May 7, 2013
Executives
Scott J. Montross - Chief Executive Officer, President and Director Robin A.
Gantt - Chief Financial Officer and Vice President
Analysts
Kanchana Pinnapureddy - Jefferies & Company, Inc., Research Division Brent Thielman - D.A. Davidson & Co., Research Division Barry Vogel Gerard J.
Sweeney - Boenning and Scattergood, Inc., Research Division Matthew Sherwood
Operator
Welcome, and thank you all for standing by. [Operator Instructions] Today's conference is being recorded and if you have any objections, you may disconnect at this point.
Now I will turn the meeting over to Mr. Scott Montross, CEO.
Sir, you may begin.
Scott J. Montross
Thank you, Fred. Good morning, and welcome to Northwest Pipe's Conference Call.
My name is Scott Montross, and I'm the President and CEO of the company, and I'm joined by Robin Gantt, our Chief Financial Officer. As we begin, I would like to remind everyone 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 SEC filing on Form 10-K for a discussion of risk factors that could cause actual results to differ materially from expectations. I will now turn to Robin who will discuss our first quarter results.
Robin A. Gantt
Thank you, Scott. Our net income was $9.5 million or $1 per diluted share in the first quarter of 2013 compared to $4.7 million or $0.50 per diluted share in the first quarter of 2012.
Water Transmission sales increased 34.5% to $78.6 million in the first quarter of 2013 from $58.4 million in the first quarter of 2012. Water Transmission gross profit as a percent of sales increased to 25.3% in the first quarter of 2013 from 16.6% in the first quarter of 2012.
The increase in sales was due to a 53% increase in tons produced, partially offset by a 12% decrease in selling prices per ton. The increase in gross profit and gross profit as a percent of sales was driven by a decline in material cost per ton, particularly fuel costs, and significantly higher volumes, which had a positive impact on the fixed portion of our cost of goods sold.
Tubular Products sales decreased 26% to $62 million in the first quarter of 2013 from $83.7 million in the first quarter of 2012. Volume decreased 19% and selling prices per ton decreased 9%.
We sold 53,900 tons in the first quarter of 2013 compared to 66,600 tons of the first quarter of 2012. Tubular Products gross profit as a percent of sales was 2.2% in the first quarter of 2013 compared to 8.1% in the first quarter of 2012.
Our energy products comprised approximately 75% of Tubular Products sales in the first quarter of 2013 compared to 76% in the first quarter of 2012. Gross profit and gross profit as a percent of sales was negatively impacted by increased competition from imports, which exerted significant downward pressure on selling prices and volume.
In addition, gross profit was negatively impacted by an additional $800,000 lower cost to market inventory adjustment taken in the first quarter of 2013. There was no lower cost to market adjustment in the first quarter of 2012.
Selling, general and administrative costs decreased to $6.4 million in the first quarter of 2013 compared to $7.3 million in the first quarter of 2012. There was a decrease in outside services in the first quarter of 2013 compared to the same quarter in 2012 as the 2012 results have the costs associated with the restatement completed in April 2012.
Interest expense was $1 million in the first quarter of 2013 and $1.6 million in the first quarter of 2012. The decrease was the result of lower average borrowings and lower average interest rates.
Our effective tax rates were 31.7% in the first quarter of 2013 and 37.2% in the first quarter of 2012. During the first quarter of 2013, we reported a favorable impact of the retroactive extension of the federal research and development tax credit for 2012.
In the first quarter of 2013, the company generated $3.8 million in cash from operations to support the growth of the business, mainly through our net income and depreciation and decreases in inventories and increases in accounts payable. These were partially offset by an increase in our trade and other receivable accounts.
Depreciation was $3.9 million in the first quarter of 2013 and $3.3 million in the first quarter of 2012. Inventories decreased $4 million in the first quarter of 2013 from the fourth quarter of 2012 due to a decrease in coils for Water Transmission production.
Capital expenditures were $9.8 million in the first quarter of 2013, primarily for plant capacity expansions in our Tubular Products plants and the expansion project at our Saginaw, Texas facility. The remainder was for ongoing maintenance capital expenditures.
Regarding legal matters, the shareholder class action lawsuit and the shareholder derivative action that had been filed against the company were settled and dismissed at the end of March 2013. On April 3, 2013, the SEC informed the company that the SEC's investigation had been completed and that the staff did not intend to recommend any enforcement actions against the company.
