Gary Love - VP, Finance and CFO

Aaron MacNeil - AltaCorp Capital Inc Elias Foscolos - Industrial Alliance Securities Leslie Nixon - National Bank Financial

Thank you. 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 third 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.

The downturn in the global oil and gas industry is now extended to eight quarters and well undoubtedly continue well into 2017. As the point of balance in the supply demand equation has yet to be reached.

As we've noted in previous calls, the decline in oil and gas prices have negatively impacted North America well and completion activity and global oil and gas development capital spending. These have in turn reduced revenue in each of our pipeline segment businesses.

This was again the case in the third quarter with revenue being very weak at $259 million, up just 1% from the cycle low reported in the second quarter. We do however have solid grounds for optimism as we look forward.

One area of material improvement in the third quarter was the increase in the company's gross margin which climbed from the cycle low level of 28% in the second quarter to a more favorable 33.6% in the third quarter. This in turn moved our adjusted EBITDA up $7 million from the negative $20 million in the preceding quarter.

The improvement in gross margin was due to the launch of high margin project work in Asia Pacific as well as better utilization in our North American upstream businesses and in particular our composite pipe business. For the fourth quarter of this year, we expect the more meaningful improvement in revenue as we ramp up the Shah Deniz and Sur de Texas projects in Asia Pacific.

Flexpipe continues to strengthen in North America and execute the first of two large Middle East orders and we finally mobilize booked US transmission line weld inspection work. That has been deferred from early this year.

These revenue growth factors should enable operating income to improve to near breakeven levels. This positive trend will continue and will accelerate in 2017 as we begin to execute the concrete coating scope of work for the Sur de Texas -Tuxpan project along with other work that we've been successful in capturing.

Clearly, our 2017 confidence comes from reloading of the backlog with work that has healthy margins that will ensure we deliver strong growth and financial performance next year. I'll comment in detail on our outlook in a moment but first I'll ask Gary Love, our CFO to provide some details on the third quarter financial results.

Gary?

Yes. Thanks, Steve.

As Steve noted, third quarter revenue remained quite weak, down 47% from the third quarter a year ago and up by near 1.5% from the second quarter. Compared with the year ago, revenue decreases were reported at all with the pipeline segment regions with declines ranging from 33% in Asia Pacific to 78% in Latin America.

Compared with the second quarter, the small improvement in revenue marks a significant gain in Asia Pacific where we launched the Shah Deniz flow assurance work and in North America where we had a 10% increase in revenue from higher composite pipe sales and revenue gain at each of our integrity management businesses. Offsetting these positive factors was a 27% decline in EMAR revenue due to lower project activity in the UAE, Norway and Italy.

The growth and activity in Asia Pacific and North America was very beneficial to gross margin. With the pipeline segment gross margin increasing to 35% from 26% in the second quarter.

Our Petrochemical and Industrial segment continue to deliver good result, however, revenue did decline by 5% from the second quarter and segment gross margins decreased by three points to 28%. As a result, petrochemical and industrial segment operating income fell to $6.4 million from $9.8 million in the second quarter.

On a consolidated basis, adjusted EBITDA for the third quarter is $7 million, this compares with an adjusted EBITDA loss of $20 million in the second quarter. In addition to an increase in gross profit of $16 million, the third quarter saw SG&A expenses decline quarter-over-quarter by $7 million, R&D expenses decreased by $3 million and foreign exchange gains increased by $1 million.

Adjusted EBITDA excludes impairment charges of $156 million that are included in the operating loss for the third quarter. This impairment charges consist of $109 million for the write-down of Desert NDT acquisition goodwill, $41 million of the write-down of ideal equipment at the company's pipe coating operations in Italy and $6 million for write-down of intangibles and surplus equipment at the CSI operation in Western Canada.

I'd like now to review cash flow in the quarter. Cash flow from operating activities generated $22.6 million in the third quarter, largely due to a $22 million reduction in non-cash working capital.

The reduction in working capital was primarily due to a build in deferred revenue of $47 million for upfront payment we received on the Sur de Texas – Tuxpan project. This was partially offset by higher accounts receivable associated with the build up in revenue late in the quarter.

Total net non-cash working capital at the end of the third quarter is $103 million, compared to $122 million at the start of the quarter and $260 million a year ago. Cash flow used in investing activities in the second quarter was $13 million which included capital expenditures on property plant equipment of $18 million offset by proceeds from the sale property of $1 million and a decrease in other assets of $4 million.

