FreightCar America Inc (RAIL) 2006 Q3 法說會逐字稿

Ladies and gentlemen, good morning. Welcome to the FreightCar America Inc. third-quarter 2006 earnings conference call. At this time, all participant lines are in listen-only mode. There will be an opportunity for your questions at the end of today's presentation. Please note this conference call is being recorded.

I would now like to turn the conference over to Kevin P. Bagby, Vice President of Finance and Chief Financial Officer of FreightCar America. Mr. Bagby, please go ahead.

Thank you, John. Before we begin, we would like to remind everyone that statements made during this conference call relating to the Company's expected financial performance or future business prospects, events and plans may include forward-looking statements, as defined under the Private Securities Litigation Reform Act of 1995.

Certain risks and uncertainties may cause forward-looking statements to differ from actual results, including, among other things, the cyclicality of our business; adverse economic and market conditions; fluctuating costs of raw materials; and additional risk factors described in our earnings release for the third quarter of 2006 and in our annual report on Form 10-K filed with the Securities and Exchange Commission.

Forward-looking statements represent our estimates and assumptions only as of the date of this call. We expressly disclaim any duty to provide updates to our forward-looking statements, whether as a result of new information, future events or otherwise.

The discussion today may reference the following non-GAAP financial measures, EBITDA and pro forma earnings per share. Reconciliation of our net income to the Company's EBITDA and reconciliation of our net income per common share attributed to common stockholders to our pro forma earnings per share are available in the supplemental disclosures included in our press release for the third quarter of 2006. This earnings release is posted on the Company's Website at www.freightcaramerica.com.

I would now like to turn the call over to John E. Carroll Jr., our President and CEO.

Thank you, Kevin, and good morning to everybody. Joining Kevin and me today is Ed Whalen, our Senior Vice President of Marketing and Sales. We would like to welcome you to FreightCar America's third-quarter earnings call.

I am going to discuss the highlights of the Company's performance in the third quarter of 2006, and Kevin will provide a detailed review of our financial performance.

Total revenues from the third quarter of 2006 were $395.8 million compared with $263.4 million in the third quarter of 2005. I'm extremely pleased to report we achieved net income in the third quarter of 2006 of $36.8 million compared with $17 million for the same period in 2005. Third-quarter pro forma earnings per share were $2.88 on a fully-diluted basis compared with pro forma earnings per share of $1.35 in the third quarter of 2005.

Railcar industrywide, 21,466 new cars were ordered in North America in the third quarter 2006, up 18% from the second quarter of 2006. Tank car orders totaled 12,093 units, accounting for 56% of all the cars ordered and up 52% from the second quarter, while covered hopper cars experienced order activity of 6,336 units, or 30% of the total orders received during the quarter.

Industrywide deliveries of 19,008 new freightcars in the third quarter were down slightly from the second quarter, decreasing 2%. The industry backlog, therefore, increased about 2400 units in the third quarter to a very strong 88,116 units at September 30, 2006.

FreightCar America's order activity in the third order was 357 units. As you know, order activity in our industry tends to be uneven from quarter to quarter. However, since the end of the third quarter, we have received verbal and written commitments for the purchase of 2073 new railcars -- 2073.

A separate press release was issued this morning announcing an exclusive supplier agreement with TXU -- that's Texas Utilities -- generation development, to provide up to 7650 aluminum coal cars to be delivered in the second half of 2008 through 2009. Our current backlog does not include this agreement, as TXU's commitment is conditioned on the successful permitting of their new coal-fired facilities in Texas. Orders from TXU will be entered into our backlog as notices to proceed with the production are received.

The TXU agreement is the second long-term supply agreement that we have negotiated this year. In addition, we remain extremely bullish on the long-term demand for coal. There are currently some 154 new coal-fired electric plants on the drawing board in 42 states according to the National Energy Technology Laboratory.

Our total backlog of unfilled orders of 12,176 railcars at the end of the third quarter compared to 19,134 at the end of the third quarter of 2005 and 16,846 at the end of the second quarter of 2006. We have worked diligently to develop a competitive backlog position, and we are now prepared to match the delivery capability of our primary competitors.

