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The Greenbrier Companies (NYSE:GBX)

F3Q08 Earnings Call

July 8, 2008, 11:00 am ET

Executives

William A. Furman – President, Chief Executive Officer

Mark J. Rittenbaum – Executive Vice President, Chief Financial Officer, Treasurer

Analysts

J. B. Groh, CFA – D. A. Davidson and Company

Paul Bodnar – Longbow Research

Frank Magdlen – The Robins Group

Wendy Caplan – Wachovia Securities

Jim Laventhol – Laventhol and Company

Joe Radigan – Keybanc Capital Markets

Joseph Ciampi – Southpaw Asset Management

Ryan Keeley – Keeley Asset Management

Mulan Von Redden – Happy Capital

Logan Stevens – Morgan Keenan & Company, Inc.

Todd Maden – BB&T Capital Markets

Christopher Beard – Symphony

Operator

Hello, and welcome to The Greenbrier Companies’ third quarter of fiscal year 2008 earnings release conference call. Following today’s presentation we will conduct a question and answer session. Until that time, all lines will be in a listen-only mode. At the request of Greenbrier Companies, this conference is being recorded for instant replay purposes.

At this time I would like to turn the conference over to Mr. Mark Rittenbaum, Executive Vice President, Chief Financial Officer, and Treasurer. Mr. Rittenbaum, you may begin.

Mark J. Rittenbaum

Good morning and welcome to our fiscal third quarter conference call. After we review our results and make a few remarks about the quarter that just ended we’ll provide an outlook for 2008 and beyond, and then we’ll open up for your questions.

As always, matters discussed in this conference call include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Throughout the discussion today we will describe some of the important factors that could cause Greenbrier’s actual results in 2008 and beyond to differ materially from those expressed in the forward-looking statement made by or on behalf of Greenbrier.

Today we reported our third quarter fiscal results. Our GAAP net earnings were $0.49 per share on revenues of $382.1 million compared to net earnings of $0.81 per share on revenues of $386.6 million in the third quarter of 2007.

We remain very liquid as we’re in the process of amending one of our loan agreements and we’ll have $160 million of additional borrowing capacity under the various terms and financial covenants once this amendment is completed.

Our refurbishment and parts, leasing, and services in marine businesses continue to perform well and we anticipate this momentum will sustain. Including our recent acquisitions, these businesses are expected to generate over $770 million in annual revenues on a current run-rate basis, exceeding those generated by new rail car manufacturing in North America and Europe.

The increased contribution from our refurbishment of parts and leasing and services businesses improved overall gross margins by $14 million sequentially over the second quarter of 2008. The strong performance of these business units offset a sequential decline of $4 million in manufacturing margins, which results from the increasingly competitive new rail car environment and rising raw material costs.

Focusing specifically on the refurbishment and parts segments, we have made two acquisitions this year on top of the two we made last year and are extremely pleased with the performance thus far. Revenue from this segment now earned a run-rate which exceeds $600 million per year. In addition, margins continued to expand and reached 21% during the third quarter. This segment has benefitted from higher scrap prices, which provides a natural hedge to rising raw material costs in the new rail car manufacturing. We anticipate growth for this business will continue and believe that margins in the upper teens are sustainable.

The leasing and services segment includes results from our own lease fleet of 9,000 rail cars and managed fleet of 138,000 cars. Lease fleet utilization for the quarter was 96.1% compared to 97% last quarter. The current quarter includes $5 million in gains on equipment sales, flat with the gains realized in Q3 of 2007 and compared to $1.2 million in Q2 of 2008.

As we have previously stated, equipment fails are hard to forecast as they are opportunistic in nature. Recently we have been taking advantage of high scrap steel prices by scrapping some of our older rail cars rather than keeping them in leasing service. The remaining fleet has also benefitted from increases in steel pricing through higher residual values.

When you pull out gains on equipment sales, our margins for this segment were 46.7% of revenues this quarter, similar to the margin for the last two quarters.

