Greenbrier Companies Inc (GBX) 2020 Q1 法說會逐字稿

Hello, and welcome to The Greenbrier Companies First Quarter Fiscal Year 2020 Earnings Conference Call.

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

(Operator Instructions) At the request of Greenbrier Companies, this conference call is being recorded for instant replay purposes.

At this time, I would like to turn the conference over to Mr. Justin Roberts, Vice President and Treasurer.

Mr. Roberts, you may begin.

Thank you, Sarah.

Good morning, everyone, and welcome to our first quarter of fiscal 2020 conference call.

On today's call, I'm joined by Greenbrier's Chairman and CEO, Bill Furman; Lorie Tekorius, President and COO; and Adrian Downes, Senior Vice President and CFO.

They will discuss the results for the first quarter and fiscal 2020.

Following our introductory remarks, we will 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 a slide presentation posted today on the IR section of our website.

Also, if you're in Portland today, our annual meeting will be occurring today at 2:00 p.m.

Pacific at The Benson Hotel.

A link to a webcast of the meeting is also live on our website and you can follow along to the activities and events as well.

Matters discussed on today's conference call include forward-looking statements within the meaning of the Private Securities and 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 2020 and beyond to differ materially from those expressed in any forward-looking statement made by or on behalf of Greenbrier.

And with that, I'll hand it over to Bill.

Thank you, Justin, and good morning, everyone.

As we enter 2020, Greenbrier enters its fifth decade of operations, and we're operating at a much larger scale than the very small leasing company founded nearly 40 years ago, with only 300 railcars in Huntington, West Virginia.

Just in the last year, we've achieved much greater scale through the acquisition of the ARI manufacturing assets, building on our various initiatives in international markets.

In normalized markets, Greenbrier with its present platform should be capable of reaching $4 billion in annual revenue and perhaps more.

Of course, we have to get margin and financial performance to match that revenue, but we believe we are firmly on the right track to do so.

Our top objectives for calendar 2020 is to continue to integrate and extract value from the growth over the last 2 years.

In its early stages, growth often results in uneven short-term financial performance.

We ask our shareholders to be patient while we go through this process.

And although this can be expected, we are dedicated with an action plan to improve operating performance and align financial metrics to our increased scale, all to produce shareholder value.

Greenbrier, as you know, has a 4-part strategy: First, we're strengthening our North American core markets.

Setting aside ARI for a moment, North American manufacturing operations during the first quarter of fiscal 2020 were broadly in line with our expectations.

We continue to progress on key areas, including cost reduction, succession planning, smart manufacturing initiatives, quality and customer satisfaction.

The ARI acquisition strengthens our geographic footprint, bringing product diversity and a larger scale in domestic markets.

Second leg of Greenbrier's strategy, international operations, has also brought diversity and stability.

These investments are producing results.

In Q1 and in the last quarter of fiscal 2019, we had a very strong turnaround in operations.

And post quarter during the month of December, a strong order book came from relationships in the GCC, European orders and long-awaited momentum in Brazil, borne out by significant multiyear transaction for several thousand railcars.

The third and fourth elements of our strategy are robust development of Greenbrier's talent pipeline and bringing the business to a larger scale.

Talent investment is occurring throughout our organization.

Of course, the ARI deal has brought us excellent talent and greater scale in our core domestic markets.

New employees in important roles will help us integrate ARI into Greenbrier and also serve Greenbrier's existing manufacturing platforms.

We believe ARI will be accretive to Greenbrier as operations are fully integrated.

Despite a slow start, as Lorie and Adrian will describe, we're seeing cost synergies as expected and remain on target with our goals.

In 2019, we identified challenges and deployed remedial actions in our European, Brazilian and repair operations.

The positive trends in our European business continued in Q1 with the second straight quarter pretax profit.

This contrasts with steep losses throughout most of fiscal 2019 as a result of legacy issues.

Although overall resorts in Europe -- or results in Europe will remain choppy through 2020 due to some older transactions at Astra Rail, the reversal of Europe's drag on earnings has already occurred and is meaningful to our bottom line.

In Brazil, we're happy to see the return of significant railcar demand as a result of rail privatization, concession renewals, highway congestion and government policies.

Brazil's backlog and orders have intensified significantly in recent weeks as referenced by the multiyear railcar order I mentioned a moment ago.

The South American railcar market is better positioned in 2020 than at any time since Greenbrier first entered that market in 2015.

It is obvious in North America that there's a clear disconnect between economic conditions in the North American freight car markets and the U.S. and North American economy in general.

