Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Forward-Looking Statements
This Management’s Discussion and Analysis of Financial Condition and Results of Operations and other sections of this Quarterly Report on Form 10-Q for the quarter ended March 31, 2019 (“2019 Q1 Form 10-Q”) contain “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 and Section 21E of the Securities Exchange Act of 1934, as amended, that are based on current expectations, estimates, and projections about our business, management’s beliefs, and assumptions made by management. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” “forecasts,” “should,” “could,” and variations of such words and similar expressions are intended to identify such forward-looking statements. These statements are not guarantees of future performance and involve risks and uncertainties that are difficult to predict. Therefore, actual outcomes and results may differ materially from what is expressed or forecasted in such forward-looking statements as a result of a variety of important factors. While it is impossible to identify all such factors, those that could cause actual results to differ materially from those estimated by us include changes in demand and market prices for our products, product mix, bidding activity, the timing of customer orders and deliveries, production schedules, the price and availability of raw materials, price and volume of imported product, excess or shortage of production capacity, international trade policy and regulations, changes in tariffs and duties imposed on imports and exports and related impacts on us, our ability to identify and complete internal initiatives and/or acquisitions in order to grow our Water Transmission business, our ability to effectively integrate acquisitions into our business and operations and achieve significant administrative and operational cost synergies, the impacts of the Tax Cuts and Jobs Act of 2017, and other risks discussed in our Annual Report on Form 10-K for the year ended December 31, 2018 (“2018 Form 10-K”) and from time to time in our other Securities and Exchange Commission filings and reports. Such forward-looking statements speak only as of the date on which they are made, and we do not undertake any obligation to update any forward-looking statement to reflect events or circumstances after the date of this 2019 Q1 Form 10-Q. If we do update or correct one or more forward-looking statements, investors and others should not conclude that we will make additional updates or corrections with respect thereto or with respect to other forward-looking statements.
Overview
Northwest Pipe Company is the largest manufacturer of engineered welded steel pipe water systems in North America. Our manufacturing facilities are strategically positioned to meet North America’s growing needs for water and wastewater infrastructure. Our solution-based products serve a wide range of markets including water transmission, plant piping, tunnels, and river crossings. Our prominent position is based on a widely-recognized reputation for quality, service, and manufacturing to meet performance expectations in all categories including highly-corrosive environments. These pipeline systems are produced from several manufacturing facilities which are located in Portland, Oregon; San Luis Río Colorado, Mexico; Adelanto, California; Saginaw, Texas; Tracy, California; Parkersburg, West Virginia; St. Louis, Missouri; and Brea, California. In the second quarter of 2018, we closed our leased facility in Salt Lake City, Utah and ceased production at our Monterrey, Mexico facility. The Monterrey, Mexico facility was sold in December 2018.
In July 2018, we completed the acquisition of 100% of Ameron Water Transmission Group, LLC (“Ameron”) for a purchase price of $38.1 million. Ameron was a major supplier of engineered welded steel pressure pipe as well as reinforced concrete pipe. In addition to strengthening our position in the water transmission pipe market, this acquisition expands our bar-wrapped concrete cylinder pipe capabilities and adds reinforced concrete pipe and T-Lock
®
— a proprietary polyvinyl chloride (PVC) lining for concrete pipe sewer applications — to our product portfolio. In connection with the acquisition, we acquired pipe facilities in Tracy, California and San Luis Río Colorado, Mexico, as well as a protective lining facility in Brea, California.
On April 21, 2019, there was an accidental fire at our Saginaw, Texas facility which resulted in damage to the coatings building. There were no injuries, but the ability to coat at this facility will be impaired while we assess and repair the damage. Our other production locations can be deployed to absorb whatever lost production we have as a result. We have insurance coverage in place covering, among other things, property damage and business interruption up to certain specified amounts, and have notified our insurers of the incident.
Our water infrastructure products are sold generally to installation contractors, who include our products in their bids to municipal agencies or privately-owned water companies for specific projects. We believe our sales are substantially driven by spending on new water infrastructure with a recent trend towards spending on water infrastructure replacement, repair, and upgrade. Within the total range of pipe products, our products tend to fit the larger-diameter, higher-pressure applications.
Our Current Economic Environment
We operate our business with a long-term time horizon. Projects are often planned for many years in advance, and are sometimes part of 50-year build-out plans. Long-term demand for water infrastructure projects in the United States appears strong. However, in the near term, we expect that strained governmental and water agency budgets along with increased capacity from competition could impact the business. Fluctuating steel costs will also be a factor, as the ability to adjust our selling prices as steel costs fluctuate depends on market conditions. Purchased steel represents a substantial portion of our cost of sales, and changes in our selling prices often correlate directly to changes in steel costs.
