Shawcor Ltd

TSX:SCL

Earnings Call Transcript

[Operator]

Good day, ladies and gentlemen, and welcome to the Shawcor Q2 2018 Results Webcast and Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would like to introduce your host for today's conference, Gaston Tano, Chief Financial Officer. You may begin.

[Gaston Alfonso Tano, Senior VP of Finance & CFO]

Good morning. Before we begin this morning's conference call, I'd like to take a moment to remind all listeners that today's conference call includes forward-looking statements that involve estimates, judgments, risks and uncertainties that may cause actual results to differ materially from those projected. The complete text of Shawcor statement on forward-looking information is included in Section 4 of second quarter 2018 earnings press release that is available on SEDAR and on the company's website at shawcor.com. I will now turn over the call to Shawcor CEO, Steve Orr.

[Stephen M. Orr, President, CEO & Director]

Good morning, and thank you for joining us on this morning's conference call. Gaston and I are hosting this call from our Calgary office, following several days of operational visits and the Shawcor board of directors meeting that was held here yesterday. The site visits and reviews certainly highlighted the strength of Shawcor's organization and their pursuit to deliver value to our customers through innovative solutions.In our last quarter's call, we continue to highlight our expectation that the full year 2018 results would be aligned Q4 2016 adjusted EBITDA annualized and that 2018 had the potential to be a pivotal year and a set up for stronger earnings in future years. Our results this quarter were solid, and as we expected. Adjusted EBITDA in the second quarter of 2018 was $37 million, an increase of 6% over the first quarter of 2018. And the revenue was $358 million, an increase of 2%.This quarter's results demonstrate that the actions that we have been taken to diversify the portfolio are gaining traction, and have resulted in the emergence of a supportive base business and the reality that pipe coating projects are progressing, but they are late cycle. At a high level, the second quarter results were positively impacted by the continued demand for the company's products and services in its day-to-day business and better utilization, particularly in North America. The quarter was negatively impacted by the low activity for pipe coating that for the most part is tied to projects in the international and offshore markets.Shawcor's financial performance is determined by the level of capital spending of our customers. With North America recovery well underway, the next step up will be impacted by the latency or the forecasted late-cycle nature of international and offshore markets that are now strongly indicating an upward inflection point. For Shawcor, there is increased confidence that 2018 will be a pivotal year. Pivotal due to the fact that we are demonstrating the strength of our base business, which now has surpassed prior downturn levels, together the base business and securing the pipe coating projects, which support earnings growth for future years. With increased confidence in the base business performance, the securing of projects and healthy balance sheet, coupled with strength in industry long-term fundamentals, we are fully backed to executing our growth strategy. I'll comment in more detail on this and our outlook in a moment, but first, I'll ask Gaston Tano, our CFO, to provide some details on second quarter financial results.

[Gaston Alfonso Tano, Senior VP of Finance & CFO]

