FreightCar America, Inc. (RAIL) Q3 2020 Earnings Report, Transcript and Summary

Greetings, and welcome to FreightCar America's Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded. I would now like to turn the conference over to your host, Joseph Caminiti, Investor Relations. Thank you. You may begin.

Thank you and welcome. Joining me today are Jim Meyer, President and Chief Executive Officer; Chris Eppel, Chief Financial Officer; and Matt Tonn, Chief Commercial Officer. I'd like to remind everyone that the 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 2019 Form 10-K and its third quarter 2020 Form 10-Q for a description of certain business risks, some of which may be outside of 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 2019 Form 10-K and earnings release for the third quarter of 2020 are posted on the company's website at freightcaramerica.com. With that, let me now turn the call over to Jim for a few opening remarks.

Thank you Joe. Good morning and thank you all for joining us today. While it has only been three weeks since our special call to provide you with an update on our business repositioning process, we have continued to make progress and we're excited to provide some additional updates for you today. Let me take a few minutes to recap some of the critical steps we have taken and that we are still in the process of completing to finalize the restructuring. First, we successfully completed the acquisition of the remaining 50% of our joint venture in Castaños, Mexico in mid-October. Production at the new Castaños factory started in July with the first car completed in August, and I'm happy to announce that the manufacturing facility is now fully certified by the Association of American Railroads, or AAR. To the best of our knowledge, this was completed at record time, which was due entirely to the strong team we have at Castaños. As a result, we will be shipping our first railcars from the facility this week. So in short, Castaños is manned with a highly experienced workforce, is AAR-certified, is producing and is now generating revenue. During the third quarter, we also successfully negotiated the early termination of our lease at the Cherokee, Alabama or Shoals facility. As of October, we have no additional ramp due at Shoals and we have agreed to sell and transfer certain basic infrastructure at the facility to the landlord in exchange for early termination. Again, there is no additional capital required as part of the lease at this stage. By early 2021, our entire FreightCar portfolio will be produced in Castaños. We will continue to produce aftermarket parts for our parts business in Richland, Pennsylvania and this is not expected to change. And as I always do, I want to thank our employees at Shoals for their dedication and commitment to completing our remaining orders at that facility. They continue to work with both professionalism and pride. This is what we have accomplished in recent months, but what exactly are we trying to create? First and foremost, let us remember what we are. We do not have a big lease fleet to fall back on, and that isn't what our customers want from us anyway. What we are and what our customers want us to be is a pure-play manufacturer. And given this, we better be the best in the business at it for cost, for quality and on-time delivery performance. We have been working for almost three years now to create the best cost structure in the business and with the recent announcement describing our final transformative steps we believe we are there. No one else in our industry is producing from a single efficient site and on the cost structure that we have in Mexico. Nobody else can start turning a manufacturing process on the volume levels that we will soon be able to do. And in addition, we have almost three years of product reengineering and strategic sourcing initiatives from our back to basics work, which transfer with us to the new footprint. Starting now, we can compete in every product category in which we have an offering. Let us next talk about quality. We have said for some time that our goal is to be the industry leader in quality. Our move to Castaños is fully aligned with this objective. Beyond the careful attention that went into the design of our new factory, we are assembling the very best workforce in the business. Now for the first time, we are located in the heart of railcar manufacturing for North America with access to a large pool of highly trained railcar manufacturing personnel. We are hiring the best period. The fact that a, we delivered the first deal to the plant in July and completed our first car in August; and b, we had our on-site inspection audits from the AAR in September and were formally certified just one month later are a testimony to this. And again, we will start shipping cars to customers this week. By moving all production to Castaños by early 2021, we will have reset our cost base and are multiple steps closer to reaching our goal to become the highest-quality and lowest-cost producer in the industry. Lastly, our industry remains in a cyclical downturn, which has been greatly intensified by a once-in-a-century pandemic. While there are some initial signs of market stabilization and small wins, which Matt will talk to in a few minutes, we cannot be certain how long the downturn will last. As a result, we have done several things to mitigate the risks associated with these external conditions. First, we have accelerated our business repositioning plan as the full shift of production to Castaños provides significant financial and operational flexibility to write out these headwinds. We have lowered our breakeven economics to less than 2000 cars per year and the Castaños facility will be scaled quickly once we see signs that the pandemic and its economic effects are leaving us for good. I would argue we will be in one of the best positions in our industry to navigate this pandemic with this new lean and scalable business profile, and that it will allow us to emerge quickly and from a position of strength when conditions allow. We have also obtained a new asset-backed credit facility, and we are in the final steps of completing a $40 million term loan. I will talk more about the latter later in the call. With that brief overview, I'll pass the call to Chris to talk more specifically about our financial results and performance in the third quarter. Chris?

