NWPX Infrastructure, Inc.: Form 10-Q for the period ended Mar 31, 2023

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, 2023 (“2023 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 and order cancelations;
• timing of customer orders and deliveries;
• production schedules;
• price and availability of raw materials;
• 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;
• economic uncertainty and associated trends in macroeconomic conditions, including potential recession, inflation, and the state of the housing market;
• interest rate risk and changes in market interest rates, including the impact on our customers and related demand for our products;
• our ability to identify and complete internal initiatives and/or acquisitions in order to grow our business;
• our ability to effectively integrate Park Environmental Equipment, LLC (“ParkUSA”) and other acquisitions into our business and operations and achieve significant administrative and operational cost synergies and accretion to financial results;
• effects of security breaches, computer viruses, and cybersecurity incidents;
• impacts of U.S. tax reform legislation on our results of operations;
• adequacy of our insurance coverage;
• supply chain challenges;
• labor shortages;
• ongoing military conflicts in Ukraine and related consequences;
• operating problems at our manufacturing operations including fires, explosions, inclement weather, and floods and other natural disasters;
• material weaknesses in our internal control over financial reporting and our ability to remediate such weaknesses;
• impacts of pandemics, epidemics, or other public health emergencies; and
• other risks discussed in Part I — Item 1A. “Risk Factors” of our Annual Report on Form 10‑K for the year ended December 31, 2022 (“2022 Form 10‑K”) and from time to time in our other Securities and Exchange Commission (the “SEC”) 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 2023 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 a leading manufacturer of water-related infrastructure products, and operates in two segments, Engineered Steel Pressure Pipe (“SPP”) and Precast Infrastructure and Engineered Systems (“Precast”). For detailed descriptions of these segments, see Note 11, “Segment Information” of the Notes to Condensed Consolidated Financial Statements in Part I – Item 1. “Financial Statements” of this 2023 Q1 Form 10‑Q.

In addition to being the largest manufacturer of engineered steel water pipeline systems in North America, we manufacture stormwater and wastewater technology products; high-quality precast and reinforced concrete products; pump lift stations; steel casing pipe, bar-wrapped concrete cylinder pipe, and one of the largest offerings of pipeline system joints, fittings, and specialized components. Strategically positioned to meet growing water and wastewater infrastructure needs, we provide solution-based products for a wide range of markets under the ParkUSA, Geneva Pipe and Precast, Permalok®, and Northwest Pipe Company lines. Our diverse team is committed to quality and innovation while demonstrating our core values of accountability, commitment, and teamwork. We are headquartered in Vancouver, Washington, and have 13 manufacturing facilities across North America.

Our water infrastructure products are sold generally to installation contractors, who include our products in their bids to federal, state, and municipal agencies, privately-owned water companies, or developers for specific projects. We believe our sales are substantially driven by spending on urban growth and new water infrastructure with a recent trend towards spending on water infrastructure replacement, repair, and upgrade. Within the total range of products, our steel pipe tends to fit the larger-diameter, higher-pressure pipeline applications, while our precast concrete products mainly serve stormwater and sanitary sewer systems.

Our Current Economic Environment

Demand for our Precast products is generally influenced by general economic conditions such as housing starts, population growth, interest rates, and rates of inflation. According to the United States Census Bureau, privately-owned housing starts were at a seasonally adjusted annual rate of 1.4 million in March 2023 and December 2022, and the population of the United States is expected to increase by approximately 2 million people in 2023. Additionally, while recent and anticipated future increases in the federal funds rate by the Federal Reserve are expected to temper demand for housing, the immediate impacts have been muted by the demand for housing, stymied by recent labor and commodity shortages currently limiting the supply of new homes.

Our SPP projects are often planned for many years in advance, as we operate that business with a long-term time horizon for which the projects are sometimes part of 50 year build-out plans. Long-term demand for water infrastructure projects in the United States appears strong and we have experienced an improvement in recent short-term demand for our engineered steel pressure pipe. Medium-term demand prospects could be negatively impacted by recessionary economic forces or, conversely, positively impacted by increased funding expedited by the Bipartisan Infrastructure Deal (Infrastructure Investment and Jobs Act) and the Inflation Reduction Act.

