Fuel. Water & Wastewater. Industrial. Oil & Gas. Financial Report First Quarter 2017

Transcription

1 Financial Report First Quarter 2017 Water & Wastewater Fuel Oil & Gas Industrial

2 Message to Shareholders-Q Q1 Summary- As ZCL enters our 30 th Anniversary year, we remain optimistic about our future. Although 2017 is off to a seasonally slow start, caused in part by poor weather conditions in large parts of North America, we remain reasonably confident that for the full year we will achieve our 2017 objectives. As we have shared in the past, our 10/10/10 objective for achieving minimum 10% Compound Annual Growth Rates (CAGR) in revenues, earnings, and our dividend, all while being responsible stewards and prudent allocators of capital, forms the foundation for our long term strategy. However, ZCL operates in markets that lead to seasonal variation in our revenues, with the first quarter of every year being the slowest quarter in terms of both revenue and earnings. Given that our products are used primarily in projects dealing with underground construction and installation, we can be subject to even greater seasonal variation when poor weather conditions impact construction projects that use our products. This was the case in the first quarter of 2017, especially when it is compared with the very strong performance during the same period of ZCL achieved earnings of $0.05 per share in the first quarter of 2017 before the impact of US withholding taxes on the repatriation of cash, which is notable because positive first quarter earnings were not always achievable in the past. The successful restructuring of our business over the past five years has enabled ZCL to report 24 consecutive quarters of profitability, and we see that trend continuing. Capital Allocation- The 50% increase in our quarterly dividend, from $0.08 per share to $0.12 per share, and the Special Dividend of $0.65 per share, have demonstrated ZCL s commitment to sharing our success with shareholders. We are being responsible stewards and prudent allocators of capital, investing in profitable growth opportunities whenever possible, but also use our dividend to reward shareholders for their support of ZCL. Fuel Markets- Our 2017 outlook for the Fuel Markets remains positive. All signals, including feedback from our customers across North America, indicate that we should achieve our growth expectations for the year. In particular, activity in Canadian Fuel Markets is at the highest levels we have seen in several years. This high level of activity in Canada is being led by sales to independent fuel retailers through our distribution network. In addition, we are seeing an increase in the number of orders from major oil company fuel retailers in Canada. This upward trend is particularly encouraging after a couple years of slower sales to this retail group due to reduced capital spending in response to the drop in commodity energy prices. Retailer consolidation in the Fuel Markets continues. Numerous transactions have been announced or are in the process of closing, and multiples being paid for retail sites have been described as pricey according to Oil Express, a retail fuel industry newsletter. This consolidating activity indicates Fuel Markets retail assets continue to be attractive to consolidators looking to grow their market share. Among the larger deals are 7-Eleven recently acquiring the US retail assets of Sunoco, Couche-Tard acquiring CST s US retail assets operated under the Valero brand, Brookfield Partners LP acquiring Loblaw s gas station business and Parkland s acquiring both Chevron Canada s downstream fuel business and CST s Canadian retail assets operated under the Ultramar brand. Also, in 2016, Imperial Oil completed the sale of its Esso branded Canadian retail sites to a group of buyers including Couche-Tard, 7-Eleven, Parkland, Harnois 1

3 Group petrolier, and Wilson Fuels. ZCL is the sole source supplier of underground fuel tanks for virtually all of the Canadian and many of the US acquiring companies in these transactions. Industry consolidation can sometimes lead to slower spending by the acquiring firms in the short term as retailers rationalize their new holdings. However, we do not expect these transactions to materially impact our 2017 results either positively or negatively. Retail consolidation is positive for ZCL over the long term as the acquiring companies are committed to retail fuel and will continue to invest in their retail network assets as they execute their growth strategies. In the US, cash flow continues to improve for Convenience Stores. C-stores control the majority of retail fueling, selling over 80% of retail fuel in the US according to the National Association of Convenience Stores (NACS). US fuel sales volumes were up 2.6% year over year and C-stores saw record in-store sales of $233 billion. According to several industry publications, C-store operators continue to have a positive outlook for their business going into Water & Wastewater Markets- Similar to our outlook for the Fuel Markets, our market intelligence and customer feedback give us reasonable confidence that we will meet our 2017 growth objectives in the Water & Wastewater Markets. According to several industry sources, the outlook for construction spending on both the residential and non-residential fronts is positive. While municipal spending on water projects is expected to decelerate later in 2017 and into 2018, the industrial, institutional, and commercial construction sectors are forecast to return to growth. This, along with our strong sales pipeline, supports our expectations for a return to growth for our Water & Wastewater Markets group in Oil & Gas/Industrial Markets- As noted above, the Oil and Gas and Industrial sectors continue to bounce along the bottom in terms of new capital investment. While we do see some green shoots emerging in terms of spending in these sectors, they are substantially below the spending levels prior to the commodity energy price crash. We are getting some maintenance and replacement orders from the existing installed Oil and Gas infrastructure base in Western Canada, but we do not expect these sectors to be an area of growth for ZCL in I want to thank all of our stakeholders for their continued support of ZCL and we hope to see many of you at our Annual General Meeting of Shareholders on May 4, 2017, in Edmonton. Sincerely, Ronald M. Bachmeier President & CEO, Director 2

