Greetings and welcome to the MRC Global Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms.

Monica Broughton, Investor Relations for MRC Global. Thank you. You may begin..

Thank you and good morning, everyone. Welcome to the MRC Global second quarter 2020 earnings conference call and webcast. We appreciate you joining us today. On the call, we have Andrew Lane, President and CEO, and Kelly Youngblood, Executive Vice President and CFO.

There'll be a replay of today's call available by webcast on our website, mrcglobal.com, as well as by phone until August 12, 2020. The dial in information is in yesterday's release. We expect to file our quarterly report on Form 10-Q later today and it will also be available on our website.

Please note that the information reported on this call speaks only as of today July 29, 2020 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, adjusted EBITDA margin, adjusted SG&A, adjusted net income and adjusted diluted earnings per share.

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..

Thank you, Monica. Good morning and thank you for joining us today and for your continued interest in MRC Global.

Today, I will provide an update of our COVID-19 pandemic response, the company's second quarter 2020 highlights, as well as progress against our strategic objectives, including our e-commerce initiative, and I'll wrap up with some recently announced customer contract wins.

I'll then turn over the call to our CFO, Kelly Youngblood, for a detailed review of the financial results. First, let me start with an update on the disruption caused by the global COVID-19 pandemic and our response.

As you are well aware, the pandemic and related mitigation measures have created significant market uncertainty and severely reduced current demand for oil and gas.

Consequently, we took a $301 million pretax charge this quarter related to an impairment of our goodwill and intangibles, along with restructuring charges for severance, facility closures and inventory write-downs.

The demand deterioration and associated customer spending reduction was also evident in our results, particularly in upstream, which followed the decline in completions. However, our end-market diversity proved to be a mitigating factor.

While there continues to be significant uncertainty as to the duration of this disruption, we continue to proactively take aggressive measures to optimize our cost structure and better position the company for the ultimate recovery.

We are a critical supplier to the global energy infrastructure system and a designated essential provider, and fortunately, have had no closures of any of our facilities.

In order to limit exposure and provide a safe working environment, we have implemented various safety measures for employees, including remote working for those whose jobs permit it, which covers about 60% of our total workforce, including nearly all our corporate employees.

This quarter, as the number of virus cases began to decline, we began slowly phasing back employees to return to working in our facilities. However, as hot zones appeared and new restrictions were put in place in certain states, we have slowed, stopped or rolled back our return-to-work plans.

We have also made changes with respect to our real estate and office locations by moving some employees to a permit work-from-home status, allowing us to downsize our footprint in certain facilities. We require daily body temperature checks before entering our facilities.

We continue to stagger shifts at our warehouses to promote social distancing and are providing personal protective equipment as well as additional deep cleaning at our facilities. From a supply chain perspective, the key manufacturers that we rely upon have all returned to normal capacity levels.

Given our inventory position and the reduced demand, we have fulfilled orders with little disruption. However, if shutdowns are reestablished at our suppliers' locations, order fulfillment risk could increase. Moving on now to our second quarter results. This quarter has been one of our most challenging, with customers significantly reducing spending.

Our revenue declined 24% sequentially as all sectors declined except gas utilities, which was up slightly, highlighting one of our positive attributes of our business.

Our diversity of end market sectors is providing a significant level of protection against the steep activity declines the industry is experiencing in the upstream and pipeline sectors. With that said, market conditions continue to be challenging and the deterioration in commodity prices and customer budgets have been severe.

Therefore, we have acted swiftly to aggressively optimize our cost structure to better align with current revenue levels and our expectations for the near future. We are focused on managing the levers of the business we can control, and operating cost is completely within our control.

The profitability improvement measures we've implemented include headcount reductions and the closing of facilities as well as the acceleration of our e-commerce initiatives, which I'll cover in more detail shortly. In the second quarter, we reduced headcount by over 300 for a total of 380 this year or a 12% reduction.

Since mid-year 2019, we reduced headcount by 687 or 19%. We also closed or consolidated an additional 11 facilities in the second quarter, on par with the expectations we provided last quarter for a total of 13 facilities this year.

Since the middle of 2014, we have closed 97 facilities or 36% of our global facilities and reduced headcount by 2,133 or 43%. However, we are now taking further actions to reduce our footprint and currently plan to close an additional 12 facilities in the second half of this year.

With all the actions we've taken in our planning, we are projecting over a $100 million annual reduction in SG&A from 2019 on a normalized basis. Additionally, we are targeting a Q4 exit SG&A run rate of approximately $100 million, significantly lower than our previous guidance.

We generated $47 million in cash from operations in the second quarter, bringing the year-to-date total to $84 million as we continue to work down inventory and optimize our branch structure for optimal working capital efficiency. We continue to target over $200 million in operating cash flow for the year.

Debt reduction is my top near-term priority, and so far this year, we have reduced overall net debt by $64 million since year-end 2019 and we're on track to pay off the ABL balance by the end of the year. We are committed to providing our customers exceptional service and delivering value to our shareholders regardless of the economic conditions.