Purchased steel typically represents approximately 35% of cost of sales, and higher steel costs generally result in higher selling prices and revenue; however, volatile fluctuations in steel markets can affect our business. SPP contracts are generally quoted on a fixed-price basis, and volatile steel markets can result in selling prices that no longer correlate to the cost available at the time of steel purchase. Steel markets have remained volatile through 2023, with prices increasing significantly in the first quarter. The increased steel costs are expected to be realized in our financial results in the second half of the year and offset by increased average selling prices.

Economic uncertainty, including the impacts of raw material shortages, inflationary pressures, potential risks of a recession, and the continued disruptions to and volatility in the financial markets could have an adverse effect on our business. The extent of the impact of these uncertainties on our business will depend on future developments, which are uncertain and cannot be predicted. Additionally, we have experienced effects of the current labor shortage at certain manufacturing facilities, for which we are mitigating the impact through the use of overtime and third-party outsourcing as warranted. It is possible that a prolonged shortage of qualified, available workers could have an adverse effect on our business.

Implementation of Enterprise Resource Planning (“ERP”) System at ParkUSA

In the third quarter of 2022, we implemented our ERP system at the ParkUSA manufacturing facilities. Due primarily to an underinvestment in systems preceding our acquisition, and vastly broader product offerings, this implementation has caused, and may continue to cause, disruption and inefficiencies in ParkUSA’s operations. We currently expect these disruptions to be limited to physical inventory counts, which have been required at greater frequency than desired in order to ensure the accuracy of our inventory quantities. Additionally, we have hired consultants to assist with an evaluation of the ERP system, process, and workflow design.

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, 2023 Compared to Three Months Ended March 31, 2022

Net sales. Net sales decreased 9.4% to $99.1 million in the first quarter of 2023 compared to $109.3 million in the first quarter of 2022.

SPP net sales decreased 14.9% to $63.5 million in the first quarter of 2023 compared to $74.7 million in the first quarter of 2022 driven by a 4% decrease in tons produced resulting primarily from changes in project timing and an 11% decrease in selling price per ton due to decreased materials costs. Bidding activity, backlog, and production levels may vary significantly from period to period affecting sales volumes.

Precast net sales increased 2.7% to $35.6 million in the first quarter of 2023 compared to $34.6 million in the first quarter of 2022 due primarily to an increase in selling prices resulting from high demand for our concrete products, in addition to increased materials costs.

Gross profit. Gross profit increased 12.1% to $16.6 million (16.7% of net sales) in the first quarter of 2023 compared to $14.8 million (13.5% of net sales) in the first quarter of 2022.

SPP gross profit increased 8.2% to $7.8 million (12.2% of SPP net sales) in the first quarter of 2023 compared to $7.2 million (9.6% of SPP net sales) in the first quarter of 2022. SPP gross profit in the first quarter of 2022 was negatively impacted by $2.0 million for a product liability settlement reserve.

Precast gross profit increased 15.8% to $8.8 million (24.7% of Precast net sales) in the first quarter of 2023 compared to $7.6 million (21.9% of Precast net sales) in the first quarter of 2022 primarily due to improved pricing.

Selling, general, and administrative expense. Selling, general, and administrative expense increased 26.7% to $11.9 million (11.9% of net sales) in the first quarter of 2023 compared to $9.4 million (8.5% of net sales) in the first quarter of 2022 primarily due to $1.0 million in higher incentive compensation expense, $0.9 million in higher base compensation and benefits expense, $0.3 million in higher professional fees, and $0.3 million in higher administrative expenses.

