Greetings, and welcome to the MRC Global’s Third Quarter 2019 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brieft 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, Jim Braun, Executive Vice President and Chief Financial Officer. Thank you, Mr. Braun. You may begin..

Thank you and good morning everyone. Welcome to the MRC Global third quarter 2019 earnings conference call and webcast. We appreciate you joining us today. Monica Broughton, our Executive Director of Investor Relations is on maternity leave. So on the call today in to addition myself we have Andrew Lane, President and CEO.

There'll be a replay of today's call available by webcast on our website mrcglobal.com, as well as by phone until November 15th, 2019. 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 November 1st, 2019 and therefore you're advised that information may no longer be accurate as of the time of the replay. In our remarks today we will discuss adjusted gross profit, adjusted gross profit percentage, adjusted EBITDA and adjusted EBITDA margin.

You're encouraged to read our earnings release and security 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, the 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, Jim. Good morning and thank you, all, for joining us today and for your continued interest in MRC Global. Today, I will review the company's third quarter 2019 operational highlights. And then I'll turn the call back over to our CFO, Jim Braun, for a more detailed review of the financial results.

The focus on returns of invested capital by our customer base across our 3 market sectors continues to take hold. The result is that customers are pursuing a disciplined approach to spending. And consequently, our third quarter sales were lower than in the second quarter, a significant deviation from historical experience.

We believe this trend of spending restraint will continue in the fourth quarter. Given this market backdrop and the weaker Q3, we took actions to reduce operating costs beginning last quarter with several cost reduction efforts, including a voluntary retirement program.

We also decided to go further and are continuing with additional cost reduction efforts in the fourth quarter. The savings results from these programs will become more evident in the fourth quarter and will be fully realized next year after these initiatives are complete.

We also continue to make progress toward our long-term strategic objectives to maximize shareholder returns by gaining market share, maximizing profitability and working capital efficiency and optimizing our capital structure. I'll address how we are progressing toward our strategic objectives. But first, let me start with the third quarter results.

Third quarter 2019 revenue was $942 million, a 4% decline from the second quarter of this year. This decline was entirely in our midstream businesses as our upstream and downstream sectors each reported modest growth. Our gas utility business, while somewhat lower than we had originally expected, continues to grow.

In fact, gas utility sales for the first 9 months of 2019 are 7% higher than they were in the first 9 months of last year. Given our current view of the year, we expect to generate more cash from operations than previously projected, which is consistent with our business model.

Inventory and receivable balances are declining from second quarter levels. This generation of cash flow from operations, which was $126 million in the third quarter allowed us to not only fund our relatively small capital expenditure needs and our preferred stock dividend, but also lowering net debt by $100 million in the quarter.

Consistent with our working capital strategies, we expect to achieve our working capital to sales target of 20% by the end of the year, supporting our cash from operations view of at least $200 million for the full year, which implies a free cash flow yield for 2019 of more than 15% at current stock price levels.

Now I would like to highlight our progress on one of our key strategic objectives, to grow market share with new customers and maintain market share with existing customers. This quarter, we were awarded several new contracts in our midstream sector, 2 of which were with gas utilities.

First, we were awarded a new integrated supply agreement with CenterPoint Energy, which includes the recent acquisition of Vectren. CenterPoint is the sixth largest gas utility in the country, serving over 7 million metered customers across 8 states. We expect to implement this new contract through the middle of next year.

And when it is fully implemented, CenterPoint will become one of our largest midstream customers. Second, we also won a new pipe fitting and plans contract with Southern California Gas, also known as SoCalGas, which is a subsidiary of Sempra, the largest gas utility in the country serving 22 million customers. This is a new customer opportunity.

And with this contract, we are now serving 9 of the 10 largest gas utilities in the country. We are focused on gas utilities since 2006 and our service is unmatched in that space. The subsector continues to grow independent of commodity prices, and we expect this trend to continue as gas utilities continue to upgrade and expand their networks.

We are uniquely positioned in this space and continue to grow through our combination of comprehensive expertise and superior service levels. Third, in the transmission and gathering subsector, we signed a new 2-year contract with ONEOK, a leading midstream service provider in the United States, to supply them with valves for their pumping stations.

As we have emphasized before, expanding market share is a core component of our strategy.

Consistent with our strategy to high-grade our portfolio to higher-margin product and service offerings, we announced last quarter that we were -- completed the initial construction of our 127,000 square-foot midstream valve and engineering center, expanding our Houston operations complex in La Porte, Texas.

