L.B. Foster Company (NASDAQ:FSTR) Q4 2016 Earnings Conference Call March 2, 2017 5:00 PM ET
Judy Balog - Investor Relations Manager
David Russo - Vice President, Chief Financial Officer and Treasurer
Robert Bauer - President and Chief Executive Officer
Jeremy Javidi - Columbia Threadneedle Investments
Greetings, and welcome to L.B. Foster’s Fourth 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 Judy Balog, Investor Relations for L.B. Foster. Thank you, Ms. Balog. You may now 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 fourth quarter 2016 operating results.
My name is Judy Balog and I’m the Investor Relations Manager of L.B. Foster. Hosting the call today is Mr. Robert Bauer, L.B. Foster’s President and CEO. Also on the call is Mr. David Russo, L.B. Foster’s Chief Financial Officer.
We do have a fourth quarter presentation on our website under the Investor Relation’s tab for those who have online access. This evening, Dave will review the company’s fourth quarter financial results and certain full year results as well. Afterwards, Bob will review the company’s fourth quarter performance and provide an update on significant business issues, as well as company and market development. 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 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, 2016, 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 EBITDA, and certain other metrics where we have added back the effect of impairment charges. Reconciliations of U.S. 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 measure.
With that, we will commence our business review discussion, and I will turn it over to Dave Russo.
Thank you, Judy. Net sales for the fourth quarter of 2016 were $106.6 million compared to $139.1 million in the prior year, a decrease of $32.6 million or 23.4%. Gross profit margin was 17.6%, a decrease of 380 basis points from the prior year quarter. We experienced margin compression in all three segments, but most notably in the Rail Products and Services segment. The margin decline in the Rail segment was driven principally by a $1.2 million transit-related warranty charge as well as inventory rationalization actions taken in the quarter.
Moving on to expenses, consolidated selling and administrative expenses decreased by $4.5 million or 18.3% to $20 million, due to our ongoing cost reduction initiatives and strategic spending cuts totaling $4.2 million as well as to lower incentive costs of $1.5 million, which were partially offset by a $0.9 million charge related to the anticipated settlement of an employee dispute, an increased Union Pacific Rail Road litigation expenses of $0.3 million.
As a percentage of sales SG&A increased by 118 basis points to 18.8%, driven by the lack of leverage from the decline in sales, partially offset by a healthy reduction in expenses.
Amortization expense decreased by $1.5 million to $1.8 million in the fourth quarter due to the asset impairment charges taken in the second and third quarters as well as some small intangible assets being fully amortized.
Interest expense increased by $1 million, due principally to increased rates as well as to the write-off of $0.4 million of deferred finance charges due to the fourth quarter amendment to the credit agreement. The company’s income tax expense for the fourth quarter was $36.6 million. The company recorded a valuation allowance of $29.7 million. The company also recorded deferred U.S. income taxes and foreign withholding taxes of $7.9 million in 2016, as we no longer intend to permanently reinvest a significant portion of our unremitted foreign earnings outside of the United States.
Fourth quarter 2016 net loss was $40.9 million or $3.97 per diluted share compared to income of $3.3 million, or $0.32 per diluted share, last year. EBITDA was $3 million in the fourth quarter compared to $13.4 million last year.
Full-year 2016 adjusted EBITDA was $18.5 million compared to $60.6 million in 2015. As an aside, one of our revised credit agreement covenants is an $18.5 million minimum EBITDA for 2016 and for the first two quarters of 2017 on a trailing 12-month basis. EBITDA as defined by the credit agreement has certain non-cash adjustments that a traditional financial EBITDA calculation might not incorporate.
As a result, the EBITDA calculation pursuant to the amended credit agreement is approximately $5 million higher than the $18.5 million adjusted EBITDA that I referred to and which is calculated in the non-GAAP reconciliation in our earnings release.
The 23.4% fourth quarter sales decline was due to a 34% decline in the Rail Products and Services segment and a 27.2% decrease in the Tubular and Energy Services segment.
The Rail sales decline was due to reductions across all product categories, most notably a 38.9% decline in rail distribution and a 66.4% decline in North American transit products. Most of our Rail product categories were negatively impacted by relatively soft North American rail traffic. However, commodity car-loadings did grow by 0.4% in the quarter and North American Intermodal shipments were up by 2.7% versus the fourth quarter of 2015.
Total North American rail traffic did increase by 1.5% in the quarter. The Tubular and Energy Services sales decline was driven by decreases in all product categories with the exception of the threaded water well products business. The protective coatings division sales declined by 50.3%, while the precision measurement systems division reported a 25.4% reduction in sales.
As a percentage of fourth quarter 2016 sales, Rail accounted for 47.4%, Construction was 36.1%, and Tubular and Energy Services was 16.5%. We have also included a slide with a full year income statement, which details the year-to-date results which included 22.6% decline in sales to $483.5 million and gross profit margins at 18.7%, down by 270 basis points from 2015.