Income taxes. Income tax expense was $1.0 million in the first quarter of 2023 (an effective income tax rate of 28.7%) compared to $1.3 million in the first quarter of 2022 (an effective income tax rate of 27.4%). The estimated effective income tax rates for the first quarter of 2023 and 2022 were impacted by non-deductible permanent differences. The estimated effective income tax rate can change significantly depending on the relationship of permanent income tax differences and tax credits to estimated pre-tax income or loss and the changes in valuation allowances. Accordingly, the comparison of estimated 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 dated June 30, 2021 with Wells Fargo Bank, National Association (“Wells Fargo”), as administrative agent, and the lenders from time to time party thereto, including the initial sole lender, Wells Fargo (the “Lenders”), as amended by the Incremental Amendment dated October 22, 2021 and the Second Amendment to Credit Agreement dated April 29, 2022 (together, the “Amended Credit Agreement”). From time to time our long-term capital needs may be met through the issuance of additional debt or equity. Our principal uses of liquidity generally include capital expenditures, working capital, organic growth initiatives, acquisitions, and debt service. Information regarding our cash flows for the three months ended March 31, 2023 and 2022 are presented in our Condensed Consolidated Statements of Cash Flows contained in Part I – Item 1. “Financial Statements” of this 2023 Q1 Form 10‑Q, and are further discussed below. We are actively managing the business to maintain cash flow and believe we have liquidity to meet our anticipated funding requirements and other near-term obligations.

As of March 31, 2023, our working capital (current assets minus current liabilities) was $170.5 million compared to $187.9 million as of December 31, 2022. Cash and cash equivalents totaled $3.9 million and $3.7 million as of March 31, 2023 and December 31, 2022, respectively.

Fluctuations in SPP 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. A portion of 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.

As of March 31, 2023, we had $62.6 million of outstanding revolving loan borrowings, $10.8 million of outstanding current debt, $93.0 million of operating lease liabilities, and $3.3 million of finance lease liabilities. As of December 31, 2022, we had $83.7 million of outstanding revolving loan borrowings, $10.8 million of outstanding current debt, $94.2 million of operating lease liabilities, and $3.0 million of finance lease liabilities.

Net Cash Provided by Operating Activities

Net cash provided by operating activities was $26.3 million in the first quarter of 2023 compared to $1.6 million in the first quarter of 2022. Net income, adjusted for non-cash items, provided $8.3 million of operating cash flow in the first quarter of 2023 compared to $8.8 million of operating cash flow in the first quarter of 2022. The net change in working capital provided (used) was $18.0 million of operating cash flow in the first quarter of 2023 compared to $(7.2) million of operating cash flow in the first quarter of 2022.

Net Cash Used in Investing Activities

Net cash used in investing activities was $4.4 million in the first quarters of 2023 and 2022. Capital expenditures were $4.4 million in the first quarters of 2023 and 2022, which was primarily for standard capital replacement. We currently expect capital expenditures in 2023 to be approximately $24 million to $28 million, which includes approximately $4 million of investment in our new reinforced concrete pipe mill, and associated ancillary equipment, and the remainder primarily for standard capital replacement.

Net Cash Provided by (Used in) Financing Activities

Net cash provided by (used in) financing activities was $(21.6) million in the first quarter of 2023 compared to $3.1 million in the first quarter of 2022. Net borrowings (repayments) on the line of credit were $(21.1) million in the first quarter of 2023 compared to $3.5 million in the first quarter of 2022.

We anticipate that our existing cash and cash equivalents, cash flows expected to be generated by operations, and additional borrowing capacity under the Amended Credit Agreement and other loans will be adequate to fund our working capital, debt service, 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 necessitate additional bank borrowings or other sources of funding.

On November 3, 2020, our shelf registration statement on Form S‑3 (Registration No. 333‑249637) covering the potential future sale of up to $150 million of our equity and/or debt securities or combinations thereof, was declared effective by the SEC. This shelf 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 2023 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 2022 Form 10‑K.

On September 2, 2022, we entered into an Open Market Sale Agreement (the “At-the-Market Offering”) with Jefferies LLC (“Jefferies”), pursuant to which we may issue and sell shares of our common stock, par value $0.01 per share, having aggregate offering sales proceeds of up to $50 million (the “Shares”) from time to time through Jefferies as our sales agent. We may sell the Shares in amounts and at times to be determined by us from time to time subject to the terms and conditions of the At-the-Market Offering, but we have no obligation to sell any of the Shares under the At-the-Market Offering. The Shares to be sold under the At-the-Market Offering, if any, will be offered and sold pursuant to our shelf registration statement on Form S‑3 discussed above, and the prospectus supplement dated September 2, 2022 filed by us. We will pay Jefferies a cash commission of up to 3.0% of gross proceeds from the sale of the Shares pursuant to the At-the-Market Offering. We have also agreed to provide Jefferies with customary indemnification and contribution rights. No proceeds were raised under the At-the-Market Offering during the three months ended March 31, 2023.

