Good day, ladies and gentlemen, and welcome to the Shawcor First Quarter 2019 Results Webcast Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session, and instructions will be given at that time. If anyone should require operator assistance, please press star then zero on your touchtone telephone. As a reminder, this conference may be recorded. I would now like to turn the conference over to your host for today, Gaston Tano, CFO, you may begin.
Good morning. Before we begin this morning's conference call, I would 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 Four of the first quarter of 2019 earnings press release that is available on SEDAR and on the company's website at shawcor.com. I'll now turn it over to Shawcor's CEO, Steve Orr.
Good morning, and thank you for joining us on this morning's conference call. Q1 2019 results were marginally lower than we had expected. Adjusted EBITDA in the first quarter of 2019 was CAD 28 million, an increase of 17%, and revenue was flat at CAD 350 million over the fourth quarter of 2018. This quarter's results were supported by continued demand for composite pipe and shale plays in the United States, girth weld inspection for large-diameter pipelines and international projects, and a resumption in demand for heat shrink products post the Q4 seasonal slowdown. In the quarter, and as expected, we continued to have costs related to the readiness of pipe coating facilities needed for future work and to pursue projects, and international pipe coating activity remained low.
However, even though we forecasted softness in Western Canada, we underestimated the weakness in demand for small-diameter line pipe coating, joint protection, and tubular inspection services in this market. I'll speak in more detail in a moment, but in summary, on the one hand, there is increased uncertainty in activity related to drilling completions in North America and how spending will move over the next several quarters. But on the other hand, international and offshore spending is improving, and the recovery in these markets is now firmly underway. As a result of these two factors, we expect that Shawcor may see short-term volatility in quarter results, but that the second half of the year will be an improvement over the first.
Overall, 2019 is still forecasted to be an improvement over 2018 before consideration of the ZCL Composites acquisition, but with a softer Q1 than expected, North American upstream-related activity uncertain, and the always-present potential of movements from one quarter to another of pipe coating project revenue, there is risk. The priorities for management that will determine the results for 2019 and for the years that follow are very clear. There are three. First is the dynamic management of the uncertainties and optimization of the base business of Shawcor's expanded portfolio that now includes ZCL Composites. Second is the building of the backlog and the execution of pipe coating work from plants that have been idle for several years. Third is the capital discipline and actions required to return the balance sheet to the historical level of strength.
I'll now ask Gaston Tano, our CFO, to provide some details on the first quarter financial results.
Thanks, Steve. As Steve mentioned earlier, the first quarter results were slightly softer than our expectations. Revenue in the first quarter decreased by 1% over the fourth quarter of 2018. The pipeline segment revenues decreased by 4%, primarily due to lower demand to the company's products and services in Western Canada and a negative impact from the accounting of hyperinflation for Argentina, partially offset by higher activity in pipe coating and pipe weld inspections in the EMAR region. Petrochemical and industrial segment revenues increased by 15%, primarily due to higher activity for our automotive heat shrink products, particularly in the EMAR and North America region and for our wire and cable products in North America. Consolidated revenues in the first quarter of 2019 was slightly lower than the first quarter from a year ago.
This reflects lower revenues in the pipeline segment, which declined by 2%, primarily due to lower pipe coating activity in the Asia Pacific and Latin America regions and softer demand for the company's products and services in Western Canada. This was partially offset by higher revenue levels in the U.S., mainly from the continued demand for our composite pipe products, large-diameter coating, and girth weld inspection services. Revenue for the petrochemical industrial segment increased by 8% compared to the prior year's first quarter, primarily due to higher revenues for our automotive heat shrink products, particularly in the EMAR region, and for our wire and cable products in North America.
Consolidated gross margins for the first quarter were 28.1%, basically in line with the 28.2% reported in the fourth quarter of 2018, but lower than the 33.3% in the first quarter a year ago. The pipeline segment gross margin for the first quarter was 27.9%, lower than the 33.6% a year ago, reflecting lower large project activity in Latin America and lower utilization of our facilities in the EMAR and Asia Pacific regions. The petrochemical industrial segment gross margins were 29%, higher than the 27.9% in the fourth quarter of 2018, and below the gross margin of 31.3% that was reported in the first quarter a year ago.
