Ladies and gentlemen, thank you for standing by, and welcome to the Shawcor First Quarter 2020 Results Webcast and Conference Call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you will need to press star one on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I will now turn the conference over to Paul Pierroz, Senior Vice President for Corporate and Investor Relations. Thank you, and please go ahead, sir.
Thank you, and 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's statement on forward-looking information is included in Section Five of the First Quarter 2020 Earnings Press Release that is available on SEDAR and on the company's website at shawcor.com. I'll now turn the call to Shawcor's CEO, Steve Orr.
Well, thank you, Paul. Good morning, and thank you for joining us on this morning's conference call. Yesterday, we discussed and released our Q1 2020 results. Like many companies in our industry, the first quarter was challenging for Shawcor as the dynamics that drove activity changed quickly to the negative as the dual impact of the COVID-19 pandemic and the oversupply of oil and gas was felt. These unfurled events have translated into a very difficult environment in a period where our social and economic outlook is extremely uncertain as we adapt and work through the new and complex challenges in front of us. I'm very proud of the commitment of our teams across Shawcor and their ability to quickly adjust to this new environment. I wish for all of them and their families to stay healthy.
As the quarter progressed, it was clear that we were heading into a storm, and it was imperative that we narrow our focus and set clear priorities. They are number 1, protecting the health of our employees. Number 2, safely delivering products and services needed by our customers. And number 3, taking the actions to strengthen the balance sheet. Driven to limit propagation and ensure containment, if one of our sites was exposed to the virus, we have had great success in keeping our employees safe and healthy. This is due in large part to the actions our teams took to move early and develop, communicate, and implement new health monitoring and operation protocols. Our approach is centrally managed and locally implemented. Coupled with our strong safety culture and execution ability, it aided greatly in mitigating the risk, supporting our employees, and servicing our customers.
With much lower immediate market demand for the company's products and services and a wide band of uncertainty for the near-term outlook, we moved to address the balance sheet concern. In our March 16th and later in our April 21st press release, we highlighted actions we have taken and will take to remove cost and conserve cash. Now, turning to Q1 2020, Adjusted EBITDA was CAD 6 million versus CAD 30 million in the fourth quarter of 2019. Revenue for the quarter was CAD 319 million, a 5% decrease over the previous quarter. These quarterly results were not as expected. The impact of exploration and production operators reducing capital budgets in North America was seen in composite pipe, small diameter pipe coating, and girth weld inspection.
Further negativing the impact of the quarter was the disruption that COVID-19 had on our operations, supply chain, and customer demand levels across energy, transportation, and infrastructure markets. Despite these challenges, our teams were successful in winning new business, and order intake continued an upward trend, which resulted in the backlog exceeding CAD 575 million at the end of the quarter. Looking into Q2, we fully expect that the negative headwinds will intensify, and it will be not until Q3 that we expect we'll see any real stabilization. Although the future is extremely difficult to forecast, we do expect that work in our backlog will be executed, that there will be a gradual return for demand in our book-and-turn businesses, and when combined with actions we are taking to reduce cost, strengthening will be visible in the second half of the year.
Beyond 2020, the outlook becomes more unclear and difficult to estimate. However, we do expect that our diversified portfolio, which has both early and late-cycle oil and gas exposure and a growing non-oil and gas component, has positioned the company to weather the storm and emerge a stronger, more profitable organization when spending recovers in energy, transportation, and infrastructure markets. I'll provide more detailed comments in a moment, but I'm going to turn the call now over to Gaston Tano, the Shawcor CFO, to discuss the numbers.
Thanks, Steve. As Steve mentioned earlier, the first quarter results were challenging due to the negative impact caused by the COVID-19 pandemic and the rapid decline in oil prices, resulting in lower demand for our products and services. Consolidated revenue in the first quarter was CAD 319 million, 9% lower than the first quarter of 2019. The pipeline and pipe services segment revenues decreased by 17% compared to the prior year, primarily due to lower demand for pipe coating and girth weld inspection services as a direct result of the significant capital spending cuts by North American E&P operators and delays in land submission projects. As expected, the current quarter's revenues were also negatively impacted by the execution of work to resolve the fourth quarter 2019 service quality event in our Channelview, Texas facility.
