UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

(Mark One)

 

Or

 

 

 

L. B. Foster Company

(Exact name of Registrant as specified in its charter)

 

 

 

(412) 928-3417

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.  (Check one):

 

 

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

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L.B. FOSTER COMPANY AND SUBSIDIARIES

 

INDEX

 

 

 

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L. B. FOSTER COMPANY AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1. FINANCIAL STATEMENTS

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  In the opinion of management, all estimates and adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included.  However, actual results could differ from those estimates.  The results of operations for interim periods are not necessarily indicative of the results that may be expected for the year ending December 31, 2012.  Amounts included in the balance sheet as of December 31, 2011 were derived from our audited balance sheet.  For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2011.

 

Certain accounts in the prior year period condensed consolidated financial statements have been reclassified for comparative purposes principally to conform to the presentation of discontinued operations in the current year period.

 

2.  BUSINESS SEGMENTS

 

The Company is organized and evaluated by product group, which is the basis for identifying reportable segments. The Company is engaged in the manufacture, fabrication and distribution of rail, construction and tubular products and services.

 

The following table illustrates revenues and profits from continuing operations of the Company by segment for the periods indicated:

 

 

 

 

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Segment profits from continuing operations, as shown above, include internal cost of capital charges for assets used in the segment at a rate of, generally, 1% per month. There has been no change in the measurement of segment profit from continuing operations from December 31, 2011.  

 

The following table provides a reconciliation of reportable segment net profit from continuing operations to the Company’s consolidated total:

 

 

 

 

 

 

3.  GOODWILL AND OTHER INTANGIBLE ASSETS

 

On June 4, 2012, the Company divested $2,588,000 in goodwill attributed to the Rail Products segment in connection with the sale of its railway securement business.  Intangible assets with net carrying value of $170,000 were also included with this sale.  These intangible assets had a net carrying value of $177,000 at December 31, 2011.  More information regarding this sale can be found in Note 9.

 

Excluding amounts attributed to discontinued operations, the carrying amount of goodwill at September 30, 2012 and December 31, 2011 was $41,237,000, of which $38,026,000 is attributable to the Company’s Rail Products segment and $3,211,000 is attributable to the Construction Products segment.    

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Identified intangible assets of $2,305,000 are attributable to the Company’s Construction Products segment and  $44,452,000 are attributable to the Company’s Rail Products segment.    The components of the Company’s intangible assets are as follows:

 

 

 

 

 

 

Intangible assets are amortized over their useful lives ranging from 5 to 25 years, with a total weighted average amortization period of approximately 20 years.  Amortization expense from continuing operations for the three-month periods ended September 30, 2012 and 2011 was $703,000 and $699,000, respectively.  Amortization expense from continuing operations for the nine-month periods ended September 30, 2012 and 2011 was $2,097,000 and $2,096,000, respectively.

 

Estimated amortization expense from continuing operations for the remainder of 2012 and the years 2013 and thereafter is as follows:

 

 

 

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4.  ACCOUNTS RECEIVABLE

Credit is extended based upon an evaluation of the customer’s financial condition and while collateral is not required, the Company often receives surety bonds that guarantee payment.  Credit terms are consistent with industry standards and practices.  Trade accounts receivable from continuing operations at September 30, 2012 and December 31, 2011 have been reduced by an allowance for doubtful accounts of ($1,306,000) and ($1,726,000), respectively.

 

5.  INVENTORIES

 

Inventories of continuing operations of the Company at September 30, 2012 and December 31, 2011 are summarized in the following table:

 

 

 

 

Inventories of the Company’s continuing operations are generally valued at the lower of last-in, first-out (LIFO) cost or market.  Other inventories of the Company are valued at average cost or market, whichever is lower.  An actual valuation of inventory under the LIFO method is made at the end of each year based on the inventory levels and costs at that time.  Interim LIFO calculations are based on management’s estimates of expected year-end levels and costs.

 

6.  INVESTMENTS

 

Investments of the Company consist of a nonconsolidated equity method investment of $4,137,000 and $3,495,000 at September 30, 2012 and December 31, 2011, respectively.

 

The Company is a member of a joint venture with L B Industries, Inc. and James Legg until September 30, 2019.  The Company and L B Industries, Inc. each have a 45% ownership interest in the joint venture, L B Pipe & Coupling Products, LLC (JV).  The JV manufactures, markets and sells various products for the energy, utility and construction markets.  Under the terms of the JV agreement, as amended, the Company was required to make capital contributions totaling approximately $3,000,000.  The Company fulfilled these commitments during 2011.  The other JV members are required to make proportionate contributions in accordance with the ownership percentages in the JV agreement.

 

Under applicable guidance for variable interest entities in ASC 810, “Consolidation,” the Company determined that the JV is a variable interest entity, as the JV has not demonstrated that it has sufficient equity to support its operations without additional financial support. The Company concluded that it is not the primary beneficiary of the variable interest entity, as the Company does not have a controlling financial interest and does not have the power to direct the activities that most significantly impact the economic performance of the JV. Accordingly, the Company concluded that the equity method of accounting remains appropriate.

 

The Company recorded equity in the income of the JV of approximately $310,000 and $643,000 for the three and nine months ended September 30, 2012, respectively.  The Company recorded equity in the income of the JV of approximately $287,000 and $570,000 for the three and nine months ended September 30, 2011, respectively. 

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The Company’s exposure to loss results from its capital contributions, net of the Company’s share of the JV’s income or loss, and its net investment in the direct financing lease covering the facility used by the JV for its operations.  The carrying amounts with the maximum exposure to loss of the Company at September 30, 2012 and December 31, 2011, respectively, are as follows:

 

 

 

The Company is leasing five acres of land and the facility to the JV over a period of 9.5 years, with a 5.5 year renewal period.  Monthly rent over the term of the lease is approximately $10,000, with a balloon payment of approximately $488,000 which is required to be paid either at the termination of the lease, allocated over the renewal period or during the initial term of the lease.  This lease qualifies as a direct financing lease under the applicable guidance in ASC 840-30, “Leases.” The Company maintained a net investment in this direct financing lease of approximately $933,000 and $971,000 at September 30, 2012 and December 31, 2011, respectively.

 

The following is a schedule of the direct financing minimum lease payments for the remainder of 2012 and the years 2013 and thereafter

 

 

 

 

 

 

7.  DEFERRED REVENUE

 

Deferred revenue consists of customer payments received for which the revenue recognition criteria have not yet been met.  The Company has significantly fulfilled its obligations under the contracts and the customers have paid, but due to the Company’s continuing involvement with the material, revenue is precluded from being recognized until the customer takes possession.

 

8.  BORROWINGS

 

United States

 

On May 2, 2011, the Company, its domestic subsidiaries, and certain of its Canadian subsidiaries entered into a new $125,000,000 Revolving Credit Facility Credit Agreement (Credit Agreement) with PNC Bank, N.A., Bank of America, N.A., Wells Fargo Bank, N.A. and Citizens Bank of Pennsylvania.  This Credit Agreement replaced a prior revolving credit facility with a maximum credit line of $90,000,000 and a $20,000,000 term loan.  The Credit Agreement provides for a five-year, unsecured revolving credit facility that permits borrowing up to $125,000,000 for the U.S. borrowers and a sublimit of the equivalent of $15,000,000 U.S. dollars that is available to the Canadian borrowers.  Provided no event of default exists, the Credit Agreement contains a provision that provides for an increase in the revolver facility of $50,000,000 that can be allocated to existing or new lenders if the Company’s borrowing requirements should increase.  The Credit Agreement includes a sublimit of $20,000,000 for the issuance of trade and standby letters of credit.

