Greenbrier Companies Inc (GBX) 2014 Q3 法說會逐字稿

Hello and welcome to The Greenbrier Companies third quarter of fiscal year 2014 earnings conference call.

Following today's presentation, we will conduct a question-and-answer session.

Each analyst should limit themselves to only two questions.

Until that time, all lines will be on 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 conference over to Ms. Lorie Leeson, Senior Vice President and Treasurer.

Ms. Leeson, you may begin.

Thank you, Shirley.

Good morning, everyone, and welcome to our third fiscal quarter of 2014 conference call.

Today I am joined by our Chairman and CEO, Bill Furman, and CFO Mark Rittenbaum.

Mark and I will provide a few remarks about the quarter ended May 31 and our outlook for the balance of 2014; and then Bill will provide some comments on the overall industry.

We will then open up the call for questions.

In addition to the press release issued this morning, which includes supplemental data, additional financial information and key metrics can be found in the presentation posted today on the IR section of our website.

As always, matters discussed in today's conference call include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.

Throughout our discussion today, we will describe some of the important factors that could cause Greenbrier's actual results in 2014 and beyond to differ materially from those expressed in any forward-looking statements made by or on behalf of Greenbrier.

The third quarter of fiscal 2014 was a record quarter for Greenbrier in revenue, net earnings, diluted EPS, adjusted EBITDA and backlog.

Highlights for the quarter include adjusted EBITDA of $78 million, net earnings of $33.6 million, or $1.03 per diluted share, on record revenue of $593.3 million, driven by deliveries of 4,300 railcars.

Our tax rate for the quarter of 26.3% was driven by the geographic mix of earnings, and specifically our GIMSA joint venture.

Since 100 % of GIMSA's results are included in our pre-tax numbers, but we are only taxed on our half of the earnings, the tax rate can be significantly impacted when GIMSA has an outstanding quarter, as was the case this quarter.

This is consistent methodology with prior quarters, and our partner share of GIMSA's earnings is reflected in non controlling interest, also known as minority interest, on a pre-tax basis.

Since the last earning call, we've made several orders announcements.

Orders for the third quarter totaled 15,600 new railcars valued at $1.64 billion, bringing broad-based backlog to a robust 26,400 units valued at $2.75 billion.

Our book to bill for the quarter was 3.6 to 1; and since May 31, the end of the quarter, we've received additional orders for 2,700 units valued at approximately $320 million.

In addition to the rail activities, marine backlog grew to approximately $110 million this quarter.

As part of our ongoing efforts to return capital to shareholders, under our $50 million share repurchase plan, we purchased 352,000 shares of common stock during the quarter at a cost of $16 million and average price of $45.50 per share.

Cumulative repurchases under the program totaled 641,000 shares at a cost of $26.3 million, or an average price of $40.98 per share.

The activity during the quarter was muted, as our trading window was closed for much of the period prior to the announcement of our repair joint venture.

We do expect these share repurchases to continue.

Now I'll turn it over to Mark for other highlights from the quarter.

Thank you, Lorie, and good morning, everyone.

In addition to our share repurchase program, as part of our balanced approach to capital allocation, we also declared a quarterly dividend of $0.15 per share payable on August 5, 2014 to shareholders of record as of July 15, 2014.

This is also in response to investor feedback and a strong signal to the market about our confidence in operations and cash flow generation through the cycle.

Over the past year, and in fact over the past year and a half since we announced our margin enhancement and capital liberation goals, we have been singularly focused on our strategic initiatives and operational efficiency.

This quarter's results illustrate that our planning is paying off.

Our gross margin for the third quarter reached 16.3%, significantly ahead of Q2 and far ahead of our stated minimum goal of a 13.5% aggregate margin by the fourth quarter of fiscal 2014.

This is also in addition to having exceeded our capital efficiency goal of freeing up a minimum of $100 million from our balance sheet.

Gross margins in all segments of our business were up sequentially, and we believe this momentum is sustainable.

As demand continues to climb, so will our focus on maximizing value through all of our production facilities and particularly, in manufacturing.

In our Wheels, Repair & Parts segment, subsequent to quarter end we announced a JV -- joint venture -- with Watco to create GBW Railcar Services.

This entity will have the largest independent railcar repair shop network, with 38 locations across North America, including 13 certified tank car shops.

We're very excited about this new venture, which we expect to close this fiscal year, and we look forward to meeting increased demand for general freight cars of nearly all types and for tank car repair, recertifications, linings and retrofits.

We'll provide more details on this JV after it closes, and it's still too early to determine whether or not the JV will be consolidated on our balance sheet and on our financials.

Our Leasing & Services segment continued with its strong momentum.

We continue to drive more volume through our leasing model, syndication volume, that ultimately, a large portion of it shows up in our manufacturing segment; but we also continue to grow our Management Services business, while reducing the permanent capital invested in this business.

During the quarter, we announced an alliance with Mitsubishi UFJ Lease and Finance, along with other syndication partners, both institutional investors and their leasing companies.

