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Edited Transcript of SCL.TO earnings conference call or presentation 9-Aug-19 1:00pm GMT

Q2 2019 Shawcor Ltd Earnings Call

ETOBICOKE Aug 19, 2019 (Thomson StreetEvents) -- Edited Transcript of Shawcor Ltd earnings conference call or presentation Friday, August 9, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gaston Alfonso Tano

Shawcor Ltd. - Senior VP of Finance & CFO

* Stephen M. Orr

Shawcor Ltd. - President, CEO & Director

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Conference Call Participants

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* Aaron MacNeil

TD Securities Equity Research - Analyst

* Elias A. Foscolos

Industrial Alliance Securities Inc., Research Division - Equity Research Analyst

* Greg R. Colman

National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst

* Maggie Anne MacDougall

Cormark Securities Inc., Research Division - Director of of Institutional Equity Research

* Michael Mazar

BMO Capital Markets Equity Research - Equity Analyst of Oil and Gas Services

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Shawcor's Second Quarter 2019 Results Webcast Conference Call. (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host, Gaston Tano, CFO. You may begin, sir.

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Gaston Alfonso Tano, Shawcor Ltd. - Senior VP of Finance & CFO [2]

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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 2019 earnings press release that is available on SEDAR and on the company's website at shawcor.com.

I'll now turn it over to Shawcor's CEO, Steve Orr.

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [3]

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Good morning, and thank you for joining us on this morning's conference call. Adjusted EBITDA in the quarter was $36 million, an increase of 28% over the first quarter of 2019. Revenue for the quarter was $412 million, 18% increase over the previous quarter. This quarter's results were supported by the addition of ZCL Composites, continued demand for girth weld inspection for both large diameter pipelines and international projects, increasing demand for pipe coating associated with large diameter land transmission lines and offshore lines and steady demand for heat shrink and wire and cable products.

In the quarter and as expected, we continued to have costs related to readiness of pipe coating facility needed for future work and to pursue projects. Western Canada remained very depressed and the first 2 months of the quarter experienced very low composite pipe sales.

In the quarter, 12-month backlog grew to $519 million that now includes ZCL Composites' booked orders and work secured beyond 12 months has grown solely due to pipe coating project wins. Also in the quarter, we generated about $70 million of cash from divest -- activities.

In last quarter's conference call, I stated that Shawcor's future success would be determined by our ability to execute on 3 priorities. The first was the real-time management and authorization of the book and turn businesses that make up much of our base business. The second was capturing our share of pipe coating work that will be awarded in the upcoming quarters and the successful operation of our coating facilities. The third execution priority was maintaining the capital discipline and taking the actions required to return the balance sheet to its historical strength.

We are pleased with what we delivered in Q2 2019 and the traction we have gained in all 3 of these priorities. I'll speak in more detail in a moment. But in summary, momentum in international and offshore spending is continuing, and the industry's efforts to reduce cost and bring certainty to project execution coupled with increased global demand for gas has increased the confidence that projects will be sanctioned.

North American onshore drilling completion activity continues to be uncertain due to takeaway constraints, and how our customers' recent focus on capital discipline will impact their spending. As a result of these 2 factors, we expect that Shawcor will see short-term volatility in quarterly results. The second half of the year will be an improvement over the first, and the expected results for the full year 2019 will be on par to 2018 before the consideration of the ZCL Composites acquisition.

Shawcor's diversified portfolio has been expanded beyond late cycle oil and gas pipe coating and has the potential to bring long-term stability, but it still has retained the potential torque and performance of the pipe coating business. With stability currently being demonstrated, we are looking forward to the future as pipe coating demand strengthens.

I'll now ask Gaston Tano, our CFO, to provide some details on the second quarter financial results.

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Gaston Alfonso Tano, Shawcor Ltd. - Senior VP of Finance & CFO [4]

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Thanks, Steve. As Steve mentioned earlier, the second quarter results were positive on several fronts. Consolidated revenue in the second quarter increased by 18% over the first quarter of 2019.

The pipeline segment revenues increased by 21% primarily due to higher revenues in North America, reflecting a full quarter impact from the acquisition of ZCL Composites and increased activity in large diameter pipe coating, girth weld inspection and engineering services. This was partially offset by lower demand in North America for small diameter pipe coating, flexible composite pipe and tubular management services due to softness in Western Canada and the capital discipline focus of E&P operators.

The quarter also benefited from higher levels of pipe coating activity in our facilities in the EMAR region, while revenues in Latin America and Asia were lower due to lower activity levels.

In Petrochemical and Industrial segment, revenues were lower by 1% primarily due to lower activity for our automotive heat shrink products, partially offset by higher demand for our wire and cable products in North America. Consolidated revenues in the second quarter of 2019 were also higher by 17% in the second quarter a year ago primarily due to the reasons mentioned earlier.

