L.B. Foster Company (FSTR) Q3 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the L.B. Foster Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded for replay purposes. I'd now like to turn the call over to Mr. David Russo, Chief Financial Officer. You may proceed.

Thank you, Francis. Good morning, ladies and gentlemen. Thank you for joining us for L.B. Foster Company’s earnings conference call to review the company’s third quarter 2012 operating results. My name is David Russo and I am the Chief Financial Officer of L.B. Foster. Hosting the call today is Mr. Robert Bauer, L.B. Foster’s President and CEO. This morning, Bob will provide an overview of the company’s third quarter performance, give an update on critical business issues and discuss market conditions. Afterward, I will review the company's third quarter financial performance and then we will open up the session for questions. Means to access this conference call via webcast were disclosed in our earnings press release and were posted on the L.B. Foster company website under the Investor Relations page. This webcast will be archived and available for 7 days. During today’s call, our commentary and responses to your questions may contain forward-looking statements, including items such as the company's outlook for the remainder of 2012 and beyond, our thoughts regarding the concrete tie warranty claim, cash flows, margins, and capital expenditures. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. These forward-looking statements reflect our opinions only as of the date of this presentation and we undertake no obligation to revise or publicly release the results of any revisions to these statements in light of new information or future events. All participants are encouraged to refer to L.B. Foster’s annual report on Form 10-K for the year ended, December 31, 2011, as well as to other documents filed with the Securities and Exchange Commission for additional information about L.B. Foster, and to learn more about the risk factors that may affect our results. Additionally, while forward-looking statements will be made today, L.B. Foster does not provide specific earnings guidance. With that, we will commence our discussion. And I will turn it over to Bob Bauer.

