MRC Global Inc. (NYSE:MRC) Q3 2020 Earnings Conference Call October 29, 2020 10:00 AM ET
Monica Broughton – Investor Relations
Andrew Lane – President and Chief Executive Officer
Kelly Youngblood – Executive Vice President and Chief Financial Officer
Conference Call Participants
Sean Meakim – J.P. Morgan
Doug Becker – Northland Capital Markets
Jon Hunter – Cowen
Ken Newman – KeyBanc Capital Markets
Greetings and welcome to the MRC Global’s 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. [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 by 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’re advised that information may no longer be accurate as of the time of replay.
In our remarks today, we will discuss adjusted gross profit, adjusted gross profit percentage, adjusted EBITDA, adjusted EBITDA margin, adjusted SG&A, adjusted net income, adjusted diluted earnings per share, free cash flow, and free cash flow after dividend. 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 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.
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 continues 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’s still substantial uncertainty in the broader market resulted in limited visibility. Given this, we continue 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 it designated a central provider. Today, 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’s 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 divided working environment tailored to local conditions. We continue to require daily body temperature checks before entering our facilities in addition to staggering shifts that are 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 on upon all returned to normal capacity levels. Given our inventory position and reduced demand, we have failed orders with little disruption. However, if there is a second wave of the pandemic, and shutdowns are re-established, 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 two 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 multi-year 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, and succeeded. In the first nine 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 of our 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 headcount by approximately 140 for a total of 520 this year, or 16% reduction since the end of 2019. We also closed or consolidate an additional nine facilities in the third quarter for a total of 22 facilities this year.
We have plans to close or consolidate another six for a total of 28 this year. With all the actions we’ve taken and are planning, we’re expecting more than $110 million annual reduction in SG&A from 2019 on a normalized basis, even better than we have previously estimated. Approximately two-thirds 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’re also focused on generating cash and optimizing the capital structure. So far this year, we generate $178 million in cash from operations as we continue to work down inventory and rationalize our brand structure for optimum working capital efficiency. We’re 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 to a world-class customer experience that facilitates online purchasing and a range of other value adding features. Consistent with that direction in April 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 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. Where 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 learning into our premium MRCGO managed account solution, consistent with our goal the increased large customer e-commerce adoption and parallel with transaction of customers.
Globally, over the last 12 months, a third of our revenue was generated to 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 three years. We also continue to drive market share gains by obtaining and expanding multi-year 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’re 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 on a low single-digit decline.
Now, I would like to remind you that 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 is 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 companies business into our existing customer contract. Also, in many cases, it can open new doors as the operator re-evaluates their supplier options, and our offering is uniquely tailored to serve the larger operators.
We have a unique and different differentiated position in that respect. In all 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 utility 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 our 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, the 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 US 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 utility sector, which is now our largest sector, and has distinctive characteristics, compared to other our other businesses. Gas utility sales were 208 million in the third quarter of 2020, 3 million or 1% higher than the second quarter. This sector is 99% U.D.-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 the gas distribution networks to safely provide natural gas to homes and businesses.
We supply these customers not only with traditional PBF, 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. But 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 utility 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 ones 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 the [Technical Difficulty] 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 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 clients 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. Mid-stream 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 consists 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 logics 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 cost for the third quarter 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 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 two-thirds 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 auctioning, 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 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 nine 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 nine 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 four 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 four 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 3.8 times, 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 times to 3.5 times 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 billion 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’re 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 customer 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 focused 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?
Thank you. [Operator Instructions] Our first question comes from the line of Sean Meakim with J.P. Morgan. Please proceed with your question.
Thank you. Hey, good morning.
Good morning, Sean.
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 past to 50% of sales from e commerce over the next three years? Assuming how that how that can translate into impact on G&A as a percentage of sales.
Yeah Sean, I’ll start off with that one, and Andy may want to add on, but yeah, e-commerce. You know, if you look at the total company right now, we said this in the prepared remarks, it’s about a third of our global revenue, you know, building very rapidly, we got to 48% of our North America revenue here in the month of September, you know, it’s kind of exiting the quarter, but making really good progress. And, you know, the commitment we put out there on the transactional customer base primarily as we’ve been moving those customers onto the platform is to, you know, kind of generate another $5 million to $10 million of profit over the next, you know, year or two.
And you know, that’s going to be made up of, you know, kind of a reduction in internal sales reps, it’s, you know, less handling of inventory, it’s lower freight costs, you know, because we’ll be able to centralize more and reduce our working capital in our RDCs, you know, 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, and, you know, we’ll continue to help grow margins as we go forward. And so that’s, you know, that’s one of the benefits, and that’s why we’re continuing to invest in.
Sean, let me – if I can, let me just add a couple of comments, Kelly covered it well. You know, it fits our business model very well. That’s why we’ve been investing in this area for several years. And of course, the current COVID environment is accelerated the adoption of this, but our business model is multi-year 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 we’ve been working on this. We feel very confident. We’ll get to our 50% of revenue. It 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 the investment in our regional distribution centers have now been converted into fulfillment centers. So, there’s not a big cap back.