This new facility is focused on midstream valves and will provide us the expanded capabilities to better penetrate that market. We believe the near-term sales opportunity in midstream valves alone could be $100 million over the next 2 years, allowing us to expand our share in the midstream sector.

In the first 9 months of 2019, valve sales were 39% of our total sales, and we are on track to deliver 40% of our sales from valves in the near future. Furthermore, we plan to increase sales from the valve product group to 45% of total sales in the next 3 years.

The addressable oil and gas valve market in the United States is $2.6 billion across upstream, midstream and downstream. And we have approximately 40% of that market with plans to grow our overall share.

Last quarter, 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. This initiative fits in with our broader strategic objective to grow market share by enhancing the customer experience.

We are rolling this out to the current catalog customers first and expect to continue to expand this to our largest customers over the next 12 to 18 months. This initiative is fully on track and will support a more streamlined cost structure over time as well. Over the next 3 to 5 years, we expect our revenue through e-commerce to nearly double.

And then finally in the third quarter, we continued to return cash to shareholders as part of our capital allocation strategy. As previously announced early in the quarter, we repurchased an additional $13 million of shares, leaving $12 million remaining under our current authorization.

Since 2015, when we began our share repurchase program, we have repurchased a total of 23.4 million shares, returning $363 million to shareholders. We have committed to maximizing shareholder returns while we continually evaluate all capital allocation options, making a determination based on both short and long-term cash needs.

And finally this week, the Board of Directors and I amended my employment agreement pursuant to which the term of my employment was extended until May 2023. The prior employment agreement was set to expire in May 2020. I look forward to continuing to serve as President and CEO for the next several years.

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

Well, good morning again. Total sales for the third quarter of 2019 were $942 million, which were 12% lower than the third quarter of last year, with each of our sectors in geographic segments reporting a decline in the year-over-year comparison. Sequentially from the second quarter, revenue decreased 4%. U.S.

revenue was $763 million in the third quarter of 2019, 11% lower than the third quarter of 2018 with decreases across our 3 market sectors. In addition to the capital discipline exhibited by our customers, U.S. downstream revenue declined by $22 million because of the winding down of the Shell Pennsylvania chemical project. U.S.

midstream sales were impacted by a 26% decline in the transmission and gathering subsector. And U.S. upstream sales were down 11% with lower activity levels and customer-specific timing and circumstances driving the decrease.

Canadian revenue was $57 million in the third quarter of 2019, down 27% from the third quarter of last year as the upstream sector continues to be adversely affected by weak Canadian oil prices and the government-imposed production limits. Canada continues to be structurally challenged, and we see little likelihood of improvement in the near term.

We undertook actions there to reduce cost to fit current activity levels and plan to continue this work into the fourth quarter, resulting in a more streamlined cost structure going into 2020.

International revenue was $122 million in the third quarter of 2019, down 9% from the same quarter a year ago due primarily to the concluding of a major project in Kazakhstan as well as the impact of weaker foreign currencies.

Excluding the project and the FX impact, sales grew $23 million, reflecting improving international market conditions particularly in Norway and the United Kingdom. And now let me summarize the sales performance by end market.

Upstream sector third quarter 2019 sales decreased 15% from the same quarter last year to $287 million across all geographic segments. Specific to the Permian Basin, our revenue declined 18% in the third quarter of 2019 versus the same period last year. Yet the Permian remains our most active upstream area.

Midstream sector sales, which were primarily U.S.-based, were $370 million in the third quarter of 2019, down 12% from the same quarter in the prior year. Our transmission and gathering subsector was down as several customers are spending less due to a more disciplined approach to spending and project timing.

Our gas utility business, which represents 23% of our overall revenue in the third quarter, continues to show growth. Since 2012, this part of our business, which is not related to commodity prices, has a compound annual growth rate of 8%. And we expect another year of mid to high single digit growth in 2019.

In the downstream sector, third quarter 2019 revenue was $285 million, down 8% from the third quarter of last year. The U.S. downstream sector drove the decline primarily due to the winding down of projects, including the Shell chemical project mentioned earlier. Now turning to margins.

Gross profit percent increased 240 basis points to 18.5% in the third quarter of 2019 as compared to 16.1% in the third quarter of 2018. The improvement reflects a benefit of $2 million from LIFO income in the current quarter as compared to $26 million of LIFO expense in the prior year.