Thanks, Jim. Turning to financial results. Consolidated revenues for the third quarter totaled $25.2 million, compared to $17.5 million in the second quarter of 2020 and $40.7 million in the third quarter of 2019. We delivered 163 railcars in the quarter, compared to 100 in the second quarter of 2020 and 467 in the third quarter of 2019. As previously noted, our current backlog of 2020 orders scheduled to ship in the year, is heavily weighted to the second half of the year. That said, we shipped fewer cars in the quarter than we expected as we made the strategic decision to shift some of our orders from Shoals to Castaños in order to take advantage of the certification timing and the improved economics of the new facility. This resulted in a push-out of deliveries from Q3 into Q4 and beyond. Thus, we still expect to come within the bottom end of our guidance range we provided for you last quarter, but have narrowed it to 750 to 850 railcars in the second half of 2020. Our gross profit improved to a negative $4.1 million compared to a negative $6.1 million in the second quarter of this year and a negative $5.4 million in the third quarter of 2019. Gross profit performance reflects the previous cost reductions and a mix of higher-margin railcars, which offsets the impact of negative efficiencies due to lower production volumes. SG&A for the quarter totaled $7.2 million, up from the $6.5 million in the second quarter of 2020, but down from the $7.8 million in Q3 of 2019. Sequential increase included several onetime costs related to the deal activity and certain commercial reserves for approximately $1 million. The company expects to have additional SG&A costs related to the new financing in both Q4 of this year and Q1 of 2021. Excluding these costs, the company's SG&A will remain under $7 million going forward. Consolidated operating loss for the third quarter 2020 was $41.3 million, compared to an operating loss of $12.9 million in the second quarter of 2020 and a loss of $36.3 million in the quarter a year ago The sequential increase in the loss was primarily attributable to the $30.1 million of restructuring impairment charges, incurred during the quarter. As a reminder, the majority of these charges specifically related to the exit from our Shoals facility. The charge included $17.5 million non-cash impairment charge to reduce the Shoals' facility lease asset to its fair value a non-cash impairment charge for property plant and equipment of $9 million and employee severance and retention charges of $3.4 million. Furthermore, the final agreement with the landlord was reached in the beginning of the fourth quarter which requires us to write down the lease liability associated with the facility in that quarter in line with Generally Accepted Accounting Principles. As such we will report a non-cash gain related to the lease in the fourth quarter results. Moving to the balance sheet, we finished the quarter with cash and cash equivalents including restricted cash and certificates of deposits of $32.9 million, down from $52.4 million at the end of Q2 and down $37.1 million from the year end 2019. Part of the decline in our cash results is attributed to the build in our working capital. Inventories increased to $60.2 million from $47.1 million last quarter and from $25.1 million as of December 31st, 2019. This increase is related to the delivery guidance we are providing. Capital expenditures for the third quarter 2020 totaled $1.3 million, the majority of which was related to the needs of our Mexican facilities to support our production ramp-up. The company anticipates between $1 million and $2 million of additional capital investments in 2020. This will allow us to complete the first phase of our Mexican production capacity. Now, I'd like to turn the call over to Matt for a few commercial comments related to the third quarter and moving forward. Matt?

