Gary Love - VP, Finance and CFO Stephen Orr - President and CEO

Scott Treadwell - TD Securities Greg Colman - National Bank Financial

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 4 of the second quarter 2016 earnings press release. It is now available on SEDAR and on the company's website at shawcor.com.

I'll now turn the call over to ShawCor's CEO, Steve Orr.

Thank you, Gary, and thank you ladies and gentlemen for joining us on this morning's conference call. In our first quarter earnings press release we advised that the company would report a significant loss in the second quarter, as the weakness in North America was expected to continue and large project pipe coating activity would be limited or even absent until work recommenced for the final portion of Shah Deniz.

This unfortunately is exactly what transpired over the quarter. Revenue was very weak in all regions of our Pipeline segment, which contributed to low gross margins and operating losses in the segment.

In addition we incurred over $15 million in costs for restructuring, debt pay down and asset impairment as we continued our efforts to reduce cost structure and match resources in business units that have been impacted by the continuing decline in our customer's budget. The industry has now been under tremendous pressure for more than seven quarters.

For many companies, both E&P operators and service companies, the outlook is very uncertain, as variables associated with long term sustainability have yet to show any tangible signs that our industry is exiting the bottom of the cycle. For ShawCor this is not the case.

When we look ahead we are confident that the second quarter will prove to be the trough in our performance in this cycle. In other words the actions we have taken to rescale businesses and to reload our backlog, coupled with continuous strong bidding activity has positioned us for improvements in financial results going forward into 2017 and beyond.

I'll comment in more detail on our outlook in a moment. But first, I'll ask Gary Love, our CFO to provide some details on the second quarter financial results.

Thanks, Steve. The second quarter financial performance was extremely disappointing, with very weak revenue and a significant operating loss.

Overall revenue declined by 30% from the first quarter to $255 million. Versus a year ago the decline in revenue reached 36%.

Revenue decreases were reported at all of the Pipeline segment regions; in North America, new well completions reached a new low for the cycle with the resulting impact on our oil field leveraged businesses. In our EMAR, Latin America and Asia Pacific regions, what stands out is the almost total absence of revenue from large pipe coating projects.

This is unprecedented and speaks both to unfortunate timing but also the global trend where customers delay capital projects to preserve cash flow. Very low revenue had a devastating effect on operating margins in the Pipeline segment.

The project mix was such a minimal contribution from large projects, coupled with low facility utilization that impairs operational efficiency drove Pipeline segment gross margins down to 26% in the second quarter, fully 10 percentage points below the Pipeline segment gross margin in the first quarter. Pipeline segment SG&A also increased over the first quarter as a result of restructuring charges for staff reductions and facility consolidation of $11 million.

Combining the gross margin decline with the restructuring pushed the Pipeline segment into a $43 million operating loss for the quarter. In contrast to the weakness in Pipeline segment activity, our Petrochemical Industrial segment continues to perform very well.

Revenue increased by 6.5% on a year-over-year basis. But what was most impressive in the second quarter was a jump in the segment gross margin to 31% and an overall segment operating margin of 20%.

This is the first time that the Petrochemical and Industrial segment has delivered a 20% operating margin. Adjusted EBITDA for the second quarter is a loss of $20 million.

This amount excludes debt retirement cost of $2 million, fixed asset impairment charges relating to a facility that was closed in the quarter of $1.4 million, and gains on sale of land of $511,000. Adjusted EBITDA does however include total restructuring charges of $12.6 million, of which $600,000 is included in cost of good sold and $12 million is included in SG&A.

Of the SG&A amount $11 million was attributable to the Pipeline segment and approximately $1 million was incurred at the corporate level. Overall SG&A was $86 million, down $17 million or 16.5% from a year ago.

SG&A did however increase by $2 million from the first quarter of this year, although this was due entirely to the $12 million of restructuring cost incurred this quarter. The consolidated adjusted EBITDA margin in the second quarter is negative 7.9%, consisting of negative 11.8% in the Pipeline segment and a segment record, 21.6% in the Petrochemical and Industrial segment.

I'd now like to comment on cash flow for the quarter. Cash flow from operating activities consumed $32 million of cash in the second quarter consisting of cash flow before changes in non-cash working capital of negative $22 million, and $10 million use of cash to build working capital.

The negative cash flow before working capital resulted directly from the loss in the quarter while the increase in working capital was largely due to a reduction in current liabilities that exceeded the reduction in accounts receivable and inventory, both of which declined in line with the fall off in the revenue during the quarter. Total net non-cash working capital at the end of the second quarter is $121 million.