Adjusted gross profit for the third quarter of 2019 was $188 million or 20% of revenue as compared to $215 million and 20.1% for the same period in 2018. Adjusted gross profit was flat due to less low-margin project work this year and higher relative sales in our valve product lines, offset by deflationary pressure in line pipe prices.

We continue to shift our product mix to higher-margin valves as part of our valve-centric strategy. Line pipe prices were lower in the third quarter of 2019 versus the same quarter in 2018 as the effects of tariffs and quotas and a softer line pipe market have been priced in.

Based on the latest Pipe Logix All Items Index, average line pipe spot prices in the third quarter of 2019 were 19% lower than the third quarter of 2018. Line pipe pricing today is below pre-tariff levels.

The combination of lower sales prices due to soft demand, oversupply in small-diameter pipe and the higher cost of inventory on hand has put pressure on line pipe margins. Line pipe prices are expected to continue to remain under pressure given the soft demand in oversupply situation.

SG&A cost for the third quarter of 2019 were $137 million or 14.5% of sales as compared to $140 million or 13.1% of sales in the same period of 2018. Third quarter SG&A expense includes severance cost of $5 million.

The cost reductions in the third quarter eliminated 180 positions, which is expected to result in annual savings of approximately $12 million. We plan to continue our cost reduction efforts in the fourth quarter with further actions that are expected to result in additional severance and restructuring charges.

Our effective tax rate for the quarter was 28%, up slightly from our prior guidance. The effective tax rate in the third quarter a year ago was 0 as a result of $6 million in discrete tax benefits primarily related to the adjustment of provisional amounts recorded in 2017 associated with the Tax Cut and Jobs Act of 2017.

Net income attributable to common shareholders for the third quarter of 2019 was $15 million or $0.18 per diluted share and $18 million or $0.20 per diluted share for the third quarter of 2018. Net income attributable to common shareholders for the third quarter of 2019 includes after-tax severance charges of $4 million or $0.05 per diluted share.

Adjusted EBITDA in the third quarter of 2019 was $62 million versus $80 million for the same quarter a year ago. Adjusted EBITDA margin for the quarter were 6.6% as compared to 7.5% in the third quarter of last year driven by the lower sales volume this year. All 3 of our segments generated positive adjusted EBITDA this quarter.

Our working capital at the end of the third quarter of 2019 was $828 million, $68 million lower than it was at the end of 2018. Working capital, excluding cash as a percentage of trailing 12-month sales, was 20.6% at the end of the third quarter 2019.

We expect to continue to work inventory down to achieve our targeted working capital level of 20% by the end of the year. We generated $126 million of cash from operations in the third quarter of 2019 as inventory and receivable levels fell as expected with the slowdown in the business.

For the full year of 2019, we expect to generate cash flow from operations of at least $200 million. Capital expenditures were $6 million in the third quarter of 2019 for a total of $12 million for the first 9 months of the year. Our debt outstanding at the end of the third quarter was $627 million compared to $684 million at the end of 2018.

And our leverage ratio based on net debt of $602 million was 2.5x, up slightly from the 2.3x at the end of 2018. The availability on our ABL facility was $477 million, and we had $25 million cash at the end of the third quarter. Regarding our outlook for the remainder of 2019.

As is our customary practice, we don't plan to update the full year guidance this late in the year. However, we do expect the fourth quarter to be down seasonally from the third quarter.

Historically, it's down in the 5% to 10% range, and we expect that it will be at the high end of that range or greater considering the capital discipline from customers and budget exhaustion. Looking ahead to 2020, given that our customers are just beginning the budgeting process now, it's too early to give a complete guidance.

Nevertheless, some early estimates show a double-digit decline in U.S. spending, which will primarily impact our U.S. upstream business, although our midstream and downstream customer base are also now focused on returns and capital discipline.

However, the new modification shop, new contract wins and a strong gas utility business should help offset the lower overall activity levels. And as we've done in the past, we will continue to execute our long-term strategy even against the softer market, and we are well-positioned regardless of where we are in the cycle.

And with that, we will now take your questions.

Operator?.

[Operator Instructions] Our first question is from Sean Meakim, JPMorgan..

Andy, I'd like to maybe dig in -- there's a lot to dig in to here from your prepared comments. I'd like to focus on the areas where you have some control. So I was thinking revenue mix and cost.

So if we start with the mix, can you talk about what a normalized gross margin could look like if you're able to take that valves mix to 45% in a few years? What's required to get you there? And what does that come at -- what products does that come at the expense of them? I'm thinking maybe line pipes.

