Q3 2023 L B Foster Co Earnings Call
Participants
John F. Kasel; President, CEO & Director; L.B. Foster Company
Stephanie Schmidt; IR Manager; L.B. Foster Company
William M. Thalman; Executive VP & CFO; L.B. Foster Company
Alexander John Rygiel; Associate Director of Research; B. Riley Securities, Inc., Research Division
Chris Sakai; Analyst; Singular Research
Presentation
Operator
Good day, and welcome to L.B. Foster's Third Quarter of 2023 Earnings Call. Later, we will conduct a question-and-answer session and instructions will be given at that time. As a reminder, this call is being recorded. I would now like to turn the call over to Stephanie Schmidt, the company's Investor Relations Manager. You may begin.
Stephanie Schmidt
Thank you, operator. Good morning, everyone, and welcome to L.B. Foster's Third Quarter of 2023 Earnings Call. My name is Stephanie Schmidt, the company's Investor Relations Manager. Our President and CEO, John Castle; and our Chief Financial Officer, Bill Thalman, will be presenting our third quarter operating results, market outlook and business development this morning.
We'll start the call with John providing his perspective on the company's third quarter performance. Bill will then review the company's third quarter financial results. John will provide perspective on market developments and 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.
John F. Kasel
Thanks, Stephanie, and hello, everyone. Thanks for joining us today for our third quarter earnings call. As you can see on Slide 5 of our presentation materials, the improved growth and profitability profile of our business driven by strategic transformation, continued to gain momentum during the third quarter. You'll recall that we previously announced the exit of the Bridge Grid deck product line, which is included within our Steel Products & Measurement segment.
The costs associated with the product line exit in the quarter were $4.1 million, which included an update and the expected value of certain commercial projects being completed as we wind down the product line.
In addition, we recorded a $900,000 provision for bad debt expense associated with the customer in the U.K. who filed for administrative protection. Adjusting for these nonroutine items, we reported a 12.6% organic sales growth and adjusted EBITDA of $10.6 million, which was up 14.2% year-over-year.
Gross margins continue to expand in the quarter with adjusted gross margins of 21.2%, improving 40 basis points year-over-year. On a year-to-date basis, adjusted gross margins were up 250 basis points versus last year, highlighting the significant progress we have made improving the profitability profile of our business.
I am pleased to report that cash flow generation was particularly strong in the third quarter, with cash flow from operations of $18.6 million, representing the highest level achieved since the third quarter of 2019. The cash generated was used to reduce borrowings on our revolving credit facility with net debt being reduced by $16.9 million.
As a result of our lower borrowings, we finished the quarter with a gross leverage ratio for our credit facility at 2x. This is down from the 2.5x we reported in last quarter and more significantly down from the 3.3x we reported at the end of last year's third quarter.
After a very strong order intake in the second quarter, order rates for third quarter were somewhat soft. Third quarter orders totaled $100.3 million with a book-to-bill ratio standing at approximately 0.7:1. I However, it's important to note that the trailing 12-month book-to-bill ratio was 1.03: 1, indicating continuing order book expansion.
Backlog remains healthy at approximately $243 million with the $29.6 million decline year-over-year due entirely to the strategic divestiture and exit activities we completed over the past year. So with that, we are confident in the growth prospects for our key domestic and end markets, but somewhat more cautious in the outlook for our business in the U.K., given the current conditions in that region.
As a result, we maintained the midpoint of our guidance for sales and adjusted EBITDA for 2023, while narrowing the range for both metrics. I'm very pleased with the progress we have made thus far in 2023 and look forward to a continued strong finish to the year and further progress in 2024 and beyond.
Next, Bill will cover the detailed financials for Q3, and I'll come back at the end with some closing remarks on our outlook. Over to you, Bill.
William M. Thalman
Thanks, John. Good morning, everyone. I'll begin my comments covering the consolidated highlights of our third quarter on Slide 7. As always, the schedules in the appendix provide more detailed information on our financial results, including non-GAAP measures Stephanie referenced in her opening.