Part of our long-term strategy is to gain market share, while maximizing profitability and optimizing working capital, and we believe our e-commerce platform, MRCGO, allows us to accomplish this. It delivers a robust customer experience that improves our service levels and reduces our operating cost to serve.

We are committed to this solution and have designated an executive to lead this change and accelerate adoption of digital interaction with our customers. On a trailing 12-month basis, 31% of our total revenue is generated through e-commerce and 45% of our top 36 North American customers transact electronically.

In the second quarter of 2020, e-commerce was 36% of our global revenue, and we expect these percentages to continue to increase over the next few years. Consistent with our digitalization and e-commerce strategy, we recently met a milestone with respect to our goal to service more customers from this platform.

We currently sell to thousands of small volume, yet important customers. We have begun to migrate these transactional customers to the platform, offering them a new online sales channel. This solution leverages and extends the capabilities of our MRCGO e-commerce platform, which was previously only available to the larger managed accounts.

This new channel features a centralized customer service center, located at our Houston operations complex, and enables a more differentiated service offering for different customer tiers. We aim to transition these transactional customers to MRCGO by the end of 2020.

Deliveries will be made from our regional distribution centers directly to the customer delivery location and supporting our efforts to consolidate inventory and drive down our working capital.

By implementing this lower cost to serve model, coupled with direct shipping savings and improved price differentiation, we are targeting to deliver annual profitability improvements between $5 million and $10 million by 2022.

As we expand this channel, our intent is to build the customer experience learnings into our premium MRCGO managed account solution, consistent with our goal to increase large customer e-commerce adoption in parallel with transactional customers, leading to overall revenue growth in the years to come.

We also continue to drive market share gains by obtaining and expanding multiyear MRO contracts with customers. This quarter, we have renewed several agreements with gas utility customers, including 3 of our 10 largest, PG&E, Dominion and TECO Energy, each for five years.

This sector continues to grow as our customers continue to grow and execute their multiyear gas distribution integrity management programs. We are the undisputed leader as one of the only PVF suppliers to this sector due to our deep expertise and reputation for superior service quality.

Growing market share, especially in a shrinking market, is an important strategic objective and we have a proven track record of achieving this objective.

Also, there have been recent corporate transactions and asset divestiture announcements among some of our customers, including the sale of BP's downstream refining assets to INEOS, the announced plan by Shell to sell selected refining assets and the announced acquisition of Noble Energy by Chevron.

While change always creates some level of uncertainty, we are well positioned with each of the customers at the facility level as well as the corporate level and expect to maintain or increase market share in each of these transactions.

We continue to be focused on our long-term strategic objectives, delivering superior service to our customers and delivering value to our shareholders. We are the PVF market leader with a strong balance sheet. We are not just managing through this market turbulence to survive. We are investing in the future to thrive.

With the permanent structural facility and personnel reductions and MRCGO investments that we are making in 2020, we will have the most efficient operating structure in my 12 years at MRC.

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

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

Thanks, Andrew. And good morning, everyone. Total sales for the second quarter of 2020 was $602 million, 39% lower than the same quarter last year, with each of our geographic segments and sectors reporting a decline in year-over-year comparisons. Sequentially, revenue decreased 24%, as all sectors declined, with the exception of gas utilities.

The monthly revenue progression this quarter started with a 27% decline in April sales compared to March, followed by an additional 8% reduction in May.

The first half of June was tracking to be similar or even lower than May revenue, but we experienced an end-of-quarter rebound with June coming in stronger than expected with a 13% month-over-month improvement.

US revenue was $474 million this quarter, 41% lower than the second quarter of 2019, with declines in all sectors, led by upstream production followed by downstream and industrial, the midstream pipeline sector and, finally, gas utilities.

The US upstream production sales were down 65% in the second quarter over the same quarter last year due to significant customer budget reductions and related curtailment in activity levels. The reduction in revenue was in line with a 62% decline in well completions over the same period.

The US downstream and industrial sector revenue declined by 41% in the second quarter compared to last year as customers delayed maintenance and turnaround activity and closed facilities due to lower demand as well as non-recurring project work.

The US midstream pipeline sector revenues declined 49% in the second quarter compared to last year due to reduced customer spending and the timing of certain projects.

The US gas utility sector sales declined 18% year-over-year as customers paused spending due to the impact of COVID-19 restrictions, but are expected to resume their originally planned budget spending in the second half of this year, barring any additional impediments due to the virus.

Canada revenue was $28 million in the second quarter of 2020, down 52% from the second quarter of last year as the Canadian upstream production sector was adversely affected by the pandemic and associated customer budget cuts as well as the midstream pipeline sector, which was lower due to non-recurring projects.

International revenue was $100 million in the second quarter of 2020, a decline of 17% from the same quarter a year ago, driven primarily by reduced spending in the downstream and industrial sector, followed by upstream production due to the conclusion of the future growth project for TCO in Kazakhstan.

Weaker foreign currencies relative to the US dollar also unfavorably impacted sales by approximately $6 million. Now, let me summarize the sales performance by sector. The upstream production sector second quarter 2020 revenue decreased 53% from the same quarter last year to $134 million.

