L.B. Foster Company (FSTR) Q3 2016 Earnings Report, Transcript and Summary

Greetings, and welcome to the L.B. Foster Third Quarter 2016 Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. David Russo, Thank you. You may begin.

Thank you. Good evening ladies and gentlemen, thank you for joining us for L.B. Foster Company's earnings conference call to review the company's third quarter 2016 operating results. My name is David Russo and I'm the Chief Financial Officer of L.B. Foster. Hosting the call today is Mr. Robert Bauer, L.B. Foster's President and CEO. We do have a third quarter presentation on our Web site under the Investor Relation's tab for those who have online access. This morning, Bob will review the company's third quarter performance and provide an update on significant business issues, as well as company and market developments. Afterward, I will review the company's third quarter financial results and then we will open up the session for questions. During today's call, our commentary and responses to your questions may contain certain forward-looking statements, including items such as the company's outlook for our businesses and markets, cash flows, margins, operating costs, capital expenditures and other key business metrics, issues and projections. These statements involve a number of risks and uncertainties that could cause actual results to differ materially from statements we make today. 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, except as required by law. All participants are encouraged to refer to L.B. Foster's Annual Report on Form 10-K for the year ended December 31, 2015, as updated by subsequent Form 10-Qs or other pertinent items filed with the Securities and Exchange Commission for additional information regarding risk factors that may affect our results. In addition to the results provided in accordance with United States Generally Accepted Accounting Principles, our commentary includes certain non-GAAP statements, including EBITDA, adjusted EBITDDA, and certain other metrics where we have added back the effect of an impairment charge. Reconciliations of US GAAP to non-GAAP measurements have been included within the company's 8-K filing. Statements referring to EBITDA, adjusted EBITDA, as well as certain measures, excluding the impairment charges are considered non-GAAP measures, and while they are not intended to replace the presentation of our financial results in accordance with GAAP, the company believes that the presentation of these measures provides additional meaningful information for investors to facilitate the comparison of past, present, and forecasted operating results. Our accompanying earnings presentation reconciles these non-GAAP measures to the corresponding GAAP segment profit measure. As disclosed in our earnings press release, in the third quarter we recorded an additional $6.9 million pre-tax charge resulting from the finalization of the June 1, 2016 impairment analysis that we discussed during our second quarter call when we recorded an impairment charge of $128.9 million to write-down certain assets that were deemed to be impaired. The additional $6.9 million resulted from the completion of that review, and it related to a $4.4 million goodwill impairment charge at the rail technologies reporting unit within our rail products and services segment, as well as $2.5 million reduction of certain lived intangible assets at the Chemtec Energy Services reporting unit within the tubular and energy services segment. The net after-tax impact of these adjustments was $5.9 million, or $0.58 per diluted share. As a reminder, these charges are non-cash charges that do not impact our EBITDA, cash flows, or bank covenants. With that, we will commence our business review discussion, and I will turn it over to Bob Bauer.