Turning to remanufacturing, we booked four additional barge orders during the quarter and our backlog grew to 158 million. Annual revenues for this operation exceed $60 million and, again, we anticipate continued growth in this sector and the outlook is bright. Furthermore, our entire marine backlog allows for pass through of material cost increases to our customers.

New rail car deliveries for the quarter were 2,200 units compared to 3,000 units in the third quarter of 2007. Our backlog as of the quarter end was 17,500 units and we expect to deliver 1,400 of these units in the fourth quarter of this fiscal year based on current production plans.

We made progress during the quarter at our Mexican joint venture, our Greenbrier-GIMSA operations with improved efficiencies and financial results.

Manufacturing margin for the quarter continued to be pressured by rising steel prices and surcharges, lower production rates, and a loss reserve on certain future production and backlog. In the near term, we believe these forces along with an extremely competitive market and softer demand will continue to put manufacturing margins under stress.

About one-third of our current backlog contains fixed price contracts. Due to rising raw material costs, the current estimated cost to complete some of these fixed price contracts is expected to exceed the contractual sales price. In response, we’ve accrued $5.3 million during the quarter for estimated loss contingencies on a portion of these contracts. There are about 1,000 fixed price rail cars in our backlog for which the anticipated loss is not yet estimable and a loss contingency has not yet been approved. We are aggressively working to mitigate all these exposures on various fronts that we’ll further address later on and are working very diligently to mitigate or reduce these exposures.

Our selling and administrative expenses increased $2.4 million sequentially from the second quarter of 2008, but this doesn’t really tell the story that there are a number of things going on in that increase and we’re aggressively working to cut our overhead in G&A costs in the current environment. A number of factors included in the noise during the quarter include: there’s $1.3 million as severance costs related to cost-reduction initiatives; a $0.7 million increase in professional fees related to strategic initiatives which should discontinue after this quarter; $0.6 million of integration costs and increase G&A related to our two acquisitions during the quarter; and $0.8 million increase in incentive compensation related to higher earnings. So we anticipate a sequential reduction in these costs in our fiscal fourth quarter and again are working to reduce these costs overall.

Last quarter we mentioned that we expected the tax rate to run about 63% for 2008. We have implemented strategies to more efficiently manage our tax rate in different geographic jurisdictions and have made significant progress during the quarter as our tax rate was 50%. We expect a slightly lower rate in Q4.

Looking ahead, D&A expense should run $35 million. Manufacturing capex should run about $30 million, but again this is primarily related to our planned expansion in Mexico for which our partner picks up half of the expenditure. We are not doing much manufacturing capex beyond that in Mexico. Our refurbishment and parts capex runs about $10 million, and again most of that is discretionary capex. And our leasing capex this year is about $30 million to $35 million on a net basis.

As I mentioned earlier, we remain very liquid and expect to have the $160 million of additional borrowing capacity based on our financial ratios. During the quarter we completed a $50 million leasing term loan on very favourable terms.

Our near term financial focus remains on cost reductions consistent with the current macro-economic trends, paying down post-acquisition debt, and strategies to continue to reduce our effective tax rate.

While the current operating environment is challenging, we remain optimistic about the long-term fundamentals of the rail industry and we believe we are well positioned, both in the near and long-term, to successfully compete as a result of our strategic decisions.

I will now turn it over to Bill Furman, our CEO, and then we’ll open it up for your questions.

William A. Furman

Thank you, Mark. As Mark has indicated in the press release, demonstrates our financial reports, our results have improved considerably this quarter. We are pleased about that. This is due mainly to increased momentum and volume margins in our refurbishment and parts segment, but is also supported by a strong leasing and marine manufacturing set of fundamentals and increasing marine backlog.

Consistent with our diversification objectives over the past two years and the goals of our integrated business model, the revenue and margins from these areas should continue to shift away from manufacturing during the present, more economic, more difficult economic environment.

Manufacturing for new cars on a stand-alone basis we believe will continue to be a very difficult business in which to make money in the near term. However, it fits in well with our integrated model and it gives the company considerable upside in more normalized economic times.