Thanks Chris. Our industry continues to navigate the challenges of this cyclical downturn. Key market indicators including rail traffic and railcar storage levels are trending in the right direction, although the economy in general remains uncertain due to the pandemic. Our view is that customer sentiment remained very cautious in the third quarter and thus we don't expect meaningful demand improvement in the near term. Although down from the second quarter, third quarter inquiries represented a greater mix of car types that FreightCar America is well suited to deliver. Our third quarter orders reflect the continued weakness and caution in the industry. We are extremely confident that the move to Castanos will strengthen our competitive position and allow us to earn our share of orders once the market begins to return to some level of normalcy. Despite the pandemic and the associated travel restrictions, we remain focused on staying engaged with our customers. Through the use of video, we have started hosting live and virtual customer meetings from Castanos and have received great feedback on the facility and experienced leadership there. I'll end with a review of our backlog. Our order backlog as of September 30th, 2020 consisted of 1,776 railcars compared to 1,839 railcars at the end of the second quarter. Our backlog has an estimated value of approximately $195 million. We've had no order cancellations as a result of our manufacturing shift and again continue to receive positive feedback from customers about both Castanos and our new business repositioning plan. With that, I'll now turn the call back over to Jim for a few closing remarks. Jim?

Thanks Matt. We've spent the last few weeks talking about the critical business repositioning process and we have had a few consistent questions, so I thought the best thing we could do today is to address these questions on this call. The first question is why now? Why does FreightCar America need to execute such an aggressive repositioning plan in the middle of a pandemic when the market is in the middle of a down cycle? To start, our Back to Basics strategy made significant progress in lowering our cost per car, but it hasn't been enough not in this pandemic and the resulting prolonged industry downturn. We entered 2020 with cautious optimism, but the impact of the down cycle and pandemic forced us to accelerate our plans. We must change our cost structure and we must do so quickly. We cannot afford to sustain the current level of losses and we must put quarters like this one behind us once and for all. This move gets us to where we need to be. And the good news is that through the Back to Basics work and then the JV formation and the Castanos plant start-up, we can do it now as in right now and we can do it without disruption and without giving up future scale and upside. We will just no longer be paying for that scale until we actually need it. The next question involves the structure of our purchase of the remaining interest in our joint venture in Mexico. Specifically, why did we choose to purchase the Gil family's 50% interest in the JV in exchange for approximately 14.5% of our common stock? The simple answer is that Castanos is our future. And with the decision to move all of our production to Mexico, we needed to ensure more complete management control of our soon-to-be only manufacturing facility. We also needed to have complete ownership of the profit stream coming out of it. We did the deal at stock versus cash for two reasons. One, cash must be managed carefully in this time of economic uncertainty; and two, we did the deal at stock because, we believe it was absolutely critical to directly align our interest with those of our partners. As to the amount, approximately 14.5% consider that the JV is where the majority, the large majority of our future profits are expected to be earned. So, we believe strongly that purchasing 50% of the future profits coming out of Mexico for approximately 14.5% of the company equity represents very good value for our stockholders. The third question involves our new term loan and investors obviously, want to better understand, why we need this capital today. There are really two answers to this question as well. One involves risk management and the second is focused on the need for growth capital. In terms of risk management, our cash position is down nearly $40 million since the end of 2019 and the pandemic has clearly elongated the current downturn in our industry cycle. Not only do our investors see that, but our customers do too. In a capital-intensive business like ours, we need strong liquidity and customers need to know, we have a balance sheet that will allow us to fulfill our commitments to them. Without the proper balance sheet, winning business becomes that much harder. But equally important, is when this industry downturn finally reverses and it always does, we need to be in a position to leverage the opportunity. That will require additional capital to ramp up production, build the third and fourth production lines at Castaños and support working capital needs to build inventory. We must leverage the next up cycle to win share and become a larger company again and that's going to need capital to support it. This incremental funding is vital to our plan and vital to our future. Lastly, we've had a common question around our capital raise process. Some investors view the term loan structure as expensive, since it includes a warrant that provides our new lending partner with the ability to purchase up to 23% of the company's outstanding common stock for $0.01 a share. So the question has been, what was the process and why this deal? So let me start by saying, this solution was not entered into lightly. This team ran our process for nearly a year. We went to the market with a plan and asked what it would cost to underwrite it. This plan wasn't backed by assets and it wasn't backed by a strong positive EBITDA stream. Rather, it was focused on value creation and the expectation that we can turn around past negative EBITDA results into real profitability in the future. We reviewed countless proposals and it quickly became clear that every solution requires some degree of equity for whichever partner we selected. The bottom line is this was the best solution available to us. We will not find a better deal and remember that we are in the middle of a pandemic, causing great uncertainty. We need to reposition this business and we need to do it now. We need this capital to complete the restructuring, reassure our customers that we have the same power, back stop the business through the pandemic and fund our future working capital and growth investment needs. So while we understand that this business repositioning plan will require roughly 35% in total dilution for our stockholders, through the JV purchase and the new term loan, it's the right solution. Owning a business that's struggling to compete and isn't growing with limited capital to fix itself, versus a business that has a clear path for becoming the lowest-cost, highest-quality producer in the industry, one that will grow and earn profit at a significantly higher rate is an easy decision. Thus I'm asking all of you as stockholders to vote for our plan by submitting your proxy in support of this new term loan. This is an extraordinarily important decision and we need your support. That concludes our prepared remarks. And I'll now turn the call over to the operator for Q&A.