The pipeline segment revenues increased by 20%, reflecting higher revenues in North America from the full quarter impact from the acquisition of ZCL Composites and the increased activity in large diameter pipe coating and girth weld inspection services. This was partially offset by lower demand in North America for small diameter pipe coating, flexible composite pipe and tubular management services due to the softness in Western Canada and the capital discipline focus of E&P operators.

The EMAR region experienced higher levels of pipe coating activity, while revenues in Latin America and Asia were lower due to lower activity levels.

Revenues for petrochemical and industrial segment decreased by 1% compared to the prior year second quarter primarily due to lower revenues for our automotive heat shrink products, partially offset by higher demand for our wire and cable products in North America.

Consolidated gross margins for the second quarter were 28.5%, higher than the 28.1% reported in the first quarter of '19, but lower than the 32.2% reported in the second quarter a year ago. Despite the negative impact from the inventory revaluation related to the ZCL acquisition, the pipeline segment gross margin for the second quarter was 28.5%, higher than the 27.9% in the first quarter of '19 due to higher facility utilization in North America, Latin America and EMAR regions driving -- driven by increased large diameter pipe coating activity and the positive start of execution of Liza II project in our Veracruz facility.

Compared to the 32.8% reported in the second quarter of 2019, the pipeline segment's current quarter volumes were lower due to lower large project load out activity in Latin America, lower facility utilization in Asia Pacific and a negative impact from the inventory revaluation related to the ZCL acquisition in the current quarter.

The Petrochemical and Industrial segment gross margin was 28.1%, lower than the 29% in the first quarter of '19 and below the 28.7% that was reported in the second quarter a year ago primarily due to unfavorable product mix. Although we expect to continue to incur costs to maintain idle assets, reactivate plants and pursue large projects, consolidated margins in the second half of 2019 are expected to improve at a similar pace as the first half as higher pipe coating activity in international and offshore markets positively impact facility utilization.

The current quarter results were impacted by several nonrecurring items outside the company's normal course of business. Positive items include the gain of $33 million on the sale of land in Edmonton, a $10 million gain on the redemption of investment in associates. This was partially offset by ZCL acquisition costs and related items of $12 million and a loss of $1 million related to the hyperinflationary accounting for Argentina.

Excluding these items, adjusted EBITDA for the quarter was 36%, 28% higher than the $28 million reported in the first quarter of '19. This increase reflects the higher revenues discussed earlier, which includes the recently acquired ZCL business. Excluding the impact from the ZCL acquisition costs and related items, the current quarter was negatively impacted by an increase in SG&A primarily due to the addition of ZCL's ongoing SG&A expenses and higher costs for warranty, decommissioning and equipment.

Adjusted EBITDA for the quarter was slightly lower than the $37 million reported in the second quarter of 2018. This decrease is primarily due to higher foreign exchange losses in the current period, higher SG&A expenses primarily due to the addition of ZCL's ongoing expenses, partially offset by higher gross margin from higher revenues, albeit a lower gross margin percentage compared to a year ago and the positive impact from the adoption of IFRS 16 in the current quarter.

Let's now discuss cash flows for the quarter. Before changes in noncash working capital, cash flow provided from operating activities for the second quarter is $19 million, in line with $19 million from operating activities in the first quarter of 2019. This reflects higher net income in the current quarter, which was entirely offset by a change in noncash items and asset sales.

Compared to the $25 million as provided from operating activities in the second quarter a year ago, the current quarter is primarily down due to the change in noncash items and asset sales in the quarter, partially offset by higher net income. The change in noncash working capital in the second quarter was a net cash outflow of $40 million compared with an outflow of $1 million in the first quarter of 2019 and an inflow of $3 million in the prior year period.

The $40 million cash outflow from working capital in the current quarter is primarily due to higher accounts receivable and unbilled revenue and lower accounts payable and other liabilities, partially offset by an increase in contract liabilities, representing advanced project payments received in the quarter.

Cash used in investing activities in the second quarter was $225 million primarily due to the $291 million that was used to acquire ZCL Composites, partially offset by $69 million of proceeds generated in the quarter from the sale of land in Edmonton and the redemption of investment in associates.

During the second quarter, cash provided in financing activities was $271 million, reflecting borrowings to fund the ZCL acquisition, net of debt repayments made in the quarter and the payment of lease obligations in our regular quarterly dividend. Net cash flow for the second quarter of 2019 was positive $25 million compared to a negative $119 million in the first quarter of '19 and negative $7 million a year ago.

With respect to the balance sheet, our financial position at the end of the quarter remains positive. The company's cash and short-term investments increased during the second quarter to $122 million. The increase is primarily related to the proceeds of $69 million from the sale of land and the redemption of investment associates, partially offset by debt repayment of $40 million made in the current quarter.