We expect consolidated margins in the first half of 2019 to continue to be negatively impacted by the continued low pipe coating activity in international and offshore markets and higher costs to maintain idle assets, reactivate plants, and pursue large projects. On a consolidated basis, adjusted EBITDA for the first quarter was CAD 28 million, higher than the CAD 24 million reported in the fourth quarter of 2018. The current quarter reflects a positive impact of CAD 4.8 million related to the new accounting rules for leases under IFRS 16. The current quarter performance reflects the soft demand for the company's products and service in Western Canada, the ongoing investments in the pipe coating business for idle assets and project pursuits, and the continued demand in the U.S. for our composite pipe products and integrity field inspection services.
SG&A expenses in the quarter decreased by CAD 5 million compared to the fourth quarter of 2018, primarily due to lower costs for equipment, professional and legal fees, and the positive impact in the adoption of IFRS 16, partially offset by an increase in incentive-based compensation. Adjusted EBITDA for the quarter was 19% lower than the CAD 35 million reported in the first quarter of 2018. The decrease is primarily due to lower pipe coating activity in Asia Pacific and Latin America regions, and a softer demand for the company's product service in Western Canada, partially offset by the continued demand for our composite pipe products and integrity field inspection services in the U.S.
In addition, the current quarter reflects a decrease of CAD 12 million in SG&A expenses compared to a year ago, primarily due to lower costs for equipment, professional fees, insurance and other items, and a positive impact from the adoption of IFRS 16. Let's now discuss cash flows for the quarter. Before changes in non-cash working capital, cash provided from operating activities for the first quarter is CAD 19 million, a decline from the CAD 24 million from operating activities in the fourth quarter. This decrease is primarily due to lower net income, partially offset by a change in non-cash items in the quarter. Compared to the CAD 22 million that was provided from operating activities in the first quarter a year ago, the current quarter is also primarily down to lower net income, partially offset by a change in non-cash items in the quarter.
The change in non-cash working capital in the first quarter was a net cash outflow of CAD 1 million, compared to an inflow of CAD 27 million in the fourth quarter of 2018, and an outflow of CAD 52 million in the prior year period. The CAD 1 million cash outflow from working capital in the current quarter is primarily due to higher accounts receivable, contract assets, and inventory, and negative impact from foreign exchange, partially offset by higher accounts payable and lower prepaids. Cash used in investing activities in the first quarter was CAD 18 million, primarily due to capital expenditures and property, plant, and equipment to support current activity levels and growth in our businesses.
During the first quarter, cash used in financing activities was CAD 118 million, reflecting the net impact on the repayment of the senior notes of long-term debt, the repayment of lease obligations, and the payment of our regular quarterly dividends. Net cash flow for the first quarter of 2019 was - CAD 119 million, compared to the +CAD 27 million in the fourth quarter of 2018 and - CAD 41 million a year ago. With respect to the balance sheet, our financial position at the end of the quarter remains positive. The company's cash and short-term investments decreased during the first quarter to CAD 103 million. The decrease is primarily related to the partial cash funding of the repayment of senior notes long-term debt during the quarter.
Non-cash working capital at the end of the first quarter was CAD 152 million, down from the CAD 174 million at the end of the fourth quarter 2018, primarily related to the recognition of short-term lease liabilities under IFRS 16. During the first quarter, the company closed its new U.S. CAD 500 million, four-year senior unsecured revolving credit facility. This facility partially funded the repayment of senior notes long-term debt in the quarter. As of March 31, 2019, the company had a low net debt leverage with long-term debt of CAD 169 million and CAD 38 million of standard letters of credit. With the new facility in place, the company had available unused borrowing capacity of over CAD526 million at the end of the quarter. I'll now turn it back to Steve for his commentary on the company's outlook.