This compares with a $109 million at the start of the quarter and $213 million one year ago. Cash flow used in investing activities in the second quarter was $22 million, which included capital expenditures on property, plant and equipment of $15 million and the payment of this third [ph] consideration related to the Lake Superior Consulting acquisition totaling $7 million.

During the second quarter, financing activities used net cash of $111 million, of which $102 million was used to retire debt and $10 million was used to fund the regular quarterly dividend of $0.15 per share. Based on the cash flows in the quarter, cash plus short-term investments decreased to $118 million at June 30, 2016.

This is down from $281 million at the start of the quarter. In addition to the current cash position, the company also has available unutilized credit facilities of approximately $400 million.

On that note, I will now turn it back to Steve for his commentary on our outlook.

Thank you, Gary. As I mentioned at the outset of this call, our difficult and disappointing second quarter was, we believe the bottom of this cycle for ShawCor.

Gary mentioned the revenue weakness that we experienced and the fact that it resulted primarily from the two factors; the weakness in North America oil field leveraged businesses and also very low large project pipe coating revenue. The impact of low commodity prices on the spending of our customers in North American businesses is a factor that we cannot control nor predict with certainty.

Therefore, our efforts have been focused on reducing costs, and gaining share where possible and expanding our geographic and products and services offering. The certainty of large project activities is also a factor that cannot be controlled.

However we do have confidence that we will now see a pickup in large project activity. Going to more details, I’ll start with our backlog.

During the quarter our booked order backlog increased by $148 million or 41% to end the quarter at $506 million. The largest single factor in the growth of our backlog was the award of the concrete coating scope of work for the Sur de Texas - Tuxpan project in Mexico.

In addition to this award we’ve received a letter-of-intent for portion of the anti-corrosion coating of the pipe that will be supplied from Japan for the Sur de Texas - Tuxpan pipeline. Including the anti-corrosion coating the Sur de Texas - Tuxpan project has an estimated revenue value to ShawCor in excess of 350 million.

Of this amount approximately 30% is included in the backlog at June 30, 2016 with the remainder set to enter the backlog between now and December 31, 2016 based on the 12 month forecast production. The Sur de Texas - Tuxpan contract win is hugely important for ShawCor since it provides us with a strong book of business that will provide a base of supportive margins and operating income for the company in 2017.

Before we get to 2017 we also expect to see a lift from several projects in the backlog that will commence in the second half of the year. with the most notable being the planned execution of flow assurance coating for the Shah Deniz project at our Kabil, Indonesia facility starting in the third quarter and reaching full production in the fourth quarter.

Additional confidence in future performance comes from the large diameter pipeline girth weld inspection in the United States. We have contracts in hand that have experienced a number of delays but now have firm execution schedules and are being mobilized.

This work totaling over $40 million will greatly improve operating margin in our Shaw Pipeline Services integrity management business in the fourth quarter and into 2017. Our North American businesses have been under great stress although the sentiment of the industry is slowly improving we are not seeing any tangible infection point in activity that could be interpreted as the turn in the cycle.

Our customers are telling us that they will focus on opportunities that have short-term payback and are being flexible in their spending until the commodity price exits the current period of fluctuating volatility. Post second quarter actions, Discrete [ph] and Flex pipe are now scaled that so they will to contribute to margins of the company at the current low activity level.

The company has invested a great deal of time and effort to reduce cost structures. Total staff levels have been reduced by greater than 35% compared to September 2014, the start of the downturn.

As a result, any improvement in market activity will provide strong leverage for higher operating margin. Based on these factors, we should expect that our third quarter will be weak, although a substantial improvement over the second quarter.

By the fourth quarter, we expect the company will return to operating profitability. As we move closer to the start of the execution at Sur de Texas - Tuxpan project, our backlog will grow and this will set us out very well for stronger performance in 2017.

With the Sur de Texas and North Stream pipe coating bid activity now complete, we will increase our focus on other large project opportunities. The volume of opportunities continues to be very high as evident by our firm bids outstanding, with an aggregate value of approximately $700 million.

In addition, we are working with clients on projects, where we have provided budgetary estimates with an aggregate value in excess of $1 million. We will continue to dedicate the resources to capture these large projects and sustain our financial performance beyond 2017.

With cost reductions in place, the award of Sur de Texas - Tuxpan project and the strengthening of our backlog, we have a much improved outlook for cash flow in 2017 versus where we were at this time last quarter. We are now well positioned to focus on organic growth opportunities, particularly in integrity management, where we are capturing new market opportunities for our NDT inspection businesses that flow from the Lake Superior acquisition.