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Borrowings under the Credit Agreement will bear interest at rates based upon either the base rate or LIBOR-based rate plus applicable margins.  Applicable margins are dictated by the ratio of the Company’s indebtedness less cash on hand to the Company’s consolidated EBITDA, as defined in the underlying Credit Agreement.  The base rate is the highest of (a) PNC Bank’s prime rate, (b) the Federal Funds Rate plus 0.50% or (c) the daily LIBOR rate, as defined in the underlying Credit Agreement, plus 1.00%.  The base rate spread ranges from 0.00% to 1.00%.  LIBOR-based rates are determined by dividing the published LIBOR rate by a number equal to 1.00 minus the percentage prescribed by the Federal Reserve for determining the maximum reserve requirements with respect to any Eurocurrency funding by banks on such day.  The LIBOR-based rate spread ranges from 1.00% to 2.00%.

 

The Credit Agreement includes two financial covenants:  (a) the Leverage Ratio, defined as the Company’s Indebtedness less cash on hand divided by the Company’s consolidated EBITDA, which must not exceed 3.00 to 1.00 and (b) Minimum Interest Coverage, defined as consolidated EBITDA less Capital Expenditures divided by consolidated interest expense, which must be no less than 3.00 to 1.00.

 

The Credit Agreement permits the Company to pay dividends and distributions and make redemptions with respect to its stock provided no event of default or potential default (as defined in the Credit Agreement) has occurred prior to or after giving effect to the dividend, distribution, or redemption.  Dividends, distributions, and redemptions are capped at $15,000,000 per year when funds are drawn on the facility.  If no drawings on the facility exist, dividends, distributions, and redemptions in excess of $15,000,000 per year are subjected to a limitation of $75,000,000 in aggregate.  The $75,000,000 aggregate limitation also includes certain loans, investments, and acquisitions.  The Company is permitted to acquire the stock or assets of other entities with limited restrictions provided that the Leverage Ratio does not exceed 2.50 to 1.00 after giving effect to the acquisition.

 

Other restrictions exist at all times including, but not limited to, limitation of the Company’s sale of assets, other indebtedness incurred by either the borrowers or the non-borrower subsidiaries of the Company, guaranties, and liens.  On July 9, 2012, the Company amended the Credit Agreement to increase the limitation of the Company’s sale of assets from $10,000,000 to $25,000,000.

 

As of September 30, 2012, the Company was in compliance with the Credit Agreement’s covenants.

 

The Company had no outstanding borrowings under the revolving credit facility at September 30, 2012 or December 31, 2011 and had available borrowing capacity of $123,824,000 at September 30, 2012.  

 

Letters of Credit

 

At September 30, 2012, the Company had outstanding letters of credit of approximately $1,176,000.

 

United Kingdom

 

A subsidiary of the Company has a working capital facility with NatWest Bank for its United Kingdom operations which includes an overdraft availability of £1,500,000 pounds sterling (approximately $2,424,000 at September 30, 2012).    This credit facility supports the subsidiary’s working capital requirements and is collateralized by substantially all of the assets of its United Kingdom operations.  The interest rate on this facility is the financial institution’s base rate plus 1.50%. Outstanding performance bonds reduce availability under this credit facility.  The subsidiary of the Company had no outstanding borrowings under this credit facility as of September 30, 2012.  There was approximately $61,000 in outstanding guarantees (as defined in the underlying agreement) at September 30, 2012.  There were no borrowings or performance bonds outstanding on this facility as of December 31, 2011.  This credit facility was renewed effective August 30, 2012 with no significant changes to the underlying terms or conditions in the facility.  The expiration date of this credit facility is August 30, 2013.

 

The United Kingdom loan agreements contain certain financial covenants that require that subsidiary to maintain senior interest and cash flow coverage ratios. The subsidiary was in compliance with these financial covenants as of September 30, 2012.  The subsidiary had available borrowing capacity of $2,363,000 at September 30, 2012.

 

 

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9.  DISCONTINUED OPERATIONS

 

On June 4, 2012, the Company sold substantially all of the assets and liabilities of its railway securement business, Shipping Systems Division (SSD), for $8,579,000 to Holland, L.P., resulting in a pre-tax gain of approximately $3,508,000.  On August 30, 2012, the Company sold substantially all of the assets and liabilities of its precise structural products business, Precise, for $2,643,000 to Cianbro Fabrication and Coating Corporation, resulting in a pre-tax loss of approximately $315,000. 

 

The operations of these divisions qualify as a “component of an entity” under FASB ASC 205-20, “Presentation of Financial Statements – Discontinued Operations” and thus, the operations have been reclassified as discontinued and prior periods have been reclassified to conform to this presentation.  Future expenses of discontinued operations are not expected to be material.

 

Net sales and income, including the pre-tax gain of $3,193,000, from discontinued operations were as follows:

 

 

 

 

The effective tax rate in the nine-month period ended September 30, 2012  was significantly impacted by  $2,588,000 of goodwill allocated to SSD for discontinued operations which was not deductible for income tax purposes.

 

The following table details balance sheet information for discontinued operations:

 

 

 

 

 

 

 

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10. EARNINGS PER COMMON SHARE

 

The following table sets forth the computation of basic and diluted earnings per common share:

 

 

 

 

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11.  SHARE-BASED COMPENSATION

 

The Company applies the provisions of FASB ASC 718, “Compensation – Stock Compensation,” to account for the Company’s share-based compensation.  Share-based compensation cost is measured at the grant date based on the calculated fair value of the award and is recognized over the employees’ requisite service period.  The Company recorded stock compensation expense of $477,000 and $465,000 for the three-month periods ended September 30, 2012 and 2011, respectively, and $1,312,000 and $1,720,000 for the nine-month periods ended September 30, 2012 and 2011, respectively, related to restricted stock awards and performance unit awards.

 

Stock Option Awards

 

A summary of the option activity as of September 30, 2012 is presented below.

 

 

 

The total intrinsic value of options outstanding and exercisable at September 30, 2011 was $669,000.

 

At September 30, 2012, common stock options outstanding and exercisable under the Company’s equity plans had option prices ranging from $4.10 to $14.77, with a weighted average exercise price of $9.94.  At September 30, 2011, common stock options outstanding and exercisable under the Company’s equity plans had option prices ranging from $4.10 to $14.77, with a weighted average exercise price of $8.83 per share.

 

The weighted average remaining contractual life of the stock options outstanding at September 30, 2012 and 2011 was 2.4 and 3.1 years, respectively.

 

There were 10,000 options with a weighted average exercise price per share of $6.02 exercised during the three-month period ended September 30, 2012.  There were 10,000 options with a weighted average exercise price per share of $4.87 exercised during the three-month period ended September 30, 2011.    The total intrinsic value of options exercised during the three-month periods ended September 30, 2012 and 2011 was $225,000 and $154,000, respectively.

