L.B. Foster Company
Q1 2016 Earnings Call Transcript

Published: 4 May 2016

[Operator:]

Good day, ladies and gentlemen, and welcome to the L.B. Foster First Quarter 2016 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this conference is being recorded. I would now like to have the conference over to David Russo, Chief Financial Officer at L.B. Foster. Please go ahead.

[David Russo:]

Thank you, Karen. Good afternoon, ladies and gentlemen, thank you for joining us for L.B. Foster Company’s earnings conference call to review the company’s first 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 our first quarter presentation on our website under the Investor Relation’s tab for those that have online access. This afternoon, Bob will review the company’s first quarter performance and provide an update on significant business issues, as well as company and market developments. Afterward, I will review the company’s first 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 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 opinion 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 any subsequent Form 10-Qs or other pertinent items filed with the Securities and Exchange Commission for additional information about the 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. Reconciliations of U.S. GAAP to non U.S. GAAP measurements have been included within the company's 8-K filing. Statements referring to EBITDA, adjusted EBITDA, adjusted gross margins and adjusted net income are considered non-GAAP measurements, 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 metrics provides additional meaningful information for investors to facilitate the comparison of past, present and forecasted operating results. With that, we will commence our discussion and I will turn it over to Bob Bauer.

[Robert Bauer:]