During the second quarter, financing activities used net cash of $9 million which was primarily the regular quarterly dividend of $0.15 per share. With cash flow from operating activities offsetting cash used in investments and dividend, company's cash position was largely unchanged from the start of the quarter at $170 million.

Company also has available unutilized credit facilities of approximately $391 million as of September 30. We've noted in our financial statements that subsequent to the quarter, the company initiated two measures to improve its debt structure.

The first is an offer that has now been made to our Senior Note holders to repurchase US $75 million of outstanding notes. It is our intention to use the bank revolving credit facility to fund this debt repurchase.

To accomplish this, the company has initiated discussions with both at bank group and note holders to amend current agreement. The amended would include an extension of the bank facility term, an amended to the financial covenants in both agreements to ensure continued compliance.

And a waiver to permit use of the bank facility to fund the Senior Note repurchase. We expect to complete these amendments in December of this year.

I'll now turn the call back to Steve for his commentary on our outlook.

Well, thank you, Gary. To reiterate we've communicated for the past two quarters, we believe the second quarter was the bottom of the cycle for Shawcor.

In fact, since reaching a low point in April of this year we've had steady, month-over-month improvement into regional operating performance. This trend will continue in the fourth quarter and will accelerate in the first quarter of next year.

And most important factor in our outlook is our booked order backlog. Since March of this year the backlog has increased from $358 million to $606 million as of September 30.

Our backlog is calculated in a rolling 12 months basis and not excludes book orders that will be executed beyond 12 months of the reporting date. If we include booked orders beyond 12 months then our orderbook has more than doubled since March.

Much of the growth in the backlog can be attributed to the Sur de Texas – Tuxpan project in Mexico. Sur de Texas – Tuxpan is a pipeline that will be constructed to bring gas from US Shale production via an offshore large diameter transmission line to Mexico.

The gas will be used in the generation of electricity to replace coal and fuel oil target to start in September 2018. Our customer is a JV between IEnova and TransCanada who has won a bid to build and operate the pipeline.

In June of this year Shawcor was awarded a 100% of the concrete weight coating scope as a result of a combination of having a proven track record on large projects, mobile concrete coating technology and a logistic solution in Mexico. In the third quarter, we also were awarded the anti -corrosion coating for pipe that would be supplied by Japanese pipe well for the Sur de Texas – Tuxpan project.

The anti-corrosion coating will be carried out in our two Asia Pacific plant. Combing both scopes of work, the Sur de Texas – Tuxpan project will provide over $350 million in revenue to Shawcor.

The schedule of pipe deliveries will see us commencing the anti-corrosion coating in the fourth quarter of this year with concrete weight coating to start in the first quarter of 2017. All coating should be complete by the end of the first quarter 2018.

As of today, I can confirm we are tracking to the schedule. We have started the anti-corrosion coating of the Japanese source pipe at our Malaysia facility, we'll start later this month in our Indonesia facility and our Mexican operations are in final preparation for plant trial on schedule, setting up for first quarter 2017 ramp up for the concrete weight coating scope.

In other pipeline segment operations will continue to be impacted by low commodity prices as our customers are slow to ramp up capital spending. However, we do have some notable improvement in our North American businesses that are supporting our outlook for the fourth quarter and 2017.

First, our Flexpipe composite pipe business has seen a material improvement in demand from North America operators. And with a number of international orders, the most important is from the Middle East.

In addition, Flexpipe is moving very close to the commercialization of our new six inch and eight inch 750 psi FlexFlow composite pipe product. We expect these products to begin to contribute to revenue in the second quarter of 2017.

Second, our Shaw Pipeline Services business is now mobilizing advanced and DT inspection crew to execute several booked large diameter transmission line contracts that have been deferred from earlier this year. Finally, our integrity management strategy of developing a service offering that is leverage to the OpEx spends of our customer is beginning to deliver tangible results.

When acquired, Desert NDT lacked the technology and know-how to expand beyond the weld inspection of new gathering line. With the rate count drop this business loss traction in both volume and pricing.

