Good day, ladies and gentlemen, and welcome to Shawcor's First Quarter 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 be given at that time. If anyone should require operator assistance during today's conference, please press star then zero on your touch-tone telephone. As a reminder, this conference is being recorded. I would now like to turn the conference over to Gaston Tano, Chief Financial Officer. Sir.
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 four of the first quarter 2018 earnings press release that is available on SEDAR and on the company's website at shawcor.com. I now turn it over to Shawcor's CEO, Steve Orr.
Good morning, and thank you for joining us on this morning's conference call. In our last quarter's call, we highlighted our expectation that Q1 of 2018 would be a step down from what we delivered in Q4 2017, and a setup for the full year 2018 that is expected to be aligned to Q4 2016 adjusted EBITDA annualized. Our results were as we expected. Adjusted EBITDA in the first quarter of 2018 was CAD 35 million, a decrease of 48% over the fourth quarter of 2017, and the revenue was CAD 351 million, a decrease of 18%. This quarter's results demonstrate that actions that have been made to diversify the portfolio are gaining traction and confirm Shawcor's position as a late-cycle player.
The first quarter's results were materially negatively impacted from the absence of a large pipe coating project to replace the Sur de Texas-Tuxpan work that was completed in 2017.
On the positive side, the quarter saw continued demand for our products and services in North America and slight improvements in overall plant utilization, but not enough to offset. Shawcor's financial performance is dependent on industry capital spending. Capital spending, in turn, requires our customers to have confidence in the longer-term market fundamentals that determine their project investment economics. Approaching supply and demand balance, years of poor investing, and limited excess or spare offline production has reached a point that our customers have the confidence they need and are now moving forward in their programs. For Shawcor, the impact of the current reloading will not be fully visible in 2018 results, but it does provide the support that 2018 has the potential to be a pivotal year.
Pivotal due to the fact that our base business is expected to continue to grow beyond prior downturn levels, aided by our expanded portfolio in the tailwinds of North America and soon international markets, and the company's expectation of securing pipe coating projects for future years. With increased confidence in the base business performance, projects being sanctioned, and a healthy balance sheet coupled with strength in identified long-term fundamentals, we are 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 Tano, our CFO, to provide some details on the first quarter financial results.
Thanks, Steve. As Steve noted earlier, our results this quarter were in line with our expectations. Revenue in the first quarter decreased by 18% over the fourth quarter of 2017, primarily due to lower activity levels in the pipeline segment of the Latin American region as the Sur de Texas-Tuxpan project was substantially completed in the end of 2017. This was partially offset by higher revenues in North America driven by continued demand for our composite pipe products and small diameter coating. The petrochemical industrial segment delivered increased revenues due to higher activity levels for our automotive heat shrink products in the EMR region and for our wire and cable products in North America.
Compared to the first quarter from a year ago, revenue decreased by 3%, mainly due to lower large project activity in the pipeline segment reflecting the completion of the Sur de Texas-Tuxpan and the Shah Deniz projects in 2017. This was partially offset by higher revenues in North America, mainly from demand for our composite pipe products, small diameter coating, and non-destructive testing services. Revenue for the petrochemical industrial segment was flat compared to the prior year first quarter. Reported consolidated gross margins for the first quarter were 33.3%, lower from the 37.9% in the fourth quarter of 2017, and also lower than the 36.1% in the first quarter a year ago. The pipeline segment gross margin for the first quarter decreased to 33.6% from 36.7% a year ago, reflecting lower large project activities and the related lower utilization of facilities.
The petrochemical industrial segment gross margin was 31.3%, which is lower than the gross margin of 32.2% that was reported in the first quarter of 2017. On a consolidated basis, adjusted EBITDA for the first quarter is $35 million compared with $67 million in the fourth quarter of 2017, which excludes an $8 million in impairment charges booked in the fourth quarter. The decrease in adjusted EBITDA was primarily due to the decrease in gross profit of $45 million from lower large project activity and related plant utilization, partially offset by a $14 million decrease in SG&A expenses. The decrease in SG&A expenses in the first quarter compared to the fourth quarter was largely due to decreases of 6.7% in compensation and personnel-related expenses and a $7 million in restructuring costs.