SG&A declined by $6.7 million in 2016 and amortization expense was lower by $2.7 million due principally to the impairment charges taken in the second and third quarters of 2016. Full year interest expense increased by 49.6% to $6.6 million, due to increased interest rates as well as write-offs of deferred finance charges of $0.7 million.
Turning to the balance sheet, working capital net of cash and current debt increased by $4.1 million compared to the third quarter of 2016. Accounts receivable increased by $1.7 million during the fourth quarter and consolidated DSO stayed steady at 53 days compared to September 30, and declined by three days from December of 2015.
Inventory decreased by $8.1 million compared to September 16, while accounts payable and deferred revenue declined by $3.3 million. We feel good about accounts receivable and the inventory management results, but we believe there is improvement yet to be achieved in 2017.
Our debt net of cash declined by $2.7 million from September of 2016 and fell by $6.2 million compared to December of 2015. Gross debt declined by $9.2 million from 2015 to 2016. Moving to cash flows, cash provided by operating activities in the fourth quarter was $8 million compared to $42.5 million in the prior year quarter.
Over $30 million of the fourth quarter 2015 cash flow related to working capital improvement, which was largely due to initiatives put in place to address first-half underperformance. For the full year of 2016, cash flows from operating activities was $19.9 million compared to $56.2 million in 2015.
Fourth quarter capital expenditures were $1.2 million, compared to $3.3 million in the prior year. And full year CapEx was $7.7 million compared to $14.9 million last year, a reduction of over 48%. We anticipate our 2017 capital expenditures will be further reduced to approximately $5.5 million.
As we’ve previously mentioned, while our capital allocation protocols have been good, potential returns on projects in softer market certainly become less attractive and much easier to cancel or defer. We are currently reviewing certain potential capital programs necessary to secure new business opportunities, however we anticipate overall capital spending to be limited in 2017, unless it correlates to attractive returns.
Fourth quarter 2016 bookings were $113.4 million, a decline of 1.2% compared to last year’s fourth quarter due to a 8.2% reduction in Rail bookings as well as 36.3% decline in Tubular bookings, partially offset by a 68.2% increase in Construction segment orders.
Fourth quarter orders for the Rail segment were weaker than 2015 due to lower volumes for Rail distribution and certain North American track components partially offset by increased orders for concrete ties and transit products. Reductions in Tubular orders were mostly attributable to the precision measurement systems division reductions for the quarter.
Order backlogs stood at $147.5 million at the end of the fourth quarter, down $17.3 million or 10.5% from the prior year fourth quarter’s backlog of $164.7 million. The decrease was due to declines of 26% and 63% in the Rail and Tubular segments, partially offset by a 59% increase in the Construction segment backlog.
As mentioned in the earnings release, we feel it is noteworthy that both the fourth quarter bookings and backlog grew sequentially over the third quarter of 2016 by 2.3% and 2.5% respectively.
In closing, we expect to strive to increase sales and profitability, while continuing to emphasize working capital management and free cash flow. Our continued primary use of free cash flow will be to de-lever until the company’s debt comes back into alignment with EBITDA.
That concludes my comments on the fourth quarter of 2016, and I’ll now turn it over to Bob.
Thank you, Dave. Hello, everyone. Thank you for joining us today. As I make my remarks, there are two key messages that will recur as a result of their impact on current results, but more so from their impact associated with future expectations. The first message is centered around the cost actions we’ve taken throughout 2016 aimed at aligning cost with lower volume and creating a cost structure that puts us in a position to leverage added sales volume as markets recover.
The second message is related to a recovering market outlook. Centered around market dynamics which vary across the markets we serve, but generally speaking, reflect more signs of strengthening, often associated with an improving commodity cycle.
Turning to the results, as we wrapped up the year, our final quarter had some clear challenges, as sales volume reached the low point of the year. But we also accomplished a great deal in completing numerous actions related to our cost cutting goals. The fourth quarter year-over-year sales decline was 23%, however the year-over-year change includes the impact of backlog reduction that took place in the fourth quarter of 2015.
When comparing orders, our year-over-year decline in Q4 was only 1%. Additional cost cutting actions in the fourth quarter are putting us in a better position to deal with lower volume, however the results are not quite evident in Q4 EBITDA, as more than $2 million of one-time charges impacted gross profit and SG&A.
We’ve really made progress reducing SG&A, which was down $4.5 million from the prior year quarter including severance cost that were offset by reductions in company incentive costs. So when we look at the full year, this is obviously a very challenging year as we’ve reacted to weakness that resulted in our sales, full-year sales declining by $141 million. But it’s worth noting that the year-over-year decline is affected by $38 million of backlog that shipped in 2015, of which $32.5 million was in the Rail segment.
