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American Railcar Industries, Inc. (NASDAQ:ARII)

Q1 2008 Earnings Call

May 8, 2008 10:00 am ET

Executives

James J. Unger – President, Chief Executive Officer & Director

James A. Cowen – Chief Operating Officer & Executive Vice President

William P. Benac – Chief Financial Officer, Senior Vice President & Treasurer

Analysts

Peter Nesvold – Bear Stearns

Steve Barger – KeyBanc Capital Markets

C. Todd Maiden – BB&T Capital Markets

Operator

Welcome to the Q1 2008 American Railcar Industries, Inc. earnings conference call. (Operator Instructions) I would now like to turn the call over to Jim Unger, President and CEO.

James J. Unger

I’d like to welcome all of those on the call as well as our audio webcast listeners today. For all of those who are interested a replay of this broadcast will also be available on our website www.AmericanRailcar.com beginning shortly after this call ends. I’m Jim Unger, the Chief Executive Officer of American Railcar and with me this morning is Jim Cowan, our Chief Operating Officer and Bill Benac, our Chief Financial Officer.

We will open the call today with a brief prepared statement related to the company’s 2008 first quarter financial results. After that we will make a few comments on the status of our operations, update you on the progress of our capital program and comment on other events important to ARI. Following these remarks we will open the conference to your questions.

Bill, will you begin the conference with the review of the financial results for the quarter.

William P. Benac

I’m pleased to present our 2008 first quarter financial results. Before we get started, let me remind everyone that today’s conference 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 of the 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.

We are pleased with our financial results for the first quarter of 2008. Many of the strategic initiatives we have been working on for years are reflected in and have contributed to our financial results. After I discuss the company’s financial trends, Jim Cowen will discuss the operations themselves. Consolidated revenues were $184 million for the first quarter, up 14% or $22 million from the fourth quarter 2007 but down about 2% from the first quarter of last year when the hopper railcar market was much stronger than it is today. ARI’s strengths in tank railcar deliveries and railcar services offset much of the effect on ARI of the industry wide weakness in the hopper railcar sector.

During the first quarter of 2008 we shipped tank railcars from our existing tank railcar plant to our new flexible railcar manufacturing plant we recently completed in Marmaduke, Arkansas and also from our tank railcar manufacturing agreement with ACF Industries. In total, ARI manufacturing revenues were up 14% when compared with the fourth quarter of 2007 but reflected a 3% decline from the first quarter of last year. ARI delivered a total of 1,902 railcars in the first quarter of 2008, a 20% increase from the 1,590 railcars delivered in the fourth quarter of 2007. While we do not detail the mix of cars we ship each quarter we can say that we significantly increased the number of tank railcars that we shipped in the first quarter of 2008 when compared to the fourth quarter and the first quarter of 2007 when we shipped a total of 1,921.

At the same time we increased tank railcar deliveries, we also experienced continued growth in our railcar services business. Revenues from this counter cyclical business increased 11% when compared to the fourth quarter of 2007 and 9% when compared to the first quarter of last year. As we have said before, we are devoting increased attention to growing this important business as we complete some of the expansion and vertical integration projects we have had underway on the manufacturing side of the business. During 2008, we are allocating a significant portion of our planned capital expenditures to the railcar services segment.

ARI’s gross profit increased sequentially by $2.9 million or 15% when compared to last quarter. Manufacturing gross profit increased $2.6 million or 15.2% and railcar services gross profit increased by $251,000 or 11.7% when compared with the fourth quarter of 2007. When compared to the first quarter of 2007, our gross profit on services increased by $105,000 or 4.6%. However, the gross profit on our manufacturing business declined by $5.8 million or 22.6% when compared to the same quarter a year ago. This year-over-year decline in manufacturing gross margins is attributed to the same hopper railcar dynamics I mentioned earlier.

Our net earnings attributable to common shareholders for the quarter were $10.1 million or $0.48 per diluted share, a gain of $2.3 million or $0.11 per fully diluted share when compared to the fourth quarter of 2007. Net earnings during the current quarter were increased by an after tax unrealized gain of $1.9 million or $0.09 per share attributed to our investment in derivative securities that referenced the Greenbrier Company’s common stock. Net earnings and earnings per share both declined when compared to the first quarter of 2007 when we reported net earnings attributable to common shareholders of $13.5 million or $0.64 per diluted share.

By way of explanation, our direct investment in Greenbrier stock is accounted for as a short term investment available for sale securities. Any gains or losses on that investment go through comprehensive income and directly to our balance sheet, they are not reported on our quarterly income statement. Conversely, any gains or losses on our investment in derivative securities that reference Greenbrier stock are reported on our quarterly income statement as other income. In the first quarter the total other income related to our derivative securities was $3.1 million on a pre-tax basis, or $0.09 per share. Other income related to this invested will fluctuate from quarter-to-quarter based on the closing price of the referenced stock.