4 Management s Discussion and Analysis Management s Discussion and Analysis INTRODUCTION ZCL Composites Inc. s ( ZCL or the "Company") Management's Discussion and Analysis ("MD&A") of the results of operations, cash flows and financial position as at March 31, 2017, should be read in conjunction with the Company s unaudited interim condensed consolidated financial statements and related notes for the three months ended March 31, 2017, and the MD&A and audited consolidated financial statements for the year ended December 31, The statements are available on SEDAR at or the Company s website at The Company s interim condensed consolidated financial statements are prepared in accordance with International Accounting Standard ( IAS ) 34: Interim Financial Reporting. The notes to the interim consolidated financial statements are condensed as they do not include all of the information required in the annual consolidated financial statements. All figures presented in this MD&A are in Canadian dollars unless otherwise specified. Forward Looking Statements This MD&A contains forward looking information based on certain expectations, projections and assumptions. This information is subject to a number of risks and uncertainties, many of which are beyond the Company s control. Users of this information are cautioned that actual results may differ materially. For additional information refer to the Advisory Regarding Forward Looking Statements section later in this MD&A. Non IFRS Measures The Company uses both IFRS and non IFRS measures to make strategic decisions and to set targets. EBITDA, adjusted EBITDA, adjusted EBITDA per diluted share and working capital are non IFRS measures that are used by the Company. They do not have a standardized meaning prescribed by IFRS and may not be comparable to similar measures used by other companies. For additional information refer to the "Non IFRS Measures" section later in this MD&A. This MD&A is dated as of May 3, CORPORATE PROFILE ZCL is North America s largest manufacturer and supplier of environmentally friendly fibreglass reinforced plastic ( FRP ) underground storage tanks. ZCL has two plants in Canada, four in the US and one in The Netherlands. The Company s core market segment is Fuel. Emerging markets include Water & Wastewater, Industrial, and Oil & Gas. The Company operates using the brand identities of ZCL, Xerxes, and Parabeam. Fuel Markets ZCL is the leading provider of Underwriters Laboratories ( UL ) and Underwriters Laboratories of Canada ( ULC ) listed underground fuel storage tanks for the downstream retail and commercial markets in both Canada and the US. The vast majority of tanks supplied to these markets are double wall tanks, with single wall and triple wall models also available. In addition, ZCL operates internationally through technology licensing agreements. As an alternative to the replacement of underground storage tanks, ZCL also provides the Phoenix System. This unique UL and ULC listed tank system allows in situ upgrades of steel or fibreglass tanks to either a secondary containment system or a fully self supporting double wall tank. It is an effective alternative to tank replacement. A key component of both ZCL s double wall tank and the Phoenix System is Parabeam, a three dimensional glass fabric that is manufactured and distributed from the Company s facility in The Netherlands. Water & Wastewater Markets ZCL s lightweight, watertight and easily installed fibreglass tanks are an ideal alternative to the concrete products that have traditionally dominated this market. Applications for ZCL s underground FRP storage tanks in the Water and Wastewater Markets include onsite wastewater treatment and municipal wastewater collection, dry hydrant cisterns and sprinkler systems, rainwater collection and storm water detention and filtration, grease, oil and solids interceptors and decontamination systems, wash down drainage and leachate treatment and potable water storage. Oil & Gas/Industrial Markets ZCL also provides products for other market segments including Oil & Gas and Industrial. 3

5 Management's Discussion and Analysis Within Industrial Markets, ZCL manufactures and supplies storage tanks, piping and accessories within two geographic markets in North America. We manufacture and supply our Industrial Products in Western Canada and the Western US where we have sustaining competitive advantages. Included in Industrial are chemical processing, municipal wastewater treatment, mining, pulp and paper, agriculture, pharmaceutical, food processing market segments. Within Oil & Gas, the company serves both midstream and upstream markets. The Company supplies tanks for pipelines (midstream markets) and for oil and gas exploration companies (upstream markets). OVERALL PERFORMANCE & OUTLOOK Poor weather conditions in large parts of North America contributed to a 9% reduction in revenue in the first quarter of 2017 compared with the very strong first quarter a year earlier. Strong backlog of $50.8 million as at March 31, 2017 indicates the slow start is short term. ZCL is preparing the company for the next phase of growth by investing in areas such as sales and marketing, human capital management, information technology, employee safety and hygiene and operational improvements. Although not reflected in current gross margin results, we believe the investments we are making now will result in increasing levels of profitability as we grow our business in the future. Despite the slow first quarter, feedback from our customers and other market intelligence give us confidence in our ability to achieve our 2017 objectives in terms of growth in revenue, earnings and our dividend. As we have shared in the past, our 10/10/10 objective for achieving minimum 10% Compound Annual Growth Rates (CAGR) in revenues, earnings, and our dividend, all while being responsible stewards and prudent allocators of capital, forms the foundation for our long term strategy. We are keeping our balance sheet strong, with working capital of $51.6 million and a cash and cash equivalents ( cash ) balance of $25.1 million, after the payment of $22.5 million in dividends in the first quarter of The strength of our balance sheet allows us to maintain flexibility and preserve our ability to take advantage of future profitable growth opportunities that may arise. Financial Results Revenue Revenue from continuing operations for the first quarter ended March 31, 2017 was $31.7 million, down $3.2 million or 9% from $34.9 million earned for the first quarter of The reduction in revenue primarily resulted from Fuel Markets which were down $2.2 million compared to a year earlier. Water & Wastewater revenue was down slightly compared with a year earlier. ZCL products serving the Fuel and Water Wastewater Markets are typically installed underground. Poor weather conditions in the first quarter of 2017 in many parts of North America resulted in a reduction in revenue as compared to the same quarter a year earlier, when weather much more favorable to underground construction and installation of ZCL s products was prevalent. Oil & Gas/Industrial revenue was $0.8 million lower than the first quarter of Gross Profit Gross profit from continuing operations for the first quarter ended March 31, 2017 was $6.1 million, down $1.6 million or 20% from $7.7 million a year earlier. Gross margin of 19% was down from 22% of revenue from continuing operations for the first quarter of 2016, with the decrease attributable to both lower year over year volume as well as increased investment in selling, manufacturing and safety initiatives when compared to a year earlier. As stated earlier, these investments are expected to positively impact our results in the remainder of 2017 and into Adjusted EBITDA Adjusted EBITDA from continuing operations for the first quarter ended March 31, 2017 was $3.2 million, down $0.9 million from $4.0 million in the first quarter of Adjusted EBITDA as a percentage of revenue was 10% for 2017, compared to 12% a year earlier. Net Income from Continuing Operations Net income from continuing operations for the first quarter ended March 31, 2017 was $0.9 million, down $1.2 4