Thank you, Dave. Good afternoon, everyone. Thank you for joining us. I’ll begin by providing an overview of our financial and operational highlights in the first quarter as well as give my perspective on the current market environment, which I will spend most of my time on. And then I’ll turn it back over to Dave to discuss our financial results in greater detail. During the first quarter we delivered sales of a $126.3 million, gross profit margin of 19.0%, EBITDA of $4 million and we had a net loss of $0.28 per diluted share. Each of these results is unfavorable to prior year first quarter results. The combination of a low backlog to start the quarter and weaker than expected bookings led to missing our revenue projection for the quarter, which intern had a significant impact on operating results. The weakness was driven by ongoing challenges we faced in many of the markets we serve including the headwinds driven by the current commodity cycle. While the first quarter is traditionally or seasonally weak as quarter, the year got off to a particularly slow start with order input from the North America freight rail market and highway and other civil construction projects that were well below what we had expected. So profitability in the quarter was impacted by deleverage on lower volume as well as pressure on gross margins, particularly in the tubular and energy services segment. So with a difficult way to start the year, and although we expected a weak start to the year, we were looking for better results in our first quarter. So as I covered our results, keep in mind that the test and inspection services business is still in restructuring mode with a somewhat stabilizing environment. This business is responsible for $0.27 of the EPS loss in Q1 which was worse than expected. And currency exchange rates also had a $900,000 unfavorable impact of pretax income which we didn’t forecast. So I’m going to turn to the business segment results now and discuss some specifics regarding segment performance and market conditions and I’ll start with the rail products and rail services. The sales in this segment of $64.3 million decreased 17.2% due to lower sales across many rail divisions and a more pronounced decline in concrete ties, rail distribution and insulated rail joints. Produce sales to Union Pacific rail road accounted for more than half of a decline in the rail segment. Gross profit margin of 21.7% decreased by a 170 basis points as a result of reduced sales volume. Our operations team reacted as quickly as possible to lower cost as the weakness materialized. Although we had expected a decline in spending in the North America rail market based on forecast and commentary that we received from the large carriers, we underestimated the degree to which reductions would be made with the outset of the year. It wasn’t apparent how much maintenance inventory to break rail roads carried into the first quarter following a slowdown that was initiated last year, and with little visibility into their inventory of our products we couldn’t forecast that draw down that might occur. So as the first quarter progressed, became increasingly clear but the Class One carriers were delaying projects and drawing down inventory. Our order activity in the first two months was about half of what it was during the same period last year. Then order activity picked up in March, to levels that were much closer to prior year levels in March. But as we recognized the difficult conditions, these operator spaces since the middle of last year, there were number of factors still contributing to a challenging market environment. The North America freight rail market continues to wrestle with declining car load volumes led by significant declines in coal. There are less favorable pricing in fuel surcharge conditions which are impacting their operating results. And we’ve also used the Class One carriers as a proxy for the regional rail roads as well, and therefore forecasted that they are taking similar actions in reducing capital spending and trimming operating expenses where possible. So during the first quarter, Class One carriers reported revenue down between 12% and 18% which was driven by volume decreases between 5% and 8% based on car loadings, commodity car loads across the industry were reported to be down almost 13%, again led by very weak coal shipments. Excluding coal the decline was still around 5% and we’re also seeing for fewer projects to support crude by rail. Now despite these headwinds, there are a few potential bright spots. First off, mandatory PTC compliance as positive train control was extended for three years to the end of 2018, which could cause some PTC programs to be delayed and potential pre-cast some funds for other maintenance and operating improvement projects which could benefit us. Second, transit projects remain at solid levels, which is a key focus for us and one of our top priorities for investment. Both North American and European markets should have solid spending in the next few years on transit programs. In fact we expect an increase in project activity in our European division this year, and current order rates are supporting net forecast at the moment. But despite these positive developments, the overall market weakness is really what’s dominating our actions at the moment and leaving us to make adjustments to cope with the declining volume, including sharpening our priorities and placing the resources that we do have on our top priority programs. We’re often seeing times like this, our rail customers are extremely focused on solutions that address safety and operating efficiency and that’s exactly what our new products and acquisitions are focused on. And our operations, they’ll keep focusing on generating solid cash flow and being quick to respond to changing market conditions. Now let me turn to our construction products segment. Construction sales decreased 7% in the first quarter due to lower sales across our product lines, particularly in our pre-cast concrete products division. We are encouraged by the improving trends throughout the quarter, as January was very weak but sales improved considerably, in February and March unfortunately not enough to make up for the weakness in January. Construction grows profit margins held up pretty well in areas with lower volume such as piling products and fabricated bridge products, but were negatively impacted by a decline in margins for pre-cast concrete products. Although we experienced the sales short-fall in our pre-cast concrete products