The Composite Systems segment revenues increased by 16% compared to the first quarter of 2019, reflecting the benefit from ZCL acquisition, which was completed in April 2019. This was partially offset by lower demand for composite pipe products due to the rapid decline in North American drilling and completion activity across the segment's customer base as operators reduced their capital spend. In the automotive and industrial segment, revenues were lower by 9%, primarily due to lower demand for automotive heat-shrink products resulting from the impact of production shutdowns and government lockdown restrictions from the COVID-19 on the majority of automotive OEM assembly plants in North America and EMAR regions. Consolidated results for the first quarter were negatively impacted by non-recurring carry items outside of the company's normal course of business.
The current quarter includes CAD 203 million of impairment charges, reflecting CAD 144 million and CAD 46 million on goodwill and tangible assets for Pipeline Performance Group and Shawcor Inspection Services, respectively, and CAD 13 million on assets at two U.S. land pipe coating facilities and certain assets related to large diameter products in the composite systems business. The current quarter also included a loss of CAD 500,000 related to hyperinflation accounting for Argentina and CAD 200,000 of restructuring charges. Adjusted EBITDA for the quarter was CAD 6 million, significantly lower than the CAD 28 million reported in the first quarter of 2019.
This decrease is primarily due to the revenue declines in all three segments if you exclude the positive impact from the acquisition of ZCL in April 2019 and higher SG&A expenses reflecting the addition of ZCL business and higher costs in insurance, professional fees, and other equipment costs, partially offset by lower incentive compensation expense. Adjusted EBITDA margins for the first quarter was 2% compared to 8% for the prior year's first quarter due to the reasons mentioned earlier. The pipeline and pipe services segment margins decreased to -4% compared to +1% in the prior year. The composite systems segment also experienced a decline to 12% margin in the current quarter compared to 28% in the first quarter of 2019. The automotive and industrial segment margins declined slightly to 18% compared to 19% a year ago. Now, let's discuss cash flows for the quarter.
Cash flow provided from operating activities for the first quarter of 2020 was CAD 100,000, lower compared to the CAD 18 million in the first quarter of 2019. This decrease reflects lower net income and higher changes in non-cash items in the current quarter. The change in non-cash working capital in the first quarter was a net cash inflow of CAD 9 million compared with the outflow of CAD 700,000 in the prior year period.
The cash inflow from working capital in the current quarter is primarily due to higher accounts payable and lower taxes receivable and foreign exchange gains, partially offset by higher accounts receivable and inventories. Cash used in investment activities in the first quarter was CAD 300,000, reflecting CAD 10 million of purchases of property, plant, and equipment, almost entirely offset by CAD 9 million of additional proceeds received during the quarter from the redemption of a minority investment.
During the first quarter, cash used in financing activities was CAD 17 million, reflecting the payment of our quarterly dividend and lease obligations. This is significantly lower than the CAD 118 million of cash used in financing activities in the prior year quarter, which reflected the net impact of the repayment of the senior note's long-term debt and the payment of lease obligations and quarterly dividend. Net cash flow for the first quarter in 2020 was negative CAD 12 million compared to negative CAD 119 million in the first quarter of 2019. With respect to cash and debt, the company has cash and short-term investments of CAD 86 million, long-term debt of CAD 435 million, and CAD 37 million of standard letters of credit at March 31st, 2020. In addition, the company is in full compliance with its debt covenants as of March 31st, 2020.
However, due to the current adverse conditions caused by the global COVID-19 pandemic and the volatility in the oil and gas industry, there is uncertainty in our financial results and our ability to remain in compliance with certain covenants for the remainder of 2020. In response to this uncertainty, as mentioned earlier, the company has completed several restructuring initiatives, including the suspension of its dividend, to deliver significant cost savings and cash conservation. The company also is currently in discussions with its lenders to seek relief from certain of its covenants and expects that these discussions will be successful and that suitable terms for the relief will be obtained. Based on our actions completed and planned, our diversified business, and our current backlog, the company expects to generate sufficient cash flows to fund its operations, working capital requirements, and capital investments.
I'll now turn it back to Steve for some additional commentary on the company's performance and outlook.
Thank you, Gaston. I'll first start with providing some additional color on Q1 by segment. The pipeline and pipe services segment experienced a significant step down in demand for the company's product and services that are related to North American upstream, particularly in small diameter pipe coating and girth weld inspection that are important to our book-and-turn volumes. With activity in Canada already being very depressed, the step down was a direct result of reduced capital programs of exploration and development operators in the U.S. shale plays, now trending at a greater than 40% reduction year-over-year. The expected execution of pipe coating projects, both North American land transmission lines and offshore and international projects, was also negatively impacted by project delays and supply chain disruptions from COVID-19.