Declines were across all segments, led by the US, which was down $122 million or 65%. The upstream production sector now represents only 22% of our total second quarter revenue. Midstream pipeline sales, which are 94% US-based, were $87 million in the second quarter of 2020, a 50% decline from the same quarter in the prior year.

This sector now represents 15% of total revenue and consists of transmission and gathering customers. Activity levels typically follow the upstream sector. Many projects that were scheduled to go forward have been delayed or canceled due to reduced demand and associated lower commodity prices.

Gas utility sales were $205 million in the second quarter of 2020, 17% lower than the same quarter a year ago. The decline was driven primarily by lower activity levels from pandemic restrictions, as well as one specific customer that recently came out of bankruptcy. This sector is now 34% of our overall revenue, up from 25% just last quarter.

Because this sector is independent of commodity prices, it reduces the relative volatility in our overall revenue. And with the current market headwind, it is much more resilient than our energy-specific businesses. We continue to see significant growth opportunity in this end market.

Sequentially, the gas utilities sector increased 2% this quarter, primarily due to market share gains. In the downstream and industrial sector, second quarter 2020 revenue was $176 million, declining 37% from the second quarter of last year, driven by the US segment as maintenance spending was temporarily delayed. Now turning to margins.

Our gross profit percent was 13.1% in the second quarter of 2020 as compared to 17.7% in the second quarter of 2019. The decline reflects the impact of $34 million of inventory-related charges related to the write-off of excess and obsolete inventory, including the exit of our Thailand business.

LIFO income of $6 million was recorded in the second quarter of 2020 as compared to $1 million of LIFO income in the second quarter of 2019. Adjusted gross profit for the second quarter of 2020 was $118 million or 19.6% of revenue as compared to $190 million or 19.3% for the same period in 2019.

Adjusted gross profit removes the impact of the inventory adjustments and LIFO just described. The improvement in adjusted gross profit reflects the positive margin product mix from increased valve sales.

The sequential reduction in adjusted gross profit percentage of 20 basis points reflects primarily line pipe deflation, along with other margin pressures. Line pipe prices were lower in the second quarter of 2020 over the same quarter in 2019 due to reduced demand.

Based on the latest Pipe Logix index, average line pipe spot prices in the second quarter of 2020 were 20% lower than the second quarter of last year. Relative to the first quarter of this year, average line pipe prices were 8% lower in the second quarter of 2020.

Line pipe prices are expected to continue to decline throughout the year, which should result in further LIFO income in 2020.

Given the current market conditions and the near-term outlook for the energy sector, in the second quarter, we conducted an impairment test and recorded a $242 million pretax impairment charge related to goodwill and intangibles, which resulted in a total write-off of the goodwill in our International segment and reduces the US balance to $264 million.

The portion of the charge related to impairment of intangibles totaled $25 million and was made to indefinite-lived assets. Therefore, there was no change to future amortization expense. SG&A costs for the second quarter of 2020 were $126 million or 20.9% of sales as compared to $133 million or 13.5% of sales in the same period of 2019.

Adjusting for $7 million of severance charges, along with $15 million of charges associated with closing facilities and terminating leases, SG&A for the second quarter was $104 million or 17.3% of sales.

As Andrew mentioned, adjusting our SG&A cost is the main lever we control, and we will continue to make adjustments as needed to the market volatility. When we saw the severity of the revenue reduction this quarter, we immediately took action to help mitigate the impact.

Other than the actions previously mentioned, some of the other key levers pulled include a voluntary and involuntary reduction in force of over 300 employees, reducing certain employee benefit programs such as bonuses and other incentive awards, and our 401(k) matching.

We also furloughed personnel, which will remain in place until we get a better feel of where the market stabilizes over the coming quarters. With all the restructuring actions taken and planned, we expect over $100 million in cost savings in 2020 as compared to 2019 based on adjusted numbers.

Approximately 60% of these cost savings are structural in nature and position the company for strong incremental margins as the market improves. Other expenses also include $3 million of asset write-downs associated with facility closures in Canada and international.

Interest expense totaled $7 million in the second quarter of 2020, which was $3 million less than the second quarter of 2019 due to lower average debt levels and interest rates. Our effective tax rate for the quarter was 6%, which is lower than average due to the goodwill impairment charge, which is not deductible for tax purposes.

Net loss attributable to common shareholders for the second quarter of 2020 was $287 million or $3.50 per diluted share as compared to net income in the second quarter of 2019, which was $18 million or $0.21 per diluted share.

On a normalized basis, removing the impacts of impairments and restructuring charges as well as LIFO, adjusted net loss attributable to common shareholders for the second quarter of 2020 was $8 million or $0.10 per diluted share as compared to adjusted net income in the second quarter of 2019, which was $17 million or $0.20 per diluted share.

Adjusted EBITDA in the second quarter of 2020 was $17 million versus $60 million for the same quarter a year ago. Adjusted EBITDA margins for the quarter were 2.8% versus 6.1% for the same quarter last year, driven by declining sales volumes previously described.

EBITDA decrementals on a trailing 12-months were 13%, which is in line with historical averages as compared to the last cyclical downturn. Our net working capital at the end of the second quarter of 2020 was $615 million, $58 million lower than the end of the first quarter.