 

Options exercised during the nine-month periods ended September 30, 2012 and 2011 totaled 11,450 and 31,000 shares, respectively.    The weighted average exercise price per share of the options exercised during the nine-month periods ended September 30, 2012 and 2011 were  $6.44 and $3.93, respectively.  The total intrinsic value of options exercised during the nine-month periods ended September 30, 2012 and 2011 were $255,000 and $909,000, respectively.

 

Shares issued as a result of stock option exercise generally will be from previously issued shares which have been reacquired by the Company and held as Treasury shares.

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Restricted Stock Awards

 

For the nine-month periods ended September 30, 2012 and 2011, the Company granted approximately 26,000 and 46,000 shares, respectively, of restricted stock to employees.  During the nine-month period ended September 30, 2012, the Company also granted approximately 66,000 shares of restricted stock to an employee director.  A summary of restricted stock award activity follows:

 

 

 

These forfeitable Restricted Stock Awards time-vest after a four-year holding period, unless indicated otherwise by the underlying Restricted Stock Agreement.  Certain awards of restricted stock included in the above table provide for partial vesting over a period up to the vesting date listed.  Shares issued as a result of Restricted Stock Awards generally are previously issued shares which have been reacquired by the Company and held as Treasury shares or authorized but previously unissued common stock.

 

Performance Unit Awards

 

Annually, under separate three-year long-term incentive plans, pursuant to the Omnibus Plan,  the Company grants performance units.  Units granted during the nine-month periods ended September 30 are as follows:

 

 

 

In addition, on March 15, 2011 the Company awarded, pursuant to the Omnibus Plan, 1,500 special performance units to an employee director and 1,000 special performance units to an executive officer.  Based on the satisfaction of the underlying performance conditions, these units were converted, net of shares withheld for applicable income tax purposes, into 1,436 and 957 shares, respectively, of the Company’s common stock on March 6, 2012.  The grant date fair value of these awards was $38.46 and the aggregate fair value was $58,000 and $38,000, respectively.  

 

Performance units are subject to forfeiture and will be converted into common stock of the Company based upon the Company’s performance relative to performance measures and conversion multiples as defined in the underlying plan.  The aggregate fair value in the above table is based upon achieving 100% of the performance targets as defined in the underlying plan.  The Company reversed $1,157,000 of incentive compensation expense during the nine-month period ended September 30, 2012 caused by the impact of the product warranty charge on Company performance, as it related to the awards’ underlying performance conditions.  More information on the product warranty charge can be found in Note 14.

 

Shares issued as a result of performance unit awards generally are previously issued shares which have been reacquired by the Company and held as Treasury shares or authorized but previously unissued common stock.

 

The excess tax benefit realized for the tax deduction from stock-based compensation approximated $121,000 and $368,000 for the nine months ended September 30, 2012 and 2011, respectively.  This excess tax benefit is included in cash flows from financing activities in the Condensed Consolidated Statements of Cash Flows.

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12.  RETIREMENT PLANS

 

Retirement Plans

 

The Company has five retirement plans which cover its hourly and salaried employees in the United States: three defined benefit plans (one active / two frozen) and two defined contribution plans.  Employees are eligible to participate in the appropriate plan based on employment classification.  The Company's funding to the defined benefit and defined contribution plans are governed by the Employee Retirement Income Security Act of 1974 (ERISA), applicable plan policy and investment guidelines.  The Company policy is to contribute at least the minimum in accordance with the funding standards of ERISA.

 

The Company’s subsidiary, Portec Rail Products, Inc. (Portec Rail), maintains two defined contribution plans for its employees in Canada, as well as a post-retirement benefit plan.  In the United Kingdom, Portec Rail maintains both a defined contribution plan and a defined benefit plan.  These plans are discussed in further detail below.

 

United States Defined Benefit Plans

 

Net periodic pension costs for the United States defined benefit pension plans for the three- and nine-month periods ended September 30, 2012 and 2011 are as follows:

 

 

 

The Company expects to contribute approximately $741,000 to its United States defined benefit plans in 2012.  For the nine months ended September 30, 2012, the Company contributed approximately $421,000 to these plans.

 

United Kingdom Defined Benefit Plans

 

Net periodic pension costs for the United Kingdom defined benefit pension plan for the three and nine months ended September 30 is as follows:  

 

 

United Kingdom regulations require trustees to adopt a prudent approach to funding required contributions to defined benefit pension plans. The Company anticipates  making contributions of $231,000 to the United Kingdom Portec Rail pension plan during 2012.  For the nine months ended September 30, 2012, the Company contributed approximately $110,000 to the United Kingdom Portec Rail plan.    

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Defined Contribution Plans

 

The Company has a domestic defined contribution plan that covers all non-union hourly and all salaried employees (Salaried Plan).  The Salaried Plan permits both pre-tax and after-tax employee contributions. Participants can contribute, subject to statutory limitations, between 1% and 75% of eligible pre-tax pay and between 1% and 100% of eligible after-tax pay.  The Company's employer match is 100% of the first 1% of deferred eligible compensation and up to 50% of the next 6%, based on years of service, of deferred eligible compensation, for a total maximum potential match of 4%.  The Company may also make discretionary contributions to the Salaried Plan. 

 

The Company also has a domestic defined contribution plan for union hourly employees with contributions made by both the participants and the Company based on various formulas (Union Plan). 

 

The Company’s Portec Rail subsidiary maintains a defined contribution plan covering all non-union employees at its Montreal, Quebec, Canada location (Montreal Plan).  Under the terms of the Montreal Plan, Portec Rail may contribute 4% of each employee’s compensation as a non-elective contribution and may also contribute 30% of the first 6% of each employee’s compensation contributed to the Montreal Plan. 

 

The Company’s Portec Rail subsidiary also maintains a defined contribution plan covering substantially all employees of Portec Rail Products (UK) Ltd (UK Plan).  Benefits under the UK Plan are provided under no formal written agreement.  Under the terms of the defined contribution UK Plan, Portec Rail may make non-elective contributions of between 3% and 10% of each employee’s compensation. 

 

Finally, the Company’s Portec Rail subsidiary maintains a defined contribution plan covering substantially all of the employees of Kelsan Technologies Corp., a wholly-owned subsidiary of the Company (Kelsan Plan).  Under the terms of the Kelsan Plan, Portec Rail makes a non-elective contribution of 4% of each employee’s compensation and may also contribute 30% of the first 6% of each employee’s compensation contributed to the Kelsan Plan.    

 

The following table summarizes the expense associated with the contributions made to these plans:

 

 

 

 

13.  FAIR VALUE MEASUREMENTS

 

FASB ASC 820, “Fair Value Measurements and Disclosures,” defines fair value, establishes a framework for measuring fair value in accordance with accounting principles generally accepted in the United States, and expands disclosures about fair value measurements.   The Company applies the provisions of ASC 820 to all its assets and liabilities that are being measured and reported on a fair value basis.

 

ASC 820 discusses valuation techniques, such as the market approach (comparable market prices), the income approach (present value of future income or cash flow) and the cost approach (cost to replace the service capacity of an asset or replacement cost).  ASC 820 enables readers of financial statements to assess the inputs used to develop those measurements by establishing a hierarchy, which prioritizes those inputs used, for ranking the quality and reliability of the information used to determine fair values.  The standard requires that each asset and liability carried at fair value be classified into one of the following categories:

 

Level 1: Quoted market prices in active markets for identical assets or liabilities.