A positive spot was the seasonally high demand for engineering and integrity services from Lake Superior Consulting, as our customers contracted our technical resources to address increasing workloads and virus-related restrictions. Pipe coating for offshore projects, as expected, did see increased activity as we moved to execute work in our backlog in Norway, Indonesia, UAE, and Scotland. Additionally, backlog increased to CAD 575 million from projects that have been sanctioning and have approval and are continuing with momentum. These projects include Sangomar and Baltic Pipe. During the quarter, our teams worked closely with operators and EPCs to ensure project continuity and to support them as they review projects and capital programs, taking into consideration recent reductions in forecasted commodity prices that most likely will result in project delays. In the composite systems segment, our pipe business was also impacted by the reduced capital expenditures in the U.S.
Land shales as operators completed fewer wells and therefore required less gathering line meterage or could manage with existing inventory. Although we had orders for newly introduced large diameter composite pipe and in international markets, it only partially made up for the reduction experienced in North America. Our composite tank business continues to perform nicely, and incoming orders remain above the levels realized over one year ago and have resulted in strong backlog bookings. We continue to see strength in the retail fuel, water and wastewater markets, and continue to deliver tanks for oil and gas midstream applications. Although Q1 tank volume output and customer tank installs were negatively impacted by COVID-19 as we implemented new protocols, which resulted in factory floor inefficiencies and our customers experienced on-site construction delays.
In the automotive industrial segment, the impact of COVID-19 expanded in the quarter from a primary China operational and demand issue, one that was a material headwind across the whole segment. Operating at reduced capacity due to production shutdowns and shelter-in-place orders, demand declines and inefficiencies were seen throughout the heat-shrink business, especially late in the quarter when the OEM assembly lines were completely halted. Our specialty wire and cable business saw stable demand and did experience higher-than-usual incoming orders from electrical utilities and communication applications late in the quarter, but it too experienced supply chain challenges related to COVID-19. As I turn to Q2 and the balance of 2020, I believe everyone joining us today on the call would acknowledge we are without question in a period of extreme uncertainty. Forecasting how the upcoming quarters will evolve is a very challenging and difficult task.
However, based on what we know today, we expect the second quarter is likely to be the most disruptive quarter the company has ever experienced, as the full impact of COVID-19 and the capital spending cuts in oil and gas are felt. With limited opportunity to quickly offset the impact, we now expect the financial results for the quarter to be lower than what we just delivered this quarter. As we move to the second half of the year, we are very cautious but are expecting a gradual return of demand and lifting of restrictions that will see improved performance in our book-and-turn businesses across the company from the Q2 low point.
Should this be the case and the work we have booked and captured in our backlog, specifically offshore pipe coating, continues to remain firm, the second half of the year will be a significant improvement over what we delivered this quarter. It should be noted that we are not counting on a swift return of the activity and are planning for an extended downturn by putting our energy into what we can control. Simply stated, we are focused on executing work under order, reducing costs, and preserving cash. In terms of project activity, the company has been successful in securing work related to multiple offshore projects, and this is captured in our backlog of CAD 575 million at the end of the quarter.
Based on discussions with our customers and the reality that many projects are in advanced stages, with substantial investments already made, including pipe being ordered, we continue to expect that we will execute work secured. However, we do not hold the same confidence for projects that we are still pursuing, and we do expect that operators will pause to recalibrate their capital programs and that some projects will be delayed or even halted. An example of this is Woodside's recent decision to suspend Browse, a major offshore Australia LNG project, a very large opportunity for Shawcor that last quarter was captured in our budgetary number. However, projects that are tied to sourcing gas, such as those in the Middle East and Asia, or maintaining access, such as those in Latin America, will likely move forward.
Captured in our bid and budgetary numbers is over $2 billion in potential pipe coating opportunities that will gain support as commodity prices return and the economics improve. I should add, at the end of Q1, the company continued to have $190 million of work secured conditionally pending FID, which is not in our backlog and should be considered at lower risk. On the cost side, we are moving ahead aggressively to cut and generate additional cash. With a goal of a minimum of $60 million of cost out and $40 million of cash generated, the tasks include a reduction of our fixed pipe coating footprint with 4 plants targeted for closure this year and the exiting of lower margin markets where the outlook does not justify remaining. Before we open up to questions, I'd like to make the following point.