division in the first quarter, we are encouraged by our bookings in the quarter which were ahead of this point last year, so we continue to think this division will have a good year. Steel prices, we’ll continue to play a key role in the results of our piling and bridge division. There are few sizable grid decking projects, we forecast we’ll win to help the lighter months this year. We’re also forecasting a better second half in piling products, however, we continue to see a very competitive environment for commodity type piling as a result of low steel prices. We are seeing some firming on steel prices and attempts to pass through increases but there is still a lot of global capacity. U.S. Mills as we know have been making capacity adjustments for some time and in attempt to deal with lower volume. So our forecast don’t factor in any significant steel price movement for the remainder of the year, which is something we’ll be watching very closely as the year unfolds. So I want to turn to the tubular and energy services segment now. Segment sales were up 16.2% in the first quarter driven by sales from coated products, precision measurement systems and sales from the test and inspection services business, which we acquired in March of 2015. We started the year with a solid backlog in the segment as a result of strong bookings last year and coated pipe and precision measurement systems that came from midstream pipeline customers. And sales for both divisions were up in the first quarter. The test and inspection services acquisition, it added $1.6 million to sales in the first quarter but excluding that acquisition impact, segment sales would still be up a 11.6%. Gross profit margins that finished 15.2% declined 810 basis points, principally driven by lower margins in our test and inspection services business. Excluding this division, gross margins would have improved 225 basis points and it accounted for $0.27 of the loss of the company’s net loss per diluted share of $0.28 in the first quarter. So as I mentioned earlier, this division is still adjusting to lower volumes and the results are weighing heavily on the company’s overall results. The business climate for tubular and energy services has not changed significantly from last quarter, it remains challenged. The upstream segment remains incredibly weak and the midstream segment while it’s better, it’s still facing uncertainty as their customers make adjustments to deal with liquidity concerns. The strength that we showed in the tubular and energy segment was a result of our backlog entering the quarter in coated products and measurement systems. There are still several pipeline projects we are working on for the second quarter. The balance of the year will be dependent on whether the customers follow through with planned projects and whether there is an interruption in our coated products business which needs a few sizable orders to fill our second half reduction. The demand for gathering and pipeline infrastructure, it remains dependent on the ability production companies to make the necessary long-term commitments as they’re making decisions on cash flow and other balance sheet objectives. On the supply side, a number of tubular mills are shutdown which has removed sources for new pipe. Currently we’re not constrained by this in our supply channels for tubular and measurements system’s needs works fine. If new pipe were to begin flowing, particularly the well sites, this would be very positive for us. All of these factors have led us to continue adjusting our approach regarding the timing of an upstream energy market recovery, as we’re still assuming it will be very slow to materialize. We don’t have – we do have an improvement forecast in the second half of 2016, on the heels of some favorable movement in the price of oil recently. Although, we’re going to make decisions as a very slow recovery well on hold and therefore focus on getting our division cost structures in line with the activity level. So, let me move on to the restructuring part of this and summarize some of these outlook comments now. Given the market outlook there that I just went through, as part of our plan to achieve our targets we announced additional restructuring initiatives, we have taken steps which started last year to rationalize our expense structure to adjust to lower volume. But ongoing market conditions have caused us to further scrutinize our expense structure throughout the organization to drive greater efficiencies. We also have added expenses compared to prior year related to our SAP implementation and consulting in legal class for the Union Pacific litigation matter that we have to overcome. So we’ve already started to revisit all expenses that are not related to even cost reductions or securing new business. And we were already started to take additional actions to address reduced volume and the pressure that it’s supporting on gross margins. It is likely that we will experience some restructuring charges related to these programs, however we expect the annualized savings will justify the cost and better position the company to deliver solid results when demand does improve. So I’ll close by summarizing some of the outlook comments I made and the significant challenges ahead of us given the earnings miss in the first quarter, lower than expected rail market orders and a volatile energy market that contributed to the loss from the test and inspection services division which we’re dam finished Q1 at a $0.27 loss. Headwind such as low steel and oil prices and lack of confidence from upstream and midstream operators are contributing to ongoing uncertainty. We need to see strength in the freight rail and energy markets and especially improvement in the upstream segment to hit our annual targets. There is some concern that the North America freight rail operators maybe cutting back more than anticipated. We also need to have a good year in Europe and not be fighting currency headwinds there or in Canada or any other country for that matter. In addition, restructuring charges could create some un-forecasted expenses we’ve looked to take additional cost cutting measures. And we might incur some additional expenses related to the Union Pacific litigation. Now to help compensate for this possibility we are delaying SAP implementations, even though we went live successfully in April in three divisions. So, we will work it for us. I’m going to conclude with that summary and turn it back over to Dave and he is going to go through more specific details. Dave?