6 Management's Discussion and Analysis million, from $2.1 million a year earlier. Net income from continuing operations was negatively impacted by withholding taxes of $0.7 million on the repatriation of cash from the US operation that was used to fund the $0.65 per share special dividend announced on March 8, Earnings per share from continuing operations for the first quarter ended March 31, 2017 were $0.03, down $0.04, from $0.07 per share a year earlier. Excluding the impact of the withholding taxes, earnings per share from continuing operations would have been $0.05. Net Income Net income for the first quarter ended March 31, 2017 was $0.9 million, compared to $1.0 million a year earlier. Earnings per share for the first quarter of 2017 was $0.03, compared to $0.03 per share a year earlier. Cash As at March 31, 2017, ZCL had a cash balance of $25.1 million compared to $43.2 million as at December 31, 2016 and $23.3 million as at March 31, Capital Allocation As evidenced by our 24 consecutive quarters of profitability, ZCL has developed a consistently profitable business model from our core business, and will continue to act in a disciplined and strategic manner when it comes to investing and distributing capital. We are focused on growing shareholder value through a reasonable increase in the quarterly distributions while preserving our balance sheet strength to allow us to act on profitable growth opportunities as they arise. The key levers of our capital allocation strategy are: 1. Fund all profitable organic growth opportunities that support the objectives of our strategic plan. 2. Continue to evaluate and pursue non organic growth opportunities. 3. Continue to distribute cash dividends to shareholders. The Company attempts to maintain minimum cash and cash equivalents of approximately $10 million in order to effectively manage its self insurance obligations and fund the operational needs in foreign jurisdictions. The complexities of running international operations results in challenges obtaining debt outside of North America and therefore these operations are financed through cash. Dividends The Board has declared a quarterly dividend of $0.12 per share, the same rate as the prior quarter and a 50% increase over the $0.08 declared at the same time last year. The dividend will be paid on July 17, 2017, to the shareholders of record as of June 30,

7 Management's Discussion and Analysis Backlog Backlog is defined as the total value of orders that have not yet been included in revenue but which have a contract or purchase order specifying the scope, value and timing of an order. Backlog by Market ($millions) Mar 31, Mar 31, % Change Fuel % Water & Wastewater nil Oil & Gas/Industrial (11%) Total % backlog was up $0.3 million or 11% compared to December 31, The increase in backlog over the prior quarter was due to both the normal seasonal nature of the business and the impact of bad weather. Certain Fuel customers delayed shipment of product during the first quarter of 2017 due to poor winter weather conditions experienced across much of North America, shifting some orders into the second quarter of As of March 31, 2017, backlog was $50.8 million, up $4.4 million or 10% from $46.4 million a year earlier. A 13% increase in Fuel backlog was partially offset by a decrease in the Oil & Gas/Industrial market backlog. Water & Wastewater backlog was comparable to a year earlier. In the Fuel Markets, backlog of $42.9 million was $4.8 million or 13% higher compared to the first quarter of 2016, with the increase primarily derived from Canadian Fuel Markets which were up $3.5 million or 122%. The Canadian market strength is being driven by increased commodity energy prices which supports increased spending by Canadian major oil companies and the consolidation of independent fuel retailers which has resulted in increased activity from our distribution network. On a source currency basis, the US Fuel backlog was comparable to the same quarter a year earlier. Also within Fuel, International Fuel Market backlog was up $0.2 million compared to the same quarter in Water & Wastewater Markets backlog of $4.8 million, was comparable to the quarter ended March 31, US Water & Wastewater Markets were up slightly, compared with a year earlier. Canadian Water & Wastewater Markets were down $0.4 million compared to the same quarter in As at March 31, 2017, Oil & Gas/Industrial Market backlog of $3.1 million was down 11% from $3.5 million a year earlier. Oil & Gas backlog increased by $1.2 million compared with a year earlier, with the bulk of this increase stemming from Western Canadian markets. This increase was more than offset by a decrease in US Industrial Market backlog. The total backlog increased by $15.2 million or 43% from $35.6 million at December 31, 2016, driven by the Fuel Markets which were up $14.0 million compared to a quarter earlier. Water & Wastewater Markets were up $0.9 million or 23% and Oil & Gas/Industrial Market 6