Shawcor's diversified portfolio of late and early cycle oil and gas and non-oil and gas businesses provides a hedge that will be a benefit in these very uncertain times. Shawcor has a sustainable book of work, and it is substantial for execution over the upcoming 12 months, and the work is holding firm. Shawcor is taking the necessary and difficult actions to reduce costs and preserve cash, which is needed in these very uncertain times. And finally, Shawcor's future success continues to be underpinned by supportive long-term fundamentals that will drive investments in energy, transportation, and infrastructure. I'll now turn the call over to the operator, Bridget, to open it up for questions that you may have for Gaston and I.
As a reminder, if you have a question at this time, please press star and the number one on your touch-tone telephone. If your question has been answered or you wish to remove yourself from the queue, please press the pound key. Our first question comes from the line of Greg Colman with National Bank Financial. Your line is open.
Hey, gentlemen. Thanks for taking my questions this morning. I'm sorry, I'm having some phone problems. Just want to confirm, can you hear me?
Yeah, we can hear you fine. Yeah.
Wonderful. Thanks, Gaston. I wanted to start by talking about the backlog, the CAD 575 million. Can you talk to us a little bit about the expected margin profile of the order backlog? I know that in the past it's varied greatly and can kind of bounce all over the place. In more recent commentary, in a general term, you've talked about how the style of project awarding has changed and how you are involved in an earlier stage with your customers. So I was wondering if you could talk to me a little bit about the expected margin profile of that backlog and how it would compare to, I mean, say, the trailing 12 months of margin performance.
Yeah. So, Greg, I guess the color on the margins. As expected, the work that we're going to execute and the first work that we'll execute in the second half of the year is representative of orders that we booked as the cycle turned, and so we were filling capacity. I would look at the margins in the mid-30s to high 30s in what we're going to do in the near six months. There is work that is in there as you get closer to the end that has higher margins, but of course, it's a mix because some of the work that we want at the very beginning was just to fill capacity, and it will progressively get better. But I think mid-30s, high 30s is a good number to take.
Got it. And just for clarity, Steve, we are talking about operating margins there, obviously.
The gross margin.
Gross margin.
Gross margins. Correct. Great. Got it. On the pipe and pipe services segment, if we just focus on that for Q1, you generated negative CAD 8 million-ish in EBITDA. Can you give us a little bit of color on the regional profitability? Were all the regions you operated in on about the same at that -4%, or were some materially lower, some materially higher, in fact, contributing positive? Just looking to get a little bit of granularity there.
Yeah, you go ahead. So, Greg, I think it's important that there is a mix. I think there was better profitability in EMEA and Asia-Pacific as we executed some work there, and there was a bigger decline, specifically in North America, as it relates to both demand for small diameter coating in our U.S. land business and in Western Canada. And then, of course, the more importantly is, as we executed the work in our Channelview facility, there wasn't revenue being generated there. So there was a lot of lack of profitability in that facility because absorption of overheads wasn't with—we didn't have revenue to absorb the overheads.
Maybe, Greg, if you allow me, an extension to your question, and I think it's an important point to make, is the pipe coating business can kind of be divided into two distinct buckets. So one bucket is, call it anti-corrosion or a lower barrier to entry service. We do deliver anti-corrosion related to the second bucket, which is primarily offshore concrete or insulated coating. When primarily in the U.S. land or Canadian market, where it is primarily anti-corrosion, the margins are attractive if you have a high volume going through the plant. And it's not the absolute margins, but you can get volume uplift when you use up the capacity or the absorption rate in the facility.
When the demand for or the capital spend in North America fell in the first quarter, very quickly the volumes drop, and the margins that you make because they're not of attractive per meter that you apply in the pipe drops. So certainly, there is a difference between margins made in an offshore project that is underway in Asia versus a facility in North America that no longer can pay for the absorption rate. And you can see that's very visible in Q1.
Okay. Got it. I think I got enough color on that one to be dangerous. I appreciate the added clarity. Just two more quick ones from me. First of all, on the bid book, the firm bids fell by over CAD 200 million to just under CAD 800 million as projects were pushed out. Can you help us understand the risk associated with the remaining bid book? Is it one where, based on your discussions with these counterparties, we could expect that just under CAD 800 million to continue to wane? I mean, it's a rapidly evolving environment, but just wondering how your confidence is on that 800.
Okay. So first, let's take everything in context: the backlog, the bid, and the budgetary. So in the prepared remarks, we were very clear that a very substantial project has been removed from the budgetary. And so the budgetary was influenced by the removal of this large project because now it's out what we refer to as a planned period. We don't have any visibility on a schedule, so we pulled it out altogether, and we don't refer to it anymore as an indicative offer, similar to what we did with a project called EACOP, if you recall. So the influence on the budgetary was we have, in discussions with customers, relooked at the timing and the proposal. So any projects that kind of have a gray area on execution, we've now pushed into budgetary.