[David Russo:]

Thank you, Bob. Net sales for the first quarter of 2016 were $126.3 million, a decrease of 8.4% as compared to $137.9 million in the prior year. Gross profit margin was 19.0%, a decrease of 326 basis points as compared to 22.2% last year. We experienced margin compression across all of our segments in the first quarter. Moving on to expenses, consolidated SG&A increased by $566,000 or 2.5% to $22.8 million due to the costs from businesses that were acquired in and after March of 2015. Excluding the S&A of acquired companies, selling, general and administrative expenses declined by $755,000 million or 3.4%. As a percentage of sales, SG&A increased by 193 basis points to 18.1% driven by the lack of leverage from the lower sales results. Amortization expense increased by $1.1 million to $3.3 million in Q1 due to the acquisitions transacted since March of 2015. Interest expense increased by $557,000 due to increased borrowings related to the acquisitions transacted since March of 2015. Our revolving credit agreement is a $335 million facility currently bearing interest at approximately 2.2% per annum. Other income expense was $715,000 in the first quarter, as compared to other income of $803,000 last year, an unfavorable swing of $1.5 million. $1.3 million of that variance is principally due to the impact of a weaker U.S. dollar relative to the Canadian dollar in the current year. First quarter pre-tax loss was $4.1 million compared to pre-tax income of $6.7 million in the prior year. The $10.8 million reduction in pre-tax income was due to the dilutive impact of the test and inspection services acquisition, as well as the increased interest and amortization cost and a reduction in rail segment revenues and related profitability due principally to last June specific revenues as well weaker freight rail sales. The effective tax rate for the first quarter of 2016 was 31.7% compared to 35.7% in the first quarter of last year. The decrease in the company’s effective rate was principally due to a more favorable projected global mix of income. The first quarter net loss was $2.8 million or $0.28 per diluted share compared net income of $4.3 million or $0.41 per diluted share in the prior year. EBITDA was $4 million in the first quarter, a decrease of 67% compared to $12 million last year. The $8.4 million first quarter sales decline was due to a 17.2% decline in the rail products and services segment, and a 7% decline in the construction products segment partially offset by 16.2% increase in the tubular and energy services segment. The rail sales decline was due to the more significant reductions in concrete tie sales and in insulated joint sales as well less substantial decreases across most other product lines, except for transit products which posted a sales increase of almost 25%. The Union Pacific rail road accounted for a little more than 50% of the rail decline and many of our product categories were impacted by the continuing decline in North America car loadings and the related capital spending reductions by the Class One rail roads, which approached 24%. The reduction in construction sales was caused by declines across all product categories with pre-cast concrete products being the most significant, although our projections for the full year remain optimistic for this category. In piling products we continue to experience challenging market conditions due to declining steel prices making us less competitive in the pipe piling H beam categories. The tubular and energy services sales increase was driven by increases in coated services and precision measurement systems partially offset by decline in the credit product sales. Test and inspection sales also contributed to the quarter-over-quarter increase, as this category had a full quarter of operations in 2016 as oppose to a partial quarter last year. As a percentage of first quarter 2016 sales, rail accounted for 50.9%, construction was 25.2% and tubular energy services was 23.9% of sales. Turning to the balance sheet, working capital net of cash increased by $8.4 million compared to the fourth quarter of 2015. Accounts receivable did decrease by $3.7 million during the first quarter. Consolidated DSO declined by 7 days to 49 days at March 31 as compared to December of 2015. And our inventory decreased by $4.2 million compared to December of 2015, as accounts payable and differed revenue declined by $8.1 million. Cash used by operating activities in the first quarter was $5.1 million compared to a use of $7.4 million in the prior year quarter. Capital expenditures were $3.1 million compared to $4.5 million in the prior year. Of course, lower than anticipated EBITDA had a direct negative impact on cash flows, and weak sales caused inventory to end the quarter higher than expected even though it was reduced from year-end. We continued to expect to generate solid free cash flow in 2016 as the working capital initiatives are continuing and we expect to cut capital expenditures to the range of $6 million to $8 million this year. Our capital investments are focused on providing new and expanded manufacturing capabilities, improving service and product availability to our customers and increasing operating efficiencies in future periods that we believe will improve shareholder value on a longer term basis. While our capital allocation protocols have been solid, potential returns on projects and softer markets become less attractive and much easier to cancel or differ, except for a couple of capital programs that we expect will have swift paybacks due to their correlation to business already secured or driven by longer term strategic growth. As Bob mentioned, we have embarked on a more focused restructuring initiative that will target further cost reductions in order to improve profitability and cash flow. We will be prudent with our capital deployment this year say for these projects, our new ERP system and some necessary maintenance items. We continue to anticipate cash generated from operating activities, this year we’ll exceed our capital expenditures, debt service payments, dividends and share repurchases thereby allowing us to continue to deliver. As mentioned in our earnings release, first quarter 2016 bookings were $118 million and decline of 27.8% compared to last year’s first quarter due to a 40.8% reduction in rail bookings as well as 13.2% and 9.3% decline in bookings in the tubular and construction segments respectively. Q1 orders for the rail segment were weaker than 2015 due to lower order volumes from rail distribution, concrete ties and other track components targeted principally for freight rail markets. Reductions in tubular orders are mostly attributable to coated services for the quarter. Construction product order bookings declined principally to piling and fabricated bridge products reductions. The bridge order decline was mostly due to volume reductions in the market we often describe as lumpy. While activity is down there are still projects moving forward where we see opportunities for our product lines. Order backlog stood at $154 million at the end of the first quarter, down $63.3 million or 29.1% from the prior year quarter backlog of $217.3 million. The decrease was principally due to reductions in our rail distribution, transit products, concrete ties and bridge products categories. We did not repurchase any stock in the first quarter of 2016. Debt at the end of first quarter was $174.9 million, compared to $168.8 million at December 31, 2015, an increase of $6.2 million but down $49.4 million from the prior year at March 31, 2015, after the March 2015 test and inspection acquisition. Maximizing free cash flow in 2016 continues to be a primary focus of this management team. Our primary use of capital will be to delever the company, although we will consider alternative uses of capital as the leverage declines. That concludes my comments on the first quarter of 2016. I'll now send it back to Karen and open up the session for questions.

