NWPX Infrastructure Inc (NWPX) 2008 Q4 法說會逐字稿

Good morning and welcome to the fourth quarter 2008 earnings release conference call. (Operator Instructions) Now I will turn the meeting over to Mr. Brian Dunham, CEO and President.

Thank you, Corey. My name is Brian Dunham, I'm the President and the CEO of the Company, I'm joined by Stephanie Welty, our Chief Financial Officer. Before we begin, I would like to remind everyone that the statements we make in this call about our expectations for the future are forward-looking statements. And actual results could differ materially. Please refer to our most recent filing with the SEC for a discussion of the risk factors that could cause actual results to differ materially.

I'm pleased to announce record sales and record earnings for 2008. This is the fifth consecutive year that we have generated record sales. For the last four years, we have added record earnings as well. For 2008, we generated revenue of $439.7 million, and earnings of $32.3 million. This is an increase in revenue of 14.9% over 2007, and an increase in earnings of 55%. This equates earnings per share of $3.46 in 2008, compared to $2.26 last year. With that, I will turn this over to Stephanie to review our financial results, focusing on the fourth quarter.

Thank you, Brian. Fourth quarter revenues were $110.2 million, compared to $98.2 million in the fourth quarter of 2007. Net income for the fourth quarter of 2008 was $8.6 million, while net income for the fourth quarter of '07 was $5.6 million. This translates to $0.92 per diluted share in the fourth quarter of 2008, versus $0.60 in the fourth quarter of 2007. Moving on to the quarterly results to the two business groups, water transmission revenue was $55.7 million in the fourth quarter of '08, compared to $80.3 million in the fourth quarter of '07. Gross profit was $11 million or 19.7% of revenues, compares to $17 million or 21.2% of revenue last year.

Fourth quarter results in the water transmission group were affected by our production down time caused by postponement of a major project, inclement weather and the installation of new equipment. Weather accounted for approximately 12 days of down time, and affected all but two plants. The installation of new equipment at our California plant, accounted for a personal loss of production over about 50 days. In tubular products we are happy to report that revenue and gross profits both hit record levels in the fourth quarter for the third consecutive quarter. Tubular product sales were $54.5 million in the fourth quarter of '08, up from $17.9 million in the fourth quarter of '07. In the fourth quarter a year ago, we had virtually no energy pipe sales. We were in the process of establishing our relationship with our current sales agent, and over the course of 2008, we saw rapid growth in our energy pipe business which drove our overall revenue growth.

Gross profit for the tubular products was $13.5 million or 24.7% of revenues compared to $1 million or 5.5% of revenues in the fourth quarter of '07. In addition to volume growth, we saw significant increases in selling prices that accompanied rising steel costs and a shift to products with higher gross margins that are historical product mix. We do not expect this combination of factors to repeat in '09. Brian will provide some additional color on our expectations for the tubular products group in just a few moments. Selling, general and administrative costs were $8.9 million in the fourth quarter of '08. While an increase from last year, this is down slightly from the third quarter of 2008. We expect SG&A spending to be a bit lower in '09, compared to '08. Interest expense is $1.9 million for the fourth quarter of 2008, compared to $1.7 million for the fourth quarter of '07. Total debt grew $21.8 million, as a result of financing working capital growth driven by higher volume and compounded by higher steel costs.

For the first quarter of '09, we expect the interest expense to be down slightly from the fourth quarter. Our tax rate for 2008 was approximately 38%, and we expect the tax rate to be 37% to 38% in 2009. After adjusting for taxes, we generated net income for the quarter of $8.6 million, which equates to $0.92 per share. In the third quarter of '08, we saw significant increases in inventory, which reversed in the fourth quarter. We reduced inventory by $12.7 million, and reduced our net unbilled revenue, the equivalent of work in process in the water business by $12.8 million, both positive trends for cash flow. However, simply due to timing of raw material and capital purchases, the accounts payable came down $30.4 million in the fourth quarter. The net result of these offsetting cash flows provided $4 million of cash flow from operations in the fourth quarter.

