FreightCar America Inc (RAIL) 2008 Q2 法說會逐字稿

Ladies and gentlemen, good morning and welcome to the FreightCar America second-quarter 2008 earnings conference call.

At this time, all participant lines are in a listen-only mode. There will be an opportunity for questions at the end of today's presentation.

Please note that this conference call is being recorded. An audio replay of the conference call will be available beginning at 1 p.m. Eastern daylight Time today until 11:59 p.m. Eastern daylight Time on August 11, 2008. To access the replay, please dial 800-475-6701. The replay pass code is 953921. An audio replay of the call will be available on the Company's Web site within two days following this earnings call.

I'd 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, Pamela. Good morning.

Before we begin, we would like to remind everyone that statements made during this conference call relating to the Company's expected future 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, including increased surcharges, and additional risk factors described in our earnings release for the second quarter of 2008 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 estimates, whether as a result of new information, future events or otherwise.

Our earnings release for the second quarter of 2008 is posted on the Company's Web site at www.FreightCarAmerica.com.

I'd now like to turn the call over to Chris Ragot, our president and CEO.

Thank you, Kevin. Good morning. 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 second-quarter 2008 earnings call. I am going to discuss the highlights of the Company's performance in the second quarter. Then Kevin will provide a detailed review of our financial performance.

The macroeconomic trends and specifically the performance of the railcar sector significantly impacted our financial results on both year-over-year and sequential comparison. Total sales revenues in the second quarter of 2008 were $141.3 million, while we incurred a net loss of $900,000 or a net loss of $0.08 per diluted share.

Our operating performance included a loss contingency reserve of $3.7 million related to the rapidly increasing surcharges the industry experienced during the second quarter of this year. In addition, input costs continue to increase and adversely impacted financial performance.

While we have certainly felt the pressure of this difficult operating environment, our continued focus on strategic initiatives of improving our manufacturing footprint and enhancing our efforts towards cost reduction has positioned us to weather the current industry cycle.

Before addressing industry trends, I'd like to spend a few minutes discussing the Company's efforts to mitigate the significant input cost increases. In the past few months, we have worked diligently with our customers and suppliers to implement price adjustments and cost-reduction initiatives to generate margin improvement. Management appreciates the cooperation we've received from both our vendors and customers, as their efforts have been constructive.

We have also continued to selectively forward-purchase materials to secure prices and although the decision impacted our cash flow in the quarter, we believe it has improved our competitive position in the current environment. More importantly, since May 2008, we have provided variable price quotations, which provided for coverage of material price escalation.

Regarding other related industry issues, we are seeing increases in costs of input materials such as base metals, and we are subject to a variety of surcharges on raw materials and components. These surcharges, which have nearly tripled from this time last year, are highly unpredictable and may further erode our margins. The combination of a sharp increase in input costs and pricing pressure has affected our margins. These are all factors that are largely beyond our control. While we constantly seek to mitigate their impact wherever possible, we continue to focus on the items that are within our control, specifically our internal structure and cost-control initiatives and growth strategy.

We've taken and will continue to take the necessary steps to make our business more cost-effective to offset the macroeconomic issues we face. Using a disciplined approach, we are committed to reducing costs throughout the organization and improving our competitive position. We continue to support and measure our recently established cross-functional margin improvement teams, which have been charged with evaluating costs at every level of the organization. These teams remain focused on the identification and elimination of waste in our processes in order to foster a continuous cost-improvement culture.

Regarding the railroad market, US Canadian commodity rail loading for the second quarter of 2008 were down 1.6% when compared to second-quarter 2007 levels, while coal car loadings for the quarter were above 2000 level by approximately 2%. While Western Railroad networks are fully restored, coal loadings in the quarter were negatively impacted by the flooding that hit the Midwest in June.

The demand for export coal has continued to expand in the second quarter as global supply chain tightness has continued. Coal export activity in the second quarter increased 67% as compared to the second quarter of 2007 with export tonnage through June 2008 higher by 57% when compared to the first half of 2007. This boost in connectivity is expected to continue throughout the remainder of the year, which we expect to have a positive impact on car loadings over the second half of this year.