On a trailing 12-months basis, our working capital, excluding cash as a percentage of sales, was 19.8% at the end of the second quarter of 2020. This is within our targeted range for this year of 19.5% to 19.9%. We generated $47 million of cash from operations in the second quarter of 2020 and $84 million through the first half of the year.

We are still targeting to generate $200 million or more in cash from operations this year. Capital expenditures were $3 million in the second quarter of 2020 and $5 million so far this year as we prudently manage lease costs. We continue to spend where it makes sense, such as our e-commerce initiative.

And we expect our full-year capital spend to fall within a range of $10 million to $15 million lower than our previous guidance. Our debt outstanding at the end of the second quarter was $474 million compared to $551 million at the end of 2019. We have reduced total debt by $77 million so far this year.

Our leverage ratio based on net debt of $455 million was 3.3 times outside our stated target range of 2 times to 3 times. While we expect this ratio will increase throughout the year due to the current market headwinds, our debt is very manageable and our cash flow profile allows us to generate strong cash flow in this type of environment.

We continue to focus on debt repayment and plan to reduce the ABL balance to zero by the end of the year. The availability of our ABL facility is currently $411 million and we had $19 million of cash at the end of the second quarter. We currently have no financial maintenance covenants in our debt structure.

We have one springing covenant in our ABL that becomes applicable should our availability approach the final 10% of capacity, but we do not envision getting anywhere close to this threshold, even under extended stress scenarios.

Our backlog at the end of the second quarter of 2020 was $392 million, $87 million lower than the end of the first quarter due to fewer projects and the decline in customer spending levels. We have chosen not to provide any specific annual guidance except for the key items we control, given the extreme uncertainty and volatility.

Those items include SG&A primarily as well as capital allocation. We plan to make further reductions to our SG&A structure during the second half of this year, including reducing headcount by another 100 to 150 positions and closing an additional 12 facilities. With all these actions, we are targeting a Q4 exit rate of $100 million.

This will represent over $100 million annual improvement on an adjusted basis. From a capital allocation perspective, our priority is debt reduction and all available cash will be used to pay down debt. Regarding the second half of the year, while there is too much uncertainty to provide any specifics, we can provide some general color.

As previously mentioned, the gas utility sector experienced a slowdown from the pandemic restrictions, but we do have an expectation that it could be stronger in the second half of the year. However, it will likely not be enough to overcome the shortfall from the other sectors, which are expected to remain under pressure.

Also, given the current market headwinds, we are expecting the fourth quarter to experience significant client budget exhaustion, but it is too early to estimate the full impact.

So, in summary, our second quarter 2020 results reflect the incredible challenges of this market, but I believe also proves that our management team is committed and proactively taking the appropriate measures to adjust our business as needed to whatever market we are given.

We remain committed to our strategy to deliver shareholder value regardless of where we are in the cycle and position the company to take advantage of the eventual market recovery. With that, we will now take your questions.

Operator?.

Thank you. [Operator Instructions]. Our first question comes from the line of Sean Meakim with J.P. Morgan..

Thank you. Hi, good morning. .

Hey. Good morning, Sean. So, we just talked a little bit about it at the end. Kelly touched on it, but the forward outlook for revenue, given the diversity of end markets, it sounds like you expect further erosion on the top line.

Your US upstream activity seems like it's stabilizing, maybe at least on an exit-to-exit basis if 3Q's average will still be lower quarter-over-quarter. Just curious if gas utilities offer some kind of catch-up as COVID restrictions ease. Just maybe thoughts on downstream as we get into turnaround season in the fall.

And then, maybe just the follow-on effect, we had a pretty strong reaction in the pipelines in midstream.

How do you see that unfolding if we get some stabilization in the upstream?.

Yeah, Sean. Let me start with some high-level comments on each of those end markets, and then Kelly will give some more specific guidance related to it. But upstream, I think you're exactly right. When we look at the quarter sequentially and – we track much more closely to well completions. And then rig count, as you know.

And so, with the well completions down 55% sequentially and 62% year-on-year, in North America, that very much parallels our view of upstream. It has bottomed. I think we're sitting here around 250 rigs in the US. It seems to have leveled out some.

So, I think that will stay consistent in the third quarter, but then you'll have a budget exhaustion fourth quarter impact. Canada has had a recovery from spring break, but still very low from historic terms, around 40 rigs. Upstream completions is very low there.

So, we do see a little bit of improvement in the third quarter and a little bit of improvement in the fourth quarter in Canada. But in the US, we see it tailing off the other direction and we see a flat international activity level. In the midstream pipeline segment, it's fallen off a lot for two reasons.

One, the overall project spend from a demand standpoint. And the second impact is the line pipe pricing that we've talked about being down 20% year-on-year. So, we get both the volume and the price impact on pipelines there. But when I look at the pipeline projects out there, we have 10 active projects and 18 we're tracking.

If you go back a year or two years ago, in 2018, 2019, we'd normally have 20, 25 projects active and 40 to 50 projects we're tracking. So, the pipeline work is definitely half, which parallels the rig count drop of over 50%. The pipeline work trails a quarter or two, but it's the same metric. Gas utilities was a bright spot.