After building backlog in the first quarter of 2015, $62 million of backlog reduction occurred in the next three quarters of 2015, making the year-over-year sales comparison defer greatly from orders in certain periods. The magnitude of the sales decline in 2016 made it difficult keep pace with cost actions. In addition, nearly half of the decline came from our distribution businesses, where there is less cost to go after, forcing us to take more aggressive actions in other areas.
Approximately, $90 million of $141 million sales decline was in our Rail segment, which is a reflection of the backlog reduction in 2015, as well as the severity in duration of freight rail spending reductions in North America, coupled with the impact of declining steel prices had on us.
Throughout the year, two very influential factors are driving the North America freight rail market weakness, which were the weakness in commodity carloads including further reductions in coal among them, and industrial weakness that led to week intermodal traffic as well as far fewer industrial projects such as crude by rail.
We experienced slightly better conditions in Europe, where our base business was down 17% year-over-year or around $6 million, but of that $3.8 million was related to currency. We build momentum all yearlong in Europe and now have a substantial backlog and this market is really shaping up to be one of the more optimistic for us in 2017.
For the Rail segment globally, this translated into sales reductions across nearly all product lines. Among the hardest hit is our rail distribution business, which ended the year down 34% due to a combination of average sell price being lowered by 20% and unit volume lowered by 13%.
In our Tubular and Energy segment, where sales were down 17% year-over-year, we continued to see declining sales in the upstream segment until the market bottomed around mid-year. We worked off a strong backlog in the measurement systems division during the first half, but weakness in the midstream market eventually caught up to us and was also behind the weakness in our protective coatings business.
The test and inspection services division battled weakness in the upstream market for three quarters. Then in our fourth quarter, we began to see increasing order patterns as rig counts increased following the bottom that occurred in the second quarter.
Finally, in the Construction segment, our piling division had the second largest decline in sales to rail distribution accounting for most of the Construction segment decline. We struggled to win business due to very competitive pricing on commodity piling products, together the piling and rail distribution divisions account for nearly half of the $141 million consolidated sales decline. It was also a year in which our fabricated bridge products did not have a several million dollar project that shipped, although we booked a $15 million project, which has led to near-record backlog to start 2017.
In addition, another bright spot was the precast buildings division which grew in 2016. This division and the bridge business have a positive outlook in 2017, which I’ll speak to later.
I want to turn to what we accomplished during the year with regard to lowering the cost structure in the business. Given the magnitude of the sales decline, our cost reduction actions became more critical as the year progressed. I believe our management team has taken substantial steps towards reducing cost.
Our cost position is much better than it was in 2015, as we took several actions including workforce reductions across all business segments. We managed to exceed our goal of removing $12 million in operating expenses since the restructuring started.
We have completed the targeted consolidation actions in operations, several service center closures were made in test & inspection services business. We consolidated operations in our European division. We’ve eliminated several small offices and continued to consolidate support organizations in our administrative areas.
The net result of this effort is SG&A spending is expected to be approximately $21 million per quarter or $83 million in 2017, and this includes absorbing an additional $2 million of anticipated litigation cost over 2016.
When we turn to the market outlook portion now, by all measures the commodity super-cycle was severe and far reaching in its impact. There are several signs that this cycle was making a turn upward, while consolidated orders were down 18% on a full-year basis, we finished Q4 down 1% year-over-year. Orders in the fourth quarter improved sequentially compared to the third quarter, which was an encouraging sign, since consolidated orders normally decline in Q4 due to seasonality.
Rail segment orders were up 27% sequentially in Q4. And backlog in this segment increased. Again, this is not normally the case. We did have some nice project wins in Q4 but the project activity combined with new orders seemed to indicate some market strengthening.
With Q3 consolidated orders at $111 million, in Q4 at $113 million, we seem to have found the trough and our confidence has increased in stating that the worst appears to be behind us.
Another very encouraging development is the improvement in the upstream energy market as E&P companies put more rigs to work. The rig count bottomed in May of 2016 and has risen nearly every month since then. We have a noticeable increase in the test & inspection services division, where orders and sales in Q4 reflect three consecutive months of a sequential increase.
This is particularly encouraging because a recovery in this market has the potential to drive improvement in a division which has been weighing on company results. The midstream market is not recovering at the same pace. Pipeline companies appear to be assessing capacity and commitments, which are resulting in project delays. However, this market tends to lag the upstream segment, which is now in its third quarter of recovery, leading us to anticipate improvement in the midstream sector that we serve in the second half of 2017.
Orders in our Rail segment reached a low point in Q3 following a period where North America commodity carloads bottomed. Industrial projects and rail were hard to find in 2016, crude by rail investment virtually stopped. And North America transit projects weren’t significant enough to offset the weakness in freight rail.
But in the fourth quarter, commodity carloads increased and shipments of coal improved. North America freight rail operators were pulling cars back out of storage as traffic was on the rise. These factors lead us to believe that the North America freight rail segment may increase spending in maintenance of way in 2017.
While 2017 capital spending projections from Class I carriers reflect further declines. We think this maybe driven by the reduction in new cars to be purchased. At one point, more than 400,000 cars were in storage in 2016. The European rail market in 2016 was weak in track components, but strong in railway automation solutions.
Our sales increased each quarter in 2016 as we built momentum in project work due to our acquisition of the TEW Group that brought us automation solutions technology. We have a growing backlog of project work for Crossrail, which is a major expansion project underway in the London Underground system. The current outlook for 2017 in Europe is very favorable as the potential for more Crossrail work increases and other automation project activity looks good.
Finally, turning to Construction, spending in heavy civil construction where we participate is always balanced by growing demand for bridge and highway repair, offset by spending pressure in government budgets. Projects requiring piling look solid right now. There are some significant bridge projects to bid in 2017 as well. The backlog in the bridge division was at near record level on January 1, therefore we have a good indication already that sales should improve for the bridge division in 2017.
And our buildings business has been growing helped by programs directed at expanding into new markets and a number of new product lines.
Before I conclude remarks on the outlook, I should mention something about steel prices. Factory utilization rates in the steel industry have been improving recently and scrap prices have been increasing, which together should put upward pressure on steel prices.
The magnitude of any increase is too difficult for us to predict. Although, conditions are developing that typically provides sustainable upward momentum. If markets improve, as I’m anticipating in 2017, we are positioned to benefit from our current cost position and expect certain divisions to have good operating leverage with added volume.
Given these assumptions, I believe we have the ability to improve gross margins year-over-year by more than 100 basis points, and improve free cash flow that could make a meaningful impact on debt reduction. Our operating cash flow in the fourth quarter was $8 million and our full year 2016 was $19.9 million.
2017 has the potential for improved operating cash flow with only a modest sales volume increase, and we have plans to reduce capital spending further from 2016.
So before I finish my remarks, I want to say something about the first quarter of 2017. While, we are not providing specific guidance on Q1 earnings, I do want to outline some expectations. As weakness persisted throughout 2016, our sales have declined to levels below what they were in the first quarter of 2016.
In addition, the first quarter typically has seasonally low sales volume, and backlog builds toward the latter part of the first quarter, when we traditionally book orders for second quarter shipments. We expect this trend to apply in 2017, and therefore anticipate first quarter year-over-year sales revenue to have a negative comparison to first quarter 2016.
We are anticipating an increase in backlog in the first quarter, compared to the year-end 2016 levels. And it is very possible that bookings in the first quarter of 2017 will be above the first quarter of 2016. Our forecasted level of sales in Q1 is therefore expected to lead to a net loss in the quarter and have a year-over-year negative comparison for net income.
After which, we expect to see improving comparisons. In the second quarter, we expect our year-over-year sales to approach prior-year levels and cost cutting actions to support a return to profitable results as early as the second quarter.
I’ll conclude my remarks there and return control to the operator, so that we can take questions.
Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] And our - excuse me, our first question is from Jeremy Javidi of Columbia Threadneedle. Please go ahead.
Thank you for your time, and good afternoon, everybody. Just a clarification for the first quarter outlook and each trajectory for the next couple of quarters. I recognize the year-over-year comparisons may still be difficult, but sequentially it sounds like you had posted some fairly good numbers to report. When I look at it sequentially from fourth quarter to first quarter 2017, is it fair to say that the expected sales level will be roughly in line or potentially up?
All right, Jeremy. Are you still there?
Yes. Can you hear me?
Okay, yes. I mean, it looked like we had an interruption in our conference call. So, what I was talking mostly about was a sequential change has taken place from Q3 to Q4, which has given us some indication that things seem to be strengthening. And as I mentioned, I think bookings in Q1 could start to look better than they have looked. But in terms of getting sales out the door, there may not be much of a sequential increase from Q4 to Q1.
So it’s better to think of that as more in line than seeing an improvement. And a lot of that has to do with the fact that we just don’t have customers that want to take a lot of deliveries in Q1, and that’s what the seasonality comes from that construction environment out there where there isn’t as much that happens during that quarter.
That makes a lot of sense. Thank you.
Thank you. [Operator Instructions] Okay. It doesn’t appear that we have any further questions at this time. I would like to turn the conference back over to management for closing remarks.
Beautiful. Thank you, Manny. Appreciate everyone joining us today. We’ll wrap it up then. Hopefully, the message was clear, and we look forward to talking with you next quarter. Thank you very much. Bye, bye.
Thank you. Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. And thank you for your participation.
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