Thank you, Dave, and hello everyone. Thank you for joining us today. I'm going to focus on two areas; first, the market factors which have created the more significant challenges for us and how they have affected operating results; and second, the most significant actions we've taken to address business conditions. Starting with our third quarter sales results, as we've reported consolidated sales in Q3, we are down 35%. Our two distribution businesses, rail distribution and piling have had a significant impact on the sales decline. Both have declined in ton sold and both have been impacted by the declining price of steel. I'm going to start with rail segment sales and describe these in more detail. Third quarter rail segment sales, excluding a $3.7 million acquisition impact were down 40% year-over-year, and rail distribution accounted for $21.4 million of the $34.8 million sales decline year-over-year, or 61% of the decline. The rail distribution division, which largely serves Class-2 carriers, industrial customers in the transit market North America has been industrial projects decline significantly. Declining steel prices apply the significant role in the sales decline. Price per ton in Q3 for new rails sold was down approximately 24% year-over-year. The price per ton on new rail sales has declined sequentially now for the last four quarters. With scrap prices at low levels and factory utilization of less than optimal levels, pressure on end market pricing has increased. On a nine-month year-to-date basis, the average selling price of new rail is down 20% year-over-year. Excluding the rail distribution division, the other divisions combined in our rail segment were down 27% in the quarter. They've largely been affected by the reduction in spending in the North American freight rail market, including the Class-1 carriers all rail companies that we can track have reduced capital spending and have deferred as many new capital projects as they can. In the divisions we operate where customer projects are discretionary and have little exposure to maintenance spending are experiencing the greatest challenges. On a nine-month year-to-date basis, sales for the same group of businesses are down 26%. On the positive side, earlier this year we described the drawdown in inventory for some for our products sold into the freight rail market, and one of our division's orders have picked up recently, which maybe a signal that some carriers have worked through their inventory. I'm going to switch to the construction segment sales now. Construction segment sales were down 36% in the third quarter, and once again our piling distribution business was the key driver. Piling has been affected by the price of steel, which has lead to difficulty in winning business, particularly in the commodity piling markets, where there are more competitors that are capable of supplying H-piling and pipe piling. In addition, commodity piling pricing over the last year has declined between 9% and 12% on average, after falling a few percent in 2015. All other business combined in the construction segment was down 16%. On a nine-month year-to-date basis, the piling division is down 32%, while all other construction business combined is off only 10% year-over-year. Our bridge and precast buildings divisions have a much more positive outlook that year-to-date 10% decline is all related to our bridge decking division, as sales for precast buildings are up in the third quarter and on a year-to-date basis. The bridge decking business which can fluctuate from quarter-to-quarter with project activity now has a stronger backlog to begin Q4 with production ramping up in the fourth quarter and into the first quarter of next year. The tubular and energy services segment had a tough quarter, as one of our more consistent divisions was shut down for several weeks. Orders for coated line pipe were very weak and lead to a period where we shut down operations at our Birmingham coating facility. The sales in the quarter are well below prior year levels and the market has become more competitive. I'm happy to report that the Birmingham facility is operating again, and we have enough backlogs to fill production for the remainder of the year with projects also scheduled out into the first quarter. Throughout the year, company serving the Midstream market has been delaying projects as they wrestle with uncertainty regarding production volume. We started the year, for example, with a strong backlog for precision measurement systems and sales for this division are up more than 40% over the prior year in Q3. However, we have worked off a significant amount of the backlog as the industry has delayed new projects. But despite the situation, we have opportunities for growth by expanding into the gas market along with some new products that will add to our expertise in liquids measurement. And our test and inspection services division has been fighting weakness for several quarters in the upstream oil and gas sector, and while year-over-year sales are still well below prior year levels, I'm encouraged by recent activity for services related to the deployment of new pipe. This is not typically a backlog-driven business, as lead times are very short, but backlog is increasing and customer inquiries are clearly on the rise as well. While I'm encouraged by these signs, I still hesitate to provide an