It was up during the quarter sequentially.

It's down a little bit year-on-year, mostly because of the COVID impact, a lot of integrity work that would be upgrades of gas meters and systems in residential homes and the internal work that goes with putting the new system in place that just really got deferred in the second quarter because of COVID excess.

On refining and turnarounds, we had a pretty good spring turnaround session, but a lot got pushed to what we felt was the third quarter. We've seen some of that push not only out of the third quarter, but into next year. So, we see the turnarounds being down year-on-year, around 20% from a year ago. And that's the biggest impact on refining.

We see overall spending on refining being down also in parallel. If we look at refining utilizations below 80%, 77% or so, there should be a lot of room for turnaround activity being done, but I think construction projects that are being deferred also for COVID reasons.

So, that's kind of a high-level, but Kelly will give more specific on the sectors..

Yeah, Sean. Looking at kind of Q3 specifically, as Andrew said, visibility is still not perfectly clear. But if you look at gas utilities, we do expect, and we said that in our prepared comments, some level of improvement in gas utilities.

It feels like for the third quarter, because of the virus issues still out there, we're kind of anticipating maybe a modest single digit, like a low single-digit improvement in gas utilities for the third quarter. And then, if you switch over to downstream, it will be down, but kind of low single-digits as well.

Andy mentioned the turnaround work that we thought was going to hit Q3. It looks like that's going to get pushed into next year. So, a low single-digit type decline for downstream. And then, of course, upstream and midstream is going to be impacted the most.

And I think you had mentioned early on, maybe some stability in those markets, but for us and our customer mix, we're still anticipating that those two markets are going to be under the most pressure and will probably experience a double-digit decline.

So, when you net all of that out for the total company, it feels like we'll be down sequentially, not up, but we're not anticipating a double-digit decline for the overall company, probably more single-digit, could be mid to upper single digit. We'll see how it all shakes out. And then maybe just a little more color.

If you look at July revenue and just kind of how things are tracking right now, we talked about it in the prepared comments that we got a little bit of a boost in June in the last two weeks that we were not expecting, but unfortunately, it kind of reverted back in July.

We're running back similar to May levels from a revenue perspective, which, if you look at kind of a Q2 average revenue which was around $200 million or so, right now July is tracking to come in probably 8% to 10% lower than the average that we saw in Q2..

Got it. That's very helpful. Thanks for all that detail to both of you. So then, just the next key question, I think, is around the proper run rate for G&A. And so, when we strip out some of the pieces in the quarter, I think the underlying $104 million number for the quarter is a good one.

Historically, good times percentage of revenue, G&A maybe runs like 12% on a full-year basis. Last cycle, we peaked maybe close to 17%, kind of around those levels now, but trying to get that in line.

What are you targeting? What's a realistic target near term? And then – or let's say, the next one to two quarters versus the next four to six quarters, where do we get to the rightsizing G&A relative to that revenue base in terms of trying to protect profitability now versus having the ability to serve higher revenue numbers at some point down the line, finding that balance?.

Yeah. No, Sean, I'll take that one. Maybe just a few a few comments on SG&A in general and then I'll get back and answer your specific question. If you go back to Q1, we had reported SG&A of $126 million. But if you recall, we had about $6 million of bad debt expense that was in there. So, kind of the true normalized run rate was about $120 million.

And as we saw the revenues rapidly declining in Q2, we took very aggressive action to try to get ahead of that.

And so, if the $104 million that we have right now, if you look at kind of how that's broken out – well, probably even more important, let me mention, Sean, the Q4 run rate that we're really targeting here is $100 million compared to the $104 million that we ended this quarter.

And if you look at kind of how that's breaking out, to get from that $120 million run rate in Q1, ultimately to the $100 million that we're going to end up with at the end of the year, we had voluntary and involuntary reductions in force, that's about $8 million of that quarterly run rate.

We had facility closures of about $6 million or so in savings there to bring the number down. And those are true structural cost savings that we're going to maintain, even if things start to get better. And that represents – I think for the quarter, it was about a 60% structural number that we talked about in our prepared comments.

But if you look at – by the time we get to that $100 million, it will really be about two-thirds of the cost that we're taking out is going to be truly structural in nature versus variable. And then, on the variable side, of course, we've had furlough reductions.

We've had some change in benefits, like 401(k) matching, reduction in overtime, things like that, which makes up the difference there. But with everything moving so quickly, it's hard to give you an exact percentage. I think we were 17% or so SG&A as a percent of revenue this quarter.

I think it's probably going to hang around that level here, but we'll continue to work that down and it really is just a function of where revenue ends up and we're tracking it very closely. And as we said on the prepared comments, Sean, we're prepared.

We'll continue to use SG&A as a lever and take additional actions as needed to get that percentage down to more kind of normalized levels that you mentioned earlier..

Yeah, Sean, I'll just add – let me just add, Sean, to Kelly's comments. I think he covered it really well. We do see another 12 facilities in the second half closing. We see another 100, 150 personnel reductions that we mentioned.