As the U.S. economy still registers respectable growth, the rail sector is impacted by trade tensions and Precision Scheduled Railroading or PSR.

In the broader economic environment, the U.S. economy continues to display resiliency and there are reduced concerns about a general U.S. recession.

According to the Bureau of Economic Analysis, U.S. real GDP growth was 2.1% in Q3 2019.

Employment is also a continued positive for the U.S. economy.

There were 266,000 jobs added in November.

The national unemployment rate is a notable low 3.5%.

On the other hand, the freight rail sector is participating in a partly self-induced downturn in traffic, driven by Precision Scheduled Railroading or PSR and international trade tensions.

Approximately 400,000 cars or almost 25% of the North American fleet is in storage.

FTR Associates recently reduced its forecast for rail deliveries significantly to 38,000 units in calendar 2020 and 39,000 units in calendar 2021.

However, the settling out of trade policies that stoke economic and investment uncertainty for the past several years is a promising development if it can be fully realized.

The recently announced Phase 1 of the trade deal with China has sent equity markets higher and should help spark some recovery in North American freight loadings as it takes effect.

Another significant thing that has occurred after 2 years of hard work in December, in the course of 24 hours Congress took 2 major steps to ensure trade stability for the railway supply sector.

These advances have been championed by Greenbrier and other industry participants over recent years.

First, the House passed the United States-Mexico trade agreement or USMCA.

We expect the Senate will approve that compact soon.

It continues to advance and when signed by the President, this will eliminate longer-term concerns relating to the supply chain within our North American freight car equipment industry, and more particularly for Greenbrier, eliminate a potential threat to our heavy investment in Mexico.

Receiving less attention, but with strong importance to us, was a provision signed into law by the President on December 20 that protects the rail industry from subsidized and unfair intrusions by Chinese state-owned enterprises in the United States.

This is a serious issue internationally.

Other nations economically aligned with the U.S. are also waking up to the threats posed by aggressive Chinese intrusions on many fronts from cybersecurity to overt espionage.

In closing, we continue to treat 2020 as a year of integration, concentration, execution and building of succession planning and talent pipeline.

During the years ahead, we shall focus on absorbing our growth, generating positive cash flow, positive ROIC and creating shareholder value.

We have grown the company significantly in the last 2 years while addressing weaker areas of our business.

Greenbrier, I firmly believe, is positioned for sustained and strong performance ahead.

Companies in America cannot manage only quarter-to-quarter and build.

We're affirming the full year outlook for fiscal 2020 that we shared in October.

Lorie, over to you.

Thank you, Bill, and good morning, everyone.

I'll briefly provide some additional detail on the quarter.

Deliveries were 6,200 railcar units, and we received orders for approximately 4,500 units, valued at $450 million, with over 1,000 of these coming from our international markets in Europe and Brazil.

Orders in the quarter were primarily for tank cars, covered hoppers and gondolas.

And even though we're operating in a weaker economic environment for freight car demand in North America, our backlog worldwide remained strong at 28,500 units, valued at $3.1 billion.

And while our headline performance in the quarter was less than we expected, we continue to make solid progress in turning around previously challenged areas of our business, such as Europe and repair.

I'll provide some additional color on these operations shortly.

The operating inefficiencies at one of our ARI facilities in Q1 were exacerbated by several lost production days due to a component supplier issue and a complete disruption of gas service to the facility through the fault of the external provider.

Further, this is our first full quarter executing on our customers' agreements.

Some of these agreements are quite different from our typical contracts and we're just starting to harmonize them with our own.

The challenges within ARI are both isolated and familiar, similar to issues we're successfully fixing in Europe.

We're executing on corrective actions, and we expect to see a turnaround in the next 3 to 6 months.

Lower deliveries from our wholly owned manufacturing facilities for the quarter meant a higher share of deliveries came from our 50-50 joint venture, GIMSA in Mexico, which limits the amount of the income that flows through to our bottom line.

Most of this is just a function of timing that will reverse trend in Q2 and Q3.

Overall, Greenbrier's North American manufacturing group produced another good performance this quarter and continues to demonstrate its ability to rapidly respond to shifting demand trends.

And while integration consumes a significant amount of time and resources, the group continues to produce high-quality railcars safely even as general-purpose lines are being slowed or closed, as I mentioned last quarter, and our Mexican facilities are performing well and exceeding expectations.

Our European unit delivered a modest profit in Q1, as Bill mentioned, its second consecutive profitable quarter since the new management team took over.

And that team is successfully creating a culture focused on safety, quality and profitability.

While the global economy continues to face headwinds, the European market is demonstrating stable demand levels, order activity and backlog remains strong.