This spike in demand is being driven by several factors, including increased export activities in developing countries, including India.

Coal inventories at electric power plants remain high but have eased from their recent levels. Current data indicates that inventories at Eastern utilities have declined as domestic demand competes with robust export demand. As such, we expect overall inventory levels to continue to decline over the coming months. Our view is that coal demand is increasing as evidenced by continued upward pressure on coal prices.

In the near-term, we expect the overall market for coal car deliveries to remain relatively soft. While our order cycle remains uneven, we expect order activity to improve in 2009. On the intermediate horizon, we expect coal to remain the primary fuel source for electricity generation. We expect that coal will continue to provide roughly half the projected fuel for total electricity generated during the first table future.

There are currently 52 coal-fired plants which are either under construction, near construction or permitted for construction. These 52 plants are expected to add approximately 27,000 MW of coal-fired capacity, requiring up to 20,000 coal cars. Of these 29 plants, approximately 16500 MW capacity are currently under construction. The Department of Energy remains committed to clean coal technologies and is reallocating funding to numerous sites despite withdrawing from the Future Gen Clean Coal Project.

We remain confident that, over the long term, clean coal technology will make coal an increasingly environmentally friendly fuel source. Long-term demand for our main products and services is healthy, and we are confident FreightCar America remains well positioned to capitalize on this increased demand.

As we navigate through the difficult stage of our industry cycle, we are facing significantly lower volume levels which have generated pricing pressures with the corresponding impact on margins. Industry competitors are aggressively pricing products with both sales and lease rates fostering pricing declines approaching the high single digit level when compared with 2007. We believe that these lease rates are below markets -- market rates of return. We continue to remain rational and disciplined in our pricing decisions when competing in the marketplace.

In response to market conditions, we recently announced a decision to close our Johnstown, Pennsylvania plant. As announced on June 24, the Company has reached a tentative global settlement with representatives of Johnstown Union and the plaintiffs in the Sowers/Hayden class action litigation. On June 30, the Company announced that the settlement had been ratified by the union membership. The settlement remain subject to court approval and the process for requesting that approval is underway. Therefore, we cannot provide any further information at this time.

We are executing on several initiatives in order to position FreightCar America for long-term success. We continue to explore opportunities in the leasing sector of our industry and during the quarter. We are offering railcar leases to our customers on a selective and limited basis. We are developing new designs for an open-top hopper products offering with respects to railcars for aggregate or in taconite service.

In addition, we are in the process of expanding the breadth of our product offerings to include other car types. These updated and expanded product offerings will serve to diversify our future revenue stream.

We continue to explore strategies for revenue diversification, including organic opportunities and acquisitions, both domestically and internationally. Early this year, we announced a joint venture with Titagarh Wagons Limited in India to develop freight cars for the Indian market. FreightCar America and Titagarh will initially developed prototype cars, based on FreightCar America's designs, and assess the market opportunity in India. Assuming the successful completion of design and marketing phase, we expect the joint venture company would begin railcar production in India in 2009 using manufacturing methods that FreightCar America has developed. Although we are still in the early stages of the venture, our initial work with Titagarh has been very positive and productive. We continue to explore international partnerships in other parts of the world as we seek to -- seek avenues to expand our revenue base.

Regarding our efforts to expand activities in the refurbishment market, we remain focused on evaluating opportunities in this sector. There is a strong strategic fit with our overall portfolio of products and services. Over the long term, we believe we can enhance the value proposition to our customers by offering aftermarket services that address the entire lifecycle of a coal car.