8 Management's Discussion and Analysis Outlook The following represents forward looking information and readers are cautioned that actual results may differ from expectations. As ZCL enters our 30 th Anniversary year, we remain optimistic about our future. Although 2017 is off to a slow start, we still anticipate that for the full year we will achieve our 2017 objectives in terms of growth in revenue, earnings, and our dividend. As we have shared in the past, the foundation for our long term strategy is our 10/10/10 objective for achieving minimum 10% Compound Annual Growth Rates (CAGR) in revenue, earnings, and our dividend, while continuing to be responsible stewards and prudent allocators of capital. Fuel Markets Our 2017 outlook for the Fuel Markets remains positive. All signals, including feedback from our customers across North America, give us reasonable confidence in our ability to achieve our growth expectations for the year. In particular, activity in Canadian Fuel Markets is at the highest levels we have seen in several years. This high level of activity in Canada is being led by sales to independent fuel retailers through our distribution network. In addition, we are seeing an increase in orders from major oil company fuel retailers in Canada after a couple years of slower sales to this group due to capital spending reductions in response to the drop in commodity energy prices. Retailer consolidation in the Fuel Markets continues as numerous transactions have been announced or are in the process of closing. Multiples being paid for retail sites have been described as pricey according to Oil Express, a retail fuel industry newsletter. This consolidation activity indicates retail Fuel Market assets continue to be attractive to consolidators looking to grow their market share. Among the larger deals are 7 Eleven recently acquiring the US retail assets of Sunoco, Couche Tard acquiring CST s US retail assets operated under the Valero brand, Brookfield Partners LP acquiring Loblaw s gas station business and Parkland s acquiring both Chevron Canada s downstream fuel business and CST s Canadian retail assets operated under the Ultramar brand. Also, in 2016, Imperial Oil completed the sale of its Esso branded Canadian retail sites to a group of buyers including Couche Tard, 7 Eleven, Parkland, Harnois Group petrolier, and Wilson Fuels. ZCL is the sole source supplier of underground fuel tanks for virtually all of the Canadian and many of the US acquiring companies in these transactions. Industry consolidation can sometimes lead to slower spending by the acquiring firms in the short term as they rationalize their new holdings. However, we do not expect these transaction to materially impact our 2017 results either positively or negatively. Retail consolidation is positive for ZCL over the long term as the acquiring companies are committed to retail fuel and will continue to invest in their retail network assets as they execute their growth strategies. In the US, cash flow continues to improve for Convenience Stores. C stores control the majority of retail fueling, selling over 80% of retail fuel in the US according to the National Association of Convenience Stores (NACS). US fuel sales volumes were up 2.6% year over year and C stores saw record in store sales of $233 billion 1. C store operators continue to have a positive outlook for their business going into Water & Wastewater Markets Similar to our outlook for the Fuel Markets, our market intelligence and customer feedback give us reasonable confidence that we will meet our 2017 growth objectives in the Water & Wastewater markets. According to several industry sources, including Boenning & Scattergood, the outlook for construction spending on both the residential and non residential fronts is positive. While municipal spending on water projects is expected to decelerate later in 2017 and into 2018, the industrial, institutional, and commercial construction sectors are forecast to return to growth. This, along with our strong sales pipeline, supports our expectations for a return to growth for our Water & Wastewater Markets group in Oil & Gas/Industrial Markets As noted above, the Oil and Gas and Industrial Markets, which comprise of approximately 5% to 10% of our total revenues, continue to bounce along the bottom in terms of new capital investment. While we do see some green shoots emerging in terms of spending in these sectors, they are substantially below the spending levels prior to the commodity energy price crash. We are getting some maintenance and replacement orders from the existing installed Oil and Gas infrastructure base in Western Canada, but we do not expect these sectors to be an area of growth for ZCL in Sources include publications from the National Association of Convenience Stores (NACS). 7

9 Management's Discussion and Analysis SELECTED FINANCIAL INFORMATION Three Months Ended March (in thousands of dollars, except per share amounts) $ $ Operating Results Revenue 31,741 34,916 Gross profit 6,106 7,668 Gross margin 19% 22% General and administration 2,756 2,996 Foreign exchange loss Depreciation and amortization Finance expense Gain on disposal of assets (16) Income tax expense 1, Net income from continuing operations 919 2,132 Net loss from discontinued operations (37) (1,094) Net income 882 1,038 Earnings per share from continuing operations Basic Diluted Earnings per share Basic Diluted Cash dividends declared per common share Adjusted EBITDA (note 1) 3,171 4,048 % of revenue 10% 12% Adjusted EBITDA per diluted share As at March 31, 2017 Dec 31, 2016 (in thousands of dollars) $ $ Financial Position Cash and cash equivalents 25,118 43,208 Working capital (note 1) 51,636 73,737 Total assets 143, ,928 Total non current liabilities 3,738 4,088 Note 1: Adjusted EBITDA, adjusted EBITDA per diluted share and working capital are non IFRS measures and are defined later in the MD&A under "Non IFRS Measures." 8