That's why you see some sustainability in the budgetary numbers because as we pulled Browse out, we saw projects move from bid to budgetary. And these are the uncertainty component. Then the other thing, of course, is within the bid, if you look at it, it was over $1 billion in Q4, and of that, $240 million was this section that we call pending FID. And you can assume that Sangomar was in that. So the impact on the bid number was we saw movement into the backlog, but we also saw movement into the budgetary as it went the other way. So as it sits right now, the, say, $800 million that are in the bid, at the end of the quarter, we still had a view of production schedules that would happen.
So, I do expect that you are going to see of that CAD 800 million, with the exception of a few projects that we have confidence that will go, that you'll see a stalling of decisions of about 18 months—and we use this number historically that it was about 18 months by the time we saw a project and it moved into revenue generation. I think you're going to have to add a 12-month period at a minimum to what we thought at the beginning of March versus what we see now in the project execution.
So in reality, what we thought was going to be a very, very strong 2021, and we were quite excited about it at the beginning of March on the back of a build-up on 2020, we're going to see a build-up in 2020. It's going to extend, we expect, as we burn through the backlog into 2021.
But there may be right now, unless several key projects that we're seeing that are material move ahead, you may see a stalling, and it won't be until the second half of 2021 that the CAD 800 million starts to populate the backlog again. But to answer your question, the CAD 800 million that we have in our bid are projects that we have pricing, terms and conditions, and a schedule. If not, we've moved them to budgetary.
Got it. I appreciate that. And then just lastly for me, on your commentary regarding you talk about Q2 weakening from Q1 and then a strengthening in the second half from the first half, so sort of a trough in Q2 and some sort of letter-shaped recovery, whether it's a U, a V, or a Nike swoosh. I'm curious, is your confidence in that strengthening second half driven more so by your micro-knowledge, meaning your confidence in the work and the backlog being executed, coming through your facilities, driving up utilization, and flowing through the income statement? Or is it driven more by your opinions on a changing macro environment, meaning a restart in end-use markets like automotive and the book-and-turn activity in the land-based market?
Where my question is predicated on is, if we see a changing macro, is that very, very likely to materially change your view if that's where the majority of your confidence is? Or is it the micro that drives it, and it's that execution of the backlog that drives it mainly?
All right. Good. And again, I think there's all kinds of uncertainty right now. We're very comfortable with the backlog, project by project. And the backlog execution, and I like your term, micro, gives us confidence that the second half of the year will be a significant improvement from what we just did this quarter. So a material impact improvement. And then if I go kind of the next step, is depending on the recovery mode, things like automotive, how does that influence the magnitude of recovery off of Q2? Because we are expecting to see the full impact of zero demand in automotive from the OEM shutdown. So that's why we keep saying that Q2 could be the very difficult quarter for the company because there are businesses that have had zero activity, and we're in that workflow, so it's going to get us.
So it is the backlog that's secured in pipe coating, and we need to make sure everybody understands that today the backlog also captures backlog from our tank business, which is trending, and just look at the historical numbers, is trending better than has been historically. So we have confidence in pipe coating, and we have confidence in the ZCL profile will happen like it does every year, where the second half is substantially better than the first half. There is an element of certainty in the cost that we're seeing out of the company. So by the time we get to Q3, Q4, we're going to get the benefits of what we are doing in Q2.
And then the macro that you mentioned is just what is the magnitude and the profile of the, okay, what is the letter in the alphabet, to use your term, that it looks like on the other side in a lot of the businesses that are related to automotive, to infrastructure? We have exposure, for example, in Global Poly, and that if infrastructure in municipalities turns back very quickly, the second half, the magnitude of it changes substantially. But we do have confidence in the backlog, both through pipe coating and ZCL, and we do have confidence in the cost that we're going to take out.
Got it. Appreciate that color. That is it for me. Thank you very much.
Thank you. Our next question comes from the line of Aaron MacNeil with TD Securities. The line is open.
Hey, morning, all. Can you hear me all right?
Morning.
Morning, Aaron.
Perfect. On the composite system segment EBITDA margins, aside from the seasonal slow period for ZCL, was there anything one time in the quarter, and if so, what would normalized EBITDA margins have been for that segment?