Thank you, Gaston. Now turning to Q1. In the first quarter of 2019, adjusted EBITDA was marginally softer than management had forecasted. The quarter saw continued demand in the United States for composite pipe and shale development and girth weld inspection for large-diameter pipelines. Additionally, the quarter benefited from girth weld inspection related to international projects that are now in the process of being laid, specifically Nord Stream and Barzan, and a resumption in demand for heat shrink products post the Q4 yearly seasonal slowdown in automotive. As we expected, we continued to have costs related to the readiness of pipe coating facility needed for future work, and international pipe coating remained relatively unchanged quarter- on- quarter. The small gap in actual versus forecast for the quarter was primarily from weaker than expected drilling and completion activity in Western Canada.
Of note, Q1 is historically a peak quarter for Shawcor's Western Canadian businesses, but this year it was exceptionally weaker than expected and even below what we experienced in Q4 2018. In our previous quarter, we communicated our expectation that the full year 2019 results will be driven by two factors. The first is the continued strength in the base business, and the second is the timing of when pipe coating activity will start contributing positively and consistently to the results. Considering these two factors and the results delivered in Q1, 2019 is still expected to be an improvement over 2018, without consideration of the impact of the ZCL Composites acquisition. 2019 will be a year of two halves.
The first half will be lower, as it will be impacted by lower activities and costs related to the readiness of pipe coating facilities needed for future work and headwinds from Western Canada. The second half will be much stronger, as it will benefit from higher activity in pipe coating, field services, and product sales from work secured. I mentioned in the opening comments that the various factors could reduce or increase our results in 2019. The first, and the one that is the most difficult to predict, is the next three quarters spending in the United States land market. Third-party estimates forecast a reduction of between 5%-8% year-on-year, still very healthy, with a stronger second half of the year.
However, recent discussions with our customers indicate this may not be the case, as capital discipline may result in a flat second half and slower alignment between commodity price movements and operator spending, which has historically been tightly correlated. The second factor is the quarterly performance of our pipe coating project business. Specifically, quarterly revenue generation from individual projects that are tied to international and offshore spending. From all indicators, the industry is finally emerging, and spending is happening. The positive indicators include Brent price above CAD60 per barrel, higher offshore rig utilization rates, the increasing number of projects being sanctioned, and the very strong reported increase in orders from offshore services companies this quarter. Although Shawcor is still on track for awards, the actual quarter in which the revenue is generated can move due to many factors that Shawcor does not control.
With success in diversifying the portfolio and line of sight of near-term opportunities for our core pipe coating business, it is now all about execution. There are three execution priorities. The first priority is the real-time management and planned optimization of the book and turn business that makes up our base business. In 2019, we will leverage progress made in the last two years in demand planning to manage production and inventory placement, capacity planning to capture short lead items and orders, and field technical equipment management and internal training to accelerate time to mobilize or redirect field crews. Another part of this optimization priority is the delivery of the synergies and values associated with the ZCL Composites integration. We are excited about the combination of ZCL and Shawcor.
Cost synergies are now estimated at CAD 8 million on an annualized run rate by the end of the first year, double the CAD 4 million we previously communicated. Furthermore, 54% of the CAD 8 million, or CAD 4.4 million, has been secured since the April close. Cost synergies come from the removal of public company expenses and the organization overlap with ZCL with our composite systems business, as well as from the greater Shawcor, and operational synergies such as those that come from increased buying power and implementing process improvements. We estimate that the combination of ZCL with Shawcor has increased the addressed market by greater than CAD 500 million for Shawcor and ZCL standalone markets. There are three main opportunities to gain share in this newly available market. The first is simply using established channels to market to cross-sell established products.