Now I'll turn it over to Scott for an update on our business.
Scott J. Montross
Thanks, Robin. As of March 31, 2013, our backlog in Water Transmission was approximately $136 million.
As of March 31, 2012, our backlog was approximately $161 million. We expect that the first quarter for Water Transmission will be the strongest quarter for the year with a record quarterly gross profit that's a percentage of sales.
The backlog in Water Transmission has decreased as we've completed much of the drought-related emergency work in Texas. We expect Water Transmission sales, gross profits and margins to be lower in the second quarter compared to the first quarter, with gross margin percentages in the mid-teens.
In Tubular Products, we expect to see compressed margins for the foreseeable future as imports have had a negative impact on both volume and margins. We expect to be about breakeven in Tubular Products for the second quarter of 2013.
We also expect to spend between $30 million and $35 million of total capital, which includes some investment projects in normal capital maintenance. The biggest investment projects are the previously announced expansion at our Saginaw facility, as well as the continued modernization of our Atchison, Kansas plant.
The Atchison modernization includes the installation of a second accumulator, a new hydro tester and the replacement of the existing front end of our 16-inch mill. In conclusion, we anticipate a profitable second quarter for our Water Transmission business.
While we anticipate that the continued competition from imports of energy products will limit the profitability for our Tubular Products segment, at least through the first half of 2013 and likely into the third quarter. At this time, we will be happy to answer any of your questions.
Operator
[Operator Instructions] Your first question comes from Scott Graham.
Kanchana Pinnapureddy - Jefferies & Company, Inc., Research Division
This is actually Kanchana Pinnapureddy in for Scott. I wanted to -- I know you provided some color on 2Q for both businesses.
Could you talk little bit about how you're thinking about sales in the back half of the year for both businesses?
Scott J. Montross
I'll comment on the Water Transmission piece of the business first. As we've mentioned in the call, I think we've had a very strong first quarter for Water Transmission.
And I think in the last call, we talked a little bit about the number of jobs that are actually bidding at this point. We are probably seeing a reduction of between 35% and maybe a little bit higher percent over -- of the jobs that we saw bidding in the 2011 and 2012 timeframe.
So we're seeing many fewer jobs and not a lot of jobs out there that have a lot of size to them. So I think what we're seeing on the Water Transmission side is fewer jobs and a lot more competition and focus on the jobs that are out there that are actually having a muting affect or a depressing effect on the margins as we go through the rest of this year and into 2014.
On the Tubular Products side, it's the same story that we have discussed, I think even on the last call. I think with the high imports that we've seen and the related falling price due to the imports, I think that we're going to see a relatively tough second quarter on the Tubular Products side.
I do believe that sometime as we start going through the second quarter, we're going to see the rig count start to increase, which should increase demand in the Tubular Products side of the business. The only question is, is how much effect are the continued high levels of imports going to have on the Tubular Products business and muting what the price increases can be on that side of the business based on increased demand from higher rig counts.
So I think when we look at both parts of the business as we go through this period of time in the second quarter into the last half of the year, I think we have challenges on both sides of the business for the environments that we see.
Kanchana Pinnapureddy - Jefferies & Company, Inc., Research Division
Could you talk a little bit about what you're seeing on pricing in the Water Transmission business?
Scott J. Montross
Yes, the pricing is certainly getting more competitive. Again, we are seeing -- because of the limited amounts of jobs, we're seeing a lot more competition on individual jobs.
I think we're also beginning to see a little bit more competition from players that we would refer to as nontraditional players that are in the position of being able to buy a pipe and get pipe coated and lined, maybe by third-party processing, and doing the fab work and starting to try to compete on some of these jobs just because of the limited amount of work that we're seeing in the marketplace. So pricing, because of all those factors, has a downward pressure on it as we're moving into the second quarter, and I think through the end of this year.
Kanchana Pinnapureddy - Jefferies & Company, Inc., Research Division
Got it. And could you tell us what the Lake Texoma shipments were in the quarter?
Scott J. Montross
In the first quarter?
Kanchana Pinnapureddy - Jefferies & Company, Inc., Research Division
Yes.
Scott J. Montross
We were about $25 million of revenue for Lake Texoma in the first quarter.
Operator
Next is Brent Thielman.
