FreightCar America's (RAIL) CEO Joe McNeely on Q2 2016 Results - Earnings Call Transcript

| About: FreightCar America, (RAIL)

FreightCar America, Inc. (NASDAQ:RAIL)

Q2 2016 Earnings Conference Call

August 2, 2016 11:00 AM ET

Executives

Matt Kohnke - VP, Finance, CFO and Treasurer

Joe McNeely – President and CEO

Ted Baun – SVP, Marketing and Sales

Analysts

Justin Long – Stephens

Matt Elkott – Cowen and Company

Michael Gallo – CL King

Matt Brooklier – Longbow Research

Mike Baudendistel – Stifel

Operator

Ladies and gentlemen, thank you for standing by. And welcome to FreightCar America’s Second Quarter 2016 Earnings Conference Call and Webcast. At this time, all participant lines are in a listen-only mode. For those of you participating on the conference call, there will be an opportunity for your questions at the end of today's prepared comments.

Please note this conference is being recorded. An audio replay of the conference call will be available from 1:00 p.m. Eastern Time today until 11:59 p.m. Eastern Time on September 2, 2016. To access the replay, please dial 1800-475-6701 and enter the access code 398562. An audio replay of the call will be available on the Company’s website within two days following this earnings call.

I would now like to turn the call over to Matt Kohnke, Chief Financial Officer of FreightCar America. Please go ahead, sir.

Matt Kohnke

Thank you and welcome to FreightCar America’s second quarter 2016 earnings conference call and webcast. Joining me today are Joe McNeely, President and CEO; and Ted Baun, Chief Commercial Officer.

I would like to remind everyone that statements made during this conference call relating to the company’s expected future performance, future business prospects or future events or plans may include forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Participants are directed to FreightCar America’s 2015 Form 10-K for a description of certain business risks, some of which may include – maybe outside of the control of the company that may cause actual results to materially differ from those expressed in the forward-looking statements. We expressly disclaim any duty to provide updates to our forward-looking statements whether as a result of new information, future events or otherwise.

Our 2015 Form 10-K and earnings release for the second quarter of 2016 are posted on the company’s website at www.freightcaramerica.com.

Let me now turn the call over to Joe McNeely.

Joe McNeely

Thank you, Matt, and good morning, everyone. Our second quarter results fell short of our expectations. On a sequential basis, our results were negatively impacted by product mix as well as production inefficiencies attributable to first time car build and labor and material supply issues. We’ve taken a number of steps to address the labor and material supply issues and we'll continue to monitor them closely. However, we will likely still incur some production inefficiencies as we continue to introduce new products.

To that end, we are delighted that we have added Howard Broadfoot to our leadership team as our Vice President, Manufacturing – Shoals. In this role, Howard will lead the Shoals organization focusing on improving the production processes and continuing efforts to grow the facility in a world-class railcar manufacturing operation. He joins us from Electro-Mechanical Corporation, where he had multi-plant, multi-product line responsibility in the electrical transmission, distribution and control business for the last seven years.

Previously, he held Senior Operations leadership roles with Thomas and Betts, Newell-Rubbermaid and the ZF Group America. Howard’s strong operations and plant startup background combined with his experiences in the automotive industry in lean manufacturing will serve us well in his new role.

Also in response to macroeconomic headwinds our industry is currently facing we are implementing a cost reduction plan which is expected to reduce our annual operating costs by approximately $5 million once fully implemented. Now we’ll go into details of the plan in a bit, but the takeaway is that we have and we will continue to aggressively manage our cost structure to align it with the evolving railcar market. To our delivery guidance, we now expect full year 2016 delivery to be between 5,600 and 6,100 railcars with the preponderance of remaining backlog extending into 2017.

Ted will now provide an update on our markets and commercial activities.

Ted Baun

Thank you, Joe. Overall railcar enquiries and orders remained at depressed levels. Commodity loadings on U.S. railroads in the second quarter of 2016 were down 10.9% when compared to the second quarter of 2015. Grain loadings grew by 3.8% in the second quarter of 2016, from second quarter of 2015 levels. But coal, metallic ores and crushed stone, sand and gravel loadings all weakened.

