MRC Global Inc (MRC) 2020 Q3 法說會逐字稿

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

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

Thank you, and good morning, everyone. Welcome to the MRC Global Third Quarter 2020 Earnings Conference Call and Webcast. We appreciate you joining us today. On the call, we have Andrew Lane, President and CEO; and Kelly Youngblood, Executive Vice President and CFO. There will be a replay of today's call available via webcast on our website, mrcglobal.com, as well as by phone until November 12, 2020. The dial-in information is in yesterday's release. We expect to file our quarterly report on Form 10-Q later today, and it will also be available on our website.

Please note that the information reported on this call speaks only as of today, October 29, 2020. And therefore, you are advised that this 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, adjusted EBITDA margin, adjusted SG&A, adjusted net income, adjusted diluted per -- earnings per share, free cash flow and free cash flow after dividends. 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 views of our -- of 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.

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

Thank you, Monica. Good morning, and thank you for joining us today and for your continued interest in MRC Global. I'll begin with an update of our COVID-19 pandemic response, then the company's third quarter 2020 highlights as well as progress against our strategic objectives, including e-commerce, and then I'll wrap up. I'll then turn over the call to our CFO, Kelly Youngblood, for a detailed review of the financial results.

The third quarter experienced modest sequential improvements in activity levels in certain areas of our business, including gas utilities and downstream and industrial, as many customers were able to resume activity after pausing or slowing activity levels in the second quarter due to COVID-19 concerns, while others, including upstream production and midstream pipeline, continued to experience declines as the demand destruction for oil and gas continues.

Our end market diversity has been a positive and provides relative stability and growth compared to our peers. However, despite recent improvements, there is still substantial uncertainty in the broader market, resulting in limited visibility. Given this, we continued to take aggressive measures to optimize our cost structure, reduce debt and generate cash to better position the company for the ultimate recovery.

Given our important role in the energy supply chain, we are a critical supplier to the global energy infrastructure system and a designated essential provider. To date, we have been fortunate to not have any facility closures related to the pandemic. We saw a peak of internal cases in July, and it has trended down since. Our current global case count is 11 employees or 0.4% of our total workforce.

As part of our pandemic response plan, we have begun phasing back employees to return to the office based on local or regional virus positivity rates as well as average daily case counts for the previous week, which determines what percentage of employees can safely return. This changes weekly, and our office locations range from 25% to 100% who have returned to the office. Our plan allows us to customize our response to fit the local area to provide a working environment tailored to local conditions. We continue to require daily body temperature checks before entering our facilities, in addition to staggering shifts at our warehouses, promoting social distancing and, of course, providing personal protective equipment as well as additional deep cleaning at our facilities.

From a supply chain perspective, there has been no change since last quarter. The key manufacturers that we rely upon all returned to normal capacity levels. Given our inventory position and reduced demand, we have fulfilled orders with little disruption. However, if there is a second wave of the pandemic and shutdowns are reestablished, order fulfillment risk could increase.

Moving on to our third quarter results. This quarter has seen some encouraging improvements, particularly in our gas utilities and the downstream and industrial sectors. These 2 sectors made up 68% of our total revenue for this quarter, which supported our total company revenue decline of only 3% sequentially. Our diversity of end market sectors provides substantial protection against the steep activity declines in the upstream production and midstream pipeline sectors.

The gas utility sector is now our largest sector at 36% of total revenue this quarter. We expect this sector to continue growing as our customers grow and execute their multiyear gas distribution integrity management programs. In the next couple of years, we expect the gas utility sector to be a $1 billion per year business. This is a real bright spot in our portfolio, and we are the proven market leader in this space.

We also achieved adjusted gross margins of 19.7% this quarter despite being in a deflationary environment, as our long-term strategy to shift to a more valve-centric organization has succeeded. In the first 9 months of the year, 40% of our sales were from valves, automation, measurement and instrumentation, or the VAMI product group. We are on pace to achieve our goal of generating 45% of our total revenue from the VAMI product group in 2023.

However, while some areas of our business are positive, overall, we still face a challenging environment. Therefore, we continue to evaluate the business and aggressively cut costs to better align with the current revenue levels and our expectations for the near future. The profitability improvement measures we've executed include numerous cost saving actions, including headcount reductions and the closing or consolidating of facilities. We also have continued investing in our e-commerce initiatives, which is part of a broader long-term strategy to improve profitability, efficiency and customer relationships. I'll cover this in more detail shortly.

In the third quarter, we reduced head count by approximately 140 for a total of 520 this year or a 16% reduction since the end of 2019. We also closed or consolidated an additional 9 facilities in the third quarter for a total of 22 facilities this year. We have plans to close or consolidate another 6 for a total of 28 this year. With all the actions we've taken and are planning, we are expecting more than $110 million annual reduction in SG&A from 2019 on a normalized basis, even better than we had previously estimated. Approximately 2/3 of these cost savings are structural, which means we should have a better-than-average incremental EBITDA in a recovery. We are focused on managing what we can control, and optimizing the cost structure is squarely within our control.

