FreightCar America, Inc. (RAIL) Q1 2018 Earnings Report, Transcript and Summary

Welcome to FreightCar America's First Quarter 2018 Earnings Conference Call and Webcast. [Operator Instructions] Please note this conference is being recorded. An audio replay of the conference call will be available from 1 PM Eastern time today until 11:59 PM Eastern time on June 3, 2018. To access the replay, please dial 800-475-6701. And the replay passcode is 448010. An audio replay of the call will be available on the company's website within 2 days following this earnings call. I would now like to turn the call over to Matt Kohnke, Chief Financial Officer of FreightCar America.

Thank you, and welcome. Joining me today are Jim Meyer, President and Chief Executive Officer; and Ted Baun, Chief Commercial Officer. I'd like to remind everyone that statements made during this conference call relating to the company's expected future performance, future business prospects or future events or plans may include forward looking statements as defined under the Private Securities Litigation Reform Act of 1995. Participants are directed to FreightCar America's 2017 Form 10-K for a description of certain business risks, some of which may be outside the control of the company that may cause actual results to materially differ from those expressed in the forward-looking statements. We expressly disclaim any duty to provide updates to our forward-looking statements, whether as a result of new information, future events or otherwise. Our 2017 Form 10-K and earnings release for the first quarter of 2018 are posted on the company's website at www.freightcaramerica.com. With that, let me now turn the call over to Jim for a few opening remarks. Jim?

Good morning, everyone, and thank you for joining us today on our first quarter earnings call. Before I turn the call over to Ted and Matt to speak about specifics of the quarter, I'd like to talk briefly about the progress FreightCar has made over the course of the quarter regarding our Back to Basics operational improvement strategy. While the program is only a few months old, we are off to a good start. We continue to have the talent needed to drive change, come together as one team and embrace and make progress on the strategy and ensure that cultural change needed to address our high cost structure is happening. And despite a persistently challenging marketplace, FreightCar remains intent on focusing our efforts in areas which are under our own control such as manufacturing excellence and our sourcing and procurement functions. We obviously have a long way to go, but the work that is being completed in just the last few months gives us confidence that we are moving in the right direction, and specifically, in our ability to take out the previously announced $3,000 to $4,000 of costs per rail car on a run rate basis by the end of this year. As you will likely recall, on the last quarter call, we announced Back to Basics, which contains three primary pillars: simplifying our structure; developing, training and retaining the right talent across our organization; and implementing disciplined manufacturing processes and lean thinking. The first pillar is rooted in the simplification of our structure, which is a critical need for us to be an efficient manufacturer. One of the key components of this effort was the successful closing of the transaction announced last quarter to acquire the Navistar operating assets and activities within our Shoals, Alabama facility. Since completing the acquisition in February, we've taken full control of all manufacturing at Shoals. This includes paint and fabrication, which makes up roughly one-third of the total production process and controls both the front and back ends of production. While we have only had control of those functions for some number of weeks now, we are already seeing operational improvement from the simplification. The second pillar of our Back to Basics strategy is a renewed focus on improving our talent base and better training our workforce. In our last call, we announced several additions to our team and key leadership positions, and we continue to remain active in our efforts to bring in highly trained professional leadership. In addition to those new leaders, we onboarded roughly 150 former Navistar Shoals employees during the last quarter, and that onboarding effort has gone very well. This has been a great boost to morale, and we are excited to have these folks as part of our one collective team. With this, we are now able to train our employees and run Shoals to a single set of processes and standards. The third pillar of our Back to Basics strategy focuses on the implementation of better tools and processes that will improve the consistency of our workflow and further help us to lower our costs. From these, we have already made a significant reduction in something every plant has, car choices. With this reduction comes a decrease in factory floor idle time and improved productivity. FreightCar also implemented a better model changeover process in the quarter with principles borrowed from the auto industry. This process will allow us to reduce our changeover times, more quickly debug and wrap up faster and with better consistency. As I said, we are still very much in the early stages of Back to Basics and we have a long way to go, but we are all encouraged by this start. Shifting now to our marketplace. Despite the existing softness, we do see modest signs of encouragement. One specifically worth noting is the growing opportunity to participate more meaningfully in the conversion of existing underutilized coal cars into other car types. We are well positioned to capitalize on this opportunity. As we were the original manufacturer of the vast majority of these cars, we own the engineering and are now dedicating lines in both Roanoke and Shoals for this purpose. Given some of the progress we've made regarding productivity and our expectations to better capitalize on coal car conversions, we are cautiously more optimistic in our 2018 outlook. As a result, we have raised the lower end of the range on our delivery guidance for the year. Before I turn the call over to Ted, I would also like to state that we are adopting an imperative level of discipline and change across the entire organization. Effectively executing on Back to Basics while simultaneously maintaining the strength of our balance sheet is part of that discipline. It takes time to change a business and to change a culture, but we are building a great team that is already coming together, and again, I am encouraged. What that, I will turn the call over to Ted to discuss the commercial aspects of our first quarter results.

