The Greenbrier Companies, Inc. (GBX) Q3 2012 Earnings Report, Transcript and Summary

Hello and welcome to the Greenbrier Companies Third Quarter of Fiscal Year 2012 Earnings Conference Call. [Operator Instructions] At the request of Greenbrier Companies, this call is being recorded for instant replay purposes. At this time, I would like to turn the conference over to Ms. Lorie Leeson, Vice President and Treasurer. Ms. Leeson, you may begin.

Thank you, Christy. Good morning, everyone, and welcome to Greenbrier's Fiscal 2012 Third Quarter Conference Call. On today's call, I'm joined by our CEO, Bill Furman; and CFO, Mark Rittenbaum. We will discuss our results and make a few remarks about the fiscal quarter ended May 31, 2012. We will also comment on our outlook for the rest of the fiscal year. After that, we'll open the call up for questions. Please note that we have included additional financial information in our earnings release and a slide deck on our website that include supplemental information. As always, matters discussed in this conference call include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Throughout our discussion today, we'll describe some important factors that could cause Greenbrier's actual results in 2012 and beyond to differ materially from those expressed in any forward-looking statements made by or on behalf of Greenbrier. For our third quarter of 2012 ended May 31, net earnings were $19.1 million or $0.61 per diluted share on record revenues of $507.8 million and EBITDA of $44.6 million. This is the second consecutive quarter we achieved record revenues. It supports our view that the industry's broad-based recovery remains on track and that our strategy to expand and diversify our product offerings with a low-cost manufacturing footprint are working. We are intently focused on improving operational efficiencies. Our EBITDA margin grew to 8.8% of revenue and inventory levels declined by almost $20 million during the quarter and cash provided by operating activities were over $61 million for the quarter. And for the sixth consecutive quarter, the average sales price in our backlog grew. The diversity on our backlog also grew, and we now have 7 different car types in our North American backlog, providing yet more evidence [ph] as to the breadth of the recovery. I will now turn it over to Mark to give some additional color on our quarterly results.

Thank you, Lorie. And of course, many of you know Lorie, who is our Treasurer, who is also, over the past several years, taking over the primary contact on the Investor Relations side, and now we're happy to have Lorie participate more robustly in the -- in our conference calls, as well as throughout the quarter. So I'm going to go into some more detail on the results about -- for the quarter and the supplement, the year-over-year comparisons that are in the press release and we have provided more color in the press release and tables itself. I will provide some color more on a sequential basis than is found in the press release. Our Manufacturing segment, turning tip first, produced record revenue during the quarter of $365 million. That compares to $320 million in the prior quarter and we delivered 4,500 new railcars, up from 3,700 cars delivered in Q2. Our Marine activity picked up in Q3 as well, with 2 new orders, and our Marine backlog is now approaching $26 million compared to virtually nil at the end of the second quarter, and we are encouraged by these new orders. We believe this business will continue to grow, and Bill will make some comments on that as well in his remarks. Our Manufacturing margin for the quarter was 10.8% of revenue, up from 9.2% in the second quarter and it was primarily the result of learning curve efficiencies. As you're all well aware, we've been ramping up production quite dramatically through the year and we're seeing the efficiencies being realized as we have ramped up, as well as efficiencies of operating at higher production rates. As well, we benefited from our syndication activities during the quarter to our lease syndication activities. Turning to our Wheel Refurbishment and…

Thank you, Mark, and thanks to all of you for joining us this morning. During the quarter, Greenbrier improved manufacturing margins on the higher volumes and increased the dollar value of its backlog, continuing a shift in backlog to higher value and more diverse units. Sand cars, for example, now represent a little less than 18% of our total North American backlog at the end of Q3. We do expect that market to recover in 2013, and we are receiving solid inquiries for sand and are selling sand cars even today. But it has declined as a percentage of our backlog, which is a positive thing as we see it. We're continuing to ramp up on tank cars which are in high demand. By opening a second line, we'll be able to roughly double our tank car production in 2013 from last quarter's levels and we will be able to produce approximately 3,000 units per year. We have a solid tank car strategy and intend to continue to grow our business in the tank car area, which does look positive over the next several years. While we are mindful of the economic and political risks in the global market, we continue to see solid fundamentals in the rail sector in both North America and Europe and I'll talk to some of these. Our backlog increased in Europe during the quarter, and subsequent to the quarter, we received new orders as well. So we are not seeing softness in our European operations, exactly the contrary. Opportunities we are tracking in North America have roughly doubled quarter-over-quarter and we're seeing a fair number of a variety of cars and demand with selected customers. I'll talk in a moment about why that is occurring despite lower railcar loadings overall. While the pricing environment…