Also, we are moving to complete investments that are underway for capacity expansions in our Petrochemical Industrial segment businesses and additional investment to develop the 8-inch 750 PSI version of our FlexFlow composite pipe platform. Each of these initiatives should be additive to the underlying improvement trend we expect in our core business over the next 18 months.

My final comment is directed to the employees of ShawCor. The speed, magnitude and duration in the cycle have required a series of difficult decisions over an extended period of time.

It is well recognized, it is only your support, dedication and trust that has positioned the company to exit the cycle with the core of the company very much intact. For this I thank you.

On that note, I’ll now turn the call over to Bridget, to the operator for questions.

Thanks. Good morning, guys.

Thanks, the color on the backlog was great, Steve. I just wanted to maybe make sure I've understood it probably.

You have added in round numbers about $100 million from the Mexican project. Was the girth weld inspection work in the U.S., is that part of the other projects that would have been added to backlog in the quarter?

Yes. To be very clear, so what's added to the backlog includes a portion of the girth weld inspection, so not all of that, but contracts that are firmly in place that have execution schedule.

So this is primarily large diameter transmission lines that are multiple quarters long in U.S. land.

So yes, a portion of that probably [ph] would have gone into the backlog. But the only reason why we're going to backlog is Scott, is because we've confirmation of the schedule that the revenue will go in the next 12 months.

Okay. And just was there anything else from a geographic perspective, whether maybe it was a calendar scheduling kind of tightening up or an award of a project that contributed to that sequential growth in backlog?

We have some smaller projects that have been awarded -- I'm going to be a little bit cautious for a while identifying exact projects, because the competitiveness of the market right now. But there is projects that we have been awarded, that contributed to backlog of large project type coatings, but they are in the $10 million range in the Gulf of Mexico, in Asia-Pacific and out of our Ras Al Khaimah find that would have contributed to it.

And that's also why we have a little bit most confidence going into the fourth quarter. We expect some additional smaller awards in the $10 million to $15 million range in the next quarter.

Okay and actually a follow-up to that because those are smaller projects, those would necessarily be pretty short execution timelines, on the order of a quarter, maybe two is that fair to say?

Absolutely, yes. So they'll come in and out of the backlog, through possibly two quarters I think at the most.

We can true up a $5 million project in any one of our large plants pretty quickly.

Okay. And again without maybe getting in for too much color, is it fair to say that very little revenue came out of backlog in the quarter just given the project timing issues that you've talked about?

I would say very little, yes -- we normally -- and I think to highlight that point, the absence of the large projects just kills the utilization. And so when we -- and my comment was very clear.

So minimum large projects, or the absence of large projects was very apparent in Q2. So therefore the backlog doesn't get chewed out right [ph].

Okay perfect. Second one from me, I just wanted to maybe get a little more color on the G&A side of things.

I know in the past you have talked about, certainly in bidding for Mexico and North Stream that there was decent-sized investments in project teams or bid teams for those projects. Did that form part of this restructuring charge during the quarter or have those teams kind of just moved on to the next big projects in the bid book?

So a lot of the projects that we're associated with, the Mexico projects I would say 50 are going directly in the project to execute and the other 50 are moved -- we're actually geographically moving them to another opportunity. And then the EMAR opportunity which when we look at the $1 billion budgetary, those were where those projects are sitting.

So the teams are -- they are actually [ph] very charged up for projects that are on the 2018, 2019 horizon that they are going after.

Okay, so those teams have really just been kind of redistributed, is that fair to say?

Absolutely we're not going to lose that expertise out of the company.

Okay. And so the restructuring was really more -- was that fair -- structural or process driven type stuff or leaner?

There are two types. So one, our restructuring in the North American businesses where we've scaled them down.

But we've also, as Gary indicated in his call, we've actually shutdown some plants.

And also branch locations. We continue to consolidate branch locations.

Okay. Last one from me, just on the Flex pipe group, can you just give us a sense of your comfort level with where inventory is and how you're kind of running the lines, is it sort of start and stop a bit, maybe volatile or is it running at a sort of de minimis level that's giving you some level of utilization?

Q2 was -- so flex pipe activity was quite weak in terms of loading. Therefore it's not much of a drawdown on the inventory.

However as exited Q2, we're now starting -- we now have a backlog for flex pipe, and we've been able to run the plant continuous -- we run the plant continuous on a four day cycle now. So we don't expect that we'll have to do any, besides the seasonal or vacation type shutdowns, we're okay.

The biggest challenge in flex pipe right now that I'll identify is we actually have confirmed work looking forward quite strongly. The challenge is that customers are not adding the additional crews to take the product as quick as they have done historically.