Thank you, Dave. Good morning, everyone, and thank you for joining us. I am going to focus on 2 significant messages from our announcement this quarter. First, our Rail and Tubular businesses are having a very good year and are really driving the overall performance of the company. And second, we have made substantial progress on resolution of the Union Pacific warranty claim. I'll provide you with details on the approach to begin putting this behind us. I want to begin my comments with the Union Pacific and concrete tie warranty claim status since it did have an impact on the quarter's results and since it's reached the point where I can give you a clear explanation of how we'll resolve this. But before I go into it, I do want to mention the headlines of our press release that start with $170.3 million in sales, which was up 7.6%. That was driven by a 24% increase in the Rail segment sales and a 53% increase in our Tubular segment sales. This is driven by strong order input in the quarter for these 2 businesses, which I am happy to say more than offset the weakness that has continued in our Construction business. We did take a $3 million charge in the quarter to accurately reserve for the concrete tie warranty claims. This brought our reported earnings per share to $0.83, but without the charge, we met $1 even in our EPS number. Order entry in the quarter was good, $140.8 million. That was 12.5% above last year's third quarter. And cash flow was also solid at $21.6 million for the quarter, which has further strengthened our balance sheet as the company also remains virtually debt free. So those are the headlines. Let me start with this Union Pacific claim and the warranty charges, because I know that’s an important subject we have been covering. And of course it affects our quarterly results, just as it did last quarter. The company has been assessing warranty claims for concrete ties made in our Grand Island, Nebraska facility for some time. As we previously reported, these are ties that aren’t performing up to our expectations and don’t meet our quality standards. A large majority of the claims are from Union Pacific Railroad, although there are a few other customers that have been affected by this. I’m going to largely focus on Union Pacific, as this is the claim we’ve been reporting on since last year. In this quarter, we’ve made substantial progress with Union Pacific and I wanted to touch on the 4 main points that will help you understand how we’re moving forward. First, we’ve agreed on a process with Union Pacific for identifying or replacing ties that meet the criteria for replacement. This will apply to products sold from our Grand Island plant, some of which carried a 15-year warranty and some of which carried a 5-year warranty. We will work closely with Union Pacific as we assess track conditions and begin the process of planning and documenting their replacements. Second, in order to satisfy their concerns over possible deterioration of ties in the future, we are going to apply the 15-year warranty policy, which comes with a 1-to-1 replacement ratio to all ties which had a 5-year warranty and a 1.5-to-1 replacement ratio. This means it’s going to provide an additional 10 years of protection to help guard against any unforeseen problems and we have made this offer to them. The third point. Following the changes to the warranty policy and our current overall assessment of the scope of the problem, we recorded an additional $3 million warranty charge in order to adequately reserve for the cost of resolving the expected claims. This brings the total reserve to $27.2 million which is for all claims, not just the Union Pacific claims. And as I pointed out earlier there are a few other customers where we have the same issue. The reserve is supported by the extensive field inspection and the forensic analysis that we’ve conducted, which has included hiring a third party expert that has helped us in all of the analysis of this, now, over the course of the past year. Our fourth point and final point on the subject is that we will be able to produce the replacement ties at our Tucson manufacturing facility, which has been under a 5-year supply agreement with Union Pacific, which expires this December. UP has verbally indicated to us their intent to award us a new 5-year supply agreement for this facility with some minor adjustments to the specification and terms, which we still have yet to work out. So there will be more to do on that. So I’ll conclude my remarks on Union Pacific claims by saying that I’m happy that we’ve reached the point where the major part of the discussions are behind us on this matter. I am very pleased that we are finding a way to work closely as we resolve the unsatisfactory conditions in their track. And of course I am pleased that they are taking a favorable view towards L.B. Foster as we work through what’s been a difficult situation. So with that, let me make a few comments now on our business performance. Now with 9 months of the year behind us now we find sales well in excess of our early year forecast for the Rail business, particularly, up 15.8% year-to-date and for the tubular business which is up 51% year-to-date. These businesses have both benefited from strong underlying market performances; as rail companies and energy and exploration companies have both increased capital spending considerably this year. With respect to the Rail business. While there has been a lot of talk about coal transport being off, the increases in automotive, industrial, intermodal and energy commodities are all making up for the unexpected decline that they’ve seen in coal traffic. In fact, our data shows that year-over-year third quarter increase in petroleum products is up by 50% over Rail and the year-over-year automotive and vehicle numbers is up 12.7%. So there is some really strong increases in those 2 categories. So capital spending by the Class 1 rail companies was up nearly 11% in the quarter, and on a year-to-date basis, it’s up 19%. So we have clearly been benefiting from that, and it's now the second year in a row, where there has been some substantial increases in capital spending. I think the Class 1s have had a bullish view on the market, and clearly some of these other areas, where they are enjoying some success are helping them. We have also benefited from winning some key projects at short line railroads and transit projects. In fact, a large part of our growth this year is coming from our new rail distribution business as well as concrete ties, both of which are having a good quarter and a good year with transit projects. We see ridership growth numbers that have now been up in each of the last 8 quarters. So that's a nice thing to see in the marketplace. So these divisions helped drive