Foster L B Co Q2 FY2023 Earnings Call

Good day, and thank you for being here. Welcome to L.B. Foster's Earnings Conference Call for the second quarter of 2023. Please note that this conference is being recorded. I will now turn the call over to Stephanie Schmidt, the company's Investor Relations Manager. Please proceed.

Thank you, operator. Good morning, everyone, and welcome to L.B. Foster's second quarter of 2023 earnings call. My name is Stephanie Schmidt, the company's Investor Relations Manager. Our President and CEO, John Kasel; and our Chief Financial Officer, Bill Thalman, will be presenting our second quarter operating results, market outlook, and business developments this morning. We'll start the call with John providing his perspective on the company's second quarter performance. Bill will then review the company's second quarter financial results. John will provide perspective on market developments and our company outlook in his closing comments. We will then open the session up for questions. Today's slide presentation, along with our earnings release and financial disclosures, were posted on our website this morning and can be accessed on our Investor Relations page at lbfoster.com. Our comments this morning will follow the slides in the earnings presentation. Some statements we are making are forward-looking and represent our current view of our markets and business 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 securities laws. For more detailed risks, uncertainties, and assumptions relating to our forward-looking statements, please see the disclosures in our earnings release and presentation. We will also discuss non-GAAP financial metrics and encourage you to read our disclosures and reconciliation tables provided within today's earnings release and within our accompanying earnings presentation carefully as you consider these metrics. So with that, let me turn the call over to John.

Thanks, Stephanie, and hello, everyone. Thanks for joining us today on our second quarter earnings call. It's been 2 years since I was appointed President and CEO, and we began a strategic transformation here at L.B. Foster. And I'm very proud of the progress our team has made in such a short period of time. In summary, we completed 7 strategic portfolio transactions, growing through 3 acquisitions and 4 divestitures in a very challenging operating environment. We have also implemented profitability improvement initiatives across the portfolio to overcome a persistent inflationary environment. Capital allocation levers were also managed to secure our dry powder required to capture the growing demand of the robust infrastructure markets we serve. As you can see on Slide 5, the impacts of our efforts really came through in second quarter results. Q2 sales of $148 million were up 12.6% year-over-year, with organic growth coming in at 13.3%. The impact of our portfolio work and profitability initiatives resulted in a 410 basis point improvement in gross margins, finishing at 21.8% for the quarter. Adjusted EBITDA was $10.6 million or 7.2% of sales, up nearly 73% over last year. In fact, this quarter's adjusted EBITDA measured both in dollars and as a percent of sales was the highest level achieved since the second quarter of 2020. We continued our portfolio work with the divestiture of the CXT Concrete Ties business, which provided $2.4 million of proceeds, which were used to pay down debt. As expected, net debt increased by $8.2 million to fund working capital needs in the business. And we finished the quarter with a gross leverage ratio of 2.5x, representing a modest increase during the quarter. Order rates totaled nearly $184 million for the quarter, with our book-to-bill ratio standing at 1.24:1. And despite the concrete ties divestiture, our order book stood at a new record of $290 million at quarter end. These results speak to the strength of our performance in our end markets and the impact of government infrastructure funding. Based on the strength of our performance and our favorable outlook as reflected in our order book, we have increased our full year EBITDA guidance by $1 million at both ends of the range while maintaining our sales guidance despite the divestiture we made in the quarter. As the seasonal working capital cycle moves into the second half of the year, we expect to see improvements in free cash flow and further reduction of our leverage, which will provide the financial flexibility to fund our organic growth programs. In summary, we are pleased with the continuing progress in executing our strategic playbook, the results we achieved to date, and our prospects for the future. Next, Bill will cover the detail of financials for Q2, and I'll come back at the end with some closing remarks on our outlook. Over to you, Bill?

