American Railcar Industries, Inc. (NASDAQ:ARII)
Q2 2016 Results Earnings Conference Call
July 29, 2016 10:00 AM ET
Luke Williams - SVP, CFO and Treasurer
Jeff Hollister - President and CEO
Matt Alcott - Cowen & Company
Justin Long - Stephens
Mike Baudendistel - Stifel
Good day ladies and gentlemen and welcome to the Second Quarter 2016 American Railcar Industries’ Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, this conference is being recorded.
I would now like to introduce your host for today’s conference, Mr. Luke Williams, Senior Vice President, CFO and Treasurer. Sir, you may begin.
Thank you, Sabrina. Good morning. I would like to you to the American Railcar Industries’ second quarter 2016 conference call. I am Luke Williams, our Interim Chief Financial Officer, and I would like to thank you for joining us this morning. For those who are interested, a replay of this call will also be available on our website, americanrailcar.com, shortly after this call ends.
Joining me this morning is Jeff Hollister, our President and Chief Executive Officer. Our call today will include comments about the railcar industry, our operations and financial results. Following these remarks, we will have a Q&A session.
This conference call will include forward-looking statements, including statements as to estimates, expectations, intentions and predictions of future financial performance based on currently available information. Participants are directed to our SEC filings and press releases for a description of certain business issues and risks, a change in any one of which could cause our 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.
EBITDA and adjusted EBITDA are non-GAAP financial measures we will discuss today, that are reconciled to net earnings in our press release that was issued yesterday. The press release is available through the Investor Relations page of our website.
Now, it is my pleasure to introduce Jeff Hollister.
Thank you, Luke. Good morning everyone. Thank you for joining us.
As we look back on the second quarter of 2016, we are pleased with our results, given the current headwinds in the real industry. Over the last couple of years when the industry experienced record high demand for railcars, we were disciplined in focusing on our core business, efficiently and cost effectively manufacturing quality hopper and tank railcars.
In addition, we strategically increased our efforts and continue to grow our complementary business segments railcar leasing and railcar services. As a result, we believe our business model has become stronger now than it was during the last down cycle, which we attribute to our people, our processes, and our products.
Our people continually strive for operational excellence while constantly looking to improve upon our already well-defined and efficient processes, to provide our customers with superior product offering of the utmost quality. We believe our success in the rail industry is heavily dependent upon our greatest assets, our people, and the core values they hold and portray in our business. We have a very strong experienced group of operation managers and employees that understand our industry, our products, and our manufacturing processes. The majority of our management team and the core group of production employees have experienced these railcar cycles in the past. As a result, we believe we possess the experience necessary to address the challenges of a down market.
By diversifying our business through railcar leasing and railcar services, we are not only able to partially offset the softness in the new railcar market but also built strong relationships with key customers who provide us insight into their needs, which allows us to position ourselves to respond to the ever evolving industry. We have made a strategic effort to grow our railcar lease fleet over the past several years, which provides us with multiple benefits, most importantly, a consistent stream of cash flows extending into the future.
In addition, we have made an aggressive effort to grow our railcar services business, which not helps our key railcar customers with their maintenance needs, but we also expect this business to provide us a larger base load of consistent business.
The FTR rail equipment outlook for North American railcar markets forecast deliveries of slightly below 57,000 cars in 2016 and approximately 45,000 in 2017. While these levels are significantly lower than the record high delivery levels experienced in 2014 and 2015, ARI’s primary products hopper and tank railcars continue to make up the majority of these forecasted deliveries.
The industry reported the 7,030 railcars were ordered and 15,655 railcars were delivered during the second quarter 2016, producing a book to bill ratio of 0.4 to 1. With lower railcar loadings, lower utilization and increased rail speeds, and a shift in demand towards more specialty top railcars, industry backlog at June 30, 2016 dropped to 89,155 railcars and approximately 80% of the backlog is for hopper and tank railcars. Our current backlog also reflects these market trends, and as of June 30, 2016, consisted of 5,601 railcars, including 1,556 railcars for lease orders.
Recent inquiry and order activity we have experienced has been focused on specialty tank railcars, including pressure tanks as well as plastic pellet and pressure differential hopper railcars. We are also seeing inquiries and orders for both tank and hopper railcars, servicing various food and agricultural commodities. Although some of these types of railcars are being ordered in smaller volumes, these more complex specialized railcar types allow us to take advantage of this niche market, providing our customers with quality products from our family of hopper and tank railcars while remaining efficient and profitable.
I will now turn it back to Luke for a discussion of the second quarter financial results.
Thank you, Jeff.
Second quarter consolidated revenues were $150 million, down 22% versus $192 million for the same period in 2015. This decrease was primarily driven by our manufacturing segment with the decrease in tank railcar demand and a shift in production to a larger mix of specialty tank and hopper railcars, as Jeff previously discussed. The decrease in our manufacturing segment was partially offset by higher revenues from our railcar leasing and railcar services segments.
Consolidated manufacturing revenues were $98 million for the second quarter of 2016, compared to $144 million for the same period in 2015. The primary reasons for the decrease were lower volume of railcar shipments for direct sale, a higher mix of hopper railcars which generally have lower average selling price than tank railcars due to less material and labor content, and more competitive pricing on both hopper and tank railcars.
We shipped 932 railcars for direct sale and 85 railcars for lease during the second quarter of 2016, this was compared to 1,378 railcars for direct sale and 1,019 railcars for lease during the second quarter of 2015. Consolidated manufacturing revenues exclude estimated revenues related to railcars built for our lease fleet of $9 million for the second quarter of 2016 compared to $124 million for the same period in 2015, reflecting a lower quantity of both hopper and tank railcars shipped or leased.
Railcars built for our lease fleet represented 8% of our total railcar shipments during the second quarter of 2016 compared to 43% for the same period in 2015. Please note, because revenues and earnings related to lease railcars are recognized over the life of the lease, our future quarterly results will vary depending on the mix of lease versus direct sale railcars that we ship during a given period.
Our railcar leasing revenues for the second quarter of 2016 were $33 million compared to $28 million for the same period in 2015. Leasing revenues increased as our lease fleet has grown to 10,641 railcars at June 30, 2016 from 9,399 railcars at June 30, 2015.
Our railcar services revenues for the second quarter of 2016 were $20 million compared to $19 million for the same period in 2015. Revenue increased due to the strong demand and the additional capacity resulting from our expansion projects that continue to ramp up in 2016.
Consolidated earnings from operations for the second quarter of 2016 were $36 million, down 35% compared to $55 million for the same period of 2015. Our consolidated operating margins were 24% in the second quarter 2016, compared to 29% from the same period of 2015. Both our earnings from operations and operating margins decreased due to a higher mix of hopper railcar shipment along with more competitive pricing and higher costs associated with lower demand for tank railcars. These decreases were partially offset by the strong margins from our railcar leasing segment as leasing revenue was 22% of total consolidated revenue for the second quarter of 2016, compared to 15% in the same period of 2015.
On a segment basis, earnings from operations for our manufacturing segment were $16 million for the second quarter of 2016 compared to $17 million for the same period of 2015. Segment earnings from operations included $1 million in estimated profits on railcars built for our lease fleet for the second quarter of 2016 and $35 million for the same period of 2015. The estimated profit on railcars built for our lease fleet are eliminated in consolidation.
The decrease in earnings from operations was primarily due to the softening in new railcar demand with a lower volume of railcar shipments as well as a higher mix of hopper railcar shipments and more competitive pricing on both hopper and tank railcars, as I previously mentioned.
Railcar leasing segment earnings from operations were $20 million for the second quarter of 2016 compared to $17 million for the same period of 2015. This increase was due to the growth in our railcar lease fleet, referenced earlier.
Earnings from operations for our railcar services segment decreased by $1 million in the second quarter of 2016 compared to the same period in 2015. Operating margins for this segment decreased to 15% for the three months ended June 30, 2016, compared to 20% for the same period in 2015. These decreases were due to costs associated with the ramp-up of operations at our recently our completed expansion projects, higher depreciation expenses and additional administrative support expenses to faster anticipated growth of this segment.
Consolidated selling, general and administrative expenses for the second quarter of 2016 were $7 million compared to $5 million for the same period in 2015. The increase was primarily due to lower consulting expenses in the second quarter of 2015 as well as higher depreciation related to our new enterprise resource planning system or ERP system, in 2016.
Interest expense remained relatively flat at $6 million in both the second quarter of 2016 and the same period of 2015 with consistent average debt balances during both periods.
Net earnings for the second quarter of 2016 were $20 million, or $1.02 per share compared to $33 million or $1.54 per share for the same period in 2015. This decrease was driven by the lower earnings from operations referenced earlier.