Current Debt

The Interim Funding Agreement dated August 2, 2022 with Wells Fargo Equipment Finance, Inc. (“WFEF”), as amended January 23, 2023 and March 15, 2023 (together, the “IFA”) provides for aggregate interim funding advances up to $13.5 million of equipment purchased for a new reinforced concrete pipe mill, to be converted into a term loan upon final delivery and acceptance of the financed equipment. The IFA bore interest at the term Secured Overnight Finance Rate (“SOFR”) plus 1.75% through January 31, 2023. Effective February 1, 2023, the IFA interest rate changed to the SOFR Average plus 1.75%. The IFA requires monthly payments of accrued interest and grants a security interest in the equipment to WFEF. As of March 31, 2023, the outstanding balance of the IFA was $10.8 million, which is classified as a current liability since there is not a firm commitment for long-term debt financing.

Credit Agreement

The Amended Credit Agreement provides for a revolving loan, swingline loan, and letters of credit in the aggregate amount of up to $125 million (“Revolver Commitment”). The Amended Credit Agreement will expire, and all obligations outstanding will mature, on June 30, 2024. We may prepay outstanding amounts in our discretion without penalty at any time, subject to applicable notice requirements. As of March 31, 2023 under the Amended Credit Agreement, we had $62.6 million of outstanding revolving loan borrowings, $1.1 million of outstanding letters of credit, and additional borrowing capacity of approximately $61 million. Based on our business plan and forecasts of operations, we expect to have sufficient credit available to support our operations for at least the next twelve months.

Revolving loans under the Amended Credit Agreement bear interest at rates related to, at our option and subject to the provisions of the Amended Credit Agreement, either: (i) Base Rate (as defined in the Amended Credit Agreement) plus the Applicable Margin; (ii) Adjusted Term SOFR (as defined in the Amended Credit Agreement) plus the Applicable Margin; or (iii) Adjusted Daily Simple SOFR (as defined in the Amended Credit Agreement) plus the Applicable Margin. The “Applicable Margin” is 1.75% to 2.35%, depending on our Consolidated Senior Leverage Ratio (as defined in the Amended Credit Agreement) and the interest rate option chosen. Interest on outstanding revolving loans is payable monthly. Swingline loans under the Amended Credit Agreement bear interest at the Base Rate plus the Applicable Margin. The Amended Credit Agreement requires the payment of a commitment fee of between 0.30% and 0.40%, based on the amount by which the Revolver Commitment exceeds the average daily balance of outstanding borrowings (as defined in the Amended Credit Agreement). Such fee is payable monthly in arrears. We are also obligated to pay additional fees customary for credit facilities of this size and type.

The letters of credit outstanding as of March 31, 2023 relate to workers’ compensation insurance. Based on the nature of these arrangements and our historical experience, we do not expect to make any material payments under these arrangements.

The Amended 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 Lenders. The negative covenants include restrictions regarding the incurrence of liens and indebtedness, annual capital expenditures, certain investments, acquisitions, and dispositions, and other matters, all subject to certain exceptions. The Amended Credit Agreement requires us to regularly provide financial information to Wells Fargo and to maintain a consolidated senior leverage ratio no greater than 2.50 to 1.00 (subject to certain exceptions) and a minimum consolidated earnings before interest, taxes, depreciation, and amortization (as defined in the Amended Credit Agreement) of at least $31.5 million for the four consecutive fiscal quarters most recently ended. Pursuant to the Amended Credit Agreement, we have also agreed that we will not sell, assign, or otherwise dispose or encumber, any of our owned real property. The occurrence of an event of default could result in the acceleration of the obligations under the Amended Credit Agreement. We were in compliance with our financial covenants as of March 31, 2023. Based on our business plan and forecasts of operations, we believe we will remain in compliance with our financial covenants for the next twelve months.