Adjusted EBITDA for the first quarter was also lower than the $43 million reported in the first quarter of 2017. The $8 million decrease is primarily due to lower gross margins from decreased large project activity from the Shah Deniz and Sur de Texas-Tuxpan projects being completed, partially offset by higher activity in our North American business. Let's now discuss cash flows for the quarter. Before changes in non-cash working capital, cash flow provided from operating activities for the first quarter is $23 million, down from the $42 million that was provided from operating activities in the first quarter a year ago, primarily related to lower net income, lower non-cash expenses, and higher settlement of other provisions. Compared to $59 million in the fourth quarter of 2017, the first quarter was also lower due to lower net income, lower non-cash items, and higher amounts paid to settle provisions.
The change in non-cash working capital in the first quarter was a net cash outflow of CAD 52 million compared with a cash outflow of CAD 66 million in the first quarter of 2017. The CAD 52 million cash outflow from working capital in this quarter reflects higher accounts receivable and inventory, lower income taxes payable, partially offset by lower contract assets and higher accounts payable. Cash flow used in investing activities in the first quarter was CAD 9 million, primarily due to capital expenditures on property, plant, and equipment in all of our businesses to support current activity levels. During the first quarter, finance activities used net cash of CAD 9 million, reflecting the payment of our regular quarterly dividend of CAD 10.5 million.
Net cash outflow for the first quarter in 2018 was negative CAD 41 million compared to positive CAD 78 million in the fourth quarter of 2017 and negative CAD 50 million a year ago.
With respect to the balance sheet, our financial position remained strong. The company's cash and short-term investment position decreased during the first quarter to CAD 248 million, mainly due to investments in working capital to support current activity levels. Total net non-cash working capital at the end of the first quarter was CAD 150 million compared with CAD 89 million at the start of the year. The increase in net non-cash working capital that occurred during the first quarter was expected and reflects investments to support the continued growth of our base business in North America and the timing of collections-related 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 253 million and CAD 68 million of standard letters of credit as of March 31, 2018.
The company also has available unutilized credit facilities of approximately CAD 405 million as of March 31, 2018. I now turn it back to Steve for his commentary on our outlook.
Well, thank you, Gaston. I'll first start with some additional commentary on Q1 2018. The quarter highlights the importance of large project pipe coating to the overall performance of the company as the coating work associated with the Sur de Texas-Tuxpan pipeline was completed in 2017 and no alternative project replaced it and the emergence of a growing base business. Q1 provides confidence that investments and efforts that have been made to diversify the portfolio, both in terms of products and services and geographies, are gaining traction and will raise the base level of the performance of the company. Additionally, Q1 also is supportive that the tailwinds from the industry are impacting the results of the company, without question in North America, but now starting to see it internationally.
Q2 and the remainder of 2018 results are going to be heavily influenced by our ability to continue to capture and execute work associated with the expected sustained strong activity in North America land and the resuming of activity in the international and offshore markets that are related to FIDs that move forward in the second half of 2016 and 2017, that in most cases were smaller investment decisions such as step-outs and tie-ins. Although we continue to expect our results for the full year will be aligned to Q4 2016 adjusted EBITDA annualized, there are several factors that may influence our performance quarter to quarter that should be deemed positive for the long term but may negatively impact short-term performance. The first relates to the increased demand for our products and services in North America and the existing resources available to service this demand.
The logistics of moving products that have a heavy Canadian production footprint to the United States are now seeing issues. As a result, our composite pipe products that are manufactured in Calgary will need a broader base of shippers to keep up with demand. On the service side, we have now reached the first stage of staffing of our field crews. The first stage was supported by both the return to work of experienced hires and our onboarding and training programs. The next stage will be predominantly the latter, and with confidence in the future, we have increased the staffing programs that in turn will increase short-term costs but also increase the revenue-generating potential going forward.