Thanks, Steve. As Steve noted earlier, our results this quarter were in line with our expectations. Revenue in the first quarter increased by 2% over the first quarter of 2018, the Pipeline segment revenues increased by 1% due to the continued demand of our composite pipe products, small-diameter coating, girth weld inspection and engineering services in North America. This was partially offset by lower pipe coating activity in Latin America, EMAR and Asia-Pacific. Petrochemical and Industrial segment revenues increased by 7% due to the high demand in North America for our automotive heat shrink and wire and cable products. Compared to the second quarter from a year ago, revenue decreased by 7% mainly due to lower revenues in the Pipeline segment, which declined by 9%, reflecting the completion of the Sur de Texas-Tuxpan and Shah Deniz projects in 2017. This was partially offset by higher revenue levels in North America, mainly from the demand of our composite pipe products, small-diameter coating, girth weld inspection and engineering services. Revenue for the Petrochemical and Industrial segment increased by 11% compared to the prior year second quarter due to the higher demand for automotive heat-shrink products in North America and EMAR regions and for our wire and cable products in North America. Reported consolidated gross margins for the second quarter were 32.2%, lower from the 33.3% in the first quarter of 2018 and also lower than the 37.5% in the second quarter a year ago. The Pipeline segment gross margin for the second quarter decreased to 32.7% from 38.5% a year ago, reflecting lower large project activity levels partially offset by higher utilization of facilities. The Petrochemical and Industrial segment gross margin was 28.7%, [indiscernible] the gross margin of 30.5% that was reported in the second quarter of 2017. We expect consolidated margins to tighten in the second half of the year as we continue to incur cost to reactivate facilities and ramp up staffing in our field and engineering services. With this -- which would support future earnings growth. On a consolidated basis, adjusted EBITDA for the second quarter is $37 million, higher than the $35 million reported in the second -- first quarter of 2018. The current quarter performance reflects the continued growth in our North American base business, offset by the substantial completion of our [indiscernible] activity in the Sur de Texas-Tuxpan project. In addition, the current quarter results benefited from a $4.9 million increase of foreign exchange gains related to significant foreign currency rate fluctuations in Latin America, in particular with the Argentinian peso. Adjusted EBITDA for second quarter was lower than the $53 million reported in the second quarter of 2017. This decrease is primarily due to lower gross margins from a decrease of large project activity from the Shah Deniz and Sur de Texas-Tuxpan projects, partially offset by higher activity in our North American base business. A $5.1 million decrease in SG&A expenses and a $7.9 million increase of foreign exchange gains for the reasons I mentioned earlier. The decrease in SG&A was largely due to lower incentive compensation expenses in the second quarter, where the prior year period included an increase related to government mandated employee profit-sharing on a large project activity in Latin America.Now let's discuss cash flows for the quarter. Before changes in noncash working capital, cash flow provided from operating activities for the second quarter is $27 million, a significant improvement over the $29 million used in operating activities in the first quarter. This increase is primarily due to higher net income and lower investment or working capital compared to the first quarter. Compared to the $41 million that was provided from operating activities in the second quarter a year ago, the current quarter is primarily due to lower net income, lower amortization of property, plant and equipment and higher investment in working capital. The change in noncash working capital for the second quarter was a net cash outflow of $1 million compared with an outflow of $52 million in the first quarter of 2018, an inflow of $4 million in the prior year period. The $1 million cash outflow from working capital in this quarter reflects higher inventory, a negative impact from foreign exchange, offset by lower accounts receivable, contract assets and prepaids and higher accounts payable.Cash used in investing activities in the second quarter was $25 million, primarily due to capital expenditures on property, plant and equipment to support current activity levels in all our businesses. During the second quarter, cash used in investing activities was $11 million, reflecting the payment of our regular quarterly dividend of $10.5 million.Net cash flow for the second quarter in 2018 was negative $7 million compared to negative $41 million in the second quarter of -- in '17 and a positive -- sorry, in the first quarter of 2017 and a positive $22 million a year ago.With respect to the balance sheet, our financial position remains strong. The company's balance sheet at the end of the quarter benefited from our renewed efforts to more actively manage cash and working capital. The company's cash and short-term investments decreased slightly during the second quarter to $242 million, total noncash working capital at the end of the second quarter was $150 million, in line with $150 million at the end of the first quarter and higher than the $89 million at the start of the year. The increase in noncash working capital that occurred during the first 6 months of 2018 was expected and reflects investments to support the continued growth of our base business in North America and the timing of collections related to large project activity in the fourth quarter of 2017.From a debt perspective, the company continues to maintain a low debt leverage ratio, with the long-term debt of $258 million and $66 million of standard letters of credit as of June 30, 2018.The company also has available unutilized credit facilities of approximately $417 million. I'll now turn it back to Steve for his commentary on our outlook. Steve?