Our obligations under the Amended Credit Agreement are secured by a senior security interest in substantially all of our and our subsidiaries’ assets.

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 12, “Recent Accounting and Reporting Developments” of the Notes to Condensed Consolidated Financial Statements in Part I – Item 1. “Financial Statements” of this 2023 Q1 Form 10‑Q.

Critical Accounting 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 2023 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, goodwill, intangible assets, including amortization, 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 estimates during the three months ended March 31, 2023 as compared to the critical accounting estimates disclosed in our 2022 Form 10‑K.

For a discussion of our market risk associated with commodity prices, interest rates, and foreign currency exchange rates, see Part II – Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” in our 2022 Form 10‑K.

Evaluation of Disclosure Controls and Procedures

Disclosure controls and procedures (as defined in Rules 13a‑15(e) and 15d‑15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) are designed to provide reasonable assurance that information required to be disclosed in reports we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (the “SEC”) and that such information is accumulated and communicated to our management, including our Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”), as appropriate, to allow timely decisions regarding required disclosures.

In connection with the preparation of this Quarterly Report on Form 10‑Q for the quarter ended March 31, 2023, our management, under the supervision and with the participation of our CEO and CFO, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2023. Based on their evaluation, as of March 31, 2023, our CEO and CFO have concluded that our disclosure controls and procedures (as defined in Rules 13a‑15(e) and 15d‑15(e) under the Exchange Act) were not effective due to the previously reported material weakness in our internal control over financial reporting.

Previously Reported Material Weakness

As previously reported in Part II, Item 9A. “Controls and Procedures” of our Annual Report on Form 10‑K for the year ended December 31, 2022, subsequent to our acquisition of Park Environmental Equipment, LLC (“ParkUSA”), a privately held company, we instituted new internal controls, processes and procedures, and we converted ParkUSA to our enterprise resource planning (“ERP”) system. We have identified control deficiencies related to that system implementation project. Specifically, we did not exercise sufficient oversight, design effective controls to ensure completeness of the data conversion, or conduct sufficient testing to ensure the system would operate effectively. Additionally, we were unable to implement and evidence compensating business controls specific to ParkUSA’s sales transactions and cost of sales transactions. As a result, these business process control deficiencies, when combined with the ERP implementation control deficiencies, create a reasonable possibility that a material misstatement to the consolidated financial statements will not be prevented or detected on a timely basis. The material weakness did not result in any restatements of consolidated financial statements previously reported by us, and there were no changes in previously released financial results.

Remediation

We have taken, and continue to take, steps to remediate the control deficiencies contributing to the material weakness described above. These remediation steps, which are ongoing, have centered primarily on employee training in addition to launching our project to improve the ParkUSA business processes, which will require the assistance of external consultants. We will continue to report regularly to our Audit Committee on the progress and results of our remediation plan, and we may take additional measures to address these control deficiencies, or we may modify certain of the remediation measures described above.

Management is committed to taking the necessary steps to ensure that our internal control over financial reporting is designed and operating effectively, and we intend to remediate this material weakness as soon as possible and believe the measures described above will do so. This material weakness will not be considered remediated until the applicable controls operate for a sufficient period of time and management has concluded through testing that the controls are operating effectively. We anticipate that the remediation will be completed during 2023.

Changes in Internal Control over Financial Reporting

Except for the remediation activities described above, there were no significant changes in our internal control over financial reporting that occurred during the quarter ended March 31, 2023 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

In addition to the other information set forth in this 2023 Q1 Form 10‑Q, the factors discussed in Part I – Item 1A. “Risk Factors” in our 2022 Form 10‑K and any subsequently filed quarterly reports on Form 10‑Q could materially affect our business, financial condition, or operating results. The risks described in our 2022 Form 10‑K and subsequent Form 10‑Q’s are not the only risks facing us. There are additional risks and uncertainties not currently known to us or that we currently deem to be immaterial, that may also materially adversely affect our business, financial condition, or operating results.