Thanks, John, and good morning, everyone. I'll begin my comments covering the consolidated highlights of our second quarter on Slide 7. As always, the schedules in the appendix provide more detailed information on our financial results, including the non-GAAP measures Stephanie referenced. As John mentioned in his opening remarks, the Ties divestiture was completed at the end of the second quarter, so their operating results are included in our Q2 numbers. Q2 results also include 2022 additions to the portfolio, VanHooseCo and Skratch, but exclude the Track Components and Chemtec businesses that were divested over the last 12 months. Second quarter sales were $148 million, up $16.5 million or 12.6% over last year. Overall, the sales increase was driven by our legacy business, with organic growth coming in at 13.3%. The impact of portfolio activity largely offset year-over-year. Higher sales volumes coupled with improvements in business mix and price realization increased gross profit by 38.5%. As a result of the organic revenue growth, together with the accretive benefits of portfolio initiatives and profitability actions, gross profit margins expanded 410 basis points to 21.8%. During our first quarter call back in May, we highlighted that we expected the favorable trend in margin performance realized in Q1 to continue as volumes improved in our seasonally strong second and third quarters. We're happy to see the results come through in the second quarter, and we remain optimistic for continuing favorable trends in Q3. The $1 million transaction loss on the Ties divestiture reduced net income to $3.5 million in Q2. However, adjusted EBITDA improved by $4.5 million year-over-year to $10.6 million, with the EBITDA margin improving 250 basis points to 7.2%, with EBITDA operating leverage at 27.1%. It's been 3 years since we've seen this level of profitability from the business, which is attributable to our portfolio transformation, profitability enhancement initiatives, and robust infrastructure end markets. John covered consolidated orders, backlog, and net debt performance in his opening remarks, and I'll provide some more additional color on these items later in the presentation. We've been showing the sales and adjusted EBITDA bridges on Slide 8 over the last several quarters to highlight the performance within our legacy business and the benefits of our portfolio transformation. The chart on the left highlights the strong organic growth realized in Q2, with the $17.6 million sales increase representing 13.3% organic sales growth. The net impact of M&A decreased revenue by $1 million or approximately 0.8%. As John highlighted, we have a record backlog, and we expect organic growth rates to remain favorable moving through 2023. The net impact of M&A will present a tougher comparison in the second half due to the Chemtec and Ties divestitures, coupled with lapping the Skratch and VanHooseCo acquisitions that were completed last year. With our business portfolio work largely complete, we are now focused on executing the organic growth opportunities we see across the business, particularly those within our growth platforms and acquisitions. The chart on the right highlights the continuing progress we've achieved in improving profitability in our legacy business, with adjusted EBITDA improving by $3.7 million year-over-year, representing 21% operating leverage in the quarter. M&A activities also contributed favorably to EBITDA growth year-over-year, despite the net sales decline. The impact from M&A was somewhat tempered due to soft volumes in VanHooseCo and Skratch in Q2, and we expect this impact to improve in the coming quarters. Slide 9 provides an important perspective on the progress we've made in our sales growth and profitability over the last 2 years. The net impact of our strategy execution resulted in 12% sales growth for the trailing 4 quarters ended June 30, 2023, with double-digit sales growth achieved over the last 3 quarters. Over the same time period, gross profit increased by 30%, resulting in a 270 basis point improvement in gross profit margin to 19.9%. This achievement was despite the Crossrail contract settlement charge taken last year, as well as the VanHooseCo purchase accounting impacts that reduced gross margin by 100 basis points during the most recently completed trailing 4-quarter period. In summary, we believe our business portfolio transformation, organic growth, and focused profitability initiatives have resulted in a structural improvement in the gross margin profile of the business that should be sustainable with the long-term demand prospects from our infrastructure end markets. Over the next 3 slides, I'll cover our segment performance, starting with the Rail segment on Slide 10. Second-quarter Rail segment revenues were up 12% year-over-year at $91.6 million, with 17% organic growth partially offset by the net impact of M&A. Strong organic sales growth realized in both Rail Products and Global Friction Management was partially offset by continuing softness in the Technology Services and Solutions business in the U.K., and the impact of the Track Components divestiture. Rail margins expanded 260 basis points to 21.7% on improved pricing and business mix across the portfolio, coupled with the favorable impact from the Track Components divestiture. Partially offsetting improvements in Rail margins were headwinds from weakness in the U.K. Rail orders and backlog were up year-over-year, with new orders increasing a robust 24.8% and backlog increasing over 6%, excluding the impact of the Track Components and Ties divestitures. As reflected on Slide 11, Precast Concrete segment revenue increased by $10.3 million or 43.4% year-over-year. Revenues were up 12.8% organically, and the VanHooseCo acquisition contributed $7.2 million, representing growth of 30.6%. Gross margins were up 850 basis points to 22.7% due to improved