While the general market conditions have adversely affected our sales volume and margin performance, this management team has established and adhered to the new strategic direction for the Company by executing on the following initiatives -- adjusting our manufacturing footprint to the decision to close the Johnstown location, which will lower our cost structure and improve our competitiveness; increase our geographical presence with a joint venture in India, and continue to explore opportunities in other parts of the world; utilizing flexible manufacturing techniques in conjunction with our supply chain initiatives to lower our breakeven point in the face of rising material costs and a more competitive pricing environment; working diligently with our customers and suppliers to implement price adjustments and cost-reduction initiatives; and expanding our revenue platform with the introduction of our redesign articulated intermodal railcar as well as our new aggregate car; lastly, developing an organization with the capabilities to execute on acquisitions and organic growth initiatives.

In summary, we continue to focus on the implementation of our strategic initiatives. We believe that these initiatives will help us navigate these difficult times and will ensure a long-term success of the Company for all our stakeholders.

Now, I'd like to return the call to Kevin to address our second-quarter financial results in more detail.

Thank you, Chris.

Order activity in the second quarter was 1,436 units, which was a decrease from 2,396 units ordered in the first quarter of 2008. Our total backlog of unfilled orders was 4,917 railcars at the end of the quarter, compared with 6,785 units at the end of the first quarter of 2008 and 5,589 units at June 30, 2007.

Our backlog at June 30, 2008 includes 1237 units under firm operating leases with independent third parties. The backlog of unfilled orders at June 30, 2008 was affected by cancellations of 970 units.

We expect order activity to remain uneven for the remainder of the year, although we are extremely encouraged by our order activity during the last five weeks, as we've received orders for new railcars of 1130. These new orders are placed under escalatable contracts.

Our sales revenue for the second quarter of 2008 was $141.3 million. That compares with $195.4 million for the second period in 2007 -- excuse me, the second quarter of 2007. The decrease is attributed primarily to lower industry volume as well as lower demand for coal cars.

In addition, the railcar sector was affected by aggressive pricing competition as well as below-market lease rates.

Railcar deliveries totaled 2,326 units in the quarter, including deliveries of 1,853 cars sold and delivery of 473 leased cars. That compares to 2,679 units in the same period in 2007.

Average selling prices decreased in the second quarter of 2008 as compared with the second quarter of 2007, reflecting a shift in product mix to car types with different material costs and pricing pressures dictated by the current market conditions.

Our gross margin for the quarter was $6.6 million. That compares to $24.7 million for the second quarter of 2007, a decrease of $18.1 million. The corresponding margin rate was 4.7%, compared with 12.6% generated in the second quarter of 2007. The change in margin rate was driven primarily by the recent sharp cost increases on material inputs, lower volume and related leverage, and the aggressive pricing environment which we are operating in.

Prices for aluminum, steel and related components have risen sharply during the quarter and remain volatile. This has caused railcar component suppliers to significantly increase surcharges. Material price increases and surcharges have caused the total cost of certain railcars under fixed-priced sales contracts to exceed original amounts anticipated and in some cases the actual contractual sales price of the railcar.

A loss contingent reserve of $3.7 million related to these cost increases was accrued during the second quarter of 2008. The impact on the margin performance was 2.6 basis points.

The management team has increased our efforts on process improvements and cost reductions across the Company. We have challenged our management team to focus on all elements of the cost structure. The rationalization of our manufacturing footprint, combined with the efforts of our margin-improvement teams, have resulted in a more competitive cost structure. Management will continue to focus on the manufacturing process, product design, and material cost reductions to enhance our competitive position.

Selling, general and administrative expenses for the quarter -- second quarter of 2008 was $7.3 million compared to $8.7 million for the same period of 2007. Net interest income for the quarter was $800,000.

The income tax benefit for the second quarter was $700,000 with an effective tax rate of 44.9%. This compares with an effective tax rate of 36.7% in the second quarter of 2007.

Net loss was $900,000 for the quarter, compared to net income of $11.5 million in the second quarter of 2007. Net income was unfavorably impacted by the same factors addressed earlier.