Capital expenditures in the fourth quarter were $6.2 million, and depreciation and amortization expense was $1.3 million. We continue to invest in production capacity to prepare to serve a water infrastructure market in excess of $1 billion. We have just completed installation of a new mill in California that will provide increased throughput and process higher gauged steel. We also focus a great deal of attention on improving our manufacturing processes to increase capacity with minimal capital investment. We expect capital expenditures, including the Bossier City facility to be roughly $10 million to $12 million. In December, Northwest Pipe Asia acquired by our limited. a leading designer and builder of spiral pipe mills. The new mill in California is a buyers mill. We expect this relationship to generate a positive return from buyers space business as well as provide new insights into international water infrastructure market and potentially lead us into new ventures. Brian will now discuss our expectations for 2009.

Thank you. Obviously we are very pleased to be able to report the record results for 2008, and the very strong fourth quarter which Stephanie has just described. As you all know, the economic environment has changed significantly in it the last five months. As we look forward to the first quarter of 2009, and beyond, I will focus on the recession, the financial crisis, the changing cost of steel and finally the stimulus plan and how each of these may affect our businesses. As of the end of 2008, our backlog was approximately $190 million. While this is down from the $235 million we reported at the end of the third quarter, it is still at quite a healthy level. The change in the backlog was virtually entirely due to the tubular products business. The water transmission backlog stayed at approximately the same level from Q3 to Q4.

The change in the backlog brings to us a discussion about the recession and its effect on our tubular products group. As most of you know, the bulk of our tubular products business is a short-term inventory-type business. During 2008, sales of our energy products grew dramatically. Demand was so high for these products that we began to build a longer term backlog than we would normally expect. As the recession hit late in Q3 and early Q4, one of the consequences was the decline in natural gas drilling activity and a decline in order activity for our energy products. Throughout the fourth quarter; however, we continue to supply our customers with pipe that they had previously ordered. This grew strong results in Q4, even as the demand declines precipitously and resulted in the decline in the backlog at year end.

In addition to energy products for which the demand is driven by drilling activity, the key drivers for our tubular products growth includes highway spending, non-residential construction, and agricultural spending. As we look ahead in this recessionary environment, we expect all of these to be down at least through first half of 2009. Accordingly, we are not expecting the same kind of results in 2009, that we are able to generate last year. We also believe we are seeing a magnified effect right now, because our customers, primarily distributors, are reducing their own stocks. Accordingly, demand for our tubular products is very low. Conversely, we expect to a see a somewhat oversized increase in demand later in the year, when inventories need to be restocked at the same time user demand increases. Steel costs will also be a significant factor in our 2009 results. In 2008, steel climbed almost $1,200 per ton for the grades that we use in this business. Today those same grades of steel are selling for approximately half this amount. Historically our selling prices have adjusted to changes in steel costs. As we look ahead, we expect steel costs will increase this year, though probably only by $150 to $250 per ton. Accordingly we expect a lower average selling price throughout the year.

The financial crisis has not altered our business model in tubular products so far, as near as we can tell. Certainly some of our customers may be having more difficulty with credit lines and if so, this may reduce the amount of inventory they ultimately will carry as things improve. To date, we have not seen any financial difficulties in our customers such as bankruptcies or even dramatic changes in payment patterns and we don't believe there's a very high risk here. Drilling activity; however, can be traced to both economic conditions, ie, the recession and the credit crunch. This is generally a highly leveraged business and the lack of credit may be exacerbating the slowdown that we currently see, obviously trying to separate the impact of the financial crisis from the recession is difficult.

The stimulus plan could provide some benefits to the tubular products group. Obviously, there are dollars in the plan for highway spending and this could filter down into the traffic sign post business. Perhaps more importantly, we do make some structural products at our Atchison, Kansas division. Construction spending may increase demand for these products. At this time; however, we do not expect much of the benefit from the stimulus in the tubular products group. The real boost to this business will come as the natural gas exploration market improves. We continue to expect improvement in demand for the API products that we currently make. Obviously gas exploration has not stopped and this country's reliance on natural gas will not end. The long-term fundamentals in this business are still strong and we have a good position in this market.