Thank you. At this time, we will now conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Justin Long with Stephens.

Thanks and good morning. So maybe to start, I wanted to go back to the breakeven commentary you've provided. I know you're lowering the number of shipments that you need to break even. I just wanted to clarify that, as you think about breakeven, is that from an operating income perspective or a net income perspective?

Yes. So that's an operating income perspective Justin. But again the additional net depositary interest you know approximately what that's going to be based on the term scenario. So we're not going to give a specific additional but we do feel that there's not a giant material difference between those numbers up in that net based on the economics of the new facility.

Okay. That's helpful. And as you think about adding capacity at that facility in Mexico over time, what are the signs that you need to see in order to make that investment? And just kind of thinking bigger picture, if we transition to more of a replacement market, let's just say 35,000, 40,000 builds, somewhere in that neighborhood, is that an environment where you would expand capacity? Or do we need to see above replacement demand and production in order for you to make that investment?

Matt, why don't you go first? Justin we're in different locations now but Matt you go first.

Justin, I think you touched on a couple of those factors. Our decision to expand this plant capacity is going to be really supported by a composite of market factors including our customer engagement and the intelligence we learned from them on strategic long-term needs. All of these will be taken into consideration as we put ourselves in a position for the next demand upside.

Okay.

So I think to add to that, there's no one single piece of information that's likely to indicate to us now is the time. We're going to be looking at lots of things as anybody would. What you need – what we need to keep in mind is the way the Castaños plant was manufactured, we can add lines three and four relatively quickly. We're talking months not years. The paint shop is there. The workforce is readily available. And the benefit, as I've already said of what we have right now is during the down cycle we're not paying for what we're not using. But at the same token, we need to make sure we're there when the market does come back because we don't obviously want to miss out on that. And so in summary, we're going to be looking at a whole array of indicators. But keep in mind when we do pull a trigger to add production lines, it's multiple months but it's not a year-plus type undertaking.

Got it. That's helpful. And maybe just lastly from a modeling perspective, I think you mentioned in the prepared remarks that SG&A would be going up a little bit sequentially in the fourth quarter and next year. Any order of magnitude you can share on what that step-up could look like?

Right. Well our view is that it's going to be below where it was this quarter but it was – the guidance that I've given previously was under $7 million. We're not going to give specific timing guidance on some of these one-time charges and when they'll hit, but as we look over going forward, it will – the guidance for this year was under $7 million and we expect it to come down, as we clear out some of these one-time charges. So again, expect it to be under what we thought it would be this year, once the one-time charges have cleared. And we'll give you some more exact guidance on that at year-end, okay?

Got it. Okay. So those were all one-time items. That's good to clarify. Well I'll leave it at that. I appreciate the time.