Intermodal container loadings also fell by 3.3% over the same time period which represents the first quarter since 2009, where we’ve seen a meaningful reduction in intermodal loadings. Deliveries for the second quarter of 2016 totaled 1,372 railcars, all of which were new railcars. This compares to 2,611 railcars delivered in the same quarter of 2015, which included 1,861 new and 750 rebuilt railcars. We delivered 1,609 railcars in the first quarter of 2016, all of which were new railcars.

Our order backlog at June 30, 2016 was 6,207 railcars with a sales value of approximately $612 million down from the backlog of 14,075 railcars at June 30, 2015 and 7,735 railcars at March 31, 2016. The June 30, 2016 backlog reflects new orders taken of 426 railcars and cancellations of 582 railcars than we received in the second quarter of 2016. It should be noted that of the 426 railcars ordered in the second quarter, 227 were rebuilt railcars.

Order levels for the second quarter of 2016 compared to 1,618 units ordered in the second quarter of 2015 and orders net of cancellations of negative 496 units in the first quarter of 2016. As Joe mentioned earlier we now expect to deliver between 5,600 and 6,100 railcars for the full year of 2016, including 227 rebuilt railcars. Similar to what we said on last quarter's call, the customers continue to struggle with asset utilization as a result of lower commodity traffic continued high train velocity and a high level of existing equipment in storage.

Despite customers working to manage through these unfavorable market trends, we believe that the bulk of the order cancellations are behind us. Looking ahead to the second half of 2016, we expect deliveries to be weighted to the fourth quarter as a result of customer delivery requirements and a major line changeover in July.

Now I'd like to turn the call over to Matt to address our second quarter financial results.

Matt Kohnke

Thank you, Ted. Consolidated revenues were $126.2 million in the second quarter of 2016 compared to $235.6 million in the second quarter of 2015 and $148.6 million in the first quarter of 2016. The consolidated operating loss for the second quarter of 2016 was $600,000, compared to operating income of $10.9 million in the second quarter of 2015.

Consolidated operating income for the first quarter of 2016 was $19.6 million which included a pre-tax gain on the settlement of our hourly retiree benefit litigation of $14.3 million. This quarter’s results on a sequential basis were negatively impacted by several factors.

First, our delivery volumes were lower in the second quarter than the first quarter primarily due to the slower than expected production rates on several new car types and a timing of certain finished railcars that were not delivered until early July. Our results were also impacted by the – an unfavorable mix of cars delivered in the quarter. Finally start-up costs and production inefficiencies associated with the introduction of new railcar types increased our cost of goods sold.

Selling, general and administrative expenses for the second quarter of 2016 were $8.7 million compared to $10.9 million in the second quarter of 2015 and $10.6 million in the first quarter of 2016. The decrease on a sequential basis was attributable to lower incentive compensation expense as well as severance costs incurred in the first quarter of 2016 that did not recur in the second quarter.

Turning to our balance sheet, our financial position remains strong with no outstanding debt and $84 million in cash and short-term investments at June 30, 2016. Inventory levels of approximately $136 million at June 30 remain relatively unchanged from the first quarter as we continue to have most of our production lines busy working through the backlog.

Looking forward to year-end, we expect to see a reduction of inventory between $25 million and $30 million from current levels based on existing production and delivery schedules. Capital spending for the second quarter of 2016 was $6.4 million. For the full year of 2016, we expect capital expenditures to be approximately $14 million including the amounts already paid.

As Joe mentioned earlier, we are implementing a cost reduction plan which when complete we expect will reduce our annual operating costs by approximately $5 million. These savings will be primarily realized within selling, general and administrative expenses. The specific actions associated with this plan include a 15% reduction in the company's salaried workforce, the closure of our Johnstown, Pennsylvania administrative office and the reduction of certain discretionary spending. These actions are currently underway and are expected to be completed by the middle of 2017.

The total estimated costs relating to this program are approximately $4 million including approximately $2.5 million of employee-related costs and approximately $1.3 million in non-cash charges for asset impairments. We expect to incur approximately $1.5 million of these additional costs in the third quarter of 2016 and approximately $800,000 of these additional costs in the fourth quarter of 2016. We expect to realize savings of approximately $1.3 million in 2016 as a result of this program, most of it in the fourth quarter.

