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MRC > SEC Filings for MRC > Form 10-Q on 29-Oct-2012All Recent SEC Filings

Show all filings for MRC GLOBAL INC.

Form 10-Q for MRC GLOBAL INC.


29-Oct-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with our financial statements and related notes included elsewhere in this report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. All references throughout this section (and elsewhere in this report) to amounts available for borrowing under various credit facilities refer to amounts actually available for borrowing after giving effect to any borrowing base limitations imposed by the facility.

Cautionary Note Regarding Forward-Looking Statements

Management's Discussion and Analysis of Financial Condition and Results of Operations (as well as other sections of this Quarterly Report on Form 10-Q) contain forward-looking statements, including, for example, statements about our business strategy, our industry, our future profitability, growth in the industry sectors we serve, our expectations, beliefs, plans, strategies, objectives, prospects and assumptions, and estimates and projections of future activity and trends in the oil and natural gas industry. These forward-looking statements are not guarantees of future performance. These statements are based on management's expectations that involve a number of business risks and uncertainties, any of which could cause actual results to differ materially from those expressed in or implied by the forward-looking statements. These statements involve known and unknown risks, uncertainties and other factors, including the factors described under "Risk Factors", that may cause our actual results and performance to be materially different from any future results or performance expressed or implied by these forward-looking statements. Such risks and uncertainties include, among other things:

decreases in oil and natural gas prices;

decreases in oil and natural gas industry expenditure levels, which may result from decreased oil and natural gas prices or other factors;

increased usage of alternative fuels, which may negatively affect oil and natural gas industry expenditure levels;

U.S. and international general economic conditions;

our ability to compete successfully with other companies in our industry;

the risk that manufacturers of the products we distribute will sell a substantial amount of goods directly to end users in the industry sectors we serve;

unexpected supply shortages;

cost increases by our suppliers;

our lack of long-term contracts with most of our suppliers;

increases in customer, manufacturer and distributor inventory levels;

suppliers' price reductions of products that we sell, which could cause the value of our inventory to decline;

decreases in steel prices, which could significantly lower our profit;

increases in steel prices, which we may be unable to pass along to our customers, which could significantly lower our profit;

our lack of long-term contracts with many of our customers and our lack of contracts with customers that require minimum purchase volumes;

changes in our customer and product mix;

risks related to our customers' creditworthiness/profiles;


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the potential adverse effects associated with integrating acquisitions into our business and whether these acquisitions will yield their intended benefits;

the success of our acquisition strategies;

our significant indebtedness;

the dependence on our subsidiaries for cash to meet our debt obligations;

changes in our credit profile;

a decline in demand for certain of the products we distribute if import restrictions on these products are lifted;

environmental, health and safety laws and regulations and the interpretation or implementation thereof;

the sufficiency of our insurance policies to cover losses, including liabilities arising from litigation;

product liability claims against us;

pending or future asbestos-related claims against us;

the potential loss of key personnel;

interruption in the proper functioning of our information systems;

loss of third-party transportation providers;

potential inability to obtain necessary capital;

risks related to adverse weather events or natural disasters;

impairment of our goodwill or other intangible assets;

changes in tax laws or adverse positions taken by taxing authorities in the countries in which we operate;

adverse changes in political or economic conditions in the countries in which we operate;

exposure to U.S. and international laws and regulations, including the Foreign Corrupt Practices Act and the U.K. Bribery Act and other economic sanction programs;

potential increases in costs and distraction of management resulting from the requirements of being a publicly reporting company;

risks relating to evaluations of internal controls required by Section 404 of the Sarbanes-Oxley Act; and

the operation of our Company as a "controlled company".

Undue reliance should not be placed on our forward-looking statements. Although forward-looking statements reflect our good faith beliefs, reliance should not be placed on forward-looking statements because they involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance or achievements to differ materially from anticipated future results, performance or achievements expressed or implied by such forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events, changed circumstances or otherwise, except to the extent law requires.