Thank you, Bill, and operator, we'll go ahead and open it up for questions.

[Operator Instructions] Our first question comes from Allison Poliniak with Wells Fargo.

Bill, you've talked in the past that you thought the refurbishment in Parts business have a potential to reach $650 million to $700 million annually. With the issues surrounding coal, I mean, is there any change to your thoughts around that?

No, we have a number of initiatives, strategic initiatives, that we do have the headwinds in coal, which affects wheel replacement. But I continue to believe that, that unit has considerable potential. We're not realizing the potential. We're aware that we're not realizing it and we're working on measures to approach it. We're looking aggressively at an integrated, for example, an integrated strategy addressing the coal or addressing the tank car service business. We think that we can have some growth in that area in our Repair business, integrating with our leasing and manufacturing strategy for tank cars. So we do believe that we can achieve growth there. More importantly, we believe through the repair and parts business, we've addressed margins very successfully. We're going to attack coal directly and we're going to attack wheel replacement directly with some specific strategic implementation plans in 2013.

Okay, perfect. And then just in the manufacturing side, assuming we have these line changeovers, how should we be thinking about gross margins in that segment? Could we potentially see it down sequentially, just given some of the changeovers that are happening in the quarter?

I think for the fourth quarter, Allison, we're thinking that we've -- I think our prior quarter comments that we would see kind of flattish for the fourth quarter, perhaps some modest improvement there and we'll be providing color on our outlook for 2013 on our next call, but I think, again, consistent with our prior comments, we would expect that, as we get further up the learning curve and with these efficiencies, that there's certainly room for margin enhancement in 2013 and beyond.

Our next question from Bascome Majors with Susquehanna Financial Group.

I was curious, did you guys book any Marine revenue this quarter? I know you talked to orders, but I'm curious what might have hit the P&L.

Very nominal amount this quarter, Bascome.

Okay. And you talked about the $25 million or $26 million in orders during the quarter and laid out the expectation that they are going to continue to grow in that 2013. Could it exceed your backlog from a revenue perspective? Can you walk us through the timing of when these orders should start to translate to revenues, how the inquiries are trending in the market? And how long do you think it will take to get the production efficiencies up to the above rail margins you've historically generated in that business?

Right. So Bascome, partly, in our Marine business, the accounting that will dictate the -- there's both completed contract method and percentage of completion method that applies to our Marine business, whereas rail is all upon completion of the railcar. So one of the barges in our backlog is completed contract and the other is percentage of completion method. So there would be a bit of a lumpiness tied to -- based on those 2 barges, tied to when it would hit. And again, on our next quarter's call, we'll give a little more color on that, and of course, that it will also hold true for anything that we ultimately end up booking, as it would depend on whether it's completed contract or percentage of completion. As to margin, one of the things that we try to remind people is that barges are high labor content. So our Gunderson facility here in Portland, they're big -- it is a big absorption of overhead, and typically, margins on barges do exceed our railcar margins with the effect on margin overall far exceeds just the gross margin percentage because of the absorption of overhead.

Our next question is from Brad Delco with Stephens.

Bill, you mentioned something that I thought was interesting. You said pricing is becoming a little bit more challenging in some railcar types and then you went on to -- you talked about the diversification and what you're seeing in your backlog and then how that's a benefit. I was just curious if you could maybe -- could try to put a little bit more color on what's kind of challenging and why -- what's in your backlog is -- that you think bodes well for the current market.

