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ShawCor announces third quarter results

Published on 2006-11-06. Author : SpecialChem

Consolidated revenue for the quarter totaled $245.3 million compared to $239.2 million in the same quarter of last year. The third quarter revenue was 7% lower than in the second quarter as a result of the impact of project timing in Bredero Shaw's Far East region, partially offset by revenue growth in Bredero Shaw Americas and the start-up of a major project in the Middle East. Business activity at the Company's other divisions continued to be strong with revenue either increasing or remaining similar to prior quarter levels. On a year-to-date basis, consolidated revenue of $766.0 million was 8% higher than in the same period of last year.

Consolidated income from continuing operations totaled $16.5 million ($0.22 per share) in the quarter, compared to $34.7 million ($0.46 per share) in the third quarter of 2005, which result included the benefit of previously unrecognized income tax losses totaling $18.4 million ($0.25 per share). Third quarter consolidated income from continuing operations decreased from $24.9 million ($0.34 per share) in the second quarter of the year in line with the lower revenue. On a year-to-date basis, income from continuing operations totaled $66.2 million ($0.89 per share) compared to $61.0 million ($0.81 per share), including the $18.4 million ($0.25 per share), income tax benefit in the first nine months of 2005. The growth in earnings per share reflects both the increased revenue and operating margin improvements in the first nine months of 2006 and the impact of reduced shares outstanding through share repurchases under the Company's ongoing Normal Course Issuer Bid.

On August 8, 2006, the Company announced the acquisition of a 50% interest in Eupec Brasil Ltda., which operates a pipe-coating plant adjacent to the Vallourec & Mannesmann pipe mill in Belo Horizonte, Brazil. Eupec Brasil Ltda. was subsequently renamed Bredero Shaw Revestimentos de Tubos Ltda. and, together with ShawCor's existing operation, Thermotite Brasil Ltda. which is also located in Belo Horizonte, will enable ShawCor to offer a complete range of anticorrosion coatings and linings along with high performance insulation coatings to serve both the onshore and offshore segments of the Brazilian pipeline market.

On October 5, 2006, the Company announced that the agreement to purchase Garneau Inc. had been terminated due to delays in closing resulting from a review of the transaction by the Competition Bureau, the prospect of further delays, and the inability of the parties to resolve the outstanding issues associated with the Competition Bureau review.

As a result of the termination of the Garneau agreement, on October 10, 2006 the Company announced a $30 million pipe-coating capacity expansion in Western Canada. This investment will include the construction of a new state-of-the-art coating plant in Camrose, Alberta adjacent to the Company's existing facility, the construction of a new rail spur to double transportation capacity, and upgrades to increase the capacity of the existing Camrose coating plant. This project, which commenced in October, and is expected to be completed in phases between December 2006 and the end of the second quarter of 2007, will significantly reduce lead times, meet the growing demand for insulated pipelines in the Tar Sands region and also enable the Company's other Alberta pipe-coating facilities to become more focused and efficient.

The anticipated softness in the North Sea and Far Eastern regions of Bredero Shaw is expected to continue into the fourth quarter, partially offset by Bredero Shaw Americas pipe-coating activity which is expected to remain robust. Fourth quarter revenue is expected to be slightly below third quarter levels with operating income impacted by increased costs associated with the launch of new facilities. Revenue for the full year is forecast to be in line with 2005; however, improved operating performance is expected to result in a significant improvement in income from continuing operations per share for 2006 compared with the $0.85 per share recorded in 2005 (reported earnings per share of $1.10 less the benefit of previously unrecognized income tax losses totaling $18.4 million or $0.25 per share). In addition, the operating performance gains achieved over the past 12 months position the Company to continue to generate improved operating income in 2007.

MANAGEMENT DISCUSSION AND ANALYSIS

The following is management's interim discussion and analysis of operations and financial position and should be read in conjunction with the Consolidated Financial Statements and Management's Discussion and Analysis included in the Company's 2005 Annual Report.

Revenue and Income from Operations

ShawCor classifies its revenue and income from operations in two industry segments: Pipeline and Pipe Services, and Petrochemical and Industrial.