Level 2: Observable market-based inputs or unobservable inputs that are corroborated by market data.

Level 3: Unobservable inputs that are not corroborated by market data.

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The Company has an established process for determining fair value for its financial assets and liabilities, principally cash and cash equivalents and foreign currency exchange contracts.  Fair value is based on quoted market prices, where available.  If quoted market prices are not available, fair value is based on assumptions that use as inputs market-based parameters.  The following sections describe the valuation methodologies used by the Company to measure different financial instruments at fair value, including an indication of the level in the fair value hierarchy in which each instrument is generally classified.  Where appropriate the description includes details of the key inputs to the valuations and any significant assumptions.

 

Cash equivalents.  Included within “Cash and cash equivalents” are investments in tax-free and taxable money market funds with municipal bond issuances as the underlying securities as well as government agency obligations and corporate bonds, all of which maintain AAA credit ratings.  Also included within cash equivalents are our investments in non-domestic bank certificates of deposit.  The Company uses quoted market prices to determine the fair value of these investments and they are classified in Level 1 of the fair value hierarchy.  The carrying amounts approximate fair value because of the short maturity of the instruments.

 

Derivative contracts.  The Company uses significant other observable inputs that are readily available in public markets or can be derived from information available in publicly quoted markets to determine the fair value of its derivative contracts.  These instruments consist of foreign currency exchange contracts, are included within “Other accrued liabilities,” and are classified in Level 2 of the fair value hierarchy.  Fluctuations in the fair values of derivative instruments are recorded in accumulated other comprehensive loss and reclassified into earnings as the underlying hedged items affect earnings.  There were no such instruments as of December 31, 2011.    

 

IDSI acquisition notes.  The Company issued non-interest bearing notes associated with its 2010 acquisition of Interlocking Deck Systems International, LLC (IDSI).  The Company determined the fair value of these notes by computing the present value of the note payments using an interest rate formula applicable to the Company’s long-term debt.  This note was paid during the three-month period ended March 31, 2012.  The note was included within “Current maturities of long-term debt” at December 31, 2011.

 

The following assets and liabilities of the Company were measured at fair value on a recurring basis subject to the disclosure requirements of ASC Topic 820 at September 30, 2012 and December 31, 2011:

 

 

 

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14.  COMMITMENTS AND CONTINGENT LIABILITIES

 

Product Liability Claims

 

On July 12, 2011, the Union Pacific Railroad (UPRR) notified (the “UPRR Notice”) the Company and the Company’s subsidiary, CXT Incorporated (CXT), of a warranty claim under CXT's 2005 supply contract relating to the sale of prestressed concrete railroad ties to the UPRR.  The UPRR asserted that a significant percentage of concrete ties manufactured in 2006 through 2011 at CXT's Grand Island, NE facility fail to meet contract specifications, have workmanship defects and are cracking and failing prematurely.  Approximately 1.6 million ties were sold from Grand Island to the UPRR during the period the UPRR has claimed nonconformance.  The 2005 contract calls for each concrete tie which fails to conform to the specifications or has a material defect in workmanship to be replaced with 1.5 new concrete ties, provided, that UPRR within five years of the sale of a concrete tie, notifies CXT of such failure to conform or such defect in workmanship. The UPRR Notice did not specify how many ties manufactured during this period are defective nor the exact nature of the alleged workmanship defect.  Additionally, UPRR notified the Company that a customer of the UPRR asserted that a representative sample of ties manufactured by the Company’s Grand Island facility have failed a test contained in the contract specification.  UPRR has removed, at this customer’s request, approximately 115,000 concrete ties, which are a subset of the ties subject to the UPRR Notice.

 

On January 11, 2012, CXT received a subpoena from the United States Department of Transportation Inspector General (IG) requesting records related to its manufacture of concrete railroad ties in Grand Island, Nebraska.  The Company believes that this subpoena relates to the same set of circumstances giving rise to the UPRR product claim.  CXT and the Company have been cooperating fully with the IG. 

 

November 7, 2012 Update

 

The Company has been assessing warranty claims for certain concrete ties made in its Grand Island, NE facility.  The claims are arising from ties found in track that are not performing up to the Company’s expectations, and do not meet the Company’s quality standards. These ties were manufactured between 1998 and 2011.  The Company discontinued manufacturing operations in Grand Island in early 2011.  The large majority of these claims come from the Union Pacific Railroad (UPRR).  During the recent quarter, the Company has been working to resolve the claims in a satisfactory manner for our customers and the Company.  The Company made substantial progress with the UPRR in the recent quarter regarding the approach to remedy field failures, the details of which are in the following paragraphs.

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The Company has agreed on a process with the UPRR for identifying, prioritizing and replacing ties that meet the criteria for replacement. This process will be applied to the ties the Company shipped to the UPRR from its Grand Island, NE facility from 1998 to 2011. During most of this period the Company’s warranty policy for UPRR carried a 5 year warranty with a 1.5:1 replacement ratio for any defective ties.  The agreed upon process will result in the Company and the UPRR working together to identify and replace defective ties. The process of planning and documenting will be done by both the Company and the UPRR to ensure this is done in a timely manner.

 

In order to accommodate customer concerns,  the Company has reverted to a previously used warranty policy.  This will result in all concrete ties with a 5 year warranty and a 1.5:1 replacement ratio, now having a 15 year warranty and a 1:1 replacement ratio. This change will provide an additional 10 years of warranty protection.  The 1:1 replacement ratio will furnish one tie for each tie replaced under our claims process.    

 

Following the changes noted above to the warranty policy and our assessment of the scope of the defective ties, the Company recorded an additional $3.0 million warranty charge in order to adequately reserve for the revised cost of resolving expected claims.  This change brought the total warranty reserve for concrete ties to $27.2 million.  It is now sized to reflect the expected claims from all customers who have notified the Company of problems, especially the UPRR where the majority of claims arose.  It is supported by the extensive field sampling and forensic analysis we’ve conducted along with customer discussions.

 

Finally, the Company will produce the replacement ties in its Tucson, AZ manufacturing facility which has been operating under a 5 year supply contract with the UPRR expiring in December 2012.  UPRR has verbally indicated their intent to award the Company with a new 5 year supply contract for its Tucson facility.  The details of this supply contract have not been completed, although they are expected to closely resemble the terms in the existing contract with the exception of the new 15 year warranty policy and some product specification changes.

 

The Company is subject to product warranty claims that arise in the ordinary course of its business.  For certain manufactured products, the Company maintains a product warranty accrual which is adjusted on a monthly basis as a percentage of cost of sales.  This product warranty accrual is periodically adjusted based on the identification or resolution of known individual product warranty claims.  The following table sets forth the Company’s continuing operations product warranty accrual:

 

 

 

While the Company believes this is a reasonable estimate of these potential warranty claims,  these estimates could change due to new information and future events.  There can be no assurance at this point that future potential costs pertaining to these claims or other potential future claims will not have a material impact on the Company’s results of operations.    