We are also focused on generating cash and optimizing the capital structure. So far this year, we generated $178 million in cash from operations as we continue to work down inventory and rationalize our brand structure for optimum working capital efficiency. We are very confident in our continued ability to generate cash and expect greater than $220 million in operating cash flow this year. This cash generation, along with the cash we expect to receive from the sale of properties, will allow us to make a substantial reduction in debt above our previous targets.

So far this year, we have reduced overall net debt by $150 million to a balance of $369 million, with plans to reduce net debt below $300 million by the end of the year, which is substantially better than previously expected. This includes paying off the ABL balance by the end of the year, which we are well on pace to achieve.

We are committed to providing our customers exceptional service and delivering value to our shareholders regardless of the economic conditions. Part of our long-term strategy is to gain market share while maximizing profitability and optimizing working capital. Our e-commerce strategy, underpinned by our MRCGO platform, is a key strategic pillar for MRC Global. Our vision is to create an end-to-end digital supply that digitally links MRCGO to our customers and vendors across every touch point. Our immediate goal is to expand our digital capabilities and differentiate ourselves through a world-class customer experience that facilitates online purchasing and a range of other value-adding features.

Consistent with that direction, in April of this year, we appointed an executive to lead execution of our e-commerce strategy. And in July, we hired a seasoned Vice President of e-commerce with deep industrial distribution experience. Consistent with the importance of this initiative, we continue to invest in people and technology to enable our digital expansion.

We continue to build on our long history of digital integration with customers, which started with B2B/EDI integrations in the 1980s. In September 2020, 48% of our North America revenue was generated through our various digital channels. Over the last 12 months, 49% of revenue from our top 36 customers in North America and 68% of our gas utility revenue all came through digital interaction.

In July of this year, we started migrating smaller transactional customers to MRCGO. To facilitate this, we have expanded our centralized customer service group located at our Houston operation complex, and we have stratified these customers to facilitate a tailored service offering. We're practical and cost effective. We are delivering direct from our regional distribution centers to the customer delivery location, supporting our efforts to consolidate inventory and drive down our working capital. By implementing this lower-cost-to-serve model, coupled with shipping savings and improved price differentiation, we are targeting to deliver annual profitability improvements between $5 million to $10 million by 2022.

As we expand this channel, our intent is to build the customer experience learnings into our premium MRCGO managed account solution, consistent with our goal to increase large customer e-commerce adoption in parallel with transactional customers. Globally, over the last 12 months, 1/3 of our revenue was generated through e-commerce channels. We are accelerating our customer adoption efforts and expect that at least half of our global revenue will be transacted digitally within 3 years.

We also continue to drive market share gains by obtaining and expanding multiyear MRO contracts with customers. This quarter, we have renewed several smaller agreements with several downstream customers. Growing market share, especially in a shrinking market, is an important strategic objective, and we have a proven track record of achieving this objective.

We remain focused on our long-term strategic objectives, delivering superior service to our customers and delivering value to our shareholders. We have significantly reduced operating costs and debt in this turbulent time, exceeding our initial estimates and completely realigning the organization and the capital structure to fit the economic conditions. Our diversified portfolio of sectors is a differentiator for us and significantly helps us to reduce volatility in our revenue, as demonstrated in this quarter's results. And our e-commerce initiative continues to take root, and we are making progress in converting customers to our digital platform.

We are well positioned to take advantage of the eventual market recovery. And we will continue to execute against our strategy to increase market share, maximize profitability and working capital efficiency as well as optimize our capital structure.

I'll now turn the call over to Kelly to cover the financial highlights for the quarter.

Thanks, Andrew, and good morning, everyone. I'm very happy to report that not only did we exceed our guidance coming into the quarter, but we were also on track to meet or exceed all of the full year financial targets laid out earlier this year.

For the third quarter, our guidance was for revenue to be down upper single digits as a percentage. But we were only down 3%, largely due to our diversified business model, which has become a significant differentiator for MRC Global. On a sector basis, our actual results were in line with our guidance, except for our downstream and industrial sector, which increased 5% sequentially, exceeding our guidance of a low single-digit decline.

Now I would like to remind you of the full year targets previously laid out with an update on our progress. First was to exit the year with a normalized SG&A run rate of $100 million, which we exceeded in the third quarter with a new run rate of $97 million. Compared to 2019, we expect to end this year with at least $110 million in cost savings. I will provide more comments about our expectations for the 2021 SG&A run rate later in the call.

Second was to decrease inventory by at least $170 million, which we are well on track to exceed with a year-to-date reduction of more than $100 million. Next was to generate cash flow from operations of at least $200 million. And today, we are raising this guidance to be greater than $220 million. And finally, we committed to pay off our ABL this year, and we ended the third quarter with only a $25 million ABL balance with $40 million in cash. So I think it's safe to assume that we will easily check this box in the fourth quarter.