optimistic forecast until we see some stability over a more prolonged timeframe. Let me turn to gross profit margin performance; the gross -- consolidated gross margin results reflect a very difficult quarter for tubular and energy services. The decline of 320 basis points in third quarter on a consolidated basis had only a 70 basis point decline in rail and a 50 basis points decline in construction. And given the sales decline of roughly 35% for both of these segments, I feel like we've taken quick action to align operating costs with volume to minimize the impact to our profitability in these segments. The challenges in the tubular and energy segment drove third quarter gross profit margin decline. The shut down in our line pipe coating services operation combined with the performance of the test and inspection services division lead to a significant decline in gross profit margins. In comparison, the third quarter of last year was an excellent quarter for coated pipe services and the test and inspection services business still hadn't bottomed at that time. Looking forward, both of these divisions have upside potential; inspection services activity as I mentioned is on the rise as rising rig count along with renewed drilling activity takes place. They should drive gross margin improvement in the coming quarters from these businesses, which should in turn drive better margins for our tubular and energy segment. Another risk to overall company profit margins going forward, aside from unit volume, our steel prices, steel prices have declined toward the lower end of what we typically experienced and the a down market cycle for steel. Whether prices hold at these levels, decline further or improve from here, we are not able to forecast. If there are improving factory utilization rates in the steel industry, along with high scrap prices, which are around historic lows right now about $200 a ton, we would expect to see upward pressure on steel prices. Wrapping up on the financial part with cash flow and capital spending, just a couple of comments on that; our operating cash flow in the third quarter was 5.3 million, cash generated from working capital has not been as strong as I'd like as inventory hasn't declined in our distribution businesses, particularly piling at the rate sales have declined. And rail distribution and piling hold about 50% of the company's inventory. So we have opportunity to improve turnover in these areas, which we're currently working on. In addition, we have reduced capital spending to re-pace [ph] substantially below prior levels. Capital spending in Q3 was only 1.4 million, down from 3.4 million in the third quarter of last year, and well below the pace of 5.1 million in the first half of 2016. We made some key investments over the last two year in facility, technology, and efficiency. And I think that capital spending is paying off and helping us hold margins up in some of the areas where volume has declined considerably. On turning to the second part of my discussion on actions to address business conditions, among our top priorities are reducing cost further to get more in line with the continued decline in sales volume throughout the year, we increased our target for cost productions as market weakness persist and we have recognized that we have to be more aggressive as our sales revenue continue to decline. The actions taken throughout 2016 are now expected to result in annual savings of more than $12 million. The spending reductions are affecting both SG&A as well as cost of goods sold with the majority being in the SG&A expense categories. In the third quarter, SG&A spending was down 8.3% over prior year, but excluding acquisitions, the base company SG&A was down 10.6%, and when excluding our legal and ERP expenses, all other SG&A expenses down 15.4% year-over-year. So we are making some progress at this. Among the additional actions taken is another round of salary workforce reductions which were acted on in October, along with further discretionary spending cuts. The additional actions taken in October are going to be a key contributor to achieving the 12 million reductions in annual spending. These actions will begin to take effect in the fourth quarter, and will also result in restructuring charges in Q4 as well. Keep in mind we are still facing the impact of rising litigation costs that are offsetting the actions we've taken to reduce expenses. And I will wrap up with another important action taken recently, which is an amendment to our credit facility with terms that are more aligned with current business conditions. Dave will speak to the details of that, but I just wanted to say that our lenders helped us structure an amendment that provides greater flexibility to operate under conditions where our freight, rail customers and our energy customers are working through some difficult conditions and making adjustments to cope with the challenges they are coping with. In addition, the commodity cycles lead to declining prices for steel, which may not rebound in 2017. So the amended terms provide us with added flexibility to make the necessary adjustments in our cost structure, and to take further actions that are intended to drive cash flow and strengthen our balance sheet, which has we have continued to mention are among our top priorities. So with that, I'm going to return the discussion back over to Dave.