As John mentioned in his opening remarks, there are a couple of items that we called out in our adjusted results for the quarter as compared to last year. During the third quarter, we announced the exit of the Bridge deck product line. A change in the expected value of certain commercial projects associated with the product line resulted in a $2 million reduction in sales and $3.1 million reduction in gross margins in the quarter. This adjustment was in addition to approximately $1.1 million in other cash and noncash expenses associated with exit activities, resulting in a total impact of approximately $4.1 million on profitability in the quarter.
In addition, we recorded a $900,000 provision for a potentially uncollectible amount due from a customer who filed for administrative protection in the U.K. during the quarter.
As a reminder, net sales and gross profit in last year's third quarter included a $4 million adverse impact from the settlement of certain long-term commercial contracts related to the multiyear Crossrail project in the U.K. Noting the impact of our portfolio moves, the current quarter includes a full quarter of results for the VanHusco acquisition, which was completed on August 12 last year. Offsetting this higher inorganic revenue was the impact of track components, Chemtech and ties businesses that were divested over the last 12 months.
On a GAAP basis, third quarter sales were $145.3 million, up $15.3 million or 11.8% over last year. Adjusting net sales for the items above resulted in an organic sales increase of 12.6%, coupled with a 2.2% increase from acquisitions and then partially offset by a 4.8% decline from divestitures. All segments had organic sales increases during the quarter.
High sales volumes, coupled with improvements in business mix and price realization increased the reported gross profit by 22.2% to $28.2 million, with reported gross profit margins increasing 160 basis points to 19.4%. The increase in gross profit adjusted for nonroutine items in both periods was 12.1% year-over-year and adjusted gross profit margins of 21.2% increased 40 basis points for the quarter.
As expected, a favorable trend in margin performance has continued throughout 2023, with year-to-date adjusted margins coming in at 21.1%, up 250 basis points year-over-year. We're happy to see the adjusted gross profit consistently above 20% in 2023, and we remain optimistic for continued favorable trends in Q4 and moving into 2024.
The $4.1 million bridge grid deck exit impact and $900,000 U.K. bad debt provision reduced net income to $500,000 in Q3. However, adjusted EBITDA improved $1.3 million year-over-year to $10.6 million, with the adjusted EBITDA margin improving 30 basis points to 7.2% of adjusted sales.
This is the second consecutive quarter where we reported adjusted EBITDA margins above 7%, which is attributable to our business portfolio transformation, profitability improvement initiatives and organic growth.
John covered consolidated orders, backlog and net debt performance in his opening remarks, and I'll provide some additional color on these items later in the presentation.
We've been showing the adjusted 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 the third quarter with the $16.9 million adjusted sales increase representing 12.6% organic sales growth. The net impact of M&A decreased revenue of $3.5 million or 2.6%.
As John highlighted in his opening remarks, we continue to have a healthy backlog, and we expect organic growth rates to remain favorable in Q4. As we stated in our second quarter call, the net impact of M&A presents a tougher comparison in the second half of 2023 due to the Chemtech and tie divestitures, coupled with the lapping of the scratch and VanHooseCo acquisitions.
Our business portfolio work is largely complete, and we are focused on executing the organic growth opportunities we see across the business in line with our strategy to invest in rail technologies and precast concrete growth programs.
The chart on the right highlights the continuing progress we've achieved in improving profitability through our portfolio work. M&A activity resulted in a decline in sales, but the impact on adjusted EBITDA was an improvement of $1.5 million.
Despite the strong organic sales growth in our legacy business, profitability was down slightly year-over-year due to the higher SG&A expenses largely tied to wages and incentive costs. In summary, we're pleased with the combined results achieved through our strategic transformation, and we look forward to continued progress as we wrap up 2023.
Slide 9 provides an important perspective on the progress we've made in sales growth and profitability over the last 2 years. The net impact of our strategy execution resulted in a 15% adjusted sales growth for the trailing 4 quarters ended September 30, 2023, with double-digit sales growth achieved in every quarter. Over the same time period, adjusted gross profit increased 31.1%, resulting in a 250 basis point improvement in adjusted gross profit margins to 20.7%.
In summary, we believe our portfolio transformation, organic growth and focused profitability initiatives have resulted in a structural improvement in the gross margin profile of our business that should be sustainable with the longer-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. Third quarter Rail segment revenues of $86.9 million were up 12.3% year-over-year. Adjusting for the 2022 Crossrail settlement, adjusted net sales increased 6.8% with adjusted organic growth of 9.3%, partially offset by divestitures of 2.5%.