10 Management's Discussion and Analysis RESULTS OF OPERATIONS Revenue First Quarter ($000s) % change Revenue by Market: Fuel 26,913 29,118 (8%) Water & Wastewater 4,202 4,398 (4%) Oil & Gas/Industrial 626 1,400 (55%) 31,741 34,916 (9%) Revenue for the quarter ended March 31, 2017 was $31.7 million, down $3.2 million, or 9% from $34.9 million in the first quarter of The change in revenue reflects the factors noted below: Fuel Fuel revenue of $26.9 million, was down $2.2 million or 8%, from $29.1 million in the quarter ended March 31, The decrease in Fuel revenue compared to a year earlier was attributable to both Canadian and US markets. In the US, revenue was down $0.2 million or 1% over the first quarter of 2016 prior to a $0.9 million negative impact on the translation of US dollar sales to Canadian dollars for reporting purposes. The slight decrease in US Fuel revenue resulted from reduced sales to retail petroleum marketers, offset by an increase in US distributor sales which were up 10% over the prior year. In addition, poor weather across numerous regions of the US contributed to lower revenue in the first quarter of 2017, as customers delayed delivery of product. Canadian Fuel revenue in the first quarter of 2017 was down $1.1 million or 21% compared to the same quarter of 2016, with the decrease derived from lower sales to major oil customers which were down 32% over the first quarter of The decrease was partially offset by increased distributor sales compared with a year earlier. The softer revenue in 2017 compared with the first quarter of 2016 has also been partially reflected in the strong increase in year over year backlog for the Canadian Fuel Markets which were up $3.5 million or 122% when compared to the same period in Fuel Markets also includes revenue from International operations which was comparable to the first quarter of Water & Wastewater Water & Wastewater revenue in the first quarter of 2017 was $4.2 million, down $0.2 million or 4% compared to $4.4 million in the first quarter of The decrease in revenue was attributable to the Eastern Canadian markets which were down $0.3 million compared to a year earlier. In the US, revenue was up $0.1 million or 3% over the first quarter of 2016 prior to a $0.1 million negative impact on the translation of US dollar sales to Canadian dollars for reporting purposes. Oil & Gas / Industrial Oil & Gas/Industrial revenue of $0.6 million for the first quarter of 2017 was down $0.8 million or 55% compared to $1.4 million a year earlier. The decrease was attributable to the Industrial Markets as well as the Midstream and Upstream Oil & Gas Markets in both Canada and the US. Within the Oil & Gas/Industrial Markets, certain of the projects included in the December 31, 2016 backlog of $2.8 million, involve extensive design, engineering and production support resulting in longer cycle times from order acceptance to shipment, particularly in the upstream component of Oil & Gas, as well as the Industrial Markets. Certain of these projects were in progress during the quarter ended March 31, 2017, and are not expected to be completed until later in the year. Gross Profit First Quarter ($000s) % change Gross profit 6,106 7,668 (20%) Gross margin 19% 22% (3%) In the first quarter of 2017, gross profit of $6.1 million was down $1.6 million or 20% compared to the same quarter in Gross margin also decreased to 19% from 22% in The gross profit and gross margin decrease relative to the first quarter of 2016 was attributable to a reduction of revenue over a relatively fixed cost base. In addition, additional expenditures were incurred relative to the first quarter of 2016 with regard to investment in sales and marketing initiatives that are expected to benefit future quarters. Manufacturing expenditures also increased in the first quarter of 2017 compared to the first quarter of 2016 as additional resources were made regarding employee safety and hygiene throughout the Company. 9

11 Management's Discussion and Analysis General and Administration ($000s) First Quarter , ,996 % change (8%) General and administration ( G&A ) expense for the quarter ended March 31, 2017 was down $0.2 million compared to the quarter ended March 31, The decrease was due primarily to a reduction in professional fees when compared to the first quarter of Foreign Exchange Loss ($000s) First Quarter The foreign exchange loss was the result of fluctuations in the US dollar conversion rate and the US denominated monetary assets and liabilities held by the Company s Canadian operations. The following table details the US dollar and euro conversion rates. US Dollar and euro Conversion Rates First Quarter Avg. Close Avg. Close Avg. Change Close Change USD (4%) (2%) euro (7%) (3%) For additional information on the Company s exposure to fluctuations in foreign exchange rates see the Financial Instruments section included later in this MD&A. Depreciation and Amortization ($000s) First Quarter % change (3%) Income Taxes Income tax expense for the three months ended March 31, 2017, represented 60% of pre tax income, compared to 30% of pre tax income in The increase in 2017 relative to the same quarter in the prior year, is due to a withholding tax payment on cash repatriations from the Company s US subsidiaries that were used to fund the recently announced special dividend. Excluding this withholding tax expense, the effective tax rate for the first quarter of 2017 would have been 29%, which is comparable to the prior year. Disposal of Assets and Discontinued Operations During 2016, the Company divested certain assets and ceased operations of the former ZCL Dualam operations. The financial results from the former ZCL Dualam operations are included in Discontinued Operations in this MD&A. Comprehensive Income (Loss) Comprehensive income (loss) for each period is comprised of net income and the effects of translation of foreign operations with functional currencies denominated in US dollars and euros. For accounting purposes, assets and liabilities of these foreign operations are translated at the exchange rate in effect on the balance sheet date. The table below details the impact of the translation of foreign operations on other comprehensive income (loss) before the impact of net income. ($000s) First Quarter 2017 (742) 2016 (6,173) The foreign translation loss in 2017 was due to the weakening of the US dollar relative to the Canadian dollar throughout the three months ended March 31, 2017 from 1.34 to In the first quarter of 2016, the US dollar weakened from 1.39 to 1.30, also generating a loss on the translation of foreign operations. Depreciation and amortization expense for the quarter ended March 31, 2017 was down slightly compared to the quarter ended March 31,