So, 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 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 two-thirds or 67% of our business, and the structural cost changes, not coming back, that they’re structural and change in 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’ll come from these fulfillment centers that have 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 2021 with less than 300 million in net debt is good progress. Once again, shows the counter cyclical cash flow nature of the business. And so I understand it’s too early for guidance in 2021. You know, uncertainty is only growing this week with the macro and the oil price move, but can you maybe just think through a couple 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? And then environment? Or can we hold it flatter? On the other hand, 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?
Yeah, Sean, great question. So, yeah, I think, you know, if you think – you know, we’re not giving any guidance on 2021, obviously, but just you know, kind of talking through your scenario, if we’re in a flattish environment, or even a flat to down top environment in 2021, 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. You know, receivables are just kind of a function, you know, whatever happens with revenue.
You know, there’s no – we are very fortunate, you know, with the customer base that we have, we don’t have a lot of, you know, 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. So, we have good, you know, good DSOs from an AR perspective, but so you’ll really see I think, in 2021, you know, in that kind of scenario that you were laying out more opportunity with inventory, and that should help us continue to generate cash in 2021, even if it still is a difficult environment.
Yeah, Sean, let me – I’ll just add a couple comments. You know, 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 our low balance on the ABL. You know, the way I look at it is, as we’ve been, Kelly and I’ve been working towards this year, we’ll finish this year with 2020 with ABL paid off. And if you just do the math on our cash flow, with a cash balance, we have [indiscernible] will 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 zero debt due until 2024. We’ll be sitting on some cash and have the short-term debt paid off. And as Kelly said, you know, this is a, we have a big model, 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, you know, the first couple quarters of this year, took a while for us to switch from 2019 into this year. And so, you’re we’re not done, you’re going to see some as you saw in the third quarter some good inventory reductions, as we right size, the inventory we need to carry for this level of revenue.
We’ll have another good quarter in the fourth quarter as we’re guiding to. And as Kelly said, do we expect to have a good positive cash flow for next year? We’ll quantify it more when we get into February timeframe with our guidance for next year.
So AR will flex with sales, but inventory still more work to do, which will be helpful. Very helpful. Thank you.
That’s correct. Thank you, Sean.
Our next question comes from the line of Doug Becker with Northland Capital Markets. Please proceed with your question.
Thanks. You’ve done a really good job on 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 years, it’s 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.
Yeah, Doug. Thanks. So, let me start and then Kelly can add some to it. Yeah, you’re seeing the results of our big shift to – we call them internally valve centric strategy for the company. And we’ve been working on this for over five years. So, you can see the difference in this down here, compared to the 15, 16 downturn where our adjusted gross margins went to the 17%, 18% range. When we had a lot of heavier weighting on both line pipe and carbon fittings, those type of product lines were very heavily weighted to 40%, plus now in valve business, it’s a much more complex, we’re doing a lot more valve automation, value added services.
We most recently added modification. 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, you know, we’ve had I’ve had a goal for many years to get us the 20% plus consistently deliver on our adjusted gross profits. We’ve hit it a couple quarters, but not consistently.
So, I think yes, as we get to a return to 3 billion plus revenue, I did say, I wouldn’t go to commit to 2021, but I commit to – we’re going to get back to our original goal of the 20% plus consistently from this model.
Doug, and just maybe to add on a couple of things. I mean, Andy covered, obviously very well, but you know, I think, you know, depending on what happens with volumes, you know, just activity levels here in the fourth quarter, we could see a little bit of pressure there. You know, I think we 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, you know, so it’s definitely going to stay in the 19th or probably mid-19 top range, which is really positive for us.
You know, we’ve seen some pressure in the U.S. and Canada markets, but it’s been very, you know, 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, you know, obviously, the valve mix is very important. But, you know, 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, you know, 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, you know, 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, you know, that’s a function of, you know, projects that we, you know, enjoyed last year and early this year, just continuing to taper off. And then as Andy said, the line pipe, you know, product line, because of the, you know, the commoditized nature of it, we think we’ll continue to see pressure there. So, more maybe to term on the midstream side, but the other pieces of the business are certainly helping to prop everything up.
So, all make sense. Maybe touching on the gas utilities, kind of reiterate that $1 billion target a couple years out, does that include any expansion of your scope, or is that just kind of what you do today? And, you know, 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.
Yeah, Doug, it’s very reasonable. And a couple of things going, yeah, so historically, last 20 years, been another 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 system to higher pressure systems, or old equipment into new products for safety.
So, the inability to get into homes and do projects for the second quarter primarily and a little bit into the third quarter is really the only reason we’ll show down year-on-year, but it’s 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. We’ll quantify that more next year when we give some more guidance, but I think we’ll 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 to 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 one’s we’re attacking to from the business development side to win. So, I feel very good that you’re in the ballpark of a billion plus in 2023.