Thank you, Bob. Net sales for the third quarter of 2016 were $114.6 million, compared to $176.1 million in the prior year, a decrease of $61.4 million or 34.9%. Gross profit margin was 17.3%, a decrease of 320 basis points, as compared to 20.5% last year. We experienced margin compression in all three segments, but most notably in the tubular energy services segment. Moving on to expenses, consolidated selling and administrative expenses decreased by $1.8 million or 8.3% to $19.8 million due to our ongoing cost reduction initiatives totaling $1.6 million as well as to lower incentive costs of $0.7 million and lower acquisition and integration expenses, which were partially offset by increased litigation expenses of $0.6 million and to a lesser extend increased ERP costs. Excluding the increases related to litigation and ERP, selling, general and administrative expenses decline by $2.7 million or 13% on a consolidated basis. As a percentage of sales, SG&A increased by 500 basis points to 17.3% driven by the lack of leverage from the decline in sales. Amortization expense decreased by $1.6 million to $1.8 million in Q3 due to the impairment changes as well as some small intangible assets being fully amortized. Interest expense increased by $255,000 due principally to increased interest rates. The effective tax rate for the third quarter of 2016 was 36.1% compared to 18.2% in the third quarter of last year. The effective increase tax rate was affected in both periods by the discrete impact of asset impairments. The 2016 rate was largely offset by changes in the company's forecasted global mix of income. The 2016 third quarter net loss was $6 million or $0.58 per diluted share compared to a $57.4 million loss or $5.60 per diluted share in the prior year. Excluding the impairment charges in both years, the third quarter 2016 net loss was $36,000 or less than a penny per diluted share compared to income of $6.5 million or $0.63 per diluted share last year. Adjusted EBITDA was $4.1 million in the third quarter compared to $18.5 million last year. The 34.9% third quarter sales decline was due to a 35.3% decline in rail products and services segment sales, a 32.7% decrease in the tubular energy services segment, and a 35.5% decline in the construction product segment sales. The rail sales decline was due to reductions across all product categories, most notably a 55.7% decline in rail distribution and 54.8% decline in North American transit products. The Union Pacific railroad impact on third quarter sales was immaterial. Most of our rail product categories were negatively impacted by the continuing decline in North American car loadings which were down by 6.1% in the third quarter and the related capital spending reductions by the Class-1 railroads which were approximately 23% lower than the prior year third quarter as reported thus far by six of the seven Class-1 railroads. The construction sales decline was driven by declines in piling and fabricated bridge products, partially offset by a modest increase in precast concrete products. In piling products, we continue to experience a very competitive market due to taper demand as well as declining steel prices that make us less competitive in the more commoditized pipe pilings and H beam categories. The tubular products and energy services sales decline was driven by decreases in all product categories with the exception of the precision measurement systems business where we are staying market competitive, but at the expense of margins. Coating services and test and inspection services reported the most substantial sales reductions of the segment. As a percentage of third quarter 2016 sales, rail accounted for 49.6%, construction was 30.4%, and tubular and energy services was 20%. We've also included a slide with a nine-month income statement which details the year-to-date results, which included 22.3% decline in sales to $376.9 million. Turning to the balance sheet, working capital net of cash decreased by $0.1 million compared to the second quarter of 2016. Accounts receivable increased by $16.5 million during the third quarter. Consolidated DSO increased by six days to 53 days at September 30 compared to 47 days at June 30 and 56 days at December 2015. The increase was due principally due to decline in third quarter sales. Inventory decreased by $3.8 million compared to June of 2016, as accounts payable and differed revenue declined by $18.8 million. Debt at the end of the third quarter was $135.6 million, compared to $168.4 million at June 30 2016, a reduction of $32.8 million. $26 million of this decline was due to short term subsidiary advances. As a result cash decreased by $29.2 million from the second to the third quarter of 2016. As mentioned in the earnings press release, the company just executed its second amendment to its credit agreement dated March 13, 2015. I will highlight some of the more significant terms of the amendment as follows. The facility was reduced from $275 million to $225 million comprised of $195 million revolving credit line and $30 million term loan that amortizes radically over the remaining term of the agreement. The maximum leverage ratio covenant is eliminated through the second quarter of 2018. When reinstated, the leverage ratio will be a gross leverage ratio of 4.25 to 1 in the third quarter of 2018 and will then reduce to 3.75 to 1 for all periods thereafter. The amended agreements calls for a minimum EBITDA as to find of $18.5 million through the second quarter of 2017 and increases in various increments through the second quarter 2018 when it will be $31. After such time it will be eliminated. The amendment also provides for a fixed charge coverage ratio which is calculated as a ratio, fixed charges to EBITDA and shall be a minimum of 1 to 1 through the fourth quarter of 2017 and then steps up to 1.25 to 1 for each quarter afterwards through maturity. We have just filed a Form AK with more comprehensive details regarding the revised terms and conditions today. Moving to cash flows, as Bob mentioned, cash provided by operating activities in third quarter was $5.3 million compared to $15.6 million in the prior year quarter. For the first nine months of 2016, cash flow from operating activities was $11.9 million compared to $13.7 million in 2015. Third quarter capital expenditures were $1.4 million compared to $3.4 million in the prior year and year-to-date CapEx was $6.5 million compared to $11.6 million last year. We anticipate our full year capital expenditures to be approximately $8 million. We feel pretty good about accounts receivable management thus far this year, but we believe there is improvement yet to be achieved regarding inventory management. As we have previously mentioned, while our capital allocation protocols have been good potential returns on projects in softer markets become less attractive and easier to cancel or defer except for a couple of capital programs that we expect will have paybacks due to their correlation to business already secured or driven by longer term strategic growth. Our capital projects are expected to be limited in 2017 unless they directly correspond to new business, required maintenance capital or ERP spend for further implementation. We therefore expect 2017 capital expenditures to be approximately $5 million or less. Also as mentioned in the earnings press release, the Board of Directors has approved the suspension of the company's dividend effective immediately. While this was a difficult decision, we believe it reflects L.B. Foster's commitment to de-lever at all levels of the organization. Further to that point, we have undertaken additional cost reduction actions as Bob mentioned in October that approximates $6 million annual rate and should be mostly reflected in our results towards the end of the fourth quarter but certainly in the first full quarter of 2017. Third quarter 2016 bookings were $110 million, a decline of 23.8% compared to last year's third quarter due to a 22.5% reduction in rail bookings as well as a 52.2% decline in tubular bookings which construction segment orders were flat. Q3 orders for the rail segment were weaker than 2015 due to lower order volumes for rail distribution and concrete tiles, targeted principally for freight rail markets, as well as a reduction in transit product orders. Reductions in tubular orders were mostly attributable to coated pipe products and services, as well as test and inspection services order reduction for the quarter. Order backlog stood at $143.8 million at the end of the third quarter, down $30.5 million or 17.5% from the prior year quarter's backlog of $174.3 million. The decrease was due to a decline of 37%, and 44% in the rail and tubular segments partially offset by a 20% increase in the construction segment. In closing, maximizing free cash flow in the fourth quarter and throughout 2017 continues to be a primary focus of this management team. Our primary use of capital will be to de-lever the company during this period of weaker operating results. That concludes my comments on the third quarter of 2016, and I'll now send it back to the moderator to open it up for questions.