Switching gears now, our record earnings performance reflects the focus of execution of our management team. As the market for coal cars strengthens, we optimized our product mix. We standardized our product mix and focused production lines throughout the company on specific products. As a result, we achieved record output and productivity.

In addition, we substantially increased production rates. A combination of a pure product mix and increased production rates produced tremendous economies of scale, leading to our record performance.

Our strong relationships with suppliers have allowed us to maintain timely delivery of material components to our plants and nearly uninterrupted production. But the uncertainty related to the stability of the supply base and the price of our production materials is an ongoing issue. We continue to develop better supplier relationships in North America, Eastern Europe and China, but we remain very concerned about the cost of raw materials, particularly aluminum plate, aluminum extrusions and stainless steel plate.

In addition, we are subject to a variety of surcharges on raw material and components. These surcharges are highly unpredictable. Given this cost environment, returning to fixed-price contracts on railcars is clearly not prudent, but we continue to see more and more competitive activity in the direction.

With the short-term contraction in the coal car market, we intensified our work on development of new products to diversify our product portfolio. We expect to launch a complete covered hopper car productline in 2008, as well as participate in the North American market for double stacked intermodal cars next year in 2007. Our current double stacked cars are performing very well in service.

To produce our cars for the most competitive cost structure, we are continuing to evaluate our manufacturing capabilities. As discussed previously, our new hybrid coal cars will be produced in our Roanoke facility on a new second production line. The Roanoke expansion is progressing on schedule, and we expect the second production line to be fully operational in early 2007. And the estimated price for this product is about $10 million. We are also continuing to explore opportunities to invest in another low-cost manufacturing facility.

Our strong balance sheet provides us with the ability to fund strategic initiatives from internally generated cash flows. We still believe the aggregate amount of investment for product diversification, development of lower-cost production facilities and international and other opportunities will raise between $60 million and $80 million.

In conclusion, we are very proud of our strong performance in the third quarter. We're excited about our new products, our domestic facilities initiatives, the long-term strength of coal as an energy source, as evidenced by the agreement with TXU, and our strategic initiatives to assure a bright future in the years ahead. All of our people are focused and committed to assure FreightCar America remains a leading railcar producer.

Now I would like to return the call to Kevin to discuss our third-quarter financial results in more detail.

Thank you, John. As stated earlier, our sales revenues for the third quarter of 2006 were $395.8 million compared with $263.4 million for the same period in 2005, reflecting an increase of $134.4 million, or 50%. The increase is attributable primarily to higher volumes, as deliveries totaled 5027 units in the quarter compared to 3617 units in the similar period in 2005, or an increase of 39%. The higher revenue gains beyond unit volume reflects higher pricing related to pass-through of cost escalation.

The higher volume of railcar deliveries reflected increased production levels. A significant majority of our deliveries in the third quarter of 2006 were, again, coal-carrying railcars, which simplified our production plan and generated increased operating leverage.

Shipments of triple hopper cars accounted for approximately 5% of the total railcars delivered during the third quarter of 2006.

Our gross margin for the quarter was $65.2 million compared to $35.6 (technical difficulty) for the third quarter of 2005, or an increase of $29.6 million. The corresponding gross margin rate was 16.5% compared with 13.5% generated in the third quarter of 2005. Leverage was 22% on the incremental revenue.

This gross margin improvement was driven by higher pricing, optimization of product mix at low-cost facilities, higher volume and improved productivity. During the third quarter, we shipped 81% of our production from our low-cost facilities, which improved our performance, as our conversion cost is significantly better at these facilities. This compares to 69% in the third quarter of 2005 and 79% in the second quarter of 2006.

Higher production volumes generated better operating leverage. Standardization of production at low-cost facilities enabled substantial improvement in productivity. Finally, the product mix favorably impacted the margin performance versus the same period last year.

The shift in production mix to non-coal car production and associated launch costs adversely impacted the gross margin performance in the third quarter of 2006 as compared to the second quarter of 2006. We have indicated in previous calls that a shift in product mix to non-coal car types will have an impact on the gross margin performance. We expect to improve conversion costs related to these car types through the acquisition of a new low-cost facility.