the 24% increase in sales for our Rail business in Q3. In the Tubular products area, they have had another great quarter; sales up 53%. Demand in the oil and gas markets for coated products remains strong. We have started to even build some backlog for next year with orders that came in, in the third quarter. So that was nice to see. And of the projects that we are working on, 83% of the miles of pipe are headed for shale projects, which of course is what we have been talking about that has been driving a lot of this growth throughout the year. So as we look at the data points that we track, where there is 2000 miles of new natural gas transmission lines expected to go in each year, 1,300 miles of oil and LNG transmission lines per year, we remain bullish on this market, although we certainly expect that to have a more moderated growth rate in terms of the impact on our business. But our credit products business in Tubular has also been good. The business fell back to single-digit growth rates this quarter, but is still maintaining a double-digit growth rate on a 9-month year-to-date basis. So turning to Construction. The heavy civil construction markets are really struggling to get some traction. I don’t think that's any new news out there. Year-over-year third quarter Construction sales for us were off by 24%. Sheet piling projects really have not picked up in this timeframe. Our buildings business is off from 2011 levels. And as we watch projects that are requiring state and federal spending, which happens to be impacting or always impacts our buildings and our piling business and our bridge business, this continues to be under pressure. We do think there will be an increase in 2013. In fact, we are planning on an increase in 2013, I might say largely due to how low our current business levels are. If you look at the forecast out there, non-res construction is forecast to be up 7% in 2013, although a fair amount of that growth is forecast to come from manufacturing investments. That is what took place in 2012 as well. So we will keep our eye on the heavy civil construction piece of that going into 2013, but I think, given the levels we are at, we should see some modest rebound with that in '13. With regard to margins and earnings. Throughout our press release, we made some comments on the underlying profitability of the business without the $3 million warranty charge. This charge will be applied to our Rail business in the segment P&L reporting. We felt it was important to provide some restated profit numbers to help you understand how well the business is performing without this charge. So our reported gross profit margins for the company were 18%. Without the charge, they were 19.8%. And without the charge, as I mentioned earlier, EPS was $1 even per share. Within the Rail business. There has been some margin dilution as a result of the rapid growth of our new rail business, both in the quarter and in fact is having that impact throughout the year, but it’s been more than offset by the decline in the piling gross profit as a result of volume. Margins in the Tubular business continue to reflect the benefit of leverage from new volume there in those substantially high growth rates. But to avoid duplicating too much of the discussion on the profitability portion, Dave is going to cover that more in detail here as I turn it back over to him. So I won't go through that detail at this point. And after his remarks, we can take your questions. I did want to note, though, with regard to our sales numbers, keep in mind that our reported numbers have been adjusted for continuing operations to reflect the sale of our SSD business, which took place last quarter and now our Precise bridge business, which took place this quarter. The sale of Precise in the third quarter will remove approximately $7 million of annual sales from our plan. SSD removed about $6 million in annual sales from the company. So Dave will cover some details on the loss of the sale of Precise, which is in our Q3 numbers; it's a small number. But just to wrap up that portion. I did want to say that I don’t expect continued activity in the divestiture area at this time. I feel like we have dealt with the parts of the business that we felt had a better strategic fit with another company. So in the coming quarters here, at least short-term, you are not going to see any more of this activity that's in the divestiture area. Turning to cash. We generated $21.6 million of cash from continuing operations in the third quarter. This is usually a big quarter for us to generate cash. The year-to-date number, we have generated $24.6 million in the 9 months compared to $10.7 million in the previous 9 months of last year. So that number looks good. And our balance sheet looks good. And you will hear a little bit more about some of the specifics on balance sheet items as we go through more detail there. So finally, I wanted to just recognize 2 achievements before I turn the discussion back over to Dave for some of these details. First, to the team at our Spokane facility for getting us to the finals in this year's Best Plants award by IndustryWeek. Last year, we were a winner in this category, recognized by IndustryWeek for Best Plant in our Pueblo facility, and while we didn't place this year, it's still quite an accomplishment to be recognized among the best as a finalist in this competition. I think it speaks to our culture around operational excellence and our attitude towards continuous improvement. I want to congratulate our team and the folks that helped Spokane get to the finalist category. And then second, I wanted to follow-up on an organization announcement that took place back in August, back on August 21 appointing John Kasel as Senior Vice President of our Rail Business effective September 1. John has been a part of our senior management team. And as I look at the Rail business, we have tremendous opportunity to create more value by combining the strengths of our independent divisions into a combined business segment that will focus on utilizing our collective assets to better serve our customers. There is a lot of opportunity in the technology sharing area, customer service, and bringing solutions to the market at lower operating costs for the rail companies that we serve. And we are going to pull all of that together under John. John has been with L.B. Foster for the last 10 years, most recently serving as a Senior VP of Operations. And I am pleased that John is accepting the challenge to lead this business into the future and maximize the value that it creates for L.B. Foster and its shareholders. So with that, I will turn the discussion back over to Dave and he will go through his remarks more on our sales and profitability and business segment performance.