At this point, I will turn the call over to Joe for concluding remarks.

Joe McNeely

Thanks, Matt. Despite a disappointing second quarter and challenging industry fundamentals, we remain focused on executing our strategic plans and are pleased with our progress today, introducing new railcar types into the market. We’re also pleased to have Howard as part of our team and to lead the Shoals organization as we look to improve our overall production efficiency, take cost out of the business and continue to introduce new railcar types. I’m confident in our operational ability to provide our customers with high quality products, while creating value for our shareholders through the execution of our strategic plans.

This ends our prepared comments and we are now ready to address your questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] And we’ll go directly to the line of Justin Long with Stephens. Please go ahead.

Justin Long

Thanks and good morning, guys.

Joe McNeely

Good morning, Justin.

Justin Long

So I know you don’t give guidance, but I wanted to get a sense for the ballpark range on normalized margins once you get through these production inefficiencies from ramping new car types. And maybe the best way to ask it is, how much of a headwind was that in the second quarter if you can quantify it? And then just directionally how would you expect gross margins to trend in the back half of the year?

Matt Kohnke

Good morning, Justin. It’s Matt Kohnke. Let me answer the question related to the second quarter, we had about $2.5 million in cost impacting the gross margin that we would not expect to recur on a go-forward basis. Primarily these costs are related to new product development and higher than normal start-up costs associated with some of our newer production lines. As you said, we don't give guidance going forward on margins I rather not comment on that...

Justin Long

Okay, that’s fine. That's helpful. And then maybe this one is more for Joe. But I wanted to talk about or ask about the big picture assumption that drove the cost reduction plan. Obviously by making this decision you're assuming this weak demand environment persist but are you managing the business for demand weakness over the next year, over the next two years or a down cycle that could extend even longer than that?

Joe McNeely

Justin, this is Joe. As we look to that again if you look at the orders in this past quarter of about 4,300 non-tank cars that’s a relatively low number when you annualize it. And when you look at what the forecasters are predicting – they're predicting one to three-year cycle depending on what you're looking at. So we're preparing the business for that time, knowing also that we're still introducing car types and we still think have the resources to be able to design and take those to market.

Justin Long

Okay, great. Now I’ll ask one more and then pass it along. But if the demand environment we're seeing today continues – how should we be thinking about your cash balance going forward. Obviously your sizable cash balance helps provide a layer of protection at a below replacement market or in a down cycle. So you mentioned maybe getting a benefit from lower inventories. But if we kind of weigh that against the potential for CapEx reductions next year and everything else over the next 12 months, let's call it how do you see the cash balance trending?

Joe McNeely

I think when you look at the cash balance, I think as we said in Matt’s comments the inventory numbers are going to go down and there you see it’s monetizing the cash and as we’ve talked on prior calls, as the business slows down and your backlog gets built, it tends to generate cash. Offset on that again there's always a cash burn for your fixed costs. But I think overall as we look out we're going to have adequate cash balances.

Justin Long

Okay. And anything in terms of where you could take CapEx next year like what CapEx might look like on a more normalized basis, because I know this year, you still had some impact from Shoals.

Joe McNeely

Yes. Typically when you look at maintenance capital, what I would call kind of the normal recurring stuff, it's more maintenance capital and it’s anywhere between $4 million to $6 million for our facilities.

Justin Long

Okay, great. I’ll leave it at that. I appreciate the time.

Joe McNeely

Thank you, Justin.

Matt Kohnke

Thanks, Justin.

Operator

Thank you. And our next question will come from the line of Matt Elkott with Cowen and Company. Please go ahead.

Matt Elkott

Good morning. Thank you for taking my question. So you guys have the cost cutting plan in place to respond to the challenges you’re facing. But from a top line perspective are these challenges making you take a look at the markets you want to be in – in other words are you reconsidering your efforts to enter certain railcar type markets in order to focus on other types or maybe have a stronger competitive advantage?

