L.B. Foster Company (FSTR) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you standing by, and welcome to the L.B. Foster Investor update call. [Operator Instructions] As a reminder, this conference call is being recorded. I will now turn the conference to your host, Mr. Bauer, President and CEO; and Jim Kempton, Corporate Controller and Principle Accounting Officer. Mr. Bauer, please go ahead.

Thank you, Valerie, and hello, everyone. We appreciate you joining us today. We plan this call to explain our rationale for selling the iOS test and inspection business, which closed earlier in September and to allow investors to ask questions regarding the decision and the transaction. We described a fair amount of our reasoning in the press release, but I'll start by going through this before we get into some of the details on the transaction and the financial and tax consequences we expect as a result of the sale. I'll use the exhibits we posted on our Investor Relations tab on the company's website. These materials will help you follow along as I go through my comments. And I'm going to start on Page #3, which is the executive summary. The divestiture of the iOS test and inspection business was executed for several reasons, which we will delve into in more detail over the next several minutes, but at a high level, it accomplished a number of key objectives for the company. Among them are exiting the volatile and challenging upstream energy market, removing the negative drag that this business has been having on the company's performance. The transaction was a sale of equity, so any legacy liabilities associated with the business transfer with the sale. We've also removed the risk for any further closure activities related to this business and the corresponding cash charges associated with any of those activities. The sale is also providing immediate near-term and long-term cash benefits to the company, most notably through additional tax benefits, which total an estimated $27 million to $29 million when combined with existing tax assets associated with this business and allows our management team to focus on the core competencies that have greater opportunities rather than continue working on correcting this business. To provide some additional details on our rationale, I'd like to start by discussing our Tubular and Energy segment and how that segment serves the energy market. If you look at our Page 4, as a reminder, our Tubular and Energy segment is comprised of businesses that either a, provide services for the safe deployment of Tubulars, principally into critical energy infrastructure applications; or B, it supports the measurement of liquids and gases that are transported through those Tubulars from production locations through downstream operations that use the commodities. The iOS business was positioned in the upstream segment of the market, where test, inspection and threading services are required at the wellhead for drill pipe tubing and casing. Our company had dealt with energy Tubulars for many years and has a number of core competencies with these products. We felt that stepping into these services, expanded our footprint the energy delivery path and specifically, in a market that would have significant growth opportunities. The significant growth opportunity was expected to come from the shale revolution that looked like the most promising energy development in many years in the U.S. and would one day lead to U.S. energy independence and significant production volume of oil and gas coming from these shale territories for export markets as well. Our strategy to capitalize on what we thought would be a fast-growing market was partially accurate. Production of oil and gas in the U.S. has risen significantly. The U.S. is exporting these commodities now, and natural gas liquids have become another commodity being exported to other world markets. The various shale territories were booming as we developed this strategy, and iOS brought us a footprint where we could participate in the growth in each of the shale regions. What changed and what we and other major oil companies didn't see coming was the follow-on turmoil created by supply demand imbalances, the market share wars, and now a pandemic-related drop in demand and just how far new drilling activity would decline during these periods. Turning to Page 5. We watch the price of oil plummet twice in the last 5 years. We witnessed the dramatic pullback in spending and hyper volatility in the upstream market as a result. We witnessed the market share wars started by Middle eastern producers in an attempt to stop shale production. And most recently, we've experienced a dramatic downturn caused by significant reductions in travel associated with a worldwide pandemic. To cope with the market conditions, operators turn to suppliers like us to cut costs. These customers have pushed the supply chain very hard in order to help them preserve cash. They've shifted plans quickly based on changing well economics, some abandoning certain shale territories and nearly all decisions have been cash flow driven. We have had mill partners for energy Tubulars decide to in-source threading operations to help them lower overall costs. And then the government use Section 232 of the trade expansion act to limit the import of Tubulars from places like Korea and other countries, which was a solid source of volume for us, as we were a leader in test and inspection of foreign pipe coming into the U.S. Now turning to Page 6. The real story here is that these changes have resulted in a market that has changed dramatically. Our forecast for this market is for continued volatility. We expect shorter cycles and price wars to cause ongoing disruption, and there is far more production capacity around the world and with travel expected to return slowly, there are forecasts predicting excess supply for some time, keeping pressure on cash flow in the supply chain. As a result, we don't see a path to profit levels that would lead to an acceptable return for our company, particularly if the business requires ongoing capital and resources required to make constant changes. In addition, customers have nearly eliminated premium services in an effort to reduce costs and have imposed price pressures that have put our gross profit often at a loss. As these changes have taken place, we could either adapt or find ourselves with a dying business, while we have been adapting since 2016, but have still not achieved an acceptable level of return from this asset. Our decision to finally sell this business and exit the upstream services market comes after our assessment that ongoing restructuring to adapt to the market changes is not going to lead to acceptable returns. On Page 7, you can see the summary financials. The division has lost money in the last 2 years and has consumed capital as we have moved operations to follow demand, chasing the best well economics. We're not seeing the returns on capital that we should. In the exhibit provided, you can see the losses that we incurred from iOS in 2019 and 2020. We had also taken several charges in 2016 for restructuring purposes and asset impairments that are not shown on this exhibit. The exhibit shows how severe 2020 was shaping up to be with 6-month sales that were roughly half of the prior year volume and an adjusted EBITDA loss of $2.7 million, excluding the previous restructuring charges. While the effects from the pandemic on the growth outlook were certainly one of the final catalysts on our decision to sell the business now. An additional and significant factor in the decision to sell now was the tax benefit we expect to realize. This benefit makes the total cash proceeds to the company much greater than the headline sale price. Turning to Page 8. We completed the sale to a private company for $4 million in an equity transaction. The buyer is assuming all of the membership interests in all of the ongoing business liabilities for the iOS operating unit. The company expects to receive tax benefits, totaling an estimated $27 million to $29 million related to this business, including approximately $9 million of previously recognized deferred tax assets. The sale allows us to accelerate the realization of these existing deferred tax assets. Cash tax refunds of approximately $9 million are expected to be received within the next year and are obtainable due to the extended loss carryback provisions contained in the Cares Act passed earlier this year. We are also estimating an additional $18 million to $20 million of federal and state tax benefits that will come in the form of net operating loss carryforwards that can reduce cash taxes to be paid on earnings in future periods. And again, these tax benefits are in addition to the $4 million in proceeds already received from the buyer. So let's turn to where do we go in terms of looking forward from here on Page 9. We have a Tubular segment now with protective coatings, specializing in corrosion protection for energy tubulars and pipeline applications and measurement solutions for similar midstream pipeline applications. Now although these businesses will cycle with the energy market, they have been historically less volatile, having longer-term planning and associated backlog from a longer planning horizon. We will be focusing on our core competencies around protective coatings for corrosion protection and measurement solutions for custody transfer and metering systems, which are currently aimed at midstream and downstream applications, but also could provide a basis from which to expand in corrosion protection and measurement, not in energy-related applications. This change also changes the risk profile of the company by reducing our exposure to the Hyper Volatile Upstream segment. We expect to face a more predictable environment with cycles that allow for more time to react. We will serve customers with better cash flow. We should be more insulated from the price of oil, and midstream customers are better positioned to use premium quality products. So finally, we will report iOS under discontinued operations and recast 2020 results on that basis. So I'm going to wrap up now with my prepared comments. And I hope this summary was helpful, and we're prepared to take questions. So I'll turn the call back over to Valerie, and we can take any questions anyone might like to ask.