Okay. Thank you, Bob. As a backdrop to the financial review, the following items I believe are noteworthy related to our third quarter performance. As noted in our earnings release and discussed by Bob, we recorded an additional $3 million warranty charge related to concrete ties manufactured in our Grand Island, Nebraska facility prior to its decommissioning, which occurred in February of 2011. And save for the warranty charge, we recorded as Bob discussed, the company turned in another strong performance in the third quarter, including a solid sales performance, good margins, robust order entry and cash flows. And lastly, also as mentioned, we sold the assets and liabilities of our Precise Structural Products division in the third quarter. The operating results of Precise as well as a $300,000 pre-tax loss on the sale have been classified as discontinued operations for all periods presented in our earnings release. Moving to the financial review, sales for the third quarter of 2012 were $170.3 million compared to $158.3 million in the prior year, a 7.6% increase. The sales improvement was due to a 53% increase in Tubular segment sales, 24% increase in Rail segment sales, partially offset by a 24% decline in Construction segment sales. The Rail segment sales improvement was principally due to a 32% increase in rail distribution, as Bob mentioned, we had small downward impact on margins and a 78% increase in concrete tie sales. These increases were largely due to unit sales increases. The Tubular segment sales increase was attributable to both tubular divisions, especially coated products, and these increases were also principally volume related. The Construction sales decline was due to across the board decreases incurred by all the divisions in that segment: piling products, fabricated bridge products as well as concrete buildings. As mentioned in our earnings release, the backlog stood at $225.7 million at the end of the third quarter, up $78.2 million or 53% from September of last year. This year-over-year improvement is due to a 110% increase in our Rail segment backlog and a 175% increase in our Tubular segment backlog, partially offset by a 20% decline in the Construction segment backlog. Third quarter bookings continued its positive trend from the second quarter of this year as order entry for Q3 was $140.8 million, $15.6 million or 12.5% higher than the prior year. This increase was due to very strong bookings in our Tubular segment which increased by almost 138% over the prior year third quarter, while the Rail segment bookings increased by 22%. Construction segment bookings declined by approximately 21%. The rate of orders received in Construction declined at a steeper rate in Q3 than in Q2 and we reported only a 3% decline in bookings. Our heavy civil construction, which is a key end use market for our Construction products segment, has experienced somewhat erratic performance throughout this year. This widely dispersed sector was up overall by 8.5% at the end of August, mostly due to the power generation market. Spending in highways and bridges was up by 2.4%, but the conservation and development sector, where our piling products have significant exposure was actually down by 20.8%. Regarding our Rail business. Capital spending among the Class 1 railroads continued at a strong rate, up 11% in the third quarter and 19% year-to-date. We anticipate this trend to continue into the fourth quarter although at a more subdued rate than the first 9 months of this year. Our Tucson tie facility is operating between 85% to 90% of capacity for the Union Pacific Railroad. As we have mentioned in the past that Tucson supply contract with the UP expires at the end of this year, and also as Bob discussed, we have verbal indication from the Union Pacific for another 5-year supply agreement at Tucson and we’re working to finalize that agreement. In Spokane, we are producing concrete ties for transit authorities, other Class 1 railroads, contractors and industrial customers. We continue to see nice inquiry in bidding activity and the Spokane facility is highly utilized as well. Our Spokane concrete tie facility turned in another very strong performance in this year’s third quarter and we expect that strength to continue through the end of this year. As a percentage of this quarter’s consolidated sales Tubular accounted for 8% of sales, Construction was 27% and Rail was 65%. Regarding margins. Gross profit margins, as Bob mentioned, were 18% in the third quarter, a decrease of 70 basis points from last year’s quarter. The decrease is primarily due to the $3 million warranty charge that we took in Q3, partially offset by about $800,000 of concrete tie charges that were recorded in the third quarter of last year, as well as favorable LIFO adjustments in Q3 of this year. And when you compare them to last year, we had about $900,000 or 60 basis points of favorable adjustments there. As mentioned in our earnings release, excluding the concrete tie related charges incurred in both third quarters 2012 and '11, our third quarter 2012 margins would have been 19.8% compared to 19.2% in the last year quarter, a 60 basis point increase. Selling and administrative expenses decreased by $200,000 or 1.2% to $16.6 million in the third quarter of 2012. The decrease was due to a reduction in concrete tie testing expenses, partially offset by increased salary and benefit cost. Selling and administrative expense represented 9.7% of sales in the third quarter of 2012 as compared to 10.6% of sales in Q3 of last year. Turning to the balance sheet. Debt at the end of the third quarter was $0.4 million compared to $2.4 million at the end of the last year, a $2 million reduction in the past 9 months. Cash generated by continuing operating activities in the third quarter of 2012 was $21.6 million compared to $20.1 million last year, a $1.5 million improvement. Our capital expenditures were $1.5 million in Q3 of 2012 compared to $1.3 million in prior year quarter. Our year-to-date CapEx totaled $6.3 million compared to $8 million in prior year. Capital expenditures for the first 3 quarter of this year really haven’t change as far as what we’ve been spending on. As mentioned in previous calls, we are finalizing and putting through some of our final expenses for our new friction management facility in Vancouver, British Columbia, our new threaded pipe facility in Magnolia, Texas which we have discussed and various new plant and yard improvements across North America, where we have been investing in productivity, primarily increased productivity assets. We’ve also spent some money on computer network and telecom equipment, as well as mobile equipment this year. We anticipate the company’s full year capital outlays will range between $8 million and $9 million and as in prior years we continue to anticipate that our 2012 cash generation from operating activities will easily exceed capital expenditures, debt service payments, dividends and share repurchases. As Bob mentioned, cash at September 30 was $100.7 million, which was invested principally in AAA rated money market funds and other short-term instruments, where preservation of principal and quick access to funds has been the priority. Working capital net of cash decreased by $8.6 million compared to December of 2011 and it decreased by $9.7 million compared to June of 2012. Accounts receivable decreased by $5.9 million compared to June of this year. However, DSO increased by 1 day to 42 days on a consolidated basis. We believe that our AR portfolio continues to be in very good condition. Inventory increased by $7.2 million during the third quarter of 2012, while accounts payable and deferred revenue increased by $4.9 million. Looking forward, we believe that for at least the remainder of this year, we will continue to experience a continued competitive environment in the construction markets that we participate in as only slowing improving state and local budgets, and a scarcity of medium size projects provide headwinds in an already weak market. On a more positive note, solid Class 1 financial results as well as strong levels of capital spending continue to bode well for our Rail segment. And finally, we expect our Tubular segment to exhibit continued strength, consistent with that experienced over the last 12 months, as we become more efficient in our new threading facility and work closely with our joint venture partner. Additionally, natural gas transmission infrastructure requirements are expected to increase as new natural gas sources are developed. That concludes my comments on the third quarter of this year. We will now open up the session for questions. Francis.