12 Management's Discussion and Analysis LIQUIDITY AND CAPITAL RESOURCES Working Capital As at March 31, 2017, the Company decreased working capital (current assets less current liabilities) by $22.1 million to $51.6 million from $73.7 million as at December 31, This decrease is primarily the result of the dividends paid during the first quarter of $22.5 million, thereby reducing cash and cash equivalents. As at March 31, 2017, the Company had cash and cash equivalents of $25.1 million (December 31, 2016 $43.2 million). Management believes that internally generated cash flows, along with the available revolving operating credit facility, will be sufficient to cover the Company s normal operating and capital expenditures for the foreseeable future. Credit Arrangements The Company s operating credit facility is provided by a Canadian chartered bank. The maximum available under this facility is $20.0 million. The operating facility is due on demand and matures on May 31, The Company fully repaid the remaining balance on the term loan during the third quarter of Share Capital During the three months ended March 31, 2017, the company issued 203,622 shares on the exercise of stock options (the months ended March 31, ,597 shares on the exercise of stock options). Cash Flows First Quarter ($000 s) Operating activities 4,340 1,074 Financing activities (21,166) (16,271) Investing activities (735) (190) Foreign exchange (1) (492) (979) Discontinued operations (37) (1,087) (18,090) (17,453) (1) Foreign exchange loss on cash held in foreign currency. Operating Activities The cash flows from operating activities reflect the net impact of i) funds from continuing operations and ii) changes in non cash working capital. Funds from continuing operations totalled $1.3 million for the three months ended March 31, 2017 compared to $2.8 million for the three months ended March 31, The decrease relative to 2016 is due primarily to the decrease in gross profit, and thereby cash flows when compared to the same quarter a year earlier. In addition, withholding taxes of $0.7 million were incurred on the repatriation of earnings from the US operations thereby reducing funds from continuing operations. Changes in non cash working capital was $3.0 million for the three months ended March 31, 2017, compared to negative $1.7 million for the three months ended March 31, In 2017, the $7.2 million increase in inventory was more than offset by decreases in accounts receivable. Timing factors with regard to accounts payable and income taxes payable also resulted in differences from the prior year s working capital changes. Financing Activities Cash flows used in financing activities were $21.2 million for the three months ended March 31, 2017 due to the dividends paid. This was partially offset by proceeds received on the exercise of stock options. In the three months ended March 31, 2016, cash flows used in financing activities was $16.3 million. The increase in funds used in financing activities relative to the 2016 comparative period is primarily attributable to the increase in the special dividend paid in the first quarter of 2017, along with an increase in the quarterly dividend compared with the same quarter in In March, 2017, the Company received approval from the TSX to conduct a Normal Course Issuer Bid ( NCIB ) that commenced on March 31, The Company is authorized to purchase up to 1,500,000 common shares for cancellation. Management believes that from time to time the market prices of the common shares may not reflect their underlying value and at such times, the purchase of common shares for cancellation will increase the proportionate interest of, and be advantageous to, all remaining shareholders. No common shares were repurchased through the NCIB during the first quarter of 2017 or Investing Activities The cash flows used in investing activities were $0.7 million in the three months ended March 31, 2017 compared to $0.2 million in the comparative period in The purchase of property, plant and equipment was higher in the first quarter of 2017, compared with a year earlier. 11

13 Management's Discussion and Analysis Contractual Obligations The Company has provided a letter of credit in the amount of $0.3 million US to secure a line of credit for the same amount for our US operations. The Company has also provided two letters of credit for a total of $1.1 million US to secure claims for the Company s US workers compensation program. In the normal course of business, the Company provides letters of credit as collateral for contract performance guarantees. As at March 31, 2017, the performance letters of credit issued totalled $0.1 million. As at March 31, 2017, ZCL s minimum annual lease commitments under all non cancellable operating leases for production facilities, office space and automotive equipment totalled $12.9 million. The following table details the Company s contractual obligations due over the next five years and thereafter: ($000s) Operating Leases , , , , ,632 Thereafter 3,750 Total 12,908 TRANSACTIONS WITH RELATED PARTIES Certain manufacturing components purchased for $5,000 for the three months ended March 31, 2017 (March 31, 2016 $1,000), included in manufacturing and selling costs or inventories, were supplied by a corporation whose Executive Chairman is a director of the Company. The transactions were incurred in the normal course of operations and recorded at the exchange amount being normal commercial rates for the products. Accounts payable and accrued liabilities at March 31, 2017, included $nil (December 31, 2016 $nil) owing to the corporation. There are no ongoing contractual or other commitments resulting from these transactions. 12

