Trinity Industries, Inc.
Q3 2017 Earnings Call Transcript

Published: 26 Oct 2017

[Operator:]

Good day, everyone, and welcome to today's Trinity Industries Third Quarter Results Conference Call. At this time all participants are in a listen-only mode. Please note this call may be recorded. I'll be standing by if you should need any assistance. Today's conference call contains forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995 and includes statements as to estimates, expectations, intentions, and predictions of future financial performance. Statements that are not historical facts are forward-looking. Participants are directed to Trinity's Form 10-K and other SEC filings for a description of certain of the business issues and risks, a change in any of which could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements. It is now my pleasure to turn the conference over to Gail Peck.

[Gail M. Peck:]

Thank you, Leo. Good morning, everyone. Welcome to the Trinity Industries' third quarter 2017 results conference call. I'm Gail Peck, Vice President of Finance and Treasurer of Trinity. Thank you for joining us this morning. Similar to the format we've used on our recent earnings call, we will begin with an update on the Highway Products litigation matter. We will then follow with our normal quarterly earnings conference call format. Today's speakers are Theis Rice, Senior Vice President and Chief Legal Officer; Tim Wallace, our Chairman, Chief Executive Officer, and President; Bill McWhirter, Senior Vice President and Group President of the Construction Products, Energy Equipment, and Inland Barge group; Steve Menzies, Senior Vice President and Group President of the Rail and Railcar Leasing; and James Perry, our Senior Vice President and Chief Financial Officer. Following their comments we will then move to the Q&A session. Mary Henderson, our Vice President and Chief Accounting Officer is also in the room with us today. I will now turn the call over to Theis Rice.

[S. Theis Rice:]

Thank you, Gail. Good morning, everyone. I have previously reported on our appeal to the Fifth Circuit for the False Claims Act judgment in qui tam litigation filed by Joshua Harman pertaining to the company's ET-Plus guardrail end-terminal system. I am pleased to report that on September 29, 2017, the Fifth Circuit published a unanimous ruling that reversed the Trial Court's $682.4 million judgment and rendered judgment for Trinity as a matter of law. Reversed and rendered in this instance means that the judgment entered by the Trial Court is reversed and is now a judgment in favor of Trinity. This ruling affirms that Trinity did not violate the False Claims Act. Our defense in this case was founded upon a simple belief, that we did nothing wrong. We believe the Fifth Circuit panel's unanimous 42-page opinion was well reasoned and thorough, presenting an in-depth analysis of the facts in this case and the controlling law under the False Claims Act. We are proud of having remained steadfast in our belief and are gratified the Fifth Circuit's ruling agrees with us. We are also thankful for the commitments and contributions of our internal and external legal teams that resulted in the successful appeal. Procedurally, Mr. Harman is not without further appellate recourse, although such recourse is within the discretion of the courts and is not a matter of right. We are aware that Mr. Harman has requested and was granted an extension until tomorrow to file with the Fifth Circuit a petition for panel rehearing, or rehearing en banc, a procedure by which all active judges on the Fifth Circuit would review the matter. If the Fifth Circuit denies Mr. Harman's rehearing petition, he could ask the United States Supreme Court to hear the case. Again, however, whether or not Mr. Harman's petitions are granted or denied is wholly discretionary with the respective court. We have also reported previously on other lawsuits regarding the ET-Plus that were filed in the wake of the original jury verdict, many of which remain pending. In a number of these cases the adverse judgment, which is now reversed, is a prominent assertion used by plaintiffs to support their claims. We will continue to vigorously defend the ET-Plus in our company and these lawsuits. As the Fifth Circuit recognized in its unanimous panel opinion, the ET-Plus end-terminal system meets all applicable federal safety standards, and the government has never wavered in its approval of the product. For a more detailed disclosure of the False Claims Act case and the company's other litigation, please see Note 18 to the financial statements in Trinity's Form-10-Q for the period ended September 30, 2017, which will be filed today. Additional information on the False Claims Act case and a copy of the Fifth Circuit's opinion can be found at www.etplusfacts.com. I will now turn the call over to Tim.

[Timothy R. Wallace:]

Thank you, Theis, and good morning, everyone. I would like to begin by taking a moment to thank our stakeholders who have supported Trinity through the company's legal challenges. I'm very grateful for your continued support. The Fifth Circuit ruling is a reflection on Trinity's strong character, our confidence in our products and our business practices, and most importantly the quality of our people. While the ruling is very positive, it's not an end to the situation. We will continue to provide updates as we move through the remainder of the legal process. Our financial results for the third quarter came in ahead of our expectations, primarily driven by the performance of our railcar-related business segments. Bill, Steve, and James will report their views on our operations and financial results in their remarks. For more than a year our businesses have seen a mixture of uncertainty combined with small amounts of optimism in the majority of the end markets they serve. This appears to be the result of the political landscape as well as the economic climate. Periods of uncertainty within an industry combined with oversupply conditions create volatility in order levels and product pricing, adding layers of complexity to the planning and management of a company. During these types of markets, revenues remain relatively stable while margins decrease due to lower pricing. Lower pricing usually incent some customers to make strategic purchases of our product. This occurred during the third quarter. We are very experienced at operating in challenging markets. Our businesses continuously search for ways to reduce cost as they pursue orders to extend their production lines. The flexible mixture of Trinity's business model and culture positions our businesses to respond to a variety of market conditions. Since the Fifth Circuit ruling, the investment community has expressed increased interest in our capital planning approach and corporate strategies. I will share some brief, high-level thoughts in this area. The diversity of our portfolio of industrial businesses, combined with the cyclical swings within our railcar and barge manufacturing businesses places Trinity in a unique capital planning situation. We take a number of factors into consideration as we develop our capital plans, and we strive to maintain a balanced long-term view. Our top priority is remaining operationally and financially flexible regardless of where we are in the business cycle. We strive to maintain a strong and liquid balance sheet at all points of the business cycle so we can respond swiftly whenever strategic opportunities surface. We focus on generating significant cash flow during strong cycles, and we view cyclical downturns, while challenging situations, as opportunities to consider strategic investments. During downturns, we also strive to be financially positioned to continue to grow our railcar leasing business and support internal improvements that are more easily implemented when business activities are slower than normal. Our capital planning also takes into consideration the need to replenish our working capital quickly and efficiently as soon as market demand improves. In addition, we place a priority on returning capital to shareholders through dividends and share repurchases. During the last five years, we've returned approximately $630 million to shareholders, and these activities remain an important element of our balanced approach to capital planning. During the last up cycle, we dedicated resources to expand our railcar investment vehicle platform. We made good progress in this area, increasing the size of our managed fleet, generating a significant amount of earnings and cash flow. From a capital planning point of view, growing our RIV platform requires significant upfront investment. We strive to have a sufficient reservoir of railcars with leases readily available for sales to investors participating in our railcar investment platform. This is a unique factor in our capital planning process. During the past few years, we were deliberate and cautiously prudent with respect to capital deployment while we've worked through our legal challenges and encountered a cyclical downturn. We have been very successful in maintaining a strong balance sheet as we transitioned through the market cycle in our railcar and barge-related businesses. Our capital planning approach is working as intended. The positive ruling from the Fifth Circuit was like a breath of fresh air to our company and our capital planning process. We believe we have additional financial flexibility with regard to capital allocation. Over the years, we have built a portfolio of market-leading businesses of variant sizes, with experienced leadership teams and a unique growth opportunities in compelling end market. We believe the diversity and collective strength of these businesses provides Trinity with numerous options for continuing to create value for our shareholders. Our integrated railcar manufacturing and leasing services platform is strategically positioned across the railcar value chain, providing us the unique ability to serve a broad spectrum of customer needs. This integrated structure provides us with a variety of tangible and intangible benefit. At the same time, our industrial manufacturing and construction materials businesses play an important role in the overall economy, supplying essential infrastructure-related products and services ranging from utility structures to construction aggregates. Our board and senior leadership team engage in an ongoing series of strategic discussions about growth opportunities and corporate strategies. During our discussions, we review the makeup of our portfolio, potential strategic initiatives, and our capital plans with the overall goal of enhancing shareholder value. We're continuing to study and discuss a number of topics and ideas. I will now turn it over to Bill for his remarks.

[William A. McWhirter:]

Thank you, Tim, and good morning, everyone. During the third quarter, the financial performance of the Energy Equipment Group continued to reflect mixed demand conditions for the end markets we serve. For the quarter, revenues increased slightly over last year due to higher volumes in our wind towers and utility structures businesses, partially offset by continued softness in the group's other product lines. The third quarter margins for the group declined year-over-year as a result of pricing pressure. At the end of the third quarter, our wind tower backlog totaled $847 million, providing stable production visibility. As we indicated on our last earnings call, we expect fourth quarter revenues to decline sharply as a customer has exercised their right to defer delivery of some towers until the first quarter of 2018. The delivery will result in a compressed margin as overhead cost remain unchanged with fewer sales dollars to cover those cost. Our revenue run rate will normalize in the first quarter of next year. During the third quarter, demand for utility structures continues to improve. However, projects tend to be on the small side and the market is challenging. Our current order book provides good near term visibility. Long-term fundamentals remain intact based on need to replace aging infrastructure and improve reliability for the grid. The third quarter results for our Inland Barge Group reflect significant year-over-year volume reductions as weak market conditions persist. For the quarter, the group reported revenues of $28 million and a small operating loss. Overcapacity and declines in freight movements that transport goods along the inland waterways are expected to continue to create significant headwinds. During the quarter, we've received orders for new barges totaling $63 million, bringing the backlog to $126 million compared to $91 million at the end of the second quarter. Orders placed during the quarter were for 2018 and 2019 delivery. While we were pleased to extend our backlog, the orders received during the quarter reflect strategic buying decisions by our customers. In our Construction Products Group, third quarter revenues were down 6% compared to last year, while lower volumes in our highway products and construction aggregates businesses, partially offset by an increase in revenues generated by our shoring products business. During the quarter, we had an unusual situation that impacted revenues and operating profit. In August, an equipment failure at one of our highway products' plants negatively impacted our operating profit by approximately $2 million. The strategic investments we have made in our Construction Products Group have aligned with our positive, long-term view of growth opportunities associated with infrastructure spending. And now I'll turn the presentation over to Steve.

[D. Stephen Menzies:]

Thank you, Bill, and good morning. Rail and Leasing Group's financial performance during the third quarter continues to reflect the strength and breadth of our integrated railcar manufacturing, leasing and services business model. We generated sequential improvement in manufacturing margins and a higher level of production, maintained strong lease fleet performance, and continued growing our owned and managed lease fleet during the quarter. In addition, we enhanced our positioning as a premier provider of railcar services for institutional investors by expanding the railcar investment vehicle platform. We continue to enhance the capabilities and competencies of our integrated business model, focused on creating a strong value proposition for both industrial shippers and institutional investors as we penetrate deeper into those customers' value chains. I am pleased with both the Leasing and Rail Group's financial performance in what continues to be a challenging railcar market. While we remain encouraged by industry fundamentals showing signs of stability, albeit weak pricing levels, a number of factors may continue to delay a market recovery. These factors include high numbers of existing railcars, excess new railcar production capacity, and the lack of meaningful industrial production growth or a strong demand catalyst. Our market assessment is based upon a dashboard of strategic market indicators provided by our integrated railcar manufacturing, leasing and services platforms. This dashboard, which captures railcar utilization and lease rate trends in the existing railcar market, new railcar market demand drivers, and railcar valuations in the secondary market, positions us to quickly identify shifts in the market demand. Institutional investors continue to express interest in participating in our RIV platform. While interest remains high, we conduct extensive due diligence to identify investing partners who align with our long-term objectives. During the quarter, we sold a portfolio of approximately $155 million of leased railcars through our RIV platform to a new investor partner, and we will continue to manage these railcars. In addition, we acted as an adviser and arranger for ECN Capital Corp.'s portfolio sale of approximately $1 billion in leased railcars, earning fees as a result and retaining the management of this portfolio too. These transactions exemplify our ability to leverage our asset management capabilities to strategically intermediate portfolios of leased railcars on behalf of institutional investors and develop a meaningful new fee-earning stream. In 2017, we now anticipate full year sales proceeds of leased railcars of between $425 million and $475 million. During the quarter, Leasing and Management Services revenue and profit from operations increased 9% and 7% respectively year-over-year on high fleet utilization, increased asset management fees, and net fleet additions, partially offset by lower average lease rates. During the quarter, we added 1,720 leased railcars to our wholly-owned railcar fleet. Subsequent to quarter-end, we were retained to manage an additional portfolio of approximately 3,600 leased railcars owned by ECN Capital, bringing our total managed fleet to approximately 112,000 railcars, up 10% year-over-year. Lease fleet utilization at the end of the third quarter was 97.3%. We continue to focus on maintaining the high lease fleet utilization while growing the fleet. Lease renewal trends and lease rates remain stable at existing levels. With an average remaining lease term of 3.3 years, lease expirations for the remainder of 2017 and into 2018 are within a consistent and manageable range. At the end of the third quarter our committed leased railcar backlog is approximately $936 million. Lease fleet maintenance and regulatory compliance costs increased 5% compared to the second quarter, and 17% year-over-year. Consistent with our comments on previous conference calls, we are experiencing increased maintenance from regulatory compliance expenses associated with our growing and aging lease fleet. I expect this trend to continue in 2018. I'm pleased with the operating improvements and flexibility of our expanded maintenance services capabilities. We plan to expand our service capabilities and geographic footprint while remaining focused on servicing our growing owned and managed lease fleet and fleets of key customers. Inquiries and orders for HM-251 tank car modifications continue to increase. The Rail Group delivered improved revenue and profit performance in the third quarter compared to the second quarter of 2017, and a 9% unit railcar delivery increase to 4,420 railcars. The flexibility of our manufacturing platform supported the acceleration of previously deferred frac sand railcars into our production plants for the back half of this year. These orders contain strong margins, as they were booked during a period of peak demand, helping to support our sequential margin improvement. We anticipate full year 2017 deliveries of approximately 18,000 railcars, which includes an increase in production during the fourth quarter to approximately 5,800 railcars. Third quarter, industry orders for new railcars totaled 8,670 and represent a broad range of railcar types. Inquiries for new railcars this far in the fourth quarter are comparable to the prior several quarters. Most inquiries we have received are from customers mainly focused on strategic purchases for select growth markets or replacement of aging railcar fleets. The Rail Group received orders for 3,045 railcars with a value of $281 million in the third quarter, representing a diverse mix of railcars serving various end markets for both fleet replacement and select market growth. Nearly 73% of the orders received during the quarter were for lease. Orders for our lease fleet are fully supported by firm lease commitments from third parties. Industrial shipper railcar procurement strategies vary by transaction, which may include purchasing, leasing, or a combination of both on larger transactions. Our integrated business model including RIV platform enables us to provide an enhanced level of flexibility in responding to the procurement strategies. At the end of the third quarter, our new railcar order backlog stood at 25,555 railcars with a value of approximately $2.4 billion. The visibility provided by our production backlog is significantly better than in previous downturns. This visibility is also highly beneficial, it provides an opportunity to build operating leverage with future incremental orders. As we formulate our 2018 production plans and financial projections for both Rail and Leasing Groups, we expect pricing associated with current market conditions to prevail. At the end of the third quarter, approximately 50% of our backlog is scheduled to be to be delivered in 2018. Most of the deliveries in our backlog scheduled for 2018 were priced in the more current weaker market environment. At this time, we anticipate 2018 railcar deliveries of approximately 20,000, with approximately 65% in our backlog at quarter-end. In closing, Trinity Rail continues to demonstrate the effectiveness of its integrated manufacturing, leasing and services business model throughout the business cycle, with a unique ability to meet a broad spectrum of customer needs. Strong cash flows and consistent earnings generated by our lease portfolio, providing more stable operating platform from which to leverage our railcar manufacturing. Our financial flexibility positions us to grow organically while valuing strategic growth opportunities throughout the rail transportation value chain. Our operating and financial flexibility are important competitive advantages for us. As we move forward into 2018, we are well positioned to build upon our success, generating further growth and greater differentiation of our market-leading platform. I'll now turn it over to James for his remarks.

[James E. Perry:]

Thank you, Steve, and good morning, everyone. Yesterday, we announced our results for the third quarter of 2017. For the quarter, the company reported revenues of $974 million and earnings per share of $0.43 compared to revenues of $1.1 billion and EPS of $0.55 for the third quarter of 2016. During the third quarter, we added railcars to our wholly-owned lease fleet with a value of $161 million and invested $19 million in capital expenditures across our manufacturing businesses and at the corporate level. We completed the $42 million purchase of a trench shoring business during the third quarter, which expands our presence in that infrastructure related market. During the third quarter we sold a portfolio of $155 million of leased railcars through our RIV platform to a new investor. Our strong balance sheet provides a great deal of financial flexibility. It allows us to be operationally flexible and opportunistic during challenging market conditions. At the end of the third quarter, our available committed liquidity position was nearly $2.4 billion, which includes our cash, cash equivalents, and short-term marketable securities as well as our available credit facilities. In our press release yesterday, we provided fourth quarter EPS guidance of $0.35 to $0.45 and increased the full year 2017 earnings guidance to $1.41 to $1.51 compared to our full year 2017 guidance of $1.10 to $1.30 that we provided last quarter. The increase in our guidance reflects third quarter results, an increased level of leased railcar sales for the year, fees that we expect to record in the fourth quarter in our Leasing Group, and better visibility with respect to fourth quarter operations. In 2017 we continue to anticipate total company revenues, excluding sales of leased railcars, of approximately $3.5 billion. We expect our Rail Group to deliver approximately 18,000 railcars in 2017, which implies approximately 5,800 railcars in the fourth quarter. We anticipate revenues of $610 million with an operating margin of 11.5% to 12% in the fourth quarter. This leads to full year Rail Group revenues of just over $2 billion with an operating margin of approximately 10%, an improvement from our previous guidance of 9.5%. In the fourth quarter at the consolidated company level, we expect to eliminate $230 million of the Rail Group's revenues and defer $30 million of operating profit due to sales to our leasing company. For the full year, we still expect to eliminate $690 million of revenues and defer $90 million of operating profit from these sales. We anticipate fourth quarter Energy Equipment Group revenues of $195 million with an operating margin of 4.5%, primarily due to a significantly lower level of wind tower revenues recorded in the quarter caused by the timing of customer deliveries as indicated on our last earnings call. For the full year, we now expect 2017 revenues of $935 million with an operating margin of 9.5% for the Energy Equipment Group. We expect fourth quarter revenues of $115 million and an operating margin of 8% for the Construction Products Group. This results in full year revenues of $500 million for this group with an operating margin of 13% in 2017. For the Inland Barge Group, we expect revenues of $30 million and an operating loss of $2 million in the fourth quarter. The full year expectations are for revenues of $155 million and a slightly improved margin of 2.5% during 2017. We anticipate our Leasing Group will record 2017 leasing and management revenues of $195 million in the fourth quarter with an operating profit of $85 million. These figures include $0.07 per share after tax from a negotiated fee related to an order termination for leased railcars. For the full year, we now expect leasing and management revenues of $745 million with operating profit of $340 million, both higher than our previous guidance. The increase in guidance primarily reflects higher advisory and management fees and the order termination fee. These figures exclude sales of leased railcars. We now expect total proceeds from sales of leased railcars of between $425 million and $475 million during 2017. While some railcars with leases are sold directly from the production line, our sales of leased railcars generally are sold from our lease fleet, which emphasizes the importance of our pool of readily available railcars. These include our unencumbered leased railcars as well as those in our warehouse facility. Year-to-date proceeds from sales of leased railcars hit total $254 million, which implies fourth quarter proceeds of between $170 million and $220 million. At the end of the third quarter, the loan to value on our wholly-owned lease fleet was 27%. We realize this is low as compared to the standalone leasing business. This is due to our strong cash flows from operations in sales of leased railcars over the last few years. This has greatly enhanced our financial flexibility during the downturn in a period of complex litigation. The unencumbered lease fleet has been an efficient way to generate earnings without incurring additional interest expense. In the long-term, we expect to increase the leverage of the leasing business as we find strategic opportunity to deploy capital. Our full year 2017 EPS guidance also includes the following corporate level assumptions. Corporate expenses of between $145 million and $155 million, a reduction of $0.03 per share due to the two-class method of accounting compared to calculating Trinity's EPS directly from the face of the income statement, a reduction of $0.06 per share due to our non-controlling interest in the partially owned lease fleet, dilution from the convertible notes of $0.03 per share based on the current stock price, and a tax rate of approximately 36%. In terms of the investment, we expect manufacturing and corporate capital expenditures in the range of $80 million to $95 million in 2017. During economic downturns, we plan for a level of capital expenditures that will keep our plants and corporate infrastructure well maintained, as well as making investments that provide the foundation for future growth. We anticipate adding approximately $740 million of leased railcars to our wholly-owned fleet during 2017, which includes new additions as well as a modest level of secondary market purchases. The net investment in our wholly-owned lease fleet, after netting the proceeds from sales of leased railcars and deferred profit from new additions, is expected to be between $190 million and $240 million. In our press release yesterday, we introduced a 2018 EPS guidance of $0.90 to $1.25. We anticipate deliveries of approximately 20,000 railcars in 2018, approximately 65% of which were in our backlog at the end of the third quarter. The railcars that are in our backlog that we expect to deliver in 2018 have lower pricing than those that we will deliver in 2017. Our earnings guidance reflects a continued level of uncertainty and softer pricing, reflecting supply and demand conditions for products in many of our businesses. Our guidance also includes the profit from sales of leased railcars to our RIV platform of an expected $250 million to $350 million, as compared to the $425 million to $475 million that we expect in 2017. We are providing full year guidance for next year earlier than in prior years. We thought it would be helpful to provide some insight into our current expectations, given the uncertainties in our markets. While pricing for the products in many of our businesses markets remain challenging, we are focused on cost reductions to achieve margin enhancement. The guidance we've provided for 2018 assumes that our level of legal expenses remain in line with 2017's level due to the dynamic nature of the legal process and the various matters pending. However, we are hopeful that these expenses will decline during 2018 as we're successful in reducing the litigation matters. In the past we have found several levers to improve on our expectations of operating performance. We will seek out and execute on these opportunities throughout the year. We will provide updates on our progress and updates to our guidance each quarter as we have more insight into 2018. As we indicated in our press release yesterday, actual results in 2017 and 2018 may differ from present expectations and could be impacted by a number of factors, including, among others, the risk factors and forward-looking statements disclosed in our 10-K. We place a high priority on financial flexibility and balance sheet strength. In a difficult and challenging earnings environment over the last two years, we have enhanced our available liquidity to $2.4 billion. In prior economic down cycles, we have found assets and businesses available for acquisition at distressed prices. With the high amount of available capital and the market seeking investment opportunities, acquisition valuations have generally remained elevated. However, if we identify a highly strategic opportunity, we may be a willing buyer. We have confidence that we are in a strong position today to deploy capital in a strategic manner to create long-term shareholder value. The Trinity management team and board of directors have always considered the company's strategic options through the lens of advancing the long-term interest of our shareholders. This continues to be the case today. Trinity has a strong track record of performance over economic cycles. We've also demonstrated that we have the resources, talent, and abilities to continue to identify and execute strategies that generate shareholder value. I'm confident that we will continue to deliver these types of results. Our operator will now prepare us for the question-and-answer session.

[Operator:]

We'll take our first question from Steve Barger of KeyBanc Capital Markets.

[Steve Barger:]

Hey. Good morning, guys.

[Timothy R. Wallace:]

Morning.

[Steve Barger:]

Tim, you talked about Trinity's capital planning needs. Clearly, you've never had this much liquidity at the bottom of a cycle. Realistically, how much cash or liquidity do you need on hand to prepare for an up-cycle?

[Timothy R. Wallace:]

James, do you want to try to respond to that?

[James E. Perry:]

Yeah. Sure. There's a couple pieces to that. One part would be working capital, and working capital is down several hundred million dollars from where it was back in 2015 at the peak of the cycle. So depending on how quickly we move back to a period of strong demand, you would need to replenish that pretty quickly. You clearly do that ahead of the cash flows coming in as you buy materials to produce the products. And so that's a matter of reserving a certain amount of capital to be sure we can accomplish that. Our CapEx is another place that grows as demand grows. As we get our plans ready for growth, we're obviously at the level of about $80 million to $95 million right now, which is a low point for us as we're focused on some maintenance and replacement type projects at the corporate and the plant level. So you've got a level of CapEx you'll need to invest as you ramp up, you have working capital as you ramp up. And then, as demand picks up as well, the third thing I would mention is that the demand for leased rail cars continues to grow when demand for rail cars overall grows, and we would fund that partially through our cash on hand and then partially through available credit facilities if needed.

[Steve Barger:]

So I guess given the $1 billion in cash and an underleveraged lease fleet, does the board have a target for capital deployment for the coming year?

[James E. Perry:]

Steve, this is James. I would say that's a very dynamic conversation. As Tim and I both talked about, there's a lot of options we see out there for us. We're seeking good acquisition opportunities and other type of strategic things, and we've got some good thoughts. The management team is working with the board on those, but I wouldn't say that there's a target right now that we would talk about publicly.

[Operator:]

We'll take our next question from Justin Long of Stephens. Your line is open.

[Justin Long:]

Thanks, and good morning.

[Timothy R. Wallace:]

Morning.

[Justin Long:]

So maybe to start with a couple questions on the outlook. So first, I wanted to ask about railcar sales. I know you took the guidance up for 2017 and gave an outlook for 2018. But could you talk about how much visibility you have to that forecast? How much of that is committed with RIV at this point? And then also on the guidance, curious what you're factoring in for legal expenses for the full year in 2017.

[James E. Perry:]

Justin, this is James. I'll take this piece just to start. In terms of the RIV sales, we've got pretty good visibility on the guidance for this year. There is a range because we've not finalized the portfolios of cars that we'll sell in the market, primarily to RIV partners so there's a bit of a range. At this point we've given you a range lower for next year. It's roughly kind of where we thought we were going to be this year earlier in the year. So it's a reasonable range where we do have agreements with our RIV partners to look at that level of investment. As we've talked about before, those levels can grow if there's more appetite from RIV investors. And as we've talked about in the past, we're very specific when we work with potential RIV partners and having good long-term aligned interest, as Steve talked about in his remarks as well. So that can be fluid and dynamic and we'll update that as we have more dialogue as we get deeper into the year. But that's kind of how we look at things right now. In terms of legal expenses, we have not disclosed that exact figure, of course. Most of that sits within our corporate expenses. And what I did mention in my remarks is that our guidance right now does not assume a change in those at this point. We are hopeful and optimistic that as we get through some of the litigation matters that are pending that those expenses can come down. But for now the guidance assumes a steady level.

[Operator:]

Our next question is from Bascome Majors of Susquehanna Financial Group. Your line is open.

[Bascome Majors:]

Yeah. Good morning, and thank you for taking my question here. So to get back to Steve's question, your $2.4 billion in available liquidity, I mean that's roughly half your market cap today. And Tim and James both talked about that flexibility being an advantage for you guys as it lets you be opportunistic in the weak markets like you're seeing in a lot of your historical businesses today. From that context, I'm curious is the lack of more material capital deployment over the last couple of years as this liquidity has been there for most of that period, is it more a function of some of the potential cash calls related to the legal situation? Or has it been a greater function of just not finding the right opportunity to make that move?

[Timothy R. Wallace:]

This is Tim. I'll respond to it. As far as our objective, as I stated, when we go into a downturn is we want to be in a strong position. When we entered into this downturn – from a balance sheet point of view. When we entered into this downturn, we stated that we felt like we were preparing for an extended downturn and we wanted our businesses to remain operationally flexible as well as strategically flexible to be able to conduct business almost as usual. Of course, you have to reduce your forces accordingly. But at the same time, we wanted to be able to try to extract as much operating leverage as we could and then we wanted to be prepared for strategic opportunities that surfaced. And we've done a few acquisitions over the last couple of years, and we're ready, and we've looked at a whole lot of them. And we continue to look at a lot of them, and historically, the company has made strategic acquisitions during the down cycle. Not knowing how long the ongoing litigation was going to last as well as how long the downturn was going to last, we have tried to position ourselves, and what I described as a cautiously prudent position. Now that we have a better read on our litigation, I think it allows us to reconsider our capital structure and our capital position and we've been having conversations with our board on this. And so I assure you that we will be putting our capital to use as the market improves for our products, and as our litigation decreases in a much more effective way.

[Bascome Majors:]

Understood and I appreciate that and I realize there's a lot of opportunities out there. Can you help us think about the kind of opportunity whether it'd be M&A or even your own shares that you need to see or you're looking for in those conversations to get perhaps more aggressive on that front?

[Timothy R. Wallace:]

Well, in the acquisition area, you think larger acquisitions that are out there. And we did a large acquisition in relative size to us back – three years ago, and we have also been looking at other larger opportunities that are out there. And then, of course, as I said, we always look at the opportunity of returning cash to shareholders. In the last five years, we returned $630 million back to our shareholders and we always have ongoing dialogs in that particular area as well. When you're in a down cycle, a company can quickly – and you have the order of magnitude of litigation that we had, a company could quickly kind of shift into a crisis mode. And, fortunately, with the balance sheet that we had, we really didn't switch into a crisis mode, we stayed in an opportunistic mode. At the same time, we've been making quite a number of investments in our business with the infrastructure with the idea that when the business volume improves that we're going to be leaner and we will be more streamlined to be able to pursue these activities. An example of that is, is that our computer systems that store the records of the orders and our inventory and our enterprise-wide manufacturing systems, we're in the process of a multiyear upgrade of those systems that we have. And during downtimes, that's a very appropriate time to do that. It's kind of like a business that has an off season, but then gets into a maintenance mode. So we have our people focused on a large number of areas, and we've been able to maintain strategic thoughts and a lot of strategic discussion during the down cycle, and this is very unusual for my experience here with the company. Over the 42 years, we've never had a downturn where our balance sheet was as strong as it is. And in many eyes, I guess, people are looking at it and thinking that we overreacted, but this is a very high quality problem to have. And when you have the quality of the people and the infrastructure that we have, I feel confident that given a period of time, we will work through this positive situation that we have.

[Operator:]

Our next question is from Gordon Johnson of Axiom Capital.

[Gordon Johnson:]

Hey, guys. Thanks for taking the question.

[Timothy R. Wallace:]

Sure, Gordon.

[Gordon Johnson:]

Just looking at the leased railcar sales this year – year-to-date for over a year cash proceeds $160 million versus $37 million last year, or up 325% year-over-year. Over the same timeframe, respectively, the gains on these costs, however, $40 million next year versus $13.5 million, up 198%. So less than the 325%. Is it fair to say you guys are selling a lot more out of your fleet for less of a gain? And should we expect this to continue into next year? And then, I have a follow-up.

[James E. Perry:]

Hey, Gordon. This is James, and we could go through the numbers offline. The numbers don't seem quite there. The cars we've been selling this year, the margins have been kind of in the low to mid 20% level for the most part. We saw in the peak cycle that some sales are a little higher than that. Really where this depends on is we've been working with our RIV partners, the portfolio of cars we're selling, how new they may be, what the leases look like, the mix of cars, those types of things. So, it's hard to compare one quarter to another quarter other than peak pricing with long-term leases and those kinds of things versus some of the portfolios we're selling today. But these are good quality portfolios that we're selling to our RIV partners and we're happy to like I said earlier go through some of the numbers offline but that kind of resets a little bit of where we are.

[Gordon Johnson:]

Okay. That's helpful. And then in your press release I noticed that you guys talked about an adjustment for an order termination negotiated. Is it fair to assume that it – was that a cancellation or is it something else? And has the industry seen an increase in cancellations or is this something that maybe we're looking at the wrong way?

[D. Stephen Menzies:]

Gordon, this is Steve. Well, I can give you the specifics of that customer's issue. They had a strategic matter that just shifted the businesses that they were developing and I really see that as a unique set of circumstance with respect to that cancellation. We've not had other cancellations in the last few quarters and I'm not aware of any discussions going on today for future cancellations. So I really view that as a one-off situation.

[James E. Perry:]

And as a reminder, Gordon, this is James. That's not a cancellation provisions within that agreement, it was a negotiated agreement. We came to it at $0.07 to the fourth quarter. So, well compensated for that arrangement.

[Gordon Johnson:]

Helpful. And then last...

[Timothy R. Wallace:]

Operator?

[Operator:]

Yes. Our next question actually is from Matt Elkott of – I should take that back, Prashant Rao of Citigroup. Your line is open.

[Prashant Rao:]

Thanks. Thanks for taking the question. I wanted to circle back, Tim. I appreciate the high level comments and all of the commentary you've given on the capital deployment and allocation. I just wanted to drill down a little bit on the return to shareholder portion and specifically on buybacks, so I get sort of a two-parter. One, since the reversal of the appeal came down, have you – has there been incremental share buyback activity and where are we on the $160 million on the current program? And then I guess broadly speaking, that might seem like something that might be easier to do incrementally. Where is the conversation on that particular topic specifically with the board? And how should we be thinking about timing and how that might play into a total capital allocation package?

[James E. Perry:]

Yeah. Prashant, this is James. Let me handle share repurchase. One specific question you asked was have we been buying since the end of the quarter? I'll mention a couple of things. One, we report our purchases at the end of each quarter. That ruling was literally after-hours on the last business day of the quarter. We take ourselves into a blackout period from the end of the quarter through now when we release earnings given that we know information that the public does not with our earnings, of course. So in the last three weeks I can tell you that we have not been buying shares and we don't talk about what our plans may be. As Tim mentioned, it's certainly one of the things that we can utilize as we go through our capital planning process with the board. We do have the $162 million available through the end of the year. We renewed that a couple years ago, but we don't forecast or project publicly what we may do in terms of share repurchase in future periods.

[Prashant Rao:]

Okay. That's helpful. I guess maybe put it another way, is there any sort of color on where that fits into the dynamic of the dynamic conversation you're having with the board I guess is – would maybe be helpful.

[James E. Perry:]

I would say – this is James again, Prashant, I would it's a part of the conversation. Like I said, it's not something that we necessarily do at every quarter. It's a key component of our capital planning, as we talk to the board. And we've historically bought shares consistently year-to-year, it may move quarter-to-quarter. And I talked about we have periods when we're announcing earnings that we don't buy back shares. There's also transactional things that come up from time to time that we take ourselves out of the market when we know something's coming, like last quarter with the Element transaction coming near the end of the quarter. That was a transaction we knew would generate some earnings for us and was non-public information. So we're cautious in that respect, but again, it's a key part of what we do talk as senior management team with the board about, but hard to project where it fits or what portion of the capital allocation that may be in the future.

[Operator:]

Our next question is from Mike Baudendistel of Stifel. Your line is open.

[Michael James Baudendistel:]

Thank you. I was hoping you could help me build a bridge with the EPS from 2017 to 2018 and I have written down railcar pricing is down next year, asset sales are down next year, don't have the order termination benefit that you had in 2017 but railcar delivery volume is up. Can you just sort of put those in buckets of which are the most significant impacts and are there any other factors that I'm not thinking about?

[James E. Perry:]

Yeah, Mike, this is James. I think you've hit quite a bit of it but I'll try to help a little more. We've not given a lot of detail as to things like margins in our specific groups but you clearly hit on the current projection for sales of leased railcars. With the $425 million to $475 million projection this year and looking at $250 million to $350 million next year, there's a pretty sizable drop in that and you'll have to assume what margins you put on that. But a relatively same type margins, that's a mid teens EPS type change, $0.15 or so just at the midpoints of those levels. So that's one piece. Another piece within leasing along the same type lines is as we talked about we did report a fee in the third quarter. We've not quantified that but it added to earnings for the ECN sale that Steve mentioned of the railcars to another RIV partner. And then we're recording a $0.07 per share fourth quarter fee that we negotiated due to the order termination that Steve just mentioned. So those aren't recurring type things that we talk about necessarily. And those things add up to kind of why you have better operational results that we're projecting for 2017 within leasing. Beyond that, I think you've hit on it as we've talked about pricing pressure, and as you look at the rail volume, we've talked about pricing in the backlog that we're delivering in 2018 is lower than what we've been delivering in 2017. We talked about we've pulled forward some nice margin frac sand cars specifically that were taken in the top of that market several years ago. So that's one reason. Another piece, as Steve mentioned, we have about two-thirds of our 2018 projection already in the backlog. So we have assumptions on filling in that other third for later in the year. And then when you see pricing pressure on the railcar side, you see pricing pressure on the leasing side as we look at renewals and new leases. So without quantifying all of the exact pieces, those would be the larger areas that I would look at as you look at headwinds that we have with supply and demand conditions.

[Operator:]

Our next question is from Matthew Brooklier of Buckingham Research.

[Matthew Brooklier:]

Hey. Thanks, and good morning. So I had a follow-up question in terms of your guidance for next year within Rail Group. I understand you've talked about the volume being up. You've also talked about ASP being down. I think that's a function of – and you've highlighted a function of the orders you've taken over the past 12 months. I guess my question is, does your 2018 guidance, does that include expectations for pricing on new railcars to get worse from here? Or is it more a function of just on the orders you've taken at this point in time? Because it feels like there's some disconnect. We've been kind of stable over the past, let's call it, four quarters from a railcar, at least on the lease side of things. And it almost sounds like maybe things have gotten a little bit better on a sequential basis in the third quarter. So I'm just trying to get a feel for if your guidance contemplates current pricing getting softer as we move into next year? Or is it just more a function of the ASP and comparing it from 2018 to 2017?

[D. Stephen Menzies:]

Yeah. Matt, this is Steve. I think what I've said is that we really have seen the market dynamics stabilize, but it's at fairly weak levels. And we expect it to be flat going into 2018 from a pricing standpoint. Keep in mind, when you look at lease rates that there's roughly 20% to 25% of the North American fleet is idle today. That has a big impact on renewals. We're also renewing railcars coming off of some fairly high lease rates of cars that were booked in the last three to five years. And then you also have a manufacturing industry, a railcar manufacturing industry that arguably is operating somewhere around 50% of capacity. So what happens to any product when that industry is operating at that type of capacity utilization, you have fairly weak pricing. But I will say in the last few quarters it seems stable and we would expect in our projections that we've looked at fairly flat pricing going forward into 2018.

[Operator:]

Our next question comes from Matt Elkott of Cowen & Company. Your line is open.

[Matt Elkott:]

Good morning. Thank you for taking my question, guys. I have a question on the rail segment margin in 2018. Or in general actually, we're about two years into a down cycle or more than two years into a down cycle. I was just wondering if you can give us your thoughts on where you see the new margin floor is for that segment. So far in this down cycle you've done a good job raising that floor, and I think this is – one of your ongoing objectives is to keep raising that floor in down cycles.

[James E. Perry:]

Matt, this is James. I'll take that. Yeah, we're not providing specific guidance for 2018 or future years for any of our segments in terms of margin, it's embedded in the guidance. The guidance we have provided a wide range because we know there's some variables within that range and levers that we have available to us and what the market provides to us in that respect. We always seek to achieve higher efficiencies. The Rail Group has done a tremendous job of that this year in a difficult market, given the different orders that we've had and the different backlog that we've been delivering in achieving nice margins like we talked about in 10% this year. But, yeah, we'd like to think that as we've talked about in the past, higher highs and higher lows in different businesses for the company overall. But we're not going to get into specific margin floors or ceilings or those kind of things right now.

[Matt Elkott:]

Got it.

[D. Stephen Menzies:]

And just to add on to that. I think we've got an opportunity given the backlogs that we have, that incremental orders have an opportunity to be produced at good margins, which is a little different position than we've been in compared to prior downturns. So I'm optimistic that additional orders that we can do well with, we'll just have to see what the market provides.

[Matt Elkott:]

So just because you're guiding for higher deliveries and the implied margin from the EPS guidance would suggest lower rail segment group margin. We shouldn't necessarily infer that from the delivery and EPS guidance for 2018?

[James E. Perry:]

Again, we've not given that detail. We've told you the pricing's lower and, obviously, we're going to work on efficiency with margin. But generally speaking, we know it's in the backlog for next year's deliveries on two thirds of it are already sold and we know where the pricing is. So we've given you today's expectations and we'll update that as we proceed through 2018.

[Matt Elkott:]

Got it. I just have one more question. Some of the Class 1s are talking about increased investments in equipment over the next couple of years. CN mentioned it, Norfolk Southern, I think they've talked about homogenizing their boxcar fleet from 70 types to something like 17 types. So this could eventually improve utilization on the long-term and present a headwind for railcar demand. But I would think in the intermediate term, it could be a driver. I'd love to hear your thoughts on this and whether the rails are starting to have this conversation with the builders.

[D. Stephen Menzies:]

Matt, this is Steve. We're obviously very involved with all the Class 1 railroads and short line railroads and trying to understand and assess their needs for equipment. You mentioned boxcars specifically. That's a very old fleet that needs to be replenished in the long run. So we're keen to look at those opportunities. Typically Class 1 railroads are the quintessential example of strategic buyers. They're looking to make their big purchases at or near where we are in the market cycle. So that's something that we would expect from our position to see happening, and perhaps that's a precursor to an improvement in the market from there.

[Operator:]

I'd be happy to take a follow-up from Gordon Johnson of Axiom Capital as his line was cut off. My apologies. Mr. Johnson, your line is open.

[Gordon Johnson:]

Hey. Thanks for taking the follow-up, guys. I guess from my standpoint and a more positive note, looking at some of the different areas you guys service, sand, I guess the farm area, bulk commodities, et cetera, can you talk about currently where you're seeing the most strength? And conversely, where you may be seeing some weakness, if there is any?

[Timothy R. Wallace:]

Steve, why don't you hit on that topic and then, Bill, you fill in?

[D. Stephen Menzies:]

Sure. This is Steve. There's certainly been a lot said and written about fracking and the demand for sand. And certainly the customers we're speaking with, we see that demand for the movement of sand to continue to be strong. And I would also say that we're seeing significant investment in the petrochemical sector, particularly in the Gulf Coast area. So those are a couple areas where we see good strength. Much of the demand for the movement of agricultural products is dependent upon the strength of the dollar and export policies. And that seems to shift pretty regularly. The chemicals business seems to be fairly stable and we're obviously involved in that with our tank car fleet. But I think the point you make is an important one, Gordon. When we look at our rail business, we really think about a number of different markets that we serve, each of which has different demand drivers and characteristics that we focus on, and all those have impact on the demand for railcars. But those are just a couple of the highlights. Bill, you want to fill in?

[William A. McWhirter:]

Sure, Gordon. So from my perspective on the Inland Barge side, the manufacturers associated with downstream chemicals is the one kind of bright spot, if you will. And those tend to be in smaller barges, 10K (01

[Operator:]

We will conclude our question-and-answer session with Bill Baldwin of Baldwin Anthony.

[Bill Baldwin:]

Hey, good morning.

[Timothy R. Wallace:]

Morning.

[Bill Baldwin:]

First of all, Tim and your team there, I want to congratulate you on a outstanding job you all done in navigating through difficult markets and this challenging legal situation.

[Timothy R. Wallace:]

Thank you.

[Bill Baldwin:]

Because I've been around Trinity a long time and this is very, very good. Bill, on the – on the highway product side, I know you're not completely green-lighted there but what are your – what is the number of states now that you can sell your product in and what's your plans as far as going forward on that issue?

[William A. McWhirter:]

Yeah. I think two important markers. So one is the states I think are 21 and 22 states that it's accepted in. But the important marker is that that product is a 350 designed product, and 350 products will be sunset out towards the summer of 2018. And so we already have a product that meets the new criteria, and that product is available on the market today and it's being purchased on the market today. So I think you'll see the phase out of a phase in, kind of as the summer goes into 2018.

[Bill Baldwin:]

Okay. So you'll be qualified then to sell in all the states that you'd previously been in prior to the litigation then?

[William A. McWhirter:]

Yeah. We're working on qualifications with all those states but we have a real good run on it and it's a really nice product.

[Bill Baldwin:]

Okay. Super. Secondly, on the acquisition in the shoring area. Was that a geographical type acquisition or product, did you supplement your product exposure? Exactly what was the strategy behind that acquisition.

[William A. McWhirter:]

Yeah, we actually ended up with more of what I'd call a bolt-on. It was producing the product in the same state but it did have another brand. The shoring products are sold by brand so it allowed us to expand our brand offering and they had customers that had a little broader reach than some of our current customer base. So good customer expansion, good brand expansion and we can get a little bit of synergy running the two facilities as closely together as they exist.

[Bill Baldwin:]

Roughly what is your geographical reach now on your shoring products? What geographical areas do you market in?

[William A. McWhirter:]

Yes, it's really the United States but I would say a little less to the western part of the United States but we do ship internationally, as well. We ship a little bit down to South America. But definitely ship products into Texas, ship products into Florida, all the big Southeast and Northeast states.

[Operator:]

And once again, that does conclude our question-and-answer session. I'd be happy to return the call over to our host for any concluding remarks.

[Gail M. Peck:]

Thank you, Leo. That concludes today's conference call. A replay of today's call with be available after 1

[Operator:]

This does conclude today's Trinity Industries Third Quarter Results Conference Call. You may now disconnect your lines and everyone, have a great day.