During the past several years the demand for new rail car manufacturing is relatively robust. But this business has always been cyclical. Moreover, it has commodity aspects to it in the current climate with strong customers consolidating supply chain and a large number of car builders creating overcapacity during economic down cycles and times of uncertainty as we are certainly operating in today.

Manufacturing, however, can be very valuable during the more normal economic times and in the present economic environment it also creates value for Greenbrier as a platform for other businesses and services. The primary advantages for that platform are in engineering, design capability, and mechanical knowhow. Greenbrier has been diversifying its business to take advantage of this platform and will continue to do so.

In the past two years we’ve made major acquisitions of repair and parts businesses, all with good franchise value and complementary geographical networks. We have enhanced our repair and parts segment through acquisition of favourable pricing multiples and these businesses, in combination with the rest of our network of products and services, should significantly outperform and balance our manufacturing segment during the current economic period of uncertainty.

The reason for this is that railroad traffic, especially in many commodities, continues to be robust. The competitive case for railroading versus other modes of transportation, along with marine, remains very robust. Velocity has improved in the railroad system, and freight cars in service are working harder and they’re still aging. With high steel prices it is difficult for railroads to justify replacement with costs of new equipment today and existing equipment compares very favourably to the cost of new builds due to the cost of steel and components and scrap surcharges. Accordingly, the need to repair and extend the life of rail cars and to replace parts should continue, in our opinion, to be very strong.

Our diversified business areas include not only refurbishment in parts, but leasing management services as well as the thriving marine business, all supported by the technology of our engineering and design teams in the manufacturing units and all favoured by the many of the same forces that are making manufacturing less attractive in the present environment.

As we integrate the addition story network and we add even better value enhancements throughout organic growth we should continue to see the benefits of this strategy as we have in the numbers reported in the quarter just ended.

I want to summarize, although Mark has touched on many of these, a few of the operational strategic highlights from the quarter just ended. As Mark just mentioned, we closed on two previously announced refurbishment and parts acquisitions with annual revenues of $100 million and EBIDTA of approximately $16 million on a run-rate basis.

We received significant marine barge orders increasing our marine backlog to a record $158 million. All of our barge backlog contains pass through provisions for cost increases on steel and other commodity inputs. Our marine backlog is indexed to protect us in the event specifically of further steel pricing variations.

Our GIMSA manufacturing facility in Mexico made efficiency improvements and should prove to be a very cost-efficient facility along with our other facility in Mexico at Concarril. However, in the present environment even these low-cost facilities are struggling with the pricing and commodity cost issues besetting most manufacturing companies today.

Another important point is we added extensive review of the merits of a possible business combination with a respected manufacturing competitor, also a partner in some parts businesses controlled by investor Carl Icahn, following an investment in Greenbrier by Mr. Icahn and his affiliated companies. Our financial results during the quarter reflected the costs associated with that process, as well as the distractions such evaluations always involve. I’ll comment briefly on that a little along in my remarks.

We improved our reported tax rate, as Mark has also suggested, and we continue to work on our foreign income and losses through restructuring and other means, which will continue, we hope, to affect the tax rate favourable.

Finally we produced true financial results despite absorbing unexpected losses on steel and scrap surcharges of $5.3 million. We continue to actively manage our exposure in this area, which is due largely to multi-year transactions which had fixed pricing components year to year. We were forced to fix the prices during the current year and were caught in the process of that by some significant price increases which were not expected in steel, as others have.

We also absorbed some declining margins in our European operations due to a lapse in currency hedging and exposure to the Polish zloty, some of which was also absorbed in the earlier quarter. We have a policy to hedge against such risks, unfortunately the zloty moved unexpectedly against the Euro and we have had other issues with significant contracts in Europe. We’ve been working this quarter to revise our strategic plan in Europe and we continue to work on that during the quarters to come.

Looking at the competitive landscape, notwithstanding the current economic uncertainties, we believe that rail and marine will continue to prepare favourably to other modes of transportation, especially in the current economic environment. The current fundamentals of high gas prices, highway congestion, environmental impacts of trucking, deteriorating infrastructure, along with the weak dollar should be very favourable to rail and marine in the longer term, particularly for the transport of specific commodities.