MUL will acquire a portfolio of about $1 billion in leased railcar assets, both new and used, over a multi-year period.

This is not incremental to our backlog, but will allow us to continue to drive more leasing volume and throughput in the coming years ahead.

Our SG& A increased compared to last quarter, driven by employee-related costs associated with higher levels of activity, particularly in the tank car area, with it as a more specialized area, that also reflects increased incentive compensation with higher earnings and certain nonrecurring costs.

Now I'll turn it over to Bill.

Okay.

Thank you, Mark.

I'm going to break my comments into three parts.

I'm going to talk first about the orders received during the quarter and post quarter.

We had a very strong quarter in that regard.

And then I'm going to talk for a moment or two about tank car safety and our role in the tank car safety issue, which is very prominent today in front of our government and in the industry.

And then finally, I'll just touch on a few of the drivers of our performance and talk about the reasons I believe that this level of performance is a new base and is sustainable, as we have had operating efficiencies.

Greenbrier advanced its backlog, as Mark and Lorie have pointed out, in the third quarter and post quarter, with both a revitalized leasing model, including the initiatives with Mitsubishi and other funding partners, and with manufacturing awards across our entire product line.

For Rail, this included automotive, intermodal, tank and covered hopper cars, as well as other car types.

Our Marine backlog grew to $110 million, with forward momentum continuing.

And the opportunities that we're tracking in that area, particularly for energy-related and chemical-related products, are substantial.

We received our first major awards for dramatically safer tank car for hazmat, flammable service, out of the total 17,700 awards during and post quarter, a substantial increase over earlier levels.

3,500 of the tank cars we received were for our new, improved, and markedly safer tank car of the future.

And as Mark has indicated, we are on the eve of launching our repair initiatives with the Watco joint venture under the leadership of Jim Cowan, with the name GBW.

So next let me turn to a few remarks about tank car safety.

Greenbrier's Board has made a conscious stand to face the responsibilities with the car building industry and the railroad industry for safer transportation of oil and flammable and all hazmat service.

Our new tank car design is a dramatic improvement in safety from the present fleet, carrying oil and ethanol and other flammables and as well as other hazardous material.

That total population of cars is almost 170,000 cars.

A more robust design is expected to be adopted directionally as a new standard, when the US government issues its long-awaited car design standards for approved equipment in oil and ethanol; and we are already there with our tank car of the future.

It's important to understand that presently only the legacy DOT-111 fleet, originally designed in the 1970's, is officially approved by the government as the standard for service.

Due to operating and safety concerns, the railroad industry made mandatory an improved standard with the 1232 design in 2011, but that design has never been ratified or officially endorsed by the Department of Transportation.

This action is required, and it's required urgently.

The Greenbrier design is up to eight times safer at any speed when measured against the legacy DOT-111 car now used predominantly in service for such flammable products.

And this is as measured by conditional probability of release, or CPR, an industry accepted standard.

CPR measures the probability of breach of a tank car and spill of contents over a range of speeds, based on historical records and statistical analysis.

And our car is roughly two times safer than the state-of-the-art insulated fully jacketed post 2011 CBT-1232 car, which is the current best practice standard imposed by the railroads, not the government, but yet to be approved by the government.

So the bullet here is we need government action on the tank car design.

The Department of Transportation is trying very hard to get that done.

This will be at the White House.

It's there now.

Supporting information to my comments will be listed in our attachments to this morning's earnings release and the terms of the chart on conditional probability of release.

But just in short, Greenbrier's proud of its leadership on tank car safety.

This morning, the administer rate in Canada announced new safety regulations for rail and dangerous good requirements.

We urge the US government to follow that lead and to issue standards.

It's less important what the standards say than that the government issue them.

And we hope and trust that they will not combine that with speed restrictions, which are very complex and which could damage the US economy, having knock-on effects in grain, intermodal, automotive, merchandise and many other service, at a tremendous potential cost.

We need these regulations, and we need them now.

And we do not need, nor should they be bundled with, speed restrictions beyond those speed restrictions the US railroads have already imposed.

This is an imperative thing for our country, for our industry, and for safety of the American public.

So let's turn now to the quarter and the road ahead.

Given the quarter, I want to remind everybody of our strategy and the goals set two years ago.

I'm very pleased that we had the ability to listen to many of our major investors and to accommodate and adopt many of their suggestions.

We are now executing well on the strategy that evolved, and we've met or exceeded every goal earlier than expected.

Performance for the quarter is sustainable directionally and is the result of strategy execution over those past two years.

All parts of our business model now have wind in the sails.

While we still have ramping in the next two quarters, as we double our tank car capacity in Mexico and expand other product offerings, we finally are seeing real operating leverage in execution, as you can see in our margins.

And we believe that will continue directionally over the next two quarters sequentially -- or over the next six quarters sequentially.

And we have reminded everybody that our progress is not necessarily going to be linear, but sequentially, over a sustained period of time, we have very good visibility and we expect this operating leverage and margin enhancement to continue.