Well, there's been an awful lot of talk, for example, about softness or sudden shift on sand cars. I think that's a grossly misunderstood area because it's actually longer term, one of the great phenomenons of this decade. So I think that, that market, for example, will come back in volumes in 2013. With -- however, the surge of capacity dedicated to that type of car by several builders, we'd expect that those cars that do come out, and we did sell some in our Q3, we booked some orders for sand cars, would be more aggressively priced. That would be an example of a car type where people are equipped to address the market, may have space unlike what situation is in tank cars where space is at premium and margins continue to be high. And so, again, it depends on -- if you look at the car types that are driven by the specific car loading volume statistics that I described, the ones that are weaker would be coal cars, for example, very toughly contended, I would expect, or difficult to negotiate one of those orders. We don't make coal cars, so we're fortunately not in that situation. But I would say, for example, sand cars would be one particular car type that would be more hotly contended.

And then, Mark, maybe for you, the additional tank car line, I would assume you guys are not building that without feeling pretty good about orders and things currently. I mean, is there -- is this going to take or pull forward the timing of your backlog or is this essentially in order to support new orders that you expect to come in on the tank car side and how much is it going to cost to put in a new tank car line?

Right, I appreciate the question because it helps us clarify some of our comments. We did not add on to that line based on anticipated demand. We have firm orders to support that line. And in fact, that line would be substantially committed through our fiscal -- or through our calendar 2013, so -- and we're optimistic about -- very optimistic and feel very strongly that we'll be able to keep those 2 production lines that now we'll have committed to tank cars, very booked, fully booked throughout the cycle. So as far as the cost associated with that, to us, I think, because of this joint venture facility that is probably in the neighborhood of about $5 million, including working capital needs, and this partly gets to what we refer to as our low-cost footprint and something that we can quickly and flexibly bring up to fill demand.

Then, if I could ask just kind of one housekeeping question. I'm pretty encouraged to hear your commentary on expectation for manufacturing margins in the fourth quarter and if I remember correctly, or Mark, you may have alluded to seeing some lower lease syndication in the fourth quarter, which tend to help the margins a little bit. So we should be reading this that seeing the backlog value improves sequentially also means that the margin percent gets better with these type of cars. I mean, what are the offsets to lower lease syndication in the fourth quarter, I guess? What's the positive margin contribution that would be offsetting that?

What would be positive that would offset the lack of lease or lowered lease syndication margin. I appreciate that one of the -- going back to question that Bascome Majors asked earlier about Marine, is that we do have a Marine barge. It's not part of the $26 million that's in backlog. We do have a barge that we'll be launching in July that we will have revenue recognition on that barge. And again to my comments earlier, Marine typically both has a higher margin percentage and a big absorber of overhead, so that will be a meaningful item.

That is not one of the 2 barges that we received the orders for. Those are in addition to that one barge that was already in backlog that's a smaller barge, but...

I guess, so when we see the number of units you're delivering going down fourth quarter and you're talking about the mix improving, it's not like you're losing efficiency with your employees, right, that would be offsetting some of the margins. It's also kind of a part of the question.

So the only thing again is, when there's a line changeover, there is a little bit of down production time and then there's a learning curve efficiency. Even if we built the car in the past, which we will have been -- all the car types coming up that you do have just a learning curve ramp any time you have a line changeover.

Right. But just to add on that, that's just the one line that we're having a line changeover in the fourth quarter, so we are continuing, as we're seeing in the third quarter margins, we're hitting our stride, improving our margin percentage. So we would expect that to continue through as an offset to the lower syndication activity and the changeover.

Our next question is Art Hatfield with Raymond James.

Just back to the tank car capacity buildout, is that going to be incremental to the overall build capacity? Are you switching a particular line -- existing line over to tank car only capacity?

Art, let's say, we have one line running now. We had been running that line at a very low level under the GE contract to 2 a day. We've gone to 4 a day, 6 a day and you can just do the scale, the math, and we'll be hitting as many as 14 in the second quarter of our -- or early third quarter of fiscal 2013. So we're continuing to ramp up the current line and in order to reach the 14, we'll be opening a second line, which is a fairly modest add-on and a reconfiguration of the GIMSA facility, as Mark had described, which would allow us to achieve that higher rate of production. It is possible, according to our manufacturing planning, that we might exceed the level that we've described, take advantage of the temporary boom in tanks, but we are all in -- most of the builders at least, I think all the builders are stretched with production in 2013. So we don't anticipate having trouble selling those cars. I think we just want to produce them with quality and keeping the positive things going that we've got going now in achieving scale.