Noncash working capital at the end of the second quarter was $228 million, up from the $154 million at the end of the first quarter of 2019 primarily related to the acquisition of ZCL and the investment in working capital to support business growth.

With respect to debt, the company is in full compliance with its debt covenants and has long-term debt of $474 million and $31 million of standard letters of credit as at June 30, 2019. With the new facility in place, the company has available unutilized borrowing capacity of over $270 million at the end of the quarter.

I'll now turn it back to Steve for some additional commentary on the company's performance and outlook.

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [5]

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Thank you, Gaston. In the second quarter of 2019, adjusted EBITDA was in line to where management had forecasted. The quarter was positively impacted by the addition of ZCL Composites and increased demand for our products and services associated with large diameter transmission lines in North America.

Our businesses that delivered pipe coating, weld -- girth weld inspection and consulting services, all experienced solid demand. Also positive in the quarter was the increase in activity related to offshore projects such as Liza II, which was started in our Veracruz facility, and several Gulf of Mexico projects that are now being executed in our Channelview facility.

In the quarter and as expected, we continue to have costs related to the pursuit of projects and plant readiness. However, the focus is now swinging to Asia and EMAR regions in anticipation of the next round of project awards.

On the negative side for the quarter was the continuation of a very depressed activity in all our drilling completion-related businesses in Western Canada. This includes small diameter pipe coating, composite pipe and tubular inspection repair and management.

As I highlighted in the last conference call, we were seeing indications that composite pipe sales into the U.S. onshore primarily the Permian, could be soft. Indeed, this is what happened as customers turned to using inventory that they had on hand and staying within planned budgets rather than placing new orders in the first 2 months of the quarter.

Demand for heat shrink and wire and cable products remained steady quarter-on-quarter with lower demand in automotive, being offset by higher demand in the industrial markets. We do expect the second half of 2019 will be stronger than the first half, and we are forecasting that adjusted EBITDA for 2019 will be on par with 2018 results without consideration of the ZCL acquisition. The largest factor in the inspected -- expected improvement in the second half of the year is the increase in activity in our pipe coating businesses. However, management's forecasts for the full year does have risk as project timing and North America customer spending uncertainty adds volatility and can result in lower quarterly performance than expected.

Shawcor's expanded portfolio and the resulting diversity brings a level of stability through weighting in both oil and gas early and late cycle and participation in multiple markets that now have been extended through ZCL to include retail fuel and water and wastewater.

Our strategy was to leverage our core strengths of material science, execution and global access to diversify and bring stability to the company. This stability has provided the support needed to weather a very long cycle and will be critical for future cycles. But as important, it has allowed us to invest to maintain and enhance our differentiated positioning, a position that will ensure we participate in the growing international and offshore E&P capital spending through our pipe coating offering.

With a diversified portfolio in place and line of sight of a material swing in our pipe coating business, 2019 and future years will be determined by our abilities to execute on 3 priorities. The first priority is the real-time management and planned optimization of our book and turn business that makes up our base business. Fluctuation in activity levels are a constant challenge to manage and require a combination of quick tactical measures and longer-term repositioning.

Shawcor's approach to managing fluctuations in activity involves both individual business and cross-business aspects. An example of this was the management of the softness in composite pipe sales experienced in Q2. Once this softness was recognized, the composite business quickly reassigned sales resources to the highest potential opportunities, rebalanced manufacturing output against inventory levels and the new demand forecast and made the plan visible across the company.

All businesses across the company then relooked at their resource planning and it was determined that our Canusa facility, which was experiencing a rush of international orders, could benefit from a short period of additional shifts if it had access to trained hourly staffing. A plan was put into place to temporary move resources. And although the net result did not make up the shortfall, it assisted in limiting the impact. An example of longer-term repositioning is the decision we have made to adjust our footprint in Western Canada to better serve our customers with a more efficient and lower cost footprint.

In Q2, we closed the sale of our Edmonton property that was dedicated to small diameter pipe coating. The property was acquired in 1981 and had appreciated due to its residential development value. Shawcor currently services the Western Canadian pipe coating market from 4 coating facilities, all on owned land. The sale of this property is just one piece of repositioning that will see Shawcor relocate capabilities in Western Canada to a more efficient footprint that will include the latest technology and workflows, which are not possible from the current configuration of multiple aged locations.

An additional part of this priority is extracting value from the integration of the ZCL Composite business. We are doing this by ensuring that the base business is not disrupted during the integration and by delivering on costs and revenue synergies. One quarter into the integration has shown very positive results, and we are pleased by the progress already made. A foundation for our progress has been the similar cultures between ZCL Composites and Shawcor, which has resulted in excellent alignment on business priorities and direction. As a result of this alignment, there has been no loss of a key customer or unplanned loss of critical talent. Overall business performance in ZCL after one-off adjustments was similar to Q2 2018 for revenue and backlog with margins seeing improvements due to a combination of improved pricing, product mix and higher manufacturing labor efficiency.