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.
Reported rail margins of 19.8% were up 250 basis points year-over-year. Adjusting for the Crossrail settlement last year, gross profit declined $100,000 with gross profit margin down 150 basis points. The decline in adjusted gross profit was driven primarily by continuing weakness in the U.K. commercial markets. Rail orders and backlog were both down year-over-year due primarily to divestitures and timing of orders within Rail Products.
As reflected on Slide 11, Precast Concrete segment revenue increased $9.8 million or 33.9% year-over-year. Revenues were up 24.2% organically, and the VanHusco acquisition contributed $2.8 million, representing growth of 9.7%.
Gross profit margins adjusted for purchase accounting impacts associated with the VanHooseCo acquisition last year, were up 150 basis points to 24% due to improved volumes, price realization and strong operating performance in the legacy business, coupled with the accretive benefit of the VanHooseCo gross margins.
Order and backlog levels decreased in our precast segment by $3.3 million and $6.2 million, respectively. The backlog remains healthy at $80.4 million.
The Steel Products & Measurement segment results on Slide 12 reflects a 16.7% decrease in revenues because of the Chemtech divestiture and bridge grid deck exit impacts, I covered in my opening comments. Adjusted organic growth of 9.6% was realized because of an increase in Protective Coating sales. Reported gross margins were down 840 basis points to 8.7% due to the Bridge grid deck exit impact, resulting in a $3.1 million reduction to gross profit.
Adjusting for the Bridge grid deck impact on sales and gross profit, gross profit margin increased 480 basis points due to the favorable impact of portfolio changes and margin gains in both Protective Coatings and fabricated steel products.
Orders in backlog were down 53.9% and 10.5%, respectively, driven by divestitures and the Bridge Grid Dec product line exit offsetting strength in the legacy businesses. Last year's orders included the $18.7 million Summit pipeline coating order within Protective Coatings.
The year-to-date results on Slide 13 highlights the structural profitability improvements we've established in our business. Sales were up 13.5% year-over-year and gross profit margins have expanded 310 basis points to 20.5% thus far in 2023. Adjusted EBITDA is up nearly 54% with the EBITDA margin of 6.3%, up 170 basis points versus last year.
Year-to-date cash flow provided by operations was $15.3 million, favorable to last year by $34.1 million. And orders are up 2.3% year-to-date with improved organic order rates more than offsetting the net impact from M&A activities.
Our liquidity and leverage metrics are on Slide 14. As expected, net debt decreased $16.9 million in the quarter with strong profitability and lower working capital investment, driving $18.6 million in cash flow from operations. As a result, our gross leverage ratio per our credit agreement decreased from 2.5x at the start of the quarter to 2x at the end of the quarter. We've made significant progress improving our leverage metrics over the last 12 months with gross leverage down from 3.3x at the end of last year's third quarter.
While free cash flow provided $12.5 million year-to-date, we've actually reduced our net debt by $20.3 million so far this year as a result of divestiture proceeds. These divestitures improved our gross leverage ratio as they were essentially breakeven businesses on an EBITDA basis that were dilutive to the ratio. We expect to generate positive free cash flow in the fourth quarter, 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 with $4 million due through the remainder of this year and $8 million due in 2024. We also have approximately $100 million in federal net operating loss carryforwards that should minimize our federal tax obligations for the foreseeable future.
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, and we're starting to see the early signs of the potential with this quarter's results.
In summary, we're pleased with the progress we've made reducing our net debt and leverage following the acquisitions completed last year and diligent capital allocation along with prudent leverage management remain top priorities.
Our capital allocation priorities are outlined on Slide 15. As I just mentioned, we continue to focus on managing leverage levels while cautiously investing in organic growth opportunities we see in Rail Technologies and Precast Concrete. We're comfortable with the gross leverage around 2x, and pleased we've achieved this level 1 year after the completion of 2 strategic acquisitions in 2022.
Capital spending is expected to run at approximately 1.5% to 2% of sales on average, which is slightly higher than our historical levels due to the organic growth investments with high returns and quick paybacks.