Okay, that's helpful. Just to kind of add to that, if we think about what you're going to build this year, a little over 15,000 cars and the additional, does that make the assumption? I think the math I did, it would be your ability to do an incremental 1,500 tank cars a year. Is it fair to say that the capacity of the company is now 17,000 cars a year, or does mix change kind of change that thought process for 2013 and possibly '14?

This is Lorie. So I think that is fair to say that theoretical capacity is somewhere around 17,500 or 18,000. But we do like to stick that theoretical in the front of that comment just because, as you say, product mix can change it, so as we talked about today and on the last call, we are going to be changing over to build some of our AutoMax cars next year. Those are a much larger cars. They have a lot more hours in them. So that reduces the overall throughput in our facilities. So that would statistically bring down that unit count on an annual basis.

So it's important not to get hung up on the units in the backlog. It's important to -- and maybe we need to give more color on the valuation per unit in the mix because an AutoMax car, for example, a 3-unit car is upwards of $200,000. So that compares to a sand car in the $80,000 range, and a tank car plus $100,000. They're -- these are all very physically different and have different production functions and -- so the economics of manufacturing is quite complicated. They go much beyond the simple margin rate. It's the production rate you can achieve during the day. It's the dollars per day and it really is an interesting function. But volume and the size of these cars and the type of cars in the backlog really is much more important than the number of cars.

I appreciate that and I do get that. I just wanted to draw some clarity out from you guys on that. Just additionally, and I think a lot of the other questions that I had got answered, but one of the things that's weighed on the equity prices in this sector recently has been concerns that maybe we've reached our cyclical peak in earnings. And I know you don't want to get into too much color about the out year, but can you kind of philosophize a little bit on where you think we're at in the cycle and if you think there's still room for you, assuming the market cooperates your ability to grow earnings going forward?

Art, before Bill philosophizes, I'll...

Mark is trying to gag me.

No, not at all. I think before the -- I said earlier in the fourth quarter, we've given more color for next year during the quarter. But we definitely feel optimistic that this is not as good as it gets and that we anticipate 2013 is going to be stronger than 2012. And we don't think 2013 is as good as it gets either. But I'm going to let Bill speak to...

Well, let's take first operating efficiency. We've made -- we've been very honest and open about the issues we've had, some quality, some paint, some wheel issues that have plagued us during this substantial ramp up to scale which we've now achieved. So one of the first things, I think, looking at Greenbrier, would be how much operational improvement at steady-state levels could you obtain, assuming that we can't continue to grow volumes. But one of our goals, and it should be made very clear, is to grow our volumes and therefore, to grow operating profit dollars. And we want to do that with better working capital efficiency and with efficiency in relation to G&A costs as well. So I think one area that is perceived to be something of a weakness seemingly in reading some of the analyst reports, is our ability to produce higher-margin rates and percentage numbers. Actually, what I'm focused on is margin dollars and producing those efficiently. So I think that the ability to hit our pace to those who have been mildly critical of the margin pickup as we've gained scale, it's very difficult to quadruple your production in the course of the year. That's what we've achieved. We've done it with 14 different car types at this point. I mean, it's an amazing accomplishment our production people have delivered. And if we were to press them today to get that margin rate up, that percentage rate today, we would be suffering in the future. So I think there's a significant improvement that we can get just from operating at scale. As far as the philosophy of what's going to occur in the economy, I would leave that to fortunetellers, but it -- because we're living in a very tumultuous time. There's a lot of gloominess out there, about Europe, there's gloominess about lots of different things. But what we have to deal with is the reality of what we see the marketplace and the fundamentals of rail transportation and those fundamentals are very good, with the exception of coal, which is causing a lot of issues. But in many car types, we see a lot of strength, and I don't see we're anywhere near the end of this cycle at all. I think we're at -- worst, the midpoint of it.