 

Environmental and Legal Proceedings

 

The Company is subject to national, state, foreign, provincial and/or local laws and regulations relating to the protection of the environment, and the Company is monitoring its potential environmental exposure related to current and former Portec facilities.  The Company’s efforts to comply with environmental regulations may have an adverse effect on its future earnings.  In the opinion of management, compliance with the present environmental protection laws will not have a material adverse effect on the financial condition, results of operations, cash flows, competitive position or capital expenditures of the Company.

 

The Company is also subject to legal proceedings and claims that arise in the ordinary course of its business.  In the opinion of management, the amount of ultimate liability with respect to these actions will not materially affect the financial condition or liquidity of the Company.  The resolution, in any reporting period, of one or more of these matters could have a material effect on the Company’s results of operations for that period.

 

As of September 30, 2012 and December 31, 2011, the Company maintained environmental and litigation reserves approximating $2,112,000 and $2,184,000, respectively.

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15.  DERIVATIVE FINANCIAL INSTRUMENTS AND HEDGING ACTIVITIES

 

The Company does not purchase or hold any derivative financial instruments for trading purposes.

 

At contract inception, the Company designates its derivative instruments as hedges.  The Company recognizes all derivative instruments on the balance sheet at fair value.  Fluctuations in the fair values of derivative instruments designated as cash flow hedges are recorded in accumulated other comprehensive (loss) income and reclassified into earnings within other income as the underlying hedged items affect earnings. To the extent that a change in the derivative does not perfectly offset the change in value of the risk being hedged, the ineffective portion is recognized in earnings immediately.

 

The Company is subject to exposures to changes in foreign currency exchange rates. The Company manages its exposure to changes in foreign currency exchange rates on firm sale and purchase commitments by entering into foreign currency forward contracts. The Company’s risk management objective is to reduce its exposure to the effects of changes in exchange rates on these transactions over the duration of the transactions. 

 

During the third quarter of 2012, the Company executed derivative contracts with notional amounts totaling approximately $3,186,000 to sell Canadian funds based on the anticipated receipt of Canadian funds from the sale of certain rail products in the third quarter of 2012.    The receipt of Canadian funds did not occur when the Company expected and the Company needed to enter into another commitment to buy Canadian funds with notional amounts totaling approximately $3,388,000.  During the third quarter  of 2012, the Company settled these contracts for a recognized loss of approximately  $204,000.  This amount is included within “Other expense/(income)” in the Condensed Consolidated Statements of Operations.

 

During the third quarter of 2012, the Company entered into a new commitment with notional amounts totaling approximately $3,280,000 to sell Canadian funds based on the anticipated receipt of Canadian funds from the sale of certain rail products in the fourth quarter of 2012.  The fair value of this instrument was a liability of approximately $47,000 as of September 30, 2012 and was recorded in “Other accrued liabilities” in the Condensed Consolidated Balance Sheet.

 

The Company did not engage in any foreign currency hedging transactions during the nine-month period ended September 30, 2011. 

 

16.  INCOME TAXES

 

The Company’s effective income tax rate from continuing operations for the three months ended September 30, 2012 and 2011 was 35.4% and 31.5%, respectively. The Company’s effective income tax rate from continuing operations for the nine months ended September 30, 2012 and 2011 was 37.6% and 31.0%, respectively.  The increase in the Company's effective income tax rate is due to a reduction in 2012 Canadian research and development credits as well as the receipt of state tax refunds in 2011.

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Item 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Overview

General

 

L.B. Foster Company (Company) is a leading manufacturer, fabricator and distributor of products for the rail, construction, utility and energy markets.  The Company is comprised of three business segments: Rail Products, Construction Products and Tubular Products.

 

We reclassified our statements of operations to present the results of our Shipping Systems Division and Precise Structural Products business as discontinued operations due to their sales on June 4, 2012 and August 30, 2012, respectively.  The following discussion and analysis of financial condition and results of operations relates only to our continuing operations.  More information regarding the results of discontinued operations and the net $3.2 million pre-tax gain recognized on these transactions can be found in footnote 9 to the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q.

 

Product Warranty Claim Charge

 

We have agreed on a process with the Union Pacific Railroad (UPRR) for identifying, prioritizing and replacing ties that meet the criteria for replacement. This process will be applied to the ties we shipped to the UPRR from our Grand Island, NE facility from 1998 to 2011. During most of this period our warranty policy for the UPRR carried a 5 year warranty with a 1.5:1 replacement ratio for any defective ties.  The agreed upon process will result in us working together to identify and replace defective ties. The process of planning and documenting will be done by both companies to ensure this is done in a timely manner.

 

In order to accommodate customer concerns,  we have reverted to a previously used warranty policy.  This will result in all concrete ties with a 5 year warranty and a 1.5:1 replacement ratio, now having a 15 year warranty and a 1:1 replacement ratio. This change will provide an additional 10 years of warranty protection. 

 

Following the changes noted above to the warranty policy and our assessment of the scope of the defective ties, we recorded an additional $3.0 million warranty charge in the 2012 third quarter in order to adequately reserve for the revised cost of resolving expected claims.  This change brought the total warranty reserve for concrete ties to $27.2 million.  It is now sized to reflect the expected claims from all customers who have notified us of problems, especially the UPRR where the majority of claims arose.  It is supported by the extensive field sampling and forensic analysis we’ve conducted along with customer discussions.

 

 

Other Matters

 

In October 2012, we announced that we are in the process of changing the names of several of the subsidiary companies acquired from our 2010 acquisition of Portec Rail Products, Inc.  To more accurately brand these innovative businesses and better represent our rail product development capabilities, these divisions will be collectively referred to as L.B. Foster Rail Technologies.

 

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Quarterly Results of Continuing Operations

 

 

 

 

Third quarter 2012 Compared to Third quarter 2011 – Company Analysis

 

Income from continuing operations for the 2012 third quarter was $8.5 million, or $0.83 per diluted share, compared to income from continuing operations of $9.4 million, or $0.91 per diluted share, in the prior year quarter.

 

Included in our 2012 and 2011 third quarter results were warranty charges related to concrete ties manufactured at our Grand Island, NE facility of  $3.0 million ($0.17 per diluted share) and $0.8 million ($0.05 per diluted share), respectively.

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Selling and administrative expense decreased approximately $0.2 million in the 2012 third quarter primarily due to reduced concrete tie testing expenses associated with the UPRR product warranty claim.  This reduction was partially offset by increased employee salary and benefit expenses.  Fluctuations in the exchange rate for the US Dollar resulted in our recognizing transactional foreign exchange losses during the current quarter compared to foreign exchange gains in the prior year quarter.  Additionally, approximately $0.2 million in derivative hedging settlement losses were recognized during the 2012 quarter.  Other expense for the three months ended September 30, 2012 consisted mainly of approximately $0.2 million in fixed asset write offs.  Other income in the prior year quarter included increased amounts recognized from the deferred gain related to a revision in the remaining term of a 2008 operating lease associated with our former Houston, TX threading facility. 

 

The effective income tax rate from continuing operations in the third quarter of 2012 was 35.4% compared to 31.5% in the prior year quarter.    The increase in our effective income tax rate is due to a reduction in 2012 Canadian research and development credits as well as the receipt of state tax refunds in 2011.    