Aaron, the margins for the composite business are impacted by the seasonality of the ZCL business. It is a lower seasonality impact in comparison to what you see in the back half and in Q2. But I think the other part of it is the factor of a lower demand for our hard margin composite pipe business. So if you look at it from a perspective of margins perspective, looking at it compared to a year ago, the lower demand for a composite pipe did have a negative impact in overall because of how high the margins are on a composite pipe. So there is seasonality with ZCL, and then there's also an impact just because of higher demand, and there are no one-time items in the thing right now. It's all just business-related.
Okay. Perfect. And you mentioned in the prepared remarks or in the press release that you'll adjust the cost structure accordingly. And understanding that there's a bit of uncertainty even in the current quarter, how should we think about margins going forward, either next quarter or beyond that, whenever you can get those cost structure changes pushed through? Can we get back to maybe those historical margin levels in a lower activity outlook in the back half of the year?
Yeah. So I think, listen, I think that what's going to in the back half of the year, we will get back to close to the margin levels on the composite side of the business by the end of the half based on all the cost structures that we have, and then, of course, the growth that we continue to see in the composite tank business. But a big part of it, I think, is all related to the amount of cost that we're going to take out of the business. As we talked about here, our target is to take out $60 million of SG&A costs across the group and come to a run rate by the end of the year, annualized, at $70 million.
So it is a function of really respecting the cost that we have and some level of base business for composite tanks and some growth on the—sorry, some base business on the composite pipe, and then some strengthening in composite tanks.
Got it. And you guys touched on it a bit as part of Greg's question, but can you maybe give us a sense of the impact on the automotive industrial segment outlook for Q2 based on the headwinds you've kind of discussed qualitatively?
I can give you a range.
Yeah, sure.
It could be zero. It is very, very difficult to say right now. If I was to estimate based just on what happened to China, and because China, if you recall, COVID-19 impacted China and they shut down all the production in China for automotive, and we went to zero revenue in China very quickly, and it took us the better part of two and a half months, and we're now at kind of 70% of what we were pre-COVID-19. So I think it is very reasonable to expect that we could have a month where the revenue could be very, very low. And I'm saying that because if OEMs do not start up, then there's no demand. They preloaded demand as normal at the end of Q4.
If you estimate that, okay, they had a higher inventory at the end of Q4 as they normally do, and then they burn through that in Q1, they shut down in Q1. It could be substantial.
Understood. And then final question for me, just on the potential impact of severance in the second quarter. Do you have any kind of ranges that you'd be willing to provide, or is that something that's still ongoing?
Well, I think if you look at our press release that we had in April 21st, we did give an estimate in there, and I'm just with an estimated severance cost of $6 million.
That's still a number.
There will be other on top of that, of other things that we do, on especially closure of facilities, that will be making a greater number. But it's probably another 4 to 5, maybe. But it's still.
Okay. All right. Thanks. That's all for me. I'll turn it over.
Thank you. Our next question comes from the line of Keith Mackey with RBC. Your line is open.
Hello everybody. Good morning. Hope everybody's doing well. Steve, you just sort of touched on one of my questions in the automotive section. I was actually wondering in the composite segment whether you're seeing or have seen any preloading of inventory from customers heading into the downturn in the composite side, particularly in the North American upstream. Just trying to gauge, should we expect that segment of the business to be down commensurate with the rig count or potentially more given if customers have preloaded any inventory they needed or expected to need?
So we actually have a very good visibility. So the reels in which our pipe is stored on that the customers hold are our reels. And so we track how many kilometers are sold, how many of the kilometers the customer sits on, and what is their completion. One of the issues that we had in 2019 was a high volume of inventory on the customers. And as things got a little bit questionable in the fourth quarter and the budgets were used up, they started burning inventory. So today, it's almost real time. There is no inventory buffer with our large customers. Orders are now on a weekly basis. We don't get much visibility on what they want for the year, which is expected right now in uncertain times.
And so I expect, should activity come back, and the expectation that the activity will start first with those wells that are shut in, the services that are required to turn them back on again. Then the normal process is they'll do the drill but not completed, and then we'll start to see an uptick. And then, of course, the rigs will come back kind of as the process. I think if everybody looks at the shale plays today, there's no question that unlike any other downturn I've experienced, that the cut in the OFS sectors has been extreme. So I think there's been a substantial capacity outtake that has happened.
And so you have to think that on top of underinvestment overall in the energy sector and now a cut in the oilfield services sector that is substantial, when things turn, services companies are not going to go back to work unless they have confidence or higher margins. I think that's the case for the composite pipe as well. When things turn, we're not going to get much notice, and it will be pretty much immediate, and they don't have any buffer of inventory.