Thanks, Jim. Moving to our commercial figures for the first quarter. Deliveries totaled 1,094 railcars, of which 891 of these deliveries were new cars, 81 rebuilds and 122 leased railcars. This compares to 1,525 railcar deliveries in the same quarter of last year, of which 1,425 were newly built cars and 100 were leased. Sequentially, railcar deliveries were up compared to the 977 railcars delivered in the previous quarter, with totals comprised of 855 new, 47 rebuilt and 75 leased cars. We received 756 new orders for railcars during the first quarter of 2018, of which 156 were new and 600 were rebuilt railcars. This figure compares favorably to the 68 new orders we received during the same quarter of 2017 and the 52 orders received in the fourth quarter of 2017. Our order backlog as of March 31, 2018, consisted of 2,054 railcars with an estimated total sales value of approximately $143 million. Our quarter-end backlog figure consists of 627 new railcars, 1,124 rebuilt railcars to be manufactured for direct sale and 303 railcars to be leased. As Jim noted, while we are capitalizing on opportunities in the rebuild market -- while rebuilds typically carry a lower average selling price compared to that of a new railcar, these types of orders have served FreightCar well in the past and will continue to be good business for us, particularly through the downturn. Industry-wide non-tank car orders increased slightly and totaled 8,119 for the quarter ending March 31. This compares to 7,343 non-tank car orders received last quarter and 3,225 orders in the first quarter of last year. In addition, other railcar demand fundamentals continue to improve. Rail velocities have been slowing, the number of North American railcars in storage continues to decline and loadings remain strong overall. We are cautiously optimistic by these indicators. Based on our current outlook for the full year, we are raising the lower end of our previously articulated delivery guidance of 3,500 to 4,300 railcars and now guide for a 4,000 to 4,300 railcar deliveries across the full year. With that, I would like to turn the call over to Matt, as he will detail our first quarter financial results.

Thanks, Ted. Consolidated revenues for the first quarter 2018 totaled $83 million compared to $139.5 million in the first quarter of last year and $79.2 million in the fourth quarter. Consolidated operating loss for the first quarter totaled $8.6 million compared to consolidated operating income of $1.4 million in the year-ago period and a $13.4 million operating loss in the fourth quarter of 2017. Consolidated operating income in the first quarter of 2017 included restructuring charges of $1.4 million, while consolidated operating loss in the fourth quarter of 2017 included a contingency charge of $1.5 million. The sequential improvement in our operating results is reflective of improved gross margins and slightly lower SG&A costs for the period. The gross margin improvement was primarily the result of a more favorable sales mix of railcars delivered in the first quarter of 2018. We expect to see our gross margin level improve over the long term as we execute our Back to Basics initiatives. SG&A costs for the quarter totaled $8 million, up slightly compared to $7 million in the year-ago period but down sequentially versus $9.3 million in the prior quarter. First quarter 2018 SG&A includes approximately $300,000 of costs associated with the Shoals transaction. The decrease on a sequential basis was primarily attributable to a contingency charge recorded in the fourth quarter of 2017. Capital expenditures for the quarter totaled $182,000. For the full year, we anticipate our CapEx figures to total approximately $3 million to $4 million. Our financial position continues to maintain a strength with no outstanding debt and $123 million in the form of cash, cash equivalents, marketable securities and restricted certificates of deposit as of March 31. Our operating cash flow -- outflow for the quarter was driven by changes in working capital, including increases in accounts receivable that have been substantially collected and increases in inventory on lease. We will continue to emphasize maintaining a strong balance sheet and a high cash position while focusing on operating cash flow generation and judicious management of our working capital. Maintaining a healthy balance sheet supported by a strong cash position will provide us flexibility on how we choose to invest through any cyclical downturn, including any support required by our Back to Basics operational excellence program. With that, I would like to turn the call back to Jim for some brief closing remarks.