This is certainly the case for our conventional non-destructive testing services where the market is underserved and our existing technician pool are also the pool that are being trained to deliver higher-level non-destructive testing technology and advanced services. The second area is the efforts and associated costs to ready and reactivate our plants due to the securing of work or technology acceptance. As we expected and is the legacy case, our pipe coating work is late-cycle business and will just reach the bottom next quarter. The moving off the bottom is supported by a build in our backlog that at the end of Q1 was CAD 459 million, which does not come from just one large project but from several and therefore will require multiple plants to be turned back on and staffed.
Of note is the increase in the number of individual projects that we have bids outstanding that one quarter ago were not even visible. We expect this trend to continue. Should we be correct and the industry sentiment and actions remain positive, we would not hesitate to accelerate upfront spending to capture work. Example of this is the preparation of our Italian coating facility in Adria that is in reactivation for the recently announced Qatar project and our Channelview Texas facility that is now preparing for production schedule well into 2019 from work that is already secured. Investing post-technology acceptance is critical in successfully expanding. Shawcor has an installed base of more than 30,000 km of our priority composite pipe solutions. Converting customers to trust a composite solution requires investments upfront for testing and certifications, field and application-specific trials, and training of local install personnel.
This approach has resulted in the strong steel-to-composite conversion rate in North America that we are seeing today and the acceptance in targeted geographies internationally. One of these geographies, the Middle East, after many years of efforts, has reached a level where we strongly believe our customers see the value of composites over steel. As communicated by our recent press release, we are moving ahead to position ourselves to capture our share of the expected growing market. The final area is the pursuit of large projects. As we have communicated in the past quarters, we are in the pursuit of multiple large CAD 100 million+ projects. These projects, in all cases, are complex and require planning multiple different scenarios, technology, and expertise to bid, win, and execute.
For Shawcor to deliver as promised to our customers and not risk the long-term independence of the company should we be chosen, we must ensure we position correctly upfront. The Sur de Texas-Tuxpan project, for example, saw a peak quarterly cash outlay of more than CAD 4 million as we moved to de-risk and position our solution before any contract was signed. We expect the projects that we are pursuing will move forward, and like Sur de Texas-Tuxpan, we will not hesitate to invest upfront to secure and de-risk potential future awards. Stepping aside from the financial results, 2018 is shaping up to be a pivotal year for the company. The overall industry indicators have swung to the positive as year-over-year spending is forecasted to increase: 20% in North America and 5% in international markets. In the view of many, these numbers are underestimated.
Now, underpinned by industry recovery, our expanded portfolio is gaining traction and will result in a base business level that was not present before the downturn, and we will see plant utilization increase as more projects are sanctioned. Also, and always important, is the growing confidence that a $100 million project will be awarded this year. Backing up this excitement that 2018 could be a pivotal year is the continued strength of our bid book that is now over CAD 1 billion and our budgetary that remains strong at CAD 1.5 billion. On large $100 million-plus project awards, we have in our bid $100 million-plus projects and the first stage of a second project that has the potential to be $100 million-plus. Should these projects stay on plan, we would expect to know if we are successful between June and September this year.
Additionally, there are several large CAD 100 million+ projects in the budgetary, one of which we would expect to move to the bid in the second quarter. Shawcor is aligned to capitalize on the long-term fundamentals of aging infrastructure, reservoir depletion, and energy sustainability. We are more optimistic than ever that these fundamentals are shaping investment decisions and the company has positioned correctly and will be rewarded. In summary, confidence in long-term outlook is supported by a portfolio of products and services that has been enhanced by recent expansion efforts, project visibility and movement, our ability to execute, strong balance sheet, and the continued strength of long-term fundamentals in which we are positioning the company's growth strategy. I'll now turn the call over to James, the operator, to open up for any questions you may have for Gaston and I.
Thank you. Ladies and gentlemen, if you'd like to ask a question at this time, 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. As well, we do ask that you please place your line on mute once your question has been stated to prevent any background noise during response. Our first question comes from Ben Owens with RBC Capital Markets. Your line is now open.