Next question is from Elliott Waller with Jefferies & Company.

Can I have a quick question? If you talk something a little bit about sand cars -- if you could provide us a little color on what your current mix generally looks like in your backlog in terms of car types, I know you mentioned it's been generally 7 [ph] at this point.

Well, we have a growing percentage of tank cars in the backlog as we're ramping up our ability to produce them. And so the -- in terms of our public backlog, we would have a significant large -- much more larger share of tanks, that is as many as 30%. We have smaller percentage of mechanical refrigerated cars, surprisingly small percentage of intermodal cars in the backlog, which we think there will be another round of orders there coming for 2013. Boxcars, there's significant number in our fleet. AutoMax, we're just beginning lines with AutoMax in Europe. We have almost 1,400 cars, which would be about 12% of our total backlog.

Okay, that's helpful. And could you discuss a little bit what the impact of lower scrap prices have done in terms of margins and then how should we think about the impact to the manufacturing business as opposed to the aftermarket business?

It's a great question.

I think on the manufacturing side of the business, lower scrap prices because our contracts have like clauses in them to deal with changes in the steel and the scrap, so that on the manufacturing, it really does not have much of an impact at all. The only thing is that the lower the cost of materials, then the more attractive the car price is to a buyer. But direct impact on margin or sales, it really doesn't. In our Wheel Services business, it affects more or it affects us more closely on the Wheel Services side of the business where we do scrap wheels and generally lower scrap prices or would be a moderate negative to the Wheel Services side of the business. And then higher scrap prices would be modestly favorable as it would be on our leasing business when we go to scrap railcars out of our lease fleet or in the underlying value of a rail car in the lease fleet.

The way I see it, in terms of the total business, if scrap prices go up, it makes the climate and bidding forward on new car construction, which is by far, a much larger piece of our business today, a bit more uncertain. So it's -- we're kind of ambivalent about scrap prices and almost neutral about them because we can -- as Mark says, doesn't have a direct -- we can pass through the scrap prices, on new car construction, but it causes the uncertainty of the bids going forward to be a little harder to deal with because obviously, people push back and they like not to have those pass-throughs. So they bargain for a harder -- for a stronger -- a lower price.

Our next question is from Sal Vitale with Sterne Agee.

The first question I have is on the barge business. You mentioned, I believe, it was 20 barges worth $80 million. Now, those are not orders that you have, that's an order that you believe you will get at some point soon. Can you just give a little bit of timing? And I think you said that you will probably be sharing that with another manufacturer. Can you give us a sense of what the timing of that order might be?

It's almost totally dependent on a permitting process with the Corps of Engineers for a facility being constructed at the Port of Morrow on the upper Columbia River, and then an exit port at Port Westward, which is down on the Columbia River, on the Oregon side, roughly across from Longview, Washington. The permitting process is expected to due end -- near the end of this calendar year. So we would expect determination of the outcome of that project to be in the first calendar quarter of next year sometime. I think that it would be overly optimistic to assume that they might award equipment and terminal construction orders before they got permits for operating the barges and operating the trains as -- through those port facilities.

Okay, so it sounds like -- if anything, we should assume that some of that works to weigh into revenue probably in -- I would assume late '12 or early -- I'm sorry, late '13 or early '14?

Yes, the second half -- I would say the second half of 2013 is what we're kind of targeting for that project. I think we and the other builder are almost certain to participate in the contract, but I want piece in the ad, that's just an example of a number of different Marine activities that we're seeing. There's a resurgent interest in marine barges, witness the 2 barges that we booked during the -- on the current quarter. And we're working on a bridge into 2013. So we are hopeful that we can get other marine orders to bid that possible project. That's a very attractive project because it could be a template for Columbia River barge traffic resurgence and barge business has been down on that -- on the river and this is a particular kind of barge that we can build very efficiently. We're a good builder for this barge.

Okay, and then that's a good segue to my other question regarding the barges. On that particular project, that 20-barge project, it sounds like you just said that the margin profile on that might be better than, say, the 2 barges you currently have in backlog. Is that fair to say?