EBITDA for the quarter was $23.6 million as compared to $16.9 million and $24.9 million respectively for the fourth and first quarters of 2007. EBITDA in the first quarter of 2008 includes the $3.1 million unrealized gain on derivative securities that I just explained. The increase in EBITDA compared to the fourth quarter 2007 was attributable primarily to increased tank railcar shipments while the decrease in EBITDA when compared to the first quarter of 2007 was driven by lower shipments and selling prices for hopper railcars during 2008 which were only partially offset by increased tank railcar shipments as well as increased labor efficiencies and lower manufacturing overheads. EBITDA is a non-GAAP financial measure that is reconciled to our net earnings in our press release which was issued yesterday. The press release is also available through the investor relations page of our website.

Let me now turn the time over to Jim Cowen, our Chief Operating Officer to comment about the status of our plant operations.

James A. Cowen

The management team is excited for the future of our Marmaduke railcar manufacturing complex as the construction phase on the new plant has been completed, new railcar assembly has begun and the cost structure is better than we expected. The newly completed expansion is producing tank railcars but with its flexible design it is also capable of producing other railcar types. Production at the new plant will continue to ramp up during the remaining months of 2008.

As Bill previously mentioned, shipments from our Paragould Hopper railcar facility were lower in 2008 compared to 2007 for the quarter due to a soft market for hopper railcars and increased competition within that market. This also drove down selling prices for hopper railcars shipped during the first quarter of 2008. Our management team has done an excellent job of managing our costs and improving efficiencies during this period of low volume. We also had good performance from our other manufacturing locations. We continue to grow these businesses by diversifying the customer base to include the energy sector, large off road equipment OEMs, railroads and various smaller manufacturers.

We are pleased with our manufacturing and repair plan operations for the first quarter of 2008 in light of current market conditions. We have a number of capital projects that we expect to complete in 2008 that should improve manufacturing efficiencies and provide other cost reductions.

We continue to make good progress to further integrate our supply chain by investing in equipment to in source key component manufacturing. One such project, which was completed in the first quarter of 2008 is our wheel and axle assembly shop in Paragould, Arkansas. This facility should provide significant cost savings through production efficiencies and freight cost reductions as well as reduced inventory levels.

Construction on the axle manufacturing plant being built by our joint venture Axis, LLC is currently underway and is expected to be completed and producing axles during the fourth quarter of 2008. We are excited about the cost savings forecast for this joint venture resulting in lower costs for a major component that we use for all of our railcars.

At this time, let me turn the meeting back to Jim Unger, our CEO to make a few comments on our capital plan and other events at ARI.

James J. Unger

We had a strong first quarter in spite of the tough hopper railcar market. Our railcar backlog declined during the first quarter but remains strong and at March 31, 2008 was at 10,077 railcars or $833 million. To support our current business and to grow for the future, we continue to invest in the company. During the first quarter of 2008 we invested $15 million toward capital projects to expand capacity, reduce costs and improve efficiencies. This included funding for both the new plant at Marmaduke and the new wheel and axle assembly shop that Jim mentioned earlier.

Other major projects currently underway include a tank head production facility at our Marmaduke Arkansas tank railcar facility which we expect to be completed and operational during the second quarter of 2008. Our investment in Axis joint venture that Jim mentioned, and the vertical integration of our parts and fabrication abilities. We also expect to fund significant growth in our repair network this year.

We are well advanced in efforts to develop a joint venture with Amtek Industries, a highly regarded Indian company to manufacture and sell freight railcars and their components in India and other Southeast Asian countries. Assuming the joint venture is finalized in the first half of 2008, we estimate that construction of a facility in India could begin later this year and production could begin in 2009.

Our management team has also invested considerable time and effort in developing relations and investigating similar joint ventures in both the Ukraine and Russia. We believe that a good market exists for freight railcars in these countries and we expect to further investigate potential joint venture opportunities in the Ukraine.

We will now take a few of your questions. Operator, would you please explain to our guests how they can register your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Peter Nesvold – Bear Stearns.

Peter Nesvold – Bear Stearns

Can you spend just a couple of minutes talking about materials and how you’re handling that right now? What percentage of your production right now is getting full pass throughs? Are you hedging, etc.?

James J. Unger

A good percentage, a majority of all our production is getting pass throughs. We have no contracts beyond 2008 that’s firm pricing but we do have a few production orders that have some firm pricing but we have hedged in the steel prices on those so we feel we are protected Peter.