So in summary, our strategy was to set metrically driven goals, diversify our product mix, create revenue and product diversity across all railcar types in manufacturing, not only energy and tank cars, but all types of railcars, and drive production and leasing through lower cost, capital light models.

We think we finally have gotten our leasing model together, and we are really pleased about the results that we are getting and are going to get and the new relationships we set with Mitsubishi and other funding sources.

We also, most importantly, set goals for capital efficiency and margin enhancement, and we decided on a balanced policy to return capital to shareholders.

Our stock buyback program continues, as announced earlier today.

And as commented upon by Mark and Lorie, in this quarter, as you've heard, our Board has approved a dividend policy which would be equivalent to about 1.1% yield on yesterday's market capitalization.

We have strong cash flows from operations and the best ability I've ever seen in this business, so we'll have ample capital to invest in growth, while adding to shareholder returns through judicious stock repurchases and dividends.

So in summary, some important points, points that are much different than the environment of a year ago.

Leasing is hitting stride, performing at higher levels.

Our capital efficiency and lease funding models has been enhanced, and we have, for the first time, truly adequate capital to drive our leasing engine with a capital light model, with the major announcements we've made.

Manufacturing operating leverage has kicked in and is moving upward.

Capital liberation and margin goals have exceeded goals earlier than planned.

Our underperforming facilities in repair are trending up and have a good future in this new CBW joint venture -- GBW joint venture, pardon me.

The Marine business is strong demand and strong backlog.

Our Gunderson unit has intermodal backlog, and the outlook for stacks is up.

Double stack orders have been received.

The industry loadings for intermodal are all up.

And we've had record earnings for revenue, net income, diluted EPS and backlog.

I think the bullet there is there's more upside to come.

Finally, we have growth opportunities.

And these abound in related businesses, such as energy, and I think for that reason, we were very pleased with this quarter.

We look forward to seeing this as a new base for further growth, and see many opportunities in our space and expect continued strengths in the quarters and years ahead.

Back to you, Mark.

Thanks, Bill.

And we'll let Lorie make some concluding remarks and then we'll open it up for questions here.

Thank you.

And based on current business trends and industry forecasts, we now expect that deliveries in the fourth quarter to be between 4,300 units and 4,600 units resulting in fiscal 2014 deliveries of 15,700 units to 16,000 units.

Fourth quarter revenue to increase 4% to 6% above third quarter revenue of $593 million, resulting in annual revenue in excess of $2.2 billion.

Earnings per share for the fourth quarter in the range of $0.95 to $1.05, resulting in fiscal 2014 EPS, excluding restructuring charges, in the range of $2.98 to $3.08.

The quarterly amounts do not total to the annual amount, as each period is calculated discretely.

Further, we expect long-term growth margin improvements, but as Bill said, we believe the trajectory will not be linear.

Gains on sales to be minimal for the rest of the year.

Our annual depreciation and amortization is still at about $40 million for the year.

An annual tax rate of 29%, depending on geographic mix of earnings.

And fourth quarter earnings attributable to non controlling interests, also known as minority interest, to be similar to the third quarter.

Our fiscal 2014 gross capital expenditures should be about $90 million, driven primarily by North American manufacturing activity, and net capital expenditures, so net of proceeds from sales out of our fleet.

Net CapEx of about $40 million.

All of these estimates do not reflect any purchase price accounting adjustments or one-time transaction-related costs or other effects that may occur in conjunction with the closing of the GBW joint venture.

We'll now turn the call back over to Shirley to host the Q& A. Again, as a reminder, please limit your questions to two.

And if you have further questions, please requeue and we will address, is time permits.

Shirley?

Thank you.

We will now begin the question-and-answer session.

(Operator Instructions)

Matt Brooklier, Longbow Research.

Yes.

Thanks.

Good morning.

So I guess my first question here -- you saw a really nice gross profit margin improvement.

It sounds like that continues moving forward, just given the ramp in railcar production.

And then you also have the Marine side of it kicking in a little bit more in fiscal 4Q.

I'm just trying to get a sense for how we should be thinking about margins sequentially.

We think they're going they're going to get better.

But also remembering that you have some start-up costs with those additional tank car lines coming on.

So maybe just if you could provide some color in terms of the margins moving out, and how we should think about those start-up costs when they potentially hit, and maybe the magnitude, if you could talk to that?

Sure, Matt.

This is Lorie.

I don't know that we've said this yet, but we weren't intending to give any guidance on FY15 until we do our fourth quarter earnings release.

To your specific question, I think we've said a couple times that we don't expect -- while we expected our margins to be sustainable, they may not be linear, for many of the points that you just raised.

There's a variety of things that can happen during the quarter, and we do have some start-up.

On the other hand, we have Marine that should be kicking in very nicely during this fourth quarter at our Gunderson facility.

So it's for all of those reasons that we're not giving specific margin guidance in the fourth quarter.

We do expect the fourth quarter to be a great quarter, but we don't have particular margin guidance to give.

Mark, I don't know if you want to supplement that?

Yes.

And similarly for next year, I think as we -- we're not prepared to give margin guidance yet either.