The demand environment in Brazil is slowly improving, driven by the number of factors that Bill mentioned, and the operations were effectively breakeven in Q1.

We expect continued modest improvement throughout the year, and the team in Brazil has successfully obtained that large multiyear order that Bill mentioned.

This is the first such order in many, many years.

Our repair operation for which we instituted remedial actions in fiscal '19 are included within our business unit that also houses our aftermarkets Wheels & Parts operations.

I'm pleased to report that operational changes made last fiscal year are slowly improving performance.

One of our largest facilities that was rightsized has returned to profitability and another location has recovered to an acceptable margin to allow us to further evaluate our long-term options there.

Financial performance in repair improved sharply on a sequential basis, a trend we expect to continue given additional cost containment reductions that were made late in Q1.

There is plenty more work ahead to improve our repair operations and to sustain overall profitability, but we're clearly encouraged by these measurable results.

The Wheels & Parts operations were positive contributors in the quarter within a challenging operating environment.

With decreased rail traffic and increased railcars in storage, wheel set and component volumes will continue to be under pressure.

Despite this, we continue to expect this business to be profitable in 2020, just slightly lower levels than 2019.

I'd also add that this business unit provides strategic benefits outside of financial results.

In stronger times, having access to a stable supply of wheels and parts is vital as well as the additional touch points with customers this business provides.

Leasing revenue in the quarter was at a more normalized level with no externally sourced railcar syndication activity.

This also means that leasing gross margin percentage returned to its more typical 45% to 50% range.

Our capital markets team is gearing up for another strong syndication year although the activity in Q1 was muted due to reduced deal flow compared to the strong prior quarter.

As we look forward, flexibility is one of our key differentiators in managing through these types of uncertain environments and is central to running a company in a cyclical industry.

Our extensive experience and long-term focus underscore the importance of maintaining a core experienced workforce.

We will not ramp up and down at the drop of a hat.

Our skilled workforce is critical to our long-term success.

Safety across our organization is our #1 priority.

And while production efficiency is important and necessary, we never pursue it at the expense of safety and stability for our employees.

All that being said, we'll continue the steps I outlined in October, which are necessary to position us for long-term growth and shareholder value.

We're going to rightsize our production capabilities on certain general-purpose freight car lines.

We'll focus on reducing capital expenditures and increasing cash flow.

2020 is shaping up to be a unique and challenging year.

We continue to execute on the remedial actions identified last year to improve operational and financial results.

To this, we'll add the ARI integration, which must be successful, all against the backdrop of global economic and geopolitical uncertainty.

Our management team is confident in the long-term strategy developed with our Board of Directors.

And as a result of the talent development activities Bill mentioned, we have assembled and are investing in the right team to execute on this vision.

Now I'll turn it over to Adrian to talk about our financial performance.

Thank you, Lorie, and good morning, everyone.

Quarterly financial information is available in the press release and supplemental slides on our website.

I'll discuss a few highlights and also affirm FY 2020 guidance.

Highlights for the first quarter include revenue of $769 million and deliveries of 6,200 units.

Aggregate gross margin of 12%.

The decline from Q4 is driven by expected seasonality in deliveries and syndicated units and to a lesser extent by the operating inefficiencies that Bill and Lorie spoke to.

Net earnings attributable to Greenbrier of $7.7 million or $0.23 per share include approximately $2.2 million net of tax or $0.07 per share of integration and acquisition-related expenses.

Excluding the integration and acquisition-related expenses, adjusted net earnings attributable to Greenbrier are $9.9 million or $0.30 per share.

Additionally, as part of the accounting for the ARI acquisition, Greenbrier realized a step-up in depreciation and amortization of $2.9 million or $0.09 per share.

This depreciation and amortization step-up is not being added back.

Adjusted EBITDA in the quarter was $74.2 million or 9.6% of revenue.

New railcar backlog of 28,500 units valued at $3.1 billion.

Subsequent to the end of the quarter, we agreed in principle to remove 575 units from backlog in exchange for financial consideration.

Internationally, Europe continued with strong deliveries and had another profitable quarter.

Total liquidity at November 30 was nearly $600 million and includes more than $250 million of cash, providing flexibility for the business over the long term.

Greenbrier's Board of Directors is focused on balanced deployment of capital to create long-term shareholder value.

Greenbrier has declared a quarterly dividend for 23 consecutive quarters with periodic increases.

Today, we announced an 8% increase in our quarterly dividend to $0.27 per share.

The increase in the dividend demonstrates the high confidence that Greenbrier's Board and management have in our ability to execute our long-term strategy.