Peter Nesvold – Bear Stearns

When you look at the order book for the last three quarters it’s in cumulative only about 800 railcars and I actually had to go back to about third quarter 06 before I see a book-to-bill that’s north of one. What should I be looking for, time expectations or some event or does it just all come down to railcar loadings? When do you think we can start see that book-to-bill start to grow again?

James J. Unger

I think you’ll see it start to grow when we see an uptick in this economy and the shippers as well as the leasing companies begin to invest in new railcars. We are projecting sometime late third quarter for that to occur. But, we’re not real anxious to book orders at low margins right now as we’ve got a nice backlog.

Peter Nesvold – Bear Stearns

So it really just comes down to freight, right?

James J. Unger

Yes.

Peter Nesvold – Bear Stearns

And if CIT does sell off its railcar leased assets, is there anything in the backlog today that’s from CIT? And, what impact would that have to the business?

James J. Unger

A good part of our backlog is with CIT but those are firm orders so we’d expect if they were to sell off or joint venture with somebody it would probably be with a financial institution, another leasing company that we do business with so it should have very little, if any, impact on our business.

Peter Nesvold – Bear Stearns

Then just a couple of quick questions on GBX. You said in the prepared comments and I think in the release too that you have some derivative ownership now which I believe is new or incremental information. When you factor in the derivatives, what percent do you control of the equity of GBX currently?

James J. Unger

First of all Peter, that is not new news, that’s part of the original position. I think that was referenced in the original 13D. But, the derivative securities have no voting control or no direct interest in Greenbrier whatsoever. That is a security that was put in place, it gives us control over the economic value of 400,000 shares of Greenbrier stock. Direct investment is a little over $1.5 million shares.

Peter Nesvold – Bear Stearns

But, if there’s no voting control why are you doing this? You picked up the ownership in January, you bought it well, there’s no doubt but here we are in May and nothing has really changed in terms of the ownership. And, if part of this ownership isn’t even voting rights, it’s hard to understand how do you benefit other than just GBX stock going up?

James J. Unger

That’s a significant benefit. As we said in the 13D we felt that Greenbrier’s shares were undervalued, we felt that it was a good time to make an investment. You’ll see on our P&L this quarter a $3.1 million gain that relates directly to that so we think it was a pretty good decision. It was not part of the control decision that we made, it was an economic decision. We’ve got well over $300 million in cash available to us and we can put it in the bank at 2%, or we can earn $3 million in a quarter on it.

Peter Nesvold – Bear Stearns

I don’t want to [inaudible] but it almost sounds like it’s a little bit more of a cash management strategy than anything else because your internal operations are clearly better than anyone else out there. It would seem that you have a lot of cap ex initiatives internally in order to deploy that capital. But, if I’m understanding you correctly, much of this is just about how do you manage that cash given that a lot of that was funded through a high yield offering which isn’t necessarily cheap paper.

James J. Unger

Pete, that was an economic decision. As we said, we felt the Greenbrier stock was undervalued, apparently a lot of other people in the stock market agreed with us and as we looked at strategic possibilities with Greenbrier it made sense that we would have control of some of the additional portion of the economic value of that investment. It was just purely an economic decision on the derivatives side.

Peter Nesvold – Bear Stearns

Last question and then I’ll jump out, do you still intend to explore or are interested in business combination discussions? I think those were, loosely speaking, the words that were originally in the filing back in January? Or, is this now more just a passive investment?

James J. Unger

We are continuing to have discussions as we’ve disclosed Peter and that’s about all we can say.

Operator

Your next question comes from Steve Barger – KeyBanc Capital Markets.

Steve Barger – KeyBanc Capital Markets

I’d like to talk about ethanol. I don’t know if you can give us a sense for the percentage of your backlog that’s related strictly to ethanol cars on the tank side?

James A. Cowen

I haven’t really added the numbers up but I’m going to say probably of the tank cars to be built probably 45% to 55% is maybe ethanol related.

Steve Barger – KeyBanc Capital Markets

And I’m sure you’ve seen the articles in the paper about ethanol mandates becoming less popular with environmentalists and even some in congress. How do you or your customers see that playing out?

James A. Cowen

Well, as far as we’re concerned, our tank car facilities are very flexible facilities. We produce the whole variety of tank cars not just for ethanol but the more complex tank cars to haul chemicals and foods and oils and we are shifting some of that production as demand changes to those other commodity type cars.

Steve Barger – KeyBanc Capital Markets

Have you seen a slowdown in ethanol plant construction or maybe a delay in the desire for delivery from some of the ethanol customers as they wait to see how this plays out?