So, we're going to continue to match up the cost and operational footprint to the revenue base, knowing, though, that there's a point where we want to just maintain that core business footprint and not go too far.

But when I think about the changes over the last six years, we said in our remarks, we reduced personnel 43% since the last peak and we reduced facilities 36%. But one key message is we have not withdrawn from any of our end markets. So, we've shrunk the profile. We've consolidated branches.

We've made investments all along the way in our RDCs and our valve engineering centers. But we service the same global market and the same customer base with a significantly lower footprint. And so, I think that's the important thing.

I think the incrementals when we get back to spending increases by our customers will be much stronger than our 15% historical level as we leverage what we've done in this downturn. So, I think that's the positive on what we're doing and we just continue to monitor the revenue and costs quarterly..

Very good. Thanks a lot for all that feedback..

Thanks, Sean..

Thank you. Our next question comes from the line of Vebs Vaishnav with Scotiabank. Please proceed with your question..

Hey. Thank you, gentlemen. I guess just could you expand on your comment around double-digit decline in upstream. Like, I guess, I'm a little surprised by that.

Maybe like there's a couple of IOCs who could be still declining in activity, but just if you can provide some more color, what's driving that double-digit decline in upstream?.

Yeah. Vebs, it is customer-specific for us because a lot of the major customers held in with rig counts well into the second quarter and a lot of the bigger – large independents and IOCs that are our main customer base really have their reductions coming in the third and fourth quarter.

So, the small one rig – the huge drop in rig count wasn't really our customer base that impacted earlier. So, that's why we're still – even if you assume a flat 250 rig count, it's really our impact on revenues.

And if you think about it, if you look at our Chevron, Shell, ExxonMobil, of course, they're integrated up, mid and down, but their revenues that normally shelter us through the down cycle, their spending and our revenues with them all going to be down, those top three IOCs, 30% to 40% this year.

So, we're seeing not only a general industry spending decline, but even in our best customers that normally spend through the cycle, really retracting in spending this year. Not so much in gas utilities. We see those really low spending declines. And our largest refining customer down 40%.

So, what used to shelter our revenues even more, we're seeing that kind of spending decline in even our best top four customers.

Kelly, do you want to add anything?.

No. I think that covered it perfectly..

Thinking about new the midstream segment, so just gathering and other capital projects, can you help us think about how are you thinking about the non-gathering? So, like, gathering would be driven by just whatever the US drilling activity – drilling and completions activity do.

But how are you thinking about the other capital projects maybe in second half? And also, if there's any insight into how you're thinking about 2021 for those capital projects..

Yeah, Vebs. So, you're exactly right. The gathering for us is flow lines. It really ties to the overall completion activity. So, it's the infrastructure that tie in the wells once it's completed to the tank battery. So that very much parallels the completion activity. But major pipelines, it really talks about the need for additional capacity.

Now, in the first half of this year, we had some carryover pipeline activity from last year. The Permian – for a couple of years, we had the bottleneck in the Permian. We've worked through that, of course, with activity and production declining there. We have a very small percentage of what we had for the last two years.

So, I don't see a lot of big pipeline infrastructure. I see projects right now in the fourth quarter – third and fourth quarter being deferred into next year on some of the – both gas, oil and NGL. We play in all three pipeline projects. And so, that, I think, will slow into next year.

And so, of course, we won't have the higher activity in the first half. So, I see it being a difficult year in pipelines next year. And then, we mentioned it previously, but if you add the – we look at price and volume on line pipe.

If you look at a 9% price down in the quarter and 11% volume down, you get to this lower run rate on both the price and volume from a line pipe. And so, we're down kind of on the $1,300 to $1,400 a ton on line pipe.

So, that lower level from the pricing of $1,700, $1,800 a ton to start the year gets you down to a lower price and volume on line pipe going into next year also. Those two things, the gathering will reflect the amount of completions, but the big pipelines and the lower line pipe pricing starting will both make it a difficult start in 2021..

Okay. And if I may squeeze in one and I apologize if you guys addressed this. Just how to think about the gross margin, the adjusted gross margin. So, they declined modestly As we go into the second half, given the pricing, I would assume, it's still under pressure.

But, like, do we still have a 19% handle or do we actually fall below 19% margins?.

Yeah, Vebs. Let me start and Kelly will give you more guidance. So, with the line pipe we just referred to, discussed will pressure margins, but we still have a trend towards our higher valve mix and we've reached the record in the second quarter of total revenues, 41% coming from our valve business. So, that's the offset on the much positive side.

And we also see a nice pickup in our automation part of the valve business, which also is a positive on the margin. So, the line pipe is the negative and the valve part – mix change is still the positive.

And so, Kelly?.

Yeah, Vebs. As Andy mentioned, there is pressure there and we anticipate additional pressures as long as this downturn goes on. But the beauty of this business, we're talking like tens of basis points, not hundreds of basis points. And so, I think for the rest of this year, we're – and you asked the question, 19% or better.

That certainly is what we're targeting. We're pushing back real hard not to get below that kind of level. But I would expect it to decline slightly from what we reported this quarter..

That's very helpful. And thank you for taking my questions..