Currently, our annual dividend represents a dividend yield exceeding 3%.

We successfully achieved $2.8 million of pretax cost synergies in the quarter, and today we are affirming the $15 million of expected cost synergies that we announced in October.

Based on current production schedules, business trends and the macroeconomic environment that Bill spoke to, we expect Greenbrier's FY 2020 to reflect deliveries of 26,000 to 28,000, which includes approximately 2,000 units from Greenbrier-Maxion in Brazil; revenue to be approximately $3.5 billion; diluted EPS of $2.60 to $3 per share, excluding approximately $20 million to $25 million of integration and acquisition-related expenses from the ARI acquisition.

Additionally, our supplemental information for 2020 is unchanged and is as follows: We expect operating cash flow of between $150 million and $200 million; depreciation and amortization is expected to be $110 million, reflecting the full year impact of the acquisition; unconsolidated affiliates to break even, with potential to contribute modestly; proceeds from equipment sales of $95 million, generating gains on sale of $15 million to $20 million expected as we finish rebalancing our lease fleet.

Capital expenditures are expected to total approximately $140 million as we continue investing in the lease fleet and enhancing our facilities.

Combined with sales out of our lease fleet, net capital expenditures are expected to be approximately $45 million.

We expect G&A to be between $230 million and $235 million, excluding any integration or acquisition-related costs, flat as a percent of revenue with 2019.

The majority of the increase is driven by the acquisition, but Greenbrier also continues to invest to strengthen and develop the next generation of leaders.

Earnings attributable to noncontrolling interest is expected to be approximately $55 million to $60 million.

Our consolidated tax rate is expected to be 27% and typically fluctuates due to geographic diversity of earnings and other discrete items.

One item I'll highlight since we had strong performance at the GIMSA JV in Q1, that dynamic can have a disproportionate impact on our consolidated tax rates which only reflects our 50% ownership stake.

The cadence of earnings is still expected to be back half weighted, but probably closer to a split of 25% to 30% in the first half.

Currently, we expect fiscal Q2 will be the weakest quarter of the year due to production line changeovers and a higher number of leased assets on the balance sheet due to a greater proportion of quarterly production flowing through our syndication model.

And now, operator, we'll open it up for questions.

(Operator Instructions) Our first question comes from Bascome Majors with Susquehanna.

A couple for you.

Number one, on the backlog adjustment where you took some compensation for -- from that customer, was that recognized in the quarter?

Or will that be recognized in a future quarter?

And can you just help us size up where that is and how much it was on your financial report?

So Bascome, this is Lorie.

Happy New Year.

It was not recorded in our first quarter results.

That is a result of something that happened during the second quarter.

We're probably not going to get into any more detail or to quantify exactly what that financial settlement was.

Would that show up in manufacturing or in the leasing business segment report?

Manufacturing.

No, it's just in manufacturing.

Okay.

And to Adrian's last comment on the cadence of earnings.

You commented on the second quarter and the second half.

Can you walk us through -- I mean, do you have a sense between 3Q and 4Q, where the bulk of that earnings ramp-up sequentially is happening?

And can you kind of walk us through the drivers of that assumption?

Just thinking about how we kind of go from where you expect to be in 2Q to where you expect to exit the year.

Yes.

Bascome, this is Justin.

So we would expect that Q2 will be a little bit more -- probably similar to Q1, but we're going to see a pretty big step-up in Q3, probably similar to what we saw in our fiscal 2019, and then another similar step-up in our fiscal Q4 from that fiscal Q3 level.

Part of the driver of this relates to syndication activity.

So as we are producing railcars at our facilities, putting them on our balance sheet and then syndicating them, some of it is just a matter of timing and finishing up production runs and then packaging them.

It's not an overnight process as it were.

So ultimately, those are kind of the biggest drivers.

We do have some line changeovers in Q2 that will kind of impact some of that activity, which is why we're -- we see a bit of a dip, I guess, in Q2, but ultimately, it's really just driven by the higher levels of syndication in Q3 and then into Q4.

This is more about syndication than it is necessarily about manufacturing changeovers it sounds like, at least directionally?

I would say, directionally, you're correct.

Our production rates are -- there's not any kind of a big ramp or anything occurring from that perspective.

Okay.

Last one for me.

You made some comments on syndication.

Certainly, the activity was much lower this quarter than it has been.

Can you just high-level talk about how those conversations are going with those partners?

I mean we've had, I guess, some changes in the railroad -- leased railcars and asset class in the last few years with volatility in funding cost, but also some declines in utilization that may have surprised some people.

Just how do those conversations go with your customers?

