FreightCar America, Inc.
Q4 2018 Earnings Call Transcript

Published: 27 Feb 2019

[Operator:]

Welcome to Freight America's Fourth Quarter 2018 Earnings Conference Call and Webcast. At this time, all participants are in a listen-only mode. For those of you participating on the conference call, there will be an opportunity for your questions at the end of today's prepared comments. Please note this conference is being recorded. An audio replay of the conference will be available from roughly 1

[Matt Kohnke:]

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 fourth 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?

[Jim Meyer:]

Thank you, Matt. I will begin my comments by stating a strong conviction that I have expressed on multiple occasions in the past. And that is transforming this company with more than a century of history into a competitive and relevant performer in today's macro-centric marketplace is not quick, but it is also not rocket science. Our business is about having the right products to sell, the right cost so as to earn a profit on what we sell and the right plan operations from which we can produce on time, on cost and on quality. This is what our Back to Basics business transformation was all about in 2018 and what it will be about in 2019, the year in which we expect to complete much of this work. Our financial performance this quarter was disappointing, but not dissimilar to that of the third quarter. Also like the third quarter, we continued to make forward progress in our business transformation. We started 2018 by going to work on several areas of the business that needed the change in order to improve our long-term competitive position. This included resolving our significant cohabitation issue at our Shoals facility and thereby taking control of the fabrication and pay operations from Navistar. It also included improving our manufacturing processes that were underdeveloped and inefficient and strengthening our sourcing and procurement functions. Lastly, we made significant efforts to start the process of changing our culture, driven by critical new hires and investing in the exiting workforce. As we gained traction in these areas, we then expanded our focus to also include improvements to our product portfolio and our plant fixed cost. We framed that strategic work as our Back to Basics initiative, was to design and rebuild FreightCar America from the inside out. Once more, our business is about having the right products, the right cost and capable manufacturing operations. We remain steadfast in our beliefs and ourselves to accomplish this work and that there is an important role for us in today's market. Railcar customers want more choices with respect to design customization, delivery and price. And in the case of certain financing companies, they want a choice where their supplier is not also a major competitor. Let me walk you through what we accomplished in 2018 and then after a discussion on the Q4 results, talk about what we plan to accomplish in 2019 and how we expect to be positioned at year-end. First, we started 2018 by simplifying our business structure through the acquisition of all of Navistar's operating assets at our Shoals facility. This included physical assets, the workforce and all existing systems. This transaction allowed us to take 100% control of the operations at Shoals. Shoals needed fixing and you cannot fix what you do not control. In parallel, we started to invest and I mean really invest in training our people and attracting new talent to the team. Last year, in Shoals alone, we hired more than a dozen key Managers’, Directors and Vice Presidents. These people have backgrounds in manufacturing operations, quality and cost management from Toyota, BMW, Danaher and many other equally relevant and well-known heavy equipment manufacturers. As to an example on training, we redesigned the curriculum for our in-house weld school. And by the end of this April, every Shoals production employee will have completed this new program. Collectively, these actions are paying out for the three things that matter most to any factory, safety, quality, productivity. In the most recent 12-month period, our in-plant worker accidents have achieved a 50% reduction for the second consecutive year and our internal quality scores improved by more than twofold. As to productivity, we have said on multiple instances that we will run all of our car types produced at Shoals through our new model launch process one time, essentially treating each run as the first time. The purpose of this is to make all of the improvements necessary to dramatically improve our productivity. We've also said on several occasions that it will cost us to undertake such an approach, but that we would see the results the second time we produce the same car type. We now have two back-to-back examples from which to measure our progress, one build completed and one build in progress. In the first comparison, which was for a relatively long production run, we achieved a 32 hour per unit productivity gain once we completed this relaunching phase. This is a comparison of two builds of the same car type run approximately one year apart. In the second comparison and for a completely different car type, we have delivered nearly three times the number of cars in the first five weeks of the run, with essentially the same labor compared to the first order which went through the new model launch process. This is early data, but our first two comparisons are extremely encouraging. Let me next summarize more specifically our direct cost savings during 2018. Our fourth quarter results showed a little over $3,000 of per unit savings when compared to the fourth quarter of 2017. This is a good start, although the flow-through amount could have been much larger if not for the number of changeovers and product re-launches which prevented us from capturing the gains we are making in labor efficiencies. The $3,000 plus realized in the fourth quarter results is essentially all material. Before turning the call over to Ted or Matt, let me also touch on one other important initiative that we invested in during 2018. We are in the process of creating a new leasing capability within the company. To date, we have put in place excellent leadership and built out many other back office functions. Our goal is not to grow this undertaking to a size whereby we become a competitor to our customers rather we will use leasing as a means to an incremental manufacturing business that would otherwise not be available to us, and to provide a much more efficient means than our own balance sheet to fund these incremental deals. To conclude this recap of 2018, we made progress in addressing many of the legacy issues that have plagued our company for a long time now. We have a lot of work still to do, and I will discuss this remaining work after Ted and Matt walk you through our fourth quarter and 2018 results. Ted, can you please talk us through the commercial results for the fourth quarter please?

[Ted Baun:]

Thanks, Jim. Moving to our commercial figures for the fourth quarter. Deliveries totaled 1,047 railcars, of which 827 were new cars and 220 were rebuilds. This compares to 977 railcar deliveries in the same quarter of last year which included 855 new cars, 47 rebuilds and 75 leased cars. Sequentially, railcar deliveries were up compared to the 888 railcars delivered in the previous quarter comprised of 498 new cars and 390 rebuilds. We received 835 new orders for railcars during the fourth quarter all of which were new railcars. This is up compared to the 52 new orders we received during the same quarter in 2017 and up compared to the 480 orders received in the third quarter of 2018. Our order backlog as of December 31, 2018, consisted of 1,699 railcars, with an estimated total sales value of approximately $160 million, down sequentially compared to our backlog at the end of the third quarter, which consisted of 1,911 railcars, with an estimated total sales value of approximately $167 million. Our quarter-end backlog figure consists entirely of new railcars. Industry-wide non-tank car orders increased to 13,942 cars for the quarter ending December 31. We received a reasonable share of the orders within the product segments where we are strong, albeit at lower industry volumes. More broadly an atypical 74% of the non-tank car order mix in the fourth quarter was heavily concentrated towards a select key car types from which we're not fully competitive. While we are less than pleased with our performance here, we are optimistic that our product development work when complete will give us the ability to fully complete in these markets. We expect to be well-positioned in these categories by year-end. With respect to the industry outlook going forward, we believe rail traffic growth will continue to grow at modest levels but this will be offset by railroad's operating efficiency improvements currently underway at many of the Class I railroads and their desire to take railcars offline. We anticipate railcar inquiry levels to remain at an average pace in the near future and expect to see continued interest in car types such as covered hoppers, flat cars and gondolas. With that, I would like to turn the call over to Matt and he will detail our fourth quarter financial results.

[Matt Kohnke:]

Thanks, Ted. Consolidated revenues for the fourth quarter 2018 totaled $87.8 million compared to the $79.2 million in the fourth quarter of last year and $79 million in the third quarter of 2018. The revenue increase is attributable to a larger number of new railcars delivered for direct sale in the fourth quarter. Our gross margin of negative 4.6% was essentially flat compared to the previous quarter of negative 4.9%. An unfavorable mix of railcars delivered in the fourth quarter as well as accelerated depreciation on the railcars transferred from our short-term inventory on lease classification into our long-term lease fleet was essentially equivalent to the one-time unfavorable $2.9 million of additional material costs we incurred in the third quarter related to the integration of the Navistar sourcing function. The consolidated operating loss for the fourth quarter totaled $11.3 million. This compares to consolidated operating loss of $13.4 million in the year-ago period and an $8.7 million operating loss in the third quarter of 2018. SG&A for the quarter totaled $7.2 million which is higher on a sequential basis as a result of the elimination of our incentive compensation accrual in the third quarter of 2018. Our fourth quarter G&A reflects the more normalized level of expenses going forward. Capital expenditures for the quarter totaled $1.1 million, which was in-line with our expectations. Our financial position remained strong with no outstanding debt and $58 million in the form of cash, cash equivalents, restricted cash equivalents, marketable securities and restricted certificates of deposit as of December 31, 2018. The cash on hand at the end of the year came in lower than we had anticipated due to fewer than expected deliveries primarily the result of the number of changeovers and relaunches as Jim previously described. As a result, we had inventory levels that were higher than we were expecting. We expect these levels to come down as we move through 2019. It is also important to note that we had roughly $65 million invested in our long-term railcars available for lease at the end of 2018, $37 million of which was transferred from our short-term inventory on lease during the fourth quarter. Consistent with our new leasing portfolio strategy, we will determine the best fit of these and future cars in our fleet. As a separate item, we recorded a valuation allowance against our deferred tax asset of $18.2 million or $1.48 per diluted share during the fourth quarter of 2018. Accounting guidance dictates the need to provide a reserve against these assets given the historical operating losses of the business over the last several years. A significant portion of the deferred tax assets relate to net operating losses, which can be carried forward and will offset future income tax expense and cash taxes when we return to profitability. Looking forward to 2019, we expect delivery to be between 2,500 and 3,500 railcars. We anticipate our 2019 capital spending to total between $4 million and $5 million, which will support building out our product portfolio and making necessary facility improvements. With that, I would like to turn the call back to Jim for some brief closing remarks.

[Jim Meyer:]

Thanks, Matt. I want to close today's discussion by further outlining our plan and priorities for 2019. In 2019, we will complete the work started in 2018, and add to it specifically and expanding the product portfolio, and in our manufacturing fixed cost or footprint. This final phase of Back to Basics has already started, and we expect to complete the lion's share of this work by the end of 2019. We are targeting an additional $2,000 to $3,000 of material cost savings per car on a run rate basis by the end of the year. This is on top of the $3,000 of material savings that we achieved in 2018. This new material savings, when combined with our labor productivity goals that we still expect to achieve will put our total direct savings between $6,000 to $7,000 per railcar over the two year period 2018 and 2019. Next, we are continuing to address our manufacturing footprint. Two years ago, our footprint consisted of three railcar manufacturing facilities. In my first call with you, approximately 18 months ago, we announced the permanent idling of our Danville facility, and then more recently the sale of this facility. Today, we're sharing with you that we have finalized an agreement with the landlord of the Shoals facility to shrink our presence, and ramp up to 40% commencing with the end of the current lease agreement in December 2021. Very importantly, this lease agreement extends our control over this world-class facility, and provides us with a level of flexibility as we continue to evaluate future steps. The final key addition to our Back to Basics work for this year is new and/or enhanced products. Our portfolio realignment work is very aggressive. But by the end of 2019, we plan on having a much more complete product portfolio that we can build under the proper cost structure. To give you some perspective on the expected benefit by getting this work right, excluding coal cars, we enter 2018 assessing ourselves to be competitive in 12 car types and expect to end 2019 being competitive in 24 car types. Some of these new car types include several of the higher volume India made models that Ted referred to in his remarks. We are fully aware, and as we complete the job of transforming Shoals and improving our costs overall, our next greatest need is to grow both the size and quality of our backlog. At the end of the day, our customers care about receiving the right products at the right price delivered on time. So that complete Back to Basics will give us this in full. 2019 is going to be another year of very heavy lifting for all FreightCar America employees but there is light at the end of the tunnel that at the end of this year we expect to be poised to compete much more effectively than in the past. As I have said before we are in the midst of an enormous turnaround one that will position our company for continued success in the future. A transformation and the size and scope will not be without hick-ups but we are confident in our direction, our progress to date and the teams that will take us to the finish.

[Operator:]

At this time, we will conduct a question-and-answer session. [Operator Instructions] And our first question will come from Stephens and the line of Justin Long. Please go ahead.

[Justin Long:]

Thanks and good morning. So Jim maybe I could start with the question on the product portfolio to tie into some of the comments you made at the end. You gave the number of car types that you can compete with other manufacturers today and where that's going. But can you help us understand what percentage of the market that you can currently address with your product portfolio and how you see that percentage ramping by the end of this year? And then also I was curious at what point you expect to actually secure orders for some of these new car types and begin successfully delivering them as well?

[Ted Baun:]

Sure Justin, its Ted. Let me jump in and try to address the questions. We're not going to get into the specific car types about what was in that stat but will suffice it to say that it was generally covered hoppers and flat cars. And within that -- those two segments one example is plastic pellet covered hoppers. We have plans to refine our designs in that car type to better compete in the marketplace and that will include work by engineering, sourcing, manufacturing, tooling, jigs and fixtures, investments and facility investments in order to position us better in the long-term. So that's just one example that we can share with you today. Broadly speaking, when complete, we are going to be able to address everything except for obviously tank cars and just a smattering of freight car design types.

[Justin Long:]

Okay.

[Jim Meyer:]

Hello Justin. This is Jim again. So qualitatively speaking the work getting -- that was started last year that will complete over the course of this year in a very qualitative way will take us from being providing partial coverage to much, much closer to full coverage in today's non-tank car market. So it's very significant. I can't quite frankly understate how important it is to get this work done get it done correctly. And please keep in mind this is not necessarily by any means a whole bunch of new railcars getting designed. A competitive car type is defined by do we have the product offering that meets the customer requirements and can we build it under the right cost structure? We need both. In some cases, we have one, but not the other. And then in a couple of other cases, we do have a new car type to do. In terms of the last bit of your order -- of your question how long will it take us to secure future orders on these cars, again we don't get into a lot of specifics on that. But on some of this we've already started taking orders.

[Justin Long:]

Okay. Great. That's helpful. And secondly, I wanted to ask about the order environment today. Trinity mentioned on their call that they're still seeing strong increase, but there's been a bit more hesitancy from customers as it relates to actually placing orders in 2019, with some of the macro uncertainties. Are you seeing that in the market as well? And I think you made the comment that you expect average inquiry levels to continue. So, should we be thinking about your expectation for 2019 that orders stay consistent with what we saw in the fourth quarter?

[Ted Baun:]

Yeah, it's Ted again, Justin. We commented on this in the Q3 earnings call and I still believe it's true and it's probably in line with the source that you referenced. And that is that we do see a number of customers that have sort of been in pause mode and just haven't really made decisions on railcars. A select few have. So not only was the type of railcar highly concentrated, but the customers within those types of railcars were equally concentrated. There's still a broader customer base out there, that we're talking to every day. The sales team here at FreightCar America is intimately familiar with what they want to try to get done. It's just those customers who had a hard time figuring out exactly when and how to make those investments. So, I do think, as we go forward what we're going to see is sort of average inquiry levels. It's not going to light the world on fire by any stretch. But we also don't see sort of a doom and gloom scenario either. We think it's going to maintain an average pace.

[Justin Long:]

Thanks. And I will go ahead and live it that. I appreciate the time.

[Operator:]

Thank you. Then next from Cowen and Company, we go to the line of Matt Elkott. Please go ahead.

[Adam Kramer:]

Hey, guys. This is Adam on for Matt. I guess first question on railcar demand. I was wondering how the inquiring order activity has been thus far this year. Have you received orders in the first two months of the year?

[Ted Baun:]

Hey, Adam, it's Ted. We do not comment on post quarter -- order activity and we haven't done so in the past. So, we're not going to hear. But what I will say is we still see an active level of inquiry. We're actively pursuing those inquiries. And in the end, we're comfortable with the 2019 delivery guidance that we mentioned earlier.

[Adam Kramer:]

Got it. And maybe if you could talk a little bit about the cadence of deliveries by quarter for this year? What is your guys' expectations for that?

[Matt Kohnke:]

Adam, it's Matt Kohnke. Good morning. We expect the first half deliveries to be less than the second half. We see more of an increase starting in the third quarter versus first and second quarter levels.

[Adam Kramer:]

Got it. And maybe if I could just sneak a last one quickly in here, as well. Maybe if you could just talk a little bit about pricing and how it's trended in the last few months?

[Ted Baun:]

Yes. Hey, Adam, it's Ted again. Pricing remains extremely competitive. It's proven difficult to raise prices in the current environment that we're in. Obviously, each car type tells us slightly different story, but on the whole pricing remains competitive.

[Adam Kramer:]

Got. Well, thank you so much for time. Really appreciate it.

[Ted Baun:]

Thanks, Adam.

[Operator:]

Then next from Buckingham Research, we'll go to the line of Matt Brooklier. Please go ahead.

[Matt Brooklier:]

Yes. Thanks and good morning. So you've talked about kind of furthering your lease business, in the lease product. You've done some work in terms of getting the infrastructure kind of in place for that. Maybe you can provide a little bit of commentary in terms of where the lease fleet sits today and where you think you could grow the lease fleet in 2019?

[Matt Kohnke:]

Hey, Matt, it's Matt Kohnke. The lease fleet that we have now is about 840 units that are out there in our long-term lease fleet. The vast majority of them are out on lease today. In terms of the future as Jim indicated we're going to do -- follow a crawl, walk, run fashion. We're going to start with the program in 2019 and then slowly grow that over the next several years. Again, we're looking for incremental volumes that we would -- and opportunities to make railcars that we would not have been able to make in the future. So that is key to our success in that platform.

[Matt Brooklier:]

Okay. And then just as a follow-up if we look at your delivery range of 2500 to 3500 railcars in 2019. How many cars does that incorporate from this from the expanding the lease fleet?

[Matt Kohnke:]

It's a small portion of that delivery right now is a small portion of what we expect to deliver the lease fleet.

[Matt Brooklier:]

Okay. And then just one last one if I could. We've heard a lot about PSR from the Class I rails. Just wanted to hear your thoughts in terms of its potential impact more near-term potential impact. But as you want to share your thoughts on what you think the longer-term impact is on the railcar equipment market feel free to share.

[Ted Baun:]

Sure, Matt. Ted, here. When you look at the railroads they're all implementing some form of precision railroading in an effort to get their operating costs under control. So short term, I think it's a question mark. Longer term it's probably obviously a good thing for freight by rail on the whole. But here in the near-term what we have to assess is what are the benefits that are going to be derived from them implementing these precision railroading techniques. For them it's increasing velocity, it's reducing terminal dwell time and its taking cars offline and putting the onus in some cases on the shipper themselves. So it's a dynamic we're following. I can't give you a real good answer other than we'll just have to see how it all shakes out. But we're staying close with the railroads. And by the way the railroads are still buying equipment. They're just buying it differently. Their shippers are evaluating whether they should step-in and make equipment purchases or leases. So we're staying close to all those parties and monitoring the situation.

[Matt Brooklier:]

Yeah. And just I guess is the potential thoughts on PSR the railroad is pretty more onus on the shippers to manage the equipment. Is that part of the thought process at FreightCar America to grow the lease fleet?

[Ted Baun:]

Yeah. When we pitched the lease fleet, and decided to get into it, we did so really without thinking of precision railroading, and just the merits of the fact that a vast number of shippers within several different categories prefer to lease as opposed to own. So we wanted to be responsive to our customers and provide incremental growth to manufacturing. Certainly, there could be some benefit to more shippers owning cars as a result of precision railroading, and those shippers would probably lease as opposed to purchase. So I think that is a benefit.

[Matt Brooklier:]

Okay, great. Appreciate the thoughts.

[Ted Baun:]

Thank you.

[Operator:]

Thank you. The next from Seaport Global, we'll go to the line of Willard Milby. Please go ahead.

[Willard Milby:]

Hey, good morning, everybody. I wanted to talk a little bit about the footprint in Shoals, obviously noting that you took over 100% of the operations there. What percentage of the actual I guess, square footage are you using right now? You noted potentially shrinking that down up to 40%. Where are you right now? What's it going to take to get it down to that 40% reduction?

[Jim Meyer:]

Well, today we use the entirety of the operation. It's very much then laid out the equipment to occupy all 2-plus million square feet that the building encompasses. In terms of shrinking it, we're very much in the advanced stages of developing railcar useful footprint will be in there. I'll emphasize, we will not be reducing the number of lines. We're going to maintain full capability. And in fact, I think what we'll find out is we'll pick up additional operating efficiencies improvements by investing in the footprint. When you look at this operation, and I don't have the numbers to quote right now, on cars produced per square foot kind of basis, what we outline with our Roanoke facility we're out of line with some of our competitor facilities. So we know we have more space than we need. And so it's not just good economics as -- and as we said equally importantly, it secures the footprint for the long haul, but then it also -- by shrinking it our people will be traveling, let's call it, 40% less distance. Our parts are going to be traveling 40% less distance. So there's operational improvement to pick up as part of this as well.

[Willard Milby:]

And are these, I guess updates or changes kind of baked into some of the capital spending we're doing in 2019? Just kind of curious if maybe part of these changes equate for some of the savings that you're planning with the source coming out of the railcars in 2019?

[Jim Meyer:]

We have a very large project that will make a number of footprint -- a number of changes within the Shoal's footprint. One of which of course is getting on to a smaller footprint. Some of those projects that commence this year do require CapEx, and that is part of the spending. As part of bringing some of the new products online and the enhanced facilitization if you will to build those products more efficiently, there's capital spending, there's a different equipment and layout going in. So we will be doing quite a bit of modifications to the facility this year. And then between now and the end of the current lease period, we will do the overall shrinkage on a plan then carefully thought through approach.

[Willard Milby:]

Okay. I appreciate the color there. If I could shift to the backlog, obviously, having a big as the average price per railcar coming up here, but that might not necessarily equate to profitability, I thought to look back at 2018. I think there were some lumpiness with production, with some more profitable cars getting manufactured in Q2 and maybe some more price competitive cars here in the back half of 2018. As you look at 2019 production and with the pricing of the -- flat pricing of the backlog, is there some lumpiness in quarters related to maybe more profitable cars getting delivered in one quarter versus another? And on that line, you noted overall deliveries weighted towards the second half. Is there any waiting on I guess more or less changeovers in one quarter versus another one half versus another?

[Matt Kohnke:]

Will, it's Matt Kohnke. Good morning. In terms of the lumpiness, yes, you're right. When we deliver railcars, there's naturally going to be some of that lumpiness depending upon the car type and the type that goes along with that. As we said, we look forward, the pricing environment continues to be challenged and certainly we saw that improve much in 2018. The first half of the year what will be challenged with having some more shorter production runs, a lot of changeovers that will impact the first quarter and the first half specifically.

[Willard Milby:]

Okay. And also on the backlog you mentioned two examples of, I guess, second runs of designs. As you look at your current backlog, can you talk to maybe a percentage of that its compressed cars that might be the second run types where you're pulling, I think, you noted the 32 hours of production gains or three times manufacturing efficiencies? Is there kind of a ballpark you can give us there of what's included in the backlog currently?

[Matt Kohnke:]

I think there's a healthy mix of some new car types as well as some second runs or even longer than that. So there's a mix of those cars. I can't really give the percentage exactly.

[Willard Milby:]

Okay. I appreciate the time. I’ll hop back in queue. Thanks.

[Matt Kohnke:]

Thanks, Will.

[Operator:]

Thank you. Then with that, there are no other questioners in the queue.

[Jim Meyer:]

Thank you again for your time today and your continued support in our company. I look forward to continuing to update you on our progress. Have a great day. Thank you.

[Operator:]

And ladies and gentlemen, that does conclude the conference. Thank you for your participation and for using AT&T Teleconference Services. You may now disconnect.