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Edited Transcript of MRC earnings conference call or presentation 14-Feb-20 3:00pm GMT

Q4 2019 MRC Global Inc Earnings Call

TULSA Feb 17, 2020 (Thomson StreetEvents) -- Edited Transcript of MRC Global Inc earnings conference call or presentation Friday, February 14, 2020 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Andrew R. Lane

MRC Global Inc. - President, CEO & Director

* James E. Braun

MRC Global Inc. - CFO & Executive VP

* Kelly Youngblood

MRC Global Inc. - EVP

* Monica Schafer Broughton

MRC Global Inc. - VP of IR

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Conference Call Participants

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* Blake Anthony Hirschman

Stephens Inc., Research Division - Research Analyst

* Jonathan James Hunter

Cowen and Company, LLC, Research Division - VP & Analyst

* Michael Lawrence McGinn

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* Nathan Hardie Jones

Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst

* Robert Stephen Barger

KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst

* Sean Christopher Meakim

JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst

* Vaibhav D. Vaishnav

Scotiabank Global Banking and Markets, Research Division - Analyst

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Presentation

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Operator [1]

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Greetings. Welcome to MRC Global's Fourth 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. Thank you. You may begin.

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Monica Schafer Broughton, MRC Global Inc. - VP of IR [2]

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Thank you, and good morning, everyone. Welcome to the MRC Global Fourth Quarter and Year-end 2019 Earnings Conference Call and Webcast. We appreciate you joining us today. On the call, we have Andrew Lane, President and CEO; Jim Braun, Executive Vice President and CFO; and Kelly Youngblood, Executive Vice President. As previously announced, Jim will be retiring at the end of the month, and Kelly will be assuming the role of CFO on March 1. They will both participate on the earnings call this morning.

There will be a replay of today's call available via webcast on our website, mrcglobal.com, as well as by phone until February 28, 2020. The dial-in information is in yesterday's release. We expect to file our 2019 annual report on Form 10-K 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, February 14, 2020, and therefore, you are advised that information may no longer be accurate as of the time of replay.

In our remarks today, we will discuss adjusted gross profit, adjusted gross profit percentage, adjusted EBITDA and adjusted EBITDA margin. You are encouraged to read our earnings release and securities filings to learn more about our use of these non-GAAP measures and to see a reconciliation of these measures to the related GAAP items, all of which can be found on our website.

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

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

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Andrew R. Lane, MRC Global Inc. - President, CEO & Director [3]

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Thank you, Monica. Good morning, and thank you for joining us today and for your continued interest in MRC Global. Before we get started, I would like to recognize that this marks Jim's final earnings call with us, and he will be missed. We've hosted 32 earnings calls together over the past 8 years, and Jim has contributed greatly to advancing the strategic objectives of the company, including our IPO in April 2012. I want to wish Jim well in his much-deserved retirement.

Kelly joins us this quarter with his first earnings call, and we are pleased to have him. Kelly is a proven corporate CFO and is well-positioned to take over after a smooth 3-month transition. I'm looking forward to working with Kelly and introducing him to those of you who don't already know them.

Today, I will review the company's 2019 highlights and progress on our strategic objectives. And then, I'll turn the call over to Jim for a more detailed review of the financial results for the fourth quarter, before I discuss the market fundamentals behind our current outlook for 2020, and then Kelly will wrap up with our current 2020 outlook.

In late 2018, as we headed into 2019, the market consensus was that 2019 would see a double-digit increase in E&P capital spending. That all shifted quickly in the first half of the year. Now in hindsight, capital spending for 2019 ended up being 10% to 15% lower than 2018. This was a substantial change in direction in a relatively short period of time, and we immediately responded by reducing operating costs and inventory levels. These actions resulted in substantial cash generation, which allowed us to return cash to shareholders and reduce debt. We have a sound long-term strategy to maximize returns, which we will continue to make progress against despite market conditions.

Before I address our progress on our strategic objectives, I want to highlight a couple of items from this year's performance. 2019 revenue was $3.66 billion, a 12% decline over the prior year, driven by a reduction in customer capital spending levels and the completion of several large nonrecurring projects in 2018. The year-over-year impact of which was $260 million. Excluding the nonrecurring projects, our base business declined 6%, substantially less than the overall market, due to our diversity of end markets.

We also achieved adjusted gross margins of 19.5% for the year, consistent with our 2018 margins of 19.6%. Excluding some one-off Q4 items noted in the press release, our adjusted gross profit margin was 19.7% for the year. Since becoming a public company, that is the highest annual margin we have achieved, proof that our valve-centric strategy and our continued shift to higher-margin products and services is working, even in this current challenging market.

As we saw revenue begin to fall short of expectations due to the weak market conditions, we took immediate action early in the year, beginning in Canada and then in the United States. We reduced recurring SG&A by $25 million in 2019 as compared to 2018 by reducing headcount and streamlining our operational footprint. We closed our consolidated 6 locations, including 2 U.S. regional distribution centers in San Antonio and Tulsa, which are scheduled to close early 2020. We will be able to more efficiently serve these markets from our new La Porte facility. We also decreased our headcount by 360 employees or 10% of our workforce.

In 2019, we generated $242 million of cash from operations, above our expectation of $175 million to $225 million, as we were aggressive in managing working capital. This resulted in free cash flow of $200 million and a cash flow yield of approximately 20% based on this week's stock price levels. The free cash flow was used to reduce debt and to complete our share repurchase program. Since 2015, when we began this program, we have returned $375 million to shareholders, and we have repurchased 24.2 million shares. We are committed to maximizing shareholder returns and consider all capital allocation options.

Regarding our strategic objectives. We continue to pursue market share growth as one of the major tenets in our strategy. Our approach is to increase share by obtaining and expanding multiyear MRO contracts with customers. In 2019, we renewed or were awarded several notable contracts, including Southern California Gas, which increased our gas utilities business, giving us sales or contracts with 9 of the 10 largest gas utilities in the country.