No problem, Justin. As I mentioned in my remarks, we had about $1 million what we viewed as one-time items in the number this quarter for SG&A.

Okay. Thanks, again.

Our next question comes from the line of Matt Elkott with Cowen. Please proceed with your question.

Good morning. Thank you. Matt, I think you mentioned the backlog. My question is, if we subtract the expected deliveries in the fourth quarter, what percent of the remaining backlog is for 2021 deliveries?

Hi, Matt, it's Chris. I'm just going to say, we're not going to give specific 2021 guidance right now. So we'll give you some better views on that at year-end. But again a big chunk of it as you would guess would be 2021, but we'll give you more specifics at year-end. Matt, go ahead.

No, I just -- you took the words right out of my mouth.

No, that's helpful. But I guess more of it is for 2021 than later?

Correct.

Correct.

Okay. Got it. And Matt, you mentioned that there has been some pockets of improvement and inquiries in cars that you guys have an expertise in. Can you elaborate on that? Is it mainly intermodal? Is there grain cars? Just any more insight on that front would be helpful.

I think without getting into specifics, Matt, there's been pockets of really solid rail activity both in the two segments you referenced intermodal and grain. But I think what we're seeing is a little bit more diversification of car types in terms of inquiries that have been coming through which is some positive news as the industrial economy starts to strengthen somewhat.

Got it. And just maybe a bigger picture industry question. You guys noted, the rail traffic improvement. The cars and storage numbers are coming down which is good. What do you think needs to happen beyond this for a real uptick in demand to happen if you continue on this -- on this trajectory of improving rail industry metrics?

Yes. I think Matt, as talked through on this call storage numbers although they're down consecutively in the last three months roughly 75,000 cars trending in the right direction we still need to make a lot of headway here before that really impacts demand improvement. The same goes for rail traffic. Some sectors are seeing some really great growth. Intermodal is one of those. Grain traffic is pretty strong. But clearly we need to see more cars online. We need to see increased traffic numbers. We need to see really a significant reduction in storage before we start to see a demand curve.

Okay. And then maybe just one last one. I know you guys are going for the lowest-price highest-quality manufacturer approach. Can you give us any type of feedback on how much traction you're getting with customers? I mean is that sinking in with customers? Do you have to do more to get the message across? Or is it just a matter of time you just have to prove it over the course of the next few quarters?

This is Jim. Let me start by answering that one and then I'll perhaps turn it back to Matt. Where we want our business structure to be in support and how we are positioning ourselves in the marketplace are complementary, but it's not exactly the same thing. Our position in the marketplace is to be a pure-play manufacturer. As you know, many people know the majority of railcars purchased every year are purchased by leasing companies. Our built competitors of course compete in that space as well. We don't. And so the idea that a leasing company can come and work with us and know that there's not a competitive or conflicting discussion potentially it resonates very well with our customers. We didn't quite frankly set my conference room and come up with this idea. This was brought to us by the customer base. So our position is a pure-play manufacturer. But because that's our only business principally, we need to be frankly very, very good. We need to be the very best at it. And we think we can do that. And we think what we'll define best is a combination of cost and quality and on-time performance. So that's the position and the supporting, the ideas for the underlying structure behind it. Matt do you want to add to that?

Yes. I'll just add that over the course of the last several weeks, we've conducted multiple customer engagements virtually including plant tours and various customer-specific events and responses have been overwhelmingly positive. And as a result of much of that interaction we've picked up some new customers as well. So the impact of Castanos and the view from customers has been taken very positively.

Great. Thanks Matt. Thanks, Jim and thanks, Chris. Appreciate it.

You’re welcome, Matt.

Welcome, Matt.

And with that we have reached the end of our question-and-answer session. And I would now like to turn the call back over to Jim Meyer for any closing remarks.

Thank you again for your time today. We need your support to complete this business repositioning process and to ensure our future. I look forward to entering an exciting new phase for our company with all of you and strongly believe we have the right plan to deliver strong value. Thank you and have a great day.

This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation and have a wonderful day.