NWPX Infrastructure, Inc. quarterly report, Q3 FY2015

Business context and reporting period

Northwest Pipe Company manufactures welded steel pipe, principally large-diameter water transmission systems and smaller-diameter tubular products. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2015; comparisons are with the corresponding 2014 periods. The OCTG business sold in March 2014 is presented as discontinued operations.

Financial performance and liquidity

• Margins: Gross margin was negative 4.8% in Q3 2015 versus 13.6% in Q3 2014, and negative 0.6% for the first nine months versus 10.4% in 2014. SG&A was $4.8 million in Q3 and $17.2 million year to date.
• Cash flow: Operating cash flow was $37.8 million for the first nine months, versus $31.2 million in 2014. Investing cash flow was $3.9 million provided; financing used $41.6 million. Capital expenditures were $7.7 million.
• Balance sheet at September 30: Cash was $0.6 million; working capital was $111.6 million, down from $165.7 million at December 31, 2014. Total assets were $283.4 million and equity was $230.8 million.
• Debt and liquidity: Line-of-credit borrowings were $6.6 million and capital lease obligations totaled $0.3 million. The company disclosed that it breached two financial covenants for the September quarter and obtained a temporary lender waiver. On October 26 it replaced its prior facility with a secured, asset-based revolver of up to $60 million, subject to borrowing-base limits; disclosed availability, net of letters of credit, was $39.1 million. It expected approximately $0.4 million of fourth-quarter expense from writing off old financing costs.

Material changes versus the prior comparable period

• Sales fell 55.1% in Q3 and 36.6% for the first nine months. Water Transmission sales fell 48.2% and 26.1%, respectively; Tubular Products sales fell 68.4% and 52.5%.
• Water Transmission gross profit turned to a $0.7 million loss in Q3; year-to-date gross profit declined to $8.0 million from $29.7 million. Tubular Products recorded gross losses of $1.8 million in Q3 and $9.3 million year to date.
• The company wrote off all $5.3 million of Water Transmission goodwill in Q2 2015 after market conditions indicated impairment. The nine-month operating loss includes this charge.
• Cash flow from operations improved despite net losses, mainly reflecting reductions in receivables and inventory. Working capital and line-of-credit borrowing declined as sales, billings, and production fell.

Outlook, management commentary, risks and unusual items

• Management provided no quantified earnings or sales guidance. It expected 2015 capital expenditures of approximately $9 million and stated available cash, operating cash flow, and borrowing capacity should fund foreseeable needs.
• Management cited strained municipal budgets, reduced water-project demand and project timing, aggressive competition, and lower steel prices as factors pressuring Water Transmission. It cited depressed oil markets and imported pipe volumes as weighing on Tubular Products demand and pricing.
• The Atchison, Kansas Tubular Products facility began a production curtailment in April 2015; related severance costs were approximately $0.5 million. In July, the company announced it was exploring a sale of the Tubular Products Group; no completed sale is reported in this filing.
• Water Transmission results were affected by project mix, competition, lower production volumes and fixed-cost absorption, $0.4 million of higher conversion costs related to steel-quality issues, and lower-of-cost-or-market inventory adjustments of $1.1 million in Q3 and $1.6 million year to date. Recovery of the conversion costs was uncertain.
• The Q3 tax benefit included a $2.5 million discrete benefit from a research and development credit study. A $1.9 million valuation allowance was recorded against certain deferred tax assets, reflecting, among other factors, recent cumulative losses.
• Environmental matters include the Portland Harbor Superfund site, for which the company could not estimate its potential share of cleanup costs and recorded no further adjustment; it said insurance may reimburse costs but coverage is not assured. Houston-site remediation was estimated at $0.2–$2.4 million, with $0.3 million accrued.
• Management said disclosure controls were effective and reported that enhanced controls remediated the previously identified material weakness in goodwill impairment assessment.

Important facts for investors to verify

• Whether the new borrowing-base facility provides sufficient usable liquidity and whether the company remains in compliance with its financial covenants.
• Whether operating performance, order timing, project mix, and competitive pricing improve in both segments, particularly given continuing municipal-budget and energy-market pressures.
• Progress and terms, if any, in the potential Tubular Products sale process.
• Whether further inventory write-downs, steel-quality costs, or goodwill-related charges arise, and how the tax benefit and deferred-tax valuation allowance develop.
• Updates on Portland Harbor cost allocation and insurance coverage, and on the range and timing of Houston remediation costs.