We also were awarded an integrated supply agreement with CenterPoint Energy, as we discussed last quarter, which is currently in the implementation phase, and expected to generate $20 million to $30 million in incremental revenue in 2020. Our gas utilities business continues to grow, and we expect that trend to continue. The compound annual growth rate for this part of our business since 2012 is 7.5%. In 2020, we plan to report our gas utility business, separate from our more volatile midstream transmission and gathering business to provide more transparency to this distinctly different business.

This quarter, we also were awarded an integrated supply agreement with Chevron in Canada for their MRO business. As we are currently doing their project work in Canada, this latest win means we have a substantial portion of the Chevron PVF spend under contract. This is an example of our relentless pursuit to gain share of wallet with our customers and continually finding new growth opportunities, even in the currently muted activity levels in Canada. This positions us well for future growth.

And finally, we also renewed our integrated supply contract with INEOS, a leading chemical company for another 3 years. In 2019, we continued investing in higher-margin product and service offerings as part of our strategic objective to shift towards higher-margin product offerings and increase our sales from valves. I'm pleased to say that, for the year, valve sales totaled 39% of total revenue, surpassing our previously stated goal of 38% and the highest in our history.

And specifically, for the fourth quarter, valve sales totaled 40% of our revenue, putting us on track to achieve our near-term goal of 40% to 42% of revenue in 2020, and our longer-term goal of 45% of revenue in 2023.

Our new 127,000-square foot midstream valve engineering and modification center, which we are proud to have completed in 2019, gives us additional and more extensive capabilities, and we expect to see results from this facility take shape in 2020. As we discussed last quarter, we think the opportunity for market share gains in midstream valves could be $100 million over the next couple of years.

To continue to grow market share and maximize profitability, we also made investments in technology. In 2019, we announced our comprehensive digital supply chain solution called MRCGO, a cloud-based portal that allows our customers to transact with us in an easy and seamless manner. The feedback from customers has been very positive, and we continue to roll out this solution to our customers. We currently have 80 customers on the system already, and we expect the revenue we earned through e-commerce to double in the next 3 to 5 years.

Finally, as you know, the coronavirus is impacting the world, and particularly, China. The full impact of the virus and how it will influence macro oil demand and global supply chain is still unknown. Our direct exposure is very low as sales in China were less than $3 million in 2019. We currently have only 1 employee based in China.

From a supply chain perspective, we are currently well-positioned as we have approximately $350 million of valve inventory to meet the current demand. To date, we have not seen a significant disruption to our supply chain. However, as we source many of our commodity valves from China, and China produces many valve components that are assembled in both Europe and the United States, a protracted restriction on the movement of people and product could cause delays in receiving inventory. We are actively monitoring the situation and in communication with our suppliers about their plans, as well as looking for alternative suppliers outside of China, to help mitigate any potential impact, if the coronavirus impact extends longer term.

I'll now turn the call over to Jim.

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James E. Braun, MRC Global Inc. - CFO & Executive VP [4]

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Thanks, Andrew, and good morning, everyone. Total sales for the fourth quarter of 2019 were $766 million, which were 24% lower than the fourth quarter of last year, with all geographic segments declining. Sequentially, revenue declined 19% above historical averages as customer budgets were exhausted early and they continue to be focused on cash -- capital discipline.

U.S. revenue was $608 million in the fourth quarter of 2019, 22% lower than the fourth quarter of 2018, with declines across all end market sectors, led by midstream transmission and gathering. The U.S. midstream sector sales were down 21% in the fourth quarter of 2019 over the same quarter in 2018, primarily due to gathering and processing customers, who reduced their spending throughout the year in response to the upstream sector's lower activity levels, and in favor of more capital discipline themselves.

Gathering and processing customers' activity levels are correlating with the upstream sector. Gas utilities were also down due to lower sales to PG&E related to their bankruptcy. This subsector also experienced lower sales, due to nonrecurring pipe deliveries in 2018. U.S. upstream sales were down 29% in the fourth quarter of 2019 over the same quarter in 2018, due to several customer-specific conditions as well as budget exhaustion and customer capital discipline.

U.S. downstream revenue declined 17% in the fourth quarter of 2019, over the same quarter 2018, primarily due to the conclusion of the Shell Pennsylvania chemicals project. Sequentially, fourth quarter 2019 U.S. segment sales were down from the third quarter by 20%, primarily due to seasonal clients exacerbated by budget exhaustion. Canadian revenue was $43 million in the fourth quarter of 2019, down 46% from the fourth quarter of last year, driven by government-imposed production limits.

In the international segment, fourth quarter 2019 revenue was $115 million, down 24% from the same quarter a year ago, primarily due to the conclusion of the TCO project in Kazakhstan, as well as weaker foreign currencies. Excluding both the project and the impact from currency, international sales increased $5 million or 5%, primarily in Norway and the United Kingdom.

Now turning to our results based on end market sector. Upstream sector fourth quarter 2019 sales decreased 34% from the same quarter last year to $224 million, with declines in all geographic segments as described earlier. Midstream sector sales, which are primarily U.S.-based, were $298 million in the fourth quarter of '19, down 20% from the same quarter last year. Sales in our transmission and gathering subsector were down 34% or $57 million, and sales in our gas utility subsector were down 9% or $18 million, in each case, comparing fourth quarter of 2019 to the same period in 2018.

For 2019, gas utilities represented 60% of total midstream sales. This is an important customer group, in which we have a unique competitive position, and we will continue to grow market share.

In the downstream sector, fourth quarter 2019 revenue was $244 million, a decrease of 18% as compared to the fourth quarter of 2018, driven by the U.S. The U.S. decline is primarily due to conclusion of the Shell Pennsylvania chemical project, as described earlier.

Turning to margins. Our gross profit percent increased 20 basis points to 17.1% in the fourth quarter of 2019 as compared to the fourth quarter of 2018. The improvement reflects the impact of lower LIFO expense. LIFO expense of $1 million and $14 million was recorded in the fourth quarters of 2019 and 2018, respectively. Gross profit in the fourth quarter of 2019 was also negatively impacted by $3 million for the final settlement of a multiyear customer project, and $5 million for the noncash write-off of excess and obsolete inventory in our international segment.