Overview

We are the largest global industrial distributor, based on sales, of PVF and related products and services to the energy industry and hold a leading position in our industry across each of the upstream (exploration, production and extraction of underground oil and natural gas), midstream (gathering and transmission of oil and natural gas, natural gas utilities and the storage and distribution of oil and natural gas) and downstream (crude oil refining, petrochemical and chemical, processing and general industrials) sectors. Globally, we have two operating segments through which we serve our customers in over 410 service locations. Our North American segment includes over 175 branch locations, seven distribution centers in the U.S., one distribution center in Canada, 12 valve automation service centers


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and over 140 third party pipe yards located in the most active oil and natural gas regions in North America. Our International segment includes over 50 locations throughout Europe, Asia and Australasia with distribution centers in the United Kingdom, France, Singapore, New Zealand and Australia and 12 automation service centers in Europe and Australasia. We offer a wide array of PVF and oilfield supplies encompassing a complete line of products from our global network of suppliers to our more than 12,000 customers. We are diversified by geography, the industry sectors we serve and the products we sell. We seek to provide best-in-class service to our customers by satisfying the most complex, multi-site needs of many of the largest companies in the energy and industrial sectors as their primary PVF supplier. We believe the critical role we play in our customers' supply chain, together with our extensive product offering, broad global presence, customer-linked scalable information systems and efficient distribution capabilities, serve to solidify our long-standing customer relationships and drive our growth. As a result, we have an average relationship of over 20 years with our largest 25 customers.

Key Drivers of Our Business

Our revenues are predominantly derived from the sale of PVF and other oilfield and industrial supplies to the energy sector in North America, Europe, Asia and Australasia. Our business is therefore dependent upon both the current conditions and future prospects in the energy industry and, in particular, maintenance and expansionary operating and capital expenditures by our customers in the upstream, midstream and downstream sectors of the industry. Long-term growth in spending has been, and we believe will continue to be, driven by several factors, including underinvestment in global energy infrastructure, growth in shale and unconventional exploration and production (E&P) activity, and anticipated strength in the oil, natural gas, refined products, petrochemical and other industrial sectors. The outlook for future oil, natural gas, refined products, petrochemical and other industrial PVF spending is influenced by numerous factors, including the following:

Oil and Natural Gas Prices. Sales of PVF and related products to the oil and natural gas industry constitute a significant portion of our sales. As a result, we depend upon the oil and natural gas industry and its ability and willingness to make maintenance and capital expenditures to explore for, produce and process oil and natural gas and refined products. Oil and natural gas prices, both current and projected, along with the costs necessary to produce oil and gas, impact other drivers of our business, including E&P spending, additions and maintenance to pipeline mileage, refinery utilization and petrochemical and other industrial processing activity.

Steel Prices, Availability and Supply and Demand. Fluctuations in steel prices can lead to volatility in the pricing of the products we distribute, especially carbon steel tubular products, which can influence the buying patterns of our customers. A majority of the products we distribute contain various types of steel. The worldwide supply and demand for these products, or other steel products that we do not supply, impacts the pricing and availability of our products and, ultimately, our sales and operating profitability.

Economic Conditions. The demand for the products we distribute is dependent on the general economy, the energy and industrials sectors and other factors. Changes in the general economy or in the energy and industrials sectors (domestically or internationally) can cause demand for the products we distribute to materially change.

Customer, Manufacturer and Distributor Inventory Levels of PVF and Related Products. Customer, manufacturer and distributor inventory levels of PVF and related products can change significantly from period to period. Increases in our customers' inventory levels can have an adverse effect on the demand for the products we distribute when customers draw from their inventory rather than purchase new products. Reduced demand, in turn, would likely result in reduced sales volume and profitability. Increased inventory levels by manufacturers or other distributors can cause an oversupply of PVF and related products in the industry sectors we serve and reduce the prices that we are able to charge for the products we distribute. Reduced prices, in turn, would likely reduce our profitability. Conversely, decreased customer and manufacturer inventory levels may ultimately lead to increased demand for our products and would likely result in increased sales volumes and overall profitability.