[Stephen M. Orr, President, CEO & Director]

Thank you, Gaston. I will first start with adding some additional color on Q2 2018. The quarter was solid and was as we predicted and messaged in previous calls and our AGM. The quarter's results were absent any contribution from $100 million-plus pipe coating project, that were supported primarily by our base business that is heavily influenced by activity in North America, recent broadening of our portfolio and better utilization in select plans.Within the quarter, there were several drags or tailwinds that resulted in additional cost or missed revenue opportunities. They included the real challenges in scaling or staffing up, particularly in North America field services and plant operations and in the engineering consulting business of Lake Superior Consulting. And low utilization, reactivation and project pursuit cost primarily associated with international pipe coating operations.With the solid performance in Q2, the expectation continues that for the full year 2018 our results will be aligned to Q4 2016 adjusted EBITDA annualized.Any negative deviation from this would likely be as a result of unexpected slowdown in North America and/or accelerated cost related to the pursuit of projects.In Q2, we continue to gain confidence that 2018 would be a pivotal year for the company. This increased confidence has come from continued strengthening in the overall industry that now includes international and offshore, our expanded portfolio that is delivering positive results and our positioning to rebuild the backlog as projects move forward and are sanctioned.Since 2013, we have been focused on building diversity in the portfolio through technology, geography and integration of our businesses. This focus is now resulting in very tangible wins.One such win is Shawcor's participation in the construction of a large diameter transmission pipeline that brings Marcellus and Utica's shale gas to Mid- and South Atlantic markets in U.S. The project includes the construction of a large regulated gas transmission line crossing several U.S. states with multiple contractors and very challenging terrain. For Shawcor, our participation in this project involves 4 different contractual scopes. Pipeline weld inspection on the transmission line, weld inspection of the compression stations, field coatings and auditing. Our technology is an integral part of why Shawcor was chosen. Proprietary, advanced, real-time radiographic technology is being deployed for the first time by Shawcor Pipeline Services for the inspection of girth welds. The capital investment we made earlier this year on this advanced RTR units was in support of this type of work, and today all units are fully deployed.Shawcor Inspection Services is inspecting wells in the compression stations along the pipeline route using computed radiography. This is new technology for SIS and a synergy that was part of the justification for the Desert NDT acquisition. Lake Superior Consulting is using cloud-based digital technology for remote auditing of all inspection work in difficult access locations. In addition, during the pipeline construction, the customer became aware and communicated the need for coating repair and refurbishment work on various pipeline segments. This led to field-based coating work on several pipeline segments for Shawcor's coating division who will use mobile equipment positioned near the right away. Of note, the mobile equipment was available from the Sur de Texas equipment that was demobilized earlier this year. This example illustrates that technology and synergy of Shawcor's breadth of offerings and knowledge transfer among our various brands, which allow the company to break down the many complexity of a challenging project and in the process identify additional value for the client, resulting in additional revenue for Shawcor.Altogether, the combined revenue for this project for Shawcor is expected to surpass $30 million.Another example of Shawcor's composite production systems continued effort to increase its presence internationally with a project win in Oman in Q2. Oman is 1 of 7 new countries to adopt composite technology in their oil field infrastructure and where we have established an installed base since 2014. Of note, Oman is a market that in the near future will be supplied by our Middle East facility that is scheduled to start production in the second half of 2019.Shawcor anticipates that the pace of adoption of composite technology internationally will approach what is being demonstrated in North America today. Today, we estimate North America market share of composite pipe in the small diameter line pipe market to be now approaching 30%.Now turning to our backlog. At quarter end, it was $447 million, down slightly from the $459 million reported in Q1. Our continued expectation that backlog will build in the second half of 2018 is supported by our bids that remain strong at over $1 billion, which includes several projects that are pending decision in Q3 and our assumption that we will capture our share. Additionally, included in the bid, are several projects that have potential revenue scopes that are greater than $100 million.As we have stated before, successfully capturing a project requires a project to be sanctioned or pass final investment decision and Shawcor to be selected. In Q2, although there was no project announcements, Shawcor has not been idle and has made advancements in positioning to be the selected partner of choice for pipe coating. An example of this is a multiphase project that has a second phase FID planned for late in the third quarter and has a total combined revenue potential for Shawcor of greater than $100 million for the first and second phase. With this smaller first phase now under contract and being executed, discussions to be the nominated pipe coating contractor for the second phase of the project have progressed. Although I would note that this places Shawcor in a preferred position, revenue generation is still subject to a positive outcome of the final investment decision of the second phase and a binding agreement, therefore it is not certain.Beyond our backlog and bid is our budgetary. Budgetary is defined as estimates we have prepared for customers for scopes of work associated with projects that they are considering. Budgetary estimates are subject to changes as parameters such as scope, facility, timing and/or even technology are not locked down. However, even though they are not exact, budgetary does provide an indication of upcoming customer spending and Shawcor's potential participation in this spending. In Q2, our budgetary remained strong at over $1.6 billion.Continued strength in budgetary at $1.6 billion, combined with our bid number of over $1 billion, reflects a healthy funnel of potential work for Shawcor, particularly for our pipe coating business.Shawcor's strategy is to build a company that is recognized for integrity, technology and execution.The strategy is supported by long-term fundamentals, aging infrastructure, reservoir depletion and energy sustainability. With increased visibility in our future earnings that are now supported by both a base business, global projects moving forward and a strong balance sheet, Shawcor is executing a growth strategy, which involves both organic and inorganic initiatives. Organically, the company is continuing to look to bring new products and services to market. For example, composite line pipe, advanced girth weld inspection and next-generation full assurance coatings. And to bring online additional capacity such as ongoing expansion in DSG-Canusa in Germany and China locations and in composite production systems in the Middle East.Inorganically, Shawcor continues to evaluate opportunities that are aligned to our enterprise strategy, our sustainable businesses in their own right and have clear, identified synergies. Businesses or technologies that we are currently focused on are in the areas of material science, digital enablement in sensors and in adjacent space of water. With that, I'll now turn the call over to Glenda, our operator, to open up for questions that you may have for Gaston and I.