Excluding the impact of these items, gross profit would have been 18.1% in the fourth quarter of 2019. Adjusted gross profit for the fourth quarter of 2019 was $146 million or 19.1% of revenue as compared to $202 million and 20% for the same period in 2018. Excluding the impact of the $8 million of items just described, adjusted gross profit would have been 20% in the fourth quarter of 2019.

Line pipe prices steadily declined throughout 2019, in [stark] contrast to the increases experienced in the first half of 2018, due to tariffs and quotas. Based on the latest Pipe Logix All Items Index, average line pipe spot prices in the fourth quarter of 2019 were 20% lower than the fourth quarter of 2018, and 4% lower than the third quarter of 2019. For the full year, line pipe prices were 11% lower than 2018.

SG&A costs for the fourth quarter of 2019 were $141 million or 18.4% of sales as compared to $148 million or 14.7% of sales in 2018. Both periods includes severance and restructuring costs of $4 million each. The fourth quarter of 2019 also includes $5 million of pretax charges related to the doubtful collection of a product claim against a foreign supplier, and $3 million for an end of year adjustment for insurance receivables.

Excluding these items from both quarterly periods, SG&A declined $15 million or 10%, as we cut costs to better align with market conditions. Interest expense totaled $9 million in the fourth quarter of 2019, which was $1 million less than the fourth quarter of 2018, due to both lower average debt levels and lower interest rates. Our effective tax rate for the quarter reflects $5 million of tax expense on a $19 million pretax loss. This unusual situation is due primarily to losses, including the write-offs described earlier, incurred in foreign jurisdictions with no corresponding tax benefit, and additional taxes related to new recently issued changes in certain tax regulations.

These factors are also responsible for the full year tax rate of 41%, higher than our expected rate of 25%. Net loss attributable to common shareholders for the fourth quarter of 2019 was $30 million or $0.37 loss per diluted share. Results include those certain items previously described, totaling $19 million after-tax or $0.23 per diluted share.

Adjusted EBITDA in the fourth quarter of 2019 was $23 million versus $63 million a year ago, and adjusted EBITDA margins for the quarter were 3%, down from 6.2% a year ago. Our working capital at the end of 2019 was $732 million, $164 million lower than it was at the end of 2018. And working capital, excluding cash as a percentage of sales, was 19.1% at the end of 2019, exceeding our target of 20%.

Our operations generated cash of $108 million in the fourth quarter of 2019, as the market slowed and we brought down accounts receivable and inventory levels. For the full year, we generated $242 million in cash from operations. We spent $75 million for share repurchases in 2019, $12 million of which was spent in the fourth quarter, completing our share repurchase program. We also reduced outstanding debt by $133 million to $551 million at the end of 2019, and our leverage ratio, based on net debt of $519 million, was 2.6x at the end of 2019, well within our stated preferred range. The availability on our ABL facility was $451 million, and we had $32 million in cash at the end of the year. We have no financial maintenance covenants in our debt structure, and our nearest maturity is September 2022. We have a strong balance sheet as we move into 2020.

And now I'll hand it to Andrew to provide our current macro views underlying our outlook.

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Andrew R. Lane, MRC Global Inc. - President, CEO & Director [5]

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Thanks, Jim. After only 2 years, 2017 and 2018, of a recovery in the energy sector, 2019 ended up being a much more difficult year than most thought going into it. The industry has become more efficient at drilling, and production has increased despite less wells being drilled. We have seen a reduction of 900 drilled but uncompleted wells during the past 9 months, and less capital being spent. 2020 looks to be on a similar trajectory, with analysts showing E&P capital expenditures in the U.S. to be 7% to 12% lower as compared to 2019.

Global spending in international is expected to increase modestly in 2020. However, with the non-repeat of a large capital project that finished up in early 2019, we expect 2020 international revenue to decline. The E&P spending increase in international and offshore is concentrated with national oil companies, who are not our core customers, as they buy PVF directly from manufacturers.

Following the significant slowdown in spending that occurred in November and December of 2019, we expect a slow start to the year, as customers continue to be more disciplined and cautious about spending within their cash flow, and level loading their budget throughout the year. We have more exposure to some of the larger IOCs in the United States, whose spending is increasing, are focused in areas where we operate.

We also benefit from the stability of our gas utility business, which is now 24% of our total revenue, and is not commodity price-dependent. While we are not immune to the industry trends, we do have more diversity in our end markets, supporting revenue in a soft market. We are encouraged by a moderate increase in January revenue over the low levels we saw in November and December. We have built a strong long-term strategy for all phases of the cycle, and we continue to execute this strategy to increase shareholder returns, focused on market share, higher returns and cash flow.

We plan to continue to focus on expanding market share with new and existing customers, increasing our gross margins through our valve-centric strategy as well as penetrating the midstream valve market further with our new modification job.

You should expect us to continue to invest in the future by continuing to increase customer use of our e-commerce platform, MRCGO, as we transition more customers to that platform. As we have always done, we continue to be focused on containing the operating costs and finding new ways to be more efficient.

I will now turn the call over to Kelly to cover our guidance for 2020.

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Kelly Youngblood, MRC Global Inc. - EVP [6]

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Thanks, Andrew. The coming year will, no doubt, have headwinds for the industry, and MRC Global is no exception. Our focus in this environment must be to create our own success by continuing to grow market share, optimize our cost structure and strengthen our balance sheet to better position the company for the eventual market recovery.

Given the market fundamentals outlined by Andy, we are guiding our revenue to fall within a broad range of $3.2 billion to $3.7 billion in 2020. The midpoint of this range suggests a 6% decline compared to 2019, which is significantly better than current spending estimates as a result of our diversification to different end markets, along with our exposure to large IOC customers and the gas utility sector. From a sector point of view, we expect the upstream business to decline the most in the high single-digit percentage range, as customers continue to curtail spend and focus on capital discipline.