 

Results of Continuing Operations – Segment Analysis

 

 

Rail Products

 

 

 

 

Third quarter 2012 Compared to Third quarter 2011

 

The sales improvement was due principally to increases in our rail distribution and concrete ties divisions.  Higher volumes in our rail distribution business drove the sales improvement.  While our CXT concrete tie division did report volume growth over the 2011 period, the 2011 period was also negatively impacted by a product return totaling $2.8 million.  Our trackwork division also reported improved volumes.  These increases were partially offset from sales volume declines reported by our Allegheny Rail Products (ARP) division while our Rail Technologies divisions reported flat quarter over quarter sales.    

 

Product warranty charges of approximately $3.0  million and $0.8 million, respectively, related to the Grand Island, NE concrete tie warranty matters negatively impacted our Rail Products segment in the 2012 and 2011 quarters.  Additionally, Rail Technologies gross profit declined due to increased materials costs reported by our friction management product line.  While our rail distribution divisions’ gross profit reported volume related increases, its gross profit margin remained flat. 

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Construction Products

 

 

 

 

Third quarter 2012 Compared to Third quarter 2011

 

Volume based 2012 sales declines were reported by all of our Construction Products divisions, with the most significant declines continuing in our piling division.  Additionally, our concrete buildings division reported reduced volumes in the 2012 period as compared to its record 2011 period as it relies on government funding for its orders.

 

While our fabricated bridge products division reported expanded margins, the rest of our Construction Products divisions reported 2012 gross profit declines which were generally volume related.

 

 

Tubular Products

 

 

 

 

Third quarter 2012 Compared to Third quarter 2011

 

Our Birmingham, AL coating facility continued to drive the increase in both sales and gross profit in the 2012 quarter from increased volumes as the facility is currently operating two shifts to fulfill customer orders.  Volume related growth also contributed to the expansion in gross profit through improved absorption of plant expenses at both of our tubular divisions. 

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Year-to-date Results of Continuing Operations

 

 

 

 

First Nine months of 2012 Compared to First Nine months of 2011 – Company Analysis

 

Income from continuing operations for the first nine months of 2012 was $8.1 million, or $0.80 per diluted share, which compares to income from continuing operations for the 2011 period of $16.3 million, or $1.57 per diluted share.    Included in our 2012 and 2011 year-to-date results were charges related to concrete ties manufactured at our Grand Island, NE facility of $22.0 million and $5.2 million, respectively.  Included within gross profit in the 2011 period was a nonrecurring increase in cost of goods sold of approximately $2.5 million related to the recognition of the inventory step-up to fair value from our 2010 acquisition of Portec Rail Products, Inc.

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Approximately $1.3 million of the total $2.2 million of increased selling and administrative expenses in 2012 was for concrete tie testing expenses associated with the UPRR product warranty claim.  The remainder of the increase over 2011 was due primarily to employee salary and benefit expenses and favorable adjustments to bad expense from accounts previously written off as uncollectible.  These increases were partially offset by a reversal of $1.2 million in incentive compensation expense caused by the impact of the product warranty charge on plan performance conditions.  Foreign currency hedge settlements and fluctuations in the exchange rate for the US Dollar resulted in our recognizing foreign exchange losses during the current quarter compared to foreign exchange gains in the prior year quarter.  We recognized decreased gains of approximately $0.3 million in 2012 related to the operating lease associated with our former Houston, TX threading facility due to our move to Magnolia, TX.  This amount was recorded within “Other Income”.

 

The effective income tax rate from continuing operations for the first nine months of 2012 was 37.6% compared to 31.0% in the prior year period.    The increase in the Company's effective income tax rate is due to a reduction in 2012 Canadian research and development credits as well as the receipt of state tax refunds in 2011.        

 

Results of Continuing Operations – Segment Analysis

 

Rail Products

 

 

 

 

First Nine months of 2012 Compared to First Nine months of 2011

 

The growth leaders in our Rail Products segment were our rail distribution and CXT concrete tie divisions, while our Rail Technologies businesses reported flat year over year sales.  The growth in our rail distribution business came from improved sales pricing from a shift in product mix toward premium rail and volumes.  Our two concrete tie plants continue to deliver volume growth, surpassing sales levels even from the 2010 period when we operated three plants.  Finally, decreased volumes reported by our Canadian track components business was mitigated by improved volumes at our United Kingdom friction management business.

 

Warranty charges in the 2012 period totaling $22.0 million and closure-related and warranty charges totaling $5.2 million in the 2011 period related to our Grand Island, NE concrete tie facility adversely impacted our Rail Products segment gross profit.  In addition, 2011 gross profit was unfavorably impacted by a nonrecurring increase in cost of goods sold of approximately $2.5 million related to recognition of the remaining portion of the inventory step-up to fair value from our allocation of Portec Rail’s purchase price.   Without these charges, our gross profit margins would have been 20.5% and 20.3% for the nine-month periods ended September 30, 2012 and 2011, respectively.

 

We believe this illustrates that the underlying operations of our Rail Products divisions are strong.  We also believe that reasonable carload and intermodal rail traffic, robust railroad financial results and strong spending by the Class 1 Railroads bode well for continued strong results into 2013 for our Rail Products segment.

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Construction Products

 

 

 

 

First Nine months of 2012 Compared to First Nine months of 2011

 

Entering 2012 with a lower backlog of business as well as booking fewer new orders in 2012 than the comparable prior period resulted in lower sales volumes for our piling division.  Even with these volume reductions, our piling division was able to maintain its period over period gross profit margins.  The remainder of our Construction Products divisions experienced market driven, volume related sales and gross profit declines.

 

We expect our Construction Products segment to be challenged into 2013 by continued softness in the construction markets in which we participate.

 

Tubular Products

 

 

 

 

First Nine months of 2012 Compared to First Nine months of 2011

 

Strong demand driven by the energy markets served by our Birmingham, AL coating facility led the robust sales growth in our Tubular Products segment.  This facility added a second shift during the third quarter of 2012 to satisfy this demand.  Our fully operational threaded products division in Magnolia, TX, benefitted, albeit to a lesser extent, from improved demand in the agriculture markets.  Growth in gross profit is due to the volume increases reported by both divisions.

 

While we expect continued growth in the oil & gas and water well application end markets through the end of 2012 and into 2013, we do not anticipate this growth to continue at the 2012 growth rate.

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Liquidity and Capital Resources

 

Our capitalization is as follows:

 

 

 

Our need for liquidity relates primarily to seasonal working capital requirements for continuing operations, capital expenditures, joint venture capital obligations, strategic acquisitions, debt service obligations, share repurchases and dividends. 

 

The following table summarizes the year-to-date impact of these items:

 

 

 

Cash Flow from Continuing Operating Activities

 

During the current 2012 period, cash flows from continuing operations provided  $24.6 million, an improvement of $14.0 million compared to the 2011 period.  For the nine months ended September 30, 2012, income and adjustments to income from continuing operations provided $9.3 million compared to income and adjustments to income from continuing operations providing $24.3 million in the 2011 period.  Working capital and other assets and liabilities provided $15.3 million compared to working capital and other assets and liabilities using $13.6 million in the prior year. 

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Cash Flow from Continuing Investing Activities

 

Capital expenditures were $6.3 million for the first nine months of 2012 compared to $8.0 million for the same 2011 period.    Current period expenditures were primarily used for our Burnaby, British Columbia, Canada facility, moving our threaded products operations, other yard upgrades and plant equipment.  We anticipate total capital spending in 2012 will range between $8.0 million and $9.0 million and will be funded by cash flow from operations.

