Good day, ladies and gentlemen, and welcome to the Shawcor Q2 2018 Results Webcast and 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 follow at that time. If anyone should require assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference is being recorded. I would like to introduce your host for today's conference, Gaston Tanno, Chief Financial Officer. 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 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.
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 continued to highlight our expectation that the full year 2018 results would be aligned to Q4 2016 adjusted EBITDA annualized, and that 2018 had the potential to be a pivotal year and a setup 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 CAD 37 million, an increase of 6% over the first quarter of 2018, and the revenue was CAD 358 million, an increase of 2%. This quarter's results demonstrate that the actions that we have 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 of pipe coating projects would support earnings growth for future years. With increased confidence in the base business performance, the securing of projects, and a healthy balance sheet, coupled with strength in industry long-term fundamentals, we are fully back 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 Tanno, our CFO, to provide some details on second quarter financial results.
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 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, 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 high utilization of facilities.
The Petrochemical and Industrial segment gross margin was 28.7%, on 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 costs 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 CAD 37 million, higher than the CAD 35 million reported in the first quarter of 2018. The current quarter performance reflects a continued growth in our North American-based business, offset by the substantial completion of a loadout activity in the Sur de Texas-Tuxpan project.
In addition, the current quarter results benefited from a CAD 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 the second quarter was lower than the CAD 53 million reported in the second quarter of 2017. This decrease is primarily due to lower gross margins from the decreased large project activity from the Shah Deniz and the Sur de Texas-Tuxpan projects, partially offset by higher activity on North American-based business, a CAD 5.1 million decrease in SG&A expenses, and a CAD 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 period included an increase related to government and mandated employee profit sharing on large project activity in Latin America. Now let's discuss cash flows for the quarter. Before changes in non-cash working capital, cash flow provided from operating activities for the second quarter is CAD 27 million, a significant improvement over the CAD 29 million used in operating activities in the first quarter. This increase is primarily due to higher net income and lower investment in working capital compared to the first quarter. Compared to the CAD 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 equipment, and higher investment in working capital.
The change in non-cash working capital in the second quarter was a net cash outflow of CAD 1 million, compared with an outflow of CAD 52 million in the first quarter of 2018, and inflow of CAD 4 million in the prior year period. The CAD 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 CAD 25 million, primarily due to capital expenditures on property plant equipment to support current activity levels in all our businesses. During the second quarter, cash used in investing activities was CAD 11 million, reflecting the payment of our regular quarterly dividend of CAD 10.5 million.
Net cash flow for the second quarter in 2018 was CAD -7 million, compared to a CAD -41 million in the second quarter of 2017, and a CAD +2 million in the first quarter of 2017, and a CAD +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 CAD 242 million.
Total non-cash working capital at the end of the second quarter was CAD 150 million, in line with CAD 150 million at the end of the first quarter, and higher than CAD 89 million at the start of the year. The increase in non-cash working capital that occurred during the first six 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 long-term debt of CAD 258 million and CAD 66 million of standard letters of credit as of June 30, 2018.
The company also has available unused credit facilities of approximately CAD 417 million. I'll now turn it back to Steve for his commentary on our outlook. Steve?
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 a CAD 100+ million pipe coating project, but were supported primarily by a base business that is heavily influenced by activity in North America, recent broadening of our portfolio, and better utilization in select plants. Within the quarter, there were several drags or tailwinds that resulted in additional costs 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 costs 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 costs related to the pursuit of projects. In Q2, we continued 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 Shale gas to Mid- and South Atlantic markets in the 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 four 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 via Shawcor Pipeline Services for the inspection of girth welds. The capital investment we made earlier this year on this advanced RTR unit was in support of this type of work, and today, all units are fully deployed.
Shawcor Inspection Services is inspecting welds in the compressor 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 of way. Of note, the mobile equipment was available from the Channelview, 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 allowed 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 CAD 30 million. Another example is Shawcor's Composite Production Systems continued effort to increase its presence internationally with a project win in Oman in Q2. Oman is one 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 CAD 447 million, down slightly from the CAD 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 CAD 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 CAD 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 announcement, 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 multi-phase project that has a phase II FID plan for late in the third quarter and has a total combined revenue potential for Shawcor of greater than CAD 100 million for phase I and phase II. With the smaller first phase now under contract and being executed, discussions to be the nominated pipe coating contractor for phase II 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 phase II 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 the spending. In Q2, our budgetary remains strong at over CAD 1.6 billion.