Today, leveraging the know-how from Lake Superior Consulting, strong leadership and advanced technology from SPS, over 30% of Desert revenue is now been earned from services that were not present prior to the acquisition. Services now being offered by Desert include heat treat, computed radiography and mechanical integrity inspection.

And these new revenue stream offer growth potential that is not tied to new well completion. Beyond 2017, we are closely engaged with a wide range of customers on large project opportunities that are at the fee or pre fee stage.

Although the number of firm bids outstanding has move lower to $500 million, the volume of potential projects for which we have provided budgetary estimate has expanded to an aggregate value in excess of $2 billion. Given the pressure on cash flow from the collapse in commodity prices, our customers have narrow their spending choices to investment that have a short cycle return profile and are the lowest risk in their portfolios.

However, more recently they have started to put in place teams to rework larger investment decisions with the goal of derisking the execution and securing lower cost. With confidence gain in meeting project milestones and lower economic threshold, we believe that select, large projects will be sanctioned.

As a result, we are continuing to dedicate resources to capture these large projects and sustain a financial performance beyond 2017. One final note, the employees of Shawcor who have makes this company, today as a result of their passion, energy and willingness to adopt and adapt, Shawcor has managed down cycle well.

As we enter a period of transition, they again will be the difference in the speed and magnitude of recovery. I am confident that they do well again and outperform.

On that note, I'll turn the call over to the operator, Andrea for questions. Thank you.

Good morning, guys. You guys referenced the long versus short cycle capital spending in your commentary.

And we noticed that several large oil field service company reference the tieback opportunity in their Q2 commentary. So with the largest sequential growth in the budgetary estimate number, can you maybe comment on if this increase relates to that opportunity and what the timing and magnitude of that opportunity might be?

Yes. Maybe I'll add some color.

So I think first of all within our backlog the 606 number we have captured or seen a return of -- and when I refer to lower risk portfolio of our customers, we've seen a return and we've secured work in the -- I would call it $10 million to $50 million range in businesses in particular at Asia Pacific and the Gulf of Mexico that were absent one year ago. So I'd refer -- I think that's very similar to what other oil field services companies are seeing on tiebacks for example in deep water.

In budgetary we are continuing to see this but what's quite interesting we are now starting to see large projects that were visible in 2014 that was -- were for all -- purposes just halted or stop hold in their track. A reemerging and the discussion is about really different models of execution which will derisk them and potentially ensure on time execution but also of course they are going to the exercise where procurement is involved to see if they can get a lower cost of a different procurement model.

And I think that's what we are seeing that is changed much to the good since the beginning of Q2 right.

And then my second question and again somewhat related to your commentary on integrity management. And so with your commentary as well on Q4 and 2017 representing more strength and stability than recent quarters.

Can you comment on what your position is going forward on the integrity -- on growing your integrity management business?

So if maybe -- actually it is a great question because I can tell you the opportunity to discuss other than cost cutting and the challenge to capture market and revenue in the current environment, this is a nice change of question. So first of all, our integrity management strategy was built on accessing block.

And we move forward and we access the block of deploying services to our acquisition of Desert, then we very quickly realized our strategy that we needed to block of integrity engineering and ensuring integrity and pipeline engineering that was absent so we then made the acquisition of Lake Superior. Our strategy going forward has been always to combine these blocks together with technology and the back office strength that we have in the company to start moving towards the revenue streams that are associated with infrastructure that is left behind after the capital spend or otherwise the OpEx.

And that continues to be the synergy that we are after and I am quite happy and we made some commentary that although Desert which was the acquisition to give us the workforce and boots on the ground in the basin has been decimated in line with the rig count fall in their core gathering line inspection business, we've now have seen one third of their revenue coming from new revenue streams as a result of this integrity management strategy. I think what is even more reinforcing is in the advent of more and more challenges to get existing pipeline sanctioned to go ahead or approval and stricter regulatory compliance on existing pipelines.

We are seeing a real increase in demand for integrity services or services around rehabilitation of existing pipeline. So it is following in line with as we expected.

Certainly a lot of our energy has gone to make sure that the core business of Desert is profitable, but we are now seeing some traction in revenue stream. And it will pay off dividend in the future as the core business which was in place when we acquired Desert strengthens we have this other revenue stream that now we are starting to generate nice return.

Understood. And can you maybe then comment on if there is any other blocks that you may want to add with respect to this business?