In March 2018, the President signed a proclamation imposing a 25% tariff on all imported steel products for an indefinite amount of time under Section 232 of the Trade Expansion Act of 1962. In June 2018, Mexico imposed a 25% tariff on all steel products shipped from the U.S. to Mexico, and in July 2018, Canada imposed a 25% surtax on imports of U.S. steel products. These tariffs cover our primary raw material, hot rolled coil, as well as our finished steel pipe product. We routinely ship steel pipe into Canada. The tariffs may lead to project delays or cancellations while they are in place. In addition, our facility in San Luis Río Colorado, Mexico may also be negatively impacted. Historically, the raw material has been purchased in the U.S. and shipped to Mexico for manufacturing, and the finished product has been shipped from Mexico to the U.S. If we continue this practice, we will have a tariff on the purchased hot rolled coil as well as the finished steel pipe.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based upon our Condensed Consolidated Financial Statements included in Part I – Item 1. “Financial Statements” of this 2019 Q1 Form 10-Q, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of our Condensed Consolidated Financial Statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues, and expenses, and disclosure of contingent assets and liabilities. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. On an ongoing basis, we evaluate all of our estimates, including those related to revenue recognition, business combinations, inventories, property and equipment, including depreciation and valuation, share-based compensation, income taxes, allowance for doubtful accounts, and litigation and other contingencies. Actual results may differ from these estimates under different assumptions or conditions.
There have been no significant changes in our critical accounting policies and estimates during the three months ended March 31, 2019 as compared to the critical accounting policies and estimates disclosed in our 2018 Form 10-K.
Recent Accounting Pronouncements
For a description of recent accounting pronouncements affecting our company, including the dates of adoption and estimated effects on financial position, results of operations, and cash flows, see Note 13 of the Notes to Condensed Consolidated Financial Statements in Part I – Item I. “Financial Statements” of this 2019 Q1 Form 10-Q.
Results of Operations
The following table sets forth, for the periods indicated, certain financial information regarding costs and expenses expressed in dollars (in thousands) and as a percentage of total Net sales.
|
|
Three Months Ended March 31, 2019
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|
|
Three Months Ended March 31, 2018
|
|
|
|
$
|
|
|
% of Net Sales
|
|
|
$
|
|
|
% of Net Sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net sales
|
|
$
|
62,643
|
|
|
|
100.0
|
%
|
|
$
|
33,365
|
|
|
|
100.0
|
%
|
Cost of sales
|
|
|
56,072
|
|
|
|
89.5
|
|
|
|
32,017
|
|
|
|
96.0
|
|
Gross profit
|
|
|
6,571
|
|
|
|
10.5
|
|
|
|
1,348
|
|
|
|
4.0
|
|
Selling, general, and administrative expense
|
|
|
4,247
|
|
|
|
6.8
|
|
|
|
3,385
|
|
|
|
10.1
|
|
Restructuring expense
|
|
|
-
|
|
|
|
-
|
|
|
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305
|
|
|
|
0.9
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|
Operating income (loss)
|
|
|
2,324
|
|
|
|
3.7
|
|
|
|
(2,342
|
)
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|
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(7.0
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)
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Other income
|
|
|
159
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|
|
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0.3
|
|
|
|
170
|
|
|
|
0.5
|
|
Interest income
|
|
|
4
|
|
|
|
-
|
|
|
|
77
|
|
|
|
0.2
|
|
Interest expense
|
|
|
(131
|
)
|
|
|
(0.2
|
)
|
|
|
(128
|
)
|
|
|
(0.4
|
)
|
Income (loss) before income taxes
|
|
|
2,356
|
|
|
|
3.8
|
|
|
|
(2,223
|
)
|
|
|
(6.7
|
)
|
Income tax expense (benefit)
|
|
|
191
|
|
|
|
0.3
|
|
|
|
(272
|
)
|
|
|
(0.9
|
)
|
Net income (loss)
|
|
$
|
2,165
|
|
|
|
3.5
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%
|
|
$
|
(1,951
|
)
|
|
|
(5.8
|
)%
|
We have one business segment, Water Transmission, which manufactures large-diameter, high-pressure, engineered welded steel pipeline systems, as well as reinforced concrete pipe and protective linings, for use in water infrastructure applications, which are primarily related to drinking water systems. These products are also used for hydroelectric power systems, wastewater systems, and other applications. In addition, we make products for industrial plant piping systems and certain structural applications. See Note 2 of the Notes to Condensed Consolidated Financial Statements in Part I – Item I. “Financial Statements” of this 2019 Q1 Form 10-Q for information on our acquisition of Ameron in July 2018.