[Operator]

[Operator Instructions] And our first question comes from the line of Westley Nixon from National Bank Financial.

[Westley Macdonald-Nixon]

You've given an indication now for the second straight quarter of additional capacity with increased plant utilization in South America, including Brazil and the Gulf of Mexico, is there any visibility towards higher activity in other geographies that may lead you to consider further reactivations in the back half of this year and beyond?

[Stephen M. Orr, President, CEO & Director]

Yes. So to go through what you already stated, just to be clear, so we are reactivating, of course, Brazil for work that we have secured in that market. The Channelview facility has substantial work actually for more than a year looking forward, which is related to Gulf of Mexico and other projects that we can do from that facility. Adria, of course, is coming online, and as usual projects have upfront cost associated as we reactivate. So Adria has been a solid -- pretty much a dormant plant for some time, so it's coming online with buzz on.We do see that there is a high likelihood that we will turn on the plant that is in Sicily in Italy, so our Pozzallo plant. We're looking at reactivation. And that plant was demob-ed after we did the Moho Nord project, so that would have been back in probably 2015 was the last time that plant participated. And of course, we have the plant that has been idle and we'll see how it works. So we do have a plant in Portland that hasn't done work since the beginning of Line 3. Again, that would have been early 2016 that we're looking to turn on.We are continually evaluating whether we up the resources related to the plants in the North Sea, so this is leaf and/or hanger, which are doing projects, but not certainly at the scale that we'd like to do. And so there would cost associated to ramping them up. And the -- probably the -- one of the other points I would make, we have several projects now that would use mobile technology such as mobile concrete plants or even mobile anticorrosion plants that we are dusting off out of containers.So I think reactivation historically has been probably focused on legacy fixed plants. We now have substantial work potential associated with mobile technology as well, right? And I think that -- hopefully that was picked up in Gaston's comments around possible some stresses on our margins in the second half of the year as we would have to put additional cost in reactivation or mobilization of plants, right?