14 Management's Discussion and Analysis SUMMARY OF QUARTERLY RESULTS The table below presents selected financial information for the eight most recent quarters, which should be read in conjunction with the applicable interim unaudited and annual audited consolidated financial statements and accompanying notes. The Company s financial results have historically been affected by seasonality with the lowest levels of activity occurring in the first half of the year, particularly in the first quarter. In addition, the Company is subject to fluctuations in the US to Canadian dollar exchange rate since a significant portion of its revenue is denominated in US dollars. Over the past eight quarters, the US to Canadian dollar conversion rate has ranged from a low of 1.24 in the second quarter of 2015 to a high of 1.39 in the fourth quarter of For the three months ended (in thousands of dollars, Mar 31 Dec 31 Sep 30 Jun 30 Mar 31 Dec 31 Sep 30 Jun 30 except per share amounts) $ $ $ $ $ $ $ $ Revenue by Market: Fuel 26,913 39,030 49,664 34,978 29,118 34,501 46,278 32,936 Water & Wastewater 4,202 6,433 5,902 6,213 4,398 6,758 6,794 6,783 Oil & Gas/Industrial 626 1,139 2,319 3,528 1,400 3,139 2,564 1,750 Total revenue 31,741 46,602 57,885 44,719 34,916 44,398 55,636 41,469 Net income Continuing operations 919 5,749 7,741 4,396 2,132 4,774 7,896 3,883 Discontinued operations (note 1) (37) 146 (1,249) (2,842) (1,094) (889) (2,691) (483) Total net income 882 5,895 6,492 1,554 1,038 3,885 5,205 3,400 Adjusted EBITDA (note 2) 3,171 9,418 12,125 7,387 4,048 7,062 12,172 6,619 Basic and diluted earnings per share Continuing operations Total Adjusted EBITDA per diluted share (note 2) Dividends declared per share Note 1: The discontinued operations are the ZCL Dualam operations which were exited in the third quarter of 2016, due to continued and expected future operating losses. Note 2: Adjusted EBITDA and adjusted EBITDA per diluted share are non IFRS measures and are defined later in this MD&A under "Non IFRS Measures." OUTSTANDING SHARE DATA As at May 3, 2017, there were 31,005,061 common shares and 887,507 share options outstanding. Of the options outstanding, 351,976 are currently exercisable into common shares. In 2016 and 2017, ZCL repurchased and cancelled nil shares through the Normal Course Issuer Bid ( NCIB ). 13

15 Management's Discussion and Analysis FINANCIAL INSTRUMENTS The Company s activities expose it to a variety of financial risks including market risk (foreign exchange risk), credit risk and liquidity risk. Management reviews these risks on an ongoing basis to ensure they are appropriately managed. The Company may use foreign exchange forward contracts to manage exposure to fluctuations in foreign exchange from time to time. The Company does not currently have a practice of trading derivatives and had no derivative instruments outstanding at March 31, Foreign Exchange Risk The Company operates on an international basis and is exposed to foreign exchange risk arising from transactions denominated in foreign currencies. The Company s objective with respect to foreign exchange risk is to minimize the impact of the volatility related to financial assets and liabilities denominated in a foreign currency where possible through effective cash flow management. Foreign currency exchange risk is limited to the portion of the Company s business transactions denominated in currencies other than Canadian dollars. The Company s most significant foreign exchange risk arises primarily with respect to the US dollar. The revenues and expenses of the Company s US operations are denominated in US dollars. Certain of the revenue and expenses of the Canadian operations are also denominated in US dollars. The Company is also exposed to foreign exchange risk associated with the euro due to its operations in The Netherlands, however, these amounts are not significant to the Company s consolidated financial results. On an ongoing basis, management monitors changes in foreign currency exchange rates and considers long term forecasts to assess the potential cash flow impact on the Company. The tables that follow provide an indication of the Company s exposure to changes in the value of the US dollar relative to the Canadian dollar, as at and for the three months ended March 31, The analysis is based on financial assets and liabilities denominated in US dollars at the end of the period ( balance sheet exposure ), which are separated by domestic and foreign operations, and US dollar denominated revenue and operating expenses during the period ( operating exposure ). Balance sheet exposure related to financial assets, net of financial liabilities, at March 31, 2017, was as follows: (in thousands of US dollars) $ Foreign operations 8,145 Domestic operations 8,976 Net balance sheet exposure 17,121 Operating exposure for the three months ended March 31, 2017, was as follows: (in thousands of US dollars) $ Sales 19,694 Operating expenses 16,995 Net operating exposure 2,699 The weighted average US to Canadian dollar translation rate was 1.32 for the three months ended March 31, The translation rate as at March 31, 2017, was Based on the foreign currency exposures noted above, with other variables unchanged, a 20% change in the US dollar would have impacted net income for the three months ended March 31, 2017, as follows: (in thousands of US dollars) $ Net balance sheet exposure of domestic operations 1,337 Net operating exposure of foreign operations 307 Change in net income 1,644 Comprehensive income would have changed $1.0 million due to the net balance sheet exposure of financial assets and liabilities of foreign operations. The timing and volume of the above transactions, as well as the timing of their settlement, could impact the sensitivity of the analysis. Credit Risk Credit risk is the risk of a financial loss to the Company if a customer or counterparty to a financial instrument fails to meet its contractual obligations. The Company is exposed to credit risk through its cash and cash equivalents and accounts receivable. The Company manages the credit risk associated with its cash and cash equivalents by holding its funds with reputable financial institutions and investing only in highly rated securities that are traded on active markets and are capable of prompt liquidation. Credit risk for trade and other accounts receivable are managed through established credit monitoring activities. The Company also mitigates its credit risk on trade accounts receivable by obtaining a cash deposit from certain customers with no prior order history with the Company, or where the Company perceives the customer has a higher level of risk. 14