volumes, price realization, and strong operating performance in the legacy business, as well as the accretive impact of the VanHooseCo acquisition. Orders and backlog remain robust in our Precast segment, with VanHooseCo contributing $15.8 million and $20.2 million, respectively. The Steel Products and Measurement segment results on Slide 12 reflect a 13.6% decrease in revenues as a result of the Chemtec divestiture. Organic growth of 2.4% was realized as a result of a 93.5% increase in Protective Coatings sales, partially offset by weaker volumes in Fabricated Steel Products. Improved gross margins, which were up 460 basis points to 21%, were driven by higher volumes in Protective Coatings as well as the favorable impact of the Chemtec divestiture. Orders and backlog were up 17% and 39.4%, respectively, with the Protective Coatings business recovery more than offsetting the impact of the sale of Chemtec. The year-to-date results on Slide 13 highlight the structural and profitability improvements we've established in our business in the first half of 2023. Sales are up 14.4% year-over-year, and margins have expanded 380 basis points to 21.1% thus far in 2023. Adjusted EBITDA is up over 104% with the EBITDA margin of 5.7%, up 250 basis points versus last year. While year-to-date operating cash flow is a use of $3.3 million due primarily to working capital needs in the second quarter, it's favorable to last year by $10 million. And orders are up nearly 17% year-to-date due to our M&A work, the strength of our offering, and strong end markets. Turning to liquidity and leverage metrics on Slide #14. As expected, net debt increased by $8.2 million during the quarter, as we funded working capital needed to support the robust growth in sales and backlog. As a result, our gross leverage ratio, per our credit agreement, increased slightly from 2.4x to 2.5x during the quarter. While free cash flow has been a use of $4.8 million year-to-date, we've actually reduced our net debt by $3.4 million so far this year, as a result of our divestiture proceeds. In fact, the divestitures improved our gross leverage ratio, as they were essentially breakeven businesses at an EBITDA level that were dilutive to the ratio. We expect to generate positive free cash flow in the second half of 2023, which should allow us to further reduce our net debt. As a reminder, our Union Pacific warranty settlement obligation will be fully satisfied in 2024, and we have $100 million in federal NOLs that should minimize our cash taxes for the foreseeable future. Both of which should contribute to improving free cash flow in the near future. And with our capital-light business model, improving profitability, and beneficial free cash flow drivers in place, we believe a favorable free cash flow inflection point is imminent. In summary, we're pleased with the progress we've made reducing our net debt and leverage following the acquisitions completed last year, and further improvement remains a top priority. Our capital allocation priorities are outlined on Slide #15. As I just mentioned, we continue to focus on deleveraging while cautiously investing in organic growth opportunities we see in Rail Technologies and Precast Concrete. Capital spending is expected to run at approximately 1.5% to 2% of sales, which is slightly higher than our typical level due to the organic growth investments we see with high returns and quick paybacks. We also continue to evaluate opportunities to return cash to shareholders through our stock repurchase program, which was initiated in Q2 with a 0.5% reduction in the shares outstanding. We continue to evaluate small tuck-in acquisitions that would extend our product portfolio within our growth platforms of Precast Concrete and Rail Technologies. And while distributing value to shareholders through a dividend is not a current priority, we're keeping it on our radar as the prospects for stronger, stable free cash flow improve in the coming years. My closing comments will refer to Slides 16 and 17, covering orders, revenues, and backlog by business. The book-to-bill ratios on Slide 16 reflect the continuing strength we've seen across the business, with a step-change increase realized in the second quarter. The book-to-bill ratio over the trailing 12 months was 1.13:1, with orders outpacing sales by $70 million. The consolidated book-to-bill ratio in the second quarter was particularly strong at 1.24:1, which was up from 1.21:1 in the first quarter, with all segments increasing their order books in the quarter. And lastly, our consolidated backlog on Slide 17 reflects the robustness of the commercial activity across the majority of the business and the net benefits of the M&A actions completed over the last 12 months. The Precast Concrete business backlog increase, which was up 28% over last year, is attributed to the VanHooseCo acquisition, while order rates remain robust across the legacy Precast business. Backlog in Steel Products and Measurement was up nearly 40% versus last year, despite the impact of the Chemtec divestiture, highlighting the continuing improved demand in our Protective Coatings product line with a $30 million increase in their backlog. Finally, our Rail segment backlog was flat year-over-year at $132 million, despite the divestiture of the Track Components and Ties businesses, which reduced the order book by approximately $8 million. The order book reduction from divestitures was offset by an increase in Friction Management and Technology Services and solutions, signaling some level of recovery in the U.K. In summary, our second quarter and year-to-date results highlight the momentum we're seeing in the business and reinforce our confidence in our strategic playbook. We look forward to reporting continuing progress through the balance of 2023 and beyond. And thank you for your time this morning. I'll now hand it back to John for his closing remarks.