Brent Thielman - D.A. Davidson & Co., Research Division
Scott or Robin, could you provide capacity utilization for the Texas plant and Water Transmission and then utilization for the rest of the segment, I guess, excluding Texas for the quarter?
Scott J. Montross
Brent, you're not coming through very loud. Was that capacity utilization for the Texas plant, the Saginaw plant?
Brent Thielman - D.A. Davidson & Co., Research Division
That's right.
Scott J. Montross
Okay. I think when you look at how we've been running through the fourth quarter and actually into and through the first quarter at our Saginaw plant, we've probably been running very close to what the rate of capacity is at that plant.
And when you say those things, you're really talking somewhere in the area of 90%. It really depends on the mix of products.
As we go forward, because of the limited amount of jobs that we currently see bidding, we see that capacity utilization going down pretty substantially. We're still out into the marketplace, bidding on jobs, working on getting additional jobs to increase what we have to run on not only that facility but all facilities, but I think it's down substantially over where it's been in the fourth and the first quarter.
As far as the rest of the Water Transmission plants, it's a little bit of the same story. We've had a -- we've been able to enjoy the Lake Texoma job at more than just the Saginaw plant.
We've been able to produce that at our Parkersburg, West Virginia plant, as well as a little bit at our Denver plant. So obviously, with that being over, the utilizations will be off at those plants.
And we've also had some other jobs that we enjoyed in the first quarter of the year -- moving into the first quarter at our Adelanto plant, which we'll be winding down and finishing off, so our utilization rates will be lower there. So I think what you see is utilization rates that are down pretty significantly across all Water Transmission because of these jobs that are coming to an end in the slowness of the market that we see going through the end of the year.
And I don't remember, did you ask about the Tubular Products segment also? Was that part of the question?
Brent Thielman - D.A. Davidson & Co., Research Division
No, but if you've got it, that's great.
Scott J. Montross
Well, I couldn't remember if you asked that. I'm not begging for another question, but just little color on that.
I think on the Tubular Products side of the business, when we came out of the fourth quarter, we were at about 40% capacity utilization across all 3 of our plants. In the first quarter, we were 52% to 55% capacity utilization, and we expect to be in that 55-or-so percent utilization as we go through the second quarter and through the rest of the year based on what the current market conditions are.
Brent Thielman - D.A. Davidson & Co., Research Division
Okay, appreciate that. And then back on Water, can you talk little bit more about how you managed to get to the 25% gross margin?
I know you had the benefits of these large projects and we shouldn't think it's sustainable in the subsequent quarters. But when we look at this level of margin, I mean, how much is it a function of some of the changes you've been making in the business and plants?
And then kind of how much is attributable just to better operating leverage?
Scott J. Montross
Well, I think one is, when you have the kind of operating rates that we had in the fourth quarter to carry through the first quarter, really, it comes down to the heavy volume and the spreading of fixed costs over the first and the fourth -- the fourth and the first quarter. And what we've seen in our history is that when you get on these larger projects like Texoma, the longer that you produce them, the more efficient that we get on these projects, so the better gains that we get on the projects.
And as you know, we were on Texoma for a long period of time, so that was a big contributor. And I would contribute that kind of volume to a big 80%, 85% of the increased profitability.
But as we've talked about in these meetings before, we've also had -- have had a pretty significant focus on our cost-reduction activities. I think that the idea of trying to maximize our tons per man hour and reduce our overhead cost per ton, work on our maintenance cost, work on our quality systems to reduce customer claims and things like working on our -- on the amount of steel that we buy and leveraging what we buy have all contributed pretty significantly to what those margins levels were in the fourth quarter.
Now I hesitate to really throw a number on this because we're in a period of time on Water Transmission from the fourth quarter through the first quarter, obviously that it's a pretty high operating rate. So I'll feel more comfortable as we go through a period of time, the second, third, fourth quarters of this year as the operating rates are lower, probably talking about how much that those cost savings initiatives have generated as far as percentage of what the profitability is.
But I think one thing we've said before is we cannot control what the price is in any of these markets, but what we can control is our costs and focusing on our costs and working on our costs to make ourselves as profitable as we can be in both of these segments. So that's what we're doing.
Brent Thielman - D.A. Davidson & Co., Research Division
Okay. That's helpful, Scott.