Greenbrier’s manufacturing operations have been particularly affected by the downturn in the housing market and by a softening of the international import demand, which has affected intermodal loadings. However, intermodal over the longer term is expected to continue to be a backbone of the economic system and we believe, as the economy normalizes and returns to a more prosperous time in the years ahead, that the company will therefore have a great deal of upside by maintaining a manufacturing platform.

Considering the company’s merits in some of the changes that we have made, our strategy, and the integrated business model, we believe we are well positioned to deliver shareholder value across the business cycles and we believe we have a competitive advantage over other car builders who are pure car buildings plays.

We recognize we must deliver on the promise and the opportunities of the changes we have made over the past few years at Greenbrier, particularly in the areas of integration and cost cutting, as Mark also mentioned. And we are dedicated, as our board is dedicated, to achieving that goal.

Looking at M&A specifically, our investments in the refurbish and parts business have transformed the company considerably over the last two years. These investments have not only been timely, but profitable. We’ve grown this business in parts and repair and refurbishment from about $100 million in revenues in 2005 to a run-rate of over $600 million annual revenues at the current time. This growth has occurred both organically and through strategic acquisitions, although more heavily balanced on the strategic acquisition front and most notably with American Allied and RBI during the quarter, in addition to the Rail Car America and Meridian Rail Holdings, both in 2006.

We now have the largest independent shop network in North America with 39 locations to provide our customers seamless, high quality service in close proximity to our shop network and quick turnaround times. This network can also be used as a platform to distribute parts and to enter other businesses that lend themselves to a retail location which would take advantage of some of the current economic environment, particularly in salvaging assets and increasing scrap yield from our normal operations.

While we are integrating our recent acquisitions we also remain focused on continuing to grow this business, particularly in organic ways. This quarter we plan to add another shop to our network with a class one railroad providing a baseline business. A base loaded business. I’m sorry.

In addition, our parts businesses provide exciting other growth opportunities. We currently sell approximately 15 different rail car parts for a variety of rail cars and we import through our global sourcing network as many as 50 different parts and sub-assemblies for the use of our own businesses.

I want to talk briefly only now about two things: one, commodity prices, and the conclusion of our recent conversations with American Rail Car Industries. One of the key factors facing all manufacturers today is commodity pricing and the uncertainties surrounding that pricing caused by surging global demand, supply constraints, and the weakening US dollar. Currently we are facing the dual effects of not only a weak demand for rail cars, but high input costs in the manufacturing segment, and we are not alone.

We are managing this aggressively and in the past this would have had a very significant adverse effect on our business. Today, however, the effect is muted in large part to our diversification efforts described earlier and in our public documents. these efforts have provided a natural inflation hedge and commodity hedge to not only weaker demand for new rail cars but also rising input costs having to do with commodity increases as we salvage parts and other pieces from rail cars which we process through our shop network.

While the new rail car market remains soft, we will have our GE covered hopper car and tank car contract beginning in 2009 and we are protected on this contract with pass through of steel cost increases.

Finally, I want to turn to the conclusion of our discussion with American Rail Car Industries. As I’ve said before, this is a very well respected company. A company we’ve done business with and have an active joint venture with, along with another supplier in the industry. In the castings business. Ultimately we determined in congenial discussions with Mr. Icahn’s organization and with him that we could not come to an agreement favoured both parties. His focus, I’m sure, and our focus, for sure, was on a business case that made good sense for our shareholders. In this particular arrangement we were unable to come to mutually beneficial terms in which we believed and our board believed would achieve that goal.

With our business model and identified market opportunities we feel that we are well positioned to take advantage of the current economic climate. We’ve worked hard to do that. And in a way we would be doubling down in a manufacturing segment by merging in the rail car manufacturing business today. Nonetheless, there were compelling structural reasons for considering an opportunity of that sort. We remain open to considering ways of improving shareholder value and we were flattered by Mr. Icahn’s interest in Greenbrier. We’re pleased that investment worked out well for him.