We are also in the process of re-commissioning our plant in Bossier City, Louisiana, and modifying it to focus on OTCG products for natural gas drilling. Because we already own the land and buildings and the major manufacturing equipment, we will be able to enter this market on a cost effective basis; however, when we began this project, we certainly planned on higher drilling activity than is currently forecasted. In order to minimize our risk and conserve capital, we are not going to finish the plant at this time. We will complete the main manufacturing line, but we will not add the downstream operations to finish the products. This will allow us to access the market by sending products out to a processor for finishing and to rapidly complete the plant when the market conditions warrant. We believe this strategy will prove to be very effective in maximizing our return on this investment.

Turning to water transmission, and, again, focusing on the recession, the financial crisis, the cost of steel, and the stimulus package, we see a very different story. First of all, as I have said before, the water transmission business does not always run according to a business cycle. Projects are often planned for many years in advance and are sometimes part of 50 year build out plans. Near-term issues can certainly delay products but fundamentally this is a business with a very long-term time horizon. As we look at the effects of recession, we do not see anything like the impact that we have seen in tubular products. In fact, our three-year outlook is actually higher today than it it was six months ago, or a year ago. We see a significant number of projects ahead of us, primarily new construction that will provide greater market opportunities in our future than we have seen to date. There are many concerns about the funding issues for these projects. The credit crunch or credit freeze has been widely reported but it's important to make distinctions between markets.

First, there's a common perception that water projects are funded out of tax revenues. However, this is not the case. Water projects are typically by revenue bonds which are backed by connection fees monthly water rates and no tax dollars involved. The key to funding is the municipal bond market and particularly the revenue bond market.. After temporarily freezing in October, we see the municipal bond market functioning again today. For the first several weeks of this year, bond sales have averaged around $5 million per week and rates have come down as well. This market looks to be well on its way to recovery. To be more specific about funding issues, last quarter, we surveyed many of the municipal agencies that we felt would have significant activity in 2009. We found that approximately 90% of these agencies had funding in place for upcoming projects or had no concerns about funding. We have -- we have updated that research in the last four days and generally found the same answers. For most agencies funding is not the last component to be put in place. We believe that in most cases, the projects we will be bidding in 2009 are already funded.

That being said, we always see delays in the water transmission business. Nearly half of all projects are delayed from their original planned bid dates for a variety of reasons. In the fourth quarter of 2008, we saw well over $100 million worth of projects postponed that we had expected to bid during the quarter. This obviously affected our backlog at year end. As we analyzed these postponements we found only one agency that's has postponed work for a significant period of time due to funding issues. This particular agency recently adopted an approach that they would get the funding in the last step of developing a project as they saw the municipal bond market freeze up in the fourth quarter and rates go higher, they moved all of their projects out. The other project delayed out of Q4 generally moved for a variety of reasons having nothing to do with funding. All of these projects have new expected bid dates within the next six months. One or two appear to have delayed as they waited clarity on the stimulus package. Even though they may have had funding already in place, they wanted to see if a new source of funding might become available. Now that the stimulus is finalized we hope to see these projects proceed rapidly.

The cost of steel will also have an impact on this business. As steel costs fell our selling prices adjusted as well. Steel is not nearly as big of a component of our cost in the water transmission business as it is in tubular products. And the input cost of selling price relationships is not as tight but raw material price is still an important factor. Based on our forecast of steel costs we expect our average selling price in 2009 will be lower. Finally, the stimulus package. Obviously this package went through numerous changes before it was finalized and signed by President Obama last week. There are a few pieces to the package that are significance to us. First, the act provides for $6.4 billion, primarily for water infrastructure to be administered by the EPA. Of this total, $4 billion is targeted for projects under the Clean Water Act and $2 billion is targeted for projects under the Safe Drinking Water Act, the most important component for us. In addition, $1.375 billion was appropriated for rural water programs, $200 million was distributed to the Army Corps of Engineers for water-related projects and the bureau of reclamation also received $1 billion for water projects.