Recent Trends and Outlook

During the first nine months of 2012, the average oil price of approximately $96.11 per barrel for West Texas Intermediate ("WTI") was flat compared to the first nine months of 2011. Natural gas prices declined to an average price of $2.54/Mcf (Henry Hub) for the first nine months of 2012 from an average of $4.22/Mcf for the first nine


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months of 2011. At September 30, 2012, the natural gas price was $3.08/Mcf (Henry Hub). Behind the sustained strength of oil prices, North American drilling activity increased 4% in the first nine months of 2012 as compared to the same period of 2011. We continue to see a shift in rig utilization from natural gas to oil, with oil drilling representing over 69% of the total North American rig count during the first nine months of 2012 compared to 54% for the same time period in 2011.

Activity levels in the upstream sector remain strong. In the U.S., the average rig count was up 7% in the first nine months of 2012 as compared to the first nine months of 2011 although rig counts have leveled off since peaking in the fourth quarter of 2011. Continued development within the Eagle Ford and Bakken shale regions and the Permian Basin primarily drove this increase in rig count. In Canada, the average total rig count for the first nine months of 2012 declined 10% as compared to the same period in 2011 having peaked in the first quarter of 2012 primarily due to the decline in natural gas drilling. However, maintenance, repair and operations ("MRO") activity, particularly in the heavy oil and oil sands regions, has remained strong, mitigating the downturn experienced in shallow natural gas drilling elsewhere in Canada.

Within the midstream sector, which includes gathering, transmission pipelines and natural gas utilities, new wells coming on line and the continued need for infrastructure within the shale basins continues to drive growth in gathering and transmission. As a result of the shift in E&P activity from natural gas to oil, we have experienced a shifting in activity from the primarily natural gas regions of the Barnett, Haynesville, Woodford and Fayetteville shales to the Marcellus, Bakken, Eagle Ford and Niobrara shales and the Permian Basin and Mississippian Lime region, which are regions producing relatively greater proportions of oil and natural gas liquids. At the same time, increasing focus on pipeline integrity work and the need for utilities to repair or replace aging pipeline infrastructure has had a similar positive impact on the gas utilities portion of our midstream business.

Our downstream and other industrials sector performance continues to improve. Within refining, market participants are experiencing high utilization rates with corresponding need for MRO turnarounds but are still cautious with respect to major project capital spending because of international refining capacity additions and domestic demand levels. However, we believe there will continue to be increased turnaround activity by our major customers in the U.S. refining sector in 2013. The chemical portion of our downstream sector continues to experience strong levels of operational activity, driven at least in part by reduced pricing for the chemical industry's key feedstocks, natural gas and natural gas liquids.

Internationally, we continue to see some improvement in prospects, although in Europe the outlook will be partly driven by Eurozone sentiment that will impact market confidence. Our Australasian business benefited from the March 2012 acquisition of MRC PSA, and early indications of business activity post acquisition are encouraging. Refining customers remain cautious, particularly with the shift in production from Europe to Asia.

As part of our strategy to focus on our higher margin product lines, we continue to rebalance our OCTG business. We expect to accomplish this by continuing to reduce our OCTG inventory, which was $110.2 million on September 30, 2012. Historically, this product line had contributed up to 25% of our revenue and was 17% of our revenue in 2011. We are currently anticipating that OCTG will constitute approximately 10% of our revenue and inventory going forward in 2013.

We determine backlog by the amount of unshipped customer orders, either specific or general in nature (including orders held under pipe programs), which the customer may revise or cancel in certain instances. There can be no assurance that the backlog amounts will be ultimately realized as revenue or that we will earn a profit on the backlog of orders. Our backlog at September 30, 2012 was $749 million, including $591 million in our North American segment and $158 million in our International segment. Approximately three quarters of the $108 million decline in our backlog from June 30, 2012 relates to OCTG. This reduction is consistent with our strategy to rebalance the OCTG portion of our business.