 

In January 2011, we made our final, net payment of approximately $9.0 million for the remaining outstanding shares of common stock related to our 2010 acquisition of Portec Rail. We also contributed approximately $0.6 million in capital to our JV investment.

 

Cash Flow from Discontinued Operations

 

We sold our Shipping Systems Division on June 4, 2012 for $8.6 million and our Precise Structural Products business on August 30, 2012 for $2.6 million.  As part of these sales, we recognized a net pre-tax gain of $3.2 million which is included within cash flows used by discontinued operating activities.

 

Cash Flow from Financing Activities

 

While we did not purchase any common shares of the Company under our existing share repurchase authorization, we did repurchase 23,066 shares from employees and nonemployee directors to pay their withholding taxes in connection with the exercise and/or vesting of options and restricted stock awards.

 

Financial Condition

 

As of September 30, 2012, we had approximately $100.7 million in cash and cash equivalents and a credit facility with $123.8 million of availability while carrying only $0.4 million in total debt.  As of September 30, 2012 we were in compliance with all of the Credit Agreement’s covenants.  We believe this capacity will afford us the flexibility to take advantage of both organic and external investment opportunities.

 

Included within cash and cash equivalents are investments in tax-free and taxable money market funds.  The money market funds include municipal bond issuances as the underlying securities as well as government agency obligations and corporate bonds.  Our priority continues to be short-term maturities and the preservation of our principal balances.  Approximately $37.3 million of our cash and cash equivalents was held in non-domestic bank accounts.  There are no material restrictions in converting those funds into other currencies and they are available to meet the liquidity needs of our foreign operations. 

 

Borrowings under our Credit Agreement bear interest at rates based upon either the base rate or LIBOR-based rate plus applicable margins.  Applicable margins are dictated by the ratio of our indebtedness less cash on hand to our consolidated EBITDA.  The base rate is the highest of (a) PNC Bank’s prime rate or (b) the Federal Funds Rate plus .50% or (c) the daily LIBOR rate plus 1.00%.  The base rate spread ranges from 0.00% to 1.00%.  LIBOR-based rates are determined by dividing the published LIBOR rate by a number equal to 1.00 minus the percentage prescribed by the Federal Reserve for determining the maximum reserve requirements with respect to any Eurocurrency funding by banks on such day.  The LIBOR-based rate spread ranges from 1.00% to 2.00%.

 

Critical Accounting Policies

 

The condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States.  When more than one accounting principle, or method of its application, is generally accepted, management selects the principle or method that is appropriate in the Company’s specific circumstances.  Application of these accounting principles requires management to make estimates about the future resolution of existing uncertainties.  As a result, actual results could differ from these estimates.  In preparing these financial statements, management has made its best estimates and judgments of the amounts and disclosures included in the financial statements giving due regard to materiality.  Except for the previously disclosed warranty charges recorded during the second and third quarters of 2012, there have been no material changes in the Company’s critical accounting policies or estimates since December 31, 2011.  For more information regarding the Company’s critical accounting policies, please see the Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Company’s Form 10-K for the year ended December 31, 2011.

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Off-Balance Sheet Arrangements

 

The Company’s off-balance sheet arrangements include operating leases, purchase obligations and standby letters of credit.  A schedule of the Company’s required payments under financial instruments and other commitments as of December 31, 2011 is included in the “Liquidity and Capital Resources” section of the Company’s Annual Report filed on Form 10-K for the year ended December 31, 2011.    These arrangements provide the Company with increased flexibility relative to the utilization and investment of cash resources.  There were no material changes to these arrangements during the nine-month period ended September 30, 2012.

 

Outlook

 

We believe that we are well positioned to benefit from strong rail and energy markets in which we participate but we continue to anticipate a weakened construction market into 2013.  We expect to generate cash flows from operations in excess of capital expenditures, scheduled debt service repayments, share repurchases and dividends. 

 

Our CXT Rail operation is dependent on the UPRR for a significant portion of its business.  In connection with the 2005 award of a long-term concrete railroad tie supply agreement from the UPRR, CXT completed the construction of a new facility in Tucson, AZ on land we lease from UPRR.  Pursuant to the supply agreement, UPRR has agreed to purchase minimum annual quantities from the Tucson, AZ facility through 2012.  In connection with the progress we’ve made in moving toward resolution of the UPRR product warranty claims, more fully described in Note 14 to the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q, the UPRR has verbally agreed to a new five year supply contract and a related extension to the lease through December 2017. 

 

Class 1 Railroad capital spending is expected to remain strong through the end of 2012 and we anticipate reasonable carload and intermodal rail traffic, which bodes well for our rail business.  We were rewarded with our largest order ever ($60 million) for an elevated transit system in Honolulu, HI in May 2012 which we believe illustrates the strength in our underlying Rail Products operations.

 

Our tubular divisions end markets in oil & gas and water well applications are driven by energy and agriculture.  The growth in these two segments should continue into 2013, but at slower rates than we experienced during 2012.    

 

We anticipate weak to slightly improving market conditions for our Construction Products segment.  Additionally, approximately 30 US states are projecting budget deficits in the current fiscal year that may present challenges to many of the end markets in which we sell that rely on state government funding.  Certain of our businesses sell to markets that rely heavily on spending authorized by the federal transportation funding bill, Moving Ahead for Progress in the 21^st Century (MAP-21), enacted in July 2012.  This legislation authorized transportation spending over a two year period at levels similar to its predecessor bill, SAFETEA-LU.

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Total Company backlog from continuing operations at September 30, 2012 was approximately $255.7 million and summarized by business segment in the following table for the periods indicated:

 

 

 

 

As of September 30, 2012, we maintained a total product warranty reserve of approximately  $28.1 million for our estimate of all potential product warranty claims.  Of this total, $27.2 million reflects the current estimate of our exposure for product warranty claims from all customers who have notified us of problems related to our Grand Island, NE concrete tie production.  Included within this amount is the cumulative $22.0 million warranty charges recorded in 2012 associated with Grand Island concrete railroad ties.  While we believe this is a reasonable estimate of our potential contingencies related to identified concrete tie warranty matters for the affected customers, we may incur future charges associated with new customer claims or further development of information for existing customer claims.  Thus, there can be no assurance that future potential costs pertaining to warranty claims will not have a material impact on our results of operations and financial condition.