Midstream is expected to decline by mid single-digit percentage, driven by the transmission and gathering subsector, which typically tracks closely with the upstream portion of the business. This decline will be partially offset by gas utilities, which is expected to continue its growth trend. We believe gathering and processing customers will spend less this year, in response to lower upstream spending and capital discipline. We expect to continue to participate in the Permian takeaway buildout projects with our transmission customers.

However, transmission activity outside of the Permian will likely decline. Our gas utility customers will continue to spend based on their multiyear system replacement programs, and we continue to gain market share in this space. The downstream sector is expected to decline a mid-single-digit percentage as well, due to the completion of projects, partially offset by a solid turnaround schedule expected in 2020.

By geography, we expect the U.S. and Canada to decline by mid-single-digit percentage, and international to be down a low single-digit percentage. The U.S. business decline is primarily driven by projected declines in upstream and transmission and gathering spending in 2020. Our Canadian business is over 70% upstream and is expected to be negatively impacted by crude differentials and government-imposed production restrictions. Our international segment's underlying business is improving, but on a year-over-year comparison, will be negatively impacted by a $20 million decline from residual revenues related to the TCO Future Growth Project in Kazakhstan, that completed in 2019.

Regarding the projected pace of activity. We expect the first quarter of 2020 to be on par with the fourth quarter, with the year progressing like it has historically, with the third quarter being the strongest. We expect our 2020 gross -- adjusted gross profit percentage to range between 19.6% and 19.8%, above our 2019 results, as we continue to execute our valve-centric strategy and penetrate the midstream valve market with our new modification shop capabilities. Our goal is to consistently perform at 20% or higher in the next few years.

We expect adjusted EBITDA to be between $160 million and $200 million, and we expect diluted earnings per share to be between $0.19 and $0.56. Given expectations around stabilizing line pipe cost, we expect the LIFO expense in 2020 to be between 0 and $10 million of expense. In 2020, we expect SG&A expense will be approximately $510 million to $530 million, which at the midpoint is lower than 2019 by 5%. However, it is normal to see quarterly fluctuations in SG&A expense during the year.

I also want to point out that our amortization expense will decrease by approximately $14 million in 2020 as compared to 2019, due to intangible assets associated with a prior acquisition that came to the end of their useful life. We expect the effective tax rate to be 26% to 28% for the full year 2020.

And for capital expenditures, we expect to spend approximately $15 million to $20 million, in line with 2019, as we continue to invest in our e-commerce technology and facility upgrades. Cash provided by operations is expected to be approximately $110 million to $160 million, lower than 2019, due to the forecast reduction in revenue and a more stable working capital balance. We also expect to maintain a 20% working capital to sales ratio.

And after returning $375 million to shareholders over the last 4 years, our focus in 2020 will be on prioritizing the use of our excess cash to reduce debt, showing up an already strong balance sheet. Despite the lower -- the slower market conditions and reduction in revenue in 2020, we remain focused on our long-term strategy for shareholder returns through gaining market share, maximizing profitability and having an efficient working capital structure. We have historically generated cash in periods of slow or no growth, and we believe this year will be no exception.

And finally, I want to say that I'm very pleased to be at MRC Global, and I'm looking forward to working closely with Andrew and the strong executive management team he has put in place to deliver the best results possible at every point in the cycle, and provide superior value to our shareholders.

With that, we will now take your questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from Sean Meakim with JPMorgan.

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Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [2]

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Jim, congrats on your retirement. It's been great working with you over the years. And Kelly, good to have you on board and looking forward to working with you again.

All right. So with all the pleasantries out of the way, to start, maybe, could we just talk a little bit about the upstream and the midstream guides? I think this is where you're probably going to get the most pushback from investors, considering how much pressure there is from the same set of investors to be disciplined on spending. I think the drop-off at year-end of '19 probably reinforces those concerns, so I think most people on the call are going to be pretty well attuned to the strong IOC mix and the gas utilities as part of what supports those assumptions. But if upstream spending is down 10% to 15% in the U.S. in 2020, could we talk about confidence levels around this high single-digit decline in upstream and mid-single-digit for midstream?

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James E. Braun, MRC Global Inc. - CFO & Executive VP [3]

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Yes. Sean, let me start on that one. And let me start with the fourth quarter, on the tail off there. And I think from the last call, we had talked about our seasonal decline of 5% to 10%, how to be at the high end or more and it just played out even a more significant drop off. It was -- you look at October, we were right on track for what would be normal fourth quarter, around $290 million revenue, and the tail off accelerated with the budget exhaustion, and we finished December with $233 million revenue.

So you can see, it's significantly more than normal for us. In the upstream environment, it was very much concentrated on 3 major customers for us: Chevron, who had been very active through 3 quarters, curtailed a lot of budget spending in the fourth quarter; Occidental and Anadarko, both curtailed budget, and we're going through the normal merger -- major merger activities, distractions; and then CRC on the West Coast, also budget curtailment. So those 3 specific upstream customers were the bulk of our fall-off in the upstream.

And in the midstream, all of our major customers curtailed spending, the DCP, the Williams. And it also had a very low demand for line pipe and also, with the demand that we did have was very much at the lowest price of the year, with the deflation that we saw of around 18%, 19%. So it had both a volume impact and a price impact. But nothing significantly changed, except for these budget curtailments. I will say that January has picked up. And activity, as you'd expect with new budgets, pick up.

But we're basically forecasting a flat first quarter as things ramp back up from the low point of December. And certainly, January was much better than both November and December revenues.

On the 2020 outlook, it's very much specific to our customers as it is both in the tail off last year, but also in the spending. When you look at the overall spend, yes, we feel that U.S. land, upstream and midstream-type activity spending will be down, 7% to 12% as an industry. When we look at our specific top 25 customers, that make up a little over half our revenues, we see their spending down in the 3% to 5% range.