Three Months Ended
March 31, 2019
Compared to Three Months Ended
March 31, 2018
Net sales.
Net sales increased 87.8% to $62.6 million for the first quarter of 2019 compared to $33.4 million for the first quarter of 2018. The acquired Ameron operations contributed $11.8 million of the increase in net sales for the first quarter of 2019. The increase in net sales in the first quarter of 2019 compared to the first quarter of 2018 was due to a 68% increase in tons produced and a 12% increase in selling price per ton. The increase in tons produced was due to project mix. Bidding activity, backlog, and production levels may vary significantly from period to period affecting sales volumes.
Gross profit.
Gross profit increased 387.5% to $6.6 million (10.5% of Net sales) for the first quarter of 2019 compared to $1.3 million (4.0% of Net sales) for the first quarter of 2018. The increase in gross profit for the first quarter of 2019 compared to the first quarter of 2018 was primarily due to increased production volume.
Selling, general
,
and administrative expense.
Selling, general, and administrative expense increased 25.5% to $4.2 million (6.8% of total Net sales) for the first quarter of 2019 compared to $3.4 million (10.1% of total Net sales) for the first quarter of 2018. The increase in selling, general, and administrative expense for the first quarter of 2019 compared to the first quarter of 2018 was primarily due to $0.8 million in higher wages and incentive compensation related expense.
Restructuring expense.
In March 2018, we announced our plan to close our leased Permalok
®
manufacturing facility in Salt Lake City, Utah and move the production to our Permalok
®
production facility in St. Louis, Missouri, which was completed during the second quarter of 2018. Also in March 2018, we announced our plan to close our manufacturing facility in Monterrey, Mexico. Production ceased early in the second quarter of 2018, and the facility was sold in December 2018. We incurred restructuring expense of $0.3 million in the first quarter of 2018, which includes employee severance and termination related restructuring expense of $0.2 million and expense related to demobilization activities of $0.1 million.
Income taxes.
Income tax expense was $0.2 million in the first quarter of 2019 (an effective income tax rate of 8.1%) compared to an income tax benefit of $0.3 million in the first quarter of 2018 (an effective income tax rate of 12.2%). The effective income tax rate for the first quarter of 2019 was impacted by the estimated changes in our valuation allowance. The effective income tax rate for the first quarter of 2018 was impacted by the estimated changes in our valuation allowance, as well as by the tax windfall from share-based compensation. The effective income tax rate can change significantly depending on the relationship of permanent income tax deductions and tax credits to estimated pre-tax income or loss and the changes in valuation allowances. Accordingly, the comparison of effective income tax rates between periods is not meaningful in all situations.
Liquidity and Capital Resources
Sources and Uses of Cash
Our principal sources of liquidity generally include operating cash flows and the Credit Agreement with Wells Fargo Bank, N.A. dated October 25, 2018 (the “Credit Agreement”). From time to time our long-term capital needs may be met through the issuance of long-term debt or additional equity. Our principal uses of liquidity generally include capital expenditures, working capital, and debt service. Information regarding our cash flows for the three months ended March 31, 2019 and 2018 are presented in our Condensed Consolidated Statements of Cash Flows contained in Part I – Item 1. “Financial Statements” of this 2019 Q1 Form 10-Q, and are further discussed below.
As of March 31, 2019, our working capital (current assets minus current liabilities) was $118.6 million compared to $128.0 million as of December 31, 2018. Cash and cash equivalents totaled $3.8 million and $6.7 million as of March 31, 2019 and December 31, 2018, respectively.
Fluctuations in our working capital accounts result from timing differences between production, shipment, invoicing, and collection, as well as changes in levels of production and costs of materials. We typically have a relatively large investment in working capital, as we generally pay for materials, labor, and other production costs in the initial stages of a project, while payments from our customers are generally received after finished product is delivered. Our revenues are recognized over time as the manufacturing process progresses; therefore, cash receipts typically occur subsequent to when revenue is recognized and the elapsed time between when revenue is recorded and when cash is received can be significant. As such, our payment cycle is a significantly shorter interval than our collection cycle, although the effect of this difference in the cycles may vary by project, and from period to period.