Consolidated revenue from consolidated operations totaled $245.3 million in the third quarter, 3% higher than in the same quarter of 2005 but 7% lower than in the second quarter of 2006. As expected, revenue at Bredero Shaw was lower than in the prior quarter reflecting pipe-coating project timing, particularly in the Far East region. This decrease was partially offset by revenue growth at the Bredero Shaw America's region, improvements at the Pipeline and Pipe Services segment's other divisions and at the Petrochemical and Industrial segment. Consolidated net income for the quarter totaled $16.6 million ($0.22 per share) compared to $90.8 million ($1.20 per share) in the third quarter of 2005. Third quarter 2005 net income included an after-tax gain on the sale of the OMSCO drill-pipe manufacturing division of $48.8 million ($0.65 per share) and the impact of an $18.4 million ($0.25 per share) reduction in income taxes from the utilization of income tax losses not previously recognized in the accounts. Compared to the second quarter of 2006, net income in the third quarter decreased $8.2 million ($0.12 per share), in line with the decrease in consolidated revenue in the quarter. On a year-to-date basis, consolidated revenue of $766.0 million was 8% higher than in the same period last year while net income of $66.0 million ($0.89 per share) compares to $118.3 million ($1.57 per share) including the gain on the sale of OMSCO ($48.8 million or $0.65 per share) and the benefit of previously unrecognized income tax losses ($18.4 million or $0.25 per share).

In the Pipeline and Pipe Services segment, revenue in the third quarter of $210.9 million was slightly higher than in the third quarter of last year; however, was $16.1 million lower than in the prior quarter. As expected, revenue decreased from second quarter levels at Bredero Shaw as stronger business activity in North America and revenue from the KOC project in the Middle East were more than offset by lower pipe-coating activity in the Far East region resulting from the completion of major projects at the plants in Malaysia and Indonesia. Revenue at the segment's other divisions increased by approximately 2% from the prior quarter. Income from continuing operations for the third quarter for the Pipeline and Pipe Services segment was $24.0 million (11.4% of revenue), 7% higher than $22.6 million (10.8% of revenue) in the third quarter of 2005. Compared to last quarter; however, income from continuing operations and operating margins (income from continuing operations divided by revenue) both decreased reflecting the lower revenue and the impact of provisions totaling $5.4 million recorded in the North Sea and African regions related to cost reduction initiatives and facility rationalization in those areas. On a year-to-date basis, revenue for the nine months ended September 30, 2006 of $661.1 million was 7% higher than in the corresponding period of 2005. Income from continuing operations for the segment for the year-to-date totaled $97.6 million, 49% higher than in the same period of 2005.

In the Petrochemical and Industrial segment, revenue in the quarter of $34.9 million increased 17% from the third quarter of 2005 as ShawFlex and DSG-Canusa both experienced higher levels of business activity versus the prior year. Compared to the second quarter of 2006, revenue for the segment decreased 4% as lower revenue at DSG-Canusa was partially offset by improvements at ShawFlex. Income from continuing operations for the segment for the third quarter of $5.0 million (14.4% of sales) increased 67% from levels in the third quarter of 2005 and 28% from the second quarter of 2006. Operating margins in the third quarter improved 3.6 percentage points from the prior quarter, reflecting the impact of sales price increases at ShawFlex in response to copper price increases experienced earlier in the year. On a year-to-date basis, revenue for the segment totaled $106.1 million and income from continuing operations totaled $13.6 million representing increases of 14% and 31%, respectively, over the same period last year.

Finance

Financial and corporate costs consist of corporate office costs not charged to the operating divisions and other non-operating items including foreign exchange gains and losses on cash balances. Financial and corporate costs for the quarter, before net foreign exchange gains of $1.5 million, totaled $6.9 million compared to $4.3 million in the prior quarter, before net foreign exchange losses of $54 thousand, with the increase mainly due to the expensing of previously deferred costs stemming from the unsuccessful Garneau transaction and increased management incentive compensation costs in line with the earnings improvement.

Net interest income totaled $908 thousand in the quarter, compared to $424 thousand in the prior quarter and net interest expense of $1.1 million in the third quarter of 2005. The improvement over the third quarter of last year reflects the improved cash position of the Company resulting from the divestiture of the OMSCO division in the third quarter of 2005 together with cash generated during the twelve month period.