What is their risk appetite?

And how are they thinking about this business short and long term?

Sure.

I'll start out, and I'll let Bill step in maybe a few -- or Justin if they've got opinion, but I would say that we tend to partner with very strong folks who have -- are taking a long-term perspective on investing in 40- to 50-year lived assets.

So there's been a lot of news lately about railcar leasing and that whole market.

We've done a lot of checking in with our customers like we do on a regular basis.

We haven't seen anyone pulling back or shying away.

It's just like you would do with any sort of investment portfolio, they're thinking about their exposures, they're thinking about the car types they want to be invested in, and what does the long-term growth look like, but we haven't seen anyone running for the hills.

Yes, I think it's important to recognize that we're talking about domestic demographics here.

I -- we've recognized the publicity that has come out recently about leasing and bank leasing, in particular.

We actually have a very strong customer base of partners who we view as partners in the operating lease sphere who are in this business year after year and enter into multiyear transactions.

And in fact, we did enter into a multiyear transaction as part of the quarter with an operating lessor.

And that group -- people are having issues with utilization is -- as you can imagine in lease rates, as you can imagine, with so many cars stored and with the effects of PSR.

But in terms of the appetite for investing in a long-term asset, railcars attached to a lease, we still see a strong appetite for that.

We are concerned about the effects of too much supply and balancing demand.

We're analyzing carefully to what degree we contribute to that through our model.

So we are planning to make some changes in our model, some improvements in our model this year.

And I think that that business, with the exception of the areas on the bank side, which hits our syndication somewhat, is still very strong.

Yields have come down, but the money rates -- cost of money has come down.

And I think the 2 drivers there is that with lower money costs and with a lot of capital coming into this market, and then with a slump in railcar loadings and stored cars, this is something that we've seen many, many years in succession, and it will be largely self-correcting.

Our next question comes from Justin Long with Stephens Inc.

So maybe to start with a question around some of the temporary operational issues in the quarter that you highlighted, maybe this is a question for Adrian, but is there any way to quantify the impact that had on manufacturing margins in the quarter?

If we look at the 11.5% that you reported, what would that look like on a normalized basis, if you stripped out those temporary headwinds?

And then we'd just love to get your thoughts on manufacturing margins going forward and the cadence of that for the remaining quarters this year.

Yes.

So we definitely had a headwind on the issues, and that did show up in our margins.

We're not going to quantify it exactly.

But we will see our margins ramp up still in the low double-digit range over the course of the year as those items resolve themselves.

Yes.

And look, we are not in any way diminishing the effect of this first quarter on our expectations at ARI.

We had kind of a perfect storm of a number of issues Lorie touched upon.

But including -- during the due diligence, we weren't able to see with full transparency some of the costs and some of the items for competitive reasons and antitrust reasons that were going into the makeup, but we just had a series of effects.

If we can normalize that and get that back up to our expectations this coming -- this quarter we're in or next quarter, I think that will have a meaningful effect on manufacturing margins.

Okay.

But to just clarify what you said on the second quarter earlier, it was mentioned that it should be the worst quarter of the year.

So is the assumption that manufacturing margins get worse sequentially in 2Q and then kind of normalize in the back half?

And I would say, if they get worse, it's going to be a few basis points.

It's not going to be -- go from 12% down to 9%.

It's more a matter of -- is that 50 basis points, something like that.

We do expect to have considerable improvement, relatively speaking in the ARI numbers, that was a very big disappointment.

But again, we understand now and diagnosed the reasons for it.

And we don't expect that to continue at that rate -- that kind of problem to continue at that rate.

But we expect considerable improvement in the second quarter.

And I think part of the reason Adrian was saying that the second quarter would probably be our lightest quarter is more around the syndication timings that we were chatting about with Bascome as opposed to anticipating further significant headwind at the ARI facility.

Okay, great.

That's really helpful.

And then maybe lastly, Lorie, you mentioned for orders in the quarter, over a 1,000 came from international sources.

For the orders that were received subsequent to quarter end, could you share what the mix was between international and North America?

And anything you'd like to highlight in terms of the mix impact from what we're seeing in terms of the mix of international versus North American orders right now?

Sure.

And I will say that it's kind of nice this quarter to be able to finally talk to you guys about the fact that all of the investment that we're making internationally as part of our 4 pillars, our strategy to grow internationally is starting to come to fruition.

The time that we've invested in both Brazil, the GCC and Europe are really starting to turn around.

I would say the majority of the orders post quarter end, so the Q2 orders, probably about what half of those maybe were international.

Up to 2/3 [probably].

Up to 2/3, yes.