Selling, general and administrative expenses for the third quarter of 2006 were $8.6 million compared to $7.5 million for the same period in 2005. Included in the 2005 expenses were costs of approximately $800,000 related to the secondary offering of our common stock.

SG&A costs for the third quarter of 2006 reflect public company expenses related to the implementation of SOX and higher legal fees. In addition, costs for short-term compensation plans, stock-based compensation and other employee benefits accounted for approximately $700,000 of the increase. As a percent of net sales, SG&A was 2.2% for the third quarter compared to 2.8% in the third quarter of 2005.

Net interest income for the quarter was $1.7 million. Third-party interest expense was $94,000, related to capacity fees on the revolver, and amortization of deferred financing costs was $76,000.

The income tax provision for the third quarter was $21.4 million, with an effective tax rate of 36.8%. This compares with an effective tax rate of 37.4% in the second quarter of 2006. The effective tax rate decline is attributable to primarily a decrease in the blended state tax rate and an increase in tax benefits from tax-exempt interest income.

Net income was $36.8 million for the quarter, an increase of $19.8 million from net income of $17 million in the third quarter of 2005. Net income was favorably impacted by the same factors addressed earlier.

Our diluted income per share was $2.88 for the quarter compared to income of $1.35 per diluted share for the same period in 2005. Earnings before interest, taxes, depreciation and amortization, or EBITDA, were at $57.5 million for the quarter.

With respect to cash flow, we generated net cash flow from operations of $42.5 million for the third quarter of 2006 compared to cash flow from operations of $26.8 million in the same period in 2005. The increase in net cash provided by operating activities was primarily due to the addition of $19.2 million in net income, adjusted for non-cash items; the additional $11.8 million attributed to changes in primary working capital accounts of receivables, inventories and net of payables; and the use of $11.8 million in cash attributable to changes in the pension, payroll and postretirement benefits. Finally, there was also use of cash of $3.5 million for other operating activities.

Net cash flow used in investment activities was $1.5 million during the quarter, and it was primarily related to the Roanoke expansion program.

Regarding the shareholders' initiative, we have a philosophy and a culture of enhancing shareholder value, and we have worked hard since our last call to review cash returns and risk related to all significant strategic actions, and have consulted with others to validate our conclusions.

At this time, we have not concluded on the appropriate action. We have demonstrated a track record of enhancing shareholder value with our last major investment at the Roanoke plant, and we believe that our actions will continue to enhance shareholder value. We believe the evaluation and review of our strategic initiatives will be complete in the fourth quarter.

The number of shares of common stock outstanding at the end of the quarter was 12,601,522, while the weighted average total number of diluted shares outstanding was 12,782,562.

In summary, we're pleased with our financial performance. The management team continues to focus on an execution and generation of cash flow through delivery of the backlog. In addition, we have a disciplined approach to working capital management.

With that, I would like to turn the call over to John.

Thank you, Kevin. As I said before, we are pleased to report on our strong performance and the initiatives we are pursuing to ensure a healthy stream of earnings into the future. The long-term outlook for North American railcar demand is clearly positive, both due to real increases in railroad freight and the replacement of aging railcars.

In closing, I would like to thank you for participating in this call. We look forward to updating you again during our next conference call early next year. Now we are ready for questions, John.

(OPERATOR INSTRUCTIONS) Robert Lagaipa, CIBC World Markets.

Good morning. Just had a few questions. I guess one, the production levels in the third quarter, can you just talk about what you are expecting for the next several quarters? I know you had mentioned last quarter that part of the reason why you increased the production levels was due to competitive pressures.

Can you just tell us where you stand now on that front and what you are expecting -- specifically for the fourth quarter, but also into the early part of next year?

With regard to production levels, we are going to -- we raised our production levels a little bit of the third quarter, and we're raising our production levels a little bit in the fourth quarter. We actually, as I said my remarks, Bob, are competitive now with respect to delivery. And so I foresee us holding our production levels, raising it a little bit in the fourth quarter. And then as we get into 2007, it depends on how orders come in and so on.

And is the mix going to be different, would you expect, in the fourth quarter versus the third quarter or something similar?

Yes, we are already diversifying away from coal. We have some flatcars that we're building now, aggregate cars we're building now, steel triple hopper cars we're building now. And so the percentage, as Kevin said in his remarks, the percentage of aluminum coal cars is reducing as time passes.