So while the general, small customers, PE, private equity-backed customers, and others may be down more significantly, we feel good about our guidance on upstream being down high single digits as a -- based on our customer mix. On midstream, the same thing will be down on price. When you think about line pipe, starting at the current level of line pipe pricing, much lower than we started at last year. So that will have an impact on midstream and some volume to -- also on projects, mostly in the gas arena.

But then we feel very good about gas utilities. So we'll have a decline on midstream pipeline work, and we'll have an increase on the year on gas utility work. So we have that offsetting factor.

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Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [4]

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And one more small wrinkle to that. How about your confidence level in 3Q as being your strongest quarter given the seasonality we've seen in recent years in the upstream?

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James E. Braun, MRC Global Inc. - CFO & Executive VP [5]

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Yes. We're projecting that it will go back, Sean, to what's more normal. It's -- we've had very unusual experience in the last 2 years as -- I mean, especially last year, when our highest revenue was March, and it curtailed through the whole year as budgets were pulled back. But that's not normal for our business. The third quarter is the main construction quarter for both tank batteries and pipe line and gas utility work. So we believe it's going to return for us more normal from a sequential basis and improving second quarter, best quarter and third quarter, and then some tail off seasonally in the fourth quarter.

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Sean Christopher Meakim, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [6]

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Got it. I appreciate that. And just last thing then on the G&A guidance. Could you talk about the flex points around the range? So in other words, is it just based on activity? Or could we see a scenario where you hit the midpoint of revenue but still drive the G&A lower through more discipline? And just curious, what type of scenario would you see that leaves you at the upper end of that range?

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James E. Braun, MRC Global Inc. - CFO & Executive VP [7]

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You know what, let's address the second part of your question first, Sean. To hit the higher upper end of that G&A range, we tend to see revenue much up towards the high end of the revenue range, as we have to bring out some resources or additional variable cost to meet that. We have committed to spend some more on the MRCGO and commitment to IT this year, so that's going to drive some of the increase over what we spent in the past.

But if we come into the midpoint of the revenue range, we're much more likely to be below the midpoint of the operating costs for some of the reasons we've talked about in the past, where we just manage to those levels.

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Andrew R. Lane, MRC Global Inc. - President, CEO & Director [8]

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Yes. Sean, I'd just add to Jim's comment. We finished the year at a little over 3,200 employees, which was a level of less than we had in 2016, which was a very low point for the business. So we feel very good about -- we're in a strong position to see some incremental. If revenues pick up some in the second half, we'll see incremental profitability from that.

And we also took another step in 2019. We closed 6 locations that we talked about in our prepared remarks. And so we're getting to a very efficient delivery standpoint with less employees. And so I think that was both impact. And that would tend to be more towards the low end of the SG&A guidance.

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Operator [9]

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Our next question is from Vebs Vaishnav with Scotiabank.

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Vaibhav D. Vaishnav, Scotiabank Global Banking and Markets, Research Division - Analyst [10]

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I guess, we've already spoken about upstream and midstream. Thinking about downstream, that was actually a surprise for me, that downstream revenues were -- declined so much. I believe Shell-Franklin project was all already done in 2Q. So just if you can expand on why we saw a decline in downstream revenues in 4Q would be helpful.

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Andrew R. Lane, MRC Global Inc. - President, CEO & Director [11]

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Yes. Vebs, downstream in 4Q was really just general activity spending. I think some of it's profitability on the spreads for customers, some of it related to us, is always related to the IOCs, where they may be pulling back on some downstream spend as they invested and completed some budget spend in the upstream. We always have that dynamic. There was also a tail off of about $5 million in turnaround expense and activity in the fourth quarter from the third.

But you're right, there wasn't that much in the Shell. But as we think about 2020, we see an improvement in our customer base turnaround activity of double digits, which is good for us. We have to overcome $20 million of Shell that was in the first half of 2019 that won't repeat in downstream. But otherwise, we feel good. We have a very solid position in our downstream segment that it's less muted than the swings in upstream, for sure.

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Vaibhav D. Vaishnav, Scotiabank Global Banking and Markets, Research Division - Analyst [12]

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Okay, because I was also curious about the 2020 guide, where we talked about midstream -- mid single-digit decline in downstream. And if my thinking was maybe we generate like $25 million, $30 million from the Shell-Franklin project, so even if you take that out on a year-over-year basis, it looks like the underlying activity is flat to maybe modestly down. But maybe I'm underestimating the impact of Shell-Franklin?

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Andrew R. Lane, MRC Global Inc. - President, CEO & Director [13]

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No. You're exactly right on Shell-Franklin. It's right at $20 million, $23 million exactly. But right there, and then I think you're right. We're forecasting kind of a 2% to 3% decline in CapEx with our -- in the downstream portion and offset by some additional, roughly $10 million to $13 million of additional turnaround revenues in the year, positively.

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Vaibhav D. Vaishnav, Scotiabank Global Banking and Markets, Research Division - Analyst [14]

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Got it. Okay. And going to just first quarter, flat revenues, but you have talked about how January is better than November and December. I understand that upstream activity is still in flux, but typically, the midstream revenues seasonally improve in 1Q. Is that not how you are seeing this year, that midstream could be our seasonally up? Or if you can expand on why you think 1Q could be flat?

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Andrew R. Lane, MRC Global Inc. - President, CEO & Director [15]

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Yes. Let me talk through, Vebs, the segment. So international, starting there. Q1, we see it down kind of mid-single digits, and that's solely from $20 million of TCO, Chevron upstream revenue we had in the first quarter last year, that's impacting that. Overall, we see international improving, with the spending increase. But we have that onetime delta. Canada will be up double digits, as it always is in the first quarter, sequentially. So that's a positive for us. But the first quarter is always the best up there. And then the U.S., we see basically flat to a very modest increase in midstream, flat in upstream environment and then slightly up in downstream, mostly related to the turnaround spend that will occur in the first quarter. So when you take all the plus and minuses that we see basically a flat year, just because January is definitely better than November and December, but not at October's level. So we still have a pickup in activity. We have a short month in February, and we have a pickup of activity in March that we expect to have. So I think with all those pluses and minuses, we end up basically flat for the quarter as a start to year.

