $158 million to $160 million. I think your gross profit dollar guidance, suggests that gross profit, sequentially, in the back half, were really -- 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'll be actually spending more in OpEx than you would be when your run rate on an adjusted basis in Q2, why would that be? Why the deleverage in OpEx spending, particularly, based on the fact that you now know what the slope of demand is compared to before where it did surprise you a bit?
James E. Braun
Yes, you're exactly right, Sam. And again, that's kind of the high end of our expectations.
We should see some opportunities to improve on that. So that's 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. But there's potentially some upside on the operating expenses you described.
Andrew R. Lane
Sam, I'll just add a comment. We're big believers in our position in the marketplace, and while we are very disappointed in the last couple of 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.
So we are investing in additional sales and sales focus and outside sales reps and inside sales reps in our major oil basins in the U.S. And we know it's tough right now at this point to add SG&A expense, but we strongly believe that that's the right thing to do because we want to be even stronger positioned from a customer-facing standpoint in those markets that we think we can be strong, for sure, in the years to come, as an oil-based market.
Operator
Our next question comes from the line of Luke Junk with Robert W. Baird.
Luke L. Junk - Robert W. Baird & Co. Incorporated, Research Division
Andy, first question for me would be, really, a bigger picture question. I know, as we've gone through 2013 here, we continue to hear more and more about pad drilling in the upside sector -- in the upstream sector, excuse me.
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?
Andrew R. Lane
Yes, Luke, the pad drilling is very -- growing the segment, you see -- but it really impacts the drilling contractors and the oilfield service equipment companies a lot more than it does us. Because 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, it moves small amounts and drill effectively in the wells on a pad. So all that's 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 tube and encasing that goes with the shale well, 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 valves from our pad versus discrete wells.
Luke L. Junk - Robert W. Baird & Co. Incorporated, Research Division
Okay, helpful. And then a follow-up question for me would be on the gross profit enhancement initiatives.
Just the gross margin did come in, nicely above we were looking for this quarter and I realize some of that is, obviously, due to product mix. But just curious, maybe, Jim, if you could talk about some of the biggest levers that you've been able to pull in that side of things?
James E. Braun
Yes, 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 our margin opportunities with those customers, where we don't 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 largest customers.
That's certainly been one of the bigger things. You mentioned the product mix.
We've seen the benefit of that in the Oil Country Tubular Goods. And 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 opportunity for market price with our suppliers.
Andrew R. Lane
Luke, Jim covered all the key -- I would just add, the product mix is a fundamental long-term shift for us. Now, it's caused us a lot of pain to go through the reduction in revenue with the OCTG in the last couple of quarters and communicating that.
But we targeted 8% to 10% when we announced this in the end of 2012, of our revenue would be OCTG, we're at 9% at the end of the second quarter. And that's our long-term position and 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.
So both from an acquisition standpoint, internationally, where the gross margins are higher, from a valve position. So we're targeting additional companies to join that will bring in enhanced margins.
And then the mix change has been a dramatic shift for us. Despite the turmoil, we're in the best position, we are on our weighing of carbon pipe, both the OCTG and line pipe for the remainder of our products than we've been in for 5 years.
So it was hard to get to this point, but this is the platform to grow from.
Operator
Our next question comes from the line of William Bremer with Maxine.
William D. Bremer - Maxim Group LLC, Research Division
Can you touch upon a little bit, subsequent to the quarter, you mentioned July is flat, a little bit up from June. And then 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?
Andrew R. Lane
Yes, Bill. Well, 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 and the midstream valves that go with that, valves on a more global perspective, is still doing very well. Our fittings and flange businesses, still doing very well.
Probably one of the best performers was our gas products, our poly pipe and that's tied to the uptick in our gas utility business that we talked about. So those are all positives.
Stainless steel was a mixed bag, some positives in the U.S. and chemical, but also a slowdown in Australia that offset that.
So from a product line, I think that's a good general review. And then, yes, when you look at July, July is better than June, April was the low point for us.