And then I know you don't offer specific guidance, but assuming the import situation persists indefinitely and then considering some of the changes you're making within Tubular Products, when can that business get back to a more reasonable level of, I guess, segment earnings? And then the second part of that question, is there a target you'd be willing to discuss for Tubular Products in terms of either earnings or unit margins, I guess, assuming this import situation persists?
Scott J. Montross
Like we've said in the past, Brent, we're actually -- we're trying to get into the double-digit margins. Obviously, we've done a lot with working on our arrangements for heat treating, which is a big piece of our business on Tubular Products, and having longer-term arrangements for heat treating, so that we're not paying spot market pricing for heat treating.
As everybody knows, I think everybody knows, we don't have any of our own downstream processing. So a big piece of that margin goes away to the downstream processors, specifically the heat treaters.
So what we've tried to do to build on what we have right now is to create longer-term arrangements with these heat treaters, so that we can enjoy a bigger part of the margin and control our costs better. So that's one of the things that we've done that I think it's going to be a big thing going forward.
You also know about the investments that we've made in the Atchison plant. I think that when you look at the things that we've done in Atchison, specifically the investments in the accumulators and the investments that we are making going forward, those investments do a lot to take not only yield cost out of the equation, but to reduce our conversion costs.
So I think all the things that we're doing are driving us, trying to get to those double-digit margins. I think as far as the imports are concerned and how that affects things, I think as we go into this year, what's going to happen is because we've seen natural gas prices begin to move up and in some cases be above $4 per MMBTu for periods of time, and we've seen the oil prices hold in there, I think that you look at rig counts and rig counts begin to move up and all of a sudden, demand will start to move up.
And if demand starts to move up, I think pricing will begin to move up because my recent trips to Houston, meeting with a lot of the customers suggest that a lot of those people believe that we're at the bottom of the market and the price is going to start to move back up. The issue with the imports, Brent, is that -- is they will -- the imports are here and in some cases, we've talked about having 50% or more of the market.
At some point, they will be the thing that caps the price from going to higher levels and will put a limiting effect on the market in total. But again, we're going to have competition from imports ongoing whether there's trade cases filed or there's not trade cases filed.
There will always be competition, competition from imports. And we can't really rely on trade cases to generate the profitability of our business, so that's why we've done all the things at each one of these facilities, like I said, the accumulators and working on our uptime at the facilities and all those things to drive our costs down to make us as competitive as we can be so we can get to those margins even without trade protection.
Because ultimately long term, we have to be able to do that whether the market has imports or not, so...
Operator
Next is Mr. Barry Vogel.
Barry Vogel
Scott, I have a question for you on the trade cases. What is the scuttlebutt in terms of what you think is going to happen ultimately in terms of potential trade cases?
Scott J. Montross
Barry, it's hard to say exactly. I think what I can say is that we haven't seen the import levels subside significantly since we had our last discussion.
I guess, it was several weeks ago now in March. And I think imports are still affecting the market, maybe not by gaining more market share, but by the differences in the pricing level and in really, really having the impact of what the ultimate margin levels are of the domestic producers.
If you look at where some of our competitors' earnings were in the first quarter of 2012 versus where they are in the first quarter of 2013, they're half of what they were, where their margins were in the mid to high teens on API products and now they're 8% or 9%. And I think that's a relatively common theme that we've seen with our competitors and with us.
And what I would say is, is I think that because of those things happening that we are closer to the potential of a trade case now than we were 6 or 7 weeks ago. But other than that, it's really difficult to comment on it any more than that.
Barry Vogel
Okay. And as far as the capacity at the end of this calendar year for each of your 3 facilities in Tubular, can you give us some rough numbers at this point?
Scott J. Montross
You're coming through very faintly, and I'm not sure I heard the total question.
Barry Vogel
Okay. As far as the capacity at the end of 2013 at Kansas, Louisiana and Houston, Texas, what's your estimate of what the capacity will be for those 3?
Scott J. Montross
What the total capacity will be at those facilities?
Barry Vogel
Each of those. Yes, at each of those facilities.
Scott J. Montross
Okay. So total capacity at our Houston plant will -- is about 50,000 tons; at about -- at our Bossier City, Louisiana plant, it's about 125,000 tons; and at our Atchison plant, it's about 250,000 tons.