But maybe you could help us elaborate on that?.

Yes, Sean. You're exactly right. Yes, so we haven't changed our goal. Jim and I have been working on this for several years, to change the mix. I started 5 years ago when we decreased our emphasis on carbon pipe, increased our emphasis on valves. But all this has been targeted towards consistently delivering 20% plus adjusted gross margins.

And I think I'm confident we're going to get there. We are sporadically achieving that now. We did the last 2 quarters of last year. Of course, we just did in the recent quarter. So we can get there, but the goal is to consistently have that and then move up from there as we continue the multiyear plan with our valve-centric strategy.

So I'm confident in that part of it. It's a big addressable market that we talked about. We have a leading 40% market share.

We just added a brand new capability with the engineering and modification shop, which brings in-house machining, welding, painting, pressure testing, some more manufacturing-type margins in the complete midstream valve assembly that we'll do. So big provider of midstream valves and actuations.

Historically, we've sent that out to third parties to do the complete machining and assembly and painting and testing. We will now have that all in-house and delivered to our customers a complete assembly. So I'm confident there's $100 million growth in that over the next 1 to 2 years. That's a nice addressable market for us.

And I'm confident in getting to our 45% goal that we stated. And all that leads to a higher mix. Yes, you're exactly right, there will be less emphasis on the specialty lower-margin ERWs, small-diameter line pipe as a mix change. .

That sounds very positive. I appreciate that feedback. So then to come back to costs, you're taking a pretty aggressive approach to the cost structure, it sounds like. And I think given the forward outlook, that's warranted. What's the right level of G&A run rate as you go into next year? I was just thinking about the impact on your EBITDA margins. .

Yes, Sean, let me start and then Jim can really talk -- add some comments to my comments. I think it's right for us to plan to be aggressive here on the cost side to make sure we can still deliver a really strong EBITDA percent in the 6% range regardless of the macro changes on the top line.

So we've taken out 230 positions since the end of last year, so roughly 6.5% of the workforce. We are continuing to streamline. We've made some further changes in October that will impact in the fourth quarter. A couple of things. We continue to look at more efficient ways to run our business.

Hobbing up some resources in our regional distribution centers is an area where we're working on to be more efficient. And also MRCGO, our online business connection with our customers, is going to allow us to centralize more technical support, more centralized quoting support, which will be more efficient for us to serve the customers also.

So there'll be some more efficiency to come from that, mostly in 2020. So we're working on several things along with just the overall reductions to position us to be in a good position going into the next year.

Jim?.

Yes, Sean. I would say with the actions we took in the quarter and some of the things that we're planning, our quarterly run rate next year ought to be sub-$130 million a quarter. .

Our next question is from Nathan Jones, Stifel..

Following up on that last question. I think your quarterly run rate on SG&A was $133 million, maybe $132 million, if we take out severance and $12 million of savings just from that initiative alone.

Shouldn't we be able to like -- a little more meaningfully below $130 million a quarter next year?.

Well, it certainly has the potential, Nathan. I mean we're going to go through our own internal budgeting exercise here in the next several months and putting our plans together. We do have some desires and plans to continue to invest in our e-commerce strategy. So I think that's going to cause us to add some cost to our budget.

It's a nice long-term investment. We've seen some nice early success on that. So again, I think at this time, it's probably just safe to say that we ought to be under sub-$130 million. .

Okay, fair enough. And then I just want to follow up on your -- just your initial take on next year. You said probably revenue down double digits, concentrated in upstream.

That's double digits across the portfolio with, I guess, a bigger drop in upstream and a smaller drop in mid and downstream?.

Yes, Nathan, let me start. And then Jim again can add some comments. I would look at it a couple of ways. It's early on the budgeting cycle. We're specifically talking about a double-digit or 10% decline focused around the drilling rig and drilling completion U.S. spending estimates, but they vary from 5% to 10%.

So we're -- I would look at that as the big impact that we're planning for in next year. And then midstream, we will still be in a solid position. We'll have growth again in gas utilities, and we'll have growth in the Permian Basin and we'll have some growth in midstream, new contracts picked up accordingly.

The 2 new gas utility contracts were -- are significant to us. So I think it's not across the board. And in downstream, relatively flat to maybe slightly down. So it's not the 10% across the board. As Jim said in his comments, we will see what the final budgets come out for next year's spending.