In terms of cost synergies, the target remains at $8 million of cost savings on an annualized run rate by the end of the first year. At the end of this quarter, we had secured 70% of the target or $5.6 million. The target for revenue synergies is $35 million of annualized revenue per year by the end of year 3. This quarter, we have seen the quickest traction as we expected in the oil and gas segment with over $3 million of orders related to sump tanks for the midstream pipeline space on projects such as LNG Canada, Gray Oak, Trans Mountain and Line 3 replacement. We continue to remain confident that we will also capitalize on expanded revenue opportunities in water and wastewater and the fuel segments.

The second priority is winning and flawlessly executing pipe coating projects. For some time, we have been messaging the expectation that the demand for pipe coating would increase and that it would be supported by increased activity in the offshore, the supply and demand gap for LNG and the building of large diameter land transmission lines in North America.

In Q2, our composite increased as we saw continuation of project sanctioning in the offshore and the growing acceptance of the model where larger scopes of work are awarded to EPCs that often linked pre-FID engineering work with the procurement and construction that happens post FID. In support of our projected improvement in offshore activity was the record level of incoming orders subsea equipment suppliers booked in the quarter.

Adding to our confidence was the LNG decisions in the quarter that have moved projects forward as gas becomes the preferred energy supply and advancements in LNG technologies unstranding vast reserves needed to meet global demand.

In the quarter, we also experienced increased demand for large diameter pipe coating as a result of investments we made to address takeaway constraints in North America. Of note, this quarter showed the first indication that offshore E&P operators are looking beyond today's list of projects and starting to return to exploration as several service companies commented that they are sold out of formation evaluation services that are used in exploration activities.

Although management roughly estimates overall 2019 project sanctioning has moved 3 to 4 months to the right, there is no question projects are moving forward. And like this quarter, coating awards will continue.

With respect to booked orders, the backlog at the end of Q2 2019 was $519 million, which includes ZCL Composites, but does not include secured orders beyond 12 months. ZCL Composites backlog was similar to Q2 last year and secured orders beyond 12 months stepped up solely due to booked pipe coating work.

Bid and budgetary remains at a very high level with more than $2.7 billion of visible opportunities globally. The amount that Shawcor has secured but is pending project final investment decisions remains at over $150 million and is captured in our bid.

Shawcor continues to position for future pipe coating work with investments being made to see that Shawcor is selected as the coater of choice. These investments were behind why we're able to bring our Veracruz facility online at bid margins on the Liza II project in the quarter. It is also why we can secure multiple projects with EPCs that will be delivered from several facilities in one package.

In upcoming quarters, our investment will continue with a focus on visible projects that are near decision points in our Asia and EMAR regions and technology developments. Technology developments are focused on the enablement of longer offshore tiebacks, expanded operating envelopes and total workflow traceability and are structured in collaboration with our customers.

The third and final priority pertains to the actions we are taking to strengthen the balance sheet after the acquisition of ZCL Composites. Emphasis is being placed on the management of working capital and capital expenditures in all areas. We are also taking actions on Shawcor's assets that have been determined as noncore or long-term dilutive, where we have divestment opportunity. An example of this is the $29 million of cash that was received from our Zedi investment related to the initial dividend from the sale of their data management business.

Our original strategy of owning minority share in Zedi was to gain access to a technology block and ensure the block was sustainable. Since our original investment in Zedi, we have built competencies in areas that support continued advancement in data enablement across the company, including Lake Superior Consulting. Our analysis of current and future needs supported the sale and the cash generated was used to reduce our debt leverage.

Before we open up to questions, I would highlight, like I have done in past calls and our AGM, the following points on why investors should consider owning Shawcor. Shawcor's expanded portfolio is diversified and has the potential to be supportive throughout the cycle. There is an expectation that Shawcor's core business of pipe coating will see a substantial increase in activity in the near future and that this activity will continue for several years. And finally, Shawcor's alignment with strong fundamentals has the company well positioned for the long term.

I'll now -- we'll turn the call over to the operator to open it up for questions that you may have for Gaston and I. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Aaron MacNeil from TD Securities.

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Aaron MacNeil, TD Securities Equity Research - Analyst [2]

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First one, your outlook implies some confidence in transitioning the $150 million of previously disclosed large project bids into the backlog. And I guess I'm wondering, does any of the recent weakness in commodity prices change or impact your expectations for those projects or other upcoming FIDs? And do you expect -- or do you expect that your customers will take a longer-term view?