 

Forward-Looking Statements

 

This Form 10-Q contains “forward looking” statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934.  Forward-looking statements are statements that do not relate strictly to historical or current facts.  Sentences containing words such as “believes,” “intends,” “anticipates,” “expects,” or “will” generally should be considered forward-looking statements.  Forward-looking statements in this Form 10-Q may concern, among other things, the Company’s expectations regarding our strategy, goals, plans and projections regarding our financial position, liquidity and capital resources, potential impact of the UPRR claims, the Inspector General subpoena, results of operations, decisions to sell operating divisions, market position, and product development, all of which are based on current estimates that involve inherent risks and uncertainties.  The Company cautions readers that various factors could cause the actual results of the Company to differ materially from those indicated by forward-looking statements.   Among the factors that could cause the actual results to differ materially from those indicated in the forward-looking statements are risks and uncertainties related to: general business conditions, the availability of material from major suppliers, labor disputes, the impact of competition, variances in current accounting estimates and their ultimate outcomes, the seasonality of the Company’s business, the adequacy of internal and external sources of funds to meet financing needs, the Company’s ability to curb its working capital requirements, outcome of political races, taxes, foreign currency fluctuations, inflation, the ultimate number of concrete ties that will have to be replaced pursuant to the product claims, and governmental regulations.  Should one or more of these risks or uncertainties materialize, or should the assumptions underlying the forward-looking statements prove incorrect, actual outcomes could vary materially from those indicated. These and other risks are more fully described in the “Risk Factors” Section of our Annual Report on Form 10-K and in our other periodic filings with the Securities and Exchange Commission. We undertake no obligation to release publicly any revisions to forward-looking statements as a result of future events or developments.

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Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 

 

Interest Rate Risk

 

The Company does not purchase or hold any derivative financial instruments for trading purposes.

 

At contract inception, the Company designates its derivative instruments as hedges.  The Company recognizes all derivative instruments on the balance sheet at fair value.  Fluctuations in the fair values of derivative instruments designated as cash flow hedges are recorded in accumulated other comprehensive income and reclassified into earnings within other income as the underlying hedged items affect earnings. To the extent that a change in a derivative does not perfectly offset the change in value of the interest rate being hedged, the ineffective portion is recognized in earnings immediately.

 

Foreign Currency Exchange Rate Risk

 

During the third quarter of 2012, the Company entered into commitments with notional amounts totaling approximately $3.2 million to sell Canadian funds based on the anticipated receipt of Canadian funds from the sale of certain rail products in the third quarter of 2012.  The receipt of Canadian funds did not occur when the Company expected and the Company needed to enter into another commitment to buy Canadian funds with notional amounts totaling approximately $3.4 million.  During the third quarter of 2012, the Company settled these contracts for a recognized loss of approximately $0.2 million.  This amount is included within “Other expense/(income)” in the Condensed Consolidated Statements of Operations.

 

During the third quarter of 2012, the Company entered into a new commitment with notional amounts totaling approximately $3.3 million to sell Canadian funds based on the anticipated receipt of Canadian funds from the sale of certain rail products in the fourth quarter of 2012.  The fair value of this instrument was a liability of less than $0.1 million as of September 30, 2012 and was recorded in “Other accrued liabilities” in the Condensed Consolidated Balance Sheet.

 

 

Item 4. CONTROLS AND PROCEDURES

 

 

PART II. OTHER INFORMATION

 

Item 1. LEGAL PROCEEDINGS

 

See Note 14, “Commitments and Contingent Liabilities,” to the condensed consolidated financial statements included in this Quarterly Report on Form 10-Q, which is incorporated herein by reference.

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Item 1A. RISK FACTORS

 

In addition to the risk factors and other information set forth in this report, you should carefully consider the factors discussed in Part I, Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the SEC on March 15, 2012, which could materially affect our business, financial condition, financial results, or future performance. Reference is also made to Item 2 of the Quarterly Report on Form 10-Q.  The risks described below and in our Annual Report on Form 10-K are not the only risks facing the Company.  Additional risks and uncertainties not currently known or that we currently deem to be immaterial may also materially affect our business, financial condition and/or results of operations.

 

Fluctuations in the price, quality and availability of our primary raw materials used in our business could have a material adverse effect on our operations.

Our businesses could be affected adversely by significant changes in the price of steel, concrete, and other raw materials or the availability of existing and new piling and rail products.  Our operating results may also be affected negatively by adverse weather conditions.  No assurances can be given that our financial results would not be adversely affected if prices or availability of these materials were to change in a significantly unfavorable manner.

 

Prolonged unfavorable economic and market conditions could adversely affect our business.

Unexpected events including production delays or other problems encountered at our manufacturing facilities, equipment failures, failure to meet product specifications, concrete railroad tie warranty issues and the availability of existing and new piling and rail products may cause our operating costs to increase or otherwise impact our financial performance.  No assurances can be given that we will be able to successfully mitigate various prolonged uncertainties including materials cost variability, delayed or reduced customer payments and access to available resources outside of operations.

 

Shifting federal, state and local regulatory policies impose risks on our operations. 

We are subject to regulation from federal, state, local and foreign regulatory agencies.  We are required to comply with numerous laws and regulations and to obtain numerous authorizations, permits, approvals and certificates from governmental agencies.  Compliance with emerging regulatory initiatives, delays, discontinuations or reversals of existing regulatory policies in the markets in which we operate could have an adverse effect on our business, results of operations, cash flows and financial condition.

 

Item 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

Issuer Purchases of Equity Securities

 

The Company’s purchases of equity securities for the three-month period ended September 30, 2012 were as follows:

 

 

 

 

(1)  On May 23, 2011, the Board of Directors authorized the repurchase of up to $25.0 million of the Company’s common shares until December 31, 2013 at which time this authorization will expire.  The Company previously purchased 278,655 shares totaling approximately $6.5 million under this authorization.

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Item 5.  OTHER INFORMATION

 

On October 25, 2012, the Board of Directors of the Company adopted an amendment to Section 2.05 of the Company’s Bylaws to clarify the procedures by which shareholders may nominate persons for election to the Board of Directors of the Company and/or propose other business to be considered by shareholders at future meetings of shareholders (the “Amendment”). 

The foregoing description of the Amendment is qualified in its entirety by reference to the Bylaws, a copy of which is filed as Exhibit 3.1 to this Quarterly Report on Form 10-Q and incorporated herein by reference.

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SIGNATURE

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

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Item 6. EXHIBITS 

 

The Exhibits marked with an asterisk are filed herewith.  All exhibits are incorporated herein by reference:

 

*3.1                   Bylaws of the Registrant, as amended.

 

*10.1                 First Amendment to Credit Agreement.

 

*31.1                 Certification of Chief Executive Officer under Section 302 of the Sarbanes-Oxley Act of 2002.

 

*31.2                 Certification of Chief Financial Officer under Section 302 of the Sarbanes-Oxley Act of 2002.

 

*32.0                 Certification of Chief Executive Officer and Chief Financial Officer under Section 906 of the Sarbanes-Oxley Act of 2002.

 

***101.INS           XBRL Instance Document.

 

***101.SCH           XBRL Taxonomy Extension Schema Document.

 

***101.CAL           XBRL Taxonomy Extension Calculation Linkbase Document.

 

***101.DEF           XBRL Taxonomy Extension Definition Linkbase Document.

 

***101.LAB           XBRL Taxonomy Extension Label Linkbase Document.

 

***101.PRE           XBRL Taxonomy Extension Presentation Linkbase Document.

 

*                      Exhibits marked with an asterisk are filed herewith.

 

***                    In accordance with SEC Release 33-8238, the certifications contained in Exhibits 32 are being furnished and not filed. In accordance with Rule 406T of Regulation S-T promulgated by the Securities and Exchange Commission, Exhibit 101 is deemed not filed or part of a registration statement or prospectus for purposes of sections 11 or 12 of the Securities Act of 1933, is deemed not filed for purposes of section 18 of the Securities and Exchange Act of 1934, and otherwise is not subject to liability under these sections

 

 

 

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