Yes. I think eventually we will -- and I don't think what upsetting will be large block that's missing but we will eventually have to get access maybe not through an acquisition but through partnership to novel censoring on the pipeline or infrastructure that behind.

So the big gap that we are missing now is novel or an advancement approach in censoring on infrastructure. We have done a very nice -- I didn't mention it but true our minority positioning in ZI and our working relationship, we have the block of moving story and hosting data and serving data.

What we are missing is the censoring device that would sit or we would deploy on the pipeline or the infrastructure. So there is a lots of energy on our technology community to figure out what would that look like.

And maybe an acquisition but I think more likely it would be a partnering.

Good morning. Couple questions.

The first one focuses is on sort of the North American pipeline and pipe services segment. I guess I am kind of interested in a qualitative answer on this.

On a sequential quarterly basis given the new composite pipe and some large diameter work including small diameter work which probably will pick up too. Would you think that you would see a material increase in sequential quarterly revenue?

Yes. I think the message that we conveyed in the outlook of our press release and also Steve's comments is that we are expecting more meaningful growth in the fourth quarter over third quarter, certainly than we saw third quarter over second quarter.

So where will that growth come from, it is going to come from two places. It is going to come from Asia Pacific quite simply the work that we launched in the third quarter will get more volume on those projects in the fourth quarter.

And that will give us growth fourth quarter over third quarter. Secondary though is North America.

And there are several elements to that; one is our composite pipe business. We have secured, Steve mentioned this a nice order in the Middle East and we'll actually -- of course we are going to execute that production 6 location is our Flexpipe facility in Calgary, and so that revenue will actually be captured in our North American segment, reason for that is that our geographic segment is based on production location not end use customer.

So as a result, the growth in our international activity for Flexpipe translates into growth in the North American pipeline segment. The second area where we are seeing nice pickup and activity in the fourth quarter certainly versus the earlier quarters this year is in our large diameter transmission pipeline well inspection business.

That our Shaw Pipeline Services business. And we have in the backlog a pretty substantial orderbook for work for that business.

And a lot of that work we had originally expected we would be executing earlier in the year. And it has been deferred or we are now mobilizing the cruise and so we are going to see that in the fourth quarter.

And then we are going to see it again picking up little bit further as we get into early 2017. So those two areas, North America pipeline and Asia Pacific should be the key contributors to revenue growth in the fourth quarter.

Thanks very much for that color. Focusing a bit on the margin side.

We've seen a shift into concrete coating or concrete weighting I guess and that improve margin with the Tuxpan project coming on, would it be reasonable to assume that we'll continue to see that trend continue upward a bit more?

Yes. Actually just a little clarification there.

Probably the biggest single driver of our gross margin improvement in the third quarter over the very depressed level of the second quarter was in fact the flow assurance work that we are executing in Asia Pacific. That combined with better utilization in North America.

Those were the two factors. So in fact what we are seeing so far is the -- is really the positive impact of the insulation coating that we are doing for Shah Deniz.

This is the scope of work that we are executing in Asia. We started it in the third quarter, ramps up further in the fourth quarter and that's the story of the second half of 2016.

When we get into 2017, that's when we start the concrete weight coating for Sur de Texas. So it is going to launch in the first quarter.

We won't see that project running at really optimal production levels until the second quarter. And then carrying on to in the third and fourth quarter of 2017.

But that will be driven by the concrete weight coating scope of work on Sur de Texas. So 2017 story.

But it will be without a doubt the key element of our performance in 2017.

Okay. Thanks very much for that clarity.

Sorry if I missed the flow assurance part of that. In terms of how the Tuxpan revenue will come in, would it be reasonable to assume that it might be two thirds Latin America and one third Asia Pacific?

No, no. More like 90:10, about 10% of the project is anti-corrosion coating scope of work that we are going to execute in Asia.

90% is the concrete weight coating that we will execute in Mexico.

I think maybe if you allow me, let me expand a little bit on the project. So the project was secured from the JV that was constructed to build and operate the pipeline.

And in the bidding process the bidders were certainly incentivize so that a 100% of the pipe concrete coating would be done in country. And that at least 50% of the pipe would be from the Mexico.