We also committed to use all of our excess cash this year to pay down debt, which we have done and reduced our net debt balance year-to-date by $150 million to a current balance of $369 million. And today, we have a new target to reduce our net balance to $300 million or less by the end of this year. And I will provide more details on this later. So in summary, we are very proud of the progress made to date and believe our results are evidence of the proactive measures our management team has taken to pull all levers within our control in response to the current market headwinds.

Before covering the financial results, I wanted to provide our perspective on some of the recent corporate transaction announcements among our customer base. In summary, we believe the majority of these announcements are very positive for MRC Global. In the event one of our key customers, which are typically the larger E&Ps, acquire a smaller producer, it is generally positive for us, and we can easily roll the acquired company's business into our existing customer contract. Also in many cases, it can open new doors as the operator reevaluates their supplier options, and our offering is uniquely tailored to serve the larger operators. We have a unique and differentiated position in that respect. In all of the recent announcements, with maybe one exception, we are already well aligned with the acquiring company, and in many cases, the company being acquired as well. So we believe the net result of these combinations will lead to MRC Global gaining U.S. upstream market share in 2021.

Moving on to the quarter's results. Total sales for the third quarter of 2020 were $585 million, a 3% decline compared to the second quarter. U.S. revenue was $463 million this quarter, 2% lower than the second quarter of 2020, as the gas utilities and downstream and industrial sectors increased sequentially, while the midstream pipeline and upstream sectors experienced further declines. The U.S. gas utilities sector revenue increased 3% sequentially as several customers began recovering from pandemic restrictions and gradually returned to work as well as a recent market share gain with CenterPoint, which is in the early stages of ramping up. We expect our gas utility customer base to continue with their originally planned budgets, barring any additional impediments due to the pandemic, although some of the 2020 spend will now shift over to 2021.

The U.S. downstream and industrial sector revenue increased by 4% sequentially, as customers began to resume work following pandemic restrictions for critical maintenance and turnaround activity. The U.S. upstream production sales were down 8% sequentially due to continued curtailment in activity levels with certain customers but still outpaced well completions, which were down 29% for the same period. The U.S. midstream pipeline sector revenue declined 21% sequentially, as customer spending has evolved into maintenance mode and projects from earlier in the year continue to taper off.

Canada revenue was $27 million in the third quarter of 2020, relatively flat sequentially with only a $1 million decline. International revenue was $95 million in the third quarter of 2020, a sequential decline of 5%, driven primarily by reduced upstream spending from weaker demand due to the pandemic and lower overall project activity. Stronger foreign currencies relative to the U.S. dollar favorably impacted sales by approximately $2 million.

Now I will cover sales performance by sector. I want to begin with gas utilities -- the gas utilities sector, which is now our largest sector and has distinctive characteristics compared to our other businesses. Gas utilities sales were $208 million in the third quarter of 2020, $3 million or 1% higher than the second quarter. This sector is 99% U.S.-based and is now 36% of our overall revenue, up from just 25% in the first quarter.

It is unique relative to other sectors given its drivers are completely independent of commodity prices, and the customer base is different than our other end markets. Customers in this sector are regulated utilities, also known as local gas distribution companies, or LDCs, who own and maintain large gas infrastructure networks in the cities or regions for residential and commercial customers.

We have contracts with 18 of the top 25 gas utility companies in the U.S. Names you may recognize include Atmos, NiSource, Duke, PG&E and Southern Company. These customers operate under a guaranteed rate of return model and have an incentive to continually maintain and upgrade their gas distribution networks to safely provide natural gas to homes and businesses. We supply these customers not only with traditional PVF, but also with gas products such as smart meters, risers, plastic pipe, tracing wire and kitting services.

We are integrated with approximately 75% of our gas utility customers, meaning we supply all their gas products, manage their warehouses, provide logistics services and manage all their inventory. This is part of the value proposition we offer these customers, which includes our product expertise and experience as well as our efficient inventory management services. Typically, before becoming customers, most gas utilities manage their own supply warehouses and buy directly from manufacturers. The supply chain management is not always a core strength to these companies.

Over the last 20 years, we have built this business up to about $800 million annually in revenue today and expect it to grow to over $1 billion in the next few years. Since 2010, our gas utilities sector has demonstrated a 9% compound annual growth rate. Because these customers are operating in a regulated environment, their spending levels typically increase 5% to 7% per year to adequately manage their infrastructure. This provides a stable level of growth for our business as we continue to fulfill their gas product needs while also reducing the relative volatility in our overall company revenue. It is much more resilient than our energy-specific businesses and relatively recession-proof. This sector should continue to grow without market share gains.