Thanks, Vebs..

Thank you. Our next question comes from the line of Doug Becker with Northland Capital Markets. Please proceed with your question..

Thanks. As we look a little further out, just thinking about the recovery and the working capital requirements, if we look back to 2017 and 2018, MRC didn't generate free cash flow as it replenished the inventories. But you've taken a lot of steps in the facilities, the inventory analysis you've been doing, just optimizing the operating structure.

Is there a case to be made that MRC could be generating free cash flow, either neutral or positive, even if activity is increasing a little bit?.

Yeah, Doug. Let me start, but Kelly is going to walk you through this cash flow because it's something we want to address.

We definitely feel the cash flow from ops will be greater than $200 million this year, especially with our softer outlook for the second half on revenue, so that, in our countercyclical model, that leads to more inventory reductions. So, Kelly, you walk through the free cash flow..

Yeah. Yeah. Doug, you may be asking kind of longer term, but we wanted to clarify just for kind of the rest of this year because we saw some of the notes this morning that there may be some confusion that, as Andy said, cash flow from ops this year, we are still targeting $200 million or more.

We think nothing's really changed from the previous quarter. However, kind of the way we get there maybe has shifted somewhat from the way we described it last quarter. In other words, I think revenue will be coming a little bit weaker as we've already kind of talked about for Q3 and then Q4. I don't think we really talked about it.

But Q4, we do think there's going to be a seasonal decline. For us, historically, it was always kind of 5% to 10% down. But, of course, if you look at 2019, it was a 19% sequential decline. So, we're not trying to make any call on that yet other than to say that we do think the fourth quarter of this year will certainly be down. So, revenue weaker.

But as a result of that, we'll have a great working capital release, so lower AR, lower inventory. And last quarter, our inventory target, we had put out there $140 million or more because of the lower revenue. We think we'll expect for that number to go up, probably closer to more like $170 million or so on an inventory reduction.

And we lowered our capital guidance for the year from the $15 million to $20 million range, down to $10 million to $15 million, so about a $5 million drop there. If you look, the preferred dividend stays the same.

But, anyway, you kind of net all of that out and, at the end of the day, it feels like free cash flow will be greater than the number we put out there last quarter of $160 million. Now, we're targeting closer to probably around $180 million of free cash flow.

But I think going forward, I think what you were kind of getting at as well was just, in a period of growth, if we could be generating positive cash as well, and that's certainly the way we're trying to position the company. You look at the SG&A cost. We went through the structural changes that we put in place there.

We're trying to centralize more inventory and the switch to e-commerce that we have will allow us to do even more centralization of inventory. So, that should all help out from a working capital perspective. So, I think you're thinking about it correctly, Doug.

Not putting any specific targets out there right now, but that's the way we're trying to approach it for the future..

No. That's a really helpful clarification. You were alluding to it just a little bit before, just the targets for the valve growth in the intermediate term, getting to that 45% in a couple of years.

Is that still on track given what we saw in the second quarter?.

Yeah, Doug. Very much. I've given it a few – well, many years back, five, seven years back when we started the transition, we achieved the 40% target that was our initial at the start of this year. We're tracking 41% in the second quarter. I expect us to finish the year kind of 41%, 42%.

And we're still very much ramping up the midstream valve business, the modification and engineering shop. So, we've had growth there. We have $12 million in new orders just in the second quarter.

So, we're tracking very much that $50 million in the first year and $100 million of growth in the second year from that investment in the midstream valve business. And so, I feel very confident we're going to get to the 45% of total revenue probably sooner than we thought, but the guidance is still good that we will get there..

Excellent. Thank you very much. .

Thanks, Doug..

Thank you. [Operator Instructions]. Our next question comes from the line of Nathan Jones with Stifel. Please proceed with your question..

Good morning, everyone. .

Good morning, Nathan. .

Just a question on the late June surge in revenue that you saw, but it doesn't seem like it maintained into July.

Can you talk about where that came from and what your explanation is of why that surge occurred? And then again, why it didn't – it hasn't sustained as we've gone into July?.

Yeah, Nathan. Let me just make one comment and then Kelly will walk us. I think it will be helpful to walk through the U.S., Canada, International outlook. But I think a couple of things happening. We're heavily weighted, of course, to the Gulf Coast business. And in June, just like our own business of managing through COVID, we started to open back up.

And then as cases spiked in the community, we had to pull back. We saw activity pick back up in June. But then July, we've seen with the resurgence – we have very big operations in Texas, Louisiana and California, and all three were impacted in July by pullback in some spending.

So, the COVID cases spiked and then construction projects and activity get slowed. We're managing 27 cases now and we got 50 – a little over 50, 55 people quarantined. And it's all family spread and community spread, so it has a knock-on impact to spending with our customers. Whether it lasts in August and September is still undetermined.

But it definitely – I think we had some optimism, some activity picking back up in June that was encouraging. But July, at least, in the beginning here, first few weeks, it looks like it wasn't sustained. And that's really in the guidance that Kelly was talking about, just a very difficult environment to forecast now with August and September.

But Kelly, maybe by market, by geography..