Hi, good morning.
Good morning, Ben.
On the two large projects you said you're pursuing in the near term, did I hear correctly that you expect to hear the results on both of those projects between June and September?
Yeah. So the current schedule for the projects, considering that the customers still to FID, as they have communicated, we would expect to hear one large, so an announcement of a large CAD 100 million+ project between June and September is what we're looking at. And to be clear, a project first stage or phase one of a project, which actually positions the company that wins it very strongly for the second phase, and those two phases combined are over CAD 100 million, again between the June and September timeframe.
Okay, perfect. Thanks for the clarity on that. So on the backlog, backlog was up nicely in the quarter. I was wondering if you could talk about some of the specific projects or products that moved into backlog during the quarter. I'd imagine the win in Qatar was a piece of it, but could you give us some color on what else moved into the backlog?
Yeah, I think, and we haven't communicated all the awards because our threshold is CAD 30 million. Usually, CAD 30 million we would announce. Most of the projects that FID'd in late 2016 and 2017 were below that threshold. And so what had happened was we secured work, but it was outside the 12 months. And then recently, we're seeing smaller projects come back to the normal state that was in 2014 where quarter to quarter we would know the project and it would be bid and one within the quarter that would go back into the backlog, right? So projects of mentioning that would be reflective, would be the Qatar beginning of the Qatar project would start to be coming into backlog now, but a very small percentage of it. Of course, the tail end of PTT, the fifth transmission line, would be in the backlog.
Then would be several projects that would be classified, say, as tie-ins. For example, Mad Dog would now be in the backlog that would be executed in Q1 2019, for example, which is interesting because Mad Dog kind of shows the late cycle of the company. Mad Dog started drilling in January 2018, and we will coat it in late 2018, early 2019. So it tells you our cycle for pipe coating is about 12 months after the drilling. Also, in some of our contracts that we would now are under NDAs, other ones I could mention, I guess, is Liza is in the backlog as well now. Phase one Liza is in the backlog that we wouldn't press release, and it's around the threshold, but it wasn't over the CAD 30 million.
Okay, that's great. That's really helpful color. On the $1 billion in the bid figure, can you guys give us an indication of how that's distributed by geography, kind of where that $1 billion is coming from around the globe?
I think I can give you, I wish not to break it down, but I can give you geographies of interest, and I can give you an indication where those geographies are strongest, whether it be in the bid and budgetary. I think, would that be helpful?
Yeah, that'd be very helpful.
Okay. So to start with, I think the first thing I could mention is in the budgetary, and it's not all captured yet, but we are starting to see the emergence of the second wall of work in Asia-Pacific related to the replacement of LNG. And again, I would mention it's only the tip of the edge of the iceberg that's coming. So we expect, and I think it's in the media and public domain, so Browse, Scarborough, Julimar, all these projects are starting to now be visible within the budgetary, right? But not all of them, so we expect more to come. Captured in the bid and partially in the budgetary would be East Africa, would be Europe, mostly around the maintaining of gas, a share into Europe of gas, also the diversification from Russian supply is in there. Certainly, we're now starting to see early stages of Brazil.
An example would be Peregrino. Additionally, fingers crossed, we have now started to see a movement on reactivation of discussions with Western Canada customers on the transmission lines. As you're aware, there's probably two that are in the dialogue mostly, which is the Trans Mountain project and the LNG project that's being sponsored by Shell. The other area I could give some commentary on that is quite interesting for us right now is work in the Middle East. The Qatar we've already announced, but there's additional lines that are now becoming visible in the Middle East. That's kind of the areas that we're interested. It's a very nice geographical diversity that fits up nicely for our current plant infrastructure.
Great. Well, then you know.
Maybe allow me one other comment that I made in my prepared preparation. So the other thing that we've seen, which is kind of novel this quarter and has been absent, is we are now seeing projects that are skipping the budgetary and are moving directly into the bid. These projects in general are smaller, so they're in the CAD 5 million-CAD 10 million. But this is a very positive sign that the volume of FIDs are increasing, although the project numbers are smaller. And this is going to be critical for us for plant utilization to get torqued overall, right?