Terrific. And a couple other questions real quickly. On the 2000-plus unit order that you received after the quarter closed, can you just give us a little bit of color on that? Was that a fixed-price contract, was it variable, was it for a specific market, was it just coal? Can you just give us some color on that, and also what the current market conditions are in your view?

With respect to that, the commitments that we have, as I mentioned, a little over 2000 since the end of the quarter, are several orders; it's not just one. And they are mainly for different types of coal cars.

And the comment I would like to make is, yes, we are foreseeing a dip in the coal car business going into '07, but by no means is the coal car business dead. There are a number of transactions around. And the reason of the dip is, just as people probably already know, is that the two Western railroads, the BNSF and the UP, are really operating at capacity. And so its' very difficult for them to add cars right now, coming out of the Powder River.

As the hundreds of millions of dollars that are spent in the next few months start adding to capacity come out of Powder River, we foresee them taking on more cars; that will revive the coal car order rate.

Okay. And were any of those orders fixed or are they pretty much all variable? And how much would you say -- and this one might be for Kevin -- net pricing being up? I know you had said previously it was up about 1% last quarter. Is it something similar?

Pricing -- the way we look at it right now, it is probably flat.

Okay.

No fixed prices.

Terrific. And the last question, if I could. Just with regard to the cash use, John, you had mentioned I think for the last several quarters in terms of $60 million to $80 million. And it has been unclear, at least at this point, what the breakdown is versus a potential new facility, some of the joint ventures out there.

Just trying to get a sense of where that actually falls and what the timing of that cash use is going to be. And with regard to some of the strategic reviews that you are doing with regard to the cash usage, that Kevin, you had mentioned would be completed by the fourth quarter, what does that consist of? Is there a top three that is under consideration at this point? Both of those would be helpful.

Let me start and then Kevin will finish. We've already started spending on a strategic initiative, which is the second production line in Roanoke. And then that is some of the money. Some of the money is also for an additional facility that we spoke about. Some of the money is for international ventures that are moving along. And then there is one or two other opportunities, we would call them, that would take the rest of the $60 million to $80 million. Kevin, you might want to comment on the second part of his question.

I think what we're trying to do, Bob, is conclude this in the fourth quarter. We think we can do that. But as we said, we are evaluating all the options we have. So hopefully, we will have an answer in fourth quarter.

And what options are you evaluating, Kevin? Can you maybe shed some light on that?

I think the usual types of options. First, you look at what cash is required for organic growth opportunities. There may be some other opportunities internationally, as well as low-cost facilities that John just talked about. There is always return of cash to shareholders.

Okay, terrific. Thank you very much.

Jason Feldman, UBS.

Quick question about the TXU agreement. Is that on similar economic terms to the other contracts with full variable pricing?

Yes.

So (indiscernible) effective use of cash and potential return to shareholders. When you said that you expect to finish the evaluation in the fourth quarter, does that mean that we should expect an announcement with fourth quarter earnings in January -- or February?

That's a good way to look at that. If anything happens earlier, we will make an announcement then. But I would think that we would have something by the end of the quarter.

Also, there was an [ATA] filed several weeks regarding John, your employment contract, changing the deadline with which you would need to decide whether you renew it or not. Should we read anything into that about your potential retirement?

I wouldn't say retirement. My employment contract with the Company terminates December 31, 2006, and discussions with the Board are in process now, and I would foresee those negotiations being concluded in the next few days.

Okay. And then last question, is there any change -- you're still talking about opening a new low-cost facility. What about Johnstown? Is it still considering closure or continue to operate that as well as the new facility?

All of those considerations are still on the table. We've had discussions with the United Steelworkers of America here in Johnstown about the facility here. And we, as you know, have had very serious discussions about another facility.

So you think that they would be sufficient demand to both potentially keep Johnstown as well as add a new facility?

No. In other words, that is a cost reduction move.

It would be one or the other?

Yes.

Okay. Thank you.

[Allen Sonnier].