Barry Vogel
And that 250,000 tons is going to be in place at end of the year?
Scott J. Montross
Okay. So that is, right now, as we speak, after we've had the implementation of both of the accumulators.
Actually, we will have, as we add a different front end of the mill to the big mill at our Atchison facility, that capacity actually increases at the Atchison facility in the first quarter once the front end of the mill was completed. So we think that, that capacity in the first part of next year for Atchison will be about 325,000 tons.
So I think it gives us about 500,000 tons of capacity. But I think the capacity, the total capacity isn't the biggest thing for us at Atchison.
I think what it is, is even if the volumes are the same and not at capacity, we have the ability to, by replacing the front end of the mill, to run the product mix faster at a lower conversion cost to make ourselves more competitive in the marketplace. The other thing that it does, Barry, by replacing the front end of the mill is it approximately doubles the existing line pipe market that's available to us by being able to go up to heavier gauges and higher strength levels.
So if the capacity is needed, it's there. If it's not needed, we have the ability to run the current level of production at a higher rate and therefore, at a lower conversion cost, making us more competitive in the marketplace.
Barry Vogel
Okay. And now as far as Tarrant County and Houston, what does the current situation look like in terms of when bidding will progress on both of those projects?
Scott J. Montross
We have -- our most recent information tells us that the IPL project will likely be pushed to the first quarter due to Army Corps of Engineering permitting. And we expect that probably to move out one quarter further than we thought it was going to be.
We thought we would have revenue from IPL in the fourth quarter of this year, but it's likely going to start sometime in or after the first quarter of 2014. When we start talking about the Houston MSA project, you're probably looking at something in the area of 2016 or 2018, with the potential of that to push out even further.
Barry Vogel
So those -- are there any other projects that are possible for bidding beyond these 2 major projects that you know of right now?
Scott J. Montross
Yes, there -- if you look at Texas, in particular, obviously, both of these projects are from Texas, the Texas Water Development Board has about, I think, somewhere in the area of $7 billion worth of projects that have been identified in Texas over the next 15 or 20 years. So obviously, there's going to be more projects out there.
The latest information that I've read on the state of Texas and what the governor has said is that he's trying to address the drought work. He's having a little issue with the legislature, letting him use the rainy day fund down there.
But I think he's becoming pretty insistent. So I do believe as we go forward, we will see additional potential jobs out there in the state of Texas.
Of course, you probably know about the Southern Nevada job to move water down into Las Vegas and I believe actually from Lake Powell. The issue with that job is it's been talked about being 2016, 2018, but it's 300 miles of pipe, 250 miles of pipe, which flexes around and may get pulled up, may get pushed out.
But for the time being, we're not expecting anything significant out of that job in the near term. So there's jobs that are out there, it's just what's going to get approved specifically in Texas and how soon are they going to come up.
And obviously, we're looking very closely at that and working to get everything that we can out of that market.
Barry Vogel
I have a question couple of questions for Robin. Has the D&A expenses on the Texas plant affected the Tubular profits in any fashion?
Robin A. Gantt
The Saginaw work that we've been doing is for Water Transmission, so there has been no impact to Tubular Products. The Atchison, of course, had an impact on Tubular Products.
We are expecting about $15 million to $17 million in total depreciation for the year.
Barry Vogel
I misquoted myself. I think I was talking about the work in Kansas which had been fairly extensive.
Has that affected your D&A? And of course, it would affect your Tubular profits if the D&A has gone up decently percentage-wise.
Robin A. Gantt
It has gone up. The gains we've made on deals and our conversion costs has more than made up for it.
Barry Vogel
Okay. And as far as -- let's see where I was here.
Could you give us -- did I get it right, that there was a tax credit in the first quarter from R&D that was a pro forma? That's why you had a 31...
Robin A. Gantt
It was retroactive. Yes, it was a discrete event within the quarter.
The Congress and Washington approved the 2012 R&D tax credit and that happened in the first quarter in January. So we took it in first quarter relating to last year.
So we're not expecting that to happen again, of course. Our rate for the year, we think, will be about 35%.
Barry Vogel
All right, so it goes -- so the rate for the year has gone down to 35%?
Robin A. Gantt
Right.
Barry Vogel
Okay. And I noticed the interest expense has really dropped because of your astute restructuring of your balance sheet and of course, having the Fed lower interest rates to everybody.