Up to 2/3 were international.

So we're really excited about that.

One of -- the biggest part of that is going to be the order for Brazil that is something that will give us some great visibility over the course of the next several years as that market really does start to -- concessions get approved and that market starts to pick back up.

We might also mention that we have rightsized -- we reduced the scale of the actual factory in Brazil so the factory capability more matches the market.

We still have a very high market share in Brazil.

We're not trying to target a high market share, but this core order is important in terms of the predicament and places the other customers in because the amount of capacity in Brazil available to build for this next expected 5-year increase in demand, which is significant, is not a great -- it's been reduced.

And it's not a lot of car building capacity to meet this demand.

So we think this is the first -- the first block, it will fall towards a stronger performance.

We also had very strong performance in orders in Europe, and we had a transaction related to the GCC that was very helpful.

Our next question comes from Matt Elkott with Cowen.

Just a quick follow-up on the cars that were taken out of the backlog.

Did you guys say if they were for 2021 -- fiscal 2021 deliveries or this year?

We did not say at this point.

Although, I mean, it was for production later on this fiscal year.

We are not -- we do have ways to fill that gap effectively.

So we're not concerned from that perspective.

Okay.

So they were for this fiscal year delivery and the benefit -- the financial benefit from the cancellation will be recognized in this fiscal year as well?

Correct.

Okay.

And did you guys say if they were ARI cars or legacy Greenbrier cars?

We did not because we -- after -- post late July, we evaluated all combined.

So this is just part of our order book, and it's an adjustment based on the customers' needs and looking at their forward demand.

Can you tell us what type of cars they are?

We prefer not to get into that level of detail.

Got it.

All right.

Switching over to the leasing business, I saw that the lease fleet utilization dropped by about 370 basis points.

Can you guys talk about the reasons behind that?

Sure.

Again, with -- as we talked about with railcar loadings being down and cars going into storage, you can appreciate that as we get into renewal situations on cars, there are fewer cars that get renewed right away.

Our leasing and commercial teams feel very comfortable with what's going on as they're evaluating renewals.

The one thing to remember with our fleet, it's a fairly small fleet.

So it only takes a couple of hundred cars being off-lease to really move that percentage utilization.

Okay.

And then staying on the demand in North America, it looks like your orders in the first fiscal quarter were about 3,500 in North America.

If you assume a certain market share, I guess, we're trending pretty much along replacement demand for the industry, if not slightly below that.

Are you guys surprised that despite progressively worse rail traffic declines and ongoing PSR implementation, orders have not really dropped much below replacement demand for the industry as a whole?

I think it's an interesting point.

I think this is one of potentially the perverse impacts of PSR because if a -- someone who needs to use a railcar is not getting it, they're having to go out and acquire it themselves.

So it's shifting some of that ownership of where we get that, and I think that's what's bringing some of that demand back to the market.

The other thing, I mean, as Bill mentioned, we are in a bit of a self-inflicted recession for the rail freight business, and that's a great time for some people to want to step into the market to place orders.

Those people who are strong advocates for PSR, and we have one on our Board of Directors who is a railroader also from Arkansas, a very wise person, believes that this will have a -- not only a self-correcting effect but it will make the railroads much more efficient and will create the ability for them to grow their market share.

I think they are losing some traffic to trucks, and they're also encountering a lot of very stiff resistance from -- through political channels, even at the STB because the shippers -- many shippers are -- don't like the changes.

However, if it's healthy for the railroads over the long term, one has to assume it will be healthy for the rail supply industry.

Our next question comes from Steve Barger with KeyBanc.

In North America, does your ARI deal mean there's been enough consolidation that you would expect more rational pricing in downturns?

Or do you think lower traffic and the PSR conversation makes people get more aggressive about locking in share in a smaller market?

Yes, that's really a great question.

I think there's still quite a bit of capacity in the industry.

There's still overcapacity.

And I think that particularly those players that are -- that have maybe a weaker position in the market can be very price aggressive.

But I think on balance, the ARI acquisition was very helpful for longer-term stability in the business, and it certainly has helped our market share.

I think the 2 largest competitors today, Trinity and Greenbrier, and we don't measure our success by market share, but we've got -- both companies have a full range of products and the other 2 major competitors or players have a narrower range.

So we are able to participate at this point in a much broader front product-wise, and it can create an adverse behavioral tendency.

We are watching closely freight car, and they've had a lot of issues.

But I don't think that -- I don't think that that's a real candidate for either -- any of the current parties to be interested in trying to further consolidate.

Outside of freight car, would you expect any further consolidation?

Or do you think that we're -- this is what it's going to look like for a while?