Thank you. [Operator Instructions] Our first question is from the line of Robert Kosowsky from Sidoti.

Yes. I was wondering, first off to Dave, could you do the backlog numbers again? I think I missed it.

Yes, sure. The backlog at the end of Q3…

25 right, 25.8.

Yes, 25.7 at the end of the quarter, and that was up…

What was it in our Rail and Tubular?

Well, we actually - we don't usually disclose that on the call, Rob, but I think we can go ahead and give that to you. Backlog for Rail was about $155 million.

Okay. And then I guess just does that include the Honolulu project and kind of how do we think about the Honolulu project, I guess heading into the election next week?

It does include Honolulu, because obviously it's - we have a contract with a contractor performing the majority of the work there. So it does included it and it includes it to the tune that we did actually incur or report about $4 million of revenue as we had in our release from the Honolulu project. And we are certainly cognizant of the issue there. There is some political issues related to candidates that are running for the mayoral election in Honolulu. One is obviously pro this project and one is against it. And we are obviously anxiously awaiting the outcome of that election.

Okay. But no, I guess in the sense -- if he does elected, do you think that the project would probably be curtailed?

That -- there is a risk of that, Rob, but we just - we couldn't tell you right now .

Okay. And then secondly with regards to the progress you are making on the UP claim is you said you made an offer to them about changing the warranty from 1.5 replacement to 1 and extending the term. Was this offer accepted and kind of just $27 million been agreed upon by all the parties? Kind of where does that stand with kind of how firm the liability is?