Income tax expense was $8.0 million (32.4% of pre-tax income) in the quarter compared to $10.4 million (28.6% of pre-tax income) in the prior quarter and a recovery of $13.9 million in the third quarter of last year inclusive of an $18.4 million benefit of previously unrecognized income tax losses. The third quarter 2006 effective tax rate continued to be favourably impacted by the utilization of previously unrecognized tax losses in the United States; however, this benefit was tempered by tax losses in other countries, principally Nigeria, which were not tax-effected. Canadian Generally Accepted Accounting Principles allow the recording of the benefit of tax losses only when there is reasonable assurance that those losses will be utilized in the future; the foreign tax losses incurred in the quarter did not meet this test.

Cash Flow

Cash flow generated from operating activities in the quarter totaled $61.5 million, reflecting reductions of working capital and other of $34.0 million, compared to $29.4 million last quarter and $35.2 million in the third quarter of 2005. On a year-to-date basis, cash flow generated from operating activities totaled $139.9 million compared to $83.4 million in the first nine months of 2005.

Capital expenditures in the quarter totaled $21.5 million compared to $12.6 million last quarter and $13.4 million in the third quarter of last year. Major expenditures in the quarter included the continuing development of the new Portland Oregon pipe-coating facility, land development and preparation for a subcontract double-jointing facility at the new site in Camrose, Alberta, investments to expand capacity and add a research and development pilot line in the Thermotite plant in Norway and plant upgrades related to the KOC project at the pipe-coating plant in Ras Al Khaimeh. On a year-to-date basis, cash flow used in investing activities totaled $49.1 million compared to $30.3 million in the corresponding period of last year.

Cash flow used in financing activities totaled $6.5 million in the quarter and consisted of dividends paid to shareholders of $3.3 million and the cost of shares repurchased under the Normal Course Issue Bid of $3.6 million, partially offset by $378 thousand received from the issuance of shares on the exercise of stock options. Cash used in financing activities totaled $2.6 million in the third quarter of 2005, reflecting a decrease in bank indebtedness of $2.9 million and the receipt of $280 thousand on the exercise of stock options. On a year-to-date basis, cash flow used in financing activities totaled $15.1 million compared to $5.5 million in the first nine months of last year.

Liquidity and Capitalization

At September 30, 2006, the Company recorded a working capital ratio of 2.27 to 1 compared to 2.22 to 1 at June 30, 2006 and 2.08 to 1 at December 31, 2005. Operating working capital, excluding cash and cash equivalents decreased $30.5 million in the quarter to $35.2 million, mainly the result of lower receivables reflecting the decrease in revenue compared to last quarter. Cash and cash equivalents increased $24.0 million in the quarter to $269.6 million, compared to an increase of $1.7 million last quarter.

Financial Instruments

The Company manages interest rate risk and foreign exchange risk through the use of derivative financial instruments including foreign exchange option contracts and forward exchange contracts. These instruments are used to hedge exposures related to commercial activities only. The Company does not use them for speculative purposes. Short-term movements on financial instruments acquired as a hedge of a specific foreign currency purchase obligation or revenue source are deferred and matched with the specific transaction.

At September 30, 2006, the Company had notional amounts of $24.3 million of forward contracts outstanding (December 31, 2005 - $104.5 million) with a fair value of negative $1.8 million (December 31, 2005 - positive $1.9 million). These amounts are used to express the volume of transactions and are not recognized in the consolidated financial statements.

Critical Accounting Estimates

The preparation of the consolidated financial statements in conformity with Canadian Generally Accepted Accounting Principles ("GAAP") requires management to make estimates and assumptions that affect the amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the period. These estimates and assumptions are made with management's best judgment given the information available at the time, however, actual results could differ from the estimates. Critical estimates used in preparing the consolidated financial statements were materially unchanged during the quarter.

Risks and Uncertainties

Operating in an international environment, servicing predominantly the oil and gas industry, ShawCor faces a number of business risks and uncertainties that could materially adversely affect the Company's projections, business, results of operations and financial condition. There were no material changes in the nature or magnitude of such business risks during the quarter. The Company's 2005 Annual Report and 2005 Annual Information Form include a more detailed discussion of these risks and uncertainties.