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Vaibhav D. Vaishnav, Scotiabank Global Banking and Markets, Research Division - Analyst [16]

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And does that imply flat margins as well?

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James E. Braun, MRC Global Inc. - CFO & Executive VP [17]

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For margins as well, I mean, they should -- again, they should be comparable to that high 19% -- close to 20% that we had in the fourth quarter.

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Andrew R. Lane, MRC Global Inc. - President, CEO & Director [18]

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Yes. We expect the first quarter to be in our 19.6%, 19.8% range.

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Operator [19]

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Our next question is from Nathan Jones with Stifel.

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Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [20]

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I'll add my congratulations to Jim, and welcome to Kelly. I would like to start off on -- with the gross margins here, which have held in really well, despite the drop-off that you've seen in demand here. Can you talk about -- I mean, I understand you get some positive mix out of the valve business, and you've got negative pricing in the line pipe business. Can you talk about maybe the rest of the portfolio? How you're seeing competitive behavior? Whether you're seeing any downward pressure coming on pricing there?

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Andrew R. Lane, MRC Global Inc. - President, CEO & Director [21]

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Yes. Nathan, no, you hit the 2 big drivers. As we said in our prepared remarks, if you took out the one-time expenses that we booked in the fourth quarter that impacted margin, we were right at 20%, very similar to third quarter margins and very similar to the last half of the year before. So we tend to be able to still hit 20% on a basis in the quarterly. It's still our goal to get to that level. The valve mix is the biggest impact, and we said in our comments that the fourth quarter, we had 40% of our revenue coming from valves. We also have started to book revenue out of our new Midstream Modification Center, which we do a complete assembly, which includes manufacturing, welding, testing, painting, coating.

So a full assembly for our customers. So that tends to be a lot of value-add and higher-margin business. So I think that, by far, is still having the biggest positive impact. The drop-off in the midstream activity, both in line pipe demand in the fourth quarter, of course, that being our -- especially in ERW pipe, that being our lowest margin business on the mix change, has a positive impact on the overall margin. And then to the rest of your question on the other product lines, all very stable from a pricing standpoint, on flange and fitting. Of course, in our gas products, stable with a growing end market. And then just the stainless steels, very similar on the -- mostly in the chemical downstream side, and general oilfield products reflects pretty flat pricing in the tank battery upstream environment.

So we feel good about the 19.6%, 19.8% range. I feel line pipe has basically bottomed -- very close to bottoming, if it's not at bottom on -- all of the tariffs really didn't accomplish much with the run-up in inflation in 2018 and all that back out in 2019. So we're basically at the same level of $1,500 a ton that we were added at the beginning of '18. And it really has flattened out the last 3 or 4 months. So we expect that to stay at that level. And so we don't expect it to go down from a margin percentage more, but we're not also not forecasting much of an uplift from line pipe.

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Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [22]

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Okay. That's helpful. And then, I guess, the next question is a little more of a philosophical one. You guys work in a highly cyclical industry, and you're used to saying customers not necessarily be so disciplined with capital spending. Certainly, investors are putting pressure on E&Ps to spend within their cash flows. If that maintains, would we not be at a new normal level of spending? What could (inaudible) is unlikely to drive growth in upstream spending from here, outside of oil going to $70 or something like that? And if we are at a new normal level of spending for domestic E&Ps here, are there changes do you need to make to the business model, structural changes you need to make to the footprint, in order to preserve your own margins?

Maybe you need to provide a lower level of service to customers here in order to protect your own margins, given their lower levels of spending? Just any kind of commentary you could give us on how you're thinking about that over the next few years.

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Andrew R. Lane, MRC Global Inc. - President, CEO & Director [23]

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Yes. Nathan, it's a very good question. And I think about it a lot. And of course, our customer base still is very dependent on their cash flows from an oil and gas pricing commodity standpoint. So that remains and always will remain the big driver. And so, we've looked at the environment, if you stay in this $50, $55 a barrel in the WTI environment, I think it -- there's a sustaining level of CapEx they have to spend as you know probably very well, the steep declining rates in the U.S. production. So design increase in spending, you'll eventually -- production will fall off, and they'll have to invest. And so I think that is a scenario that will continue.

The bulk of our revenue base is MRO-related. And really, a bulk of our revenue in the U.S. is off of energy infrastructure. So old tank batteries, old pipelines, old refineries and chemical plants. There's a big long-term cycle of MRO replacement revenues that continues regardless of today's commodity pricing. So that gives us confidence in that. To address the -- how do we compete? I mean the one thing we focus on is taking market share and gaining a percent of wallet for the customers we already do have. And so we still see a lot of room for growth in that perspective.

We've done very well with contracts. We're very pleased with the SoCal Gas and the CenterPoint is 2 recent wins for us. And the other -- on our own, what we control is, we've done a lot of work over the last couple of years and optimizing the branch infrastructure. We now have 118 branches in the United States and 7 RDCs, and we're closing 2 in the first quarter as we can more efficiently support them from La Porte. So I think we reached a very efficient model from both the headcount and operational footprint.

The other big area we're working on is investing in our MRCGO Online, which brings us this ability, and I think this was part of your question. It gives us the ability to service the customer from a full-service standpoint through branch interaction or account management interaction and then, smaller customers. It gives us the ability to migrate them to a less -- lower service level, more of an interaction online. It's more efficient for us to service them that way.

And so you see us, over the next couple of years, take more operating costs out as we migrate and hub up into our fulfillment centers, we call them, regional distribution centers, and a more operational efficient way to serve customers. And you'll -- as we said in our comments, we expect our e-commerce business to more than double over the next 3 to 4 years.