During the second quarter of 2012, the Company's competitive landscape was altered as National Oilwell Varco Inc. (NOV) acquired the Wilson distribution business from Schlumberger Limited. Subsequently, in the third quarter 2012, NOV acquired a related Canadian distribution business, CE Franklin Ltd. The combination of these businesses has created a larger, number two distribution business in the energy industry.


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The following table shows key industry indicators for the three and nine months ended September 30, 2012 and 2011:

                                              Three Months Ended                            Nine Months Ended
                                     September 30,          September 30,          September 30,          September 30,
                                          2012                  2011                   2012                   2011
Average Rig Count(1):
United States                                  1,906                 1,944                   1,955                 1,835
Canada                                           325                   441                     362                   401

Total North America                            2,231                 2,385                   2,317                 2,236
International                                  1,260                 1,169                   1,226                 1,160

Total Worldwide                                3,491                 3,554                   3,543                 3,396

Average Oil Rig Count(1):
United States                                  1,417                 1,043                   1,351                   936
Canada                                           241                   304                     261                   270

Total North America                            1,658                 1,347                   1,612                 1,206

Average Natural Gas Rig
Count(1):
United States                                    486                   894                     600                   891
Canada                                            84                   137                     101                   132

Total North America                              570                 1,031                     701                 1,023

Average Commodity Prices(2):
WTI crude oil (per barrel)          $          92.17       $         89.49       $           96.11       $         95.17
Brent crude oil (per barrel)        $         109.63       $        113.24       $          112.14       $        111.88
Natural gas ($/Mcf)                 $           2.88       $          4.12       $            2.54       $          4.22
Average Monthly Well Permits(3)                5,236                 6,500                   5,809                 5,854
3:2:1 Crack Spread (4)              $          32.42       $         33.33       $           29.65       $         26.75
PMI Index (As of September 30
for each period) (5)                            51.5                  52.5                    51.5                  52.5

(1) Source-Baker Hughes (www.bakerhughes.com) (Total rig count includes oil, natural gas and other rigs.)

(2) Source-Department of Energy, EIA (www.eia.gov)

(3) Source-RigData (U.S.)

(4) Source-Commodity Systems, Inc.

(5) Source-Institute for Supply Management


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The breakdown of our sales by sector for the three and nine months ended September 30, 2012 and 2011 was as follows:

                                                       Three Months Ended
                                        September 30, 2012           September 30, 2011
   Upstream                           $      653.6         45 %    $      613.5         45 %
   Midstream                                 403.9         28 %           375.3         27 %
   Downstream and other industrials          393.6         27 %           377.4         28 %

                                      $    1,451.1        100 %    $    1,366.2        100 %


                                                       Nine Months Ended
                                        September 30, 2012           September 30, 2011
   Upstream                           $    1,960.3         46 %    $    1,619.2         46 %
   Midstream                               1,160.3         27 %           925.2         26 %
   Downstream and other industrials        1,143.5         27 %           981.6         28 %

                                      $    4,264.1        100 %    $    3,526.0        100 %

Sales to the upstream sector totaled $653.6 million for the three months ended September 30, 2012 compared to $613.5 million for the same period in 2011, an increase of 7%. This reflects revenue growth of approximately 21% in our upstream MRO sales for the three months ended September 30, 2012 compared to the same period in 2011. As a result of our efforts to improve profitability by rebalancing our inventory, OCTG experienced a decline of 20% for the three months ended September 30, 2012 compared to the same period in 2011. For the first nine months of 2012, sales to the upstream sector totaled $1,960.3 million compared to $1,619.2 million for the same period in 2011, an increase of 21%.

In the midstream sector, we generated revenue growth of 8% to $403.9 million for the three months ended September 30, 2012 as compared to $375.3 million for the same period in 2011. Revenue from our gathering and transmission customers increased 11% in the third quarter of 2012 as compared to 2011, while revenue from our natural gas utilities customers increased approximately 3% in the third quarter of 2012 as compared to 2011. For the first nine months of 2012, sales to the midstream sector totaled $1,160.3 million compared to $925.2 million for the same period in 2011, an increase of 25%.