Thanks, Bill. Please refer to Slide 19 for an overview of our key business and market drivers underpinning our outlook. We mentioned in the past week that we expect to announce the government infrastructure funding programs to provide tailwinds for our business. And we are pleased to say that we are finally seeing some of the expected benefits coming through in our order book. I'll cover some of those details in a moment. We also remain optimistic in longer-term prospects for growth in Rail Technologies, particularly given the emphasis on rail safety, fuel savings, and operating efficiency. It's important to highlight that the business is going through a soft patch because of recent economic turmoil driven by high inflation in that area. Having said that, we're pleased to see that inflation rates in the U.K. are beginning to soften. Their order book is up 81% year-over-year, and with a significant pipeline of opportunities, we're cautiously optimistic that recovery is on the horizon. Our Precast Concrete business remains strong, and the strategic acquisition of VanHooseCo made just over 1 year ago has bolstered the order book, expanded the technology offering, and increased our geographic reach in Precast. We've also seen a partial recovery in the Protective Coatings business with a renewed investment pipeline in projects. The same can be said of increased emphasis on bridge repairs in the U.S. We believe this is a part of our broader infrastructure spending plan that bodes well for our Bridge Forms product line now and into the future. Slide 20 reflects some of the more significant customer orders received that we can broadly attribute to infrastructure spending. Of course, not all of these orders are directly associated with the U.S. government infrastructure funding currently in place. However, a significant portion can be attributed to those federal programs. Being that our business portfolio is becoming more and more an infrastructure pure play with a broad exposure to major infrastructure markets, we remain optimistic about the longer-term prospects for continuing growth. In summary, we believe that we are in the early stages of an infrastructure investment super cycle. That could provide a strong tailwind for years to come. I'll close on our prepared comments with a perspective on our near-term goals depicted on Slide number 21, a slide titled 'Innovating to Solve Global Infrastructure Challenges.' In December of '21, we established aspirational goals of approximately $600 million in sales and approximately $50 million of EBITDA by 2025. We're beginning to refine our outlook as the majority of our business portfolio work is behind us, and we have a clear line of sight to the organic growth and profitability drivers that are designed to achieve our goals. As previously mentioned, we increased our profitability guidance for 2023, while holding the sales guidance unchanged despite the divestiture of the concrete Ties business. From the midpoint of our '23 guidance, our 2025 goals imply an annual sales growth rate of approximately 6%, with EBITDA operating leverage around 30% on the sales growth over the 2-year period. We believe these underlying growth and profitability assumptions are reasonable, based upon 3 key factors. First, our organic growth platforms, such as Rail Technology and Precast, are technology-based and realize a higher margin profile within our portfolio. Second, we expect benefit from the ongoing profitability improvement initiatives across the portfolio to maintain and expand the margins we achieved thus far. Lastly, we expect to realize fixed cost leverage, particularly in back-office SG&A, with the projected volume increases over the coming years. In summary, as I mentioned in my opening comments, I'm very proud of what we accomplished thus far. But we remain very focused. In fact, we are laser-focused on growth and profitability expansion to enhance shareholder value for the years to come. Thank you for your time and continued interest in L.B. Foster. And I'll turn it back to the operator for the Q&A session.