The Company's operations in the Pipeline and Pipe Services segment, representing 86% of the Company's year-to-date consolidated revenue, are largely project-based. The nature and timing of projects can result in variability in the Company's quarterly revenue and profitability. In addition, certain of the Company's operations are subject to a degree of seasonality particularly in the Pipeline and Pipe Services market segment. The following are additional key factors impacting the comparability of the quarterly information disclosed above:

The majority of the Company's revenue is transacted in currencies other than Canadian dollars, with a majority transacted in U.S. dollars. Changes in the rates of exchange between the Canadian dollar and other currencies could have a significant effect on the amounts of these revenues when they are translated into Canadian dollars.

On November 3, 2004, the Company announced the closure of its Mobile, Alabama facility. This event had a significant impact on the financial results for the fourth quarter of 2004. Operations at the facility ceased in the fourth quarter of 2005 and discontinued operations accounting treatment was adopted in that quarter with prior quarters restated on a comparable basis.

On September 30, 2005, the Company completed the sale of its OMSCO drill pipe manufacturing division. The division has been accounted for as a discontinued operation.

Outstanding Share Capital

As at October 27, 2006, the Company had 60,676,953 Class A Subordinate Voting Shares ("Class A") outstanding and 13,078,142 Class B Multiple Voting Shares ("Class B") outstanding. Each Class B share is convertible into a Class A share at the option of the holder. In addition, as at October 27, 2006, the Company had stock options outstanding to purchase up to 2,849,340 Class A shares. During the third quarter, 197 thousand shares were repurchased at a weighted average cost of $18.37, including brokerage commissions, under the Normal Course Issue Bid for a total expenditure of $3.6 million.

Outlook

The Company's consolidated order backlog, representing customer orders expected to be completed within one year, totaled $316 million at September 30, 2006, compared to $266 million at the beginning of the quarter.

The Company continues to anticipate a slowing of business activity in the fourth quarter of the year compared with the third quarter as lower business levels in the North Sea and Far East regions are partially offset by strong pipe-coating activity in the America's region. Fourth quarter revenue is expected to be slightly below third quarter levels with operating income impacted by increased costs associated with the launch of new facilities. Although the revenue outlook for full year 2006 is basically in line with the full year result for 2005, the Company's improved operational performance in both of its business segments is expected to result in a significant improvement in income from continuing operations per share for 2006 compared with the $0.85 per share recorded in 2005 (reported earnings per share of $1.10 less the benefit of previously unrecognized income tax losses totaling $18.4 million or $0.25 per share).

The operating performance gains achieved over the past 12 months position the Company to continue to generate improved operating income in 2007. Robust bidding activity combined with available capacity at the Company's Europe and Far East facilities, and the impact of the Company's investment program, including the North American capacity expansion and the Brazilian joint venture acquisition, position the Company for growth as new pipeline projects that are presently being designed and bid commence production in 2008 and beyond.

Forward-Looking Information

This document includes certain statements that reflect management's expectations and objectives for ShawCor's future performance, opportunities and growth which constitute forward-looking information under applicable securities laws. Such statements, except to the extent that they contain historical facts, are forward-looking and accordingly involve estimates, assumptions, judgments and uncertainties. These statements may be identified by the use of forward-looking terminology such as "may," "will," "should", "anticipate," "expect", "believe", "predict", "estimate," "continue," "intend," "plan," and variations of these words or other similar expressions. These statements are based on assumptions, estimates and analysis made by ShawCor in light of its experience and perception of trends, current conditions and expected developments as well as other factors believed to be reasonable and relevant in the circumstances. Although ShawCor believes that the expectations reflected in these forward-looking statements are based on reasonable assumptions in light of currently available information, ShawCor can give no assurance that such expectations will be achieved.

Forward-looking statements involve known and unknown risks and uncertainties that could cause actual results to differ materially from those predicted, expressed or implied by the forward-looking statements. Significant risks facing ShawCor include, but are not limited to: changes in global economic activity and changes in energy supply and demand which impact on the level of drilling activity and pipeline construction; political, economic and other risks arising from ShawCor's international operations; compliance with environmental, trade, anti-trust and other laws; liability claims; fluctuations in foreign exchange rates; fluctuations in prices of raw materials, as well as other risks and uncertainties, as more fully described in our 2005 Annual Information Form and 2005 Annual Report.

Source: ShawCor Ltd.


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