I didn't say that. Mark Rittenbaum may have said it. I wouldn't say that because I wouldn't want to have my customer hear that. Did you say that?

Not if you don't want your customer to hear it.

Well, now you just said that you're very efficient. You think you would be very efficient at manufacturing...

We would benefit from a learning curve on the start up of the Marine operation, so we think it would be -- we have our -- we think it would be an attractive margin for our operation.

Okay, good. And then if I could just shift gears to the tank car side, if we look at the weekly railcar load data, it seems that the petroleum products is up roughly 50% year-on-year. Now, at some point, that's going to normalize and crude by rail has been one of the main drivers of that. How do you think -- what are your thoughts over the next couple of years? What a more normal growth rate would be for that? And more specifically, in thinking about your tank car production over the next couple of years, how much do you think will be driven by crude by rail growth as opposed to the trend you mentioned earlier of higher chemical production here in the United States due to low feedstock prices?

Well, that's an interesting point. So you've obviously been -- you're obviously well-informed in this area. There's an arbitrage going on between the pricing on Brent crude and the distribution pattern with some of the shale fields and deposits have -- don't have pipeline access. So there's also been a shift in distribution patterns using oil tank cars as opposed to pipelines because of trading practices. So there's always 2 forces driving the demand for -- fundamentally off of the frac and shale oil and gas exploration that's been going on. It's a certainty that, in the next 2 years, we're going to see a surge in parties wanting to acquire these tank cars. That's already taken place. People have put their chips down. But after 2 more years, 2013, 2014, I would expect and we would expect a more normalized level of tank car production as new pipelines are being built. It's not going to be possible, given the nature of the frac-ing dispersion of these fields to build pipelines everywhere. So there will always be some element of new business in the tanks. So we expect this to be about a 2-year to 2.5-year phenomenon, beginning accounting 2013, as one year of the full calendar year as one year. What's going on right now, that it's putting a pause in the sand market, it's equally interesting and the longer term view on sand cars is in some ways more optimistic because this was a long term phenomenon unless it's killed by environmentalists. And it seems to me that, that will come back in 2013 as we see the effects of the drilling rigs being moved from gas exploration to oil gas exploitation in the oilfields. All of this is affected of course by energy prices. The price of oil continues to come down, but have to come down fairly significantly from current levels to affect the drilling for oil in these fields, so we're not terribly concerned about it.

Okay. And then just the last question I have is more a clarification on a question that was asked earlier. So in thinking about the incremental, the new tank car production line that will be -- it will be, I guess, it will be operational, was it by the end of this calendar year? Is that correct?

Yes.

So how should we think about -- so that -- you said that would take your tank car capacity to about 3,000, roughly double it, so call it an incremental 1,500 tank cars. Should we think about that as incremental to your internal thinking on what next year's production would be, or is it really just to replace some of it, just substituting other car types?

It's not a discrete event. The fact is that we're steadily increasing our rate of production in tank cars throughout this fiscal year and we'll reach a crossover point where we will then use the additional line to continue to expand that rate to the annualized level of 3,000 that I mentioned. I expect other car builders are also -- and I know that other car builders are also attempting to increase their output of tank cars because the space is very dear. But generally speaking, I think you're directionally correct with your comments. I have to go back on tank cars to one other item that has to be considered in the market for those cars later on down the line. The petrochemical build in products with gases as a feedstock is going to be very material. There are number of billion dollar projects now in other -- the companies that will be feeding into this market. That will have a positive enhancement in the 2014, 2015 era -- area for some -- for a continued support of the tank cars. So we're not at all thinking the tank car, market is going to collapse or go away or a bubble is being created. We just think that it's not going to be sustainable at the rates that will be -- people will be producing in 2013 and 2014.

Our next question is from J. B. Groh with Davidson.

One for Mark and maybe another one for Mark. Mark, on the CapEx, obviously that swings around a little bit because you've got quite a bit of discretion. But could you just sort of update us on what you view as your maintenance level of CapEx?