Fair enough, thank you.
Thank you, Doug.
Our next question comes from the line of Jon Hunter with Cowen. Pleased to see with your questions.
Hey, good morning, Andy and Kelly.
Good morning, Jon.
So, I just had a question on the progression of revenues in the fourth quarter here. Back at the second quarter, you’d said that July was tracking down, you know, 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, you know, 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, you know, kind of the mid-point of that 5% to 10% range is what we should be thinking about?
Yeah, yeah, Jon. I’ll take that one here to start with. No, I think you’re probably thinking about it the right way. You know, as we mentioned in the prepared remarks, the normal seasonal decline, if you take out, you know, kind of the outliers, the normal seasonal decline is that 5% to 10% range. We actually last year had a 19% fall off, but we don’t expect this to 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, you know, massive or severe fall off at this point, which is very positive.
So, I think what you said, you know, with September being the best month of the quarter, October’s coming in very similar to that, we would hope to do better than the high end of that range. But, you know, probably somewhere in the middle is, you know, kind of what I would probably do for modeling purposes right now. And, you know, if you, kind of drill down, you know, 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, you know, closer to 10%, Canada, you know, more upper single digits of a decline, but the international is actually going to have a good, very good Q4, probably up double digits.
And that’s just, you know, kind of the timing of some of the projects they have going on. And, you know, 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, you know, gas utilities, you know, it’ll fall off a little bit here in the fourth quarter, just the normal seasonal decline, but definitely pose low single digits as a decline downstream, you know, could be more of a high single digit decline.
Upstream, I think down single digits, probably, you know, feels like it’s going to be like low single digits right now. And then, midstream, as we talked about earlier in the call, you know, it’s getting a little bit more pressure. And it could be down sequentially, double digits when it all, you know, plays out. Like we said, when you net all that out, 5% to 10% range? And, you know, kind of feels like probably somewhere in the middle.
Thanks, Kelly. That’s very helpful detail. And then my follow up question is just on margins. I mean, you got it, you know, 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’s more pressure, but do you have any visibility to the pricing declines kind of leveling off in over the next couple of quarters here? Thanks.
Yeah, Jon, no, on pricing, you know, there’s obviously pressure out there we’re getting requests from customers all the time to lower pricing, but you know, I think, you know, our sales organization has done a tremendous job, you know, pushing back or offering up alternative products to help bring, you know, pricing down or cost down for our customer base. So, that’s all been very positive, you know, with some of the smaller players out there that, you know, where the downturns really impacting their cash flows right now, you see, you know, more pressure with some of those guys, reducing pricing.
So, but still, you know, going back to what we covered earlier, you look at our product mix, we have today with, you know, higher concentration of valves, lower concentration of lying pipe, you know, we have, you know, 68% of our revenue between gas utilities and downstream, which are our, you know, much more stable, you know, margin businesses for us. It, you know, I think we may experience some modest declines in our margins here in the fourth quarter. And, you know, I’m not going to call it bottom, you know, we’re not like I said, we’re not giving 21 guidance at this point, but if revenues kind of stay, you know, 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.
Very helpful. Thank you.
Our next question comes from the line of Steve Barger with KeyBanc Capital Markets. Please proceed with your question.
Hey, good morning, guys. This is Ken Newman on for Steve, thanks for taking the question.
Good morning. So, really good color on the consolidations from your customers in the last few weeks in your prepared remarks, and I am curious, you know, in the event that you’re able to integrate some of those acquired inventories for your customers into your system. You just talked a little bit about, you know, the potential price impact 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. We see all these M&A transactions, some are very favorable light. You know, it fits our model. We’re heavily focused on the major customers, the multi-year contracts, long-term agreements, and supply deals. You know, 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 a combination. 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 [views], Chevron buying Noble. Chevron well known as our largest customer for many years, along with Shell as a close number two, you know, 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, Concho same thing, ConocoPhillips much bigger customer for us than Concho, Pioneer a much 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.
You know, Equitable is a good customer of ours, because that one’s probably a neutral, and then [indiscernible] Husky, the most recent one 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 span, they look for bigger suppliers. They look for cost savings in there, probably synergy objectives. And we can help them with all that. And I think so they play to our business model more than others, and they play to our strengths. 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, 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, all of our big customers are on the platform. But then, as we said in the remarks, you know, 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 say, you know, these upstream combinations more to our general MRO, customer focus, account management strength, and – but of course, Chevron who’d be on the e-commerce platform. And as I think you’ll see others as maybe other IOC’s acquire companies that fits well with e-commerce more than these. But these been more with just our general approach to this customer base in upstream.
Got it? That’s helpful. My following question is just about the – it was really good color on your outlook for 4Q. My following question is really more about downstream maintenance demand and 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, you know, 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, the last turnarounds as more large cap investments of 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 was 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 should be a very good spring turnaround 2021 time for us.
Very helpful. Thanks.
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 in our fourth quarter conference call next year. Have a good day and good bye.
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.