James A. Cowen

We’ve seen some delay in construction and as it reflects on deliveries, there is a little push back on deliveries. But, we’ve been able to shift ethanol cars in to other tank car types.

Steve Barger – KeyBanc Capital Markets

In terms of the 9% increase in the parts and service side of the business, can you break that out as to price versus volume?

William P. Benac

That’s a complicated question. There’s a tremendous variety of car mix in these repair shops as you have wrecks and HM201 testing and various other things. I just don’t have that breakdown right now.

Steve Barger – KeyBanc Capital Markets

It’s interesting the JV news for India, Russia and the Ukraine and I know it’s really early in the process but do you have a sense for what the size of the market opportunity could be as you pursue those ventures?

James J. Unger

Initially, it’s a small market however we expect to expand in those countries as those countries continue to grow. India is suppose to, by all forecasts, be the third major economic or largest country in the world as far as economic growth in the next few years behind China and behind the US. So, we expect to expand with that economy over there. We are looking at acquiring significant acreage, we are well underway with our talks. We’ve spent a lot of time over there, we’ve had engineers over there, capital facilities people and we expect that to really help us grow in the future.

The United States, you look at the rail systems here and the infrastructure, as GDP grows, the rail systems grow. The rails have taken some traffic away from the trucks so there’s some growth there and when you talk ethanol and coal markets we see growth there. But the real growth expansion for a company like ours we feel is to participate in these third world countries where we see dramatic growth in the future. But, I caution you, it will be slow.

Steve Barger – KeyBanc Capital Markets

Are there no incumbent or high quality legacy producers in India or Russia? Is it just wide open for bringing in US style tank cars?

James J. Unger

We think it’s pretty much wide open but it takes some intestinal fortitude to deal with the people in those countries and we fell we’ve got the resources, the people here that can deal with the people and forge forward on successful joint ventures.

Operator

Your next question comes from C. Todd Maiden – BB&T Capital Markets.

C. Todd Maiden – BB&T Capital Markets

I was wondering if you could give us a little bit of color, the overall pricing environment, I know it’s been at least to say tough in the current hopper arena but more on the tank card side what you see now and what you expect going forward as we see ethanol now as it is today might not be the case a year or two from now as far as the components involved in final ethanol production. I’m just curious to see what you think the tank car pricing [inaudible] ethanol and chemical related is going to look like maybe a couple of quarters down the road and then maybe two, three years out.

James J. Unger

Well, if the economy stays soft pricing will come under pressure in those markets as well, in the tank car markets. But, if the economy picks up and the backlogs push out and production spaces become less available, pricing will hold up. But, if the economy were to stay where it is for the next three to four quarters we’d expect to see pressure on future orders on tank car margins to decrease.

C. Todd Maiden – BB&T Capital Markets

Then while we’re talking about tank cars, the proposed legislation that’s out there for tank cars carrying the more noxious chemicals to have to be able to withstand higher impact speeds, I think some of the initial estimates are that this would apply to about 15,000 tank cars. What’s your feel on that? Do you think that number is wrong, or do you think it’s going to be impacting probably more of the fleet that’s out there?

James J. Unger

Well, initially it’s 15,000 cars. However, this is just the tip of the iceberg. When you get in to other commodities and the FRA get’s there way [AAR] gets their way with these, we fell that it’s going to affect other cars and it could reach upwards to 25 to 40,000 cars depending on the commodities they target next.

C. Todd Maiden – BB&T Capital Markets

So you’re saying commodities other than chemicals?

James J. Unger

Other than these hazardous chemicals and hydroxonium and chlorine in particular.

C. Todd Maiden – BB&T Capital Markets

But still chemicals, you’re thinking chemicals, this wouldn’t lead to other commodities?

James J. Unger

No, general chemicals where they are classified as hazardous.

Operator

Your last question is a follow-up from Steve Barger – KeyBanc Capital Markets.

Steve Barger – KeyBanc Capital Markets

I just wanted to ask a question about the ramp up at the Marmaduke facility. Can you tell me where you are in terms of capacity there?

James A. Cowen

We’ve got about a 40% capacity clip right now as through of course, the month of April and we hope to finish up by the end of summer to be at a full 10 car per day production.

Operator

There are no further questions at this time.

James J. Unger

Overall, I’m very pleased with the progress ARI and its dedicated employees have made on a number of operational and strategic fronts in the US and elsewhere and that many of these efforts are positively reflected in our operating results. We believe that ARI is well positioned to take advantage of current and future opportunities in our industry and we have both the management and capital resources to do so. Thank you.

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