Our first question is from Alex Rygiel with B. Riley Securities.

Thank you. Very nice quarter. Congratulations. A couple of quick questions here. Can you comment on backlog and the potential for price realization?

Well, first of all, thanks for the question, and thanks for participating today, Alex. Our backlog stands at $290 million. We have a very nice balance between both the Rail and our Precast side right now. And then a really growing Steel Products and Measurement side, specifically what we're seeing on the coatings side. So it's something we're positioned well for, and we feel really good about the contribution margins that are coming through our backlog. Even on the U.K. side, when I mentioned 81% increase on a year-over-year basis, that is also growing at a nice rate, relative to future margins.

And as it relates to the near-term goals in 2025, gross profit of 22% to 23%, it's definitely a step-up from what you reported in this quarter of 21.8%. However, to me, it looks maybe a little bit conservative? So if you could comment on that.

Yes. Well, originally, our aspirational goals, if you recall, were 21% for 2025. So we punched through that target already. Yes, I guess we are conservative in what we do and how we do things at the company. We've got a lot of shareholder value that we need to restore. Our process and our thinking is we're hopeful that we will get there. We're confident we can achieve our goals, but we also want to set realistic expectations for what we're going to deliver on. And then, if anything, I hope we exceed those targets that we're putting out there.

And lastly, you talked about a little bit of a rebound in pipeline projects. Can you expand upon that a little bit? And is that just short-term visibility? Or is that intermediate and long-term visibility?

Yes, they're anticipating a significantly better year, much better than anything we've seen going back to pre-COVID. Specifically, we're now essentially just a midstream company. Anything we've done outside of that, we have divested. The Summit order, which has been on our books for almost a year, is a $19 million order. We're excited about that opportunity coming into 2024 and beyond. We're also observing a lot of smaller projects that are being developed in the midstream market now, keeping mills up and running. The bidding activity is very strong as well. We believe the recovery is definitely happening, and hopefully, it will continue to improve in the coming months and years.

Our next question will come from Brett Kearney with Gabelli Funds.

Congrats on the continued momentum.

Thanks, Brett.

Thanks, Brett.

Thank you for the slide deck that accompanied the earnings report. It is very thorough and useful from an investor perspective. John, you mentioned the Rail Tech portfolio and the growing emphasis on safety, fuel efficiency, and cost efficiency. What general feedback are you receiving from your customers, both in freight and passenger sectors? Additionally, do you have any updates on potential rail safety legislation from Congress, or any broader trends you’re observing from customers related to that part of the portfolio?

Okay. First of all, shout out to Stephanie here. Stephanie Schmidt has done a fantastic job assembling these materials with the team. Thanks, Stephanie, for all your work. As far as Congress, they're currently in recess, and the safety measures bill is under rewrite. I won't predict what's happening there. However, there's significant renewed interest in our products and technology unrelated to Congressional actions, particularly with our Wheel Impact Load Detector, the Mark IV. The second half of the year looks promising to us, and our bidding activity for next year is very strong. The freight markets are facing headwinds, with commodity carloads down about 50% year-over-year. The transit side has improved, with ridership increasing, but it's still about 25% off pre-pandemic levels. There is a clear focus on fuel efficiency and longevity of assets, which gives us a competitive niche and visibility going forward. The heightened emphasis on ESG from railroads, specifically in reducing their carbon footprint, is beneficial for our Friction Management products.