An example of this is the ZCL order we just received for sump tanks for a U.S. pipeline that happened through our Lake Superior Consulting business. The second opportunity is the linking of discrete components of piping, storage, engineering, and digital enablement into a differentiating solution. Already, we are seeing that in all three of the targeted markets, fuel, water and wastewater, and oil and gas, there are real opportunities. The third opportunity is the leveraging of Shawcor's global footprint and worldwide partner network to expand ZCL's Parabeam license model to more regions. With a three-year time horizon, we are targeting an additional CAD 35 million, or 7%, of the additional accessible markets of annualized revenue per year.
The second execution priority for 2019 is capturing our share of the pipe coating work that will be awarded in the upcoming quarters and the successful operations of plants that, in many cases, have got an extended period of time of being idle. Yesterday, at the annual meeting, I presented a slide with 55 projects that are captured on our bid and budgetary, that at the end of Q1 was greater than CAD2.9 billion. This number, magnitude, and global diversity of projects, and the strong underpinning markets for LNG, the offshore, and transmission lines, is very, very supportive of future strengthening of our pipe coating project leverage business.
In respect to the backlog number at the end of the quarter, the CAD454 million reported does not include the CAD30 million related to the recent award of BP Tortue project or the over CAD150 million of coating work under agreement, which is conditional on final project sanctioning. We've been investing in the positioning for future work through retaining talent, qualifying plants, and introducing technology. This investment is being made not only to secure work, but also ensure we deliver as promised and mitigate contractual penalties that come from poor execution. In Q2, we are preparing for the full production of Liza Phase 2 in our Mexican Veracruz facility that will support our results in the second half of the year. The ability to pull several plants together to offer a robust de-risk plan was critical in securing the direct award of this work.
However, we are pushing to bring Veracruz online and bring it to full production as soon as possible. In doing so, it will allow us to release capacity in the other plants where we now have visible opportunities. To give you some understanding of the workflow and resources required to start up a sizable pipe coating project, in Q2, the Liza Phase 2 preparation will involve a customer witness plant verification, a full 28-day testing of insulated properties of the actual Veracruz coated project pipe in our test vessel here in Toronto, and final plant qualification trial. The third execution priority is the capital discipline and action required to return the balance sheet to the historical level of strength. As expected, the acquisition of ZCL Composites has increased the debt leverage.
Although never off the radar, in 2019, we will put additional emphasis on working capital and capital expenditures to minimize the cash out. Additionally, we have been analyzing Shawcor's assets to determine those that are either non-core or long-term dilutive, where we have divestment opportunity. In 2019, we are moving forward with actions, and we expect that before we exit Q3, we'll be able to materialize the benefits of actions being taken. Before we open it up to questions, I would highlight the following points: Shawcor's expanded portfolio is diversified and has the potential to be supportive throughout the cycle. There is expectation that our core business of pipe coating will see substantial increase in activity in the near future, and that this activity will continue for several years. Shawcor's alignment with strong fundamentals has the company well-positioned for the long term.
I'll now turn the call over to Sylvia, the operator, to open up for questions you may have for Gaston and I.
Thank you. Ladies and gentlemen, if you have a question at this time, please press star then 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. To prevent any background noise, we ask that you please place your line on mute once your question has been stated. Our first question comes from Greg Colman of National Bank Financial. Your line is now open.
Thanks for taking my questions. Congratulations on the quarter, guys. I know it wasn't what you were expecting, but looked in line with what we were looking for. I wanted to start by looking at your added disclosure on the projects you're chasing. So thank you for the new detail in the AGM presentation on those 55 different projects you're chasing globally. At the top of that slide, you talk about 2019 being the return of pipe coating. Is it too much of a jump here for me to conclude that you assume most, if not all, of these projects, at least those ones in the bid stage, will be awarded in 2019?
Yeah, Greg, I think it's a big jump to suggest all the ones that are in the bid coating list will be awarded. Yeah, there's several of them, actually, some large ones that are going to a second version of bidding, and they won't happen until mid-2020. So they won't happen. But to that point, you know, the projects that we have here, and there's 55 of them, even as we made the inventory of the projects and the slide was prepared, projects have now, and I can call one out in particular, so there's one Eni, Agogo. The whole strategy of using insulation over production chemicals is still up for debate, so I would suggest that one is now a low opportunity to fall off.