Thanks, Matt. As I reflect on the most recent quarter, I think it's important to summarize a few key takeaways for both our investors and analysts on the call today. First, we've improved our outlook for annual railcar deliveries this year, as reflected in the positive change in our forward-looking guidance. Second, we did see sequential improvement to our gross margin performance. And while it's too early to attribute that to our Back to Basics strategy, it's an area in which we must drive more long-term improvement. And finally, and the good start on the strategy has increased our confidence to deliver on the $3,000 to $4,000 of cost reduction per railcar that we set forth earlier in the year. With that, I would like to conclude our prepared remarks and turn the call over to the operator for Q&A.

[Operator Instructions] Our first question will come from Michael Gallo at CL King.

My question, Jim, is, I guess, twofold. It sounds like it's fair to say that the improvement in gross margin that you saw -- that you really haven't gotten much of the benefit yet for many of these initiatives. Do you feel good about the traction while obviously it's early? Obviously, mix can play a factor, but certainly, the pricing that you had in the existing backlog wasn't all that great. I guess, is this a good sort of starting baseline to think of that you can build the $3,000 to $4,000 off of? And then I was wondering, given the prospect of higher steel and aluminum costs, do you see signs that pricing strengthened in the marketplace at all?

Well, let me start with -- this is Jim, and then I'll turn it over to Matt maybe for some additional comments. Our gross margin improvement this quarter, more than anything, is driven by the mix of what we built. So that's the first part of your question. The bigger part, though, is, I think, we are very pleased at the start to our Back to Basics cost reduction efforts. There's a very big supply chain and strategic sourcing component to that, focused pure and simple on material costs. And to be quite candid with you, the team is partly onboard. We're still bringing in more folks. But in spite of that, they've done a tremendous job. We have a lot of opportunity, and they're doing a great job already at capturing it. So you're not -- there's a gestation period for that, so you're not seeing that certainly in the current quarter. It will slowly begin to pick up pace and flow through the P&L as we get going here. The piece of your question around steel pricing. The -- steel is impacting just about everybody and every industry that does anything remotely close to what we do. It's a challenge for the manufacturer, it's a challenge for the customer. Contractually, like standard practice in our industry, we protect ourselves from swings in commodity movements and steel pricing. But that said, we have challenges every day in the management of that. Let's talk about -- equally important component of it is the lead times that are associated with the volatility and pricing. So it's a full-court press for us every day to keep it from impacting our bottom line performance. But I'll ask Matt, if you got anything else you want to add.

No, I think you covered it very well, Jim.

Okay. Great. And then just a quick follow-up question. The rebuild -- or the conversion opportunity on coal cars, have you been able to size how big an opportunity that would be for you and how much of a potential competitive advantage it gives you that you were the original manufacturer?

Michael, it's Ted. It's a good question. However, I do think it's tough to quantify as each customer individually is going to assess the economics of the rebuild or conversion versus continuing on with what the asset was originally intended for. So it's going to be based on their own assumptions. But we're cautiously optimistic that there is a case to be made for some out there to convert those assets into something that's going to be more productive than a coal car.