And then they also -- our major customers tend to mute that impact for us. So the majors tend to keep a longer-term view. I think their reductions will be a lot less than the double digits for the U.S. upstream. So we'll stay active with them and so I think those offset. And then the number of contract wins we have will definitely offset.

So it's too early to give firm numbers, but that will be my guidance at this point. .

I get it. I just wanted to make sure that people weren't expecting you to have double-digit declines across the portfolio then. Forgive me, if I -- if you answered this question earlier, I got on to the call a little bit late. The adjusted gross margin is getting back up to 20%.

I think, it was a very pleasant surprise in the quarter given the trajectory that those have been on.

Was that a mix issue related to increased mixture of valves? How did you actually get that back up to 20% in the quarter?.

Yes. Let me talk about the mix, Nathan. And Jim can add a little bit more comments. Yes, I mean it continues on our strategy. Our valves are doing very well. They're holding up, they're not seeing the kind of declines in other product lines. And so what -- and you're seeing -- so that's a bigger positive from the mix change for us.

We're just starting to ship some midstream complete assemblies, which are even higher margins so that's a positive. And then the negative on the margins usually has been our lower margin that we've talked about, ERWs, small-diameter line pipe sales. Those are particularly weak in the third quarter. So from that mix change, it helped us.

And then Jim, do you have anything to add?.

No..

That's the biggest driver..

So you're starting to see with -- clearly some volume challenges here and some declined spending from your customers.

Any pricing pressure on any kinds of products outside of just the deflationary effect?.

No, not really. I mean, the stainless tends to be a longer lead time to valves, but definitely longer lead time, more technical. So they tend to not react to the short-term cycle changes. Line pipe, as you mentioned, that's the big one. And that's reacting to the whole environment of the inflation in tariffs of '18, the U.S.

steel mills increasing pricing. And then in '19, demand coming down, plenty of supply and deflationary pricing all year long in line pipe. So that's the big swing factor for us. But the gas products, all fitting in plants, everything else, that's all held up really much more steady for us.

It's really just been a swing in the line pipe and the margin there. .

Maybe just one more. You've taken some head count out here, but it doesn't sound like you've taken any footprint out.

How are you thinking about whether or not you need to take any footprint out here as you go into next year?.

Yes. So we have taken footprint out. We haven't included that into the comments. But we've continued over -- well, we started in '15 and '16, 2015 and 2016, to really look at the structure of a -- in a $50, $55 barrel environment, what do we need to service our customers. So there's been a lot of streamlining over a couple of years.

We continue to -- we made a major emphasis this year in the second and third quarter to streamline the smaller branches where you struggle to, in a downturn environment, to make a good EBITDA. So we have closed additional branches this year. We also looked at small locations, consigned inventory for customers.

We looked at our footprint on pipe locations and what do we need and consolidate our pipe yards also during the quarter. So a lot of streamlining. So we -- it will be in our Q, but we have 260 locations going forward from our previous 300. .

Our next question is from Blake Hirschman, Stephens Inc..

Large projects kind of rolling off have been a hit this year on the top line, I think something like $260 million or so, which seemingly creates an easier company-specific comp next year.

Will those projects be flushed through by the end of this year? Or should we be thinking about a lingering impact into 2020 as well?.

No. Most of those projects have flushed through. We will have a little bit of year-over-year comparison or comps headwind of maybe $40 million, $50 million of revenue going into '20. But not a large amount like we had coming into 2019. .

Got it. And then on the SG&A, you mentioned some cost actions in Canada.

I was curious, how did those head count reductions split out geographically? I mean, is it mostly U.S., Canada, where? And can you cut any further or is this kind of a bare-bones level?.

Most of the reductions that we saw in the quarter, the 118 part of our voluntary retirement program were in the U.S. We have been making cuts in Canada. We continue to do that. In terms of your question about the bare bones, I'm not sure we're quite to that level yet based on the current activity levels.

So that's why we said we still have some further actions that we're looking at here in the fourth quarter..

Yes, Blake, just -- I'll give you a little more color. The cuts in the U.S. were our larger workforce was roughly 5%, cut in international was 3%, and the cut in Canada was 19% in the quarter. So we're just not optimistic about a return in Canada. But -- and as Jim said, we still look at ways to streamline the U.S. structure.

International spending is picking back up. Our intake is picking back up. So we are in a pretty good position there. So we're at 3,354 employees at the end of the third quarter, which is at a level lower than we had in 2016 when we generated higher revenue than that.