It's anybody's guess.

I don't expect it.

But certainly, we're not planning to drive it.

We're planning to assimilate and get margin and profitability out of the platform we've created over the past couple of years.

We're going to really stick to our knitting and get ROIC up, get cash flow up and run it now with the tools that we have.

Going to that point, now that you're seeing some benefit from the international investments, can you talk about unit economics?

For example, what does gross margin look like for 1,000 hoppers in Brazil versus 1,000 in Europe versus North America?

Generally comparable and possibly in the coming upturn, a little higher.

Similarly, in Europe, margins can be greater.

Some of them are smaller or lower.

But I think that both of these units have had sporadic earnings performance.

This is unfortunately one of the things that happens with a longer-term plan, but they're both now poised to obtain pricing leverage.

And I think we have 50% of the market, roughly 40% of the market in Europe.

We have approximately 40% of the market in North America.

We have something closer to 60%, 70% in South America.

And currently, we're the only company in Saudi Arabia with an established footprint.

So we think we have a good position in the GCC.

And margins, I think, over -- in these international operations are going to be good.

Do you expect the international businesses will produce free cash flow in FY '20?

I would say for fiscal '20 being not specific to a particular year, I'd say probably breakeven to modest positive cash flow.

Okay.

So that just leads me to my last question.

Operating cash flow was negative in FY '19, you expect deliveries to increase this year, which has working cap implications.

So I guess given all the moving parts that we've talked about, do you expect positive operating cash flow for the year in FY '20?

Yes, we do.

Yes.

Our next question comes from Allison Poliniak with Wells Fargo.

Going back to the ARI challenges.

Is there anything -- just asking in different way, is there a way to help us understand the incremental units that GIMSA had to deliver as a result?

And how should we think about that in Q2?

So your phone connection was a little bit garbled, but I think your question was you're trying to tie lower deliveries out of our ARI facilities to the higher GIMSA deliveries, which had a disproportionate impact on the bottom line?

Yes.

So is it like incremental units that GIMSA had to take on as a result of the challenges?

Can you help us understand that?

So Allison, this is Justin.

So effectively, we had a greater proportion of our deliveries in the quarter came out of our GIMSA, of which only -- our GIMSA joint venture, which only -- about 1/2 of it drops to the bottom line.

We would expect with an improvement in ARI in Q2 and in the rest of the remaining quarters as well, that will move back to a more balanced delivery cadence.

And so from that perspective, we don't necessarily see a significant shift in our margins in Q2 or Q3 from that perspective.

It's really more a matter of improved performance with more dropping to the bottom line from that perspective.

Understood.

Helpful.

And then just trying to understand your comments, Lorie, on the repair and wheels.

It sounds like you have 2 conflicting things.

Repair was getting better.

Wheels, getting worse with volumes.

How should we think about the exit rate for the margin in that business for this year?

I think the margin for that business will be a bit lower than what we saw in fiscal '19 in aggregate, but overall, it will be not very much lower.

And again, the wheels activity is driven by a couple of things in this quarter.

It can be a lower quarter due to where the traffic is moving, and we'll build up inventory in anticipation of cold weather and traffic pattern shifting.

We haven't seen that happen yet in the first quarter.

So we're expecting that in the second quarter.

Then with railcar loadings and more cars going into storage, you've got fewer cars on the road, so fewer changeout at the wheels.

We -- then there was a third impact of scrap pricing but we're expecting that to reverse.

So we're starting to see the signs in this quarter that ends February of some pickup.

Our last question comes from Ari Rosa with Bank of America.

So first question I wanted to ask, and I know a number of people have hit on this, but referring to the operating inefficiencies.

Maybe you could just elaborate specifically on kind of what some of those issues were and what's being done to address them?

So I'll take a couple, and I'm sure that my colleagues will jump in.

We definitely had a supplier issue, so a critical part of a tank car that was supplied that did not meet spec, and we had to spend time getting that corrected, getting replacement, having to go through the process of replacing that.

So that would have been the supplier issue.

There were also some other production inefficiencies as we evaluated the design of the particular car that was being built and some -- what we would consider some cosmetic issues with the jacket that we did some reinforcements to.

Our focus does tend to be on the customer.

So instead of arguing about that, we focused on what can we do to keep our customer happy.

That impacted the number of days of production.

And then, as I mentioned, it was kind of felt at times like the perfect storm or the not so perfect storm, we had -- there was an interruption in gas that flows to that facility by the provider.

So I think we lost about 5 production days with that.

The -- I will only add that that's a -- those are some of the major drivers or others, the 2 companies on the operating side are on different IT platforms.