[Operator Instructions] Our first question comes from Alex Rygiel of B. Riley.

Couple of quick questions. How are you thinking about redeploying the capital from this transaction, both the $4 million in the short-term and possibly the $9 million to be collected over the next 12 months?

Well, I think we're going to basically follow our -- the capital allocation model that has been a part of the strategy we try to articulate. Our priority has been debt reduction here as of recently. But we do believe that once markets start to improve, and we feel more comfortable about the economic environment that we have described our desire to look at some bolt-on acquisitions, specifically in the rail technologies' area or to support our hub-and-spoke strategy for precast concrete products. We haven't been very active in that regard. And in the last several months here, we have been more focused on liquidity than anything else. And so we're still mindful of that. We're still being a bit cautious given the fact that the market still feels a little bit weak. So if some cash were to come in the door tomorrow, or as it did a week ago, we're going to continue to apply that to debt reduction.

And does the company have any other assets up for sale right now or are you contemplating any?

Well, we have businesses that we are looking at all the time. There isn't anything that I would tell you kind of looks like this business. We decided to hold this call because we thought this was a sizable asset. It was one we've described as important to us back at the time that we stepped into this business. And again, going back in my comments, that was a time when we thought the shale revolution was going to be a really good place to be. So I can't describe anything specifically to you at this point. But it is fair to say that there are some businesses that we look at that don't have potentially a good growth outlook or an outlook from which we might be able to expand profitability or cash -- better cash flow and return and so we will take a look at those from time to time, but I can't announce anything further than that.

Sure. And lastly, it's late September. I know this isn't an earnings call, but any sort of macro thoughts on the marketplace or in the near-term or kind of in the last 3 months?

Yes. I think I really would like to reserve that for the Q3 earnings call. I'll just say that there isn't a lot that's changed since we were last talking to you in the second quarter there, not too much time has passed. But we're about to close the quarter and enter a quiet period, and I think the wise thing for us to do right now is to hold that comments along those lines until we get back together on the phone again here in about another 5 or 6 weeks.

And actually, I do have one other question. Just so I have sort of my math right, on a go-forward basis, the Tubular, Energy segment margins I suspect they're going to be kind of closer to the high 20% to 30% -- 25% to 30% range. Any chance they could be north of 30%?

Alex, I think the best way for us to take that on is to revisit that as this energy market stabilizes. What I'm concerned about at this point on ballparking a number for you is that we need to see this energy market kind of settle down because not only has this upstream piece then disruptive and really troubling. But as we talked about last quarter when we were together, we had a year-to-date number after 6 months of being down 50% on orders for the entire segment and some of that was the other businesses. So we are working to really hold margins in those other areas and I think we've been doing a good job. But I think until we see kind of a trough for those businesses and to measure that the trough is in, I'd really like to watch that settle out and say -- know that we understand the trough margins and then take a look at what we think we can get back to maybe in the near term after that.