So we have taken fundamental cost out of the business, both in facilities and in the way we operate. .

Our next question is from Walter Liptak, Seaport Global Securities..

Wanted to just ask a couple more questions on the midstream outlook. And we've seen some of the midstream capital budget projections and some of the gas gathering and process companies. We've got fairly good sized declines for CapEx in 2020, in the 20%, 40% range.

And so I wondered if -- what are you hearing from your customers, maybe the projections that we saw wrong? Maybe it's just too early to know what 2020 is going to look like.

But I guess any more color that you can give us about your customers, and not including the market share wins, just some of your major customers?.

Yes. Well, I think a couple of things. One thing in midstream, when we talk midstream for sure, you start with line pipe and pricing. And if you look at this year, the price per ton, down 17%. We think it's kind of leveled out here at this point. So we don't see that kind of drop next year, much smaller muted drop.

So of course that will stimulate some more project activity with a more costly -- cost-effective line pipe supply. And so that's one thing. And we feel very good about the CenterPoint, Vectren, the SoCalGas and the ONEOK wins, so that's market share gains. And we also previously talked the quarter before about EnLink, another big market share gain.

So those, even in a flat or down market, are nice pickups for us. And then when you look at our pipeline main business, we still have and we've talked about these 20 active projects right now, pipeline -- major pipeline projects. We do a lot of smaller gathering and tie-ins.

But 20 major revenue projects, 12 of them in the Permian, and we'll still see incrementally do $80 million in Permian pipelines this year and up -- and we are estimating $100 million next year because we still have some bottleneck situations that the work -- that our customers are working through. So that's going to happen still.

If you look at our Permian midstream business in 2019, we're up 31%. So that's a bright spot for us. So there's market share gains from the contracts. We've got some core projects going forward, and we are very strong in the Permian pipeline work.

So I think the overall market and some of the smaller MLPs and some of the overall spending could be down in the area you were talking about. But we have a few things on our favor as both contracts and market share gains that will hold up next year. .

Okay, understood. Appreciate the color.

I wonder if it's -- with the new gas utility wins, is it knowable yet about the revenue opportunity for 2020? Or is it still to be determined?.

Well, directionally, we'll be -- give you more when we give formal guidance. But directionally, it will definitely be up. That's a bit -- as we mentioned in our prepared remarks, we have 9 of the 10 top contracts now for gas utilities. A little more information, we have 18 of the top 25. And it's close to a $900 million business this year for us.

And what I clearly said is that we'll be a $1 billion revenue base plus in the next 2 years in that business. So we'll give more about the outlook for 2020. But it's a very stable business. We retained all our current contracts and then we have the new contracts that we are very excited about. .

Our next question is from Vebs Vaishnav, Howard Weil..

I guess, we've spoken about the very good gross margins. So then my understanding is more valves and lesser line pipe held 20% gross margins.

First to follow, if that's a fair way of thinking? And if you can help us think about in fourth quarter, do you think midstream falls more or downstream or upstream falls more and what could be the potential impact on gross margins?.

Yes. So Vebs, you have it exactly right. So our higher margin, because we have a longer lead time, they turned left, we have a global supply chain and we do more assembly and more value add. All those things impact our margins favorably in the valve business. So -- and in the midstream valves, which I've talked about, adds more manufacturing content.

So all those things, the more we grow our valve business, the higher better impact on our margins. It separates us from a lot of competitors in this market. So that's been our valve-centric strategy. So that's exactly the main driver. And as we mentioned, yes, the lowest-margin business we do is the small-diameter ERW line pipe.

That was particularly slow in the third quarter, which also helped the margin. And one more I would add to them, I think I mentioned previously, was the project falloff.

So projects, as Jim talked about previously, tend to be in the kind of range of 10% gross margins, well below our average, so big revenue volumes that tend to be a lower-margin business for us. When we get those projects, we had $260 million last -- in 2018. We're tracking around, as Jim mentioned, $40 million or $50 million in this year.

So that lower project revenue also had a change on the gross margin favorably. So those 3 things are the biggest movers.

And going into fourth quarter, Jim, on margin?.

Well, I think in terms of the drop-off that we're going to see in the fourth quarter, I mean I expect it to be across all of the streams, and it will probably be highest in the upstream. And the midstream, downstream, will likely do a little bit better.

And that should have a slightly favorable impact maybe on margins in the fourth quarter, all other things being equal. .