What's your best guess for net interest expense for the year now?
Robin A. Gantt
That guess would be about $6 million to $7 million.
Barry Vogel
So it's still -- even though it was less than $1 million this quarter?
Robin A. Gantt
Right, because we're going to have a little bit of a buildup because we -- our borrowings did go up at the end of Q1. And as we start working through and shipping out this Water Transmission turning into cash, our -- we expect our borrowings to go up a little bit and then that will convert into cash, but -- so probably about closer to the $6 million and the $7 million, but that is our estimate.
Operator
Next is from Mr. Frank Haflich.
Frank Haflich
Yes, can you please just give us some color on what the outlook is for steel costs and availability now?
Scott J. Montross
Well, what we've seen on steel costs is obviously, this year, we've seen some significant downward pressure on steel pricing. We have not seen, to any great extent, the run-up in steel pricing that we've seen in the first quarter for the last couple of years.
And we've seen a year-over-year decrease in coil pricing. I think when you look at what the current coil pricing is in the first quarter and just by CRU standards, it's over $100 a ton lower than what the first quarter was of 2012 and about $180 per ton lower than the first quarter of 2011.
So there's certainly longer-term structural downward pressure on coil pricing. With scrap pricing continuing to move down, I think that, that pressure stays on pricing.
I think a lot of the steel guys at this point believe that we've reached the bottom of where the coil price is going to be. But the other thing is, is when you look at -- in comparison to where the coil price -- the hot-rolled band price is in the United States versus the rest of the world, we're still pretty high in comparison to the rest of the world.
So not only do we have downward pressure from current raw material costs and overcapacity, but we also potentially have pressure from imports. So I think there's going to be downward pressure on coil pricing as we go throughout this year, Frank.
And I don't -- I'm not sure that there's going to be a whole lot of movement upward on that. I think we could get to periods of time where you'll see the price move up briefly.
But it just doesn't seem that structurally, that there is markets in place to support hot-rolled bands moving up. I think automotive has picked up to some extent, and you see some of the big steel suppliers talking about automotive.
I mean, construction is starting to pick up, but a lot of it is the residential construction piece of the business and nonresidential is still kind of even. And we've been talking about the construction markets continuing to improve for quite a while, and they're improving slowly.
I just don't know how much we're going to get out of it. So to answer your question in long form, I think there's going to be some continued pressure on coil as we go throughout this year on pricing and the pressure is going to be downward.
Frank Haflich
And you noted also, it might have been Robin, about your increase in tons there in the first quarter, that's your tons shipped, I assume, is -- was how much?
Scott J. Montross
We increased from -- what was the number, Robin?
Frank Haflich
Or a decline, was it? 50,000...
Scott J. Montross
No, it was an increase from the fourth quarter to the first quarter. We were actually probably up...
Robin A. Gantt
We're around 40,000. We were around 40,000 tons in Q4.
We went to just under 54,000 in Q1. But we did have a decrease from a year ago, which was when we had about 66.6.
Frank Haflich
66,000 is it or 56,000?
Robin A. Gantt
Right. Yes, so we had 53,900 in the first quarter of 2013.
We had 66,600 in the first quarter of 2012. But we were around 40,000 in the fourth quarter of 2012.
Frank Haflich
Right. And that is total tons shipped, right?
Robin A. Gantt
Yes, in the Tubular side, yes.
Operator
Next is Gerry Sweeney.
Gerard J. Sweeney - Boenning and Scattergood, Inc., Research Division
Most of my questions were answered, but I wanted to circle back to what Brent was talking about on the Tubular side, making some arrangements and just your overall competition with the imports. You said making some arrangements maybe not paying for the spot pricing on the heat treating.
What would the mechanism behind this be? Would this be a lower selling price to the heat treater and then they're giving you some guaranteed tonnage?
Just maybe a little bit of color as to how that would work.
Scott J. Montross
Yes, I think it's a guaranteed tonnage level over longer periods of time and a preferential heat treating price that allows us to be more competitive in the marketplace. It allows us, in essence, to enjoy more of the margin than we are if we are only running out to get spot heat treating, which has happened up to this point.
Gerard J. Sweeney - Boenning and Scattergood, Inc., Research Division
I assume it would also help with your, I guess, plant management? You would have a guaranteed amount of production to the plant and you could -- that would also help on the management side of that in throughput?