Adjusted EBITDA, which excludes share-based compensation expense was $50 million for the second quarter of 2016. This was 26% lower than the $69 million for the second quarter of 2015. The decrease resulted primary from decreased earnings from operations as previously discussed and a reduction in earnings from joint ventures of $700,000 for the second quarter of 2016 compared to the same period in 2015. The decrease in earnings from our joint ventures reflects the ramp down of production in line with industry demand.
Turning to the results for the first half of 2016, total consolidated revenues for the first six months of 2016 were $327 million, 28% lower than the $456 million for the same period in 2015. Revenues decreased as a result of lower railcar shipments for direct sale, partially offset by an increase in revenues from our lease fleet and an increase in railcar services revenue.
Total railcar shipments for the six months ended June 30, 2016, were down 54% compared to the same period of 2015. We shipped 2,062 railcars for direct sale and 285 railcars for lease during the first six months of 2016 compared to 3,395 railcars for direct sale and 1,670 railcars for lease during the same period in 2015.
Net earnings for the first six months of 2016 were $43 million or $2.18 per share compared to $68 million or $3.18 per share for the same period of 2015. This decrease was due to lower earnings from operations driven by a higher mix of hopper railcar shipments along with more competitive pricing and higher costs associated with the lower demand for tank railcars.
Adjusted EBITDA was $105 million for the first six months of 2016, compared to $140 million for the same period of 2015 with the decrease driven by lower earnings from operations as previously mentioned and a reduction in earnings from our joint ventures.
Our earnings contributed to positive cash flow from operations of $87 million during the first six month of 2016, with net working capital of $270 million as of June 30, 2016, including $199 million of cash and cash equivalents.
As of June 30, 2016, we had $584 million of debt outstanding under our January 2015 lease fleet financing facility. Our strong balance sheet combined with the $200 million available to borrow under our revolving credit facility provides us with the ability to continue to opportunistically add to our lease fleet and make future investments to further enhance our business model. We also have additional unencumbered railcars available to further leverage our lease fleet as we find opportunities to strategically grow.
On July 27, 2016, our Board of Directors declared a 16th consecutive quarterly cash dividend. This dividend of $0.40 per share will be for ARI stakeholders of record as of September 9, 2016, and will be paid on September 23, 2016. We also continue to return value to our shareholders through our stock repurchase program. During the first six months of 2016, we repurchased 445,000 shares of common stock at a cost of $16.9 million. Board authorization of $176 million remains available for further share repurchases.
At this time, I would like to turn it back to Jeff for a few comments about the outlook for the Company and our joint ventures.
While we rely on our railcar leasing and railcar services segments to help offset the softness in the tank and hopper railcar markets, we continue to view our new car manufacturing expertise as one of our main core competencies. With our flexible operations, our manufacturing segment can quickly and successfully perform seamless line changeovers, allowing us to handle smaller production orders for tank and hopper railcars more efficiently.
We offer our customers numerous railcar offerings from our family of both hopper and tank railcars, including highly specialized railcars. Our manufacturing processes have the ability to adapt to customer demand as we are able to run various railcar types down our manufacturing line without dramatically affecting our costs and efficiencies.
In addition, our skilled workforce has the expertise and ability due to their proximity to one another and the talent of our people to move between our hopper and tank railcar manufacturing facilities, helping to maintain efficiencies and continue the production of quality railcars. Now being proactive and effectively adjusting our production rates to meet the needs of the industry, we are able to better control both labor and overhead costs.
We have planted same philosophy of maintaining flexible and efficient operations at our vertically integrated component manufacturing facilities and our joint ventures, both of which continue providing key component parts for our railcars, helping to further reduce our costs.
A significant portion of our castings continue to be purchased from our Ohio Castings joint venture, and our Axis joint venture remains our primary supplier of axels. By reinforcing our supply chain with the investment in our joint ventures, we are better positioned to remain competitive. Both Ohio Castings and Axis continue to run very efficiently and add value to our business, and we continue to evaluate their production levels to align with the expected industry demand.
With our fully utilized lease fleet reaching 10,641 railcars at June 30th, we continue to benefit from this segment, which yielded a gross profit margin of 69% for the second quarter of 2016. Adding railcars to our lease fleet remains a priority to us as we strategically target key customers and key railcar types to meet their needs.
Our railcar services business had a strong year in 2015 and its momentum continues with 7% growth during the first six months of 2016 due in large part to the growth in our traditional repair and mobile operations. Railcar services remain a cornerstone of the rail industry and we have focused our efforts in recent years to enhance our repair network. The addition of our Marmaduke tank railcar manufacturing facility to our repair network and our ability to leverage ACF Milton’s repair operation, have provided us with additional capacity to complete several projects across a broad network of repair location throughout various regions of the U.S.
The remainder of 2016 looks promising for this segment, as we are evaluating several projects for completion in the second half of 2016 and into 2017. We believe our current capital expenditure plans for the remainder of 2016 will support our core manufacturing business as well as our railcar leasing and railcar services businesses, as demand may dictate. These projects are expected to support necessary maintenance needs and to further expand capabilities and reduce costs.
Further illustrating our ongoing commitment to flexible growth and cost reduction initiatives, both big and small, is the relocation of our St. Charles, Missouri component manufacturing facility to Arkansas. This move is expected to provide synergies and the features given the close proximity this component facility will have to our railcar manufacturing facilities, thus yielding savings of freight and overhead costs while helping to reduce inventory levels.
During the second quarter of 2016, we completed the final phase of the implementation of ERP system. We expect this new system to yield additional cost savings in our supply chain, providing us with more working capital. Our new ERP system also provides us with modern planning tools that are essential to our business in this ever changing railcar market. We hold the success completion of this project to our employees throughout the organization including those individuals on the ERP leadership and implementation team, their hard work is not gone unnoticed, and we’re extremely appreciative of their efforts.
Now, we’ll turn the call back over to the operator and will be happy to take your questions. Sabrina, would you please explain how our participants can register their questions?
Thank you. [Operator Instructions] And our first question comes from Matt Alcott with Cowen & Company. Your line is now open.
You guys on the first quarter call -- if I remember correctly, you said that 65% of your backlog was for 2016 delivery and I think the remainder of it was 2017. Have those percentages changed with the new orders in the second quarter, how do you feel about that going forward?
It’s constantly moving around a little bit. Most of 2016’s locked in by now, but some has moved around from late 2016 into 2017. Big bulk of our backlog is going to be filled in both 2016 and 2017. We have some that trickles over into future years but the bulk will be delivered this year and next year.
And can you give us a bit more color on the orders that you guys received in the second quarter? And did you see -- are you seeing an uptick and inquiries or orders for grain cars from the kind of trisect [ph] of favorable dynamics potentially for the rail industry for the shipment of grain?
There is a mix of orders that we received for different car types in second quarter between tanks and hoppers. We don’t really get into too many details but just want to say that it’s related to different car types and different commodities amongst the hopper and tank business.
To your second point, yes, we just recently have started seeing an increase inquiries on the grain car side. The other enquiries are pretty flat at the past quarters, and there is just pockets of more specialty type cars. Also to point out, we did get more orders on the tank car side than the hopper car in the second quarter.
And did you guys get any orders thus far in the third quarter?
We have taken a few orders but don’t care to quantify that at this point.
Thank you. And our next question comes from Justin Long with Stephens. Your line is now open.
First question I had, I wanted to ask and maybe follow up on that earlier question, if you had an expectation for the trend in production in third and fourth quarter, it’s sounds like most of this year is booked. So, could you just give some clarity around that? And then also, I know it’s early to talk about 2017, but if we just assume that order flow remains pretty steady, do you have any projections or expectations for how next year’s production could look?
Yes, Justin. So, I mean we mentioned last call that our second quarter from a shipment standpoint was going to be probably our worse quarter. So shipments were down a little bit this quarter. We see shipments bouncing back a little bit here in Q3 and then should increase a little more in Q4. So, as you look at kind of the second half, it’s going to be slightly higher than the first half as far as shipments. But keep in mind, our lease percentage for the first half of the year has been lower than normal. So, if you look at our backlog lease percentage, you’re going to see more of that type of percentage for lease cars the second half of the year.
And then, to just kind of answer your second part of that in 2017, as I just mentioned, most of our backlog is going to be filled in 2016 and 2017. So, I mean we have got some backlog for 2017. Obviously we still have some work to do. Our goal always is try to maintain our shop to be as full as possible. So, I mean obviously, we are going to try to maintain and turn in numbers next year similar to this year. If the market continues to go down, then that would mean to us going on out and trying grab market share from some of our competitors.
And at this point -- this is Luke, we are actively working with customers on inquiries to both hoppers and tanks for 2017. So, we are moving forward.
Okay, that’s all helpful. And I think last quarter, you also talked about manufacturing margins being a little bit weaker in the second quarter and then picking up some in the back half of the year. Is that still the case? Do you still expect manufacturing margins to get better sequentially the next couple of quarters? And if so, can you help us think about the order of magnitude we should be expecting?
Yes, Justin, this is Luke. I think as we’ve gone throughout the year, we’ve taken some orders at competitive pricing. So we expect the manufacturing margins to go down a little in the second half of the year. Not sure it’s going to be too drastic of a decrease, but we still expect it in the mid teens. We’re very proud of our manufacturing faculties and their ability to run efficiently even at these lower production levels. So, we’re hoping they can continue that going forward.
And then last question from me, we’ve seen some weakness in the demand environment, and if we end up seeing a multiyear down cycle in railcar builds going forward, do you think this will stimulate more consolidation in the space? And if this does occur, would you guys be open to participating in that?
Yes, Justin. I mean, obviously every time you go through a down market, the M&A activities kind of come up and opportunities are out there, whether it’s within the manufacturing sector or whether it’s in the vendor supplier sector. I mean obviously, we’ve got a lot of cash on our balance sheet; we’re always open to looking for opportunities on how we add value for our shareholders. So, I mean, nothing to comment at this time, but I mean it’s always -- we’re always looking for opportunities to grow.
And from a regulatory perspective, do you think that a deal could happen? I know Trinity, given their size, maybe it would be a little bit harder to overcome those regulatory hurdles. But, I’d love to get your thoughts on that as well?
You mean just from a competitive, combining from the size standpoint?
Yes, just the overlap with part types and size.
I guess you’re talking more from the manufacturing side. I mean, there is 4, 5, 6, big 6 layers out there. So, I mean different combination. So, it would depend on the combination on whether the size would be challenged.
[Operator Instructions] And our next question comes from Mike Baudendistel from Stifel. Your line is now open.
I wanted to ask you, you’ve referred the competitive pricing in the marketplace, which I think people were expecting. But, can you just talk about when that competitive, more competitive pricing dynamic started, was it last year and did it intensify this year? And I guess what I am really getting at is the backlog of 5,600 railcars, is there a portion of that that was priced when pricing was less competitive, unfortunately there was price more competitive and how much of each?
So, I think it really started earlier this year. I mean, most of the backlog we had late last year were big part of it was on the hopper car size, a lot of it was our plastic pellet car orders with some bigger companies that stretch out into next year, and we’ve got descent margin on those cars. So, it was more related to orders we’ve taken this year and fund more on the tank car side for later this year and early 2017, which may drive our margins down just little bit later this year and into 2017 on the tank car side. But kind offset that, we’re also getting a few orders for specialty tank cars, for pressure tank cars where we got order on a stainless steel tank cars. So the margins are descent and the lease rates are descent on kind of specialty cars. But more commodity driven type car types are going to be challenged and probably the pricing and lease rates are starting to go down on those.
And then, just had a question on the services business. You’re growing that nicely even though rail traffic is down and it sounds like you made a lot of investments there. And I just want to get your perspective of, can that services business continue to grow with rail traffic data that’s still down sort of high single digits? And wondering if you could provide a little bit more detail on some of the projects that you said you were evaluating, just give us sort of a general sense of what those are -- repairing railcars or what is that exactly?
Mike, this is Luke. We do expect that growth on the repair side to continue. I think earlier this year, we referenced a growth number in the 10% to 15% range for that segment this year, and we still feel will come around that range. The other thing to keep in mind on that as our lease fleet continues to grow, we have the ability to repair and maintain our lease cars at our existing shops. So, you don’t see that come up in the consolidated results, but you see in the segment information. So, I just wanted to take a minute to point that out.
So, the projects you alluded to, we have got some customers that we look at project work from time to time; we are look at some good work to put into our Marmaduke shop for this year and next year. And we also expect some tank qualification work to come in here over the next few years.
To expand on that, I mean if you look at the tank qualification across the industry, even though the car loads are down, there is bubble of tank qualifications that are required on tank cars, both with our own fleet and several customers that we work with. So that will help. And then, we do have one plant set up to do tank retrofit, based on the regulations. So, we have had several customers in our shop, reviewing our operations. And so, it may not happen for a while, we are hopeful to maybe get something later this year or into 2017. But eventually, we think there is going to be some tank cars that are retrofit in the market.
Thank you. And at this time, I am showing no further questions in the queue. I would like to turn the call back over to Mr. Hollister, President and CEO, for closing remarks.
I just want to thank everybody for joining us this morning. And we will look forward to talking to you next quarter. Thanks for your support.
Ladies and gentlemen, thank you for your participation in today’s conference. This does conclude the program. You may all disconnect. Everyone have a great day.
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