So as we move more and more to that platform, we'll have a low-cost interaction with small customers. We'll have a full-service interaction with our major customers. And then, we'll migrate as fast as we can to our MRCGO platform. And we said we have 80 customers already. Feedback has been excellent, and their interaction, their ability to track orders and expedite orders and work in our customer portal. So I think we are on the right track, and gives another channel to interact with the customers, and I think that's going to turn out well for us.

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Nathan Hardie Jones, Stifel, Nicolaus & Company, Incorporated, Research Division - Analyst [24]

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That makes a lot of sense. Do you think that gives you the opportunity over the next few years to reduce that 118 branches at all?

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Andrew R. Lane, MRC Global Inc. - President, CEO & Director [25]

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Yes. Definitely, Nathan. We closed 4, and so I wouldn't expect big changes. But each year, as we move more to MRCGO, and maybe more support comes out of our regional distribution centers, then needing that local branch, I expect that count to continue to go down in the U.S. for sure.

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Operator [26]

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Our next question is from Jon Hunter with Cowen & Company.

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Jonathan James Hunter, Cowen and Company, LLC, Research Division - VP & Analyst [27]

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So the first one I had is just on the guidance you provided for 2020, with revenues down 6%. If 1Q guided flat, and then assuming a typical fourth quarter decline in revenues in the mid-single digits, that would imply that 2Q and 3Q are up a high single to low double digits revenues per quarter. So could you help me think about why those increases may occur? Do you have special contracts coming online? Or projects pushed from first quarter to the second quarter that may be impacting that revenue progression?

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Andrew R. Lane, MRC Global Inc. - President, CEO & Director [28]

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Yes. John, you're right about the progression. And I think that's exactly more normal for us, and we think that's going to be the timing of it this year. We've gained contracts, we've gained market share position, we -- one example would be the $20 million to $30 million ramp up in CenterPoint activity that occurs in second and third quarter.

We also had some new contracts in midstream that will ramp up during that time frame. But it's really a return to the budget. As I said, we track our top 25, top 30 customers very well. And their CapEx spending is only going to be down 2% to 4% this year. So their budgets kick in, they normally interact and with a lot of revenue from us in the second and third quarter. So we feel good about that timing. And then I'd say we have a good visibility on the first quarter. So we know where we're starting.

And then, probably the only variable is -- will be, are we going to have a more muted tail off in the fourth quarter this year than we, of course, saw last year. Or is November, December going to be a bigger drop off? So we tend to be towards the higher end of our guidance, if we didn't have a dramatic fall off in November, December. But we feel good about the midpoint of our guidance at this point.

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Jonathan James Hunter, Cowen and Company, LLC, Research Division - VP & Analyst [29]

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Got it. And then on the margin side, you've guided to this 19.6% to 19.8%, you did 20% in the fourth quarter. You've talked about market share being focal point of your strategy in 2020, is lower pricing part of gaining your market share? Or kind of what's driving your outlook for margins to be lower in 2020?

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Andrew R. Lane, MRC Global Inc. - President, CEO & Director [30]

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Yes. It's -- no, it's not lower price strategy. We've never followed that to gain market share. I would say, there's some pricing early on as we build up that midstream complete valve assembly work with incumbent or 2 that are in that business. That's relatively new for us to give the full kit and do the full assembly. So there's some pricing pressure with the -- from the incumbents. But we're -- I have a long-term view, we're going to take that market. And so I'm not worried about that. It will return to higher margin. We see some pickup in line pipe as midstream budgets kick in this year. Of course, from a blend standpoint, that puts a little downward pressure on the mix from margin. So it's good for the top line, but it pulled in. So I think, having said all that, we feel good about the range that we're at, and then we continue, I think, as we look out a couple of years to still move that even higher up.

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Operator [31]

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Our next question is from Steve Barger with KeyBanc Capital Markets.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [32]

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Just thinking about your comment that your top 25 customers will be down low single-digit versus the industry down high single. I mean, where are you for share of wallet for that top 25? And I'm just thinking about the market opportunity to take share with customers that are outgrowing versus tracking the industry.

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Andrew R. Lane, MRC Global Inc. - President, CEO & Director [33]

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Yes. Now we have a very high market share with those. I mean that's a fundamental tenet of our business model, is to focus on these top 25 spends. Of course, on years like last year, when they tail off their spending, it impacts us a lot. But longer term, that's the model we followed. Of course, we don't have all their spend, so we work on areas of their operation where we can support them and add to our contract. That's the main strategy. The big bulk of spend that is small, 1- and 2-rig operators or private equity back spend and some of those smaller customers, that's never been our core. They usually buy more transactionally in the regions. So we really focus on these long-term, multiyear contracts and gaining share. We've worked on gain, worked with BP and ExxonMobil. We have their downstream valve contract. We're working on getting more of their XTO upstream, as an example. BP, we did a lot for downstream U.S. We're working on gaining more upstream international work for them. So those are the things that we work on. And so we -- I still feel good, we have opportunity to grow within those top 25 or 30 customers even in today's environment, that it's -- we have a good percentage of the work, but we still have room to grow with them.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [34]

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Have you identified other outgrowers where you don't have as good a market share? Or by definition, if you go take share in a softer environment like this, you're adding in people that are undergrowing the market?

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Andrew R. Lane, MRC Global Inc. - President, CEO & Director [35]

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Yes. We certainly do. In midstream, we have a targeted list of 3, 4, or 5 customers that we've been going after. And of course, in the upstream, in the Permian Basin, there's kind of -- when you get down to smaller operators, there are certainly some that we'd like to have a bigger share with. And so I would say, in the U.S. midstream, smaller operators. And then, also in the Permian Basin upstream were 2 areas where we've definitely targeted market share gains from ones we're not working for today.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [36]

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You said that there's been some modest January increase that was encouraging. Has that persisted into February?

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Andrew R. Lane, MRC Global Inc. - President, CEO & Director [37]

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Well, the run rate, on a daily basis, yes. And -- but February has fewer billing days, so the revenue is off from January because of less billing days, at least at this point, in the forecast. But on a daily billing rate, it is at the same level. So we're encouraged that it's picked back up to a new level that is definitely above November, December run rates.