Ted Baun

Yes. Hey Matt, it’s Ted Baun. I think I’ll answer that as follows. We are very comfortable with the car types that we’ve decided to get into starting about three or four years ago intermodal covered hoppers of variety of types and diversifying away from coal cars. So there aren’t a whole lot of markets that we have left to go into and we’re comfortable sticking with the ones we’ve got, and we think there’s long-term demand in those markets. And we think we will continue to reduce costs in those areas and compete long-term.

Matt Elkott

Okay.

Matt Kohnke

Joe just maybe another point or color, over the last three years we've introduced almost 20 different car types as part of our strategy and diversification. So that in a down cycle like we have we can compete across multiple car types. And so that is the kind of the basis of the strategy and that’s why we are pleased before we add an introduction of all those car types.

Matt Elkott

Okay. And I know you guys have a pretty strong competitive advantage in the open hoppers – the cars that are used for the shipment of aggregates and with the highway bill passed in December of last year we’re seeing an uptick in – may be increase into that car type. Are you guys seeing that in your conversations with your customers? Do you get the sense that people are making kind of a long-term bet that infrastructure in the U.S. will be expedited by new administration and we’ll see a meaningful uptick in the car type?

Ted Baun

Yes, Matt that is one of the markets we’re seeing strengthened and we are very close to that market.

Matt Elkott

Okay, and is that translating into orders or is it at this point more inquiries and conversations you're having?

Matt Kohnke

At this point, it’s – there are a variety of discussions being had more on the inquiry front.

Matt Elkott

Okay. And just one last, one last quick one. The cancellations you guys had in the quarter, what type of railcars were those?

Matt Kohnke

We're not going to get into the level of details with respect to the cancellation make up if you will. So we can’t get into those specifics. But what I can tell you is that there were only a small number of sand cars in the June 30 backlog and all of those have subsequently been delivered.

Matt Elkott

Got you. Perfect. Thank you very much guys.

Matt Kohnke

Thanks Matt.

Operator

We’ll now go to Michael Gallo with CL King. Please go ahead. Your line is open.

Michael Gallo

Hi, good morning. I was wondering if you could elaborate at all on where you stand on rectifying some of the production issues. I know you mentioned some of the cars are shipped in July. How many cars was that – were that shipped in July and are you fully through the production issues that you had or is it still more on that to go in the third quarter? Thanks.

Joe McNeely

I think Ted was just referencing some of the energy related covered hopper cars that were shipped in and we won’t get off specific kind of numbers but those are at – but in terms of the other production issues. What we had a combination of a number of factors none of which I'm satisfied with and happy with never getting aggressive in addressing those. But there was a vendor quality issues, there were vendor supply issues. There were some labor storage issues with some higher than expected turnover.

All of those we've taken a number of different steps to address those and to the point as Matt was talking on several things, we don't expect to see those going forward. Those things have been addressed. Now the introduction of new car types, as you start new car types you daily have some production efficiencies those we still do anticipate seeing some of those as we – there are some new car types we have yet to build and introduce.

Michael Gallo

Okay. Thank you. And then just a follow-up question, I know you mentioned the administrative office in Johnstown. I think you have a parts warehouse in Johnstown where the lease expires at year-end. Is that included in the $5 million cost plan or would that be separate? Thanks.

Joe McNeely

No, that's not. We – that facility – the parts facility is under lease and next week extending that lease for a period of time beyond that. So it's not part of the cost reduction.

Michael Gallo

Okay. Thank you.

Operator

Thank you. And our next question comes from the line of Matt Brooklier with Longbow Research. Please go ahead.

Matt Brooklier

Hey, thanks and good morning. So just a follow-up question to Joe your comment regarding the potential for further order cancellations and then having some conviction that were kind of through the worse at this point in time, I guess what gives you that conviction level that we shouldn't see a meaningful amount of order cancellations as the year progresses?

Ted Baun

Hey, Matt. It’s Ted. I'll take that one. We continue to have dialogue with our customers that are in our backlog and we’re seeing content with where they are right now.

Matt Brooklier

Okay. And then with respect to energy-related cars it sounds like that's a lesser amount of the backlog at this point in time at the end of 2Q?

Joe McNeely

It’s a fair statement. Yes.