We continue to evaluate opportunities to return cash to shareholders through our stock repurchase program, and we've been active since its inception in February of 2023 with a 0.6% reduction to the outstanding shares thus far, consuming approximately $900,000 of the $15 million authorization.
We continue to pursue small tuck-in acquisitions that could extend our product portfolio within our growth platforms and while distributing value to shareholders through a dividend is not a current priority, we will continue to evaluate this capital allocation option as the prospects for stronger free cash flow improve in 2024 and beyond.
My closing comments will refer to Slides 16 and 17 covering orders, revenues and backlog by business. The book-to-bill ratio over the last 12 months was 1.03:1, with order rates outpacing sales by approximately $15 million. The consolidated book-to-bill ratio in the third quarter was somewhat softer at 0.69:1 after a very strong order intake level in the second quarter. The decline in order rates were most notable in rail and precast concrete segments where order levels can be somewhat seasonal and lumpy. We expect overall order rates to improve in the coming quarters, building our backlog for fulfillment in 2024.
And lastly, our consolidated backlog on Slide 17 reflects a healthy backlog level with the decline year-over-year due entirely to divestiture and product line exit activities, which totaled $32.7 million. We remain optimistic in the longer-term prospects for growth and demand across our portfolio and expect this will translate into an improving backlog in the coming quarters.
In closing, our third quarter and year-to-date results highlight the momentum we're seeing in the business and benefits from our strategic transformation. We're pleased with our progress thus far, which reinforces our confidence in our strategic playbook. We look forward to finishing 2023 on a strong note and continued progress in 2024 and beyond. Thank you for your time, and I'll now hand it back over to John for his closing remarks. John?
John F. Kasel
Thanks, Bill. Please refer to Slide 19 for an overview of our key business and market drivers, underpinning our outlook. We remain optimistic longer-term prospects for growth in Rail Technologies and rail infrastructure markets, particularly given the increasing emphasis on rail safety, fuel savings, operating efficiency and on-time deliveries here in U.S. and Canada.
It's important to highlight that our U.K. business is experiencing a particularly challenging market with weaker demand levels and ongoing liquidity disruptions with some customers. As you would expect, we are working with our local team will focus on immediate mitigation actions to reduce costs and limit investment, which could help us provide and may change some flexibility as market conditions improve.
Here back in the U.S., the exit of the grid deck product line should allow for more focused effort to grow our bridge forms product line, which is seeing a boost in demand from the broader infrastructure spending programs. Also, the protective coatings business continues to see increased demand from the traditional pipeline investment projects in addition to developing alternative applications in play.
And finally, the precast concrete opportunities remain robust across the portfolio. We continue to expand our market reach enabled by the addition of VanHooseCo Company, of which we're just beginning to realize the potential growth of our combined organizations.
In summary, despite the near-term challenges we face in the U.K., we believe our overall prospects for profitable growth remains strong in light of the infrastructure investment super cycle we expect for years to come.
During our second quarter update, I unveiled our rebranded company tagline as innovating to solve global infrastructure challenges, along with the refinement to our near-term goals in 2025. You'll find this on Slide #20.
Despite short-term challenges that I previously mentioned in the U.K., we remain confident in our outlook for growth and profitability in line with our near-term goals. I will also add, we expect our progress to begin to accelerate due to 3 key factors. First, we anticipate above-average growth in Rail Technologies and Precast Concrete. Second, continued focus and execution by our management team on profitability initiatives across the portfolio. And third, we will begin to see expense leverage of SG&A against the anticipated organic revenue and margin increases.
In closing, our team has made substantial progress transforming L.B. Foster over the past 2 years, and we are definitely energized by the results we're achieving. I believe we're well prepared to execute on our next phase of transformation and look forward to sharing our accomplishments as we wrap up 2023 and continue momentum into next year.
Thank you for your time and continuing interest in L.B. Foster. And I'll turn it back to the operator for the Q&A session.
Question and Answer Session
Operator
(Operator Instructions). Our first question comes from Alex Rygiel with B. Riley Securities.
Alexander John Rygiel
So a nice quarter there. Are you starting to see any benefits from federal spending in bidding opportunities?
