Note 20.

Commitments and Contingent Liabilities

Product Warranty Claims

On July 12, 2011, the UPRR notified (UPRR Notice) the Company and its subsidiary, CXT Incorporated (CXT), of a warranty claim under CXT's 2005 supply contract relating to the sale of pre-stressed 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 failed to meet contract specifications, had workmanship defects and were cracking and failing prematurely. Approximately 1.6 million ties were sold from Grand Island, NE to the UPRR during the period the UPRR had claimed nonconformance. The 2005 contract called for each concrete tie which failed to conform to the specifications or had 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, notified CXT of such failure to conform or such defect in workmanship. The UPRR Notice did not specify how many ties manufactured during this period were 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, NE facility failed a test contained in the contract specification. At the customer’s request, UPRR removed approximately 115,000 concrete ties, which were a subset of the ties subject to the UPRR Notice.

Beginning in July 2011 through the second quarter of 2012, the Company worked with material scientists and pre-stressed concrete experts to test a representative sample of Grand Island, NE concrete ties and assess warranty claims for certain concrete ties made in its Grand Island, NE facility between 1998 and 2011. The Company discontinued manufacturing operations in Grand Island, NE in early 2011.

During 2012, the Company completed sufficient testing and analysis to further understand this matter. Additionally, in a combined effort with UPRR, the Company analyzed Grand Island, NE concrete ties in track. Based upon these findings, the Company believed it discovered conditions, which largely related to the 2006 to 2007 manufacturing period, that can shorten the life of the concrete ties produced during this period. The Company also 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. In order to accommodate the UPRR and other customer concerns, the Company 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 provided an additional 10 years of warranty protection. The 1:1 replacement ratio will furnish one tie for each tie replaced under the Company’s claims process. During the fourth quarter of 2012, the Company reached agreement (2012 amended supply agreement) with the UPRR resulting 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 an accurate and timely manner. In connection with this agreement, the Company and the UPRR agreed on a cash payment of $12,000 to the UPRR as compensation for concrete ties already replaced by the UPRR during the investigation period, including approximately 115,000 concrete ties mentioned previously.

During 2012, as a result of testing the Company conducted on concrete ties manufactured at its former Grand Island, NE facility and of the related developments of the UPRR and other customer matters, the Company recorded pre-tax warranty charges of $22,000 in “Cost of Goods Sold” within its Rail Products segment based on the Company’s estimate of the number of defective concrete ties that will ultimately require replacement during the applicable warranty periods.

Throughout 2013, at the UPRR’s request and under the terms of the 2012 amended supply agreement, the Company provided warranty replacement concrete ties for use across certain UPRR subdivisions. The Company attempted to reconcile the quantity of warranty claims for ties replaced and obtain supporting detail for the ties removed. The Company believes that the UPRR did not replace concrete ties in accordance with the amended agreement and has not furnished adequate documentation throughout the replacement process in these subdivisions to support its full warranty claim. Based on the information received by the Company to date, the Company believes that a significant number of ties which the UPRR replaced in these subdivisions did not meet the criteria to be covered as warranty replacement ties under the 2012 amended supply agreement. To date, the two parties have been unable to properly reconcile the number of defective ties which have been replaced in these subdivisions.

In late November 2013, the Company received notice from the UPRR asserting a material breach of the 2012 amended supply agreement. The UPRR’s notice asserted that the failure to honor its claims for warranty ties in these subdivisions was a material breach. Following receipt of this notice, the Company provided information to the UPRR to refute the UPRR’s claim of breach and included the reconciliation of warranty claims supported by substantial findings from the Company’s track observation team, all within the 90 day cure period. The Company also proposed further discussions to reach agreement on reconciliation for 2013 replacement activities and future replacement activities and a recommended process that will ensure future replacement activities are done with appropriate documentation and per the terms of our agreement.

During the first quarter of 2014, the Company further responded within the 90 day cure period to the UPRR’s claim and presented a reconciliation for the subdivisions at issue. This proposed reconciliation is based on empirical data and visual observation from Company employees that were present during the replacement process for a substantial majority of the concrete ties replaced. The Company has spent considerable time documenting facts related to concrete tie condition and track condition to assess whether the ties replaced met the criteria to be eligible for replacement under the terms of the 2012 amended supply agreement. During this same time period, the UPRR purchased several concrete ties for replacement of existing Grand Island ties that the UPRR deemed as their responsibility.

The accrued concrete tie warranty reserve of $6,462 as of December 31, 2013 is the best estimate of the expected value of defective ties that will be replaced as a result of our observation and analysis of ties in track. While the Company believes this is a reasonable estimate of these potential warranty claims, these estimates could change due to the receipt of new information and future events. The disagreement related to the 2013 warranty replacement activity includes approximately 170,000 ties where we provided detailed documentation supporting our position with reason codes that detail why these ties are not eligible for a warranty claim. In the event the UPRR continues to replace ties and assert warranty claims in future years in the same manner as 2013, we are likely to have a disagreement in those future years relating to the number of ties eligible for warranty claim. The Company has denied it is in material breach of the 2012 amended supply agreement and intends to continue discussions with the UPRR in an effort to resolve previously replaced ties as well as the future warranty tie replacement process.

This dispute could jeopardize our 2012 amended supply agreement. For the years ended December 31, 2013, 2012 and 2011, sales to the UPRR from our Tucson, AZ facility were approximately $12,664, $25,441 and $22,395, respectively. Additionally, as of December 31, 2013 we had long-lived assets with a net book value of approximately $1,116 associated with the Tucson, AZ facility.

There can be no assurance at this point that future potential costs pertaining to the UPRR’s claim or other potential future claims will not have a material impact on the Company’s results of operations and financial condition.

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:



		Warranty Liability
Balance at December 31, 2011	$	6,632
Additions to warranty liability		24,252
Warranty liability utilized		(15,157)
Balance at December 31, 2012	$	15,727
Additions to warranty liability		1,695
Warranty liability utilized		(9,939)
Balance at December 31, 2013	$	7,483

Included within the above table are concrete tie warranty reserves of approximately $6,462 and $14,837, respectively, as of December 31, 2013 and 2012. For the periods ended December 31, 2013, 2012 and 2011, the Company recorded approximately $612, $23,019 and $3,469, respectively, in pre-tax concrete tie warranty charges within “Cost of Goods Sold” in the Company’s Rail Products segment primarily related to concrete ties manufactured at the Company’s former Grand Island, NE facility.

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. The Company is monitoring its potential environmental exposure related to current and former Rail Technologies 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 December 31, 2013 and 2012, the Company maintained environmental and litigation reserves of $2,190 and $2,141, respectively.

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, NE. CXT and the Company have been cooperating fully with the IG.