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Robert Stephen Barger, KeyBanc Capital Markets Inc., Research Division - MD and Equity Research Analyst [38]

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Okay. Good. And then just thinking about capital allocation. You've been active on the buyback in the past few years, while also reducing some debt. If the market remains weak, and the share price reflects that, does the board lean to one versus the other, as the best kind of avenue to support the multiple or the share price?

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Andrew R. Lane, MRC Global Inc. - President, CEO & Director [39]

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I wouldn't say it leans to one of the other. We look at it and we look at it every quarter. We just had a Board meeting this week. The short-term view right now, we just completed our share repurchase from last year of $75 million, and of course, $375 million since 2015. So I would say definitely, during the last 5 years, the priority with the Board has been the share repurchase, with some debt paid down in parallel. Right now, given the short-term look and the activity had fallen off in the end of the year, we're really focused on at least, in the first half of 2020, on debt paydown as the priority from the Board. But we revisit it every quarter. So I wouldn't say that it's 100% debt paydown this year. But right now, we don't have a new authorization to act on. It's on the cash flow, at least, in the first half of the year will be on debt paydown.

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Operator [40]

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Our next question is from Michael McGinn with Wells Fargo.

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Michael Lawrence McGinn, Wells Fargo Securities, LLC, Research Division - Associate Analyst [41]

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I just wanted to put a finer point on the supply chain considerations. You mentioned valve inventory is hovering your $350 million. By my math, that could equate to 4 months of demand to start the year, given the Q4 and Q1 run rate. So I just wanted to get a sense of the lead time you typically see in that product category relative to other products. And any contingency planning you may have from a second sourcing? Or would tighter inventories ultimately equate to the better pricing for customer purchases outside of integrated supply agreements?

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Andrew R. Lane, MRC Global Inc. - President, CEO & Director [42]

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Yes. Michael, so a couple of things there. We have a relatively small direct valve business. It's viewed more as the commodity valve line with a major -- with 1 major supplier. That one would be the most suspect impacted, but that's a very small percentage of our overall valve business. It can impact the components that have come out of China that go into both Europe and U.S. manufacturing.

We haven't seen much of that disruption yet. And then, of course, we'll ramp up our -- and we have ramped up our orders from U.S., Europe, even Canada manufacturers as we've seen this impact. And so I think, we're in very good shape for at least 2, 3 quarters out. I don't think we're going to have a big impact. Now it shouldn't go even if we talk about 2 or 3 quarters out, and the virus is still a big impact. We might start seeing that. We would just double down more on our U.S. manufacturing and our Europe manufacturing components. So it's isolated to valves. We don't have any other exposure there.

But we're just going to manage it, and manage it with our manufacturers each week and see what needs to be done. But it's -- I wouldn't say it's an area we're going to just keep monitoring all the time until we see some change there.

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Michael Lawrence McGinn, Wells Fargo Securities, LLC, Research Division - Associate Analyst [43]

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Got it. This next question is a little harder to gauge, but it seems like the longer the downturn, the more market share potential there is to pick up on the back end, given your balance sheet, and you've mentioned market share gains a couple of times now. Do you have any anecdotal feedback how this 2-year downturn will compare to the 2015, 2016 downturn in terms of market share?

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Andrew R. Lane, MRC Global Inc. - President, CEO & Director [44]

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Yes. I think in '15 and '16, now that was a much more dramatic downturn. It doesn't feel like that at all. But I mean, it certainly is a slowdown. I think the 2 big players in PVF distribution made a lot of market share gains in that '15, '16 time frame. There's a lot of small distributors, couldn't get financing. And I think to a more muted extent this time, but to the same thing, I think the 2 largest players will do just fine. And I think, pick up share in this environment and small distributors will struggle. And so I think that dynamic is the same, not to the same extent we had in '15 to 16%, but we certainly feel good about coming out of these kind of periods with more market share than we went in.

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Michael Lawrence McGinn, Wells Fargo Securities, LLC, Research Division - Associate Analyst [45]

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Okay. Okay. I appreciate that. And if I can just sneak one more in, regarding the SG&A run rate. I think it implies $130 million per quarter, which is still down year-over-year, but less than, I think, the implied rate you mentioned last quarter. So is this just -- constitute your plan for the worst and hope for the best? Maybe some potential back half incrementals?

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James E. Braun, MRC Global Inc. - CFO & Executive VP [46]

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Well, I think it reflects what we mentioned earlier about an incremental increase in IT and MRCGO spend. And we also have the phenomenon going into 2020 with planning for budgeting for incentive payouts at target levels.

We came in significantly below that in 2019, so we're refreshing the accrual for the incentives in '19. But you're right about the average run rate, and it generally will run at those levels.

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Operator [47]

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And our final question is from Blake Hirschman with Stephens.

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Blake Anthony Hirschman, Stephens Inc., Research Division - Research Analyst [48]

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Just a quick one. On the large projects for the 2020 guide. It sounds like -- something like $40 million, $50 million headwind year-over-year, pretty equally distributed between up and downstream. Is that all?

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James E. Braun, MRC Global Inc. - CFO & Executive VP [49]

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Yes. I was going to say it's $44 million for the year, and it's split roughly equal between up and down.

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Blake Anthony Hirschman, Stephens Inc., Research Division - Research Analyst [50]

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Okay. And are -- as far as the quarters, should those wind down by like the first half of the year or in the 3Q?

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James E. Braun, MRC Global Inc. - CFO & Executive VP [51]

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Well, then, that comparison, by the time you get to the third quarter, it will be a good comparison. There won't be any headwinds by the time you do a third quarter.

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Operator [52]

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We have reached the end of the question-and-answer session. I would like to turn the conference back over to Monica for closing remarks.

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Monica Schafer Broughton, MRC Global Inc. - VP of IR [53]

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

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Operator [54]

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