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [3]

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So I think -- and I'll speak specifically to the work that we have secured that is pending FID. So I'll speak to that specifically. And I think, Aaron, that's what you're referring to is the greater than $150 million that we have, contractual agreements that we are the pipe coater of choice, but the project has to move ahead. Is that correct?

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Aaron MacNeil, TD Securities Equity Research - Analyst [4]

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Yes.

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [5]

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Okay. So I think there's 2 factors to consider. So certainly, the commodity price is important, but probably the most -- to narrow it even further is really around the long-term contracts particularly in the offshore Australia, Asia Pacific region that are tied to the oil price versus the delta to the spot price. I think that is a concern. And we -- and I think in the economics for the operators for the LNG projects to go ahead, those are the ones that we're kind of waiting for. The confidence is that the big delta in spot price and the long-term contracts have been there for a couple of quarters, and we're seeing LNG projects go.

The second one, which I don't know -- and I can't really put a percentage or likelihood on it is geopolitics. Some of the projects that are in the secured, but pending FID are in international geographies, often in emerging economies that -- whether it be governmental elections or the possibility of retrading -- the government working to retrade with the operators on the commercial agreements on the assets are something we don't have any control of and often control an FID several quarters later. So those are the 2 that I would -- that we're watching.

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Aaron MacNeil, TD Securities Equity Research - Analyst [6]

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Okay. That's helpful. And could you give us a bit more of a detailed update on how your composite product lines are faring, particularly in the U.S., given your customers' disciplined capital spending? And I guess how long do you think your customers' inventory draw will last? And are you still expecting continued market share gains versus steel? Or are your customers gravitating back to cheaper steel products?

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [7]

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Okay. So our composite business now includes what I would say is storage and transport. So first, we'll talk about the tanks. The tanks, we've been pretty clear that it's similar to what ZCL delivered prior quarter last year. So still strong demand for the fuel business. It's a steady business with a replacement cycle. The only volatility really in the business is around weather and can they actually get the tank in the ground. So it's -- we see no impact from the capital spending of our customers. In fact, because we're trying to use our distribution channels and as I demonstrated in the prepared remarks, we're gaining traction on oil and gas for our tanks.

For the pipe business, we had a complete pullback for 2 quarters, so very -- 2 soft quarters of piping. Those -- not 2 quarters, so 2 months in the quarter. We were very successful in selling pipe in 2018. The overhang on inventory in the customers, I think it was a quick calibration where they realized the pipe they had on the ground versus what they needed in the budget. And so they stalled the spending in the first 2 months of the quarter, but the spending has now returned the last month. And it wasn't as bad as we first anticipated it could have been.

We're forecasting Q3 will be fine, but it's a book and turn business. So we don't live off a backlog. So it can swing very quickly. What we do track though is we manage the number of reels that go into the field, the number of wells completed and the kilometers of line needed both off the wellhead and for produced water. So we expect that we will be somewhat buffered from the decrease in rig count that happens. And we are a needed part of the capital spending to maintain production. So certainly, we will see some softening if they pull back. But in our forecast, we're expecting to see the same run rate that we had in the final month of the quarter throughout the year. But it is a function of what infrastructure they're building and what pipe they have on the ground. But inventory took a big draw in the second quarter, and it was an inventory that was built out from '18.

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Aaron MacNeil, TD Securities Equity Research - Analyst [8]

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Okay. That's really helpful. And you touched on this one a bit on your prepared comments as well, but how are you thinking about your Guardian service line or your other Canadian energy-weighted businesses in the context of a pretty challenging outlook over the longer term? You obviously sold the small diameter pipe coating facility in Edmonton. But could we expect to see more rationalization of your Canadian footprint in the near future?

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [9]

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Yes. To be clear, we're doing it for 2 reasons. The first reason is, it just makes a lot of sense to consolidate our footprint to deliver a more efficient delivery to our customers. And in several of our cases, both Guardian and in our pipe coating, we have facilities that do, for example, 34th Street that we just sold, did just small diameter. We have other facilities that will do small diameter and large diameter and new Guardian, we have some facilities that do machining, some facilities that do inventory. And so we want to consolidate for the site. So the sites will do more than 1 of the service lines. So in Guardian, it doesn't make any sense to do the inspection, the management, but then have another site to do the machining. So what we're going to do, just like we're doing with the small diameter, you can anticipate, we will exit sites, but we're not exiting the market. We're just putting it on 1 footprint. And in some cases, we will spend capital to increase the storage of pipe in the facilities that we move to, to accommodate the additional lengths of pipe that are there that we need now and for the future market. But to answer your question, Guardian, you will see movement to op of property and a consolidation.