Thanks for taking my question and great quarter. I am continuing to struggle with your production rate. Can you discuss what your thoughts are as we head out into the next couple quarters? It just seems as if at this rate the backlog a couple quarters from now will be seriously depleted. And what are your options at that point in terms of production? Why not moderate production now?

Well, because you have -- the reason we can't moderate production now is because we have customer commitments. And so you have to deliver it to your customers in accordance with the schedule that you've agreed to. And so, I would foresee us moderating our rates as we get into '07, depending on demand that we see at that time.

Okay, and I would encourage you to be conservative in terms of use of cash, particularly as it relates to share repurchase, given the potential risk to production in '07.

That is part of the consideration.

Thank you very much.

Barry Haimes, Sage Asset Management.

Good morning. Great quarter. Had just a couple follow-up questions. Looking at the current production rate and looking at the current backlog, in terms of where your next production openings are or holes, if you will, it would be more in the second half of '07. Is that approximately correct?

I would say second to third quarter, depending on the rate. We will start changing current production rates in the second quarter.

Got it. And second question was, I think you said that you had orders for over 2000 cars since the end of the quarter. Was that correct?

I said we had commitments, oral and written commitments for 2000. That is from several different sources. That is not from one customer.

And that doesn't include anything from the TXU --?

No. None of the TXU will be entered until TXU get their plants permitted, and then they will commit to us for the cars they need based on the permitting of their plants, their new facilities in Texas.

Got it. And my last question was, could you just talk a little bit about the risk and how you think about entering the new car types? Because this is an industry where in the past, and even way back in the old Johnstown America, entering new car types is risky in terms of the technology. Obviously, you don't have as much unit volume as the entrenched players. And it's not just true for you; it's true for anybody in the industry who goes into a new car type. The entrenched guys have more volume and therefore lower costs.

So what is going to be your competitive edge, and why should we get comfort that you guys will be successful going into these new types? Thanks.

Just because he has volume doesn't mean he has lower costs, and that is why every call we talk about lower costs. In order to enter a segment -- you are exactly right -- to enter into a new sector, a new market segment, you have to have low cost. In another company I was with, we entered the covered hopper car business from nothing and built a very strong position in about three years. And you build it by having a competitive design with low cost.

There is not -- building railroad freightcars is not exactly rocket science. It is a low-tech industry, and so we compete on a cost basis with competitive designs.

Thanks. Appreciate that.

[Justin Sink], a private investor.

My first question has to do with the contribution to pensions. Is this more than you expected to contribute this year? Do you expect to contribute more to liability this year. And how does this affect your earnings this quarter?

I think you are making an assumption that we made a contribution to the pensions that was beyond the normal requirement. Is that what your question is?

Yes, yes.

First of all, it didn't have any impact on earnings in the quarter. The benefit would come in subsequent quarters as you got additional returns on assets. Does that cover your issue?

Yes, I thought you were -- I think in the 10-K you mentioned $10 million of additional to the pension liability.

We made an incremental contribution, that's correct.

Okay. The second one is on your operational effectiveness, operational leverage. How much of that is volume-related and how much of that is from lower costs and higher productivity? Or in other words, if you lower your volume, how much will that affect your operational leverage, just --?

It depends on -- if you are really good cost managers, as volume decreases, you manage your fixed costs and your manufacturing overhead costs, and that is what we do. We would, even though it is difficult to do, you have to cut your manufacturing overhead and your fixed costs of production as your variable costs go down -- or as your production rates go down.

Do you foresee your leverage decreasing back to where it was at previous volumes, or do you have added benefit from productivity gains --?

No, no, no. By adding our plant at Roanoke and increasing the output of our plant in Danville, we have consistently lowered our costs, and we plan to continue to lower that cost. The second line in Roanoke will run at a lower cost than anything you've seen from us so far.

Great to hear. Great quarter.

Adam Comora, EnTrust Capital.

I just had a quick follow-up on the TXU announcement. Are these cars -- I assume they are for the eight new plants that are going to be fueled by the Powder River Basin coal. Is that correct?

That's exactly right.

Okay. And none of those plants have been permitted. And I thought the timing on those plants was probably fall of '09 and into the middle 2010. Is that correct?