[Westley Macdonald-Nixon]

Yes, no, absolutely. You made a comment that the international composites opportunity could be roughly the same size as North America is today? Just as we think about quantifying that, would that be in the $200 million to $500 million range? And how much of that global market could eventually be supplied out of the Middle East facility that's slated to start up in 2019?

[Stephen M. Orr, President, CEO & Director]

So maybe I'll back up a little bit. So the comment that I actually made was the expectation that composite acceptance would grow to the point in the international markets similar to they had in North America, so the comment was really not pertaining to the size of the market -- international market. What we are seeing is, today, composites are fully embraced in the North American market, so it's taken some time, it takes a lot of effort to get your product certified, but it is now an established alternative to steel and conversion continues to grow. And our estimate is that if you were to kind of stop right now and you look at the amount of pipe that's being sold for small diameters, 30% of it is now composites. So our expectation is the international market will be there, right? In terms of the Saudi plant, I think we've been pretty upfront that we think that the -- the potential of the Saudi plant would be around $60 million, right?

[Westley Macdonald-Nixon]

Got it. We've seen just in terms of a little bit more of a macro view, we've seen a recovery in offshore jack-up tenders this year and utilization rates have moved up. Is there room for Shawcor to participate in the growth, in this market perhaps through -- on the realm of smaller projects such as -- for coating offshore line pipe?

[Stephen M. Orr, President, CEO & Director]

Yes. So actually I was hoping somebody would ask that question. So our challenge really is the latency of coating. And I'll use an example, right, so in -- everybody is aware of Mad Dog, so from the time they drill, so they started to commence drilling, we coated the work 1 year later. So we started the coating 1 year later. So the to-be-found number especially in the international and offshore market -- the plug that we would put in the annual today is 0. The good news is, as all of these projects are starting to come back and we saw as a result of tie-ins or infield short-cycle offshore work, we're now coating that work now. And it should be visible that -- we're generating revenue in pipe coating and our backlog is staying pretty much flat and we're not making any project announcements. So we are picking up work of the smaller to-be found tie-ins, the $10 million, $15 million projects. So that's happening. And we only see that shrinking as we go forward.

[Westley Macdonald-Nixon]

Got it. And last one just for me. How should we think about the working capital ramp when and if one of these large projects is awarded, maybe in terms of timing and magnitude?

[Stephen M. Orr, President, CEO & Director]

I'll turn the question over to Gaston because working capital is something he's focused on a lot.

[Gaston Alfonso Tano, Senior VP of Finance & CFO]

Yes, so I think you know and as -- the working capital that we have today will continue to support the growth in our North American base business and we've done some renewed efforts to maintain -- to ensure that we are actively managing our working capital and our cash. With respect to our large products, there would be a ramp-up in respect to ramp up costs and -- but it really depends on the type of project, the level of working capital that would be required based if it's in CapEx, of course, or depending if it's in some place where we have to mobilize assets or using existing facilities. Our current view is looking at large products that we would most likely find these products are now going to be cash neutral and therefore the working capital would be something that would be a manageable size for our balance sheet. And that's why we continue to maintain the amount of cash that we have is one of the reasons is related to these -- is related to the investment that would be required in a ramp-up for a large project award. But as size-wise, it would really depend on what type of project it is and where it's being executed.

[Operator]

[Operator Instructions] And I'm not showing any further questions over the phone lines. I'd like to turn the call back over to Steve Orr for any closing remarks.

[Stephen M. Orr, President, CEO & Director]

Well, thank you very much for the participation on this morning's earnings call, and we look forward to speaking with you again next quarter. Thank you.

[Operator]

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program, and you may now disconnect. Everyone, have a great day.