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Executives

Dale Davies – CFO, SVP and Treasurer

Jim Cowan – President and CEO

Analysts

Art Hatfield – Morgan, Keegan

Alison Wolf – Longbow Research

Alexander Walsh – KeyBanc Capital

Tyson Bauer – Wealth Monitors

American Railcar Industries (ARII) Q3 2010 Earnings Call Transcript October 28, 2010 10:00 AM ET

Operator

Welcome to the third quarter 2010 earnings call. My name is John and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Mr. Dale Davies. Mr. Davies, you may begin.

Dale Davies

Good morning. I would like to welcome all of you to the American Railcar Industries third quarter 2010 conference call. I'm Dale Davies, the Chief Financial Officer, and I would like to thank you for being with us this morning. For all those who are interested, a replay of this call will also be available on our Web site, www.americanrailcar.com, shortly after this call ends. Joining me this morning is Jim Cowan, our President and CEO.

Our call today will include a discussion regarding the railcar industry, our planned operations, and the company's financial results. We will also make a few comments about our joint ventures. Following these remarks, we will have a Q&A session.

Before we get started, let me remind everyone that today's call contains forward-looking statements, including statements as to estimates, expectations, intentions, and predictions of future financial performance. Participants are directed to American Railcar Industries' SEC filings and press releases for a description of certain business issues and risks.

A change in any one of which could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements. Also, please note that the company does not undertake any obligation to update any forward-looking statements made during the call.

Jim, will you please start the call with a few comments about our industry and our operations.

Jim Cowan

Certainly. Thank you, Dale, and good morning. The US economy and the railcar industry remain weak, but both have experienced modest improvements during 2010. Railcar loadings have increased during 2010 from the prior year. And during the third quarter, the industry saw the highest weekly average since the fourth quarter of 2008. Although the reported idle US railcar fleet remains sizeable at 22% or approximately 331,000 railcars, it has continued to decline from the recent high level of 32% or approximately 503,000 railcars in June of '09.

In addition, industry-wide new railcar orders were almost 9,200 and new railcar deliveries were approximately 3,700 during the third quarter of 2010. This has been the highest quarterly level of orders and deliveries during 2010, and the highest level of order since the second quarter of 2008. As a result of the continued increase in order levels, industry backlog has increased in each quarter of 2010. Deliveries are forecasted to be approximately 14,000 cars in 2010 and 29,000 in 2011.

Based on these figures, we believe the first half of 2010 appears to be the low point for the railcar industry. We continue to quote on new railcar order opportunities and were successful in securing orders for approximately 640 new railcars in the third quarter of 2010, resulting in a backlog of approximately 1,420 new railcars as of September 30th and we continue to book new business this month as well.

We have noted previously that the customers active in the market are railroads and shippers primarily seeking new specialty railcars, whereas leasing companies have been fairly inactive. In addition, many of these customers currently have a greater need for hopper railcars as compared to tank railcars. Most of our orders during 2010 have focused on specialty hopper railcars with many orders taken at very competitive prices. While new railcar production will remain at low levels, we have increased production at one of our railcar manufacturing facilities to meet our customers' needs.

During the third quarter of 2010, we began producing our first open-top hopper railcars for use in iron ore service that have began to ship in the fourth quarter. We are seeing benefits from vertical integration projects, which have lowered the cost of parts used to manufacture railcars. We will continue to use some available capacity at our railcar manufacturing plants for railcar repair work. This allows us to effectively utilize our seasoned workforce and superior facilities to earn additional revenue.

Our railcar service segment experienced increased revenue and improved efficiencies in 2010 due to completed expansion projects and the utilization of our railcar manufacturing plants as previously mentioned. We expect that these expansions will further grow our presence in the railcar repair market. Our repair plants have seen improved demand due in part to railcars that were idle and are now being repaired and returned to service. However, we are seeing some customers limiting repairs to mechanical maintenance and deferring paint and lining work.

I will turn the call back to Dale for discussions of third quarter 2010 financial results.

Dale Davies

Thanks, Jim. Revenues for the third quarter of 2010 were $65 million, down from revenues of $78 million in the third quarter of 2009. Deliveries for the third quarter were approximately 420 railcars, down from approximately 610 for the same period of 2009. The reduced revenues in deliveries resulted from depressed demand for new railcars. Although revenues decreased year-over-year, this is the second sequential quarter we've experienced an increase in manufacturing operations revenues.

We believe that the recent industry trends of increased railcar loadings and reductions in stored railcars should support a rebound in the demand for new railcars. Thus far, in 2010, we have received an increased number of requests for quotations and have been successful in securing orders for approximately 2,010 railcars. As of September 30th, we had railcar orders for approximately 1,420 railcars in our backlog. We expect that our current backlog will take our production schedule through the first quarter of 2011. Shipments and revenues in 2011 will primarily be dependent upon our ability to secure additional new railcar orders.

Revenues for our railcar services segment were $16 million for the third quarter, which is a slight increase from the same quarter of 2009. The increase is primarily due to railcar repair projects performed at our railcar manufacturing facilities. Gross profit margin for manufacturing operations in the third quarter of 2010 decreased to a loss of 2% from a profit of 9% for the third quarter of 2009. The decrease in margin reflects lower shipments, competitive pricing pressures to secure new railcar orders, and the impact of fixed costs in a low production environment. The gross profit margin for railcar services for the third quarter of 2010 was 20%, up from 19% in the third quarter of 2009. The margin improvement during the quarter was the result of increased efficiencies and the utilization of excess capacity at our railcar manufacturing facilities for railcar repair projects.

Adjusted EBITDA, which excludes gains on short-term investment activity and stock-based compensation expense, was $2 million for the third quarter of 2010 versus $7 million for the same period of 2009. The decrease is primarily the result of lower volumes and a decreased gross profit margin, all partially offset by a decrease in selling, administrative and other costs, excluding the stock-based compensation expense, and a decrease in joint venture losses. Let me remind everyone that EBITDA and adjusted EBITDA are non-GAAP financial measures that are reconciled through our net loss in our press release, which was issued yesterday. The press release is available through the investor relations page of our Web site.

Net loss for the third quarter of 2010 was $6 million or $0.29 per share, as compared to earnings of $1 million or $0.05 per share for the third quarter of 2009. Our net loss for the quarter was affected by the factors previously mentioned that impacted adjusted EBITDA, along with an increase in net interest expense and a decrease in other income. Net interest expense increased due to the sale of corporate bonds in the third and fourth quarters of 2009 that had earned a higher rate of return than our current cash investments. Other income decreased due to the gain on the sale of corporate bonds during the third quarter of 2009.

For the three months ended September 30th, 2010, our income tax benefit was $3.9 million as compared to income tax benefit of $1.2 for the three months ended September 30th, 2009. And that change was due to a one-time $1 million adjustment to approved taxes due to certain tax benefits becoming recognizable in the third quarter of 2009. For the nine months ended September 30th, 2010, revenues were $178 million, down 48% from the nine months ended September 30th, 2009. Manufacturing revenues were down 58% when compared to 2009, primarily due to the downturn in the railcar industry driven by the weak economy. Revenues for railcar services were up 17% over the first nine months of 2009 driven by increased volume.

Adjusted EBITDA for the nine months ended September 30th was $2 million versus $32 million for the nine months ended September 30th, 2009. The decrease was due to decrease in railcar shipments, a decrease in gross profit margin, and an increase in joint venture losses, all partially offset by a decrease in selling, administrative and other costs. Net loss for the first nine months of 2010 was $19 million or $0.90 per share compared to net earnings of $5 million or $0.23 per share for the first – for the same period of 2009. Our net loss for the year was affected by the factors previously mentioned along with an increase in net interest expense, a decrease in other income, and an increase in our effective tax rate.

Net interest expense increased due to sales of corporate bonds in the third quarter and fourth quarter of 2009 that had earned a higher rate of interest than our cash investments. And our other income decreased due to the gain on the sale of corporate bonds in the third quarter of 2009. Our income tax benefit for the nine months ended September 30th was $12 million or 38% of our losses before income tax as compared to income tax benefit of $1.2 million for the nine months ended September 30th, 2009 or 20% of our earnings before income taxes.

The company's liquidity position is strong with $311 million of cash and total borrowings of $275 million, representing our unsecured senior notes, which are due in 2014. We have focused on managing overhead costs at all of our locations during these tough times. We plan to continue to manage our costs and capabilities to match market demand. We have kept our capital spending low and have focused our resources on maintenance projects and any other projects that will reduce costs and better position us for improved profitability when the railcar market recovers.

At this time, I'd like to turn it back to Jim for a few comments about our joint ventures.

Jim Cowan

Thanks, Dale. Consistent with other events in the quarter, we continue to see an increase in the number of domestic and international orders at our axle manufacturing joint venture, Axis. While volumes are still low due to the depressed domestic rail car industry, we are optimistic about the long-term prospects for this joint venture when the US demand for new railcars strengthens. To offset the impact of the weak US market, Axis International shipments have increased with more axle production going primarily to Brazil.