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Aaron MacNeil, TD Securities Equity Research - Analyst [10]

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Okay. And obviously, you made some great strides in the quarter on deleveraging the balance sheet. But can you maybe quantify the other potential opportunities for Guardian or your other noncore assets globally to further reduce leverage?

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [11]

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I'll make a clear statement. We're not considering the sale of Petrochemical and Industrial. That's been asked multiple times. And we will continue to see one-off cash coming from the divestures, but I think this quarter was exceptional.

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Aaron MacNeil, TD Securities Equity Research - Analyst [12]

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Okay. Makes sense. And last one for me. Can you provide any additional details on the $12 million of transaction costs related to the ZCL acquisition? And I guess specifically, how much of that cost would have been related to achieving the synergies target that you disclosed? And can we expect more onetime costs in the next couple of quarters as you work towards achieving the remaining 30% of that synergy target?

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Gaston Alfonso Tano, Shawcor Ltd. - Senior VP of Finance & CFO [13]

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Yes. So the 12 -- so the $12 million cost basically represents costs that we pay for fees to investor banking fees, banking fees and then includes a significant portion related to the integration. So about $8 million of that is in the integration costs that we have. In the -- in related to getting those synergies on the cost side, a good chunk of it is related to severances. And then we also have about a $4 million impact related to gross margin, which is the revaluation that's required with the ZCL purchase price accounting. So there will be a little bit more of that in the third quarter as we flow through that inventory. And there should be some smaller costs, but the majority of the costs that we've achieved, or that we've incurred to date will be -- they won't be that significant going forward. So most of that's been done.

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Operator [14]

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And our next question comes from Greg Colman from National Bank.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [15]

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Congrats on the backlog growth there, gentlemen, and the solid quarter. I wanted to start on that backlog of the $519 million. And I think I might have missed this, so I'm very sorry if I did. How much of that was attributed to the inclusion of ZCL? Is it materially different from the $41 million that ZCL had reported as a backlog at the end of 2019? Or '18 rather?

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [16]

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Yes, it's -- the number was higher, I believe, Greg, if you look at it in Q2, but it was similar.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [17]

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Got it. And then Steve, in your prepared remarks, you talked about how you define backlog. I just wanted to dive into that a bit. How -- do you have any awarded work that is in excess of the $519 million, but stretches out beyond the 12 months? Or is that all you have, that $519 million?

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [18]

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So as I made in my prepared remarks, so the backlog is 12 months' outlook. In the quarter, the work that we secured, increased the work that extends beyond the 12 months, so stepped up. And I think you -- a good way to look at it is we made a recent announcement of a consolidated group of projects with 1 APP. About 50% of that extends beyond 12 months.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [19]

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Would you be willing to quantify in dollar amounts the awards you have been given that aren't conditional, that stretch out beyond the 12 months, i.e., if someone was to define a backlog differently, what would the backlog look like if it stretched out 24 months?

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Gaston Alfonso Tano, Shawcor Ltd. - Senior VP of Finance & CFO [20]

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So I think that's what Steve just mentioned, Greg, if you look at the recently announced bundle of awards that we got with EPC, about 1/2 of that is beyond 12 months.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [21]

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No problem. That's helpful.

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Gaston Alfonso Tano, Shawcor Ltd. - Senior VP of Finance & CFO [22]

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So kind of give you a magnitude right there.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [23]

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Got it. On the bid book, $1.1 billion of active bids, your historic win rate, which we think, and I'm not putting words in your mouth here, but we think it's around 50%. Is this a reasonable place to be thinking of for what you consider to be a good risk-weighted approach to those bids? Or is there any reason that your win rate would be materially higher or lower than your historic average?

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [24]

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The only caveat I'll put in this time, Greg, is normally the bid would be risk on, number one, are we the pipe coater of choice? And number two, does the project go ahead? I believe the bid now is less risky because for over $150 million of that bid, we are the coater of choice. So if the project goes, we will get the work. And so I think we're going to have to wait and see how the historical win rate changes versus the go-forward with this new model, right? I think we'll have to wait to see. We're pretty excited about our positioning and the foresight that we had to start preparing facilities so that we could secure work pre-FID because this was a new model this time, right? So to get a plan qualified, so that we are the coater of choice before FID, it requires a decision to invest, right?

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [25]

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Got it. That makes sense. Sort of staying on that, but moving over to one of the plants that you activated in the quarter. How much of the Liza project was captured in Q2? I mean I guess I'm trying to figure out did the Veracruz facility come on all quarter? Or halfway through? Or 2/3 of the way through? I'm getting pickier, but I'm basically trying to determine if there's a lift in the back part of the year, simply with these being a full quarter.