No, it is earlier than that. It is '08 into '09. And as soon as they start the permitting process -- and it is not an easy matter. I mean, you read in the press about this. As soon as the plants become permitted, they will commit for the cars.

We have already agreed on detailed delivery schedules with TXU, and it would start in '08 and finish in '09.

But how much before the plants are operational do they need the cars delivering coal?

Well, they have to build up the coal pile. Inventory has to be built up, so probably six, nine months, something like that, in order to build up inventory of coal to have something to cook.

Okay. So if we thought the plants were going to be operational -- I know everybody's got their own timeframe -- in the back of '09 or 2010, I would subtract six to nine months about for when they would actually need the cars?

And that is not inconsistent with our announcement.

Okay. Terrific. And just one other follow-up on the operational leverage. We are getting terrific flowthrough with the additional deliveries now of about 22%, I think you said. Is it right to assume then 22% would be on the downside if we start losing volumes?

It depends on how well we control costs on the downside. I think I addressed that earlier, to say that we will try very hard not to lose that. And I don't think we will lose all of it.

Okay. And how long do you think these industry issues are going to persist in terms of no place to put the cars and what is driving the order rates lower?

I believe -- this is something we look at very, very closely, because this is our lifeblood. We believe -- and we've had discussions with the management of the BNSF and UP railroads -- BNSF actually is selectively adding cars now. They have already started putting new cars onto their lines. The Union Pacific has said publicly they believe that they will start adding new trains at about the end of this year into early next year.

And so it will take a while to assimilate the cars that are out there, and that is why I said I think, as we get into the latter part of '07, I foresee the order rates coming back to life.

So back half of '07, you think we will start to see an uptick again?

Order rates, yes, into '08. And I see production increasing as we get into '08, mid to late '08. And looking at the TXU, here is a typical example. There are going to have to be trains run on a railroad to (indiscernible) capacity. And so they need to add that capacity to take care of TXU alone.

My last question -- and I appreciate you taking the time -- why didn't we see or why aren't we seeing any replacement orders? In other words, it sounds like a lot of the orders that are coming in are based on new capacity of railroads or new coal facilities. It feels like the replacement market isn't giving us that stable base.

Well, we got the order for the first 1200 of these hybrid cars we discussed in the last -- from Norfolk Southern Railroad. Those are basically replacement cars. So that is 1200 cars. And we foresee the Eastern coal car replacement going on for 10 to 15 years. And that is only going to grow. (multiple speakers) The replacement of the Eastern fleet is going to go on.

Okay. Thank you.

Howard Goldberg, Morgan Joseph.

Thank you. Good morning. Was hoping you could clarify for me the distinction between the new cars delivered number, which you give in precise terms, and production levels, which you talked about on the call. Are they roughly the same, or is there some difference that you can share with me?

No, that is essentially the same. Production levels is our output level for us. And when we gave delivery, that was both FreightCar America deliveries and industry deliveries for the quarter.

Right. And was it --?

We don't have finished goods inventory, is another way of saying it.

Did you mean to imply that your new cars delivered should be similar in the fourth quarter for the third -- as what you reported for the third?

Yes.

Great. Thanks very much.

George Melas, Lord Abbett.

Good morning. Question on the non-coal car types on the Intermodal and the others. What kind of support do you have from potential customers, especially on the Intermodal side because it is such a concentrated volume market. But mainly also if you could comment on the other car types, please.

Especially what? I didn't understand what you said.

It is such a concentrated buyer market on the Intermodal side.

Intermodal, yes. Oh, you mean TTX. Well, I think we will have buyer support in Intermodal and covered hopper cars. We've had buyer encouragement already. We've had a 20-, 30-year relationship with TTX.

Okay. And can you also say where you plan to produce these cars?

The Intermodal cars will be produced either in one of -- simple answer -- in one of our current facilities or our new facility.

Okay. Thank you very much.

That was our last question. Please go ahead.

Thank you very much, everybody, for participating on the call. We look forward to talking to you early next year.

Ladies and gentlemen, this conference will be available for replay after 2:30 PM today through midnight, November 1, 2006. You may access the AT&T Teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code 843754. International participants can dial 320-365-3844. Those numbers again are 1-800-475-6701 and 320-365-3844, with the access code of 843754.

That does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.