US Railcar, our joint venture that was formed to design, manufacture and sell DMUs to public transportation authorities, presented a bid for an order in California in September. Based on preliminary discussions, we do not expect to win this order. We also plan to bid on the passenger railcars for the Ohio sea corridor, a significant transit project as we expect to have additional clarity in the next few months about the future plans from the state of Ohio.

We continue to focus on international opportunities to utilize our expertise. During the first quarter of 2010, we made a $9.8 million equity contribution through our India joint venture, of which we have a 50% ownership interest. The joint venture also completed its financing during that quarter and construction of a manufacturing facility near Kandahar is currently underway. We expect to build prototype railcars for the India market in the second quarter of 2011 in order to achieve certification and showcase the products we plan to deliver into the Indian market.

Management and the Board of Directors will continue to look at opportunities that will further diversify our business domestically and expand our international presence. We will now take a few of your questions.

Our operator, John, would you please explain to the guests how we can register their questions.

Question-and-Answer Session

Operator

Certainly. We will now begin the question-and-answer session. (Operator Instructions) Standing by for questions. And we have a question from Art Hatfield from Morgan, Keegan. Please go ahead.

Art Hatfield – Morgan, Keegan

Thank you. Hi, good morning, Jim and Dale. Jim, thanks for the update on the JVs. I was wondering if you could go into a little bit more depth, if possible, for instance with regards to the current losses and how that may break down between the different JVs. And how we can think about a way to model those going forward given what it's going to take to get those things to break even to profit levels.

Dale Davies

Okay. Art, this is Dale. As you know, the biggest JV that we have is our Axis JV. And that's a JV that manufactures axles for us and as well as some other companies that are in the JV with us. That probably is the largest loss we had so far this year. The volumes are low at that joint venture at this time. It's reflecting the demand in the industry, but we are seeing improving results there. One thing that's helped us this year is we've had a lot of export axles going to Brazil. We expect that to continue in 2011 or probably even to increase at higher levels than we've had this year.

The other thing is our demand is expected to probably improve a little bit next year and some other partners that will be taking axles from this JV. We're taking very few axles in the early part of 2010 due to inventory situations they had and other commitments they had. And now I think some of that's going to work through and we're seeing improving demand from them. So our anticipation is that the volumes will be improving in Axis as we move forward. We're already seeing some of that now and it will continue to improve. And that's going to continue to reduce the losses we have. Of course, the losses there are – it's after covering depreciation, it's after covering interest expense on that, too. So as we look at it, it's a pre-tax income loss that we put into our books.

Art Hatfield – Morgan, Keegan

And then the other two, are they just much smaller and more dependent on just getting those things ramped up and generating revenue?

Dale Davies

Yes. One of the other ones that we have is our Ohio Castings joint venture, and we have a one-third interest in that joint venture. And that plant produces the side frames and bolsters and some other couplers. It actually is idle at this time. We idled that last year and it's going to probably remain idle until some demand returns for those parts. We don't see that being too far of, but it's probably not this year and it will probably – it might be beyond next year. We're not sure yet.

Art Hatfield – Morgan, Keegan

Okay.

Dale Davies

When the demand comes back. But it's, right now, been in an idle state. The losses are not very large there. The plant has been downsized where there's basically a maintenance staff in place.

Art Hatfield – Morgan, Keegan

Got it. That's very helpful. Thank you. And then just one other thing, as we think about going forward and the mix of business and I think it was Jim, you mentioned some of the orders you've gotten were at competitive prices, competitive pricing. Can you talk a little bit how we can think about the – how the mix of the backlog or what you expect that the backlog to – as it evolves over the next year, how that may impact, for instance, the revenue line from a pricing per unit standpoint?

Jim Cowan

Yes. As we said, it's been very competitive. We are finally seeing, as we mentioned, we thought the toughest bid components were in the first half of the year. So from that perspective, pricing is gaining some strength right now. Not in any big strides, but it still is very competitive. There's no doubt. I will say this, with having the leasing companies on the sideline, that's always been a fairly big piece of our business. It's one reason why when we're taking the orders that we're taking, they're fairly selective. We're not looking to obviously lose money on orders. And like I say, they are at a very competitive level. But I think once the leasing guys start coming back in the market and I expect – they are in small ways today, but in very small ways. But I think that will help strengthen the demand and, of course, make improvements certainly into the first half of next year.

Art Hatfield – Morgan, Keegan

Right. Thanks for your time, as always. I'll hop back in line.

Operator

Our next question comes from Alison Wolf from Longbow Research. Please go ahead.

Alison Wolf – Longbow Research

Hi. Good morning. This is Alison Wolf calling in for Paul Bodnar. And I have two questions. The first has to do with just a little bit more detail on the US Railcar. Last conference call you had talked about the two bids and I understand that one in California you did not expect to get and you referred to the Ohio corridor one in your remarks. Last time you'd said that you expected revenues from these two potential bids in the $80 million to $100 million range. So what do you see, with the California order probably not coming in, being revenues and margins from the potential Ohio one?

Jim Cowan

Well, no. The Ohio order hasn't changed. The entire project statewide approved by the federal government was $400 million. That was announced back in the first quarter by the Department Secretary, LaHood. He went to Columbus and made that announcement. They've done a study internally in the state to see how the cost of that operation would be going forward. We think it's going to be either late fourth quarter or early first quarter when they're either going to do something on this project or possibly even cancel the project. But the rolling stack portion of the $400 million, we're guessing, is around the $120 million range.

Alison Wolf – Longbow Research

Okay.

Jim Cowan

That's the (inaudible).

Alison Wolf – Longbow Research

Okay. All right. And then, also in terms of more detail on your expectations for the leasing companies, they're pretty inactive now, when do you expect them to maybe come back?

Jim Cowan

Well, I think it's going to be first half of next year, as I just mentioned. But like I say, they are – don't think they're not out there. But they are getting a few 20, 50, 80, 100 car inquiries here and there. It does take place. But they're not in anyone's backlog, certainly ours, in any big way. But they have replacement demand that goes on quarter after quarter. So they will have to make some additions to their fleet as they retire different products. And so I think the first half of next year, they'll be back in the market fairly well.

Alison Wolf – Longbow Research

Thank you.

Operator

(Operator Instructions) We have a question from Alexander Walsh from KeyBanc Capital. Please go ahead.

Alexander Walsh – KeyBanc Capital

Hi guys. I was just wondering if you could possibly comment on sequentially the robustness or what you're seeing in terms of inquiries compared to maybe the prior quarter. And also, I note that you said that for specialty hopper types have been getting more RFQs for tanks, but I guess just could you compare that to some prior quarters?

Jim Cowan

Well, we have seen, I guess, progress on the inquiry desk the last few quarters, and even the month of October. So we've had, I think, a fairly good month from a booking perspective here starting in the fourth quarter as well. And as I said, we are seeing some pricing firm a little bit. But the one thing we did note on the tank car area, again, because leasing companies do dominate that market. It's very soft. It has been for over the last year. And we're hoping, like I said, in the first half of next year that they could start increasing some of the levels they've been at.

Alexander Walsh – KeyBanc Capital

All right. Thank you.

Operator

(Operator Instructions) We have a question from Tyson Bauer from Wealth Monitors. Please go ahead.

Tyson Bauer – Wealth Monitors

Hi. Good morning, gentlemen.

Jim Cowan

Good morning.

Tyson Bauer – Wealth Monitors

Given your comments about the leasing companies in the Q – or the first half comeback in 2011, does that imply that they are seeking bids now currently and when would you expect that to be into backlog or when would we start to see announcements, before the end of this year or will that go into 2011?

Jim Cowan

Tyson, that's really hard to say. We talk to these leasing guys all the time. And like I say, they're looking at their retirements that were in 2009 and 2010. They haven't been very aggressive certainly this year. And they are going to have to be making some additions to their fleet. I'm giving you my best guess with the data points we're getting that in the first half of next year, they're going to have to get a little more aggressive in the market.

Tyson Bauer – Wealth Monitors

Okay. In regards to repair and services side of the business, I guess there's been some rumblings that there're opportunities that exist in the marketplace possibly from the railroad companies themselves that are looking to move some of those facilities. Are you seeing any activity or any opportunities where you could pick up some facilities in that segment?

Jim Cowan

No, not really. We look at different facilities all the time. Most are fairly small. And like I say, on the greenfield perspective, we always are looking for ways to grow that business, again, at a fairly small level. Once we can get a customer doing a certain geography, we try to accelerate that. But, no, to answer your question, we're not.

Tyson Bauer – Wealth Monitors

Okay. And can you give us a sense of how you see the tank car market playing out for you and is that something you expect also to pick up some interest as we go into 2011?

Jim Cowan

Well, it's clearly – the tank car market, the expectations this year are around 5,000 and the expectations are it could be closer to 9,000 next year. So again, that's the best forecast that we have. And again, we think that's what we're going to be seeing.

Tyson Bauer – Wealth Monitors

All right. Thanks a lot, gentlemen.

Operator

At this time, I show no questions.

Jim Cowan

Okay. Well, John, we'll wrap it up. But we obviously want to thank everyone for your interest in ARI. And we look forward to improvement in the business, improvement in this market sector going forward. Thank you very much.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may now disconnect.

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