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [26]

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Not material, low single digits of revenue. So it came on the last -- the last part of the quarter. The excitement around Liza is we don't normally turn on facilities from scratch, or from extended period of time being idle at bid margins for a project. Normally, the project progression on margins is we actually have a very rough time usually at the beginning as you get the momentum of the plant, and then you make it up at the end. This model and Liza was one of the examples of a project that we secured, pending operator sanctioning. We turned the plant on in the last of the quarter, and the low volume of revenue went through. We brought it up to full staffing almost overnight and it delivered margins that were online with what we did. This is exceptional. We haven't done this before. So to answer your question, low revenue, single-digit but very acceptable margins for a start-up of a new facility at the bid price.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [27]

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Got it. And we should see full quarter contribution for the back half of the year?

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [28]

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Yes. Yes, so we finished (inaudible)? Yes. Yes. So Liza will be with us for the remainder of '19.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [29]

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Excellent. And then just on the debt. We've had a lot of questions on that. I think you're doing great things to address that. And you've talked about your comfort levels of debt. With the closing of ZCL, and with your guidance for the back part of 2019, which I'm kind of doing a little bit of "reading of the tea leaves" here, but I think it's around $160 million being 2018, EBITDA plus 3 quarters of ZCL plus synergies. Do you have a target debt-to-EBITDA ratio that you anticipate being at by year-end when you think about likely asset acquisitions, your likely EBITDA, even though it's a moving target, that we could just kind of circulate around? And I don't want to pin you down a specific number, but at least a range you're targeting.

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Gaston Alfonso Tano, Shawcor Ltd. - Senior VP of Finance & CFO [30]

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Yes. So I think we'll be at similar levels for the end of the year. There'll be some pluses and minuses, but we're talking about tens of millions, Greg. But really what we keep talking about is that we believe -- we continue to believe that by the end of 2020, that we'll be down to our targeted net debt level of leverage of 1.5x, which will both be an expansion of lower debt level and expansion of EBITDA in the business. So that's really what we're targeting right now. But I don't expect significant amounts of debt repayments occurring this year. And Steve already talked about that the proceeds that we received this year were exceptional, and we -- we're not expecting that kind of levels, another in a single-digit of millions of dollars of proceeds that we can get from other assets, plus just cash generation from the normal business.

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Greg R. Colman, National Bank Financial, Inc., Research Division - MD and Energy Services & Special Situations Analyst [31]

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Got it. Gaston, sorry, that ratio you mentioned that 1.5, that was by the end of 2020?

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Gaston Alfonso Tano, Shawcor Ltd. - Senior VP of Finance & CFO [32]

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Correct.

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Operator [33]

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And our next question comes from Mike Mazar from BMO Capital Markets.

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Michael Mazar, BMO Capital Markets Equity Research - Equity Analyst of Oil and Gas Services [34]

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Just 1 quick one here. We got the purchase price allocation with regards to ZCL. There's about $190 million, almost 2/3 of the purchase price allocated to intangibles. For those of us who never covered SCL, can you kind of walk us through what's in that number? And then what it is you bought like -- or what it is, specifically, that was attributable to intangibles?

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [35]

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Yes. So there's -- basically sorry, there's 3 buckets of intangible. This is all accounting driven, Michael, and figuring out how you allocate and the 3 key buckets for the intangibles over and above just regular goodwill are in related to customer relationships primarily as a result of the retail fuel side, which is a business that we don't have experience in. So you do a calculation for the value there. We also did a value calculation for technology that we have purchased as part of the ZCL acquisition, technical know-how, plus the core material that we use for building our tanks, which is a paraben, 3D woven fabric that we use to create a dual wall in our tanks and it is part of the UL and ULC certifications. And then finally, is also the air permits that we have to use in our facilities in the U.S. that are grandfathered and have -- and have significant value and a barrier to entry for the business. So those are the 3 key components of intangibles beyond (inaudible).

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Michael Mazar, BMO Capital Markets Equity Research - Equity Analyst of Oil and Gas Services [36]

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Okay. So just for those of us that you said...

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [37]

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I'm sorry, 1 other -- I'm sorry, and one more there. I forgot, is also brand, which is basically the ZCL and Xerxes brand. But Michael, I just want to reiterate, this is an accounting kind of price allocation. It's not necessarily an accurate thing that we could sell off these things to someone else at these values. It is just a valuation perspective of what you purchase when you purchase a company and what is remaining value for goodwill.

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Michael Mazar, BMO Capital Markets Equity Research - Equity Analyst of Oil and Gas Services [38]

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Yes, of course, I understand. I guess with the customer thing, is it based on sort of contracts or something like you said there's a [calculation].

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [39]

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No. It's just revenue. And then just what you would pay a distributor -- somebody to get you those contacts or a distributor percentage of that. It's very room entry. It's not -- it's nothing to go with contracts as it is today, but it does look at the stability of revenue in that market, and that was one of the reasons why we bought this company, and the stability of the customers and the [resurgence] of their business.