Continued strength in budgetary at CAD 1.6 billion, combined with our bid number of over CAD 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 on future earnings that are now supported by both a base business, global projects moving forward, and a strong balance sheet, Shawcor is executing its 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 flow assurance coatings....
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, are 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, and sensors, and in the 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 or I.
Thank you. Ladies and gentlemen, at this time, if you would like to ask a question, please press star then one on your touchtone telephone. If your question has been answered or you wish to remove yourself from the queue, you may 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 the line of Westley Nixon from National Bank Financial. Your line is now open.
Morning, gentlemen.
Morning, Wesley.
You've given an indication now for the second straight quarter of additional capacity with, so with increased plant utilization in South America, including Brazil and the Gulf of Mexico. Is there any visibility towards, you know, higher activity in other geographies that may lead you to consider further reactivations in the back half of this year and beyond?
Yeah. So, to go through what you've 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 costs associated as we reactivate. So Adria has been pretty much a dormant plant for some time, so it's coming along with Batam. 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 demobilized after we did the Moho Nord project, so that would have been back in 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 out, but 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 Leith and Orkanger, which are doing projects, but not certainly at the scale that we'd like to do, and so there would be costs associated to ramping them up.
And probably 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 anti-corrosion 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?
Great. You made a comment-
Okay, and I think that's 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 costs in reactivation or mobilization of plants, right?
Yeah. 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 CAD 200 million-CAD 500 million range? And how much of that global market could eventually be supplied out of the Middle East facility that's, you know, slated to start up in 2019?
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 market similar to it had in North America. So the comment was really not pertaining to was really not pertaining to the size of the market, the international market. What we're seeing is up to today, composites are fully embraced in the North America 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 diameter, 30% of it is now composite.
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 potential of the Saudi plant would be around CAD 60 million, right?
Got it. We've seen, just in terms of a little bit more of a macro view, we've seen a recovery in offshore jackup tenders this year, and utilization rates have moved up. Is there room for Shawcor to participate in the growth in this market, perhaps through, you know, in the realm of smaller projects, such as, you know, for coating offshore line pipe?
Yes. So actually, I was hoping somebody would ask the question. So our challenge really is the latency of coating, and I'll use an example, right? So in... Everybody's aware of Mad Dog. So from the time they drilled, so they started to commence drilling, we quoted the work, one year later. So we started the quoting one year later. So the to-be-found number, especially in the international and offshore market, the plug that we would put in, in the annual, today, it's zero. The good news is, as all these projects are starting to come back, and we saw it as a result of tie-ins or, or infield short- cycle offshore work, we're now quoting that work now.
And it should be visible that we're generating revenue and pipe coating, and our backlog is staying pretty much flat, and we're not making any project announcements. So we are picking up work on these smaller to-be-found tie-ins, the CAD 10 million, CAD 15 million projects. So that's happening, and we only see that strengthening as we go forward.
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?
I'll turn the question over to Gaston, because working capital is something he's focused on a lot.
Yeah. So I think, you know, as the working capital that we have today will continue to support the growth in our North American-based business. And, you know, we've done some renewed efforts to maintain, to ensure that we are actively managing our working capital and our cash. With respect to a large part, 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 if it's, and CapEx, of course, for depending if it's, you know, someplace where we have to mobilize assets or using existing facilities. Our current view is looking at large products that, you know, we would most likely find these products are now going to be cash neutral.
Therefore, the working capital would be something that would be a manageable size for our balance sheet. That's why we continue to maintain the amount of cash that we have, is one of the reasons related to the investment that would be required in a ramp-up for a large project award. But the size, Wesley, would really depend on what type of project it is and where it's being executed.
That's, that's really good to hear. Thanks for your time.
Thank you.
Thank you. As a reminder, if you would like to ask a question, please press star then one. One moment, please, for any further questions. 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.
Well, thank you very much, everyone, for their participation on this morning's earnings call, and we look forward to speaking with you again next quarter. Thank you.
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.