[Operator:]

Thank you. [Operator Instructions] And our first question comes from the line of Mike Baudendistel from Stifel.

[Mike Baudendistel:]

Thank you. First I just wanted to ask you, I don’t think you said anything about the guidance that you drew out there the last quarter. Are you withdrawing the guidance today?

[Robert Bauer:]

Mike, no we’re not withdrawing it. We elected to provide a lot of commentary on the outlook to provide as much in size as possible with respect to have the first quarter unfolded as well as a lot of color I think on how the rest of the year actually looks. We felt like with one quarter behind us we were not going to go ahead back and revisit the subject. I think as you can see, we got off to a slow start of course, we missed that estimate that we put out there for Q1 but we felt like that we needed to watch the year unfold a bit more before commenting further on exact numbers and circling back on any of the estimates that we could put out there last quarter.

[Mike Baudendistel:]

Okay. And I guess also wanted to ask you, you talked about some of the expenses you’re cutting related to other types of cost reductions or securing new business. And I know you mentioned SAP is one area where you’re cutting, what are some of the other areas that you’re cutting, can you give any detail there?

[Robert Bauer:]

Well, largely what’s taken place is that we’re making reductions in facilities, we have some salary headcount reductions that are taking place. We have a number of discretionary budgets that we can look at all across the company, most of the funding that is in place for new product development and those sorts of things are staying in place. And the programs that are important with regard to what we want to fund in the new acquisitions those are also staying in place, but similarly if we can cut it in capital spending as well so differing equipment, machinery those sorts of things and there is always cost associated with putting those sorts of things in place. We’re holding a line on facility improvements and replacement of items, and even the things you go after like travel expenses and those sorts of things. So, it’s one of those situations where everything is on the table at this point, given the softness that we’re seeing in the market and the way profitability targets are going to be real challenge this year. So, as I said, if it’s not about getting new business then we’re going to question whether or not we want to spend that money.

[Mike Baudendistel:]

Okay, that’s a good detail. I guess I also wanted to ask you just on SG&A, can you talk a little bit about how much you expect that, I assume it’s going to come down from $22 million in the most recent quarter to going forward. Are you able to quantify how much you could raise if that’s good to go?

[Robert Bauer:]

You want to take that Dave out, because you can bring a number.

[David Russo:]

Yeah. So Mike, all the things we’re looking at, a lot of or I should say some of it rolls up in G&A and some of it obviously doesn’t not, there is a lot of the cost we’re looking at that roll up in cost to good sold. So if you take a look at our first quarter run rate related to SG&A we’ve certainly expect Q2 to be less than Q1 as these things begin to take hold and show. We may incur some cost as we move along, taking some of these actions but we look at the first quarter run rate, we certainly expect Q2 to be down – there are some costs like sales commissions that will could bump up in the summer months as our construction season kicks in and commissions are earned but we expect our numbers to start to drop. So we don’t have a target for you right now, we’re still working on pulling some of that together.