As we've said many times, this is a journey of many steps and so we still see a lot of opportunity for margin enhancement.

As you've noted, we'll be moving into new facilities and those will be lower-cost facilities.

We'll be adding additional tank car capacity, which is a higher margin business.

We'll have the wind at our back for Marine, and our European operations has a brighter outlook for next year.

But having said all that, we're going to withhold for now on that specific, either for next year or on a quarter-by-quarter basis.

Okay.

Fair enough.

And then in the past, I think you talked to a theoretical maximum in terms of railcar deliveries moving out into peak.

What are your thoughts here, given the run rate of what you're doing, the additional capacity that is expected to come on.

Is that number still in a 21,000 to 22,000 unit number, or do you think you could do something north of that?

Sure.

So I'm not certain about 21,000 or 22,000.

I think what we've said previously is maybe closer to 20,000.

But that is very dependent on the product mix.

So particularly in a year where we have a considerable amount of intermodal demand, we can definitely drive to much higher volumes.

As you're aware, tank cars, as well as the automotive products that we're building and manufacturing, all take a larger number of hours, so the production rates on those don't get up quite as high.

So I would say that theoretical is still somewhere in the 20,000 to 21,000, depending on the product mix.

But that's -- we're just excited about where we are for FY14 and look forward to giving you guys further guidance on FY15 in a few months.

Okay.

And then just to clarify, the 20,000 to 21,000, that includes the additional tank car manufacturing?

Yes, it does.

As well as Europe.

Okay.

Got you.

Thanks for the time.

Thank you.

Justin Long, Stephens.

Good morning, and congrats on the quarter.

First question I had was on the backlog.

I was wondering if you could break out the rough split between tank and non-tank in the backlog today.

And then as a follow-up to that, looking into 2015, I know you're not giving specific guidance now, but clearly there's a lot of visibility in the backlog.

Could you just speak to how much build capacity you have left for 2015?

Or are you completely full at this point?

So we'll take this in parts, Justin.

This is Mark.

Of our existing backlog, about 40% of it is tank car and the balance, a broad mix of general freight cars, as Bill described earlier.

We do still -- with that backlog, there is some multi-year backlog in there.

And obviously, with 26,000 railcars, that would stretch beyond the year, even with simple math.

We still have open production slots for 2015.

But again, at the end of our year, we'll break out how much of the backlog goes in, is related to 2015 and how much of it is beyond.

But with this backlog, we have very good visibility into our 2015 and beyond, obviously.

I just want to at hasten to add that while we have some open space on some lines in 2015, that this is very specific to car types and we're running -- our goal is to run the long runs of cars on each line so that the space available is selective to car types.

In tank cars, we expect substantial demand for tank cars as the regulations are finally sorted out, and we are selling space selectively to our core customers in order to be able to meet their requirements.

Okay.

Great.

That's helpful.

Thank you.

As my second question, one thing that you noted was the liquidity position.

You noted that in the release.

And it seems like the free cash flow profile should be getting better, too, given the visibility you have.

Have you refined your thoughts at all on your plans for this capital.

And also, when you're looking at different ways to invest this capital, is there a certain level of ROIC that you're targeting?

We are in a -- generally speaking, reaching our operating efficiencies and getting operating leverage, we're in a refinement phase now.

We really saw this operating leverage kick in in the last quarter, continuing in June.

And in that regard, we are looking at selective projects, putting a lot of attention to selected projects, jigs picturing, engineering enhancements, value engineering, with very high rates of return for those selective projects.

Those are basically no brainers with multiples of -- in many cases, returns in less than a year, and certainly, a two-year payout with that kind of efficiency enhancing, margin enhancing, selective investment.

We also see considerable growth opportunities beyond the capital we're allocating for return to shareholders.

We are going to throw off quite a lot of cash in the next three years, four years, with visibility out effectively into that range.

So we see selective opportunities in our core businesses in both leasing, manufacturing and repair, parts, wheels, and in Europe.

Okay.

Great.

I'll leave it at that.

Those are my two.

Thanks for the time.

Thank you.

Thanks, Justin.

Bascome Majors, Susquehanna.

Yes.

Thanks for the time this morning.

I wanted to ask a little more on the backlog and your visibility.

You said you have some slots available next year.

Is your additional tank car capacity sold out for next year at this point, as you're bringing that on?

Effectively, it is.

I think when we're selling these out, we have some capacity reserved for our leasing customers.

So we are optimistic that we can handle the customers that have brought us to the party, particularly on tank cars.

But we have very strong backlog for tanks and we expect that the demand for tanks will continue to accelerate.

And to that point, on the slides you said you do have -- you said it was available, or specific by car types.

What types do you have some capacity left for that you could incrementally fill up next year?

I'm not sure how granular my financial guardians here will allow me to be.

So I'm going to turn that back to you, because you're -- what we're going to do here at the end of the year is give a lot more transparency.

We've said that we -- a year and a half ago, at a conference in New York, we said we were going to be much more transparent, explain our metrics.