The diluted loss per share was $0.08, compared to net income of $0.93 per diluted share for the same period in 2007, and the impact of loss contingency was $0.22 per diluted share. Our working investment increased in the first half of the year, primarily as a result of our inventory levels, which reflect the current competitive and material-cost environments. At the end of the second quarter, our inventory of $95.2 million included working in process of $82.8 million and finished goods of $12.3 million. The finished goods inventory reflects timing issues associated with delivery. In addition, the work in process inventory included forward inventory purchases of approximately $22 million that are intended to proactively offset price increases in the marketplace. Inventory levels are expected to normalize by year-end as we shift completed orders and convert our raw materials.

Finally, in support of our leasing activity, we have $46.4 million of lease assets held for sale.

With respect to cash flow, we generated negative cash flow from operations of $9.1 million for the second quarter of 2008, compared to negative cash generated from operations of $4.1 million in the same period of 2007. The investment in inventory was primarily responsible for the cash flow performance. Net cash used in investing activities was $1.5 million. Net cash used in financing activities was $300,000.

In summary, we continue to focus on cost controls and execution of our diversification initiatives to maximize returns for our shareholders.

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

Thank you, Kevin.

We face a challenging macroeconomic environment and intensive competition. Our management team is focused on improving our cost structure and our competitive position, which will benefit FCA as the market returns to normalized production levels.

In closing, I would like to thank you for your interest in our company and for participating on this call. We look forward to updating you again during the next conference phone call.

We are now ready for questions, Pamela

Thank you, sir. (Operator Instructions). Paul Bodnar, Longbow Research.

Good morning. A couple of questions -- one was just what to expect in the second half on the gross margin side here. I mean, are there more fixed contracts that could also be written down that would impact that?

I think we are, based on the current facts and circumstances, we are comfortable with our current reserve. That reserve includes our entire backlog, so at this point, we don't anticipate any additional write-towns in the second half of the year.

Then I guess going to wear gross margins, I mean is it mid-single digit number, where it should shake out, or a little bit higher than that or where do you think --?

Yes, I think we are comfortable with that figure.

On the gross margin side?

Yes.

Then secondly, just in terms of deliveries, I think, last quarter, you had said you were looking at delivering 95% of your backlog. Obviously, you had this order cancellation which I'd also like I guess a little clarity on. But does that impact, you know, what's your second of deliveries for? Was that an '09 order or what kind of detail on that?

Our backlog is about 4900 units, and we expect to deliver that in the second half of the year.

Okay. Then any details on the canceled contract, exactly what happened there?

Not really, that's a competitive issue.

Bob Schenosky, Jefferies.

Good morning, thank you. The first question -- in regard to the pickup in orders over the last five weeks, somewhat surprising, given that new orders have variable pricing. Any color as to what led to the pickup, and does that offer any optimism as we get into the back half?

I think, remember, our orders tend to be a little lumpy, and they are generally related to specific plant additions or train modifications. I think, in the macro environment, coal loadings have remained strong, as Chris has pointed out. Also, we've seen the surplus of existing cars decline during the quarter, so I think -- and as well as coal stockpiles decline. So I think the overall environment is still very positive, and that has contributed to the increases we see and that we expect going forward here.

Bob, I'll also add that the international activities for coal continues to remain strong. We also feel pretty confident that, during the next 30, 60 days, there will be some additional orders that will be made available.

I know you don't want to speak about a specific competitor, but given that you've moved to variable pricing and we are seeing some near-term orders, do you believe that the competition could ease up on some of the loss-making contracts that they've been buying into?

Well, we are not sure. At the end of the day, I can't speak for the competition. I would hope that there is a rationalization process going through -- throughout the sector.

All right. I may have missed this but can you comment on the balance sheet, the leased assets held for sale?

The total amount is $46.4 million.

Okay, those are rail cars?

Yes, they are.

Okay. In terms of the cancellations, is it fair to say that these may have been some built-up delays which are now -- you've just basically taken the combination of those and put them into a canceled file, if you will, as opposed to a single customer just coming in and just canceling an order?

Well, no, I don't believe it's an accumulation of events.

It's really, when it comes down to it, one customer/one order.