I think we would view kind of the end, the refurbishment and wheel refurbishment and parts area, about $8 million to $10 million, and in manufacturing, probably a similar type number. Certainly, what you've seen in this year's numbers in manufacturing represent expansion that we talked about on numerous occasions and so that number is much larger. And certainly, in our Wheel Services business, we have our facility, our North Platte Wheel Services facility that came onboard this year. That was a facility that was built, if you recall, a few years ago. We had a fire at one of our facilities. A lot of that is being built with insurance proceeds that the CapEx is hitting this year too. And of course, on the leasing side of our business, it is virtually 100% discretionary.

Right, and so then you're not a factor -- okay, there's going to be $5 million extra next year, including working capital for the new tank line, it's what you said, right?

Right. I want to clarify. Let me go through -- on leasing, it's 100% discretionary, kind of what we view as replacement CapEx is our depreciation, is that kind of because that go in line our lease depreciation. But I do want to clarify that the $5 million for the additional line that I referred to relates to the CapEx piece of it, and there would be a working capital piece to that as well that would not likely exceed an additional $5 million.

Okay, so that's plus. Okay. And then, in the 8-K that you guys filed on the wheel issue and then you mentioned that you've identified half the cars, is that half of the 550 or so, or is that half of the -- there was 7,800 or so that varied from some mounting standard?

Yes, on the 7,800, those variances, we do not believe represent a safety risk at this stage. We've been monitoring through the auspice of UP [ph] and other railroads with their very impressive technical wizardry as trains go through, so it can see if there's any deviation or variance on wheels. While this was a technical deviation, we have support of the AR at this point, and I don't think that, that's going to result in any action on those units. If we find deviations selectively, we will address those and remove those wheels and replace them. But we think the major risk, which could've been, that this would've spread through a mandatory early warning or recall across the board, it might have been a rather arbitrary thing that could occur, did not occur because frankly our people got ahead of this and really went out and there really is not a safety issue on those wheel sets. So that's very pleasant thing to be able to report and significant because it could be a cloud that was hanging over us. I think we're pretty much out of the woods on it now.

Okay, but -- so when you say that you've identified half of the wheel problem is the past of the 540 [ph]...

[indiscernible] Half the cars that have the wheels that's on them, they have been remediated, the wheels have been changed [indiscernible] rest and...

And that would benefit...

Benefit all the cars, almost all the cars.

That's of the 591, so we've replaced out about 200 of those, not quite 200 of them. But again, we fully reserved for the estimated cost of replacing all 591 of the wheel sets that we've identified.

Yes, some of these are queued up and -- or stored or -- we can't find -- we can't get access to them but the important thing is to identify them and get them queued for replacement. So we're on top of it and we've accrued for it.

Okay. And it seems like you have a pretty accurate guess there with 200 already done, okay.

Our next question is from Ken Hoexter from Bank of America Merrill Lynch.

It's actually Wilson sitting in for Ken. I guess also my question is on the operational side have been answered, but if we dig little bit deeper into perhaps how you guys are thinking about your debt profile going forward. You guys mentioned that you paid down about $35 million in the quarter. Could you, a, specify which part of, I guess, your revolvers or term loans you paid off, and b, kind of how you think about that pay down going forward, especially given some of the, I guess, increased working capital that you got to devote to the new tank car line? Are there any other modifications you're making going forward as far the production does pick up or what have you?

Right. So on the first part of the question, the debt we would've paid done would've been our revolving debt, and primarily, our U.S. revolver. So we have 3 pieces of revolving debt: Our U.S. revolver, our European revolver and our revolver specifically tiered to our GIMSA joint venture facility, and it would be primarily our U.S. revolver that we've paid down. So we will have kind of some competing things going on as we look into 2013. We're still going to be bringing up capacity as Bill referred to, and we'll have and some ramping up production, so we'll have some working capital needs associated with that if the -- so that is going to be a consumer of working capital at the same time. We are looking to have efficiencies, improved efficiencies in working capital usage next year, as we're just starting to hit some of our goals in this area. So I think it's a little too earlier for us to provide a specific guidance on next year other than our goal is to definitely improve our free cash flow in 2013 with the focus to continue to pay down and retire debt. Of course, we'll have our 2013. We have $67 million of bonds coming that have a first put date on them in May of 2013, and we would anticipate now that the need to retire those bonds and we would feel very comfortable retiring them out of our North American revolver, given our liquidity that we haven't made any final determination. That's what we'll do. We know we have the liquidity to pay it off through operating cash flow and our revolver.