Thank you [Operator Instructions] Our first question comes from the line of Brent Thielman with D. A. Davidson. Please state your question.

Hi, good evening.

Hi, Brent.

Hello, Brent.

Hey, Bob, on the tubular and energy services segment, I mean a multitude of different headwinds going on there I think in terms of revenue and margins. Can you kind of help parse out between which aspects of the business you are seeing the most pressure on? I guess, I am kind of curious to on that idled facility and how much of a headwind that was for you in the quarter in terms of margin pressure?

Well, the idled facility which belongs to our coated services operation was a significant headwind in the third quarter. We wound up with sales that were very minimal in the quarter, and as result, we weren't covering a number of costs that are associated with that business. So, as we were shutdown in excess of six weeks in the quarter, it had a substantial impact on our results. So the inspection services piece of that continues to struggle and really those two businesses were the ones in the third quarter that were having the most significant unfavorable impact on gross margins. And that business is still down year-over-year, as I mentioned last year, it hadn't hit the bottom. I'd like to say that the bottoms end [ph]. Certainly we've seen an increase in now in rig counts and other activity that I mentioned that's given us some reason for optimism, but I'd like to see that turn into results before we'll talk about how this thing is really turning up. It's those two businesses that have had the most significant impact.

Okay. I understand. And I guess with the coating operation I think it's up and going now, that presumably you should see some margin benefit here I think going forward, is that fair?

It is. Running at this point in time we have some nice backlog in the facility. We're working on a substantial project at the moment that has production schedules filled at least for single shift operations through the rest of the year and in through the first quarter. So I do anticipate that that's going to have better -- contribute to better results in the months ahead.

That's encouraging. And then on the construction product side, the backlog in bridge decking projects, is there some kind of lumpy projects involved in there, or are you seeing somewhat that's a little more sustainable in terms of order trends in that particular area?

Well, the demand in the marketplace actually looks pretty decent at the moment, but that business is always lumpy. If you ever look at it in terms of whether it's bookings or sales from one quarter to the next, it clearly reflects a market where we sometimes have some substantial projects, substantial being $5 million to $10 million size projects where we can see that activity affect our sales output in any given quarter. So as such, while our year-over-year comps at this point and an even on a year-to-date basis this year haven't looked so good, we booked a lot of business in the second quarter. And so, we're getting exit the year with near-record backlog in that that will make the coming quarters here at least the near future look pretty good. But you know, the demand for that sort of product line from us is still decent in the marketplace, but as I always tell people you know there'll be times where it won't go up and down just based on that project activity.

Okay. That's all I had. Thank you.

Yes. Thanks, Brian.

[Operator Instructions] I'm showing no further questions at this time. So that does conclude our question-and-answer session. I will now turn it back to Mr. Bauer for closing remarks.

Okay. Well, thank you that was a light quarter on Q&A. I guess that's okay. We'll look forward to talking with you here at the end of the year when we hold our next conference call. So, we appreciate everyone joining us. Thank you very much.

This concludes today's conference. Thank you for participation. You may disconnect your lines at this time.