There were no borrowings under the Credit Agreement as of March 31, 2019. Borrowings under the Credit Agreement were $11.5 million as of December 31, 2018.
Net cash provided by operating activities in the first three months of 2019 was $10.4 million. Cash provided by operating activities was primarily the result of our net income adjusted for noncash charges and the fluctuations in working capital accounts that included decreases in trade and other receivables, contract assets, net, and prepaid expenses and other offset by increases in inventories and decreases in accounts payable and accrued and other liabilities.
Net cash used in investing activities in the first three months of 2019 was $1.6 million, primarily due to $1.6 million of capital expenditures, which was primarily standard capital replacement. Total capital expenditures in 2019 are expected to range between $9.0 million and $12.5 million for standard capital replacement, which do not include amounts to replace equipment damaged in the Saginaw fire.
Net cash used in financing activities in the first three months of 2019 was $11.6 million, primarily due to net repayments on line of credit of $11.5 million.
We anticipate that our existing cash and cash equivalents, cash flows expected to be generated by operations, and amounts available under the Credit Agreement will be adequate to fund our working capital and capital expenditure requirements for at least the next twelve months. To the extent necessary, we may also satisfy capital requirements through additional bank borrowings, senior notes, term notes, subordinated debt, and finance and operating leases, if such resources are available on satisfactory terms. We have from time to time evaluated and continue to evaluate opportunities for acquisitions and expansion. Any such transactions, if consummated, may use a portion of our working capital or necessitate additional bank borrowings or other sources of funding.
On September 15, 2017, our registration statement on Form S-3 (Registration No. 333-216802) covering the potential future sale of up to $120 million of our equity and/or debt securities or combinations thereof, was declared effective by the Securities and Exchange Commission. This registration statement provides another potential source of capital, in addition to other alternatives already in place. We cannot be certain that funding will be available on favorable terms or available at all. To the extent that we raise additional funds by issuing equity securities, our shareholders may experience significant dilution. As of the date of this 2019 Q1 Form 10-Q, we have not yet sold any securities under this registration statement, nor do we have an obligation to do so. Please refer to the factors discussed in Part I – Item 1A. “Risk Factors” in our 2018 Form 10-K.
Borrowings on Line of Credit
As of March 31, 2019, we had no outstanding borrowings and $1.6 million of outstanding letters of credit under the Credit Agreement. The Credit Agreement expires on October 25, 2023 and provides for revolving loans and letters of credit in the aggregate amount of up to $60 million, subject to a borrowing base (the “Revolver Commitment”). We have the ability to increase the Revolver Commitment to $100 million, subject to the provisions of the Credit Agreement.
The borrowing base is calculated by applying various advance rates to eligible accounts receivable, contract assets, inventories, and fixed assets, subject to various exclusions, adjustments, and sublimits. As of March 31, 2019, we had additional borrowing capacity of $49.5 million, net of outstanding letters of credit and the amount required to avoid a covenant trigger event. Based on our business plan and forecasts of operations, we expect to have sufficient credit availability to support our operations for at least the next twelve months.
Borrowings under the Credit Agreement bear interest at rates related to the daily three month London Interbank Offered Rate plus 1.5% to 2.0%. The Credit Agreement requires the payment of an unused line fee of between 0.25% and 0.375%, based on the amount by which the Revolver Commitment exceeds the average daily balance of outstanding borrowings (as defined in the Credit Agreement) during any month. Such fee is payable monthly in arrears.
The Credit Agreement contains customary representations and warranties, as well as customary affirmative and negative covenants, events of default, and indemnification provisions in favor of the lender. The negative covenants include restrictions regarding the incurrence of liens and indebtedness and certain acquisitions and dispositions of assets and other matters, all subject to certain exceptions. The Credit Agreement also requires us to regularly provide financial information to Wells Fargo and to maintain a specified fixed charge coverage ratio upon certain triggers.
In connection with the execution and delivery of the Credit Agreement, we and certain of our subsidiaries also entered into a Guaranty and Security Agreement with Wells Fargo (the “Guaranty and Security Agreement”). Pursuant to the Guaranty and Security Agreement, our obligations under the Credit Agreement are secured by a security interest in substantially all of our and our subsidiaries’ assets.
Off
-
Balance Sheet Arrangements
We do not have any off-balance sheet arrangements that are reasonably likely to have a current or future material effect on our financial position, results of operations, or cash flows.