Before I turn the call over to the operator for question and answer, I’d like to say that I’m pleased with how our business model has played out. We have much to do and particularly we have a lot of work to do in integration and recognizing the market potential in the franchise network we’ve now established.

We need to produce more tangible reductions in our G&A costs and to adapt to the changing economic environment that all of us face today. Our board and our team are dedicated to doing the hard work to make that happen and we hope that we can continue to produce better results as the next year plays out.

With that I’ll turn the mic back to Mark.

Mark J. Rittenbaum

Thank you, Bill. Operator, we’ll go ahead and open it up for questions now.

Question-and-Answer Session

Operator

Thank you very much. We’ll now begin the question and answer session. (Operator Instructions). One moment, please, for the first question.

Our first question then is from Frank Magdlen with The Robins Group. Your line is open.

Frank Magdlen – The Robins Group

Good morning, Bill.

William A. Furman

Good morning, Frank. How are you doing today?

Frank Magdlen – The Robins Group

I’m fine, I think. Can you go over the loss contingency a little bit more? You have 1,000 cars. Is that for delivery this year or next year?

William A. Furman

I’m going to let Mark address that.

Mark J. Rittenbaum

Right. So Frank, as you’ll recall, we did have $5.3 million accrual this quarter and we also noted that there’s 1,000 cars in backlog for which we believe there could be a loss for which we had not yet accrued that loss since it’s not estimable. Most of that production would be in fiscal 2009. Some that production would take place in our fiscal fourth quarter.

Frank Magdlen – The Robins Group

Now, when you accrued it, does that mean that it went through this quarter’s P&L or is it sitting on the balance sheet?

Mark J. Rittenbaum

No. Included in cost of sales is $5.3 million of loss contingencies on production that would take place in future quarters. So that did hit the P&L through cost of sales.

Frank Magdlen – The Robins Group

Third quarter and some more to come.

Mark J. Rittenbaum

Correct.

Frank Magdlen – The Robins Group

Okay. And then could you tell us how many barges are in total backlog and what marine revenue was or deliveries in the quarter?

William A. Furman

Let me come back to that, Frank, as to the number of barges. If you can just give me....

Frank Magdlen – The Robins Group

I’d be happy to. Are you willing at this time to give us a figure as to what the confirmed backlog is for 2009?

Mark J. Rittenbaum

Are you talking about barge backlog?

Frank Magdlen – The Robins Group

No. Rail car.

Mark J. Rittenbaum

On rail cars.

Frank Magdlen – The Robins Group

Or both. I’ll take both.

William A. Furman

Well, in answer to your barge question, Frank, there’s 13 barges in backlog when we, in answer to your question on how many were delivered. We account for these on a percentage of completion method, but it’s roughly one plus type, one plus barges that are reflected in the revenue figures. So one complete barge and a partial barge that would be reflected in the revenue figure for the quarter.

As far as deliveries of rail cars in 2009, we have not broken that out yet. That would in part depend on production plans. But we haven’t broken out the backlog for them in the press release.

Frank Magdlen – The Robins Group

All right. I’ll jump back in cue. Thank you.

Operator

Our next question is from J. B. Groh with D. A. Davidson. Your line is open.

J. B. Groh, CFA – D. A. Davidson and Company

Morning, guys. I just wanted to get a little more detail on Frank’s question on this $5 million plus or minus accrual. You said you have 1,000 cars where you don’t know what the number’s going to be. How do we look at the $5 million in terms of how many cars does that represent? You said you had some material price protection on some. I’m just trying to get a feel for how big the potential could be. Is that $5 million the whole enchilada ex the 1,000 or how should we look at that?

Mark J. Rittenbaum

So the $5.3 million that we accrued this quarter is roughly on 900 rail cars that are in backlog. And then there’s an additional 1,000 cars in backlog for which we believe we have exposure that we have not yet accrued. I think directionally, based on the information that we have today, that you can interpolate from the 900 and say that’s within the range, kind of the bigger than a bread basket, to give you the size, perhaps the magnitudes that we could be looking at on the 1,000 cars.