So let's say -- that means really like you're going to be ending up, call it, high 19s of gross margins for 2019? And it sounds like that is sustainable for 2020.

Would you have -- like what are the puts and takes against that?.

I think that's fair, Vebs. I think you're going to see us finish the year strong from a margin perspective and helps us going into next year relative to where we finish '19. .

Got it. And last question, if I may.

If I just think about the cost savings or cost-cutting efforts you are taking, when do you think you will be done with that? And like what would be like a normal quarter? It will be like the first quarter or is it more second quarter?.

We'll be done, Vebs, with it in the fourth quarter. What -- I hate to say done because you react to the market. But with everything we planned and with our outlook for next year, we'll be done with our cost-cutting in the fourth quarter. So the first quarter ought to be a clean quarter at the new lower run rate. .

Our next question is from Michael McGinn, Wells Fargo..

Congrats to Monica and the great quarter. .

Thanks, Michael. .

Just had a couple of quick questions. One, on the digital.

How are you guys -- what are your KPIs for this? How are you tracking this? Whether it's gross margin per invoice, SG&A per touch point? Is that a future savings opportunity going forward? And what's the kind of absorption rate of your customer base into that platform? Into the MRCGO platform?.

Yes, Mike. I'm very excited about this part. So we have roughly an $800 million base business today. It was a little bit higher in '17 and '18. Those were 2 years when we did a significant amount of revenue with TC Energy, and they were a very big customer in the catalog.

So it's tailed off a little bit to the -- just because of the changes with that one customer. But the way I look at it, we have 80 customers on the platform now.

We have 175,000 of our SKUs on the platform, and we're really focused on ramping up and converting our current major customers, which would be the top 25 to 30 customers and moving them on to our platform. So it's much better -- bigger than just a catalog.

It's a customer portal, gives them a lot of functionality to retrieve the documents, see their orders, expedite their orders, see our inventory. Everything is in real-time with them, ask for technical support, ask for quote support and get it all online and it all has their -- these are all with our major customers at multiyear contracts.

So it's all their contract pricing and their AML is what's visible to them. So we've done a lot of work over the last 2 years to get to this point. So our main metric right now is the number of customers and continuing to get the SKUs over on the platform. And we're really tracking that. That is -- because we're in the very early stages.

But I have outlined the goals for the group we -- while we'll be at $800 million run rate this year, we'll -- by 2022, '23, we expect to have $1.5 billion of our business on that platform. So we'll have more metrics related to that when we get a little bit bigger on this. But we've also looked at the efficiency.

We think this will bring some -- both a structure standpoint, a branch structure and also of personnel, primarily in the quoting we do today and technical support we do today in all the branches. We think there's a more efficient model that comes out of this growth in e-commerce. So I would say we're very much early days.

We're very pleased that a lot of very good customer feedback on the new platforms and new portal. So I think we have a very good strategy there, and we're going to continue to implement. .

Great. That was definitely helpful color. And if I could just switch gears to the EBITDA commentary from earlier. I think if I go dig into the 10-K, amortization is supposed to come down.

So are we left to infer the margin that you're targeting on the EBITDA side, if that's coming from better core ops performance and SG&A savings? Can you just add a little color there?.

Sure, yes. I mean the EBITDA performance is driven by those 2 things that you just said. It's leveraging the cost base, including the cost reductions and bringing more revenue, more margin dollars through our system.

The drop-off in amortization next year, it will have -- it has a positive impact on our reported net income and earnings per share, but that's factored out of the EBITDA. So when you look at the EBITDA improvement, it's coming out of those operational issues, not that amortization rollout. .

Yes….

Yes. The amortization will benefit us nicely next year when you think about it. And then just a little color on our segments. Canada, of course, is a very difficult market. Our EBITDA is running 2% there. International is recovering nicely at 4%. And then the U.S. is close to 7%.

So we still -- it's the mix of the business, and we feel very good about continuing to move the U.S. number up. .

Yes. And then if I could just sneak in a last one on the market. Historically, we've seen the last 2 recessions more of a V-shaped kind of recovery. This seems like a more of a melt lower and a U-shape.

Can you just give us a little context on what the competitive dynamics have been from a large or small competitor standpoint? And how that plays into your growth, whether it's project bidding going forward?.

Yes, just on a very high level, I would say in our space, in the oil and gas PVF markets that we compete in heads up, there's really 2 big players over all the years of consolidation that go back to 2012, 2015 -- '14, '15 time frame. So it's a big market, 2 large competitors. I think both doing well in this market.