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Operator [40]

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And our next question comes from Elias Foscolos from Industrial Alliance.

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Elias A. Foscolos, Industrial Alliance Securities Inc., Research Division - Equity Research Analyst [41]

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A question related to the SG&A and ZCL. I just want to make sure I've got this correct. Should we be looking at a run rate basis at some point in time, taking $12 million off your Q2 number? Does that seem correct?

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Gaston Alfonso Tano, Shawcor Ltd. - Senior VP of Finance & CFO [42]

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No, it's actually -- it's, Elias, as I mentioned earlier, of that $12 million, $4 million is a revaluation of the acquired inventory from ZCL. So that's in gross margin. So really, what you should be taking is our reported number of $88 million minus $8 million to get us to around $80 million on a normalized basis or low 80s and expectation that we have for Q3 and Q4 of this year.

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Elias A. Foscolos, Industrial Alliance Securities Inc., Research Division - Equity Research Analyst [43]

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Okay. Just diving on to the 2019 kind of guidance that you're providing. Is your 2019 number inclusive of IFRS 16? I'm just trying to calibrate, excluding, of course, you've been very clear on excluding ZCL, but I wanted to know about that portion.

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [44]

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Yes. So it's on a reported basis. So it includes the adoption of IFRS 16 in the current year.

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Elias A. Foscolos, Industrial Alliance Securities Inc., Research Division - Equity Research Analyst [45]

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Great. I don't consider ZCL business to be pipeline or pipe services. Do you plan on re-segmenting at some point because there's probably a lot of industrial now in that segment?

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [46]

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No, we committed, like we committed, and we were very clear at the AGM when we knew that the ZCL will be part of the company. We will segment report ZCL and our composite business as one.

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Elias A. Foscolos, Industrial Alliance Securities Inc., Research Division - Equity Research Analyst [47]

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Okay. So no expectation that, that will change any time -- no expectation it will change, period.

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [48]

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Oh, no. We will pull out. We will have 3 segments within the company on the fourth quarter.

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Elias A. Foscolos, Industrial Alliance Securities Inc., Research Division - Equity Research Analyst [49]

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Okay. By Q4. Thanks. Sorry about that. Last thing, this hasn't been mentioned in a while. So I'm interested in an update on the Saudi joint venture. Is that still progressing? Or have there been some delays?

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [50]

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So I think several calls ago, we gave visibility that our intention and our goal is to target first revenue in 2019. That's unlikely. So what we've decided to do is we've gone ahead, and we've secured the land, and we're doing civil construction and the building erection now. We have moved the capital that we spent online, and we're receiving the lines now in Canada to assemble them. But we have waited until we finished the testing in North America and the installation in North America of larger diameters, global product, and then we will go ahead with the final construction of the lines in Saudi. So it now becomes a 2020 event.

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Elias A. Foscolos, Industrial Alliance Securities Inc., Research Division - Equity Research Analyst [51]

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Okay. So that's been pushed out a bit from what I thought would have been Q4 '19?

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [52]

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Yes. And it's primarily from the realization that as the plant comes online, our 4-inch product does not really address the true potential of the market, and we need to move to a larger spoolable. It doesn't have the same transportation limits that we have in North America. So you can put larger spools and larger diameter pipe spools. So actually, today is a good day for us, as it's quite exciting. We pushed and did our first field test of our 5-inch spoolable product into the market in a Canada operator. So we will do this first and then in 2020, we will commission the plant primarily to build larger diameters spools with sort of 4 and 5 inch.

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Operator [53]

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(Operator Instructions) And our next question comes from Maggie MacDougall from Cormark.

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Maggie Anne MacDougall, Cormark Securities Inc., Research Division - Director of of Institutional Equity Research [54]

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A lot of my questions have been answered by you guys already. So I'll just keep it simple, and I apologize if you answered this. I jumped on after your prepared remarks, but I'm curious, we've talked about a drag from pipe coating of about $15 million per quarter the last several calls, and interested to know if that is still the case? Or if it's narrowed a bit in recent months.

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [55]

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No, we -- I think that's a very good estimate on what we're going to spend in the upcoming quarters, we'll say at around the $15 million mark.

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Operator [56]

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And I'm not showing any further questions at this time. I would now like to turn the call back to Steve Orr, Shawcor's CEO, for any further remarks.

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Stephen M. Orr, Shawcor Ltd. - President, CEO & Director [57]

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I'd like to thank everybody for joining us this morning, and I know our call was earlier than usual, so for making the time. It's very much appreciated, and we look forward to talking to all of you next quarter. Thank you.

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Operator [58]

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Ladies and gentlemen, thank you for your participation in today's conference. This does conclude today's program. You may all disconnect. Everyone, have a great day.