William M. Thalman
Yes. We don't necessarily -- we didn't see it in the $100 million we talked about in the bookings for the quarter. However, we were very pleased with the October results that we saw in bookings, which is in line with what we were saying how we're going to finish the year.
Activities is -- bidding activity is very strong right now. So it's been years, Alex, since we talked about this money being out there, and we're starting to see it now flow through the state and government.
Alexander John Rygiel
For sure. And then sort of kind of on that topic, Book-to-bill in the quarter was a bit soft. You obviously referenced some seasonality there. You have some divestitures. Anything kind of more broadly than that, that might have affected the third quarter, appreciating that October was strong heading against the fourth quarter.
William M. Thalman
Yes. Well, first of all, Q2 was fantastic for us. Of course, we're looking over the period of time, which was favorable over the last 12 months. And as I mentioned, October was strong too heading into the fourth quarter.
I went back and looked at it over the last couple of years, and we're flat basically on a year-over-year basis. But if you look over a 2-year period, we're 6.7% up on our backlog and 17% over a 3-year period. So, it's choppy. We're construction, but we're really starting to see a lot of activity starting to come through. So we're feeling very good about our prospects in '24 and beyond.
John F. Kasel
The other thing I might highlight, Alex, is that the backlog margin profitability is much better than what the higher balance would have been in the past because of the divestiture work and the accretion that the acquisitions bring to the portfolio.
William M. Thalman
That's right.
Alexander John Rygiel
And then I know it's a little early to kind of think about 2024 and guidance and all of that. But any sort of maybe broader kind of comments as it relates to organic growth expectations for 2024? Are you thinking low single digit? Do you think at high single digit, low double digit, especially given the strength this year?
William M. Thalman
Well, let's put it this way. First of all, we put our guidance or your aspirational goals in 2025. We're not backing off of those. So '24 is really a stepping stone to make that happen. And if you look at our 2x leverage right now, we've got a lot of opportunities now to take some of that cash that we generate specifically in this quarter and plow it into some really specific programs we have, organic programs that we're very, very pleased with. So you'll see more of that coming in the Rail Technologies and precast side. But next year will be a transition to our aspirational goals in 2025. We'll leave you with that.
Operator
Our next question comes from Chris Sakai with Singular Research. Chris.
Chris Sakai
Yes. Can you talk about new orders for the quarter? It seems -- was this seasonality that it was -- they were down? And how are things looking for the next quarter?
John F. Kasel
Yes. Well, thanks for the question. Thanks for joining us again today. We are -- it's choppy. We do a lot of large bids, as you know, Chris. So sometimes they hit the magical quarter. Sometimes they extend into the next quarter, and that's kind of what we're seeing right now. So we're off to a strong start in Q4. October came in in a very nice shape it really lines up well to finish the year. So we don't get too worked up about what happens in the specific quarter. We're more looking at the activity we're seeing and make sure that we're getting those jobs that we think we should get.
And as Bill just mentioned, we're really focused on profitability of the company. That portfolio changes that we made were significant. So the fact that we took some backlog out $29.6 million of backlog. Now those are very low-margin type work and really consumed a lot of management time as well as working capital.
So the work we're getting now much more in line with our strategy, our technology innovation changes we're making and become a global company. So we feel pretty good about our situation where we're at today, and more importantly, where we're heading into '24 and beyond.
Operator
(Operator Instructions). Our next question comes from John Blair with Ascent Wealth Advisors. [Opearor Instructions). I'm not showing any further questions. I'd like to turn the call over to John Castle for any further remarks.
John F. Kasel
Thanks, Michelle. Really appreciate it. Thanks for joining us today for our third quarter earnings. We -- I guess, how we leave this meeting today is we're really excited about our cash generation for the quarter. This is something the company has been working on now. We hit a number that we haven't seen since 2019. And I think it really gives the shareholders as well as investors feeling a case to where we were at once before. And our focus is continuing to do that, focus on our gross leverage ratio down to 2x right now. That's -- we're feeling very good about that as well as the opportunities we see here in the short term as well as heading into next year. So thanks for your time again. And more importantly, thanks for your interest in L.B. Foster, and take care, everybody. We'll talk to you after the close of the year. Bye-bye.
Operator
Thank you for your participation. This does conclude the program, and you may now disconnect. Everyone, have a great day.