We are tracking a few large projects that are financed at least in part by either the bureau or the corps and while it is not a significant part of our overall business, we also make piling products and any increase in highway construction may benefit this segment as well. In spite of the funding provided in the stimulus package, we are not currently counting on any benefits. We do see upside potential, however. We think the stimulus will tend to accelerate certain projects. As noted earlier, we know of some agencies who have postponed major projects waiting for some clarity on the package, based on our review, it appears they may be eligible and will undoubtedly work to get included and this means moving quickly. We now know of a few other agencies that are planning to move bids from 2010 to 2009 for some specific projects in order to access stimulus funds. The act is clear, the projects need to be started soon in order to qualify for funding. The biggest piece of the package that is applicable to us is the $2 billion for the Safe Drinking Water Act. This amount will be distributed to states according to a pre-existing formula. The states will find local projects to qualify and pass the funds through to these projects. Importantly the requirements for matching funds has been waived and a certain proportion of these funds may be grants, industry loans or even negative interest loans. This will be very attractive to local municipalities and it's certainly possible we will see an uptick in near term bidding activities as agencies seek to access this funding source.

One last point regarding stimulus packages, Canada has also adopted a package and their package they have roughly $10 billion targeted towards construction projects. We are very well situated to serve western Canada. To the extent monies are funneled into water projects in this part of the country, we may also benefit north of the US border. So as you attempt to pull all of this together and get a sense of where Northwest Pipe is going in the next year, I would suggest this in summary. Tubular products will be challenged in the first two quarters of the year. Assuming some improvement in the general economy and in drilling activity, will be quite a stronger in the second half. Per unit pricing will clearly be down as will raw material costs. We believe the first quarter revenues will likely be off 20 to 30% year-over-year. Water transmission revenues in the first quarter will be off somewhat year-over-year, due to the down time caused by the installation of the new mill in Adelanto which was just completed last week and to weather issues.

Revenues will be somewhat better in the second quarter and quite a bit better in the second half, based on expected bidding activity and the timing of production. Benefits from the stimulus package, if any, will not take effect until the third quarter at the earliest and most likely the fourth quarter. Because of lower input costs we expect lower selling prices and this will tend to reduce overall water transmission revenues, but should not have a detrimental impact on margins. We have made the decision to temporarily close the Pleasant Grove, Utah, facility. This division has performed very well since we acquired it and its people are first rate; however, there's simply not enough work locally to maintain the facility. We do see jobs coming up in the Utah region, but they are for pipe sizes that are out of our range at this facility. We hope to see more project activity in the future and the opportunity to reopen this division. At this time, we expect to be operating this facility through the end of April.

Overall, we are adjusting our cost structures in order to react to the changing market conditions we see. Our objective is to find ways to perform well during these challenging times and be prepared to take advantage of better conditions as the economy improves. I'm confident that the long-term drivers of our businesses are strong, and I believe we will come through this economic cycle successfully. In conclusion, I'm once again very pleased to be able to report these record results for 2008. But we certainly have some favorable market conditions during the year. We also face many challenges and I'm proud of the way our team executed. I expect to be just as proud of their performance a year from now when we look back at 2009. At this time we will be happy to answer any questions you may have. Corey?

Thank you. (Operator Instructions) Our first question comes from Brent Thielman of DA Davidson. Sir, your line is open.

Good morning, Brian, Stephanie, congratulations on a great quarter.

Thank you. you.

Brian, I just wanted to confirm. I think I missed the number. Did you say on the tubular business, you expected first quarter revenues off 20 to 30% year-over-year?

Yes.