Got it. Thanks for that color. Next question is just on working capital. Do you still expect to see a release in the second quarter? And if so, can you maybe just give us a little bit more on what magnitude you might expect?
Well, it's difficult for us to really determine what the actual amount is. There will be some in the second quarter, but it's going to be a little more in the back half. That is part of the $40 million target that we have on cash conservation, if you think beyond the $9 million that we've received in our minority investment. But right now, Keith, it's difficult to estimate, but we do expect a release as we expect our book-and-turn business like composite pipe to be impacted. There will be a release of working capital.
Got it. Thank you. And finally, just on the bank line and the covenant relief, appreciate things are still ongoing. Maybe if you could just talk a little bit more about some of the inputs into that decision. Is it more just a matter of waiting to see how things look, to know how much relief you should be asking for, or just is there something else that you're working through as part of that process?
No. I think it's important to note as I mentioned in my comments that we are seeking relief on covenants. We currently believe that the company will generate sufficient cash flows to support the working capital, the capital spend, and fund our obligations. It is really just relief in our covenant. It is really directly related to our outlook. But this is a long-term view that we're trying to get here in respect to the uncertainty that we have in our results. And we are fortunate that we have a very cooperative syndicate of banks that we're working with, and we're working through how long relief we require and sufficient room for us to stay on side, take care of some of the uncertainty that exists in our outlook.
Got it. Okay. That's it for me. Thanks very much.
Thank you. Our next question comes from Tim Monachello with AltaCorp Capital. Your line is open.
Hey, good morning, everyone. Most of my questions here have been asked, but I suppose I'd like to understand a little bit better if you've had any price discovery on the book-and-turn businesses through this downturn and what you expect to see on the pricing level if you see a rebound in demand for those product lines.
No change in pricing. It doesn't matter. If you reduce pricing, the demand for the products in Q1 and I expect in Q2, it doesn't matter. Of course, like everybody in the industry, we're being asked by customers on price decreasing and payment terms delays, and we're doing the same to our suppliers. But there's no concessions on pricing because there's no commitment on work volumes right now. So I don't see any deterioration in pricing, but I also don't see until the demand increases that there's an opportunity to move pricing either. I did make a comment on pricing on work that we have secured, and it's a variable. I think the pricing on work that we have secured is the poorest, the earliest that we secured to work, and it gets better as we get to the end of it.
So that's how we got the average of that mid-30 on gross margin.
Okay. Gotcha. And then a question on the impairment. I was a bit surprised to see a mention of the large diameter composite pipe of the Alberta facility. I was wondering if you could sort of put that in context of some of the other commentary around your view that you expect increasing demand and increased products used in that large diameter segment?
Okay. So I think we need to separate the large diameter into two different platforms. So we have a large diameter that we introduced into the market that's a spoolable product late last year. And I mentioned that yesterday on the AGM, so 5-inch and above. And I mentioned on this call that it's gaining success. And then we have a large diameter product that is a stick pipe. And it today has a commercialized 6-inch, and we're preparing to formally push into the market 8-inch and larger diameters.
In light of the demand and the way it works, as you have indications of impairment, and then certainly that's what we have today with the decrease in the commodity prices, our decision to retract resources that are put into the 8-inch and focus them on the larger diameter spoolable results in a change in revenue and margin profile going forward, and that's why you take the hit. It does not by any means deter the strategic direction to continue to push for a stick large diameter platform because the spoolable, you're limited on how much bigger we can go. It just doesn't become economical to move the reels around, and internationally, it doesn't work. So we need, as a long-term as a company, to be successful in a stick large diameter platform.
At this time, if we don't make it a priority to invest in and the market is soft, it results in an impairment.
Okay. Understood. And then just maybe a little bit of clarity on the second half guidance being stronger than the first half based on some of the stuff that you've already mentioned. Does that guidance include the one-time fees for severance and restructuring, or do you expect it to be worse, flat if you did include those fees? How should I think about that?
No. The guidance excludes those fees. Tim, what we believe is really talking about the run rate that we expect to have in the second half if you exclude the one-time items.
Okay. Gotcha. All right. I'll turn it back. Thanks so much.
Thank you.
Thank you. Our next question comes from the line of Matthew Weeks with Industrial Alliance. Your line is open.
Good morning. My first question is just a bit of a clarification question, and sorry if this has already kind of been answered. But on the cost reduction side, that kind of CAD 60 million in targeted cost reductions, was that mostly on the G&A side, or will a lot of that be reflected in the cost of sales as well?