Next, we'll go to Matt Elkott with Cowen.

It's good to see the continued strength in the order activity. I'm sorry if I missed it, but can you guys give us some color on the types of orders you got in the first quarter and if you've seen the inquiry in order activity continue into -- the momentum continue into the second quarter?

Yes, sure. It's Ted again. We did state that we received orders comprising of rebuilds as well as new cars in our prepared statements. So it was a mix of several new cars as well as the rebuild order.

But by end market, did you -- intermodal versus open hoppers, covered hoppers, did you...

Yes, we're not going to get into a whole lot of specifics there other than I'll say that the car tanks were generally covered hoppers, open-top gondolas, open-top hoppers.

And has this strength in inquiry in order activity continued into second quarter, Ted?

Yes. We've seen a continued strengthening of inquiries. There are certain inquiries that, I think, we assess higher probabilities to. But there are still a portion of inquiries where we are uncertain as to whether the customer is serious and whether the customer will act. But overall, the inquiries have improved from last quarter.

Got it. And I also noticed that the backlog ASP declined about 8%, it looks like. Can you give us a sense of how much of that is attributable to the deliveries you made and how much of it to the orders you took in the quarter?

It's Matt Kohnke. I would say the biggest impact or driver of the decline in the ASP is driven by the 600 order cars that we took --- received in the first quarter for rebuilds. As you recall, we've commented in the past that rebuild typically has a purchase price of somewhere around two-thirds the value of a new car, and that had an impact on ASP.

That makes sense. And just one final question. On the coal car conversions, can you give us any type of margin insight on those opportunities?

Yes, we don't comment on margins by car type in the past, and we'll continue that today.

Our next question will come from Justin Long at Stephens.

So looking at the backlog this quarter, it declined, but the bottom end of the production guidance for the full year went up. Could you give some more color on why that's the case, whether that's because of orders you've received so far in the second quarter or just better productivity? Some additional color on that would be great.

Ted here. Our full year delivery guidance really is based on the Q1 deliveries, our current backlog and the quality of certain inquiries that we're seeing in the marketplace. So in the end, I'll just leave it at that but state that we feel confident about our guidance that we provided.

Okay. And is everything in the backlog today planned for 2018 delivery?

Yes.

Okay. Also wanted to ask about new railcar pricing and what you're seeing. I'm guessing that steel prices could be causing some inflation. But outside of that change, how has the new railcar pricing environment progressed on a sequential basis?

I would say this is competitive now as it has been in recent quarters. So it's remained competitive. And you brought up steel, that has an impact on it, obviously. So we're just working through all of that. But pricing is still very competitive as we sit here today.

Okay. And then lastly, a couple quick modeling questions, if you can provide any color of. I wanted to ask about the cadence of deliveries over the remainder of the year, what's baked in to the guidance there and then also any updated thoughts on the SG&A run rate.

It's Matt. The delivery cadence over the remaining three quarters should be pretty consistent for each quarter. And SG&A, we kind of see where we've been running the last several quarters, and we try to call out some unusual items on there to help make sure everybody understood the onetime-type events that are happening and driving SG&A.

Okay. But what we saw in the first quarter in SG&A, did that feel like that's a decent run rate going forward? Or is there anything else unusual we should keep in mind going forward?

Yes. The only unusual item that we called out in the quarter was the -- some of the transaction costs.

Right. The $300,000. Okay, great.

We go now to Matt Brooklier with Buckingham Research.

So a couple more questions on the rebuild orders that you took in the quarter, can you maybe give us a little bit of background in terms of what end markets these rebuilt coal cars could end up in? I'm just trying to gauge what's a good fit for a used coal car in terms of transforming it into another car type and where it could eventually end up from an end market commodity perspective.