So a particular large customer, I'll give an example on U.S. land as a large PO issued with us.

And we have the secured quarter and we're ready to manufacture. But they're not taking the pipe because they won't put on a spect and lay, a lay team [ph].

So they're not going to put a second team together that will -- they would rather do it in series rather than parallel. So therefore the ability for us to actually recognize the revenue has slowed down.

I think what's going to happen is that they're going to start increasing the intensity. So meaning, that they'll start paying overtime and running this crew on weekend.

And then they'll add the second crew, is what we're going to see going forward. But flex pipe we're quite comfortable with now that it's at the right spot for the remainder of the -- at the bottom of the cycle anyhow.

Okay, perfect. As always guys I really appreciate the color.

That's all I have. I'll turn it back.

Thanks very much. Just a question on kind of where your heads are sitting regarding capital deployment.

With the project backlog book looking far more predictable now that you've got Texas in the books and North Stream not, are you looking to get more active on the M&A side versus the tuck-ins you've been doing for the past little while or per, Steve your opening comments are you looking more at just organic CapEx investments?

For the near term I would say, until we get into 2017 and we have additional support for the cash flow, other than the large project backlog comfort. So we need to see the North American base business increase.

Our focus right now on capital deployment in terms of priorities is we have to fund the -- we still have a quite of bit of capital to push out to execute the Mexico project. So we need working capital for the iron ore and we need capital to finish the two large plants and put them in and the rolling stock to put them in place.

So that's the priority. The second is we have some real tangible opportunities that we predict we're going to be sold out on capital, on revenue generating organically that we will fund in next.

So for was downfall on our NDT spreads we are now at a point where the push of large projects in FPS that I mentioned in my comments, that were delayed, that were all mobilizing, putting tremendous pressure on the inventory of collars that we have. So we'll deploy capital in that area.

M&A, we still have kept an active M&A team in place. But we are going to be little bit selective on spending any capital for a while, until -- that's not saying we are going to be absent from the market.

But until we get some comfort on the cash flow and the overall strength of the business, we are going to hold off for a while.

That makes sense. So I could paraphrase back to you, just to make sure I understand.

We shouldn't be too surprised that we see one or two little things. But as far as anything from a sizable capital deployment that's probably not until the actual cash flow from the increased backlog flows through the operation.

Absolutely, yes. I think that's a very fair thing, and we may do something that we've done in the past, where we take minority positions of companies with predetermined rates of buyout.

So very little cash outlay, we expect some synergies. But we have a transparent vehicle for ownership.

Got it. Okay and my next kind of question so here is kind of half modeling and accounting and half trying to get ahead on a few moving parts.

So please bear with me for a quick second, while I jump out of [indiscernible]. But can you just confirm for us where the $12 million restructuring cost in the quarter was put in the income statement?

Was that all in the SG&A line of $86 million?

Yes, that's right. So there is $12 million in SG&A, actually it's about $12.1 million I think precisely within SG&A.

And the split of that and maybe I'll give you two splits on that. Of that $12 million, roughly $11 million was in the Pipeline segment and a $1 million was at corporate.

And the composition of the $12 million, the split was roughly $7 million for, let's say, employee related severance type costs and $5 million was facility consolidation-related cost.

Okay. So factoring [ph] that out is the $74 million sort of quote clean SG&A number what we should be thinking about for the size of the company now, or should we be thinking about the higher number given the recent [ph] Shah Deniz and Texas?

One of the factors that is extremely depressed right now is incentive compensation. So our accruals -- because of obviously the financial performance of the company.

So our accruals for incentive compensation are negligible. So we would certainly not expect to sustain that as we get into 2017.

We would certainly hope that, that would increase. And similarly our accruals relating to the long-term incentive program, which is kind of stock priced driven now there is, one would hope, some upside potential there.

So those could translate into higher SG&A in 2017 over the levels we’re at today.

Got it.

Mitigating that somewhat would be the fact that we have taken cost out and those cost reductions we will see the benefit of that as we move forward. So plus and minus there.

Right. So maybe in the mid-70s will be a good run rate in the near-term that, but that will rise as your activity levels rise, which is probably good news probably to have?

We would definitely expect it to rise as activity levels rise, yes.

So with the understanding that the onetime restructuring -- or I’m not going to call onetime but restructuring was in the SG&A. That does suggest gross margin in sort of the high 27% range was a clean gross margin number.

And then with the addition Q3 is going to be moving in the right direction, but still a bit challenging. But how should we be thinking about gross margins kind of once we see Texas start to kick in and Shah Deniz start to kick in a little bit of recovery here.