William A. Furman

I’m sorry, let me add that what we are doing with these accruals is we are booking what we believe are certain losses that we can identify because of pricing, a commitment that we’ve not been able to change to deliver the cars, and committed steel input. We are obviously going through a mitigation process to address all three of those variables in the backlog that has not been adjusted. So I wouldn’t want you to read into Mark’s comments any more than we have taken a hit on losses we can reasonably identify and we’re continuing to work on the issue in any remaining exposure as aggressively as we can.

J. B. Groh, CFA – D. A. Davidson and Company

Okay. But you may do better. I mean, just because you’ve accrued you could do better than that if those cost initiatives come in better than you expected.

William A. Furman

Yes. It would affect more. What we took your question to mean was is there more of this to come if we believed that it was certain that more was to come we would have booked it. We’re trying to follow a very conservative policy and strict compliance with GAAP. But we are trying to mitigate it and it’s possible that we could claw back something that we already booked if we abruptly change the commitments that we have agreed to. We, as our customers, this is a hardball environment and it’s three dimensional. We have three parties to it: ourselves and all parties like us who are in this position, the suppliers who are passing on these very unpredictable cost escalations, and then customers who can’t either negotiate or work or not with the other parties to try to have a win-win situation. There are a number of ways we’re trying to mitigate it. We have had a lot of success in the past on this, but this is what we’ve booked and this is the hit we took this quarter. We’re going to continue to be very objective about this and if we see that the expectation will have a loss we’ll book the loss.

J. B. Groh, CFA – D. A. Davidson and Company

And then on a positive note, on the refurbishment and parts business, that margin at 21%, it seems like every quarter the bar kind of moves higher and we keep hearing that the sustainable margin is a little bit lower than what you got in the quarter. Has the bar moved higher there? I think previously you said kind of mid-teens. Now it’s like you’re saying high-teens in terms of margin potential there. Am I reading that correctly?

William A. Furman

The way I look at it, which is probably too simple minded for the massive intelligence that’s on this call – I honestly mean that – I look at this in a very simple minded way. We took a $5 million hit on what ought not to have occurred. We should not have had this happen, but we got caught, as others have been caught. We’re sorry about it. We’re taking the hit. We took a very big hit this quarter. We have some residual, other issues, problems that occurred in our European operation. This is very ironic because there’s a very prosperous environment in Europe and we just have not been able to seem to get it right. So we took some hits this quarter. We also had some sales of leased assets that caused some noise in the quarter. But the return in the refurbishment business has been very, very strong. I don’t expect that we can sustain those kinds of high margins, but I believe that the margins will continue to be greater than they have been. The reason that I don’t expect that those margins can be sustained is that we’re just going to have a lot of push back in this elbow swinging environment that we’re in. We’ve got a good model and it’s working very well, but whether we can keep that kind of margin I don’t know. But even if we can’t, we have, once we get to a normalized run rate we’ve got a lot of slack in there where we can give up some of that margin if we’re not screwing up on steel and other things. We should be able to do much better than we have in the past.

J. B. Groh, CFA – D. A. Davidson and Company

And then finally, Mark, do you have an organic growth rate for the refurbishment parts business or what the acquisitions contributed?

Mark J. Rittenbaum

Yeah, I think the organic growth rate would, as Bill mentioned, there’s a lot of things in our integrated business model that we’re working on that has a lot of upside potential, but our organic growth rate today is probably less than 5% with a lot of upside potential to it.

J. B. Groh, CFA – D. A. Davidson and Company

Okay. Thanks a lot.

Operator

Our next question is from Wendy Caplan with Wachovia. Your line is open.

Wendy Caplan – Wachovia Securities

Thank you. Hello?

William A. Furman

Hi, Wendy. We thought you’d gone off to do great things. You’re still paying attention to us.

Operator

Actually, I have to say her line is disconnected.

---Laughter

Operator

I’ll move on to Paul Bodnar with Longbow Securities. Your line is open, Sir.