That's all really helpful color. I appreciate it. I'll hand the call back. Thanks.
Thank you. Our next question comes from Aaron MacNeil with TD Securities. Your line is now open. Good morning, guys.
Good morning.
Good morning, Aaron.
A couple of questions. First, is it fair to assume that the mobilization of the Altamira plant is related to one of the large bid you referenced in your remarks?
No. I don't know. Most of the concrete weight coating plants are in the process of repositioning, but it would not be anything that would be exceptional. So we're moving them back where we think they'll be used next, but it's not referenced to a project that would be in our bid right now. It's probably more in the budgetary.
Okay.
So they're being repositioned. You probably are aware. One facility came from Siberia, and the other one was newly built. We believe there's two regions in the world that have an opportunity for the plant, so we're repositioning them back to those opportunities, but they're more focused towards the budgetary.
Understood. With respect to the volume of FIDs increasing and the projects that are skipping the budgetary into the bid, given that they're smaller projects, do you think that you'll see the positive impact on margins in 2018, or is that probably still a 2019 story?
So I think that's a—I mean, very good question. So I think we will not see much of an impact in the backlog from these smaller FIDs because they get consumed very quickly, right? So they're not held. But I do expect, which is probably addresses a question that was asked last quarter, that we will see stronger margins or performance of the company towards the later half of the year. So we've signaled very strongly that 2018 will be an annualized run rate of Q4 2016. I would expect, and we are modeling and forecasting that it will be stronger as we get towards the end of the year. And so you'll see a margin, and it's based solely on our model where if we have day-to-day smaller projects going through our facility, the absorption rate and utilization is much better.
That's really, pricing is important in pipe coating, but what's probably the dominant factor on margin is utilization of plants.
Okay. And then last one for me, could you provide any more detail on your flex pipe expansion to the Middle East in terms of timing, potential revenue, etc.? Anything you'd be willing to share?
Yeah. I think maybe give reference, and then maybe you can put some color on. So we have said, and if you recall, as the downturn took hold, that our North American business, and we actually put it in the investor presentation, was about CAD 500 million on a peak run rate level. And of that CAD 500 million, FlexPipe contributed about CAD 180 million. So that'd be great. So my starting point to tell you that we are certainly back to that CAD 180 million mark for FlexPipe, right?
Okay.
And then if you then look at the press release, and we gave an indication of the additional capacity, and it's in the press release, you could take that portion of the CAD 180, and that would kind of give you a benchmark for the additional revenue that could be made from this Middle Eastern plant. That's probably a good way to approach it. I'll let you do the math. We have signaled that we expect the plant to be running in 2019.
And then would it be at full utilization, or could it be at full utilization by the end of 2019, or is it further along?
No, I think the market is supportive, so I would expect we would get, and with full expectation, we'd add capacity if we need it, but the original capacity would certainly be there by 2020, right?
Understood. Okay. That's perfect. That's all for me. Thanks.
Thank you. Once again, ladies and gentlemen, if you do have a question, please press star, then one. Our next question comes from Elias Foscolos with Industrial Alliance. Your line is now open. Elias, if your line is muted, can you please unmute?
Sorry about that. It was muted. Good morning.
Good morning, Elias.
Something that I didn't hear in the prepared remarks, but maybe I missed it, is the company has a tremendous balance sheet flexibility, and growth has been focused, as I've listened to the call, mostly on organic or internal organic projects. Is there anything outside that scope that you could be looking at that we might consider?
Yeah, sure. Elias has a gas fund. So I think first, let me just talk about where we're using our balance sheet today and how we see it. We are investing in working capital to support the current activity levels. We do have our capital expenditures, and we have spoken about those numbers in the past, about maintenance CapEx being about CAD 45 million-CAD 50 million a year. Now, with our announcement with the expansion for composites and other expansion capital that we have line of sight in, there's probably another CAD 20 million or CAD 30 million on top of that. And then we have placeholder for large products and the pursuit of large products. And we'd be happy to spend all that because that's all related to growth beyond 2018.