Well, let me comment on the warranty policy first. When you look at all the product we shipped out of Grand Island, there was a transition that was made back in the early 2000 period around 2003. We used to have a 15-year warranty policy with a 1-to-1 replacement ratio and we went down to a 5-year warranty with a 1.5-to-1 replacement ratio. It's all of those ties that had a 5-year warranty policy attached to them that we have made an offer to revert back to the 15-year warranty protection policy and a 1-to-1 replacement ratio. And Union Pacific has agreed that, that is a direction that they want to take, and we are working out the details and using that as the premise from which we are proceeding. It is also the basis upon which we are evaluating our exposure in the reserve, but the reserve that we have taken, kind of Part 2 of your question there, we don't discuss that with anybody outside of the company so we are - that reserve is based on our anticipated claims from all customers based on the rate at which we think we are going to see field failures occur. So there isn't a dollar amount that we are negotiating with Union Pacific. We are moving forward on the basis that they will have - that we’ll have a warranty policy, that will protect them and that we’ll stand behind our product and we are beginning to very soon now move into the phase of managing the replacements in the field .

[Operator Instructions] Your next question is from the line of Brent Thielman from D.A. Davidson.

Yes. I guess, any initial indications or expectations you could offer for the Rail business into 2013 just based on kind of what you are hearing maybe from the Class 1s and elsewhere?

Well, the Class 1s have not published anything at this point and they typically don’t until we get into the year. Probably what we are focusing on more than anything else as this year was a significant year in terms of increased capital spending, on top of 2011 being a significant increase in capital spending over 2010. So they have certainly restored their capital spending to a level which is pretty high compared to what they will normally spend. So at this point in time to think that 2013 will be another banner year would probably be too early to tell. And I think 3 years in a row on that might be a little too bullish for how things are going. I like the fact that these guys are winning business. When you look at the petroleum products that they beginning to carry, the crude oil they are beginning to carry, all these things that are making up for some of the coal that’s gone down, if you think that maybe there will be a little bit more restored in coal traffic next year, a lot of things are pointing in a good direction for them. So I don’t think that they are going to have a tough year next year or be curtailing anything, but it’d be hard to sit here to say that they are going to boost it again by a considerable amount after 2 years of some really strong increases .

Sure, that’s helpful. And then I guess with regard to the balance sheet, cash around $10 a share, what’s your plans initially that you are looking at here.

Well, I gather that’s an acquisition question.

Could be.

We are always, through, our strategic planning process looking at ways to utilize that cash and invest it in the right areas for the company. Of course, I wouldn’t be able to share anything with you in terms of acquisition activity, but I think you know from the discussions that we do have publicly that it is a key part of our growth strategy going forward. We have our eyes wide opened and are looking for opportunities in the marketplace, but we also want to be prudent and not act too quickly and we are not anxious to just go out and do a deal for the sake of boosting our top line. We are very much focused on a strategy that we have in the company right now. We have some particular areas that are much more attractive to us than less and we are working them. And the timing of those sorts of things is always difficult to predict.

Okay. And then just kind of the housekeeping question, Dave. Any significant expenses in SG&A related to the UNP claim this quarter that shouldn’t be there going forward?

Just some concrete tie testing costs, Brent, but that’s really about it. And those are – you know, on a year-to-date basis, they were somewhat significant, just probably a little under $2 million, but for the quarter less so, we spent a lot less in Q3 as we were obviously spending more time analyzing the results of all the work that the material scientists have done for us over the past 16, 17 months.

At this time, we have no other questions in the queue. I would like to turn the call back over to Mr. Robert Bauer for your closing remarks.

Okay, great. That was a short one. I gather that comes from having a good explanation maybe along the way here, but thank you for joining us. We appreciate your interest, as always, in the company and in how well our business is going, and we'll look forward to the next time we meet to close out the year here, which, with the way things are going, we will have a good news report, I am sure for 2012. So thanks for joining us. Bye-bye.

Ladies and gentlemen, this concludes your presentation. You may now disconnect and have a good day.