Paul Bodnar – Longbow Research

Hi, how are you guys? Quick question here on the overall pricing in the railcar environment. Obviously it’s a difficult scenario. I mean, our contracts, are they looking to buy at fixed rates? Are you able to get escalators in there? Too, is the pricing, if you do kind of adjust it for where steel should be played, is it really just unattractive to buy new cars?

William A. Furman

You want an honest answer to that question? The environment stinks. The pricing environment stinks. The demand stinks. There’s a lot of surplus cars. It’s just not a very pleasant time to manufacturing new cars. It comes and goes. We think it’s a great place to be. We have low cost facilities. We’re making some real progress there. But the customers have a lot of leverage because there aren’t that many deals out there and there’s a lot of surplus cars lying around because of the improvements in velocity.

At the same time, you cannot predict what your costs are going to be unless you’ve got, miraculously, multi-year steel contracts. And I don’t know very many people who’ve been able to negotiate with the steel companies. So it’s very, very difficult.

But we are insisting, as others have insisted, on, we got tempted in the last half of the year to take some contracts that turned out to be not so good. We’re stuck with some multi-year agreements. We’re working those off. So as far as we are concerned we are going to stick to a pass through on costs of steel in our future behaviour. If we can’t get that we’re just not going to build the cars and sell them. We’ll maybe lease them or something.

Paul Bodnar – Longbow Research

I’m glad to hear that part of it. The other aspect is just on Europe. Is that a business now that, obviously you’re taking another look at it? Are you looking at potentially exiting or are these issues that can be resolved?

William A. Furman

Oh, I think all things are on the table. We had in the last two quarters a very unfortunate thing happen with moving of currencies. We’ve had some issues there on a major contract in the supply chain as we have had in the United States. One positive is that they have been able to get better pass through agreements on steel that seems to be something that’s absorbed over there. And the markets consolidated, unlike the United States or North America where there are still a lot of builders. The western market in Europe is whittled down to only a few.

There’s a booming environment in Russia and other parts of the east. I think we put a lot of money in over the last decade in Europe. We’ve had spotty results, to say the least. We really have to examine whether it’s worth the candle. But we haven’t concluded that it’s not. Our goal is to get it to profitable position or at least break even in the very, very near term, quarter to quarter. I think we can do that. We’ve made some management changes. We believe that we’re just going to have evaluate that to see what our options are.

It’s been very disappointing though. I agree.

Paul Bodnar – Longbow Research

And then lastly, I think you mentioned this, maybe I misheard you, you said you had contracts that were fixed and they were fixed at the start of the year on some of the deals. Is that how that works? On some of the backlog?

William A. Furman

Yes, that is correct and the only other comment I’d make to that is part of that is a multi-year contract and part of that is the market that we were in and in the competitive market place we wanted transactions. We were forced to take them on a fixed-price basis and in retrospect that did not turn out well.

Paul Bodnar – Longbow Research

So will that next group be fixed at the start of your next fiscal year or would that kind of come up with the calendar year? Or is there another group on that?

Mark J. Rittenbaum

No, there is not. What we’ve disclosed is what remains. The 1,000 cars what remains and there is nothing left under that multi-year deal for which we’d be exposed.

Paul Bodnar – Longbow Research

Okay. Thanks a lot.

Operator

Thank you. We’ll go back to Wendy Caplan with Wachovia. Your line is open, Ma’am.

Wendy Caplan – Wachovia Securities

Thank you. Sorry. Can you hear me now?

William A. Furman

We can hear you. We’re just delighted you’re back, Wendy.

Wendy Caplan – Wachovia Securities

I’m back. Yeah, a little equipment problem.

I wanted to understand these fixed-cost contracts a little better, if I could. The multi-year contracts that you had told us about a long, well, when you booked it, I thought, as I recall, we could have walked from that based on pricing if it had been unfavourable. Could you talk about, Bill, strategically why you decided not to walk from that contract?