It's Ted. We have several designs, numerous designs for end market use. Broadly speaking, they are open-top hoppers, gondolas, and in some cases, certain covered hoppers. So we're not going to talk about the specific end use markets of those cars within this past quarter, but I think will suffice it to say it's generally several and -- in type as well as several in market -- end use market.

Okay. And -- I appreciate that answer. And then in terms of the rebuilds, the orders that you took in the quarter, were there any orders for rebuilt coal cars?

No, no. There is no end use market for coal.

Okay. And your sense is that given the current environment that likely you're not going to see a lot of orders for rebuilt coal cars over, say, the next couple of quarters?

That's accurate. I think, longer term, we might see something as that suite continues to age the eastern fleet. But for the next several quarters, I would agree with your comment.

And our next question will come from Willard Milby at Seaport Global.

I believe you talked a little bit about the favorable mix kind of helping out a little bit on the margin front this quarter. And I know we're going through the improvement phase. You're trying to bring out those COGS from the railcars. Kind of holding that aside, if you look at your -- as you look at your backlog and mix going forward, would you expect that the mix is less favorable in the second half of this year, Q2 onward?

It's Matt Kohnke. We're not going to comment prospectively on margins by quarter or the impact of the mix on our backlog. Again, I think, as Jim talked about earlier, we remain confident delivering the $3,000 to $4,000 cost reduction per unit by the end of this year, and that will certainly help to contribute as we exit 2018.

All right. Fair enough. And I believe you said these rebuilds are flowing through Roanoke and Shoals. Is that correct?

Yes.

And probably heavier in Roanoke. Is that the way to think about this?

Yes, we're not going to comment on where we're building -- the mix by plants.

Okay. I was just curious. Are the order levels sustainable enough for, I guess, continued operations without having to consider mothballing Roanoke again?

It's Ted. What I'll say is we now have a wide breadth of product portfolio. It stretches from open-top hoppers and gonds and the covered hoppers, flat cars, intermodal box cars. So we're comfortable that we have a broad enough portfolio right now to sustain the long-term demand in this industry. And so we'll continue to place orders where they make sense to be placed as far as whether it's Roanoke or Shoals.

Well, this is Jim. Let me just add to that a little bit because it comes up in each call, what about Roanoke? It's fair enough and we all know this. With the industry where it is and the size of the business, what it is at the moment, we've got more than enough capacity between the two plants, that's for sure. But for now, our team in Roanoke is doing an absolutely magnificent job of building cars for us. And our focus is to keep selling positions and to keep that plant running and then stay focused and deliver what's in front of us. What we do long term is -- will be decided in the long term.

Okay. And if I could just sneak in one more there. Can you talk about the competitive advantage to being the original manufacturer on these rebuilds, owning the engineering specs ahead of time? And what advantage that gives you when you're going out to find customers or maybe being able to offer more competitive pricing while still keeping a healthy margin on those?

Yes, Willard, it's Ted. I do think we have a competitive advantage when you look at the fact that we were the original builder of many of those cars. We have the engineering knowhow, the manufacturing knowhow. And we also have very competitively, centrally located plants to do those conversions. So that's a big piece of it. And we like where our plants are located. And so just when you look at the total package as well as what I talked about earlier with respect to our broader portfolio of new cars, we have a lot of options to offer the marketplace.

Right. But I guess owning the specs of the car that you build helps you out, I guess, with efficiency planning. Is that kind of the way to think about where you think your competitive advantage is there? The steps to, I guess, disassemble and reassemble the most efficiently, is that kind of how we think about that?

This is Jim. I may just make a comment and just back up just a second. First of all, when there's a customer interest in such a discussion, we're obviously and natural in first place for them to want to come and have that discussion. So that's the first point. Secondly, as the original manufacturer of the vast majority of these cars, we own the engineering, we own the tooling and the fixturing and we own the manufacturing knowledge. And that goes for the original potential donor car as well as it makes it easier for us to engineer the conversion under discussion. Again, we have the starting engineering footprint and the in-house knowledge to do that. So I think we have a couple of natural advantages.

And at this time, there are no other questions in queue.