And then water, I don't think you gave-- you quantified-- you expect it to be down as well on a year-over-year--

Yes, I think it will be down a little bit year-over-year, and as we said, the -- the new mill installation (inaudible) is certainly a big part of it. It carried into 2009. We have also had several weather events during 2009 as well, that even though it it didn't seem to be a very extreme winter, it hit at the wrong time and the wrong places. So we were down for several days because of weather in the first quarter already.

Okay. And I guess in tubular products, can you give us any sense of where average selling prices are now, I mean, relative to the fourth quarter? In other words, how much of the strength in price maybe you experienced in Q4 will continue into the first quarter.

Well, it's a little bit difficult to do that, because it varies from product to product and as you know we have a variety of different product lines which have different pricing. I would say in tubular products, it is historically true that the price does adjust to the changing cost of steel.

Yeah.

And so steel is down, figure steel down at least $500 a ton in Q1 from where it was at the peak. By now, the prices have pretty much adjusted to that number.

Okay. That's helpful. And on the Utah facility, do you have an estimate of annual cost savings related to that closure?

It will be roughly $2 million annualized.

Okay. And then I guess just looking at the water transmission margins they did tick up from the third quarter, obviously a positive sign, but despite what appeared to be increased down time at your facilities, can you explain what helped contribute to that in the quarter.

Yes, I think it was really just a better mix of projects going through the plants, because the down time, obviously, tends to reduce your overall margins. So that was not a bad performance.

Okay. And I guess do you see any significant near term margin opportunities with the lower cost of steel for that business right now?

There's some possibilities, Brent. Nothing that I can quantify at this point.

Sure. Sure. And then just lastly, do you see or foresee any near term issues with steel availability, just given the degree of production cuts by mills?

We don't at the current time. We do expect supply to get a little tighter. We do think that we'll see probably some increases, small increases starting in April, and steel costs and we also think we will see lead times start to extend a little bit, somewhere in that time frame. But at the moment we have no concerns.

Okay. I will jump back in queue, thanks, guys.

Brian Connors of Boenning & Scattergood. You may ask your question.

Good morning, Brian and Stephanie.

Hi.

A couple of questions. First off, I wanted to talk about fix cost leverage, Brian. I know you talked about the steel prices and the impact of that on variable cost and you talked about some of the facilities actions that you are taking. I wonder if you could talk about the fixed cost base in each of the two business units. Maybe in terms of the breakdown between fixed and variable costs over the last few quarters. Just trying to get an idea of what kind of -- I guess in particular, on tubular products, trying to get an idea of what kind of negative operating leverage, if you will, what the impact of that might be on margins, especially in the first half as you discussed with volumes maybe down significantly.

Well, I'm not exactly sure how you want to approach that discussion. There's the concept of fixed versus variable cost in accounting is not quite the same way it works in reality. We typically have more what I would call semi-fixed costs within our range of production. And as we'll adjust, our production, what we will try to do is stay at the right end of that range, if you will.

Mm-hmm.

And that generally means looking at shifts as opposed to smaller changes in terms of staffing levels. For example, in our Atchison plant, we have two shifts today, where we were at three shifts a few months ago. The true fixed costs in this business, you can -- are not as great as you might expect and I don't have the numbers in front of me, Brian, but we can go through that in more detail.

Okay. So it sounds like you don't expect any kind of major impact in terms of having to spread a fixed cost base over a larger volume, even in a tubular business.

We think we are going to adjust reasonably effectively, but, yes, there are some fixed costs and it will be hard to leverage against the fixed costs with lower volumes. There will be some negative impact, but we should be able to adjust pretty efficiently.

Okay. And then I guess just the same discussion on the SG&A side, I mean, obviously, historically you have run fairly lean there, you know, 7, 8% of sales is how we look at it, percentage of sales, but given the dollar run rate there, could there be -- will that percentage increase on a percentage of sales basis and if so, could it be meaningful, at least in the first half?

Yes. At least in the first half, there's a possibility. We do see some reductions in costs there as well. Obviously we are doing the same types of things that many people are in order to manage our costs better. So we're aiming at not seeing that go up, but as we look at this year, as you have just implied, we see a very -- a significant difference between the first half and the second half. And so first half might be a little more challenging.