Excellent. Very helpful. And then on the Precast side, you noted, I guess, continued strong momentum in the legacy business. I know that business is coming off all the demand from the American Outdoors Act. Just curious about the end markets and the continued strength you're seeing there.

Well, the legacy business faced significant challenges in the past couple of years due to order constraints. Our team has done a fantastic job of navigating the supply chain, bringing products in, and getting competitive market pricing that provides a better margin profile going forward. Our VanHooseCo operation has been performing well. This Friday marks the 1-year anniversary, and the markets in the South and Southeast remain robust, above pre-pandemic levels concerning housing starts and civil infrastructure work. We're excited about our accomplishments and expect to grow our Precast base moving forward.

Our next question is going to come from the line of Chris Sakai with Singular Research.

Yes. And nice quarter. Just interested in the Coatings section. I wanted to see what's driving the rebound there. And do you foresee that continuing?

Yes. Thanks, Chris. I appreciate you joining us today. I know everyone is busy with various reports coming out. The rebound in the Coatings segment was unexpected, but we're pleased with what we're seeing in the midstream markets. Based on current bidding activity, we anticipate this momentum will continue into next year. The Summit order, a $19 million project, is a significant opportunity that we hope to kick off in the first or second quarter of next year, which would set a great foundation for the next year.

Okay. Sounds good. And then on Slide 8, you have the changes to adjusted EBITDA for M&A at 0.8. I was wondering, in the future, where do you see that number going? Any insights would be great.

Yes, sure. I'll start, and then I'll flip it over to Bill. What I'm most excited about is the legacy number of the business, $3.7 million. When we established our playbook, we discussed where future growth would come from M&A and then transitioning that organically. Our legacy group has really energized and wants to contribute to the future growth of the company. We've made significant changes in recent M&A that we believe will positively impact order books and overall performance. Bill, would you like to add anything?

Yes. The only thing I'd add is that number you see, will start to lapse the VanHooseCo and Skratch acquisitions on a year-over-year basis. So it will become part of the legacy, and which we will be calling out specifically in future results. The Track Components and Chemtec divestitures are now going to be separate in that column. Those businesses were barely breakeven at an EBITDA level, resulting in no significant impact on our financials. As mentioned before, we are now focusing on organic growth across the portfolio, especially in Precast Concrete and Rail Technologies.

Okay. Great. Yes. So to get back on that organic growth you're discussing. Should we not be expecting any more new acquisitions? And could you talk about whether there are future divestitures planned?

Yes. As you continue to ask questions, I do appreciate it. Our playbook has evolved over time, and our focus has shifted. We achieved 13.3% organic growth in the quarter, so we feel good about our 12.6% overall growth. Our intention is to conserve dry powder and focus on core markets, seeking small acquisitions that can expand our product lines and geographical reach. While we're always considering market opportunities, the major portfolio work we planned over the last 2 years is largely complete. However, we're still looking for ways to be competitive and ensure ongoing shareholder value in the future.

And I'm showing no further questions. And I'd like to hand the conference back to John Kasel for any further remarks.

Thanks, Michelle. Really appreciate it. Thanks for joining us today. I do want to mention that Bill and I will be presenting at several investor conferences in the coming weeks and months. Look for those appearances. We've also completed an update to our Investor Relations deck, which will be published on our website by the end of this week. In this updated deck, you'll find our compelling investment thesis, growth drivers for the business that are currently in place, and our capital allocation priorities for increasing shareholder returns into 2025 and beyond. So again, thank you for your time today and your interest in L.B. Foster Company. Take care.

This concludes today's conference call. Thank you for participating. You may now disconnect.