However, we continue to penetrate this market with new customers, and we have multiple avenues to grow by widening our reach with existing wins as well. For example, we recently began implementing a new contract with CenterPoint, which we will see the full benefit of as we enter 2021. We are uniquely positioned in this space as the undisputed leader with differentiated expertise.

In the downstream and industrial sector, third quarter 2020 revenue was $185 million, a sequential increase of 5%, driven by the U.S. segment, as described earlier. The downstream and industrial production sector now represents 32% of our total third quarter revenue.

The upstream production sector third quarter 2020 revenue decreased $16 million or 12% sequentially to $118 million. Declines were across all segments, led by international, which was down $10 million due to less project and MRO work, primarily in Norway. The upstream production sector represents 20% of our total third quarter revenue.

Midstream pipeline sales, which are 88% U.S.-based, were $74 million in the third quarter of 2020, a 15% sequential decline. This sector now represents 12% of total revenue and consist of transmission and gathering customers. Activity levels typically follow the upstream sector, and many projects that were originally scheduled coming into the year have been delayed or canceled due to reduced demand and associated lower commodity prices.

Now turning to margins. Our gross profit percent was 19.5% in the third quarter of 2020 as compared to 13.1% in the second quarter. This increase reflects the impact of $34 million in inventory-related charges recorded in the second quarter as well as LIFO income of $11 million recorded in the third quarter of 2020 as compared to $6 million of LIFO income in the second quarter. Adjusted gross profit, which adjusts for the impact of inventory-related adjustments and LIFO, for the third quarter of 2020 was $115 million or 19.7% of revenue as compared to $118 million and 19.6% for the previous quarter, a 10 basis point improvement.

Line pipe prices were lower in the third quarter of 2020 as compared to the second quarter due to reduced demand. Based on the latest Pipe Logix index, average line pipe spot prices in the third quarter of 2020 were 4% lower than the previous quarter. Line pipe prices are expected to continue to decline, which should result in further LIFO income in 2020.

Reported SG&A costs for the third quarter of 2020 were $100 million or 17.1% of sales as compared to $126 million or 20.9% of sales in the second quarter. Normalized SG&A for the third quarter was $97 million or 16.6% of sales, after adjusting for the net impact of $5 million of severance charges, partially offset by a $2 million recovery of a supplier bad debt. We will continue to adapt our cost structure as needed based on how the market progresses in the coming quarters.

We have reduced operating costs by $77 million so far this year as compared to last year on a normalized basis, and we are on pace to deliver $110 million or more of cost savings in 2020. Approximately 2/3 of these savings are structural in nature, which not only makes us a more streamlined organization, but should also allow us to have stronger incremental margins once the market begins to recover. At the end of this year, we plan on eliminating our employee furlough program that has been in place since July 1. However, even after eliminating this program, due to further reductions we are in process of actioning, we expect our 2021 quarterly SG&A run rate to be at $100 million or less.

Interest expense totaled $7 million in the third quarter of 2020, the same as the second quarter. And our effective tax rate for the third quarter was 63%, which is higher than average due to losses in foreign jurisdictions for which there is no corresponding tax benefit and the reversal of a current year net operating loss benefit recognized in a prior quarter but no longer expected to be realized.

Net loss attributable to common shareholders for the third quarter of 2020 was $3 million or $0.04 as compared to a loss of $287 million or $3.50 per diluted share in the second quarter. On a normalized basis, removing severance and restructuring charges and the recovery of bad debt as well as LIFO, our adjusted net loss attributable to common shareholders for the third quarter was $8 million or $0.10 per diluted share, which was the same as the second quarter of 2020.

Adjusted EBITDA in the third quarter of 2020 was $24 million as compared to the previous quarter, which was $17 million despite a lower revenue base, driven by strict cost controls and slightly higher gross margins. Adjusted EBITDA margins for the quarter were 4.1% versus 2.8% for the previous quarter. Year-to-date adjusted EBITDA is $75 million, the same as the full year 2016, which was the trough of the last downturn. By comparison, year-to-date third quarter adjusted EBITDA margins are 3.8% versus 2.5% in 2016, a 130 basis point improvement on the same level of adjusted EBITDA.

Our net working capital at the end of the third quarter of 2020 was $537 million, $78 million lower than the end of the second quarter. On a trailing 12-months basis, our working capital, excluding cash, as a percentage of sales was 19.5% at the end of the third quarter of 2020. This is at the low end of our targeted range for this year of 19.5% to 19.9%.

We generated $94 million of cash from operations in the third quarter of 2020 and $178 million through the first 9 months of the year. As previously mentioned, we are on target to generate greater than $220 million in 2020. Our third quarter free cash flow was $91 million, and our free cash flow after the preferred stock dividend was $85 million. For the first 9 months of the year, our free cash flow was $170 million, and our free cash flow after the preferred stock dividend was $152 million.