And we've had little integration issues having to do with understanding that cost system.

We've also had other production flow issues that just have an accumulating -- just had a very major effect on the one facility that builds tank cars.

The company had been struggling with some quality issues, which have been addressed, but we still had a legacy of some of those and some inspection, logistics that were relating to that that would allow cars to ship.

So there's just a number of these.

We're -- I can assure you, we're going through this very carefully in our Board meetings.

Our manufacturing people are on top of it, we believe, and we think that it's a very good company.

We're very pleased with the people.

We think it will be a very good geographic diversification for us.

So we hope that we can report next quarter and the quarter after this that we've got this under control.

Got it.

Okay.

That's really helpful color.

Second question I wanted to ask was -- and this is kind of a longer-term outlook question.

But looking at the market and this condition of oversupply that you described, Bill, obviously, earnings are pretty substantially where they were a couple of years ago when the market was maybe a little bit hotter.

Is there a prospect for getting back to kind of $4 a share in EPS or even $5 a share in EPS, which is kind of what the numbers looked like a couple of years ago?

And obviously, you guys have gone through some operational improvements, obviously, you've done these acquisitions, you've expanded internationally.

But it doesn't seem to be flowing to the bottom line quite like maybe we would have expected to, if we had gone back a couple of years and said, okay, you're going to go through all of these operational improvements and expansions in terms of geographic reach and this is what the EPS picture is going to look like.

So in terms of getting back to that $4 level, is it really a factor of waiting for the North American market to rebound?

Or are there other things that you guys can do in terms of cutting costs or improving margins or something of that sort that maybe starts to see that EPS number creep back up?

I think that's a great question, and it goes right to the heart of shareholder value.

We're cognizant that our TSR has declined.

We're a cyclical company.

We have a longer-term plan to build a much larger scale company.

We have -- if you go back at our numbers, we've gone from $2 billion.

We're striving to get to $4 billion in revenue.

And it's fair to say that we've had some execution issues in getting out of the gate.

The European operation was a very big disappointment last year.

That's turned around, and we're making a profitable contribution.

More importantly, the drag on earnings has been eliminated.

In fact, all of 4 areas that we were having difficulties with last year have been greatly remediated.

So I think that we easily can get back to where we were and exceed that.

It's hard to remember that these businesses are substantive ventures, and they can't be operated really quarter-to-quarter and judged by quarter-to-quarter performance.

But I think that the longer view in the next year or 2 as things stabilize in the market, we should be able to eclipse where we have been before.

And we certainly didn't take these complicated steps to make the company bigger to make less money.

We are doing it to return profit to our shareholders and to be responsible citizen in the community to our -- the communities we're in, have a strong employee base and serve our customers.

Okay, great.

That's helpful.

Maybe I'll just ask one follow-up there.

Maybe you could -- I don't know, is there a way to quantify the magnitude of the headwind that's represented by this kind of overcapacity or oversupply in North America?

I mean is it really a matter of seeing a pickup in railcar volumes before we can actually anticipate that that condition corrects itself?

The turnaround in the negative effects of precision railroading, PSR, if that inflection point occurs and the traffic -- and there are some indications that that is beginning to occur.

Just the fact that traffic is down, forgetting about PSR, when the traffic is down, velocity always improves.

So velocity has improved.

And it's -- the rate of change is slowing.

If the railroads reclaim their franchises, and they're not looking at reporting only quarter-to-quarter profits, but they're looking at the basic franchise over a 2-, 3-year basis, they should be able to reclaim market share.

Secondly, this trade cloud in double stacks, intermodal cannot be underestimated.

The tensions with China have created very severe effects on agricultural movements and other movements in the United States.

Many American producers have lost their markets to, say, for example, Brazil, which is one of the reasons we wanted to have a footprint down there.

So I believe that this is -- actually, the industry is healthy.

The good news is the railroads have very healthy financial performance, and I don't think they're going to abandon their franchise.

And if they were to attempt to do so, I don't think the U.S. government, over time, would allow them to do it.

They're too vital to the U.S. economy.

Okay, great.

That's really helpful color there.

And clearly, we appreciate that there are some headwinds that are out of your control.

So a nice job operating through some of those.

Thanks, Ari.

Thank you very much, everyone, for your time and attention today, and have a good rest of your Wednesday.

And again, just a reminder, if you're either in Portland or interested in dialing in, we will have our Annual Shareholder Meeting at 2:00 Pacific today.

Thank you very much.

Thank you.

That does conclude today's call.

Thank you all for participating.

You may disconnect your lines at this time.