We're doing that.

And it's not that I don't want to answer the question.

I'm not sure I want to answer it now.

Right.

I know the answer, but I'm not sure I can tell you the answer yet, because he won't let me.

And partly for competitive reasons, too, we don't want to break out our open slots by car type or by product lines.

I think it's -- one area it's safe to say and comment on is that, as compared to this time last year in intermodal, for example, we have much more visibility and a stronger intermodal backlog.

At the same time, were there to be additional demand for intermodal cars, which we're very optimistic about, we could ramp up that production further than we already plan to operate in 2015.

We have some long-standing customers.

TTX is one.

You know in our industry there's mutual reliance, and so we want to be there for those customers, as part of our service model.

So we work very closely with these customers.

But in general, the backlog is very strong and we have a -- we're in some respects in a rationing position, which is, frankly, good on the pricing side.

And that's part of the margin enhancement we'll see moving forward.

Okay.

And just one more.

On the leasing segment, the revenues and profits were much stronger than they've been recently in the quarter.

You mentioned in the slide deck some of this was due to syndicating third party produced railcars.

Can you just walk us through what's happening there and whether or not this is a sustainable base to build from or kind of a one-time spike?

We don't see it as one time at all.

We have a pipeline of both capital and transactions that we're driving more business through our leasing model.

As we do that, we're also financing outside products, as well, in our space.

We're buying railcars originally built by others.

We're managing railcars originally built by others.

And our management business and leasing business is really taking off.

We're, in effect -- that's a -- it's an emerging part of the business that is really very exciting.

So several elements contributed to the momentum in the leasing business.

We see the leasing business as a growth engine, and we've got a very good team of professionals running that business.

They've done a great job of finally getting our model down.

We have a capital light model.

Our ROEs are very high and are expected to be very high.

So I'm very bullish on our leasing business, and I think it's a sustainable model, as is our manufacturing base with the current outlook.

Thanks for the time this morning.

Thank you.

J.B. Groh, D.A. Davidson.

Thanks.

I've just got a couple.

Hello.

How are you doing?

Mark, could you talk about the tax rate going forward?

I know you don't want to give 2015 guidance, but as more production goes to Mexico, I guess it's probable that we'll see that tax rate below 30%?

It's a good question, J.B. And I think that is correct, that as more goes to Mexico and more is driven through our GIMSA joint venture, which has this kind of funky accounting for taxes, that around a 30% tax rate would be a good tax rate to use.

Okay.

And then can you talk about -- you mentioned some sort of one-time items on the G&A line.

Could you talk about what's sort of implied in your Q4 number for G&A?

Sure.

I think implied in there is probably something a little bit less than what's -- a little bit less than in Q3.

And then if I could sneak one more in, could you talk about the Marine revenue in the quarter and how you expect that to ramp with the backlog that you've got over the next couple of quarters?

Right.

So the Marine revenue in the quarter was less than $10 million.

We would expect that to be higher in the fourth quarter, maybe up to double that.

And while, again, we'll defer overall on next year, I think it would be safe to say for next year that, so $15 million in the fourth quarter is an approximation.

If you multiply that by four, that's $60 million.

I think for us as an annual run rate, and we would expect in 2015, that annual run rate would be higher than Q4.

Can I go up a few thousand feet on that question J.B.?

It's a good question.

Actually, our Gunderson facility here in Portland is primarily a marine facility and an intermodal facility.

We do make one other specialized car type there, mechanical refrigerator cars.

All three of those markets are now much stronger.

We've had a two-year hiatus.

2012, Gunderson produced EBITDA close to $25 million.

It's been a drag on our manufacturing production in the last two fiscal years, 2013 and most of this year, but now it's kicking in.

And we see in 2015, compared to the current run rate, lots of -- we think it can return to that level of performance.

So there's probably $20 million of EBITDA in there, if we can make everything work the way it's supposed to work, and we have the visibility, which we believe we've got.

We certainly have it in Marine.

We believe we have it with the kind of growth in intermodal.

Growth in intermodal has been strong, even though overall car loadings for the last month, on January, were a little flat.

You've got to look at the specific car types, and 4% growth in 2014, another almost 4% growth is expected in 2015.

Velocity is falling in the industry, something that we all need to be aware of.

And this whole energy issue has a big, big potential impact on velocity and service availability to grain shippers, intermodal shippers, all kinds of folks.

As you know, J.B., if you have velocity fall, you need more cars to carry the same amount of service.

So it's a very complicated environment.

We've had a disruptive event in the energy sector, and that's going to have a ripple effect through the entire economy.

So we hope that those in Washington who are pondering these great things really get it figured out and make the right decisions.

Otherwise, we're going to have some high demand for freight cars, a spike demand that the industry can't fill, and lower velocities.

And that's all giving us a lot of wind at our backs in Gunderson, and that's probably expected for the next couple of years.

Great.

Thanks for your time.

Thank you, J.B.

Ken Hoexter, Bank of America.

Great.

Good morning.

Just before I jump into the question, just a clarification.

You mentioned the 170,000 number on cars.

Is that what you think has to be replaced, or is that just replaced and refurbished or retooled?

That's 170,000 cars that are currently in hazmat service, the DOT-111 and 1232 cars.

And about 100,000 of those are in flammables.

Of the flammables, about 68,000 are in oil and ethanol.

American Petroleum Institute has said that all oil is the same.

The Bakken is no more flammable or explosive than any other.

I don't agree.

That's what they say.

And almost all of that's going to have to be carried in an improved car.

Turning to the other flammables, we are seeing every day here in Portland, Oregon and in Seattle and in San Francisco, stories about the threats to rivers and the environment from carbon.

And if all of you haven't noticed it, there's a real effort to kill carbon in all of its forms by some of the more radical environmentalists.

The rivers are very vulnerable.

So I believe that this safety consciousness will be driven by those folks, and we're going to see a need for stronger protection for any cars that have hazardous material.

And that kind of stuff could be things that are carried in the rest of the 170,000 cars that are not flammable, such things as pesticides that caused the river -- the Sacramento River poisoning and before the turn of the last century -- at risk.

That threat is still there.

And so stronger cars.

As these older cars get retrofit and recycled into service, they're very suitable for higher and best use as the older, older cars get retired.

So it's a very interesting dynamic.

It's truly a disruptive event driven by high-speed trains.

And I think that that's what everybody misses when they look at this issue.

The railroad system today has to run at high speeds or they can't carry traffic.

You've got intermodal unit trains.

You've got grain unit trains.

Now you've got oil in the trains.

These things weigh 15,000 tons.

And if they move at 50 miles an hour, everything is cool.

But they can't do that through towns or cities and the railroads are responsibly adapting those policies.

But the impact of all of this on the environment is something not to be -- I think our industry is really -- with the exception of the railroads, have been very responsible about this.

And I think our industry has been very slow to realize the threat to the economy from deterioration of rail service.

Go ahead.

Were you going to say something?

Railroads have been very -- they've really stood up to their responsibilities.

And I think it's time for the rest of the industry to do this, as well.

So I think that there will be a trickle-down effect into these other car types, and that's -- it's a very disruptive event that's happened that affects all hazardous cars eventually.

And we just have to, with higher speed trains, we need to have stronger cars.

And it's just that simple.

That's really helpful, just at least to visualize the tail on -- because it was only the 50,000 or so cars that are carrying the crude.

Then you've got pretty much got that nearly covered with your backlog and the industry's backlog.

But that's a great vision on how it continues.

But that's not really true.

I understand why that's tempting to say that.

But all of the cars that are being added today are for growth.

We haven't really touched the need to replace the legacy cars that have been out there that are a major portion of the problem.

If you've got a car that's eight times more likely, at higher speeds or any speed, to release its contents, the danger of pool fires, like we're having or seeing almost every month, increases.

And that's why it's very important that the Department of Transportation go on with it.

And they're trying to.

And OMB needs to get on with it, and the White House needs to get on with it and issue some standards, so we all know what it is we're supposed to be doing.

So we haven't addressed this issue whatsoever, in many ways.

This current backlog, we're not even sure if it's going to be acceptable to the government.

So the government's got to act, and that's really what is needed.

And a lot of us are getting very frustrated.

We're trying to behave responsibility.

We can't.

It's not unlike the situation with General Motors.

I mean, this is a safety issue that's paramount.

We can make the cars safer.

We've been trying.

We have to have the government accept it.

And they're trying, too.

But we need to get on with it.

Appreciate that insight.

Now on the -- to my question on the triggers -- you noted that your goal was 13.5% margins.

You've moved up to 17%.

I understand it's not linear, but maybe can you dig into what occurred in the quarter that was maybe more permanent in nature, because you've jumped so significantly from where you were a year ago.

So what is maybe more permanent, maybe what is more related to price and mix adjustments that can be that volatile and nonlinear nature?

So what is the new base rate, at least just based on the changes that you and Cowan have made in terms of the operations?

Well, Cowan is almost entirely preoccupied with GBW.

He's going to have 38 facilities, and he's going to have his hands full getting those, between Watco and ourselves, corralled and increasing their margin.

And we're going to issue some guidance at the end of our fiscal year.

And probably that's the time to talk about being more granular on that kind of a question.

I will say that the momentum -- the operating momentum we're seeing was seen by others earlier.

It wasn't seen, in our case, because we've been in a constant stage of ramping and diversification of products.

If you think about it, we're a totally different company than we were five years ago.

We have Auto Maxx, Maxi, the Multi Max auto cars.

We have the new plastic pellet design we're just launching this week.

And we've been really innovating a lot.

We want to have a broad footprint with product diversification.

We don't want to be a one-note samba and trade present margins for future uncertainty.

So now, as we have slowed our ramping, as we have longer runs in each individual car type, we're able to get operating efficiencies.

And of course, the market climate has allowed selective pricing adjustment to levels where they should be.

But when you talk about nonlinear, you're not talking about going down 400 or 500 basis points.

Are you talking about maybe it's a 100 basis points swing?

Just want to understand the magnitude of shifts you're referring to.

Exactly, Ken.

All the drivers here, production efficiencies, operating at higher volumes, mix, pricing, all those drivers are permanent in nature.

And then we also talked about some other things that are positives, such as our Gunderson facility operating at higher rates than intermodal and in Marine and Europe picking up.

And at the same time, you're exactly right that these are all more permanent in nature, that we can see, just as we bring down a line and bring up a line, that you can have an up or down in one quarter.

But directionally, we believe this sets more of a new base than where we were earlier.

Yes.

What we're really trying to say is that quarter by quarter, I don't think one ought to expect an acceleration of this kind of increase that happened in the Q3.

We're not talking about material declines, either.

What we're simply saying is that nothing happened that was particularly different.

This quarter, everything is just humming along.

And we've got a lot of wind at our backs now with Gunderson and marine and intermodal, everything we're talking about in the last year or so that was looking like it was coming together.

The general freight car market has got strength, has got legs on it.

And we just have the luxury of executing.

And we are doing that.

And we expect, over time, margins to increase.

But given that this is our third quarter, and at the end of the year, we'll set new targets and we'll be much more transparent about what our goals are for the coming year.

That's helpful.

And just lastly, again, another clarification, if I can.

You noted you would invest in growth.

Are you talking about, with your great cash flow you mentioned before, are you talking about adding more capacity to help meet the backlog, or is it growth in another way?

Well, we are not entirely masochistic.

No.

We're not intending to -- other than selective capacity increases to meet specific markets, we have no grand plans to build out more capacity in the rail space.

But we want to tune the capacity we have so we can improve our margin efficiency.

And I think that's where CapEx can really improve our margins and provide for growth.

We make our base more productive, more efficient so we can compete head-to-head with anybody in the business across a broad range of products.

That's our goal.

Enhanced by our leasing model, as well.

Truly appreciate the insights and time.

Thanks.

Thank you.

Mike Baudendistel, Stifel.

Thank you.

I wanted to ask on the service centers, it sounds like performing retrofits with tank cars with added safety features is a big opportunity for you.

Have you thought about how many cars you could retrofit in a given year, given your new capabilities?

Yes.

In fact, the industry is studying that.

Many believe that the industry does not have the capacity to retrofit the potential demand.

Keep in mind that the government standards in Canada that were just issued today and the government standards the United States is expected to issue will not and are not expected to make standards on retrofits.

Retrofits will be derived from improvements in the standards they make and the timeline they set for what type of car design they'll allow in flammable service.

And that's what this rule making is all about.

There will be two markets for these retrofits.

One will be the 1232, probably the non-jacketed car will have to be upgraded over some period of time, we think.

And that's one sub market.

And then there's another market of what do you do with the DOT-111 legacy cars.

Many of those cars are new -- newer.

They've got a lot of fixed costs in those cars.

They will not have to be scrapped, but with modest improvements in the -- in retrofitting those cars, they can be used for an extended period of life, if not in high combustible service, then in other hazmat service.

So we expect a very strong market for safer products in retrofits there.

If we looked at -- which we don't expect to happen at these DOT-111 cars to be totally compliant with what we expect in these standards might be, you're looking at -- we have a capacity to do about 25% of the total need, several thousand cars a year.

And we have the capacity to turn on other facilities over, given a year or two.

So it is fair to say that there will be capacity to do whatever is required.

But the whatever is a very, very important thing to understand.

We don't have the standards in place yet.

We're not expected to get those standards from the government.

But I think the industry will have to decide for itself how safe do they want their cars to be in operation, and that will drive that retrofit market.

So there's adequate capacity to do the retrofits that are required, and it will be an important but not a crucial part of our GBW strategy.

Great.

That's helpful.

And I also wanted to ask, there were some of the press releases in the quarter.

I think one of them you mentioned that you are -- the tank car of the future has added safety features, but it doesn't take away from the payload in the car.

I know that's been an area of controversy.

Maybe you can talk a little bit about why there's been a difference of opinion there.

Okay.

Well, I'm really glad you asked that question, because it's something that's personally annoying to me.

And I'd love to -- I love to talk about this.

The DOT-111 legacy car has plus -- a little more than a 30,000 gallon car.

It's not jacketed.

It, in some cases, has some head shielding.

The ones we built did.

Some cases it has none.

And the car that we have designed is approximately 30,100 gallons.

There are other competitors in this space that have that type of capacity.

We're a fully jacketed, heavier steel car.

The slick 1232 car has less capacity.

It has a capacity for -- well, a slick car has more capacity, 31,800 gallons.

That's the car that people are comparing to.

But the slick car is not a car that's expected to survive this in its current form.

And it might be some of them might be grandfathered with some modifications over time.

And that's the retrofit market that people are talking about.

But the basic car that is safe for use, or will be safe for use, if the railroads have their way, and they should know -- we have to listen to these engineers, not the political scientists here -- will be about 33,000 gallons, exactly what we've been running in the industry for years, for the last five years.

And so I don't get this capacity argument.

In any case, it's certainly not more dangerous to have lower capacity cars.

And there's a lot of just silly arguments going on out there that really get in the way of a sober and somber view of our responsibilities as engineers and car builders to produce a product that's safe, that protects the public, and that's responsible.

Great.

Thanks very much.

Thank you.

Sal Vitale, Sterne Agee.

Good morning.

Thanks for taking my questions.

I appreciate it.

Just a quick question, just a clarification on the Marine revenue side.

So I think on the last call, you said that Marine revenue was roughly $5 million per quarter in 1Q and 2Q, and now 3Q is a little less than $10 million.

So should we think about the full year 2014 being roughly, say, $35 million or so?

Is that the right way to think about it?

Probably, Sal, a little bit closer to $40 million.

But $35 million is pretty darn close to $40 million.

Okay.

And then that FY15 being roughly $60 million, is that a good ballpark estimate at this point?

I think at this point, that's probably a minimum number, Sal.

We said in Q4 we would be operating exactly at $15 million, so annualized, it's $60 million.

But we would expect probably to be operating at higher rates than that in 2015.

Okay.

That's helpful.

And then just refresh my memory, on the timeline in terms of when the additional tank car capacity is coming on, are we still thinking -- was it late calendar year 2014?

Is that the right way to think about it?

So one of the lines will come on in late calendar 2014 and the other, at our central Mexico facility, where we're transitioning a line that's currently producing non-tank cars and we're converting that over to tank cars, that'll happen, I'd say, early to mid calendar 2015.

Okay.

That's helpful.

And then, just the touch base on the margin progression.

Very impressive in 3Q.

Is there any potential for any issue to result in a sequential decline in margins, on the manufacturing margin in 4Q?

I think again, just Sal, part of what we were talking about earlier of whether it relates to mix or line changeover, or as we move out of our Bombardier facility into a new facility, that from quarter to quarter, it can move a little bit in one direction.

But as was asked earlier, this represents -- this quarter represents closer to a new baseline than where we were operating at previously.

We don't expect to drop down to where we were in Q1 and Q2.

But again, from quarter to quarter, it may move a little bit in one direction or the other.

And as we said before, we'll give guidance on 2015 next quarter.

But Sal, in terms of a little longer view, two, three, four quarters ahead, we expect sequential strengthening of margin.

That's going to be a new goal.

We're not going to give guidance yet.

We're certainly happy that we exceeded our target of 13.5, and we certainly don't expect to go back down to that level in even any sort of variation that might be driven by some unusual event.

Interesting thing about this quarter, again, there's nothing unusual about it.

It's just business as usual, with a lot more tailwinds.

And those tailwinds are going to really contribute to margin.

When Gunderson starts kicking in, you're going to see really big improvements in 2015.

So we think that our challenge is to set realistic goals that our Board will accept and the Street will accept as not being too modest in 2015 and beyond.

Well, Bill, thank you for that insight.

I appreciate that.

And if I could just build on that.

If we look out over the next few years, where do you think the potential for peak manufacturing gross margins are at this point?

Well, I think that we would benchmark the competitors that have been in some of these spaces longer than we.

Running tank cars, for example, we've been in it for six years.

It's not an easy business to get into.

The people that are going to try to attempt to get in it, here in this phase of the market, are going to have a really hard time.

I know we did.

So we're sequentially hoping to build our margins to the equivalent to our peers.

I don't think we will be able to meet the margins that Jim Cowan was able to obtain at ARI, simply because part of that was pricing, and the fact that he was selling a lot of that to the parent.

But the Trinity margins would be a good goal for us to look to, certainly on the tank car side.

Okay.

That's very helpful.

And Bill, if I could just ask one last question, which you may have addressed earlier.

On the 76,000 car universe of other hazardous material service cars which are nonflammable, do you think that that universe of cars is addressed by the regulations at a later date?

So do you think whatever regulation we get will be, I guess, two tiered, that first they address the flammable universe of cars and then the nonflammable?

I don't have an expectation yet.

We don't know what the government will do, as was obvious with the government if we look at the turmoil in DC.

I can say that Secretary Fox is doing his very best.

He was handed this whole issue a year ago, after a month in office.

And he intends -- and if you watch the video that he had with the commentator, he's very clear that he's going to impose a higher standard.

Whether that will be picked up and taken for other kinds of cars will depend on many, many factors.

But I would think that all of the publicity on this issue of tank car safety, what we know now about the relationship between speed, manifest, and weight of trains, you could expect that the General Counsel's office of every shipper in America and every railroad in America would weigh in and say safety is very important.

And so I think the market for that level will either be driven by government or, more likely, by the market itself for safety.

Okay.

And with that, we appreciate everyone's attention and listening, and all the great questions that we've had on our third quarter.

Any further questions, we can take those calls off-line later this afternoon.

Thanks again for all your time.

Thanks, everyone.

Have a good day.

Goodbye.

This does conclude today's conference.

We thank you for your participation.

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