Northwest Pipe Company — Q3 2014 Form 10-Q
Business context and period: Quarterly period ended September 30, 2014. The company manufactures welded steel pipe, principally through its Water Transmission and Tubular Products groups. The results below are in U.S. dollars; financial amounts are in millions unless stated otherwise. OCTG operations, sold on March 30, 2014, are reported as discontinued operations.
Financial performance and position
| Metric | Three months ended Sept. 30, 2014 | Three months ended Sept. 30, 2013 | Nine months ended Sept. 30, 2014 | Nine months ended Sept. 30, 2013 |
|---|---|---|---|---|
| Continuing-operations sales | $116.5 | $78.5 | $301.1 | $273.8 |
| Gross profit / margin | $15.8 / 13.6% | $11.3 / 14.3% | $31.5 / 10.4% | $49.4 / 18.0% |
| Operating income | $9.3 | $5.7 | $13.6 | $31.9 |
| Income from continuing operations | $5.9 | $2.7 | $7.8 | $19.3 |
| Net income (loss), including discontinued operations | $5.0 | $1.0 | $(3.9) | $16.1 |
| Diluted EPS | $0.52 | $0.11 | $(0.41) | $1.69 |
- Cash flow: Nine-month operating cash flow was $31.2 million, compared with $21.4 million in 2013; the 2014 amount includes $11.7 million from discontinued operations. Investing provided $18.2 million, including $29.8 million of OCTG sale proceeds, while financing used $49.9 million, principally for net debt repayments. Cash ended at just $0.072 million.
- Liquidity and debt: At September 30, working capital was $161.3 million, versus $195.4 million at year-end 2013. Debt included $46.6 million drawn under the $165 million credit agreement and $1.8 million of capital leases; no term-note balances remained. The company reported $60.2 million of revolver availability, net of letters of credit, and compliance with its covenants. Revolver maturity is October 2017.
- Balance sheet: Total assets were $369.0 million and stockholders’ equity was $259.0 million, compared with $433.5 million and $261.9 million, respectively, at December 31, 2013.
Material changes and operating drivers
- Third-quarter continuing sales rose 48.4% year over year, while nine-month sales increased 10.0%. The quarterly improvement reflected higher volumes in both segments. Nine-month continuing income and gross profit fell sharply despite sales growth.
- Water Transmission sales increased 64.1% in Q3, driven by higher production on major projects, but average selling prices per ton declined 40%. For the first nine months, sales were down 0.8%; gross profit declined 25.6%, reflecting lower prices, weak first-quarter demand, project mix and $2.0 million of Permalok purchase-accounting adjustments and intangible amortization. The company recorded $1.7 million of reductions in estimated Permalok contingent consideration, which benefited cost of sales.
- Tubular Products sales rose 25.1% in Q3 and 32.0% for nine months, supported by higher production capacity and project shipments. The segment had a $0.7 million Q3 gross loss, versus $3.3 million gross profit a year earlier; nine-month gross profit declined to $1.7 million from $9.5 million. Higher steel costs, weak price recovery and a $1.4 million lower-of-cost-or-market inventory adjustment weighed on margins.
- One Water Transmission customer represented 27.1% of Q3 continuing sales and 18.4% of nine-month sales, creating customer concentration exposure.
- OCTG was sold for total consideration of $42.7 million. Net proceeds were $29.8 million, and the company recorded a $13.5 million loss on disposal for the nine months, including a further $1.4 million Q3 loss from a working-capital adjustment. The sale materially contributed to the nine-month net loss.
Outlook, risks, contingencies and unusual items
- Outlook: No specific revenue or earnings guidance was provided. Management said strained municipal budgets would continue to affect Water Transmission in the near term. Capital expenditures for 2014 were expected to be approximately $15–16 million.
- Business risks: Management identified demand and market prices, project bidding and timing, product mix, production schedules, steel costs and availability, capacity, imports and trade policy as factors that could affect results. Water Transmission project activity and margins can vary considerably between periods; Tubular Products margins are sensitive to steel costs and market pricing.
- Environmental matters: Portland Harbor remediation costs and allocation among more than 100 potentially responsible parties could not be estimated; no additional liability was recorded. The company agreed to fund $360,000 of a natural-resource injury assessment, of which $216,000 had been paid by the filing date. It anticipated less than $0.1 million in further Portland source-control work during 2014. Houston groundwater and soil issues were being addressed through a voluntary cleanup program; potential cleanup costs were not yet estimable and insurance would not cover them. Possible reimbursement depends on the purchaser exercising an option to buy the property under specified circumstances.
- Controls: Management concluded disclosure controls were ineffective as of September 30, 2014 because of a material weakness in controls over goodwill impairment assessments, including review of assumptions, data and indicators of impairment between annual tests. Management said the weakness had not caused a financial-statement adjustment, but could allow a material misstatement to go undetected. Remediation was planned and was not yet complete.
- Other items: The company had $3.1 million of standby letters of credit. It reported no off-balance-sheet arrangements reasonably likely to have a material effect. Permalok contingent consideration was a Level 3 fair-value estimate based on internal revenue forecasts.
Important facts for investors to verify
- Whether the Water Transmission project mix and volumes can sustain Q3 performance, and how competitive bidding affects realized prices and margins.
- Whether Tubular Products can restore margins amid steel-cost and pricing pressures, and whether the inventory adjustment is recurring.
- The quality and repeatability of reported operating cash flow, given its working-capital drivers and contribution from discontinued operations, alongside the very low cash balance.
- Available borrowing capacity and covenant headroom, including the effect of future capital spending and working-capital needs.
- Final costs and allocation for Portland Harbor and Houston environmental matters, and whether insurance or purchaser reimbursement will cover any obligations.
- Progress and independent effectiveness of remediation for the goodwill-impairment control material weakness.
- Further adjustments to the OCTG sale proceeds and Permalok contingent consideration, as well as the valuation assumptions underlying goodwill and other estimates.