Yeah. No, I think it would be helpful. We kind of talked earlier to the Q3 guidance. But when you look at a full-year forecast, just to kind of maybe put it in perspective of kind of the way we think things are shaking out, as Andy said, look at it on a segment basis.

Q4, as I mentioned earlier, is there's a lot of uncertainty around how much budget exhaustion we'll see there. So, that's going to be a big question mark on how all of this shakes out at the end of the day. But if you look at US specific, it feels like just a full-year 2020 versus 2019, we're probably talking more than 30%.

We'll see how much more depending on Q4, but certainly more than a 30% year-over-year decline. Same thing for Canada. Obviously, very highly tied to the upstream market. So, more than a 30% decline there as well. International is holding up a little bit better for us. We think it will be a double-digit decline.

Hopefully, a lower double digit, but that's holding in a little bit better than maybe what some of the market expectations are out there. And maybe switch back to streams real quick from a full year perspective. Upstream is falling closer in line to what some of the spend estimates are out there, 50% or more.

I think we may hopefully do a little bit better than that. But certainly, as Andy talked about early, just the customer mix and the way some of our big clients are going to be shutting down – not shutting down, but reducing activity levels here in the second half of the year, that's going to put a lot of pressure on upstream.

Midstream will closely follow that on a year-on-year basis, maybe not down quite as much as upstream, but we are expecting more of a fall off, as Andy talked about earlier, in the second half of the year. And then gas utility is down, but more of a single-digit type number, maybe mid-single digits kind of range.

And then downstream, we talked about last quarter that historically downstream would be about 50% of whatever reduction that you saw for the US. It feels like it's heavier this year. And we're looking right now at probably about a 30% year-over-year decline just based on our current estimates..

Just on that downstream side, that's primarily a function of – you had expected deferrals out of the second quarter in the spring turnaround season. Obviously, it was difficult to get into people's facilities at that point with all the shutdowns from COVID.

I think the expectation was, some of that would be made up in the fall, some would maybe go into 2021. You're seeing a larger amount of what you'd expect it to go into the fall season, now being shifted out 2021..

Yes, Nathan. That's exactly right. And I would say it's still largely impacted with the COVID impact and the impact on construction. The planned spend, when you think about – we track this very closely because we're the largest refining and chemical turnaround company in the US by a large amount.

But you look back, in 2018, they spent 75% of what they planned. In 2019, they spent 104%. And in 2020, we expect them to only spend 41% of their planned budgets and the rest being pushed out into 2021. So, a significant decline in the amount of spend. The projects are there, the visibility is there, the refining utilization is low.

So, you certainly have an opportunity to get the work done. But we don't think the construction projects with the current health crisis environment is going to allow it to get done.

So, that's a really low percentage from 20 years of being in the refining and turnaround business of amount they will actually spend from what they started to talk about at the beginning of the year..

Okay. Then I have a bit more of a philosophical question, a bit of a follow-up to a previous question too that was talking about that 12% to 17% SG&A range. It seems that, over the last few years, you've really increased your efficiency, probably reduced the cost to serve customers with transitioning people online to MRCGO.

Do you feel like that range has structurally shifted to the left, so structurally shifted down? And I could maybe give you an example. In 2018, you did just under $4.2 billion in revenue, just over 13% SG&A.

Over the last couple of years and maybe over the next couple of years that it maybe takes to get revenue back to that level, would you expect that structural SG&A to be around the same percentage? Would it be potentially 100 basis points lower, a couple of hundred basis points lower? Any kind of color you can give us on just how you think that structural need for SG&A to serve your customers might have changed over the last few years?.

Yeah, Nathan. I made the comment in the prepared remarks, it is the most efficient operating structure we've had in the past 12 years. And as Kelly mentioned, a lot of it, even what we're doing in 2020, is structural and lower cost. And the big thing that's evolved over the last two, three years is what you've mentioned, the move online and MRCGO.

We've been focused on our largest customers. We've just this month made a change on 1,500 smallest transactional customers, moved them to an online interaction with us. And our percent of revenue continues to grow with 31% total on a trailing 12-month. It was 34% in the second quarter. So, we continue to move our model to that.

That brings a lot of efficiency, permanent efficiency to our model. All these deployed internal sales resources and service centers that are out in all the branches decrease significantly over the next year to two years.

And we're already targeting $5 million to $10 million next year – by the end of the end of next year to get to that lower cost structure. But as things ramp back up, to answer your question, I expect it to be – as the revenue comes back, the incrementals will be more like 20% than 15% and I expect a lower cost structure to be more permanent.

So, we would be at – when you get back to those same kind of revenue levels, we'll be at the 12% SG&A, but I'd expect it to be lower because of the MRCGO, the e-commerce impact. So, it's yet to be proven out, but we certainly won't be going the other direction, adding costs back into the branch as revenue picks back up.

We'll be moving more customers to that platform. So, I do believe it will have a permanent, positive impact..

That's very helpful. Thank you..

Thank you, Nathan..

Thank you. Ladies and gentlemen, we have come to the end of our time allowed. I'll now turn the floor back to Ms. Broughton for any final comments..

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

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation..