Greenbrier Companies Inc (GBX) 2004 Q2 法說會逐字稿

Welcome to the Greenbrier Companies second-quarter 2004 earnings release teleconference. Following today's presentation, we will conduct a question and answer session. Until that time, all lines will be in a listen only mode. At the request of Greenbrier Companies, this conference is being recorded for instant replay purposes. At this time I would like to turn the meeting over to today's conference host, Mr. Mark Rittenbaum, Senior Vice President and Treasurer. Sir, you may began.

This is Mark Rittenbaum and I am joined this morning by Bill Furman, our CEO. Welcome to our second-quarter conference call. After we review our earnings release and make a few remarks about the quarter that just ended and the outlook for 2004 and beyond, we will open it up for your questions.

As always, matters discussed in this conference call include forward-looking statements within the Private Securities Litigation Reform Act of '95. We will describe some important factors that could cause our actual results in 2004 and beyond to differ materially from those expressed in any forward-looking statement made by or on behalf of Greenbrier. With that disclaimer, I'll talk about the quarter that just ended February 29, our second quarter where we reported net earnings of $2.2 million or 15 cents per diluted share on revenues of 167 million. This compares to net loss of 1.2 million or nine cents per diluted share on revenues of 119 million in the second quarter of fiscal 2003.

As will be discussed in greater detail, the quarter that just ended had a number of special or unusual items, both of a positive and negative nature. The balance of the fiscal year should have a lesser number of these unusual and nonrecurring items to it. The Company anticipates continued profitability through the balance of fiscal 2004.

During the quarter, the company decided to complete the recapitalization of its European operations with internal funds. This final negotiations with our Canadian investors proved unsatisfactory. We will continue to hold our European investment and accordingly European financial results are included in continuing operations for all periods presented. As a result of this recapitalization, parent guarantees at the European operation have been reduced by about $20 million, and the parent will no longer guarantee any future obligations of the European operation as well.

During the quarter, Greenbrier also settled its arbitration claim relating to the acquisition of operations in Germany in 2000. And Greenbrier realized a 6.3 million pretax reduction in its purchase price liabilities associated with the acquisition. What we mean by this is prior to the settlement, Greenbrier had purchase price obligations of $6.3 million in cash to be paid over five years. This obligation was extinguished as a result of the settlement.

Also during the quarter the Company wrote off the remaining book to value of European patents and designs at 7.5 million pretax. Both of these items are included in special charges but after this write-off of the patents and designs, that is the remaining value of the patents and designs that were on our books in Europe, and similarly we had written down the book value of property planned shipment in prior quarters.

The Company's combined European and North American New railcar manufacturing backlog at the end of the quarter was 10,000 units valued at 560 million. This compares to 11,500 units valued at a 620 million at the end of our first quarter at November 30, 2003. Subsequent to our quarter end, the Company received orders for 1400 railcars valued at 110 million.

Now turning to manufacturing, revenues for the quarter were 149 million. In North America and Europe we delivered 2300 railcars. This compares to 1900 cars in Q-1 of this year, and 1300 cars in Q-1 of '03, and I'm sorry -- 1500 cars in Q-1 of '03 and 1300 cars in Q-2 of '03.

During the quarter a number of items resulted in the delay in production of about 250 cars. These items include weather-related shutdowns in Canada and Oregon, the need to rework certain defective components that went on some cars, certain slowdowns in production's due to shortages and availability of the castings. In addition, nearly 300 cars were produced in Q1 and Q2 which are hung up as inventory on the balance sheet as a part of our normal lease syndication process. These cars can be sold in Q3.

We anticipate the deliveries in North America and Europe will be about 10,000 units for the fiscal year as a whole. Our manufacturing margin for the quarter was 6.5 percent, lower than our earlier expectations of the 8 to 9 percent range. As Bill will discussed further and is disclosed in our press release, the margin was impacted by some of the items I just discussed which resulted in manufacturing inefficiencies. As well the margin was impacted by a number of items on the cost site. These include costs of about 1 million to rework certain defective components, and the effects of about volatile steel marketplace where we absorbed scrap surcharges of about 1.5 million.

We are taking aggressive action to manage the steel issue and help mitigate effects on future earnings. Our initiative -- these management initiatives came into effect too early or were too late in the quarter to have meaningful results on the quarter that just ended but as I mentioned should help future quarters.

As well, the other item relating to the negative effects of defective components is behind us, and so again, Bill will go into these in greater detail.

Our leasing and services marine manufacturing industrial forage and route services business continue to be profitable and provide a stable revenue base and cash flow. Our leasing and services segment had revenues of 18 million in the quarter similar to that of the prior quarter.

Leasing margins improved to around 42 percent, up from the high 30s in the prior couple of quarters as a result of higher lease rates and increases in lease fleet utilization. We anticipate similar margins for the balance of the year which is slightly higher than our earlier expectations.

Our lease portfolio provides somewhat of a natural hedge against rising manufacturing costs as our leased equipment is renewed at higher lease rates and the value of our lease portfolio increases. During the downturn in '01 and '02, our strategy was to enter into shorter term leases rather than lock into long-term leases that at low lease rates. Now we are able to realize the benefit of this strategy as our leases generate higher earnings.

During the year our lease utilization has increased to 96 percent, up from 92 percent at the beginning of the year. There is no pretax income from the sale of leased assets in the quarter. Our fleet consist of 12,000 owned units and 113,000 managed events.

Turning to GNA expense, it was 10.9 million for the quarter compared to about 10 million in Q1 of '04. The quarter was particularly impacted by legal fees associated with settling the European arbitration claim and patent litigation on the drop deck center petition car suit. We expect GNA expense to run at slightly lower rates for the balance of the year. The tax rate for the quarter was usual in that we recorded a tax benefit rather than tax expense even though we had taxable income. This was because our settlement of the arbitration claim in Europe was a non-taxable event. We expect a tax rate and Q3 in Q4 should run about 38 percent, similar to Q1 of '04.

Turning to the balance sheet, I'm sorry, turning to the line item equity and loss of unconsolidated subsidiaries, this reflect the Company's 50 percent investment in (technical difficulty) railcar manufacturing facility and 33 percent investment in the rail castings joint venture. Both ventures incurred a loss for the quarter. Concrail (ph) was impacted by lower production rates due to shortages and availabilities of certain materials, including castings. The castings venture was impacted by the start-up of the Alliance facility and equipment issues at the Cicero facility.

Depreciation was 5 million for the quarter and should run about 20 million in '04. We still intend to aggressively deploy capital in leasing assets and anticipate net CAPEX, that is gross CAPEX minus sales from the leased fleet of about 25 million.

Turning to our balance sheet, and our cash flow, we remain a very liquid company even though our cash balances have been reduced by 73 million for the year. I'd like to go into a bit greater detail about this. Since the beginning of the year we had paid down about 27 million of debt in participation expense and we've had leased fleet additions of 18 million. As well, if you take a closer look at the cash flow statement, you'll see that there are normal fluctuations in working capital where both accounts receivable went up for the quarter and accounts payable went down for the quarter. Perhaps in greater amounts then we'd anticipate for the balance of the year, the AR balances should start to come back down as there were some payments that received subsequent to quarter end.

Similarly on the inventory side, as I mentioned earlier, we had about 250 railcars, about $30 million representing $30 million of assets that we intend to sell later in the third quarter and this is just a timing difference due to lease syndication activities.

As we mentioned in earlier quarters, that's about $32 million of railcars which we previously had delivered to a customer and they had paid for with a contractual contingency to it and we believe that contingency and therefore it has not been recorded as a sale yet, rather as inventory and deferred revenue and we believe that contingency will be removed over the balance of the fiscal year, removing that item from the statements.

Our unused lines of credit remain at about $100 million and again we remain very liquid. With that, I will turn it over to Bill and then we will open it up for your questions.

Thank you, Mark. While there were in number of unusual forces acting on our second-quarter results, and I think that I'll highlight some of these and try to knit together how not only the results were affected but how that might affect the outlook for the balance of the year.

A number of the items that Mark touched on a moment ago in inventory are the results of an aggressive management program was but in place in January having to do with the materials issue. And some of the inventory policy that we have adopted to stockpile some of the factors of production that we require, both castings and steel. Our venture in castings has allowed Greenbrier to not only build in its own factories but to outsource over 1600 railcars to an affiliated company in the castings business and that has been a very successful strategy in connection with the management of the materials operation. As Mark had indicated, the business in the quarter was affected by $1.5 million in concessions to suppliers as we renegotiated supply contracts. In the last quarter's conference call, we indicated that we firm contracts in place for most of our backlog and while that is true, industry behavior led us to negotiate with the suppliers and we did absorb some costs in this quarter.

In January, the Company organized a steel management issues team consisting of senior manufacturing and financial managers and an action plan was developed to deal with the projected cost increases and the effects of the materials and steel business changes in the marketplace. The steel prices have been on their way to doubling; there's been some relief in this area recently but behavior on the part of suppliers has changed dramatically. It's been -- it was a very stressful quarter in terms of dealing with a number of these issues.

Our basic plan is to identify the amount of our exposure with potential renegotiation of supply contracts and then to offset that exposure with claw-backs and revenue enhancements and other means. We have at the end of January, identified -- we had at the end of January identified approximately $9.5 million of potential exposure in contract renegotiations and potential offsets during the balance of the year into the backlog period for 2005 of 7.2 million. We have executed on approximately 5 million of those claw-back objectives and we anticipate that while the second quarter had significant adjustments for materials on a pretax basis of almost $1.5 million, or approximately $1.5 million, that in the future quarters the timing of the offset programs that we are pushing through in our materials management plan will mitigate a great deal of that and perhaps reduced a surplus.

So we believe that we have the materials issue reasonably under control and in fact our forecast for the balance of the fiscal year in consideration of all the forces operating on us in the second quarter, the visibility and outlook in our forecast slightly improved as a result of these various changes.

Some other items that occurred that were unusual, inclement weather in both Trenton and Gunderson, very severe storms, both ice and other calamities occurred, everything but grasshoppers and famine. We had a roof collapse at our Gunderson facility, slowing production for over a week and cutting -- causing the plant to be shut down during the quarter. We had issues at Trenton having to do with weather as well. Similarly in the Cicero operation in castings, we had some unusual operating and equipment events coupled with what was an effect of flood at as a result of a transformer outage, so that the operating losses at Cicero were more than we expected for the quarter.

During the period in the castings venture, the startup of Alliance as planned resulted in charges to the three partners in this venture of approximately 1.8 million, our share was about 600,000 of that. And the total losses from castings business during the quarter, pretax, were approximately $900,000. So this was an unusual quarter in our casting operation. Having said all of that, without the castings investment, we would have had a much more severe issue to deal with -- the castings investment in terms of transfer pricing has been very successful and we anticipate a return to normalcy after the startup of Alliance proceeds and is in full production. Production is going well there and we are getting castings as planned although the castings situation during the quarter continued to cause some slowdowns in our Mexico facility.

During the quarter, some other issues that affected us were the management of our backlog. As part of our materials plan, we've gone through our backlog looking at the those transactions that have lower than desirable margins. We renegotiated a number of those transactions and have identified several million dollars in value enhancements from these initiatives.

During the quarter, 250 of the -- I'm sorry, 275 of the drop deck center being cars that have been in backlog were swapped out for orders during the quarter so our net backlog increased in North America only slightly. But we had a very good improvement in the quality of that backlog in terms of the margin built into the backlog.

During the quarter, we also concluded negotiations with a major customer on the remaining drop deck center beam cars and subsequent to quarter end swapped the balance of that out for some doublestack cars which will have a very good margin. So we have been making some major changes in the quality of the backlog in the margin built into the backlog during the quarter.

At the end of the quarter we had moved production from for some doublestack cars to our Mexican facility in anticipation of a potential strike at our Canadian facility, however that strike was avoided and we did complete successfully the negotiations and achieved a contract with the steel workers at our TrentonWorks facility. During the quarter, the efficiencies of the plant suffered from those contract negotiations and we are happy to see that the contract was concluded and that operation is now running with respect to our labor agreements under a new three-year contract which we have just baked will improve the profitability and efficiency of that operation going forward.

We have also, during the quarter, a number of other items that have affected our future prospects including a reorganization of our manufacturing operation, some new personnel assignments and work in global sourcing having to do with the change in our policy in Europe. We took a special write off in the quarter for warranty items on the castings in the Trenton facility as Mark earlier indicated and as referenced in our press release, and that write-off is part of a global outsourcing program that we are very happy with. We've generated several million dollars of savings in the program, but we did have an adjustment which we realized in the quarter having to do with quality of some of the parts that were coming in in that facility.

In general, the European operation has been profitable for the past three quarters, continues to have a very strong backlog, the backlog has been growing, we were successful during the quarter in receiving significant aid from the U.S. Government through the State Department and negotiations with the Polish Government and secured guarantees from a government-related entity that would allow U. S. foreign direct investment to remain in Poland. We are pleased that we've had this recognition from the Polish Government and anticipate that the European operations with the written down assets there will be profitable in the future.

Having said that, we do intend to insulate Europe from the parent guarantees that have been offered on performance and other bonds in Europe and on bank lines and we've recapitalized Europe so it will have adequate equity and financial strength to conduct its operations. Europe has adequate banking and other facilities available to it now to conduct its business we believe profitably and will produced positive cash flow ultimately for the parent.

I think that concludes my remarks. We have just had a number of issues during the quarter that come together to create a more difficult quarter to analyze, however, the outlook in the industry is very positive. During the quarter, we stopped taking orders, or soliciting orders for railcars without price escalations consistent with the changing materials market. We have had protection in the past but the type of protection we've had in these contracts for materials and sourcing in the past has not been adequate to cover the dramatic change in the materials cost that have been experienced by the industry.

We have been successful in entering into a number of contracts that require materials escalation and passing on of the materials costs and while we did lose some market share in the quarter, deliberately we believe that this is a better policy and will protect us as we continue to operate in an environment where materials are a key item and factor cost. Thank you.

With that, Operator, we will open it up for questions, please.

At this time, we will open up our Q&A session. (OPERATOR INSTRUCTIONS) Mike Niehauser (ph).

Mike Niehauser. Could you elaborate a little more on the backlog? It sounds like there was some changes in the mix but the size declined and I guess where I'm headed is your outlook to 2005, if it's as strong as it was last quarter or if its increasing or stabilizing?

Mike, we think the outlook for 2005 is very strong and we base that on not only orders we are currently tracking and negotiating, and orders that were awarded subsequent to quarter end, but the announced plans of the major intermodal buyer in the marketplace, TTX to acquire significant numbers of intermodal platforms. Beyond that, the demographics of the industry are such that the railroads are going to require more equipment in areas where we are strong and have strong market share.

Finally, I think that this has been a quarter of adjustment to some very severe materials dislocations. We've taken a hit in this quarter in terms of reserves of a conservative nature across the board, we've realized some tax benefits, and we essentially froze our new marketing activity for a couple of months while we were analyzing the landscape. But I think the issue is not whether there will be a lot of good business, there will be. But its the selection of that business so that it can be done profitably and to take advantage of the rising market.

During 2005, we anticipate focusing on optimum optimizing our manufacturing flows through Gunderson in doublestacks and determining which at the two other facilities we want to make a core facility with Mexico and analyzing both our facility in Mexico and Trenton. We also anticipate doing major amounts of outsourcing as we have before with other builders to accommodate changes in the strength of the Canadian dollar and changes in currencies.

I'm sorry. I think I cut you off.

Mike, did that fully answer your question?

Yes and just reading between the lines, it sounds like you mentioned that you might have lost a little bit of ground of market share by reworking your contracts to include steel building in the steel prices, but is it too much to say that with the demanded strong and with what you're doing for customers that you've kind of won the ability to successfully integrate that in?

We had a very strong backlog going into the quarter and the ability to obtain business as a function not only of your price competitiveness and delivery but also delivery competitiveness. I think other competitors in the marketplace have adjusted their backlog by pulling out of the market for a few months while we calibrated our marketing strategy to this materials, this changing in materials environment, a very dynamic materials environment. We passed on some orders. But I think there will be plenty of orders. If you look at the first quarter of 2004 that just came through, our market share during the quarter dropped dramatically from the levels that had existed in the past. But you're not -- you're certainly not going to get orders if you are not bidding on orders and we were not bidding on orders where we could not get adequate materials coverage.

Some of our competitors are pricing to lose money and I think they are being successful in that goal. It is simply too dangerous to take long-term backlog without a hedge in place on some of these materials costs. We have been successful on orders that we are taking and orders we will take in hedging that exposure that exposure in the future. Having said that, we think that we're also at a point in pricing on steel, we don't expect it to go down to levels it had before. It's been a very, very interesting dynamic this quarter.

I think the final thing I would say about that is that as that materials issue is digested by our segment of the industry, as you look at the economy and you look at the commodities surge that's been caused by the cheap dollar and commodity movements and you look at the velocity statistics on railroads, railroads are just needing a lot more railcars to carry the same traffic. There is a lot more traffic to be carried. I think it's going to be in the next few months, during the summer quite apparent that the railroads will be in a position where the will have to add capacity even at the higher pricing and materials costs that are being required by the market.

But it looks to me like 2005 is going to be a year to pick good orders and looking at the last quarter, the quarter exceeded the entire year -- (indiscernible) a couple of ago, 17, 18,000 units. Backlog has increased to 41,000 units. There is still a constraint on supply through the balance of this year with castings. So I think this is a good time to operate to make money. And in order to do that you have to adjust to some of these stresses that have taken place on the materials side.

That is a very good answer because I was kind of getting at what the competitors were doing that if they were not able to include these, and didn't have the ability that they would be falling farther behind. You mentioned in 2005 we will be able to pick good orders. Does that mean that if you get a handle on steel prices or that 2005 you can see gross margins in the 10 percent area?

I don't know that we want to put a number on it. As Mark has indicated during this quarter, our gross margins have declined but again, this quarter took the brunt of some of the adjustments that we're making in negotiations with materials suppliers, particularly steel and even some castings suppliers. We had a very unusual thing that occurred in this last quarter, not only weather, but other things, and with respect to some of these traditional suppliers, their behavior changed dramatically. They simply refused to honor some agreements. This is nothing, everybody is not aware of, it became very, very tense. We reacted aggressively with a management plan. We have five or six areas where we can offset and compensate for that, including as Mark indicated, a natural hedge which existed in our short position in the leased fleet. These short positions are very, very valuable. We have almost 1000 railcars remaining that are recently constructed that are on short positions in the railroad service and we are raising rates and terming those out and creating a substantial present value as we go a long to do that.

It's just a very unusual -- it's was a very unusual quarter. We took some hits with reserves during the quarter, we had some very unusual large transactions that affected us and returned as conservator results to optimize our tax benefits. I think in the future we will be able to manage this much better and I'm hoping that we will have a much better margins in 2005. I certainly think there will be a lot business available in 2005.

I think, Mike, we are just a little early to give guidance on 2005.

I cut you off again, I'm sorry.

That is all right. I didn't have much else to add.

That's plenty helpful. It does look like you have had plenty to do in the last quarter. With what's happened with the European operations and with the -- including that in your numbers -- is this going to be something you're going to be retaining or can I get you to comment on the future of that operation?

We were intending to dispose of it or dispose of a major interest in it and recapitalize it. Some of our planning was tax related because we realized substantial amount in cash benefits during the downturn by writing off all of our assets in Europe. We just completed during this quarter a write-down of others we could identify.

I think though that the European market place, having said that, has changed dramatically. In the last two years, the number of competitors that are viable competitors in that marketplace declined to only a few. There are profitable contracts available. We are making money in Europe. We have been making money in Europe. Our difficulty in Europe has been the banking and financial structure that we had in place over there consistent with our tax position.

With the assistance of the Polish Government, with the ability to get off of all of these bank lines and to have support for product guarantees and with the strength of the euro relative to the zloty, our facility in Poland is in a very, very good place. I know that our major competitor over there is losing money, we are making money and we intend to operate our businesses to make money. So we are going to evaluate this probably in another six months to a year, but I anticipate that now with a much reduced basis on that facility almost all of the issues that contributed to problems in the past having been resolved, a recapitalization of the business with the assistance of the Polish Government, that we will be a much better different position. And all of these factors contributed to decision to keep Europe as opposed to take an opportunity to dispose of a major interest in it.

Excellent. And just one small question and I'll leave. Is interest expense -- look like that was up for the quarter. Is that a matter of rates or borrowings and do you have some idea of a run rate for that?

It's really due to the higher usage of our revolving credit lines. Where the quarter is, you can see at the end of the quarter we ended up actually in our credit lines. For the balance of the year, we're expecting that they are going to run at somewhat similar to slightly lower levels.

Thank you very much.

Matthew Kelleher (ph) .

What is your overall industry order for this year? What do you think the whole industry is going to be for orders?

I know that the data for -- the published data for the deliveries in the orders in 2004 for total deliveries, the forecast is something in the 47,000 range, that's roughly equivalent to the current backlogs, so there's about -- and that seems to be consistent. I think that the order rate in this first quarter of 2004, 18,000 units, is above the rate that is sustainable. It's very, very difficult to predict the degree to which there will be overreaction to all of these forces that are operating on the railroads today. In effect we have the same forces that are operating in materials are going to operate on the railroads. You are going to see a lot of business opportunities; they are going to try to increase their rates. They are going to try to restrict some service areas to improve margins. But they are going to get caught by the same tide that has caught the steel industry and people who rely on the steel industry. Whether or not they will respond as sometimes they have in the past by simply going out and ordering thousands and thousands of rail cars, I just don't know. It is unlikely that at current price levels they would consciously want to do that, but on the other hand they are caught in the dilemma because they have to have the cars to move the traffic.

If they don't have the cars, they can't move the traffic and some of that traffic remains very probable. I don't know what they're going to do but it's not a very great -- it's not a great position to be in. It's going to be interesting to see how the railroads respond. Very, very difficult to say anything other than there should be awfully strong demand for across all commodity types and Intermodal will be very strong. I just think 2005 is going to be a very good year.

Even though orders make come -- may drop off due to pricing pressures?

I'm surprised at the level of orders in the first quarter of 2004. I wonder where the castings are going to come from for deliveries during the second half of 2004. By 2005, we should have enough castings to fulfill a higher rate. The railroads really want to orders 70, 80,000 cars. I am hopeful that doesn't occur because every time that does occur, it creates a bubble and I would hope that the rate would be somewhere in the 50,000 car range which we believe is normalized and is what is expected over the next four, five years as an average rate.

50,000 cars is about the right level at which in the current climate the railroads ought to be replacing their fleets. The problem is they buy cars when they're very expensive and they don't buy them when they are cheap and they create in their own behavior a rollercoaster ride for those companies that are trying to provide for them. Instability in the supply business has been acute and it continues to be an issue that the railroads are going to have to deal with and the consequences of this type of pattern. It can be very severe for the railroads themselves.

So I hope that they will have as much restraint as they can and we won't have a boom in the railcar building. Having said that, I don't know what they are going to do. They are going to have to do something because they need the cars to move the freight. And as velocity falls, they need even more cars to carry the same amount freight, the same amount of much tonnage. It is a very, very tough spot. With the dollar down and interest rates low and an economy that seems to be bouncing back; looking at retail sales this morning, my goodness, it is just going to be a very tough position for them to be in.

They are going to be forced to pay very high prices for railcars and it's not us that is going to make a tremendous windfall profit, or our brothers and sisters in the car-building business, it is going to be largely due to just high materials cost. It would be great if the railroads sometime could get on a program that would level this out and achieve levels of investment that would get them a good pricing, and an average basis as opposed to buying at the peak and not buying when prices are very low.

But that's just my perspective on it. It's very, very hard to say, but I would think it's going to be easily a 50,000 car year. Even more than that.

Two more kind of questions. I didn't know -- I know the castings would hold it down a little below that and what percentage of -- ?

(multiple speakers) I think your question was orders wasn't it?

Yes What percentage of your backlog having the escalation clauses for your steel prices? Were you hedged going into this at all?

The way we do that is we put an allowance in our bid for materials escalation based on history. It was traditional in our business, five or ten years ago to have cost escalations. Over the course of the last five years, those have gradually been eroded away out of contracts. Most builders have not had full cost escalation protection. The way we do it though is we go out and we lock in materials prices, so on the buy side you don't have typically the market power to have a full escalation of materials coverage. On the buy side -- on the customer side, on the materials side, typically you would do back to back orders. So that if you -- and you lock in pricing with the suppliers. We had most of our backlog with the exception of some tonnage for steel and marine and the cars that we swapped into Mexico, covered with firm pricing and firm relationship commitments.

The scrap surcharges always have been something that have reasonably been absorbed but not in the kinds of levels that have been required during this peak period. So what we've had is this supplier or something come and say we're not going to honor the contracts and we got some very tough negotiations, we pushed back and in some cases where they had leverage with us we have to compromise and order especially to get tonnage -- we would have to compromise and that is what occurred in this quarter.

But we are slogging through this and we have a very organized plan for dealing with it and I think we are very successful so far. It is just that some of the efforts which have culminated in almost $5 million of offsets haven't been realized in the current quarter. And won't be realized in subsequent quarters.

We are currently though in all of our bids requiring customers to absorb this exposure or a major part of the exposure, so we will get this in balance on any orders we've taken since the end of calendar 2003.

Thank you very much.

Mike Peasley.

Good morning, Bill and Mark. Just to stay on steel, I want to make sure I understand this. Bill, I think you said that you have identified in your backlog $9.5 million exposure to steel pricing. And that, beyond that you believe with certain initiatives you can mitigate 7.2 million of that? And then I guess you've already realized 5 million of that? Is that the right way to look at that?

Well, those are numbers that set. Let me explain them. We have already executed on 5 million of offset in our total backlog which stretches into 2005. We've executed in those and have them in the can. We have identified potential, and I emphasize potential, concessions and renegotiations of supply agreements in the 9.5 to $10 million range. And we've identified easy potential offsets in the 7.2 million range. I was surprised at the ease with we would execute the $5 million benefits during this quarter. And unfortunately we can't recognize them until subsequent periods, but that's fine. We just have an unusual quarter. The potential offsets are potential and the ones we have identified as potential exposures are potential, we are doing everything we can to bring those at least parity and hopefully achieve a surplus. One of the things we're doing aggressively is managing our short position cars. On these cars that are out and we had 1000 of them out or in short positions, these have become very, very viable because as steel prices increase, and opportunity cost therefore adjusted as look at buying cars at more expensive pricing, the value of those cars go up.

If we lock in longer contracts, we can -- through our syndication efforts, sell a few of those and make significant profits.

You are speaking of --?

That is only a part of the total picture. We've gone back to customers and asked them for assistance on materials and some of them responded, some of them did not. But we've gotten $1.5 million in that category and we've gotten a lot more yield from our scrap, our internal scrap program. We have done some trading opportunities that we've taken advantage of. We think we can bring over the course of the year these things into reasonable parity but it's anybody's guess on whether we will be able to execute them when timing will exactly offset each quarter.

So the $5 million that you were able to get back, at least working with your customers, I imagine -- so you're going back to your customers and explaining to them the situation and they have been agreeable enough to work with you, is that what you are saying?

In some cases, yes, in other cases not. We really had more fun in dealing with the suppliers. The kind of dialog that's going on -- has gone on, most of this is now passed and we've identified the places where we're going to concede and the places where we haven't. A supplier comes in and says I know we have a commitment to produce this kind -- to give you this delivery and this tonnage and this price, I'm sorry, we can't do it. We are going to have to increase the price by 20 percent, 30 percent. And we say no and they say yes and we say no and they say yes and we say no and we say yes and then they say go to hell and we say go to hell and there is tension and pretty soon you reach some compromise. You either take the tonnage under protest or you fight with them or they have you over a barrel and you have to concede and protest it later on.

But you go through his cycle, and it's a stressful cycle. There is usually some resolution that claws back a sizable amount of whatever it is they want or just some stonewalls. In a lot of cases, we're not accepting these price increases. Only with those companies where we really, really have to have the material and there are several instances where that's the case. Have we accepted anything that wasn't in the contract.

So to be clear, Mike. Again, the 5 million that Bill referred to is from various initiatives, whether it be customers agreeing to absorb this or pushing back on suppliers or through our own scrap sales or leased lead initiatives or all the various initiatives together.

We had for example, during the year, Mike, on the leased fleet forecasted trading sales out of our leasing portfolio of a few million dollars. We now see the opportunity to enhance that are dramatically, and that's a source of offset. We see and modified our own scraping policies to improve scrap efficiencies from internal scrap sales and we will get $1 million out of that probably during the year. So it's sort of a moving process, but it's one that's working and I think will get through the next two quarters and have this thing digested. Then it's going to be the turn of the customers to deal with a similar issue on their side. How are they going to deal with the commodities surge that caused the steel price escalations to begin with; how are they going to deal with the commodities surge in their basic business? Are they going try to buy a bunch of rail cars or are they going to turn away traffic? What are they going to do? Are they going to renegotiate at a very try premium some of these short leases because a lot of them are short on their lease fleet? 60, 70 percent of railroad fleets today are not owned by railroads but they are owned by private institutions. It's going to be a tough position.

That's a good answer. Looking at 2004 here, you estimated that you will probably deliver somewhere around 10,000 cars, all in Europe and North America. Can you give me an idea how many cars would be delivered in Europe versus North America and then maybe how many in Mexico?

The split overall is probably about 80 percent North America, 20 percent Europe, roughly. And the deliveries in North America, approximately 8000 in North America that we forecast that left probably about 1000 or less would come out of Mexico and the rest would come out of our various other facilities and outsource facilities that we're using.

And then further in 2004, you know your backlog is good, deliveries are good; you have your challenges with steel which you're working on. Castings seem -- that may be even a bigger problem as we move here through the second half of your fiscal year. If it reasonable to think where you stand today, halfway through 2004, that doing $1 in earnings, is that reasonable?

Mike, we really haven't given any guidance on earnings expectations for the year, and it's been our policy not to give guidance. I think we've made some comments about particular line items or about visibility or unusual items, but I don't think we want to make a statement about earnings expectations for the year.

But you did state that you expect to remain profitable through the year.

Correct. We do expect to remain profitable during the year. We have described this quarter as being a complicated quarter where many unusual forces have come together, and our own internal forecasts for profitability during the balance of the year, and we actually expect to finish this year in reasonably good shape. The only reason we are being cautious is there is just a lot of these industry forces that are swirling around out there. So we don't want to disappoint, but I think we're probably being -- we're erring on the side of being too cautious.

Our EBITDA forecast for the year internally has really not changed except positively in connection with the balance of this fiscal year and into the backlog period for 2005. So we anticipate that this quarter was a very unusual quarter. We are anticipating and forecasting better quarters ahead.

In '05, I know we don't need to talk about guidance, but in terms of volumes, Bill, you said that it's going to be a good year and you might have the opportunity to be more selective on your orders in terms of better product mix. Is it a goal in '05 to do -- to deliver more railcars, or is it more focused to deliver more profitable railcars?

Let me say it this way, it's very hard for our marketing department to be put on hold, when we've had 25 percent and 30 percent market share, to take a pass on an entire quarter's orders. A lot of the orders that came out this last quarter were products that we don't have a high market share in generally, but it's very hard just to stand down. But the reason we have to do that is that we have a practical limitation on our market share in terms of capacity constraints. We've addressed some of that by entering into special relationships such as we have with Castings Co. and with the car building arm of that company. We are very, very pleased with that relationship, and it's been very useful in enhancing our market share.

But we had to adjust, -- it doesn't do a lot of sense for us to just add backlog and not focus on profit margins at a time like this. When we're really booking in 2005 our open space, we don't want to get too eager to lock that up. We really have to digest the inventory and the backlog issues that exist. We're really working hard on that, and I think we're going to work on it successfully and I think we're going to have plenty of opportunity to add profitable backlog.

We are turning away business. I mean there's no doubt about it by our own behavior, and it's not just because we want to hedge the steel. We want to be sure we're getting the right products in our plant, getting the right baseload.

Is it possible, I mean if the orders are there, if the right orders are there, for you to deliver 12, 13,000 railcars in a year?

Yes.

Is a something that you think could be done in '05?

Well, it certainly is now -- you're talking about North America or you're talking about Europe?

Well, I guess I was talking about North America. Yes, in North America.

We can certainly deliver that when we look at the association we have, and as long as we maintain an association with another car builder, which we will want to do as long as the Canadian currency is at the levels that it has been. But in terms of our own internal capacity with the three facilities, that would be a bit of a stretch.

Just a couple more and I'll turn it over. Europe, you decided to hold onto it. Was that -- it's been profitable for the last three or four quarters. Was your decision based more on what you thought you could get for it and you didn't, or did the fact that fundamentals are improving over there, did that factor more into your decision-making process?

We had announced in Europe an agreement with a Canadian investment group with whom we're already affiliated in Canada, that we would recapitalize the company and we would sell a majority stake. We did that for a variety of reasons. We thought it was the right plan at the time. But the outlook has improved in Europe. We have profitable backlog. Our backlog is growing, our market share is growing in Europe. We're operating profitably, whereas our competitors are not, particularly our major competitor there. I don't know why they are not, but they are not. So it suggests to us that we have a good franchise there.

To the second part of the question, the deal we had with the other investors we probably could've executed on it but it wasn't coming through as advertised so we with a combination of the two reasons, we decided to keep it. We also found a way to protect ourselves on the tax concerns that we had. And finally, we received very very attractive offers from not only in support of the Polish Government but in support of our commercial banking organizations in Europe so that we could reduce our exposure in Europe by over $20 million. The financial exposure and that helped to make the game look a lot more interesting to us.

That kind of leads to my last question. And maybe Mark you went on to answer this. Was any of the increase in debt related to bringing Europe back on or was that mostly funding working capital?

Well, all periods that you see included Europe in it so any period that has been restated or any prior periods you're looking at includes Europe in it. The increase from August, you see notes payable is up about that 10 million -- that is roughly due to some working capital requirements in North America as a result of these increased usages of working capital for the quarter that we discussed earlier.

The cash used by operations year to date as we discussed earlier was pretty high. Some of this on a temporary basis due to the increases in our receivables and reductions in payables and then the payment of participation expense.

But he was talking specifically about Europe.

The Europe usage is roughly similar to what it was at the end of end of the year where we were about 20 million or 21 million into bank lines in Europe. Again, the balance would be North America.

Let me be clear about Europe, though, because we have continued with a plan to recapitalize Europe with its own equity base so it is a stand-alone operation and we have severed the financial ties with respect to guarantees in Europe. So that what we would expect from Europe is consistent with our ability to repay trade funding and tax concerns. We anticipate that it will be able to operate as a stand-alone operation and it will be able to begin producing cash positive to us in the future looking at it's current gain plan.

Secondly with regard to Europe, one of the values and I should have mentioned this, to us from Europe has been the experience we've added in supply chain management including some of the mistakes that we made there and the lessons we've learned. As we look more at a global supply chain with a European component and Asian component, the fact is with our manufactures facilities, Europe can be a very, very good supply chain partner. So these are the factors that causes European situation to change. We don't see a material investment, a big investment in Europe for cash as a consequence of all this. We've really done it with restructuring of credit lines and support of the Polish guarantee agency.

I said this twice, I think but this is definitely the last one. I think you mentioned at the beginning that you were talking about TTX and maybe I missed it, but did you state that they have made public their capital expenditure plans with regard to maybe their inner modal fleet?

I'm not sure what the terms were that I used but they have, we have been in communication with them as other car builders have and we believe we have identified and they have identified their estimates for capital expenditures in 2005. And they are consistent with what you would expect with double-digit growth in intermodal traffic. There really isn't any alternative to that, that's why we continue. And so there is going to have to be a significant intermodal car build in 2005.

There will probably be more trailer cars built in 2005 than have been traditionally part of the mix because trailer traffic has been in recent quarters, coming up materially compared to container traffic, but container traffic is very, very strong as well. But I don't know what to what degree they've made -- made their capital plans known publicly and public announcements. They usually disclose their formally their CAPEX plans after they have an event in the Novia (ph) Island in late April.

We did receive during -- or subsequent to the end of the quarter a notice for TTX that we received for the 13th consecutive year in both our wheel services business and our manufacturing operations, each of them, Trenton and Gunderson, that have been building cars for TTX in Mexico. The TTX quality which is the premier quality award that is given out in the industry and that's -- we received that award in each of the 13 years that TGX has given it so we are very proud of that record.

We are proud of the quality reputation and the liability that goes along with it. And we're hopeful that as it has in the past will that TGX will continue to be a very good customer. We have filed in the S.T.B. Docket supporting TGX's application for pooling authority with some reservations on the scope of that authority and that will be an important event to which as they've proceed for reauthorization of their pooling agreement service transportation award this spring and summer.

And then Bill, you said the backlog, the industry backlog was about 41,000 with 18,000 orders at the end of Q1 there? Did you get that from the Rail Supply Institute because I hadn't seen -- ?

Yes. It just came out. It came out yesterday. I don't know if they made that public, but the internal circulation came out yesterday. The deliveries, the year-to-date orders and the orders for the first quarter, calendar year or the March would be orders were 17,900, deliveries were 10,012 and that caused a backlog to increase to 41,000. That may not fit with earlier ARI documents because they have a footnote in this report and I just have a one-page summary of it. It indicates that figures may not track to reflect revisions to a prior quarter made subsequent to that quarters reporting. But the backlog stands at 41,000 units and the deliveries for the quarter at 10,000, and the orders 18,000, roughly, 17,962 units.

I apologize for taking so much of your time. But thanks for the answers.

Mike Niehauser.

I apologize. I got a couple more questions, two if I could. It was mentioned that the deliveries are expected to be 10,000 units and I got a little bit lost between North America and Europe. But my notes had 8000 units from prior calls. Is that unchanged or is that actually an increase in expectation of deliveries?

No, Mike, you are correct. In prior quarters, when Europe was treated as a discontinued operation, when we talked about deliveries, we were talking about North America. And now that we include Europe back in continuing operations, the 10,000 increase there is a reflection of Europe being included in the totals.

Okay.

Mike, I would also like to clarify. Earlier, you asked a question indicating the interest expense has gone up for the quarter and I think if you looked a little closer, it's actually comparable to what it was in Q1, that both Q1 of this year and Q2 of this year were at 2.6 million. And we expect this. And again, Q2 is about the same even though we paid down a bunch of term debt because we're in our revolving lines higher. And for the year as a whole again, we expect Q3 and Q4 to run similar to or slightly less than Q1 and Q2. For the next two quarters, similar to Q1 and Q2.

Could that be because of the European operations weren't included last quarter?

Yes. In last quarter's results, that was correct. Now if you look at the detail of the press release on page 8 of the press release, it restates the first quarter of this year and the first two quarters of last year to include European operations, in continuing operations. I think if you look at the detail of page 8 you will get all the comparable periods restated.

Okay. A little more work to do there. The prior question about intermodal and earlier in the call you mentioned the velocity slowing yet the same amount of product has to cross the lines. Does that -- I think that was related to commodities but does that speak to increased demand for intermodal because more product needs to be carried in the intermodal -- ?

No, I think intermodal is reasonably efficient and these are expedited trains. I haven't -- frankly I don't have the information on intermodal velocities. So I would surmise that would be the case. That they would have better velocities been other car types. But generally across the board, velocity has dropped on almost all of the railroads in particularly in commodity car types.

I think that the intermodal business is reasonably in balance supply and demand is reasonably in balance but growth requirements in 2005 and just as long as the loads continue at the pace they are on -- they are on a fairly frenetic pace right now. Growth requirements are going to be fairly sizable in 2005. If velocity suffers, then that is going to add some pressure to the build requirement and there's certainly a -- could be some concern about that if other -- if some of the congestion and other issues that are plaguing the railroads right now cannot be addressed. There are some serious service issues that some customers in nonintermodal areas are beginning to be pretty vocal about.

It just seemed to be the value of cars that carry more -- are more efficient would be going up and should be strong. One very last obscure kind of question. But with maintaining the Polish facility, do they market cars to Russia? I'm just curious if -- I thought they had a different gauge track -- ?

No, almost all of the output of Poland is in Western Europe so we have customers like -- we export to the United Kingdom, to companies like Freightliner. We export to Scandinavian countries, France, Germany, companies like DB, very little historically has done in central Europe from our facility in Poland. It's mostly in Western European exporter of Polish labor and materials. And the Polish Zloty has tracked closely the U.S. dollar which gives it some tremendous currency benefit in terms of trading into the Europe market because the euro, as we know, has increased by about 40 to 50 percent over the relevant time period against the U.S. dollar. And with the Zloty weaker, that means the production out of Poland is attractive. But that would also be true of factories in other Central European locations like Romania. What's really emerged is on the supply side there. There are only a couple of remaining contenders in the freight car market. That market -- the Western European market has some issues with it but it looks favorable to the freight business in the future.

I think our -- I think the concept of entering Europe was good, our execution wasn't very good, we lost a lot of money in Europe. We decided to trim our sales when the U.S. market tanked and we didn't want to have two losers at the same time. But now that circumstances have changed and the U.S. market is stronger, our problems are behind us. We are making money over there.

It will be a good platform for -- a continued good platform for export. There is opportunity trading in the Central European countries and that will be a bonus when that finally materializes, including potentially with Russia.

That is what I was thinking. It sounds like with completing the recapitalization, the European facilities, and how you have diligently handled steel prices, it sounds like you've had a very successful but complicated quarter and thanks for taking my calls.

It has been complicated. It is hard to explain it all and I am sure we haven't done a very good job of it, but we are looking forward to an easier quarter to explain in the next few quarters.

Thank you.

(OPERATOR INSTRUCTIONS)

We would just like to say hello to John Rogers, but we know he must not be on the call, because he would otherwise be asking a question here. John, wherever you are, hello.

Don Sabo (ph).

Just a point of clarification. You said that the exposure that you identified in the backlog, did you say that was 9.5 to 10.5 million?

Could you repeat the question, please?

Just a point of clarification.

You're talking about the steel, the potential steel? That is a potential number, and again identifying that, those would be potential cost concessions that we might consider for future periods, running out into the -- through the second fiscal quarter of 2005, in the case of our fiscal year.

Does that contemplate --?

That's a forward exposure. In other words, it's certainly all not going to occur in one quarter. And $1.5 million of it experienced roughly in this quarter that we accepted and locked in.

Then just to understand that point further --.

Let me just clarify, the 1.5 million is also part of the 10 million. The 1.5 million realized this quarter was part of the 9.5 million exposure that we identified.

Does that contemplate current steel prices, or would that exposure be higher if steel were to move from here?

That is at the peak of steel pricing, which we believe was at peak a few years ago. And now pricing and surcharges have been backing off by about $30 per ton, but we expect more potential slacking off as the year proceeds, and that would reduce the estimate or the exposure accordingly. And again, this is a very subjective effort in measurement, but it was using pricing and proposals or demands that were being presented to us by suppliers, if we were to honor these contracts, what would it cost us. If were to honor these demands, what would it cost us.

Does that include just direct steel purchases, or would that also include steel-related components where you're seeing similar pressures?

Good point. That includes both price, attempted price escalations by steel suppliers and the scrap surcharge component of billings from or anticipated billings from the specialty suppliers. By specialties I mean axles, wheels, truck castings, and so on. We have something of a hedge in our truck casting investment because we have favorable transfer pricing in effect through ownership of two -- part of ownership in two major castings facilities at Cicero and Alliance. Now with Alliance coming up, we anticipate having at least access to Castings on reasonable terms there.

You mentioned, I think you characterized it as a swapping out within the backlog from one type of car to another. Was that included in the 7.2 and potential offsets?

No, actually it was not. We haven't quantified that benefit, but since we're comparing this off of our forecast, that would be an additional plus.

So it would be fair to say that you are basically trading an old order for a new order, and presumably in the new orders there is that improved protection via the escalators?

I guess, yes. Boiling it down to its simplest equation, all of a sudden you have no friends whatsoever, your suppliers are attacking you; your customers are unhappy because you're asking them to modify an agreement. You're having to pass some of this cost along, and it is a generally very unpleasant period. However, the way to address the problem has been quite simple. Resist the supplier, say no; just say no to a supplier. Ask for cooperation with the customer, plead, beg, get out your knee pads. Careful not to threaten the customer, not a very good idea. But you can negotiate with customers, and we have managed through creativity to negotiate away some contracts with vary marginal margins and have replaced them with margins that are attractive, all at the same time refusing to accept orders that don't have automatic hedges or price escalations built in.

It does get very complicated, but trying to boil it down to its simplest form, we took a hit in this quarter. We had a number of reserves that passed through our financial statement. We believe we have a controlled process for dealing with materials through the balance of the year. We have identified offsets that are within shouting distance of the potential concessions we may choose to make. We may not make all those concessions, so one way of managing the problem is bring that number down. We're not going to just go sign checks for $10 million. We're going to say no, no, no. And they're going to say, well, we won't ship you. And we'll say, make our day, and that's the way it's been going.

But it's almost all behind us now. I think that most of the agreements have been hammered out or we've identified where we're likely to take them. And we are making some concessions; we have to in order to keep our factories running. We don't want to shut a line down. It costs us too much money to get into a lawsuit over it. So we have to absorb some of it. We should have seen this coming. We didn't see it coming as much as we should have, but I think we see it now. And I think we have a plan in effect that will deal with it, and within the next two quarters we'll see this pass through our system. Then we're out in the clear ground, and 2005 will be a completely different matter. And we expect a return to normalcy, whatever that is in our industry.

That was helpful. Just one last question. I think on the last conference call, you talked fairly extensively about lease portfolio opportunities and perhaps leveraging the balance sheet. Given these near-term issues with supply constraints and margin issues, has that sort of changed your view as to how much capital you may deploy, and then ultimately what you may do in terms of stock buybacks or dividends?

I'm not sure I understand the question. I think I understand the first part of the question. We talked about deploying our cash and earning assets, and we've been very successful of that. I was unfortunately stricken in articulating when we first tried to describe all of the things that we've achieved in the last few months. There is a fairly stupefying list of things that have really gone well, and that's one of them.

Our lease fleet utilization has improved from year-end from 92 percent up to almost 96 percent. Our yields are increasing in the lease fleet. We've been deploying cash into the lease fleet, somewhat kind of concealed, however, by the runoff of part of our older Golden West leasing portfolio on finance leases by the Union Pacific Railroad. So we have some finance leases terminating and being bought out. At the same time, we're putting cash into cars that were purchased with cheap steel and adding them to our leasing fleet, and in terming those out. So it's fairly complicated, but we are doing that. The second part of the question, I'm not sure if I got that part.

Just further on the first question, we had identified early in the year that our CAPEX for leasing on a gross basis was going to be about 35 to $40 million, and then we said on a net basis our total CAPEX is going to be about 25 million, because we also have assets coming out of our lease fleet. But that gross number of 35 million, we've already identified the equipment and some of that has already been taken into the lease fleet, about half of it. The other half we still expect to come on in the second half of the year and is not going to be affected by any of the issues that we discussed earlier.

Something, though, to keep in mind on leasing capital expenditures, they are not like manufacturing capital expenditures which are permanent with you forever and ever and ever. Our leasing capital expenditures are, while sizable, quite liquid, and we often trade them out so that we don't see them in the same light as we do manufacturing capital expenditures.

Right, understood. I just thought maybe with some of the price pressures that maybe the return on invested capital may look a little less attractive today than it was before, but I guess what you're saying is the lease rates are more than offsetting the potential increase on the investment side.

Correct, we're happy with the yields that we're looking at, and getting enough in early in the cycle as to the prices we're paying for the cars.

Okay, thank you.

I show no further questions at this time.

Thank you very much for your participation in today's call. We appreciate and we look forward to our third-quarter call. Have a good day.

Thank you for participating in today's teleconference. Have a great day.