Business Context and Reporting Period
L. B. Foster Company (Foster) is a manufacturer, fabricator, and distributor of products for the rail, construction, utility, and energy markets. This Form 10-Q covers the quarterly period ended June 30, 2012, and the six-month period ended on the same date. The filing was submitted on August 9, 2012. The Company operates through three segments: Rail Products, Construction Products, and Tubular Products. Notably, the Company sold its Shipping Systems Division on June 4, 2012, and its results are presented as discontinued operations.
Key Financial Metrics
| Metric | Three Months Ended June 30, 2012 | Six Months Ended June 30, 2012 |
|---|---|---|
| Net Sales | $164.9 million | $280.9 million |
| Gross Profit | $12.7 million (7.7% margin) | $34.9 million (12.4% margin) |
| Net (Loss) Income | $(2.1) million | $1.3 million |
| Income from Continuing Operations | $(3.2) million | $0.02 million |
| Diluted EPS (Continuing Ops) | $(0.31) | $0.00 |
| Cash and Cash Equivalents | $77.2 million | $77.2 million (Balance Sheet) |
| Total Debt | $0.7 million | $0.7 million |
| Operating Cash Flow (Continuing) | N/A | $3.5 million |
Material Changes vs. Prior Period
- Revenue: Net sales for the three months ended June 30, 2012, decreased 3.8% to $164.9 million compared to $171.5 million in the prior year period. Year-to-date sales decreased 2.1% to $280.9 million.
- Profitability: The Company reported a net loss of $2.1 million for the quarter, compared to net income of $6.4 million in the prior year quarter. This was primarily driven by a significant warranty charge (detailed below).
- Segment Performance:
- Rail Products: Sales increased 14.1% quarter-over-quarter, but the segment reported a loss of $10.0 million due to a $19.0 million warranty charge.
- Construction Products: Sales declined 32.0% due to volume reductions in piling and fabricated products.
- Tubular Products: Sales increased 44.4% driven by energy market demand.
- Discontinued Operations: The sale of the Shipping Systems Division resulted in a pre-tax gain of $3.5 million, contributing $1.1 million to net income for the quarter.
Guidance, Outlook, and Material Risks
Product Warranty Charge (Critical Item)
The Company recorded a pre-tax warranty charge of approximately $19.0 million in the second quarter of 2012 within the Rail Products segment. This charge relates to concrete railroad ties manufactured at the Grand Island, NE facility between 2006 and 2011, following a claim by Union Pacific Railroad (UPRR) regarding premature cracking and failure. The charge is based on estimated replacement costs. Management notes that future costs could vary if customers disagree with estimates or if litigation arises.
Outlook and Guidance
- Capital Expenditures: Total capital spending for 2012 is expected to range between $8.0 million and $9.0 million.
- Market Conditions: Management anticipates strengthening rail and energy markets but expects continued weakness in the construction market through the end of 2012.
- Backlog: Total backlog from continuing operations was $255.3 million as of June 30, 2012, a significant increase from $143.8 million in the prior year, driven largely by a $60 million elevated transit system contract in Honolulu.
- Liquidity: The Company maintains a $125 million revolving credit facility with $123.8 million available. Total debt is minimal at $0.7 million.
Risks and Contingencies
- UPRR Claim: Uncertainty remains regarding the ultimate cost of the concrete tie warranty claim and its potential impact on future contract negotiations with UPRR.
- Construction Market: The segment faces challenges due to lower backlog and potential state budget deficits affecting government-funded projects.
- Raw Materials: Fluctuations in the price and availability of steel and concrete could adversely affect operations.
Investor Verification Checklist
- Warranty Reserve Adequacy: Verify the assumptions used to calculate the $19.0 million warranty charge and the total $25.3 million warranty reserve.
- UPRR Contract Status: Monitor the status of negotiations regarding the extension of the Tucson, AZ supply agreement and lease with Union Pacific Railroad.
- Construction Backlog: Assess the impact of the lower backlog in the Construction Products segment on future revenue visibility.
- Discontinued Operations: Confirm that no further material expenses are expected from the divested Shipping Systems Division.
- Cash Flow Sustainability: Review the ability of continuing operations to generate sufficient cash flow to cover capital expenditures and dividends without drawing on the credit facility.