Our next question is from at Matt Brooklier from Longbow.

Quick question, where are we in the production line changeover process?

I saw the focus on changeovers. I'm not really sure where that all came from because this is really not something that I am focused on as an issue. So we're -- have you guys been talking about changeovers?

In the fourth quarter, yes, you're right, we are going to -- we do have a changeover scheduled in the fourth quarter. It has not occurred yet but it is in the fourth quarter. And the reason that we identify that is just because it will -- could have an impact on efficiencies and margin as we do that changeover. It's just one of the things, as you say, Bill, we have lots of different lines, lots of car types being built and so just trying to make certain that we clarify that while we are getting ramp ups and efficiencies on existing lines, we do have some changeovers. So that will happen in the fourth quarter.

Okay. So that is yet to happen, but it sounds like you have pretty good conviction it should be at the smooth process, given your gross margins and manufacturing are expected to be kind of flat to maybe up a little bit in the fiscal fourth quarter?

That's correct. And just to clarify, we will also likely have another changeover in the first quarter of next fiscal year.

All right. These are -- as we're producing the same car though, these are fairly routine and then we have one new -- we have one car type that we haven't produced for a while. I think that's the one you guys are focused on, which would occur this year.

Okay. And the changeover in fiscal fourth quarter, that's a changeover for a car type that you're very familiar with, and again, that's part of an easier transition process?

In the first quarter, you mean? Yes.

Okay, and...

In both cases, yes. And in both cases, that would be true.

Okay, good. And then if we look...

I don't anticipate a big issue with that because we keep talking about it. I'm going to go look into that again, but I really don't know why we're so concerned about it. I think it's fairly routine at this point that we -- when we will be able to absorb it without...

Okay, good. Good. And then turning over to the lease segment, you mentioned utilization being down. Part of that story on utilization was coal cars. If maybe you net coal cars out of the lease fleet, can you talk a little bit about what utilization look like sequentially without the coal cars?

Good question.

Yes. Without the coal cars, there would've been virtually no change modestly up. They're the only cars in the fleet that did go into storage and there was a net few that came out. So it would've been modestly up without the coal cars.

Okay, that's good to hear. And the -- and just going back to the total number of cars that came off lease and I think are in storage, is the number 240 at this point?

That's correct, some of those were, during the quarter, most of it was during the quarter and a few more after the quarter.

Okay, and again, the thought process is hopefully at some point we find a new home customer, home for those cars.

That's correct. We are, notwithstanding what's going on in coal, we are optimistic that we will get those back in service in a reasonable time. I think some of the things to remember with a fleet of less than 10,000 cars, these utilization statistics, you have 100 cars or 200 cars that go off rent. It's not going to be a dial mover on the lease side of the business, but it makes the statistics seem a little funky because then you have a 2% decline or a 1% decline in utilization for something that were not a big driver to the business overall.

Right, smaller part of the business. And how much of a drag I guess were the coal cars coming off leasing going into storage on to Leasing & Services gross profit margin? Were you able to separate that out?

Yes. I mean, to give an example, the coal car market, the cars were renting anywhere from $300 to $400. These are used cars. They're renting for $300 to $400 a car, among these are not high dollar value cars. So if you do some math on that and these are cars that just came out this quarter, so if you do some math, you really see that 200 cars times $300 a month is not meant...

In our supplemental information, we have broken out some trailing 4 quarters of comparative data, and just on that point of gross margin leasing, our gross margin leasing went from 48.6% last quarter to 50.2%. So actually, those 2 statistics seem to be somewhat -- offset each other. So it's just not a really big event for us.

Operator, I think we'll turn it back to you now. That concludes our remarks in that time here. And we appreciate everybody's attendance on the call. And I will be happy to follow up with any of you afterwards. Thank you for your participation today. Have a good day.

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