All right, very good. Then you mentioned that you anticipate the pickup in '09. Is that effectively based upon the new utilities that are being constructed as of today, or are you anticipating either like a Norfolk or a CSX or somebody else coming into the market in '09?

It's a combination of all of those and a general improvement in market conditions for coal, a continuing increase in cold loadings, both for domestic and international use.

Okay great. Then one final one -- it appears that the -- and I know you've mentioned earlier that you can't comment specifically on the labor agreement, but in terms of the dollar value of the agreement, is it unchanged and when do you anticipate that being paid out?

The cash component of that is going to be paid out over time, so we don't expect any cash, major cash changes in the near term. The complete adjustment, or settlement, has been reflected in the balance sheets and income statement. So it's a total of what was done at the fourth quarter of 2007, as well as what occurred in the first half of the year.

Okay, very good. Thanks, Kevin. Thank you very much.

Steve Barger, KeyBanc Capital Markets.

Good morning. Just to follow-up on that last question, when I look at the first six months income statement, I see that special charge, which looks like it's a $17 million, that wasn't there when you reported first quarter. That's related to Johnstown, and you're saying that everything has been accrued for and the cash has -- the major amount of cash that has to go with that has been paid already?

Well, the total reflected -- you have to look really at the balance sheet because the total accumulation of the charge we took in the fourth quarter of 2007 and, again, charges that occurred during the first half of 2008. The cash component of that is paid out over time.

Just so I understand, there will not be a significant -- let's say, more than $1 million -- cash outflow in any one given quarter related to the settlement going forward?

Yes, we tend to stay away from that because, as you know, the settlement has not been approved by the court. We like to, on the advice of our attorneys, try to minimize our comments related to the settlement.

Okay. In the prepared remarks, you said you are buying material forward, which is helping your competitive position. On the last call, however, you kind of talked about some inventory that you had bought forward; I think it was $20 million of raw material. You had another $19 million in finished cars. That doesn't appear to have necessarily helped in this quarter. Was that prior inventory already purchased before the fixed-price contracts, or where are you now for material and finished cars, and how will that help from a competitive standpoint?

Well, it's an ongoing program that we've engaged in, and we believe that will reduce the costs, material costs going forward. So as we deliver railcars, the costs related to those cars are fixed at this point in time. That's the thought process behind buying forward.

Yes, I understand that. The $19 million in finished cars that you referenced on the last call, are they gone? Have you shipped those out physically?

For the most part, right.

The $20 million in raw material that you had bought forward, did you use that in your manufacturing process in the last quarter?

Not in the first quarter, no. They will be used predominantly in the third quarter.

Okay. Should I think about it -- are you shipping more steel cars? Because aluminum is not up nearly as much as steel is, so should I be thinking about the mix as it relates to your increased costs?

There are a large number of steel components also on the aluminum cars that are affected by these surcharges. So it's something that applies to both steel and aluminum cars.

So your mix hasn't significantly changed?

It has not, no.

One last question -- in one of your focus points, you talked about using more flexible manufacturing techniques to lower costs. What does that really mean? How have you changed how you manufacture a rail car to take the costs out?

We are basically applying more and more lean activities at the factories in Roanoke and Danville. They've always done a good job of being a very cost-effective production facility, and we've been spending more and more identifying areas of waste in the process they use there. So we are not expecting huge changes there, but we challenge our organization all of the time to identify waste and define ways of eliminating it or at least minimizing it.

Okay, thanks. I will jump back in line.

[David Engel], Morgan Stanley.

Steve actually asked most of my questions, so I'm down to just one. That has to do with the aftermarket business. I'm really just looking for some narrative color on how you are doing in terms of margins and market share there.

Well, the aftermarket piece is something we continue to explore. We think we get (inaudible) coal car aftermarket services to enhance the life cycle of the cars themselves. So you know, we have the majority of the markets out of the Powder River basin, the cars coming in and going out, and we would like to see us playing a more significant role in the aftermarket services for those cars. So I'm pretty excited about the opportunities, and we are in the midst right now of finalizing some analysis we are doing in that area.

