Shawcor Ltd.

Ladies and gentlemen, thank you for standing by and welcome to the Shawcore Q3 2021 results webcast. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you need to press star 1 on your telephone. If you require any further assistance, please press star 0. After a brief pause, your conference call will begin. One moment.

Good morning. Before we begin this morning's conference call, I would like to take a moment to remind all listeners that today's 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 Shawcore's statement on forward-looking information is included in Section 4.0 of the third quarter 2021 earnings press release that is available on CDAR and on the company's website at shawcore.com. I'll now turn it over to Shawcore's President and CEO, Mike Reeves.

Good morning, and thank you for joining Shawcore's third quarter conference call. Today, Megan and I are joined by our CFO, Gaston Tano. Key macro drivers for our business continue to evolve favorably, with increasing global investment in critical infrastructure, accelerating demand for premium and electric vehicles, and strengthening commodity price fundamentals. Cumulatively, these underpin our confidence that a multi-year upcycle for SureCore's business is developing. During the third quarter, the company continued to deliver on its commitment to support critical infrastructure markets with highly engineered materials-based solutions, generating revenue increases in all three business segments compared with the same period last year, excluding the impact of the products business, which was sold in late 2020. We also increased our backlog on a quarter-over-quarter basis, with new business capture exceeding backlog consumption in all reporting segments, including a slightly earlier-than-expected build in pipe coating backlog. This improvement in backlog and the even more favorable change in our budgetary quote balance reflect an increasingly positive macro environment. Despite this positive mid- and long-term outlook, in the immediate term, seasonal cycles, a low in pipe coating project activity, and constriction in raw material supply chains are expected to drive earnings in the next two quarters to be slightly below Q1 2021 levels. Tightness across much of Surecore's raw material supply base remains challenging. Whether our products incorporate specific polymers, resins, metals, or glass fiber, we continue to experience supply limitations, extended lead times, and sometimes volatile costs, both for the materials themselves and related shipping activities. Based on the expected timing of producers bringing incremental capacity online, it is reasonable to expect these challenges will continue throughout the remainder of 2021, before abating during the first half of 2022, with the availability of certain specific materials now expected to be tighter in Q4 and the early part of 2022 than previously anticipated. Across the company, we continue to work respectfully with our customers to ensure incremental input costs are fairly reflected in our selling prices. Built on many years of close cooperation with suppliers, the strategic diversity of sources, and the ability to lever our balance sheet for risk-lowering forward material purchases, we remain confident that Surecore is well-positioned to navigate these continuing global supply challenges, but related near-term volatility remains a risk. Regardless of these near-term impacts and the elimination of government subsidies, which have enhanced results in the last 18 months, We are confident that Surecore's annual earnings will once again increase in 2022. Turning to segment business activity, our composite system segment is primarily influenced by two market forces. The first is demand for premium UL listed underground storage tanks within the North American retail fuel and water markets. The second is demand for reliable spoolable composite pipe to connect newly completed oil and gas wells into existing processing and storage infrastructure. Third quarter composite system segment revenue rose by $6.4 million, or 7%, when compared to the second quarter of 2021. Q3 shipments of Surecore's market-leading underground storage tanks were higher than Q2, as sustained fuel station construction and refurbishment activity and demand for the company's hydrochain stormwater management systems continued. This demand drove tank-related backlog to a new record during the quarter and enabled the company to adjust billing practices with most clients. now invoicing at the time of product completion rather than at the time of physical shipment, which is expected to accelerate cash flow and lower seasonal volatility within this business moving forward. Market demand for both fuel and water-related underground tanks is expected to remain robust in the foreseeable future, albeit with normal seasonal softening in Q1. Unfortunately, tank-related raw material availability has tightened further in recent months and continues to be highly volatile. We currently anticipate this will cause our tank production output in Q4 and early 2022 to lag demand, lowering revenue and negatively impacting plant utilization for the segment in the coming two to three quarters. Our actions to qualify additional supply sources and our suppliers actions to increase production are expected to lower the supply chain effects as we move through the first half of 2022. North American demand for composite pipe rose in Q3 versus the prior quarter. as improved oil and gas commodity prices drove continued growth in well construction activity in the U.S. and Canada. While most onshore oil and gas operators remain conservative in their capital spending plans, provided oil and gas commodity prices remain favorable, we anticipate North American demand for these products will grow further in 2022. Normal Q4 seasonal impacts are expected to lower demand for composite pipe compared to Q3, with demand rising again in Q1 of 2022. At this time, our composite pipe business is not significantly impacted by raw material availability issues, although price escalation has continued, which the company has generally been able to pass through to customers with a modest time lag. Outside North America, we continue to observe elevated quote activity for composite pipe products driven by an improving customer capital spending outlook. While several contract award decisions are expected late in 2021, It is likely 2022 before meaningful incremental revenue tied to these awards is delivered. Pipe shipments associated with the substantial Middle East order noted in our Q1 earnings release continue throughout Q3 and will do so for the coming 18 months. In summary, we anticipate robust demand across the composite system segment throughout 2022 and likely beyond, but we'll see lower revenue and earnings contribution during Q4 and Q1, as seasonality and raw material availability impacts are observed. Moving to Surecore's automotive and industrial segment, during the third quarter, this segment saw revenue rise $4.7 million, or 7% compared to the second quarter, reaching a new record high in both revenue and adjusted EBITDA. Increased