And so what has happened is a Japanese pipe mill will supply plate to a Mexican pipe mill that will form the pipe greater than 50% and then the remainder will go through Japanese pipe mill and that pipe will go through our Asia Pacific anti-corrosion lines in Malaysia and Indonesia. And I think this is an important point because when I made the commentary on the schedule, why are we starting to have a stronger degree of confidence of when this is going to happen.

Well, we derisk the pipe arrivals in Mexico on the Japanese portion through the use of two of our facilities. So there are six orders of pipe coming from Japan into Asia Pacific.

So one would go to Malaysia, the next one will go to Indonesia and until we have all six orders arrived. We'll start then shipping out coated pipe in December to Mexico.

So that's the schedule. We are quite comfortable now as we go forward because we are starting to control the arrival of pipe into Mexico through our ability in two very, very, strong legacy outperforming plant in Malaysia and Indonesia that will ship the pipe in advance of the concrete weighting coating starting off in Mexico.

So we have right now in Malaysia and our coating. We have received pipe in Indonesia, so we are on loading as we speak and we will start coating certainly before the end of this month.

And so as we are now control of the pipe going into and we know the status of our readiness in Mexico. We are becoming more and more comfortable that the start up date of the ramp up will be in Q1 as per the schedule of the plant right.

Okay. For my simplistic analytical mind, it sounds like your parallel processing a little, is that correct?

Absolutely. We have derisked -- we have used every element we have within company both in terms of our plant and our resources.

And when I say resources it is our plant infrastructure in Mexico and our workforce in our Mexico and our mobile expat population along with the mobile technology that we had in other locations to ensure this project is executed with the lowest risk of having an upset right.

Good morning. As we start thinking about the gauging the timing and the magnitude of recovery in North American gathering line the small diameter, do you look towards the pipe manufacturers like Tenaris and TMK as the world's potential lead indicators?

And I was curious whether or not maybe volume or the price at those pipe manufacturers are more important to potentially offering some leading indicators towards the upstream business?

Actually, so Tenaris in particular we would look for probably more and more for the large diameter scope and particular the offshore scope line pipe for our businesses. So we had a question already on the tie-in the net opportunity.

When we talk about North American businesses we can divide them from the large diameter and separate from that from the gathering line would be a smaller diameter. In North America in particular most small diameter goes through distributors.

So distributors' resource pipe from multiple pipe mills both domestic and internationally, we will then stage the pipe and will generate revenue as we coat pipe and ship it out. And then on the large diameter of course, it is large capital project and then refurbishment of a large transmission volume.

And so when you look upstream, I think it is very hard to try to triangulate and I'll explain why in a minute on the production of type and how it relates to our revenue because in some cases the pipe is already in inventory and has been manufactured and is sitting potentially with distributors which we or -- and in lot of cases private distributors. So you would not have leading indication there is a buffer.

In our particular case, I'll just highlight one thing that's really changed. When the downturn occurred, pipe that we had on hand had a waiting of pipe that was there so yet to be coated.

And sorting of pipe that was already coated in preparation to go to the right away or course of the well ahead in the case of gathering line. If you now look at our facilities, there is in the case of small diameter most of the pipe work we do has a yellow coating so yellow jacket.

In our yards today, there is no inventory of yellow jacket. So what has happened is the distributors have gone ahead and shipped whatever pipe that we had in our inventory to the right away to reduce their inventory.

So now at the same time, the price of steel is dropped and so we are sitting on coated pipe in our yard of higher cost than if the distributor was to go and procure new pipe. And so what I am trying to demonstrate is that our revenue no longer has any buffer associated with pipe that sits in our yard that's already coated.

And so as activity picks up, we are starting to see that the most likely scenario is a real time alignment to our revenue because the buffer of pipe is already produced are sitting in our yard or pipe that can be procured at a lower cost will go directly to the right away because there was no inventory of coated pipe sitting around. Does that explain kind of the setup that's happening right now?

Yes. That actually -- that's clarifies a lot.

I guess just building off of that, would you say that most of the pressure in that line of business, is it been volume based or have you also seen some pricing pressure from the distributors as well?

So the biggest impact to our -- our profitability is highly, highly impact to get our facility to a utilization threshold that's profitable. So that's the first one.

But without question pricing in some market in particular [fusion and bonded] to proxy in the US land is at unsustainable level.

Well, again we'd like to thank everyone for their participation and interest in Shawcor. And we do look forward very much for the Q4 call to hosted again.

So thank you very much.