Do we start to see a come back to the low to mid 30s, where your operating leverage really starts to move the needle?

Yes, so the 27.8% was the consolidated gross margin. I mentioned in my comments that the gross margin in the Pipeline segment was actually 26%.

And I also mentioned it was 10 percentage points below where it was in the first quarter. So it's a clean number.

There is no escaping it. 26% was the gross margin in the Pipeline segment, in the second quarter.

There was a small factor there for restructuring, $500,000, $600,000. But it's basically the number that we got.

Now why was this so low? It was so low because the revenue was so low.

There is simply a point, where facility utilization is so low that you've got costs that are in costs of goods sold that you cannot offset in a scenario like we had in the second quarter. So the combination of exceptionally low facility utilization and the mix, the fact as I mentioned that there was almost complete absence of large project revenue.

So the mix was very unfavorable. And so those two factors drove gross margin down to levels that I hope I never see again.

We should not have gross margins in the Pipeline segment below 30%. Now we'll have a -- it’s going to be a measured pace of recovery here.

But by the time we get to the fourth quarter, a return to operational profitability, which is what we’ve signaled in the fourth quarter, will be driven by an improvement in gross margins in the Pipeline segment. That's a necessary precondition for us to achieve our objective to returning to operational profitability in the fourth quarter.

Okay, got it. I think you gave enough tools to kind of work ourselves into what we think make sense there.

So I really appreciate that. And then just finally, when we look at what of the contracts is in the backlog and what isn't of Texas, Sur de Texas there.

The fact that only one-third of it is in backlog with the other two-thirds coming by year end, just by definition of the way backlogs work, that suggests that the vast majority of that project is backend weighted in 2017, does it not?

Yes, absolutely, the second half of 2017. So, roughly two-thirds.

You have to appreciate that this is still a moving target. So we know when we're going to start work, the pace at which we execute the project will depend on the performance of our facility in Altamira but it will also depend on the rate of pipe delivery.

So the pipe delivery has a profound effect, and if pipe delivery gets accelerated then we’ll work through the project more quickly. But what we're setting out in our backlog is really our best guess today what the production schedule will look like.

And it is one-third first half, two-third second half, that's how the situation looks today.

Is there any other part of that contract other than the core coating and the anti-corrosion that hasn't been awarded yet, but you're still awaiting the word on?

Yes, of course all the laying of the pipe. I think this is important to note even for North Stream.

So a lot of the visibility that we speak about is the pipe coating work that is associated with these projects. So what's still to come, and because of the portfolio of ShawCor, is the work that's associated with laying the pipe.

So our Canusa business on the joint protection and depending on who the lay contractors are we have a very high chance of securing the girth weld inspection as these projects get laid. What we coated so far, in terms of Sur de Texas - Tuxpan is only the line pipe coating, concrete weighted coding and the anti-corrosion, which is not in our backlog that we have secured.

That's all we've done. So there is lots of other work that's associated with both North Stream and Sur de Texas that we don't speak about that that's yet to be awarded.

Can you give us an idea, order of magnitude wise how big those opportunities will be relative to the size of the initial pipe coating contract?

We're in competitive tendering on that. But we'll have to take a pass on that.

I think it's fair to say that our portfolio is much more diverse than it was last time we bid North Stream. Last time we bid North Stream it was very much -- today our portfolio is quite different.

We are bidding on for [indiscernible] associated with North Stream. We will bid more for girth weld inspection for North Stream.

We will certainly bid for the field joint protection, so the Canusa product line. So there is a lot more to come on these projects that we have visibility on.

But I think at this time the contracts are issued and we're in negotiations. And we got to be pretty sensible what we say on these calls on pricing brackets as we go through this right.

No problem. You actually just reminded me something Steve of additional activity you [indiscernible] earlier in the call talking about how you had a bid team that has $1 billion revenue project capabilities.

Obviously it was working on North Stream previously and hasn't been released and is working on other stuff for 2018, 2019 and beyond. Can you give us any insight as to what that other stuff would be or are we going to be taken through various new sources to try to uncover what those potential projects are?

I can give you geography so they are in our EMAR region, and they are associated with advanced coating.

Great, we'll start [indiscernible]. That's it from me, challenging quarter fellow, but I think really bright outlook for you.

So congrats on securing that contract net outlook.

Thank you.

Thank you.

All right thank you very much Bridgette. So I think in my closing remarks are really focused on the -- on how rough the quarter actually is for the company.

But with a very clear understanding that 2017 will be a much better year for the company, just based on the three items that we've ran through the call. And finally I'd like to thank you all for taking the time for making the call and look forward to speaking to you next quarter.

Thank you.