demand for heat shrink products within automotive applications and for engineered wire and cable products by electrical utilities and communication providers are fueling growth in this business. We anticipate these demand dynamics continuing throughout 2022 and likely beyond. However, they are subject to supply chain disruption risks. Specifically, the automotive marketplace remains challenged by a well-publicized shortage of microchips, which in recent months has extended into the premium chip sector. This development has led several large automakers to reduce production activity of premium vehicles during Q4, which in turn has temporarily lowered demand for Surecore's related heat shrink products. tempering our expectation for this business in the coming quarter. Potential impacts beyond the current quarter are difficult to predict at this time. When microchip shortages abate, we see a further opportunity for growth in our automotive and industrial business as customer ordering expands to normalize inventory needs. During Q3, the shore flex wire and cable business benefited from substantial deliveries of premium products into 5G communication build-out and nuclear refurbishment projects. elevating revenue and creating a favorable margin impact. This margin benefit was further enhanced by the utilization of advanced purchased copper wire, which we discussed in prior quarters. It should be noted that 5G communications build-out activities are project-based, having variability quarter to quarter, and we currently anticipate 5G-related shipments will return to more modest levels in Q4 and early 2022. During Q3, our ShoreFlex business reached a new record backlog. driven by a broad array of critical infrastructure renewal and expansion projects. We continue to have a constructive view of the mid- and long-term market trends which impact this business. Lastly, our pipeline and pipe services segment revenue during Q3 fell by $24.8 million, or 17%, compared to the second quarter, as lower pipe coating activity in all geographic regions was partially offset by higher, major project-driven pipeline inspection and engineering activity. Despite this lower revenue level, efficient pipe coating execution coupled with substantial recent footprint and cost optimization enabled the segment to deliver a positive adjusted EBITDA contribution during the quarter. We continue to focus significant attention on further cost and footprint rationalization while ensuring we retain the talent, capabilities, and geographic presence to support our customers globally. Looking forward, we anticipate these lower levels of pipe coating activity to persist in Q4 and the first part of 2022 before activity rises in the second half of 2022 as secured projects commence. The specific geographic and product mix of pipe coating activity scheduled over the next two quarters is likely to result in approximately breakeven adjusted EBITDA for the segment during this period. As we have discussed many times, Surecore's pipe coating business is tied primarily to the timing of offshore pipeline project sanctioning, which inherently leads to volatility from quarter to quarter. However, continued favorability in oil and gas commodity prices, coupled with elevating global demand for natural gas, is driving an increase in pipeline investment planning activity, with multiple mid-size and several large pipeline projects expected to reach final investment decision in the coming months. Pipecoating backlog grew modestly during Q3, improving slightly sooner than previously expected and reflecting the early phase of what the company expects to be a multi-year offshore pipeline capital spend cycle. Turning to backlog, at the end of Q3, the company's committed backlog of work to be completed within the next 12 months stood at $507 million, an increase of $18 million when compared to the prior quarter. This improvement was the result of new order capture exceeding backlog burn in all three reporting segments, with backlogs in our composite systems and automotive and industrial segments reaching new record levels. Previously, the company had anticipated pipe coating backlog to decline until year-end, before benefiting from new contract awards early in 2022. However, with some customers demonstrating increased urgency, we now believe our pipe coating backlog will build modestly in Q4, and then more substantially as we enter 2022. Surecore's bid number reflects the value of work where the company has issued a firm price with proposed contract terms against an explicit scope of work with a defined timeline for execution. At the end of Q3, the bid balance was $911 million, a decline of $61 million when compared to the prior quarter, reflecting the transition of several bids into backlog. Included in the bid number are now $237 million of conditional awards pending the client's final investment decision, up from $151 million in the prior quarter as multiple midsize coating projects were conditionally awarded during Q3. SureCause's budgetary number, reflecting the value of indicative pricing submitted to allow customers to build a project budget ahead of formal procurement activities, grew substantially. from just over $1 billion in Q2 to approximately $1.5 billion at quarter end. This supports our expectations that pipe coating activity will rebound during the latter part of 2022 and into 2023, which, when combined with a constructive outlook for composite and automotive and industrial product demand, provides confidence in our long-term outlook for short-haul. In parallel with Surecore's focus on business execution, we continue to also evaluate our ESG performance and seek opportunities to lower our environmental impact, both through the products and services that we provide our customers and our own environmental footprint. Next week, we will be releasing our annual sustainability report, which will include specific ambitions to significantly reduce our Scope 1 and 2 GHG emissions and materially elevate diversity within our senior leadership team over the coming decade. We have spent the last 12 months carefully reviewing tangible actions to drive achievement of these ambitions and are confident in our pathway forward. Surecore has driven substantial improvement in multiple ESG-related metrics versus our 2019 baseline and will continue to share our progress year over year. Finally, on October the 8th, we announced that Gaston Tano has elected to step down from the company at the end of May next year after transitioning his CFO responsibilities to Tom Holloway. who will join Surecore in December, initially as Chief Accounting Officer. This extended, thoughtful executive succession plan is consistent with Surecore's long-held practices and ensures minimal disruption to the organization's tactical and strategic initiatives. While Gaston and I will enjoy several more quarterly earnings calls together, I would like to take this opportunity to appreciate his selfless dedication to the company and tireless commitment to value creation for all stakeholders. the entire Shawcore team wishes him the very best in the next phase of his career.