Matt Brooklier

Okay. Bigger picture question. I'm just trying to get my arms around what you guys look like from a manufacturing footprint perspective than we know that coals been in a secular decline for some time now. I'm just trying to get a sense for if there is the potential for further rationalization of your coal manufacturing facilities right now, it seems like they're running in minimal levels and I realize one of them is I think shuttered at this point in time. But bigger picture longer term. What are your thoughts on you know shrinking what you look like on the coal side of things?

Joe McNeely

Yes. I think I will – the thoughts are pretty consistent with where we’ve been or Shoals’ plant panel, the most of our new product introductions. Danville rock primarily coal, but other cars types that are similar manufacture to those, Roanoke had a pretty good backlog at this point, Danville’s the one we significantly control operations that but we do have a small order that we're going to put in there at a roughly full pace of rest of the year. And Danville future and all our plans really have made order level that we get for the car types that we can produce.

Matt Brooklier

Okay. So it doesn't sound like imminent plans I mean you’re obviously doing some things on the cost side meaningful things on the cost side at this point is just it doesn't sound like there's going to be a change in terms of potentially maybe consolidating some of those facilities if that’s a possibility. And then my last questions we have the targeted $5 million of cost savings through some of the initiatives that you're doing. This is an addition to the USW settlement and then if it is can you just remind us of the cost from the settlement that you guys announced I think it was earlier this year?

Joe McNeely

Yes. The $5 million over and beyond that settlement that we've settled in the first quarter of this year the going costs were about $3.4 million of savings as a result of that settlement.

Matt Brooklier

Okay. So potentially you’d plus $8 million of run rate cost savings, as we look out over the next 12 months.

Joe McNeely

Correct.

Matt Brooklier

Okay. That's all I got. Thank you.

Joe McNeely

Thanks Matt.

Operator

Thank you. [Operator Instructions] We will now go to Mike Baudendistel with Stifel. Please go ahead.

Mike Baudendistel

Thank you. I just want to ask you on the employee reductions, where those employees unionized and if so is there anything in the union agreement that creates severance or other issues?

Joe McNeely

Michael, this is Joe. The employees, we talked about its reduction around the salary workforce, non-union.

Mike Baudendistel

Okay. And then I wanted to ask you on the cancellations you mentioned. It seems like you had more cancellations than your peers in the railcar manufacturing industry. Is there anything different about your backlog either few are the units in your backlog to leasing companies or anything there? And can you also say whether the 500 units that were cancelled this result of bankruptcy?

Joe McNeely

This is Joe. Let me – I’ll take that one. In terms of how we're different than those I don't know – because I don't know what's on the other backlog in the conversations that we’ve had. I’m not sure the information, we have there's a number of customers looking at certain car types. But we kind of report that – we report it I don't know what's in the other numbers. And we’re not going to comment on the detail behind the cancellations.

Mike Baudendistel

Okay. And then significant portion of your backlog is for rebuilds clearly the newly build railcars can you just tell us what you expect the ASP is on rebuild cars and then maybe just order of magnitude I know you don't give the absolute numbers is it two-thirds or is it just where is it?

Joe McNeely

Michael, this is Joe. I think the rebuilt numbers are actually pretty small in the backlog now there is only a 227 of the total. So in those – rebuilt definitely less from an ASP than a new car cost in this particular order they know it varies, but this particular order it probably around a half of what a new car would cost.

Mike Baudendistel

Okay, great. That's all I have. Thank you.

Joe McNeely

Okay.

Operator

Thank you. And we do have a follow-up from Michael Gallo with CL King. Please go ahead.

Michael Gallo

Just a follow-up question, I wasn’t sure if I heard you right, at this point do you not have any frac sand cars remaining in the backlog or is it they’re mostly out of the backlog or is that….

Ted Baun

Hey, Michael, it’s Ted. You did hear that correctly, at the end of the quarter we had a handful of sand cars. And they are now subsequently been delivered.

Michael Gallo

Thank you very much.

Operator

At this time, there are no other questions in the queue. Please continue.

Joe McNeely

This concludes today's conference call. Thank you for joining. A replay of this call will be available beginning at 1 p.m. Eastern Time today at 1-800-475-6701, passcode, 398562. See you next quarter.

Operator

And that does concludes your conference for today. We thank you for your participation and for using AT&T's Executive Teleconference Services. You may now disconnect.

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