But there are two other ones that have now come visible that are being fast-tracked that I could replace. So it's a very dynamic slide, but I think it does give everybody an indication that there are real projects. The projects not only are globally diverse, but you can certainly see the delta in bid and budgetary, where the offshore and transmission lines and LNG percentages are changing. And there's a much heavier weighting to offshore and LNG, where Shawcor's technology and plant placement is a real differentiator.
On the budgetary side?
Yeah. So you'll see, right? If I was to present this slide even two years ago, offshore and LNG probably wouldn't be presented to be in the low single digits. So both in bid, offshore and LNG are strongly represented, but in budgetary, there is even a higher percentage, which gives us the confidence for the future years.
Got it. So if you think about that, close to CAD3 billion in both bid and budgetary, how would you think about the cadence of it coming to market throughout, I suppose, 2019, 2020, and then potentially into 2021?
So I think we're gonna have a step change in backlog as we go into 2020. So I think 2020 backlog numbers, as we exit 2019 and for work in 2020, will be quite strong. So you're gonna see a slug of awards over the next two, three quarters. So there's quite a bit of discussions on the final preparation. And then I think you're going to see probably a couple quarters stalling of several very large projects are probably not gonna be awarded until the mid-2020 period. So I think you're gonna have kind of two cycles here. You're gonna see the FIDs that have occurred. Of course, we're late cycle, I get FIDs, and about 18 months later, we actually start generating the revenue. But we have. When the FID happens, we have the picture of the work.
So I think by 2020, the volume of work that we have secured pending FID is gonna be clear, and so that slug of work is gonna go into the backlog. And we'll, you know, that is at risk, but I think a much lower risk than stuff, of course, that we don't have an agreement with. And then mid-2020, you're gonna see another slug of activity moving forward. I would highlight one other point, is that we talked about the backlog, and we calculate the backlog very analytically of both in terms of time, when we get the secured work. We have received the POs for the CAD30 million Tortue. So I would say there's our backlog and a view that the CAD30 million that we announced is not at risk, so that is secured work.
Then there is another CAD 150+ million, which is secured, but is at risk because it's pending FID. But those projects have a high certainty of going ahead.
Got it. Just diving in on that, as you mentioned it, the commentary regarding the CAD150 million unsanctioned project currently outside of the backlog because it hasn't been sanctioned yet. Is that the same as the CAD 100 million Australian project that you were discussing last quarter, or is it additive, a different project?
Within the CAD 150 million is a CAD 100 million-plus project in Australia.
Got it. Okay. So that it's within the CAD 150 million, and then there's more in addition to that CAD 100 million?
Yeah. So what is secured pending FID is greater than CAD 150 million, and included in that is a project of magnitude of CAD 100 million related to gas from Australia, yes.
Got it. And when we look at this potential project, roadmap here, how would you describe the competitive landscape for the larger projects in this cycle or series of cycles as opposed to the prior cycles? And how does Shawcor's competitive positioning within that competitive landscape stack up?
You know, it's a very good question. I think the legacy of pipe coating companies, and mostly our competition is regional, of never dying and coming back. There's a history of that. But I would start first and foremost, offshore insulated work. Our competitive position is even stronger than it has been before because of the advent of introduction or expansion of technology outside of the region, and Ultra is what I'm pointing to. So insulated offshore pipelines, we're in a very strong position. And I would go all the way to the other side of the scale on this map that we presented, land transmission lines that only require anti-corrosion coating on fusion bonded. We have extreme competitive pressure because of the ability for pipe mills to do their own coating.
It's kind of two different sides of the spectrum, right?
Got it. And then just the last one for me, and then I'll turn it back. Just a modeling thing. In the quarter, you referenced CAD 4.8 million in IFRS impact for EBITDA. Is that a good quarterly run rate for the full year and into 2020, or is there any reason that it should rise or fall from a quarterly perspective?