It's probably too much to ask but what kind of margins are you hoping to get out of that business?

Typical aftermarket margins on parts and services -- obviously, in this market, probably those margins -- two things, there is less cyclicality in that particular type of sector and also the margins generally are good.

Okay, thanks.

[Zack Turnage], Harbor Management.

Yes, I have a couple of questions. The first one would just be I would like an explanation with regards to your outlook as far as the leasing market. The first two quarters, you've stated that the leasing market does not appear rational, yet you continue to grow there.

My second question just relates to pricing. Just backing into the numbers, it appears that pricing is down more along the line of a midteens number. Am I missing something there? It looked like the first quarter pricing was down less and you guys are talking about a 10% number. What's the outlook for pricing?

I will take the question second one. This is Kevin Bagby. Zack, really what you're seeing is a shift in product mix, and that's the majority of what's impacted the pricing. As I say, we think we are about a 9%, maybe a 10% reduction year-over-year on some of the existing car pricing, which you'll also see a shift in mix, which is accounting for the remainder of that.

Did that answer the second half of the question, Zach?

Yes.

Could you repeat the first part of the question, Zach?

Sure. The first part of the question was I just wanted you guys to comment on the leasing business. You guys have said several times that you don't feel like the leasing market is rational yet right now and you're growing into that business and it's creating a drain on cash flow, so I just wanted to see why you are growing there.

We are basically using leasing very selectively to try to maintain and improve our market share.

[Jeff Capp], JCM Capital

Just a couple of questions -- first, just a clarification. The leased cars that you have, the 1237 leased cars, are those in the 4900 backlog or were those removed from the backlog in the first quarter when you put them into leases?

They are in the backlog today.

They are in the backlog?

Right.

The, the second, just on the backlog, you mentioned that you feel comfortable with the reserve you have now. Can you just explain that a little bit? How does that work? Of the 4900 cars in backlog, how many are fixed-price? Is it just simply that you've taken a reserve against where current market prices are, or have you somehow hedged that so that there's no additional exposure?

Well, you base it on current facts and circumstances, but you do look out to the future to determine whether you think those costs are going to be increasing or not. So, it should reflect and it does reflect, in this case, costs going forward.

But you haven't closed -- I mean, essentially, it's an open-ended hedge for the cost escalation. You haven't closed that with your supplier. They haven't -- you haven't gone back and said "Okay, well, we will take this reserve and we'll pay off our suppliers so that there aren't any further costs escalations." You've locked it in. It's just kind of where it stands now?

I think that's really two different issues. The reserve is a non-cash reserve, so it doesn't have any cash related to it. The pre-buys that we are doing, yes, in effect does support fixing the cost today.

Okay. Just one last question on orders if you don't mind? On the cancellations, the 970, are there other orders that can be canceled in the book, or how does that work? Is there a penalty fee for that cancellation? What's the ramification for the buyer, if they decide to cancel, and how does the 4900 that's in the backlog expose to that?

In that particular case, we negotiated to a cancellation with that supplier and I don't think we'd care to discuss the settlement of that.

Okay, but could you maybe just address then the risks to the rest of the book? Is there --?

That's a question on the rest of the book?

Well, I'm just trying to understand what the --

We don't see a significant risk to the existing backlog regarding cancellations. With this environment, obviously there could be some, as there always could be some, but right now, we don't see a significant risk.

Okay, great. Thank you very much.

[Dennis Saba], Jodocus Capital.

Just one question -- the 1200 cars that are in backlog designated for leasing, are those already under leasing contracts or are those sort of "let's kind of go out there and see what the markets like", or are there customers currently lined up for those cars?

Yes, those are under contracts.

Those are, okay. That's all my questions. Thank you.

Thank you. We have no further questions in the queue at this time. Presenters, I will return the conference to you.

Thank you, everyone, for joining us today and have a nice day, everyone. Bye-bye.

Thank you. Ladies and gentlemen, that does then conclude our conference for today. We thank you for your participation and for using AT&T Executive Teleconference service. You may now disconnect.