May was a little better. June was the best month of the quarter.
And in July, it's just a little bit better than June, but not near the pickup that we've expected. So it's in the positive direction, which ties to our 2% guidance increase for the back half.
But 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.
William D. Bremer - Maxim Group LLC, Research Division
Yes, I think that's important to note because 2 of these specialty contractors reported the last couple of days, both very, very strong backlog figures, quarter-to-quarter. And more importantly, both of them called out midstream products, as well as continued downstream almost running at full capacity.
And that's sort of being echoed here. So I guess, is that sort of -- is that sort of in sync to what you're saying?
And then what we really need to see is the upstream turn?
Andrew R. Lane
Yes. Bill, that's exactly in sync.
The upstream has to turn but we're 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 strong pricing on oil.
And if that materializes into increased spending at the end of the third quarter into the fourth quarter, that would be the positive for upstream. We do like -- and that's 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's 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. So we're muted a little bit on that.
But we see that is the potential upside. And then, downstream, we didn't talk too much about it but we will have a better second half in both refining and, with the turnaround activity, in chemical.
We will have a good second half in Canada because the fourth quarter will be very strong for us this year, again. And then international, we expect that we hit the low point in Australia activity and we expect that pickup.
So I think from just a high level, we're very much aligned with what you're seeing from the others.
Operator
Our final question comes from the line of Matt Duncan with Stephens Inc.
Matt Duncan - Stephens Inc., Research Division
Andy, I just wanted to follow-up on the prepared comments you had on a global supply contracts. I think you said, you'd expect to close one in the back half of this year.
I think last quarter, you would have expected that maybe in the third quarter. Is the timing on that contract slipped some?
And if so, what's causing that?
Andrew R. Lane
Yes, Matt, and that's a good point. I've probably should have expanded a little bit more on that.
I did say in the third quarter on the last 2 calls. They're tough to time exactly.
It's not in our control. It's really in our customer's control and final negotiations and then contract amendments and they're roll outs to their own organizations.
What I -- I will tell you is it's getting even better and I'm even more confident that we'll have a large one in the second half, we said now, because it might not be -- August and September might be a little bit later than that. But when I talked about having one big new contract on top, Fellaini was a smaller one, but a nice one.
When I talked about that, we were talking on 2 contracts. We're now in discussions on 4 contracts.
So 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 1 quarter, or definitely more than 2 quarters ago, talking about much broader contracts with us.
And I'm optimistic that we're in the best position in the marketplace to capture that right now. It's at 100% alignment with our strategy and the 4 costumers we're talking to are all major players in the industry.
So that trend continues the trend that we said, if will 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.
Matt Duncan - Stephens Inc., Research Division
So Andy, on those contracts, are they all looking like they could be exclusives? Are there some that you might be one of -- one or 2, or a handful of providers on those?
And on the one that you had thought might be on the third quarter, but now sounds like it could end up being in the fourth, is that slipping partially because it sounds like maybe it's getting bigger and there's more going into it? Or -- I just want to understand a little bit better.
Andrew R. Lane
Without giving too much detail, some of those we've already captured some additional scope through contract amendments, but we're waiting for the -- a broader scope contract. And so that's why it's sliding, but we've already picked up some areas that we'll talk about in the third quarter on those contracts.
But one, at least one of them is not exclusive and some will want to do broader contracts but want to keep 2 players out there. And some are talking much more exclusive for the main core product lines that we do.
So they'll take different forms. Most important thing to me whether -- because we don't mind, we love the exclusive, but if it's not exclusive, then we have to compete day-to-day to take a flexible share, we usually do very well in that environment.
But the bigger thing for me is it's picking up momentum with our large customer base that a broader scope platform is the right way to go.
Operator
At this time, I'd like to turn the conference back to management for any final remarks.
Andrew R. Lane
Yes, I want to thank all of you for joining us today and look forward to talking to you on our next call.
Operator
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