Our downstream and other industrials sector sales improved 4% to $393.6 million in the third quarter of 2012 as compared to $377.4 million in the third quarter of 2011. Substantially all of this growth was attributable to our international acquisition of MRC PSA, which is more heavily weighted toward downstream and other industrials than the business as a whole. In North America, the downstream sector declined 5% over this same time period. For the first nine months of 2012, sales to the downstream and other industrials sector totaled $1,143.5 million compared to $981.6 million for the same period in 2011, an increase of 16%.

Three Months Ended September 30, 2012 Compared to the Three Months Ended
September 30, 2011

For the three months ended September 30, 2012 and 2011, the following table
summarizes our results of operations (in millions). Corporate administrative
costs are included in the North American segment.



                              Three Months Ended
                                 September 30,
                              2012          2011         $ Change       % Change
            Sales:
            North America   $ 1,297.5     $ 1,261.9     $     35.6            2.8 %
            International       153.6         104.3           49.3           47.3 %

            Consolidated    $ 1,451.1     $ 1,366.2     $     84.9            6.2 %


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                                              Three Months Ended
                                                 September 30,
                                             2012             2011           $ Change          % Change
Gross profit:
North America                              $   235.2         $ 172.9        $     62.3              36.0 %
International                                   42.0            28.2              13.8              48.9 %

Consolidated                               $   277.2         $ 201.1        $     76.1              37.8 %

Selling, general and administrative
expenses:
North America                              $   121.0         $ 110.0        $     11.0              10.0 %
International                                   34.0            24.7               9.3              37.7 %

Consolidated                               $   155.0         $ 134.7        $     20.3              15.1 %

Operating income:
North America                              $   114.2         $  63.0        $     51.2              81.3 %
International                                    8.0             3.4               4.6             135.3 %

Consolidated                               $   122.2         $  66.4        $     55.8              84.0 %

Interest expense                               (28.2 )         (34.3 )             6.1             (17.8 %)
Other, net                                      (8.2 )           0.9              (9.1 )             N/M

Income before taxes                             85.8            33.0              52.8             160.0 %
Income tax expense                             (30.3 )         (11.1 )           (19.2 )           173.0 %

Net income                                 $    55.5         $  21.9        $     33.6             153.4 %

Adjusted Gross Profit                      $   278.8         $ 236.8        $     42.0              17.7 %

Adjusted EBITDA                            $   125.3         $ 109.6        $     15.7              14.3 %

Sales. Sales include the revenue recognized from the sale of the products we distribute and services to customers and freight billings to customers, less cash discounts taken by customers in return for their early payment of our invoices to them. Our sales increased 6.2% to $1,451.1 million for the three months ended September 30, 2012 as compared to $1,366.2 million for the three months ended September 30, 2011.

North American Segment-Our North American sales increased to $1,297.5 million for the three months ended September 30, 2012 from $1,261.9 million for the three months ended September 30, 2011. This represents a 2.8% increase, which reflects sustained activity levels, in particular, in the upstream and midstream sectors, which have been driven by activity in the oil and natural gas shale regions in the U.S. as well as the heavy oil and tar sands regions of Canada.

International Segment-Our International sales increased to $153.6 million for the three months ended September 30, 2012 from $104.3 million for the same period in 2011. This $49.3 million increase was substantially due to the acquisition of MRC PSA in March 2012.

Gross Profit. Our gross profit was $277.2 million (19.1% of sales) for the three months ended September 30, 2012 as compared to $201.1 million (14.7% of sales) for the three months ended September 30, 2011. The 440 basis point improvement in gross profit percentage was driven by a favorable change in product mix, reductions in product costs reflected in our last in, first out (LIFO) inventory costing methodology, and the leveraging of the fixed cost component of cost of sales.

North American Segment-Gross profit for our North American segment increased to $235.2 million (18.1% of sales) for the three months ended September 30, 2012 . . .

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