Capital expenditures were $3 million in the third quarter of 2020 and $8 million year-to-date. We continue to invest in critical projects such as our e-commerce initiative. And we expect our full year capital spend to fall within a range of $10 million to $15 million, in line with our previous guidance.

We recently entered into agreements to sell and leaseback 4 properties. This transaction is expected to generate net proceeds of approximately $28 million in the fourth quarter, which will be used to further reduce our net debt. As a result, we will begin incurring an additional $600,000 in quarterly lease expense beginning in the fourth quarter. However, with all our debt reduction efforts this year, including the proceeds from the sale-leaseback transactions, we expect to save nearly $6 million in annual interest expense in 2021 as compared to 2020.

Our debt outstanding at the end of the third quarter was $409 million compared to $551 million at the end of 2019. We have reduced total debt by $65 million in the third quarter and $142 million so far this year. Our leverage ratio based on net debt of $369 million was 3.8x, but is expected to decline further in the fourth quarter due to additional free cash flow generation and proceeds from our real estate sales. In the near term, we expect to operate in a range of 2.5 to 3.5x net debt-to-EBITDA and expect the fourth quarter will be well within that range.

Our debt is very manageable, and our cash flow profile allows us to generate strong cash flow in a challenging macro environment. Debt repayment remains a priority for the company. And as mentioned earlier, we expect our net debt balance to be less than $300 million by year-end compared to the balance coming into the year of $519 million. The availability of our ABL facility is currently $437 million, and we had $40 million of cash at the end of the third quarter. As a reminder, we currently have no financial maintenance covenants in our debt structure.

Regarding our outlook for the fourth quarter. Barring a significant second wave of pandemic developments, we expect the fourth quarter to experience a normal seasonal decline in activity, which historically ranges between 5% and 10%. We are starting the quarter in a strong position with October revenue tracking closely to September, which was the strongest month in the quarter. It's still too early to provide guidance on 2021. Our business is dependent on our customers' spending levels, which today, we have only limited visibility. We will plan to provide our thoughts as we receive more information, which is typically after the budgeting season takes place in the fourth quarter.

So in summary, our third quarter 2020 results reflect our proactive focus on the levers that we can control. And we have exercised strong cost controls and inventory management, resulting in robust cash flow generation, aggressive debt reduction and solid margins in a challenging market environment. We remain committed to our strategy to deliver shareholder value regardless of where we are in the cycle. Our company is well positioned to take advantage of the eventual market recovery.

And with that, we will now take your questions. Operator?

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

So Andy, Kelly, to start, the e-commerce progress has been really impressive. It's consistent with what we've seen elsewhere during the pandemic. Are you able to quantify how much e-commerce mix of sales is translating into less G&A spend and how we think about that in terms of your path to 50% of sales from e-commerce over the next 3 years, assuming how that can translate into impact on G&A as a percentage of sales?

Yes. Yes, Sean, I'll start off with that one, and Andy may want to add on. But yes, e-commerce, if you look at the total company right now, we said this in the prepared remarks, it's about 1/3 of our global revenue. It's building very rapidly. We got to 48% of our North America revenue here in the month of September as kind of exiting the quarter. So making really good progress. And the commitment we put out there on the transactional customer base primarily, as we've been moving those customers onto the platform, is to kind of generate another $5 million to $10 million of profit over the next year or 2. And that's going to be made up of kind of a reduction in internal sales reps. It's less handling of inventory. It's lower freight cost because we'll be able to centralize more and reduce our working capital in our RDCs as we centralize more. And so we're not putting any specific targets out there right now. But I can tell you, it is going to be very helpful in supporting margins and will continue to help grow margins as we go forward. And so that's one of the benefits, and that's why we're continuing to invest in it.

Sean, let me -- and if I can, let me just add a couple of comments. Kelly covered it well. It fits our business model very well, and that's why we've been investing in this area for several years. And of course, the current COVID environment has accelerated the adoption of this. But our business model is multiyear contracts, the major customers, and links electronically to them and make it easy for them to do business with us, whichever channel they want, branches, major projects or e-commerce orders. And so we've been working on this. We feel very confident we'll get to our 50% of revenue. They will have efficiency gains.

And the thing that's been done in parallel, Kelly talked about the $5 million to $10 million of cost reductions coming out as we move to this model in the next couple of years, but all of the investment in our regional distribution centers have now been converted into fulfillment centers. So there's not a big CapEx. And I want to say that message, it's a nominal amount of OpEx which is just in the e-commerce specialists. We mentioned an outside hire of a new Vice President on the commercial side.

These kind of things are incremental to us. And also a couple of million incremental CapEx on the software side, so a very minor, in my mind, OpEx and CapEx increase, but a very big efficiency gain as we've closed these branches. And it's tied to our 60 -- 2/3 or 67% of our business on the structural cost changes not coming back, that they're structural in change and manner because we won't be opening these branches, these deployed branches and the personnel in these deployed branches on the turnaround of the business. It will come from these fulfillment centers. It will come through e-commerce. That brings a great deal of efficiency to our model.

Got it. That's very helpful. I think that paints the picture well. And then -- so on cash flow and the balance sheet, well done on the execution of the working capital liquidation. I think going into '21 with less than $300 million of net debt is good progress and once again shows the countercyclical cash flow nature of the business. And so I understand it's too early for guidance on '21. Uncertainty is only growing this week with the macro and the oil price move. But can we maybe just think through a couple of scenarios and their impact on cash flow? So I'm thinking, if we get further -- so thinking about revenue next year. If we see generally sequential improvement from the first quarter, how should we think about further flex on working capital? Are we consuming cash in that environment? Or can we hold it flatter? On the other end, if we're in a flat to down environment from a revenue perspective, can we think about how much more cash can be harvested from the balance sheet next year?

Yes. Yes, Sean, great question. So yes, I think -- if you think -- we're not giving any guidance on '21, obviously. But just kind of talking through your scenario, if we're in a flattish environment or even a flat to down type environment in '21, we still think from a working capital perspective, there's still a lot of opportunity on the inventory side that we can continue to bring that number down. Receivables are just kind of a function, whatever happens with revenue. And there's no -- we're very fortunate with the customer base that we have. We don't have a lot of collection issues or aging problems. We had a few bankruptcy type hits earlier in the year, but nothing looming out there right now that really has us concerned on the AR side. And so we have good DSOs from an AR perspective.

But -- so you'll really see, I think, in '21, in that kind of scenario that you were laying out, more opportunity with inventory, and that should help us continue to generate cash in '21 even if it still is a difficult environment.

Yes. Sean, let me -- I'll just add a couple of comments. If you look at our guidance and where we sit here at the end of the third quarter and our increased guidance for cash flow and a low balance on the ABL, the way I look at it is, as we've been -- Kelly and I have been working towards this year, we'll finish this year with -- 2020 with the ABL paid off. And if you just do the math on our cash flow and with the cash balance we have now, we'll end up around $80 million, $100 million of cash balance at the end of the year. So we're going to be in a very good position. We'll have 0 debt due until 2024. We'll be sitting on some cash and have the short-term debt paid off.

And as Kelly said, this is a -- we have a big model and a big global supply chain. It takes a while to turn off some of the purchase orders on really long lead time valves that come from all over the world. So the first couple of quarters of this year took a while for us to switch from '19 into this year. And so we're not done. So you're going to see some -- as you saw in the third quarter, some good inventory reductions as we rightsized the inventory we need to carry for this level of revenue. We'll have another good quarter in the fourth quarter, as we were guiding to. And as Kelly said, we expect to have a good positive cash flow for next year, and we'll quantify it more when we get into February time frame with the -- with our guidance for next year.

So AR will flex with sales, but inventory, still more work to do, which would be helpful. Very helpful.

That's correct. Thank you, Sean.

Our next question comes from the line of Doug Becker with Northland Capital Markets.

You've done a really good job in shifting the mix to higher margins. It looks like adjusted gross margins could trough well above 19% this cycle. As we think out a couple of years, is a 21% gross margin unrealistic, revenues approaching $3 billion again? Just trying to get a sense for what the opportunity is going forward there, given the performance we've seen in the down cycle.

Yes. Doug, thanks. And let me start, and then Kelly can add some to it. You're seeing the results of our big shift to what we call the -- internally a valve-centric strategy for the company, and we've been working on this for over 5 years. So you can see the difference in this down year compared to the '15, '16 downturn where our gross margin -- adjusted gross margin went to the 17%, 18% range, where we had a lot of heavier weighting on both line pipe and carbon fittings, those type of product lines. We're very heavily weighted to 40% plus now in valve business. It's much more complex. We're doing a lot more valve automation value-added services, and we most recently added modifications. So we're doing complete valve kits for the midstream sector, both replacement pipelines and new. And so those are, of course, a lot more value added, a lot more service and engineering, so higher margin.

So we really have transformed the business to this higher-margin model. That was our strategy. It's holding up even in a bad year. So we see it going back. We've had -- I've had a goal for many years to get us to 20% plus, consistently deliver on our adjusted gross profit. We've hit it a couple of quarters, but not consistently. So I think, yes, as we get to -- return to $3 billion plus revenue, I'd just say -- I wouldn't go to commit to '21, but I'd commit to we're going to get back to our original goal of the 20% plus consistently from this model.

Yes. Doug, and just maybe to add on a couple of things. I mean, Andy covered it obviously very well. But I think depending on what happens with volumes and just activity levels here in the fourth quarter, we could see a little bit of pressure there. We -- I think we -- I touched on that somewhat in our prepared comments, but the good thing is with the product mix we have, it's tens of basis points. So it's definitely going to stay in the 19s or probably mid-19 type range, which is really positive for us. And we've seen some pressure in the U.S. and Canada markets, but it's been very kind of modest and been offset by improvement in margins actually on the international side, so that's been very positive.

And the other thing I would point out, obviously, the valve mix is very important. But as we talked about in our call, if you look at the downstream and the gas utility markets, that makes up 68% of our revenue base right now. And gas utilities is a very stable business for us, not a lot of fluctuation in margins. And if you look at the downstream part of our business, the margins there are actually accretive to the overall company margins. And so that has really helped provide some insulation to our margins this year, just the mix and the diversification that we have, which truly is a differentiator for the company right now.

But I do think in the coming quarters, probably where we will still see a little bit of pressure is in the midstream side, and that's a function of projects that we enjoyed last year and early this year just continuing to taper off. And then as Andy said, the line pipe product line, because of the commoditized nature of it, we think we'll continue to see pressure there. So more maybe to come on the midstream side, but the other pieces of the business are certainly helping to prop everything up.

All makes sense. Maybe touching on the gas utilities, kind of reiterated that $1 billion target a couple of years out. Does that include any expansion of your scope? Or is that just kind of what you do today? And if we think about that as a 2023 target, I realize you're not putting a specific date, that's about a 7% compound annual growth rate. That certainly doesn't seem unreasonable relative to history. Is 2023 a reasonable goal of achieving that, I guess, is really the way to put it?

Yes. Doug, it's very reasonable. And a couple of things going -- yes. So historically, the last 20 years has been a 9% CAGR. And so kind of guiding the 7% CAGR is more of the same, except for this down year. The only setback we've had in revenue this year was really the COVID impact of construction in homes. And a lot of this is replacement equipment, as the gas utilities upgrade low-pressure systems to higher-pressure systems or old equipment into new products for safety. So the inability to get into homes and do projects in -- for the second quarter primarily and a little bit into the third quarter is really the only reason we slowed down year-on-year. But it's back, picking back up now that we've -- can get more construction going.

So we had a big contract with CenterPoint. We've talked about on the combination of CenterPoint and Vectren as a merger and winning the combined contract. So we will be definitely up in 2021 in gas utility, and we'll quantify that more next year when we give some more guidance. But I think we get back on our track. And it's more of the same for the contracts we have. We continue to pick up share in that sector. And we continue -- like winning the CenterPoint last year, we're going to continue to target a couple of those. Even though we have a very large number of the customers already under contract, we still have a list of ones we're tracking to -- from the business development side to win. So we -- I feel very good that you're in the ballpark kind of $1 billion-plus in 2023.

Our next question comes from the line of Jon Hunter with Cowen.

So I just had a question on the progression of revenues in the fourth quarter here. Back at the second quarter, you had said that July was tracking down 8% to 10% versus the 2Q average, and September here seems to have exited at the best monthly run rate of the quarter. So coming off that high run rate, I'd expect the revenue decline in the fourth quarter to be a little bit muted versus the typical 5% to 10% decline. So is the guidance a bit of conservatism and you could be closer to that 5% mark? Or do you have visibility with your customers such that kind of the midpoint of that 5% to 10% range is what we should be thinking about?

Yes. Yes. Jon, I'll take that one here to start with. Yes, I know -- and I think you're probably thinking about it the right way. As we mentioned in the prepared remarks, the normal seasonal decline -- if you take out kind of the outliers, the normal seasonal decline is that 5% to 10% range. We were -- we actually last year had a 19% falloff, but we don't expect -- this doesn't feel like we're going to have that kind of impact this year. But you never really go -- never really know for sure until you get into kind of late November, December, what some customers are going to do. But we're not hearing of any massive or severe falloff at this point, which is very positive. So I think what you said with September being the best month of the quarter, October is coming in very similar to that. We would hope to do better than the high end of that range, but probably somewhere in the middle is kind of what I would probably do for modeling purposes right now.

And if you kind of drill down more from a segment perspective, I would say, the U.S., if you think about that 5% to 10% range, will probably be, at least the way we're thinking about it right now, at the higher end of that range, closer to 10%. Canada, more upper single digits of a decline. But international is actually going to have a good -- a very good Q4, probably up double digits, and that's just kind of the timing of some of the projects they have going on. And there's always some level of risk and deliveries happening by the end of the year, but it does feel like they're going to have a very good quarter with a double-digit improvement.

And then if I think about it from a sector perspective, I think gas utilities, it'll fall off a little bit here in the fourth quarter, just a normal seasonal decline, but definitely probably low single digits as a decline. Downstream could be more of a high-single-digit type decline. Upstream, I think down single digits, it feels like it's going to be like low single digits right now. And then midstream, as we talked about earlier in the call, is getting a little bit more pressure, and it could be down sequentially double digits when it all plays out. But like we said, when you net all that out, 5% to 10% range, and it kind of feels like probably somewhere in the middle.

That's very helpful detail. And then my follow-up question is just on margins. I mean, you guided us down in the tens of basis points in the fourth quarter. Do you have a feel for when you think margins could bottom? And kind of just generally, what are you seeing on the pricing side? It seems like there is more pressure. But do you have any visibility to the pricing declines kind of leveling off over the next couple of quarters here?

Yes, Jon. No, on pricing, there's obviously pressure out there. We're getting requests from customers all the time to lower pricing. But I think our sales organization has done a tremendous job pushing back or offering up alternative products to help bring pricing down or cost down for our customer base. So that's all been very positive. With some of the smaller players out there that -- where the downturn's really impacting their cash flows right now, you can see more pressure with some of those guys reducing pricing.

So -- but still, going back to what we covered earlier, you look at our product mix we have today with a higher concentration of valves, lower concentration of line pipe, we have 68% of our revenue between gas utilities and downstream, which are much more stable margin businesses for us, it -- I think we may experience some modest declines in our margins here in the fourth quarter. And I'm not going to call a bottom. We're not -- like I said, we're not giving '21 guidance at this point. But if revenues kind of stay where they're at here in the third, fourth quarter levels, I would say next year, we're not expecting any significant impact to our margins.

Our next question comes from the line of Steve Barger with KeyBanc Capital Markets.

This is Ken Newman on for Steve. Some really good color on the consolidations from your customers in the last few weeks in your prepared remarks. And I am curious, in the event that you're able to integrate some of those acquired inventories for your customers into your system, can you just talk a little bit about what the potential price impacts on those higher volumes? And I guess this is kind of talking or asking more towards the pricing question for those opportunities given some of those M&A deals that we've seen in the last month.

Yes. Let me take that one. The -- we see all these M&A transactions. Some are very favorable like -- it fits our model. We're heavily focused on the major customers, the multiyear contracts, long-term agreements and supply deals. So we don't have a broad exposure to the small operators. And so we really focus on this segment of the business. So we see combinations. It always has been very positive for us. I mean, Exxon with XTO, Shell with British Gas, we got a long history of our major customers acquiring other players, and we benefit from that.

So if you kind of think about these latest few, Chevron buying Noble, Chevron's well known as our largest customer for many years, along with Shell as a close #2. That will be a net positive as we integrate those together. And it fits right into our model, and it fits into our e-commerce strategy. ConocoPhillips and Concho, same thing, ConocoPhillips is much bigger customer for us than Concho. Pioneer, a much -- a bigger customer than Parsley. Devon, a bigger customer than WPX. So those all are very favorable. Of course, Equitable buying Chevron's Appalachian gas assets, upstream and midstream. We're -- Equitable is a good customer of ours. [But of course], that one is probably a neutral. And then Cenovus-Husky, the most recent announced, Husky is a much bigger customer for us in Canada. So we'll see how that works out.

But largely, when you think about all these combinations, they tend to consolidate their spend. They look for bigger suppliers. They look for cost savings and their post-synergy objectives, and we can help them with all of that. And I think -- so they play to our business model more than others, and they play to our strength. So we think that as a net positive, and I'm sure they're not done.

As I kind of think about that in the context of your e-commerce strategy, do -- any color on maybe the general mix of some of these companies getting acquired that are already on the e-commerce platform versus your bigger ones?

Yes. Well, all of our big customers are on the platform. But then as we said in the remarks, it's heavily weighted to gas utilities and downstream customers at the current level. So not so much upstream smaller players and not so much midstream, which tends to be more projects. So I'd say these upstream combinations, more to our general MRO customer-focused account management strength. And -- but of course, Chevron, it would be on the e-commerce platform. And as -- I think you'll see others, as maybe other IOCs acquire companies that fits well with e-commerce more than these. But these fit more with just our general approach to this customer base in upstream.

Got it. That's helpful. My follow-on question is just about -- it was really good color on your outlook for 4Q. And my follow-on question is really more about just downstream maintenance demand. And just any comments on what you're hearing from your customers in terms of potential pent-up demand or when they plan to really ramp up spend for maintenance.

Yes. It's -- we had a good -- as we said, in downstream industrial, we had a good third quarter, up sequentially. A portion of that was a carryover from both small cap -- we look at both large turnarounds as -- look at more large-cap investments for our customers, and then they do a lot more smaller maintenance, small-cap projects. And a lot of that got deferred in the second quarter due to COVID and due to not doing construction projects in the plants. So we benefit from that in the third quarter. You seasonally have the fourth quarter tail off, but even the bigger projects were all pushed into 2021. So I would just say a positive, definitely not quantified at this point, but a positive for us is the maintenance and more of the large-cap turnarounds. It should be a very good spring turnaround 2021 time for us.

There are no further questions in the queue. I'd like to hand the call back to management for closing remarks.

Thank you for joining us today and for your interest in MRC Global. We look forward to having you join us on our fourth quarter conference call next year. Have a good day, and goodbye.

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