[Robert Bauer:]

Well, one of the things that is also impacting that Mike, is the added cost year-over-year for the expenses we’re incurring with the litigation of Union Pacific particularly time matter. So that’s a substantial headwind to SG&A that’s causing that number to look like it’s not falling at the rate that you would anticipate it might.

[David Russo:]

Yeah, I would tell you Mike, our Q1 actual SG&A was negatively impacted by $900,000 related to the litigation.

[Mike Baudendistel:]

Okay, great, that’s helpful. And then I just also want to ask you a revenue question, I mean you break out now revenue between goods and services, I guess the $18 million in services – I assume that’s mostly in energy and rail, is it possible to just break that into the segments and also do you have a higher margin on the services segments and any just specific initiatives that to grow at the services revenue?

[David Russo:]

Well, we do have certainly plans to grow that. You’re right, the preponderance is in energy. Just the entire upstream business that was purchased last year, the test and inspection business all was primarily is all services. Our coated products business, I should say our coated services business is really all services as well, so those two really are the preponderance of it but there is other parts of the rail business that is serviced as well.

[Mike Baudendistel:]

Okay, thank you. That’s all I have for you this afternoon. Thank you.

[Robert Bauer:]

Yeah, thanks.

[Operator:]

Thank you. [Operator Instructions] Our next question comes from the line of Brent Thielman from D. A. Davidson.

[Brent Thielman:]

Hi, good morning, guys.

[Robert Bauer:]

Hi, Brent.

[David Russo:]

Hi, Brent.

[Brent Thielman:]

I apologize I missed a portion in the opening commentary, so don’t mean to be repetitive but on the civil side and some of your comments there, some other kind of the materials were talked about for better growth in the first quarter in the civil construction projects. I’m kind of wondering whether the timing issue or you’re starting to see some improvement in that market coming to you, any help there?

[Robert Bauer:]

Yeah, I wouldn’t pin it on timing, I think the construction market in general, the heavy civil construction market that we depend on is not changing a great deal. We were impacted actually more than in Q1 by our free cash concrete products, we just missed sales because bookings were good. So, there isn’t a lot of impact to our piling and bridge business coming from timing of projects in construction as it relates to the market moving. We also always depend on winning a few big orders and right now great decking orders for our bridge business we need to book a few decent size orders before the end of the year. And our big issue with piling really stems from how competitive that you come out as piling products have gotten, and what I put into that category is pipe pile on each pile. Our ability to win those projects these days has been affected by how low steel prices have gotten and how some mills will be very aggressive when it comes to winning some of those projects. And so consequently we have lost some share in commodity piling products.

[Brent Thielman:]

Okay. And then on the tubular, energy services side I mean I understand the business is difficult, profitability some respects to holding that relatively well. How do you feel the business did relative to your expectations for the quarter?

[Robert Bauer:]

It performed lower but not by much for the quarter because we thought we were at a point where the business was somewhat stabilizing. I can’t say that I still do feel that way and I’m saying that because we’re no longer seeing a decline on a slow compared to what we were seeing throughout 2015. So it does feel like we are bumping along the bottom, I thought we would do a bit better in sales volume. So we did miss what we had forecasted for that business in Q1. And we have some improvement forecast for the balance of the year, certainly in the second half. Most of what you’re hearing in the market place is there is expected to be some improvement, most people are expecting that balance of supply will start to come in much closer to demand in the second half and there’ll be some price movement. So that’s why we put some improvement in our forecast but as I mentioned we’re going to operate as if we’re not expecting a lot of it and continue to go add a lot of the costs and other things that we can do to try to protect the bottom line.

[Brent Thielman:]

Okay, thank you.

[Robert Bauer:]

Yeah.

[Operator:]

Thank you. [Operator Instructions] And that concludes our question-and-answer session. I would like to turn the conference back over to Bob Bauer for any closing comments.

[Robert Bauer:]

Okay, well thanks everyone for joining us. I hope we added color on how the market looks both in Q1 and what we think is shaping up here over the coming quarters is helpful for you. We will look forward to talking with you again after the second quarter. So, thank you for joining us today.

[Operator:]

Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program and you may now disconnect. Everyone, have a good day.