Scott J. Montross
Yes, I mean, obviously, you have to be able to sell the heat treat into the marketplace first. So it's a matter of -- it's a pull system because -- or a push system, if you will.
We got to sell the product, then once it's sold, then we have it heat treated. But one thing that we haven't had up to this point is a situation where we had longer-term arrangements with the heat treaters that we could control more of our OCTG heat-treated product costs, and we are now in that position.
Gerard J. Sweeney - Boenning and Scattergood, Inc., Research Division
Got it. And then the higher gauge on the Atchison plant, would this -- you said it doubles the market that you can compete in, but does the higher gauge carry a higher margin, or is it just a function of market size?
Scott J. Montross
Well, it's the higher gauge and strength levels. When we upgrade the mill, not only will we be able to go to 375 gauge but -- like we have the X80 product, which opens up a much larger portion of the 16-inch-and-under line pipe market for us.
So it's -- and when you're looking at higher-gauge products, obviously, when you're run those items through the mill, specifically through a mill that's been upgraded on the front end, you run that at a higher tons per hour rate which is at a lower cost, which should allow you to enjoy not only a lower conversion cost, but actually a higher margin.
Gerard J. Sweeney - Boenning and Scattergood, Inc., Research Division
Got it. And then just shifting real quick over to the Water Transmission Group.
California, I know that's a big market, it's been dead, but I'm hearing some rumblings that their municipal market or their financiers are actually coming in line. Any sense that, that market is starting to percolate in the background?
Scott J. Montross
We haven't seen a lot of major activity from California, and what we have seen has been relatively small. So I don't know that I could say that it's -- that market is actually coming to life at this point.
Operator
[Operator Instructions] And next question is from Mr. Matt Sherwood.
Matthew Sherwood
I just had a quick question on the CapEx on Tubular, and you're obviously -- you're spending a lot of money on the Tubular division that's sort of been operating break even and we've been waiting for a trade case that's been slow to come. I just want to understand the returns as we look into '14 in a difficult market from this Tubular CapEx that you're spending.
Scott J. Montross
I think the -- if you focus on where we're spending it, Matt, on the Atchison facility, I think as we look at the Atchison facility and look at how that facility has performed, we've, over a historic period or relatively long period of time, had pretty good returns from our Atchison facility. And that was, quite frankly, in a facility that needed modernization.
Got a couple of mills there that are relatively old and needed to be upgraded and yet, that facility has always generated pretty good profitability for the company, so -- and when you look at the market that it had available to it, of the total line pipe market under 16 inch, it was a relatively small portion being able to only go up to quarter-wall product and up to X60. So once we expand that, not only do you have the situation with a bigger market, but a higher rate of production, lower conversion costs.
And I think that puts us in a position with having that bigger market and lower conversion cost, to be able to drive even more profitability out of that Atchison facility. And it's been a pretty good platform for growth in that side of the business when you look at the infrastructure we have there, it being rail served, and the workforce that we have there.
So I think that's -- it's a pretty sound platform for growth, and that's why we've targeted more investment on the Atchison side.
Matthew Sherwood
So obviously, if we get a trade case and the market normalizes or the rig count goes up a lot and the market normalizes, it sounds like that facility will be significantly profitable, probably mid-teens-type margins, gross margins. But if we don't -- if we're in an environment like this like we are today, where you're operating breakeven, could you make a material profit at that facility with the CapEx?
Scott J. Montross
Yes, I think when you look at that facility -- I don't really want to talk a lot, specifically, about single facilities. But I would say that through the course of the last 12 months, that facility has done pretty well based on what we've seen in the marketplace as far as import activity and falling rig count.
It's still done pretty well profitability-wise. So I think that further investment to enhance that profitability just, if you will, enhances what that facility can do, so -- and what it will generate for the company.
Operator
All right, thank you. At this point, sir, we don't have any questions on queue.
Handing the call back to you, sir. Thank you.
Scott J. Montross
Okay. Well, thanks, everybody, for calling in.
And I guess, we'll see everybody sometime in August. Is that right?
And we'll talk on the call again in August. We do have our Annual Shareholder Meeting at the end of May, and we'll talk to everybody then.
Thank you.
Operator
And that concludes today's conference. Thank you for participating.
You may now all disconnect.