No, I think that's a good run rate for 2019. You know, and I can't see it changing significantly at this point in time for early 2020. Of course, it depends really afterwards about larger projects and mobilizations that will be required, and the accounting for those if we need to lease assets for those projects. So, it's a project-dependent aspect to it, Greg.
Roger, that makes sense. Okay, well, that's it for me. Thanks for the clarity. I'll turn it back.
Thank you. And again, ladies and gentlemen, if you do have a question at this time, please press star then one on your touchtone telephone. And our next question comes from Elias Foscolos of Industrial Alliance. Your line is now open.
Hi, good morning. This is Matthew for Elias.
Hi.
So, I just wanted to clarify a little bit on ZCL, and I apologize if this has already been mentioned somewhere. But in terms of achieving those, cost synergies, which were, you know, outlined to be CAD 8 million in year one, is there sort of any one-time cost, that we can expect associated with that, and roughly what would that be?
There will be one-time costs related to that. As you know, we would for duplicate EOs, for example, and then also for some additional costs that we need to do for changes into other aspects of compensation and the people that we let go. Those amounts are probably estimated right now in the range of about CAD 3 million to this point. But it is a fluid dynamic as we go through this. But we will be highlighting those in our future reporting and, you know, and highlighting them as non-recurring items, so.
Okay, so about CAD 3 million at this point. And, so you said you'll be highlighting those going forward. Will you also be highlighting synergies achieved to date in your future reporting?
Yeah. So we've already given you, you know, what the synergies to date that we on an annualized basis of actions that we've already taken, in excess of CAD 4 million today. So we will, you know, so we've given you that perspective, and at next call, we will continue to give that when there's material movements to that change, you know? Not, you know, we're not going to be talking about it every quarter, if there isn't any material changes from that, from that perspective.
Okay, great. And, just one last question for me, just switching over to kind of the base business in North America and the book-and-turn business. Q1 was a pretty quiet quarter. There was kind of a little bit of a freeze in drilling activity. Sort of as you go through Q2 and exit, kind of Q2, do you see this thawing a little bit, drilling activity picking up in Canada, well, in the U.S, perhaps?
So, I'll separate the markets because I think optimism on both markets are polar opposites. So, I think we've been burnt in management's expectation on what Canada, even at a low point, may do. So, I'm not expecting, and we're not forecasting an improvement in Western Canada... in our and very specifically, in our businesses of small diameter line pipe coating, small diameter field joint heat shrink business, or our tubular inspection services business. So those three, we continue to expect now or reforecast now that there won't be much of a recovery. On the U.S. land and particularly, I think the big development that moves or has the ability to go one way or another is the Permian.
The Permian is at an interesting point right now because most of the operators have hedged their production well in advance, so hedged more than one year's production ahead at CAD 60. So they have cash generation certainty, and we don't see them, therefore, spending as they would have done historically as the commodity price strengthens. So it, it's a real, it's a real uncertainty right now. Will we see kind of the same flat profile that we saw in Q1? There's a potential that there may be a pullback, or do they actually increase the spending into the second half? It will still be a good market for us, but it's just what will be the volatility quarter-over-quarter.
I think as the whole year, it will be equal to what it was last year, but there may be swings from quarter to quarter. We're kind of in this, I would say, this suspended point. You know, as we close or as we finished up April, it was business as usual. May, I'm not so sure if it will be as strong as April, but June is looking okay. It's kind of funny how the quarter will go, but I do think there'll be volatility related to the Permian as operators figure out what is their capital budget.
Okay, that's great. Thank you. I appreciate the color, and I'll turn it back now. Thanks.
Thank you. Ladies and gentlemen, this does conclude our question and answer session. I would now like to turn the call back over to Steve Orr for any closing remarks.
Well, I'd like to thank everybody for joining the call, and both Gaston and I look forward to touching base and discussing the second quarter three months from now. Thank you.
Well, ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.