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MRC Global Inc. (NYSE:MRC)
Q3 2018 Earnings Conference Call
Nov. 1, 2018, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, greetings, and welcome to MRC Global third quarter earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the program, please press *0 on your telephone keypad. As a reminder, this conference is being recorded.

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

Monica Broughton -- Investor Relations

Thank you, and good morning, everyone. Welcome to the MRC Global third 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 November 15, 2018. The dial-in information is in yesterday's release. We expect to file our third 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, November 1, 2018, and therefore, you are 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 securities filings to learn more about our use of these non-GAAP measures and to see a reconciliation of these measures to the related GAAP items, all of which can be found on our website.

In addition, the comments made by the management of MRC Global during this call may contain forward-looking statements within the meaning of the United States federal securities laws. These forward-looking statements reflect the current views of the management of MRC Global. However, MRC Global's actual results could differ materially from those expressed today. You are encouraged to read the company's SEC filings for a more in-depth review of the risk factors concerning these forward-looking statements.

Finally, please note that references in our prepared remarks to year-to-date mean the first nine months of the year that we are referencing. And now, I'd like to turn the call over to our CEO, Mr. Andrew Lane.

Andrew R. Lane -- President and Chief Executive Officer

Thank you, Monica. Good morning, and thank you for joining us today. I'm going to start with a discussion of the state of our company, and the current dynamics in our three end sectors. Then I'm going to cover our outlook, and Jim will then cover the third quarter financial results in detail.

I'm very pleased with our $1.07 billion sales for the quarter, which represents 12% growth from the third quarter of last year. It also marks the third quarter in a row where we have achieved more than $1 billion in revenue. In the quarter, we had been expecting an additional $21 million in project-related sales, which has now moved to the fourth quarter. Nevertheless, it was a very strong third quarter sales performance.

Following our 20% top-line growth in 2017 compared to 2016, this second year of the oil-and-gas recovery is evolving exactly as we expected it would, as we are on pace for an additional 15% growth in 2018 compared to last year. Total E&P capital spending declined 50% in 2015 and 2016, and after 2018, we will have recovered 38% in top-line growth from the oil-and-gas cycle bottom in 2016.

Now looking at our three sectors. First, upstream continues to be a bright spot for us, with higher oil prices driving increased customer spending, particularly in the U.S. The primary driver of our U.S. upstream business is well completions. U.S. well completions were up 26% in the first 9 months of 2018, as compared to the same period last year. Our U.S. upstream sales matched this increase, as they were up 25% over the same time period. Globally, our upstream business grew 23% over the same time period.

From a geographic standpoint, the Permian Basin remains our highest growth area, with combined upstream and midstream revenue up 62% year-to-date 2018, compared to the same period in 2017. It's up 52% for the third quarter of this year, compared to the third quarter last year, and up 20% sequentially from the second quarter of 2018. Overall, due to our diversified business model, the Permian represents 8% of our total year-to-date revenue.

In the third quarter, we continued to add new scope to our customer contract in the Permian with a large independent operator, and renewed our MRO contract with our second largest upstream customer in Canada. Second, our midstream year-to-date 2018 revenue is up 6% compared to the same period in 2017. We had a $50 million pipeline project in Australia in 2017 that didn't repeat. The U.S. midstream business is up 10% year-to-date compared to the same period in 2017, with gas pipeline work in the Northeast being strong early in 2018, but slowing in the second half of the year, while oil-and-gas pipeline work in the Permian will be active through mid-2019.

In line pipe, the Section 232 steel tariffs have had a big impact, as market prices started 2018 at an average price of $1,500 a ton, and we leveled off at a price of $2,000 a ton in the third quarter. We remain in a strong position in line pipe, with our strategic pre-tariff inventory buys in early 2018. In the third quarter, we added four new midstream MRO contracts.

Finally, in downstream, our 2018 sales are up 23% year-to-date, compared to 2017. The growth in our downstream business is led by the U.S., which grew 30% year-to-date, with increasing revenue from MRO contracts won in 2017, ramping up activity throughout 2018 and a major petrochemical project in Pennsylvania. In the third quarter, we had an active turnaround season in the U.S. with some project revenue moving into the fourth quarter. We increased activity this quarter with some of our large refining customers under recently renewed agreements, including with the largest independent refiner in the U.S. and a major integrated customers. We also added a new refinery contract in the Western U.S.

Now moving to profitability, I'm very pleased with our adjusted gross profit margin of 20.1% in the third quarter, and our year-to-date improvement to 19.5%. Adjusted gross profit margin of 20.1% is the best quarterly result since the first quarter of 2013. This improvement is the result of our multi-year strategy to change the product mix to a valve-centric business model. The positive impact of the current inflationary environment, and our pre-tariff purchases of carbon pipe, fittings and flanges, valves, and stainless products.

Now on costs, our 2018 SG&A was 13.1% of sales in both the third quarter and year-to-date periods, a decrease from 13.6%, and 14.1% in the comparable year-ago period. 2018 revenue is up 15% year-to-date, compared to 2017, while our global headcount is currently at 3,568, up 128 or 4% since the end of 2017. SG&A as a percentage of sales around 13% should be a sustainable level for us. Hiring gross profit margins and a disciplined SG&A cost strategy have led to a 16% improvement in 2018 year-to-date adjusted EBITDA over 2017 to $217 million. Our year-to-date incremental adjusted EBITDA percentage is 19.3%, and for the third quarter, it is 21.4%. The U.S. segment achieved adjusted EBITDA margin of 8.5% in the third quarter, the highest since the third quarter of 2013.

Our net income available to common stockholders has improved from a loss of $3 million for the first 9 months of 2017 to net income of $46 million and $0.50 per diluted share for the first 9 months of this year. The improved profitability and the lower U.S. corporate tax rate are driving this improved bottom-line result. I am also pleased to share that our Board of Directors authorized a $150 share repurchase program last week. This is the third share repurchase program we have implemented since 2015, having previously repurchased $225 million of shares. The latest authorization allows the customer to opportunistically buy shares in the open market and is set to expire on December 31 2019. The company is in a strong position to be able to repurchase shares, as well as continue to grow. As is customary, we will report quarterly on any share repurchase activity.

Now some final comments on the outlook for the fourth quarter. Normally, our business experiences seasonal declines in the fourth quarter from the third quarter of mid- to high-single-digits. This year, with some budgets being spent more aggressively in the first three quarters of the year in the U.S., we would be at the high end of that range. However, the delayed project revenue from the third quarter will somewhat this impact. The net impact is an expected sequential decline from the third quarter of 2018 to the fourth quarter between 4% and 7%, resulting in fourth quarter revenues in excess of $1 billion.

Our September 2018 backlog is $730 million, down from a year ago and from the second quarter. This is primarily reflective of the winding up of some of the major customer projects we have been delivering on over the past two years. In addition, we have continued to shift our focus to higher margin line pipe business, often sacrificing top-line growth for improved gross profit margins, which now leads me to our outlook for next year.

Based on our preliminary analysis of early estimates and customer spending surveys and considering about a $300 million reduction in expected project revenue in 2019 versus 2018, as major projects in each of our sectors wind down this year, we are currently expecting low to mid-single-digit revenue growth next year, with a slower start to the year, and higher spending in the back half of the year. However, we expect the reduction in project and low-margin revenue to have a positive impact on our gross profit percentage.

Keep in mind that we have yet to see final customer capital budgets for 2019, which is always a key input for our budgeting and forecasting process. I wanted to give you some additional color around how I think the next year could develop. As is our customary practice, we will provide complete 2019 guidance on our February 2019 earnings call, when it is clearer what our customer spending plans are for the next year. With everything I just discussed, I feel we are performing very well in the second year of the recovery.

I look forward to finishing 2018 on a strong note and then look to 2019, which I expect to be a third year of growth for the industry, and for MRC Global. No one has the broad, diversified MRO customer contract positions or the experienced management team and employee base that MRC Global possesses. We remain uniquely positioned in the PBF distribution space across all three energy end markets to continue to take advantage of the favorable long-term trends in energy infrastructure investment. With that, I'll now turn the call over to Jim to cover the third quarter results in more detail.

James E. Braun -- Executive Vice President and Chief Financial Officer

Thanks, Andrew, and good morning, everyone. Total sales for the third quarter of 2018 were $1.71 billion, 12% higher than the third quarter of last year, driven by our upstream and downstream sectors. Sequentially, revenue decreased 1% from the second quarter, as project deliveries were delayed and pushed out of the third quarter.

Beginning with our largest segment, U.S. revenue was $859 in in the quarter, up 13% from the third quarter of last year, led by downstream sector, and closely followed by upstream. U.S. downstream sector benefited from $14 million more in project deliveries for Shell's Pennsylvania polymers project, increased maintenance and repairs from turnarounds and outages, as well as market share gains from new and expanded contract customers. In total, the U.S. downstream was up 29%.

The U.S. upstream business increased $49 million or 30% from the third quarter last year, as well completion activity increased, driven primarily by increased activity in the Permian, where revenue was up 63% furthermore the third quarter of last year. Our U.S. upstream growth outpaced the overall increase and EI well completions in the third quarter due to our customer and geography mix. Our midstream activity decreased slightly at $3 million or 1%, primarily due to a decline in non-recurring project work for TransCanada. Excluding this project, which is classified in our transmission and gathering subsector, our U.S. midstream business grew 6%.

Revenues from gas utilities declined 3%, primarily due to large line pipe deliveries in the third quarter of 2017. Sequentially, U.S. segment sales were down from the second quarter by 2%, primarily due to midstream TransCanada project work, partially offset by increases in the upstream sector from increased completion activity and downstream from turnarounds in market share gains.

Canadian revenue was $78 million in the third quarter, up 1% from the third quarter of last year. Canadian activity continues to be somewhat muted, as spending lags due to oil price differential and capacity constraints. The Canadian segment was also negatively impacted by $3 million from weakness in the Canadian dollar against the U.S. dollar in the quarter. Sequentially, Canadian revenue declined 3% due to lower upstream activity.

In the international segment, third quarter 2018 revenue was $134 million, up 9% from a year ago. Sales were higher due to upstream project deliveries in Kazakhstan, partially offset by a decline in the midstream sector from a recurring pipeline project in Australia. The international segment was also negatively impacted by $3 million from foreign currency weakness against the U.S. dollar in the quarter. International revenue was also up 9% sequentially from the second quarter of 2018.

Now turning to our results based on end sectors. Compared to the same quarter a year ago, upstream and downstream sales grew double digits, while midstream was lower by 3%. Starting with the upstream sector, third quarter 2018 sales increased 26% from the same quarter last year to $338 million, driven primarily by higher well completions in the United States, particularly in the Permian, as well as increased project deliveries to Kazakhstan in our international segment.

Downstream sector third quarter 2018 sales grew 23% from the same quarter last year to $311 million, driven primarily by the U.S. downstream as described earlier. Midstream sector third quarter 2018 sales declined by $15 or 3% from the same quarter last year to $422 million. The decline was primarily related to a 2017 line pipe order for a major pipeline project in Australia, and to a lesser degree, lower sales in the U.S. Both U.S. midstream subsectors were down due to nonrecurring project work as discussed earlier. Excluding these two major items in our transmission and gathering subsector from both comparable periods, our midstream business increased by 6% in the third quarter 2018.

Now turning to margins, gross profit percent increased 30 basis points to 16.1% in the third quarter of 2018, from 15.8% in the third quarter of 2017. LIFO was a headwind for the quarter, as we recorded LIFO expense of $26 million and $13 million in the third quarter of 2018 and 2017, respectively. Despite the larger LIFO expense, we were able to grow gross profit percentage due to our favorable inventory cost positions. Given the inflationary environment, we now expense our LIFO expense to be approximately $64 million for the full year.

The adjusted gross profit percentage was 20.1% in the third quarter of 2018, up from 19% in the third quarter of 2017. The increase in adjusted gross profit percentage reflects the positive impact of the inflationary conditions mentioned earlier, and the favorable product mix including less low-margin project work. We expect our favorable inventory costing position to continue into the first half of 2019.

As noted, we've seen inflation in line pipe prices, which have increased considerably in 2018. Based on the latest Pipe Logix All Items Index, average line pipe spot prices in the third quarter of 2018 were 29% higher than the third quarter of 2017, and only 1% higher sequentially. Pipe inflation has leveled off as the market has adjusted to the tariffs and quotas.

SG&A cost for the third quarter of 2018 were $140 million, an increase of $10 million or 8% from $130 million a year ago, due primarily to wage and incentive increases, and volume-related increases from higher activity levels. As a percentage of sales, SG&A fell to 13.1% from 13.6%, as revenue growth exceeded increase in operating expenses. Sequentially compared to the second quarter of 2018, SG&A expense was up $4 million, due to higher personnel and operating cost. Interest expense totaled $10 million in the third quarter of 2018, which was $1 million higher than the third quarter of last year, primarily due to higher average debt balances.

Our tax rate for the third quarter was 0%, resulting in no tax expense, as we recorded a $6 million benefit related primarily to a favorable adjustment to the 2017 provisional tax amounts related to the new tax law passed last December. Consequently, we now expect the full-year 2018 annual effective tax rate to be closer to the statutory rate of 21%. Our third quarter 2018 net income attributable common shareholders was $18 million or $0.20 per diluted share, as compared to a loss of $3 million or $0.03 last year.

Adjusted EBITDA in the third quarter was up 43% to $80 million, versus $56 million in the same period a year ago. Adjusted EBITDA margins for the quarter were 7.5%, up from 5.8% a year ago, for a 170 basis point improvement. Incremental adjusted EBITDA was 21.4% for the third quarter 2018, over the same quarter a year ago, well above historical levels, as adjusted gross profit margin improved and operating expenses were aggressively controlled.

All three of our segments generated positive adjusted EBITDA this quarter, including international, which continues to benefit from the cost reduction and restructuring actions taken at the end of 2017. Our working capital net of cash at the end of the third quarter of 2018 was $962 million, $262 million more than a year ago, and $254 million more than at the end of 2017. As a result, at the end of the third quarter 2018, our working capital, excluding cash, as a percentage of trailing 12-month sales, was 23.7%, above our 20% target. However, we expect to get closer to the 20% range by the end of the year as our inventory levels begin to decline in the third quarter.

We used $7 million of cash from operations in the third quarter of 2018, which was down from the second quarter of 2018, where we used $65 million. This indicates a slower pace of building working capital in the third quarter. An expected seasonal slowdown in the fourth quarter should resulting in operating cash inflows. As such, as expect that we will generate cash from operations in the fourth quarter of 2018, but we will end up in a use of cash position for the full year of 2018.

Our debt outstanding at the end of the third quarter was $719 million, compared to $526 million at the end of 2017. Our leverage ratio based on net debt of $690 million remained at 2.7x, the same as it was at the end of last year. The availability on our ABL facility was $418 million at the end of the third quarter, and we had $29 million in cash. Capital expenditures were $6 million in the third quarter, and $15 million for the first 9 months of the year. We also received $6 million in proceeds from the sale of our Darien property, which was vacated when we moved into our new facility in La Porte, Texas. With that, we will now take your questions. Operator?

Questions and Answers:

Operator

Thank you. Ladies and gentlemen, we will now be conducting our Q&A session. If you would like to ask a question, please push *1 on your telephone keypad now. A confirmation tone will indicate your line is in the question queue. You may press *2 if you would like to remove your question from the queue. For any participant using speaker equipment, it may be necessary to pick up your handset before pushing the * key. Please ask one question and one follow-up question, and then requeue for any additional questions after that. One moment while we poll for questions.

Our first question comes from the line of Sean Meakim from J.P. Morgan. You are now live.

Sean Meakim -- J.P. Morgan Securities -- Analyst

Thank you. Good morning.

Andrew R. Lane -- President and Chief Executive Officer

Good morning, Sean.

Sean Meakim -- J.P. Morgan Securities -- Analyst

For Andy, you got line of sight now to that 8% margin we've been talking about the last few years. Things are right on schedule. 25% lower revenue than prior cycle peak, just as you said it would. We've also talked about shifting 8% from being viewed as peak of the cycle to maybe mid-cycle. I'm wondering if you have a framework on what it takes to get to 10% margins? I'm not trying to get ahead of ourselves. I know it's not necessarily a 2019 story, but is 2014 peak revenue of $6 billion a good bogey for that type of profitability or could it be somewhere in between the two? How do you think about that?

Andrew R. Lane -- President and Chief Executive Officer

Yeah, Sean, I've been really focused on that over the last couple years. I'm pleased with where we are because, as you know, we peaked on the old business model at 8.3% in 2012, and we're on a very good pace for 6.8%-6.9% this year. I felt with the changes in the model and the focus on higher margins that, as you said, we can reach peak EBITDA margins at $1 billion less revenue than the last cycle. I still feel that way. When you look at the performance in the U.S., very strong at 8.5%. Peak back in 2012 was 9.7%, and our product profitability mix is much better this cycle, as you've already seen. I think we can get back.

We still have good runway to increase EBITDA percentage in the U.S. as the market continues to increase in spending and we leverage our business model that's valve-centric now. I'm really focused on getting us back to mid-cycle EBITDA performance in 2019. It's been Jim's and my goal for a couple years now. We've really been targeting 2019 for that accomplishment. I still think we're on track for that, even with maybe a slow start in the first quarter with our shift to more MRO next year and all of our segments on inventory purchases and product line sales.

I think we're going to get in at least the bottom of that range and maybe better. It depends on how much spending comes in, but that's been the target for multiple years I've talked about. We're still on track for that for next year.

Sean Meakim -- J.P. Morgan Securities -- Analyst

Thank you for that. Yeah, I think that makes sense. Maybe just a follow-on. You mentioned the shift toward more MRO. I think in the prepared comments, mid- and downstream you highlighted the big slug of projects that's winding down here. I think that a project cliff is probably the No. 1 pushback I hear from investors, especially in midstream. This CapEx cliff. It seems like it's been on the horizon for a decade now, but it never really materializes. Maybe you can help us peel back the onion a bit. I think investors would like to understand better how you're able to backfill some of those projects in terms of the revenue you expect to generate in '19. How do we get from Point A to B? I think people would like to learn a little more about that.

Andrew R. Lane -- President and Chief Executive Officer

Okay, Sean. Good. Let me address that. There's three major projects we've been talking about for over a year now. One is midstream and that was really and accelerated buildout and project spend on gas pipelines for TransCanada in the Northeast of the U.S. So that's a $100 million drop from '18 to '19. The other $100 million drop is downstream, same Northeast U.S. for Shell polymer on the petrochemical plant. These are big projects that we played a big role in, done very well with them, but that one also is winding down in '19. So that's the second $100 million. Then the third $100 million is an upstream project, future growth project with Chevron TCO in Kazakhstan. Also a very good project for us. But those three, all very different projects. All where we played big roles. Winding down in '18. That's the whole for '19 from a project basis.

But in parallel to that, we've really been focused on MRO and expanding contract scope, renewing contracts, and we're doing very well on that. So projects tend to be larger around top-line growth for us, but less on the bottom-line contribution. So we're pivoting more toward smaller projects, projects with fabricators. If you look at our U.S. fabricator base, which is small cap projects, we don't talk a lot about that, but we serve 200 fabricators in the U.S., and our revenue there this year is forecasted to be $375 million, growing by 20%.

So part of replacing the large-cap projects is more group in the small cap projects and fabricators, which our margins are much better than the megaprojects that we referred to. Also, you're going to really see the strength of our profitability in our MRO model next year, because we're going to be primarily an MRO-focused business next year. So, growth in projects, the markets going to grow. If you do the math from where we think we'll end up this year, less the $300 million in projects, double-digit growth in spending next year, and we exceed that with our contract position, so you get to the overall guide we gave, at least preliminary guide for next year.

Sean Meakim -- J.P. Morgan Securities -- Analyst

That's very helpful. Thanks for walking through that.

Andrew R. Lane -- President and Chief Executive Officer

Thank you, Sean.

Operator

Thank you. Our next comes from the line of Nathan Jones from Stifel. You are now live.

Nathan Jones -- Stifel, Nicolaus & Company -- Analyst

Good morning, everyone.

Andrew R. Lane -- President and Chief Executive Officer

Good morning, Nathan.

Nathan Jones -- Stifel, Nicolaus & Company -- Analyst

Just following up on a few other things there. You talked about getting to 8% EBITDA margins, maybe on $5 billion of revenue, rather than $6 billion of revenue. I was taking a look at the SG&A line here. I think in your prepared comments, you talked about 13% being a sustainable level, but if we go back a few years to where your previous peak EBITDA margins were, those were down at 11%, slightly under 11%. Is there a reason why we couldn't see that SG&A number get back down toward that 11%? Is there some of the structural changes that you've made in the business model that require some higher SG&A to support?

Andrew R. Lane -- President and Chief Executive Officer

Yeah, Nathan. Let me start and Jim can add some comments too. I would say a couple things. I think my comment about 13% sustainable is really a '19 comment. I think as we continue to leverage spending increases that we expect in 2020, I think we could get down to 12%. I think there's a slight difference that you're referring to. When we had a real carbon-heavy OCDG was a low-margin business, it had low SG&A to support it. Lots of top-line growth back in the previous cycle. So we don't have that model. Higher-margin business. We have more technical content and personnel, plus we've had inflation in personnel costs, especially in the Permian and other areas in the Gulf Coast, where as the business picks back up.

Some of this is a little bit of inflation impact on costs. Some of it's a little bit in the change of our model to high-end, value-added technical services instead of low-value-added commodity sales in OCDG. But I certainly think we have some more leverage. I wouldn't say it sticks at 13%. I think we have some room in 2020 to do even better.

Nathan Jones -- Stifel, Nicolaus & Company -- Analyst

Gotcha. So some of this a little bit of the puts and takes that have to do with a little bit of a somewhat lower growth rate on revenue in 2019, so less revenue to leverage those costs across? Or less growth in revenue?

Andrew R. Lane -- President and Chief Executive Officer

Exactly, Nathan. If spending turns up more positive in the U.S. especially, in 2019, especially in the last three quarters, we'd be able to leverage that to a little better result too.

Nathan Jones -- Stifel, Nicolaus & Company -- Analyst

Got it. That makes sense. I wonder if I could get a little bit more color on some of the margin impacts from the absence of some of these large projects. You said you're going to be more focused on MRO, larger projects have lower margins. Is there any color you can give us around what the margin differentials are or what kind of tailwind that might be to gross margins in 2019? I've got to figure that's primarily where it's going to hit for you, but any kind of color you can give us around that?

Andrew R. Lane -- President and Chief Executive Officer

Yeah, Nathan. Let me give you some general comments, and we'll get more specific in February. But the way I look at the business, it's been a couple year transition. Adjusted gross profit percentage is what I'm going to talk to. 17% in '16, and 18.6% in '17. Some of this transitioning to the new model. Then this year we've had steady improvement. 19.1% in the first quarter, 19.3% in the second quarter, 20.1% in the third quarter. I would say the fourth quarter, some of that project billing that slid from the third quarter into the fourth will be, we're 19.5% to 19.75%. We'll be above that in the fourth quarter. Jim and I certainly expect with a shift to less projects and more MRO focus, as we finish this year, adjusted gross profit margin will be higher than that in 2019. And we'll be more specific on the February call, when it's clearer.

James E. Braun -- Executive Vice President and Chief Financial Officer

Nathan, just to give you a little color, but again, relatively overall company average, which as you know in the quarter was 20%, these $300 million of projects, these are margins that are down closer to the 10% to 12% range. So it certainly has an impact as you look at the mix of revenue going forward.

Nathan Jones -- Stifel, Nicolaus & Company -- Analyst

That's helpful. Thanks very much. I'll pass it on.

Operator

Thank you. Ladies and gentlemen, as a reminder, if you'd like to ask any questions, please push *1 on your telephone keypad now. Our following question comes from the line of Steve Barger from KeyBanc Capital Markets. You are now live.

Ryan Mills -- KeyBanc Capital Markets -- Analyst

Good morning, guys. This is Ryan Mills on for Steve.

Andrew R. Lane -- President and Chief Executive Officer

Good morning, Ryan.