Yeah. The majority of it is in the SG&A side. There is a smaller amount in the cost of goods. But the majority of the CAD 60 million will be seen through SG&A.
Okay. Thanks. Looking at the automotive section again, and I know this was kind of talked about earlier, but I kind of just want to get sort of an idea of where that's going to go. Basically, it's the idea that looking at China kind of as a leading indicator and seeing what happened there, we can expect in sort of Europe and North America, essentially one month, let's say April of zero to kind of no sales due to total shutdown. And then looking at China again, kind of can we expect that as economic activity restarts a little bit, that it's kind of going to be the quickest segment to come back, albeit to lower than historical levels? Is that kind of the same trend we can expect in the EMAR and North American regions?
Again, it's really hard to use the word expect. I think a point of reference certainly is the profile in China, as you have outlined. I think the challenge that we're always faced with is our automotive business in China is primarily a domestic supply into the Chinese market and a back office to our European and North America production. However, our Toronto and Germany facilities supply their international, call it Western world automotive. And so there's multiple variables in terms of countries of how they open up. So how does Germany open up? How does Mexico open up in terms of their production? But more importantly, how does the retail space open up for the demand for automotive?
So it's really hard to predict right now, but I think what is certain is for the first part of Q2, as the workflow happens, we are going to see the impact of zero production on OEMs on the automotive. So does it strengthen as we go through Q2? As I said, we expect that the demand will start to grow beyond Q2, over Q3 into Q4. And based on China, it won't be as high as it was before, but I think 70% is a safe number based on that profile. So we really kind of wait to see how the economy is opened up, but it ultimately is driven by how many cars are purchased by the retailers in the market. There are other companies that have released their results, and they have made a run at what does the automobile production look like going into the year.
It's a huge band of uncertainty. I'm not really certain on what's going to happen, but based on China, you've outlined it very nicely.
Okay. Thanks. Appreciate the color there. Last question for me is looking at you talk about in terms of restructuring, exiting certain low profitability markets. I was wondering if you'd just be able to provide a little more color on kind of which markets specifically you'd be looking at kind of product-wise and geographically.
So I'll give some direction. As I mentioned yesterday on the AGM, it's very, very difficult to identify a particular facility or product line because as you go ahead on these action items, you have to manage your employee base, you have to manage your customers, you have to manage the competitive landscape. And pipe coating in particular, shutting down a facility that's used as an alternative in a pursuit, and you give notice, may be a competitive disadvantage or relieve our leverage. However, there are businesses, and I've already alluded to it, which is such as the anti-corrosion line primarily in North America, that if you don't have confidence in volumes and has historically not recovered since 2016, you have to question why you're going to stay in it if you have no ability or expectation that you're going to get a volume of work through these facilities.
So one market that we certainly are looking at is how to become much, much more paid for the value that we deliver, and it's not in the anti-corrosion in North America necessarily. But it doesn't mean that we're going to pull out of all the anti-corrosion facilities or markets in North America, but it certainly is a product line, for example, that just doesn't make any sense to stay.
Okay. Thanks. I appreciate the color on that, and I'll turn the call back.
Thank you. Our next question comes from Greg Coleman with National Bank Financial. Your line is open.
Thanks. Just a quick follow-up and apologies if you touched on this, but I don't believe you did. On the Channelview facility rework, you identified about $7.3 million of cost in Q4 and then mentioned that it had an impact in Q1. Did you quantify the Q1 impact, and also do you expect that impact to persist into Q2 and beyond?
The $7 million impact or accrual that was booked in Q4 related to the expenses that were basically incurred in Q1. The impact that we had in Q1 was directly related to the lack of being able to execute other work to generate revenue in that facility. There was an unabsorption perspective, and no, we have not disclosed that, Greg.
Okay. Got it, Gas. So it was a lower revenue number because you were working on the rework. Is the rework wrapped up? Do you have that capacity back now, or is it going to persist into Q2 and beyond?
The majority of it has been completed. There is some remaining work that will happen Q3, Q4 timeframe. But the majority of it.
That's it from me.
Thank you. I'm not showing any further questions. I'll now turn the call back to Steve Orr for closing remarks.
Well, again, I thank you all for attending the quarter-close conference call, and I look forward to speaking to all of you again as we close Q2. So thank you very much.
Ladies and gentlemen, this does conclude the program. You may now disconnect. Everyone, have a great day.