Okay. And then -- and then I just wanted to talk about some of the trade actions, Brian. You talked in the past on tubular products, obviously there are a few trade actions out there. They are either in place or pending, that would levy fairly substantial tariffs against imports of some of the natural gas tubing products that are competing with yours. If you could just talk -- update us on your outlook there, in terms of how that impacted the outlook in terms of whether the domestic suppliers-- how that impacts the volumes for the domestic suppliers and also how that might impact the pricing in the market, with those tariffs either in place or coming on.

Well, there is-- there was a successful trade case that affects API pipe, and that is in place as well as other products. There is a proposed case on OCTG products but I really don't have any other details about that at this point in time. I will say that there was a significant amount of OCTG products that came into the country in the last -- in the last couple of months. So there is a significant amount of pipe on the ground or in the ports right now.

Okay. But you don't think -- for example, if someone were-- the school of thought that the domestic suppliers will, in theory, out perform the market because the -- some of the imports will be going away? I mean, is this any truth to that kind of thinking?

That kind of -- that thought process is certainly based in -- on sound logic. And there are efforts underway, but whether or not those will be successful at this point, I can't tell you.

Okay. And then just finally, I want to talk about the balance sheet. On the surface, certainly looks -- the balance sheet looks clean and the Company looks very well positioned to weather the downturn, but I wondered if you could address the issue of financial risk and maybe talk about what kind of scenario could possibly develop that you could envision where the Company might face some kind of financial distress? How long would the downturn have to last the? What type of scenario would you have to see?

Well, I'm thinking about the way that question is phrased. There's always an answer to that, because it's open ended. Rather than respond to that, let me tell you in terms of what we've looked at as to what we think are the likely scenarios that lay out over the next 12 months, we feel like we are in pretty good shape. As our business slows down, obviously, let's take the negative scenario where water transmission does not do as well as we think, our balance sheet tends to start to kick out a lot of cash.

So our balance sheet picture gets a lot better as that business slows down. It's almost more challenging if that business does better than we expect in order to have the capability to continue to finance it. But we have a significant amount of capacity available as we speak today. So we do not see the scenario that really gets us into trouble as being very realistic. Now, if the recession carries on for years, obviously we and everybody else will have some problems, but as we've looked at the various scenarios that we think are likely, we have not been concerned about the financing.

Okay. Well, thanks for your time. Very helpful.

[Ray Snow ] Priority Capital, you may ask your question.

Thanks. I also had a question on the imports. Are there particular products or diameters that are particularly out of balance?

I think the answer to that is probably yes. I don't think it's necessarily across the board. The -- in terms of size ranges and so on, but I couldn't give you a lot of details regarding that. OCTG products, oil country tubular goods is where the most recent surge has come from. And that is essentially what the -- if you are not familiar with that terminology, that's essentially -- think of it as down hole type products, the verticals in gas or oil exploration.

Okay. Is there any way to put parameters around the size of this glut as you described it in the press release?

There are different people? -- did I use the term "glut" in the press release?

Yes.

I've got to go back and look.There are different analysts who are far more attuned to that overall industry than I am, and they have estimates out there, some of them six months supply, some of them 10 months supply. It's probably somewhere in that range and, of course, as I said, I don't believe it's across the board. I think it will be higher in some sizes than others.

Okay. Thanks.

Mm-hmm.

(Operator instructions) Brent Thielman of DA Davidson, your line is open.

Hi. Just one more for me. I guess, Brian, as you look at near-term activity out there in water transmission, and obviously backlog, is down a little bit year-over-year, I mean, do you think backlog has an opportunity to improve from current levels first quarter, just based on what you see right now?

Yes.

Okay. Thank you.

At this time, I'm showing no further questions.

Okay. Well, that will then conclude our conference call for the fourth quarter of 2008. Thank you all for your interest in Northwest Pipe Company.