Ryan Mills -- KeyBanc Capital Markets -- Analyst

It sounds like free cash flow is going to start to be positive here. I was just curious if you could rank your capital allocation priorities, whether it be debt reduction or focusing on share repurchases or potentially M&A?

James E. Braun -- Executive Vice President and Chief Financial Officer

Ryan, let me first address the free cash flow. We're very positive. We've built up an inventory position in the first half of the year because of the tariff impact and our ability to carry more inventory at a lower cost. So I'm very pleased with where we are in inventory. But as some of these major projects shift in the third and fourth quarter, we see that leveling off. The second quarter was the peak for us at $872 million, and we finished down slightly in the third quarter at $849 million. I expect us to be around closer to $800 million by the end of the year. So from a free cash flow perspective, $50 million in the fourth quarter from inventory reduction and $25 million from receivables, so we see that as a positive $75 million in the fourth quarter. That carries into next year. And the broader question, on capital allocation, we'll always prioritize growth in the business first, organic growth. That's the priority right now.

We still believe, even with these projects rolling off, we have a really good MRO and a good customer spending increase next year coming. So we'll position for that. Of course, some of these tariffs ramp up in January, so we'll certainly be placing orders ahead of that to position us for the best cost position for inventory in the first half of '19. And so that would be the top priority. The share repurchase with the pullback in the whole sector and in our share specifically, certainly a priority for us and management and the Board, as the new $150 million authorization. So we'll be very active. We'll be in the market next week. So that's a priority besides growth of business.

Then any excess cash flow will be paying down debt. M&A would be the last priority. We're not active in anything major in that area right now.

Ryan Mills -- KeyBanc Capital Markets -- Analyst

Okay. Then I wanted to talk a little bit more about capacity constraints in the Permian. The general thought is those constraints will go away in mid-2019. It kind of sounds like that's what's baked into your guide. Is there any concern that those constraints persist out further than the mid-year of 2019? Maybe throughout all of 2019?

James E. Braun -- Executive Vice President and Chief Financial Officer

No, we don't see that. As we highlighted in our opening comments, we've had tremendous growth in the Permian. It's a big market. It's still a very important market. The slowdown that you read plenty about is in the smaller operators, the one- and two-rig operators. That's not our customer base. Of course, we're equally balanced between up and midstream and downstream. So we'll participate a lot in both line pipe and midstream valves, automated valves in 2019, as the pipelines get built out. Any little slowdown you might see us, but we don't anticipate it with our customer mix.

We're really focused with our contact position on the major customers, and they will proceed through because they have pipeline capacity. So our customer mix will be favorable. Even if there's a little slowdown in the upstream, we'll offset that with the midstream activity we have going on. We don't see it. It's going to be muted for us. We're not like the big, fat companies or the slowdown that you're seeing in fact in completions. We're much more weighted to the tank batteries and the pipeline side of things.

As we said, we track very well with a number of well completions. Our U.S. upstream is up 25%, with the completions up 26%. So that's the best metric. If well completions fall off in the early part of the year, the pipeline work will offset it. We see still Permian will be a bright spot for us, and we certainly don't see it extending past the first couple quarters.

Ryan Mills -- KeyBanc Capital Markets -- Analyst

Thank you.

Operator

Thank you. Ladies and gentlemen, we have no further questions in queue at this time. I'd like to turn the floor back over to Monica Broughton for closing comments.

Monica Broughton -- Vice President, Investor Relations

Thank you for joining us today and for your interest in MRC Global. We look forward to having you join us on our February 2019 conference call, where we're able to discuss our fourth quarter and full-year 2018 results, as well as our complete 2019 outlook. Have a good day. Goodbye.

Operator

Thank you, ladies and gentlemen. And thank you for your participation. This does conclude today's teleconference. You may now disconnect your line. And have a wonderful day.

Duration: 41 minutes

Call participants:

Andrew R. Lane -- President and Chief Executive Officer

James E. Braun -- Executive Vice President and Chief Financial Officer

Monica Broughton -- Vice President, Investor Relations

Sean Meakim -- J.P. Morgan Securities -- Analyst

Nathan Jones -- Stifel, Nicolaus & Company -- Analyst

Ryan Mills -- KeyBanc Capital Markets -- Analyst

More MRC analysis

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