And then it's really falls off to a lot of small competitors and they have some struggles on the downturn. They don't have the balance sheets to really support carrying the inventory or making the commitments like we could make on prebuying on the inflation and the tariff decisions.

So a couple of things, I think customers in a prolonged downturn like you described, the U-shaped one, large suppliers that they can count on to make large commitments for projects and longer-term buys, they need big distributor capability to prebuy and take advantage of the market, consolidate buys with major suppliers, prebuy against a tariff environment that's uncertain.

So I think those things lead to more activity centralized with the 2 major players, and I think that's the environment we're in. .

Our next question is from Steve Barger, KeyBanc Capital Markets Inc..

Just thinking about the macro challenges and the customer spending discipline next year versus the positive offsets from gas customers and new contracts you talked about, can you frame up what magnitude of end market decline you think you can offset by mix in projects? I'm just trying to think about outgrowth versus the market. .

Jim?.

Yes, I think it's going to be pretty close. I'm not sure whether the new contract wins will quite be enough to offset at least what we're hearing preliminary on market declines. But that will be our challenge for next year. But it's nice going into next year having in our back pocket, if you will, some of those contract wins to help us offset that. .

Okay.

And just so in that context, given early thoughts on the macro and some of the actions you're taking, would you expect operating cash flow next year can meet or exceed the $200 million of this year?.

Well, I'm not sure it will be quite that high because again, without a significant decline next year, more of a flat environment, we should see -- we shouldn't see much of a working capital release next year as we have or we will this year. .

Understood.

And any early thought on the implications for CapEx next year? And can you just update thoughts on capital allocation at this point in the cycle?.

Yes. So again, capital expenditures for us are fairly light. We're running pretty lean this year. I'd expect it to be somewhat similar next year. We've made the big investment in the modification shop in La Porte so that's behind us.

And then in terms of capital allocation, as we go into next year, I think we'll continue to look at it on a balanced perspective. But it's likely we'll spend a little time, particularly early on in the year, paying down some debt and continuing to keep that leverage in that 2 to 3 range. .

Our next question is from Jon Hunter, Cowen..

So I just had a couple of questions related to the upstream side of the business. Your upstream revenues increased a little bit from second quarter to the third quarter despite an overall decline in completion activity.

So I'm wondering what drove that outperformance? And then as you think about upstream revenue decline in the fourth quarter, what kind of magnitude are you thinking about? I mean, we've heard from one service company at least talk about a 20% to 30% decline in fourth quarter completions activity.

So I'm wondering how you think about your upstream revenues in that respect. .

Yes, John. I have a couple of comments on that. It's -- when you look at our upstream revenue, there's a combination of the timing for investment in the facilities and tank batteries and gas plants associated with that versus the rig count and completions. And so we did well. Given the market, we are up 1% in our U.S.

upstream business sequentially even though the rig count declined 7%, as you said. But we had some in a couple of things, there was more a decrease in the DUC count and so there was more completions. And this really depends on which customer base you have.

So our customer base completion was -- even though overall completions were down, our customer base completion activity was up slightly. So that works very well. You can look at our business over 10-plus years and our -- the completions in the United States versus our U.S.

upstream sales correlates -- I'd mentioned before correlates about 95% with the number of completions that are done. So that's by far the key metric. And then you get some variability in quarters based on the spending in the facilities that doesn't always match up.

It matches up closer to the production level than it does and planned production levels than it does the current completions we're drilling. So those 2 are in combination at what drives our upstream business.

Yes, I would say the reason we're forecasting at the top of our historical sequential decline, seasonal decline in the fourth quarter or even greater, it's because of what you referenced. I think upstream activity in the U.S. is going to be very slow.

And Canada, which normally has a pickup in activity in the fourth quarter leading into a strong first quarter of the year, is not happening this year.

So I think you're going to have a decline in the upstream, significant in Canada, and we're forecasting right now for a steep decline in upstream drilling activity in November, December, which I think many have seen in the industry. So that's really what's tailing off this year that is not in our control. .

This concludes the question-and-answer portion of the call. I would now like to hand the call back to management for final comments. .

Well, thank you for joining us today and for your interest in MRC Global. We look forward to having you join us for our fourth quarter conference call in February of next year where we will discuss our fourth quarter and full year 2019 results as well as our 2020 outlook. Have a good day and goodbye. .

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