16 Management's Discussion and Analysis The Company has a concentration of customers in the downstream retail oil and gas sectors. The concentration risk is mitigated by the number of customers, growth and diversification of the customer base and by a significant portion of the customers being large international organizations. As at March 31, 2017, one customer exceeded 10% of the consolidated trade accounts receivable balance. The Company has no concerns regarding the collectability of this balance. The creditworthiness of new and existing customers is subject to review by management by considering such items as the type of customer, prior order history and the size of the order. Decisions to extend credit to new customers are approved by management and the creditworthiness of existing customers is monitored. The Company reviews its trade accounts receivable regularly and amounts are written down to their expected realizable value when the account is determined not to be fully collectable. This generally occurs when the customer has indicated an inability to pay, the Company is unable to communicate with the customer over an extended period of time, and other methods to obtain payment have been considered and have not been successful. The bad debt expense is charged to net income in the period that the account is determined to be doubtful. Estimates for the allowance for doubtful accounts are determined on a customer by customer evaluation of collectability at each reporting date, taking into account the amounts which are past due and any available relevant information on the customers liquidity and going concern status. After all efforts of collection have failed, the accounts receivable balance not collected is written off with an offset to the allowance for doubtful accounts, with no impact on net income. The Company s maximum exposure to credit risk for trade accounts receivable is the carrying value of $16.1 million as at March 31, 2017 (December 31, 2016 $25.0 million). On a geographic basis as at March 31, 2017, approximately 17% (December 31, %) of the balance of trade accounts receivable was due from Canadian and non US customers and 83% (December 31, %) was due from US customers. Payment terms are generally net 30 days. As at March 31, 2017, the percentages of trade accounts receivable were as follows: March 31, 2017 December 31, 2016 Aged 0 to 30 days 59% 50% Aged 31 to 60 days 26% 26% Aged 61 to 90 days 3% 13% Aged 91 to 120 days 3% 9% Aged greater than 120 days 9% 2% Total 100% 100% Liquidity Risk The Company s objective related to liquidity risk is to effectively manage cash flows to minimize the exposure that the Company will not be able to meet its obligations associated with financial liabilities. On an ongoing basis, liquidity risk is managed by maintaining adequate cash and cash equivalent balances and appropriately utilizing available lines of credit. Management believes that forecasted cash flows from operating activities, along with the available lines of credit, will provide sufficient cash requirements to cover the Company s forecasted normal operating activities, commitments and budgeted capital expenditures. The Company has pledged as general collateral for advances under the operating credit facility a general security agreement on present and future assets, guarantees from each present and future direct and indirect subsidiary of the Company supported by a first registered security over all present and future assets, and pledge of their shares. The Company is not permitted to sell or re pledge significant assets held under collateral without consent from the lenders. 15

17 Management's Discussion and Analysis RISKS AND UNCERTAINTIES The Company is subject to a number of known and unknown risks, uncertainties and other factors that could cause the Company s actual future results to differ materially from those historically achieved and those reflected in forward looking statements made by the Company. These factors include, but are not limited to, fluctuations in the level of capital expenditures in the Fuel, Water and Wastewater, Oil and Gas, and Industrial markets; drilling activity and oil and natural gas prices and other factors that affect demand for the Company s products and services; industry competition; the need to effectively integrate acquired businesses; the ability of management to implement the Company s business strategy effectively; political and general economic conditions; the ability to attract and retain key personnel; raw material and labour costs; fluctuations in the US and Canadian dollar exchange rates; accounts receivable risk; the ability to generate capital or maintain liquidity and credit agreements necessary to fund future operations; and other risks and uncertainties described under the heading Risk Factors in the Company s most recent Annual Information Form and elsewhere in other documents filed with Canadian provincial securities authorities which are available to the public at Environmental Risks To conduct business operations, the Company owns or leases properties and is subject to environmental risks due to the use of chemicals in the manufacturing process. ZCL manages its environmental risks by appropriately dealing with chemicals and waste material in an environmentally safe and responsible manner, and in accordance with applicable regulatory requirements. In addition, the Company has a Health, Safety and Environment Committee that meets regularly to review and monitor environmental issues, compliance, risks and mitigation strategies. However, it is unknown whether specific environmental conditions and incidents will impact ZCL operations in the future. The Company elects to partially self insure against risk of environmental contamination at its production facilities as it has determined the risk to be low. The Company is not aware of any unrecorded material environmental liabilities. CRITICAL ACCOUNTING ESTIMATES & JUDGEMENTS The Company s financial statements have been prepared following IFRS. The measurement of certain assets and liabilities is dependent upon future events and the outcome will not be fully known until future periods. Therefore, the preparation of the financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Such estimates and assumptions have been made using careful judgments, which in management s opinion, are reasonable and conform to the significant accounting policies summarized in the December 31, 2016 annual consolidated financial statements. Actual results may vary from those estimated. Impairment The Company assesses impairment at each reporting period by evaluating the circumstances specific to the organization that may lead to an impairment of assets. In addition to the quarterly assessment, the Company also performs an annual impairment test on goodwill and certain intangible assets in accordance with IAS 36: Impairment of Assets. Where indicators of impairment exist, and at least annually for goodwill and certain intangible assets, the recoverable amount of the asset or group of assets (cash generating units) is compared against the carrying amount. Any excess of the carrying amount over the recoverable amount will be recognized as an impairment loss in the income statement. The recoverable amount is calculated as the higher of the assets (or group of assets) value in use or fair value less cost to sell. The actual growth rates and other estimates used in the determination of fair values at the time of impairment tests may vary materially from those realized in future periods. Property, Plant and Equipment, Intangible Assets and Goodwill Property, plant and equipment and intangible assets with finite lives are recorded at cost less accumulated depreciation and amortization. Goodwill and indefinite life intangible assets are recorded at cost. The unamortized balances, or carrying values, are regularly reviewed for recoverability or tested for impairment whenever events or circumstances indicate that these amounts exceed their fair values. The valuation of these assets is based on estimated future net cash flows, taking into account 16