Now, with all that in mind, we still have cash and unutilized room on our facility that we can start looking at inorganic opportunities and really focused on tuck unders and technology blocks to build where we can build our existing businesses on top for new growth opportunities. So inorganic is being discussed, and we are looking at it, but there is a lot of organic opportunities that we see in the business, and then we're investing behind.
Okay. Thank you for that. Stepping back to North American composite, did I hear things clearly that a bit of your ramp-up is held back by logistics, and it's not plant capability? Is that correct?
So I think it's fair to say that there was revenue that could have been realized in Q1 because of our need to reach out and add additional suppliers for logistics into the U.S. And so plant capacity, we're running quite hard. It's not the threshold today, so it's not the pinch point. What we were surprised by is the trucking, and in particular, the qualified drivers of trucking of the companies that we were using were now being stressed, partly because, and I think you guys are following it, the amount of oilfield equipment that's moving from Canada to the U.S. and the challenges of getting backhauls from the US into Canada is putting trucks and train drivers at a premium.
In Q1, and actually really it was visible in the beginning of Q2, we're now having to reach out to a different supplier base and work compensation deals that allow them to be compensated for backhauls that have minimum loads on it. So that's how it's going to, and the point that I was trying to make is that there will be additional cost to get the egg through the snake because of the constraints that we had. But we certainly have not missed any orders from customers, and we continue to go ahead. But it is showing strain from a Canadian production standpoint of trying to get into the U.S. There is this risk of the logistics, right? I would add one further comment. Normally, there's another contingency plan that we have that hasn't been that reliable, which is railway.
I think you guys are following the potential union or strike. We haven't been that confident to reach out and go through rail, right?
Okay. One last question. It'll focus on backlog, but maybe a slightly different approach in terms of what I would call maybe quality of backlog. Backlog in the past maybe had some very large projects like Sur de Texas-Tuxpan. It seems like backlog now probably has a much more, I'll use the word normal distribution, but maybe not skewed towards large projects. So kind of two questions. Is that a correct assessment that maybe it's a more resilient type of backlog than the higher backlog numbers we've seen in the past? And also in terms of the smaller projects, which might have been absent, and you alluded to, I'm not sure where we put the cutoff between small and mid-sized projects that don't hit the threshold. Are you happy with the intake that's coming in on those?
First, we're very relieved that the backlog doesn't drop directly proportionate to the large project consumption. In the past quarter, we would have executed CAD 90 million-CAD 100 million of Sur de Texas, and it was very reflective in the backlog, and there was no replacement. I think our backlog at the current number, ±CAD 10 million-CAD 20 million, is probably a much healthier, sustainable backlog. I think your observation is correct. And I think it's okay to clarify the way we kind of think about it. A large project, we've kind of forced it into a box of CAD 100 million+. A small project, I think it's fair to say, is probably under CAD 7 million, under CAD 10 million. And it's a small project because you win it.
It's not reflective in the backlog because you can easily chew it up in a plant in one quarter. So it doesn't really carry. So if you can replace that, it really doesn't show. So of the backlog, there are only two large projects that are influencing the backlog that we've announced. One is the fifth transmission line in Thailand, and the second is the recent Qatar award. And so that's it. So the rest is, in fact, these projects that are in probably the largest—well, there was one as I mentioned, was at the threshold of the $30 million, and the rest are smaller.
Good. That adds some color, so I appreciate that. That's all for me, so I'll turn it back. Thank you.
Thank you. I'm not showing any further questions in queue, so I'd like to turn the conference back over to Mr. Orr for closing remarks.
Well, thank you all very much for taking the time to join us on the call. Myself and Gaston certainly look forward to discussing with you next quarter the outlook for the company and the performance in Q2. Thank you very much.
Thank you. Ladies and gentlemen, that does conclude today's conference. Thank you very much for your participation. You may all disconnect. Have a wonderful day.