William A. Furman

I think, Wendy, that you are correct we have sat on multi-year contracts that a portion of that contract was subject to contingencies. Basically agreement on price. And that is set, the pricing is agreed upon at the beginning of the year. In fact, before the beginning of the calendar year. And at the time prices were just not escalating. There was an agreement on price, it was a fixed-price contract, but I don’t, simply we did not foresee the magnitude of what has occurred with steel pricing going up over two-thirds in less than eight months and scrap surcharges doubling over the course of time. And here we are.

And even a more crystallized answer to that is each year we had to make a decision. We didn’t have an opportunity to disagree at that point. But when the decision point came we had to, with the index in hand, fix the price for delivery through the balance of that year. And that’s what hit us. We did that. We made that decision to take, to build, it was a good decision and looked like it. But the multi-year agreement is a source of much of this.

And we’re not saying that we won’t renegotiate some of that or walk unilaterally either. If we can get the other party to agree that’s in our mutual interest or is tolerable. We have a good relationship with the company where some of this exposure exists.

Wendy Caplan – Wachovia Securities

Thank you for the clarification.

You haven’t met manufacturing as a whole, the segment as a whole was just above break even on the gross margin line for the quarter. Marine sounded quite healthy. Just how bad was the rail car manufacturing and how long do you think it will continue to lose money here?

William A. Furman

Well, Wendy, of course in cost is that loss contingency that we took as in the cost of sales figure. The $5.3 million is in the cost of sales figure and that’s booking the portion of the future.

Wendy Caplan – Wachovia Securities

Right. But even if we exclude that it’s still only about a low single-digit kind of margin which would imply that if marine is doing well then rail car isn’t.

William A. Furman

Yes, that’s a correct statement. We don’t break the two margins out. Based on our comments earlier, we believe that it is still going to be tough sledding out there with the competitive landscape and the weak demand out there. We believe that it’s going to be tough sledding for the near term.

Wendy Caplan – Wachovia Securities

Okay. And then one last thing and then I’ll jump off. You mentioned, Mark, the $160 million in additional borrowing capacity that you had arranged and you’re amending your debt. Should we be worried about your financial flexibility? There was no cash, essentially, on the balance sheet at the end of the quarter. What should we be thinking about this?

Mark J. Rittenbaum

I think we’re in good shape, Wendy. We usually don’t have a cash balance. We’re a net borrower. Most quarters show that we’re in our lines of credit. We use that line of credit in part for warehousing of leasing transactions. So $160 million of additional borrowing capacity is where a net borrowing is plenty of flexibility out there. This is really very consistent with prior quarters.

Wendy Caplan – Wachovia Securities

Okay. And, I’m sorry, one last thing. Your assets held for sale on the balance sheet are roughly half at the end of this quarter than they were at the end of the last prior quarter. Does that, should we assume then that sales on equipment will be lighter in Q4 than we saw in Q3?

Mark J. Rittenbaum

You’re referring to the gains on equipment sales, Wendy?

Wendy Caplan – Wachovia Securities

No, the...yes, yes. The assets held for sale is lower. So it would be that the gains would be lower in Q4. Yes. That’s my question.

Mark J. Rittenbaum

Yes. We do expect gains on equipment sales will be lower in Q4 than they were in Q3.

Wendy Caplan – Wachovia Securities

Okay. Thank you very much.

Operator

Our next question is from Jim Laventhol (sic) with Laventhol and Company. Your line is open.

Jim Laventhol – Laventhol and Company

Thank you. Good morning, guys. Just a follow up question to Wendy’s question just there. Would you be willing to let us know what your current unrestricted cash balance is and what the sources of that cash from the quarter end were?

Mark J. Rittenbaum

The unrestricted cash. Is that your question?

Jim Laventhol – Laventhol and Company

Yes. Just, you know, there’s sort of a long time period, obviously, three months before we’re next going to see a balance sheet. I was just wondering if you’d be willing to let us know something more current than May 31st.

Mark J. Rittenbaum

Well, are you asking us to forecast our cash balances and revolving debt balances as of the end of the fiscal year?

Jim Laventhol – Laventhol and Company

No, no, no, no. Just anything that you have that’s more current than May 31st. Not in the future. And if you’re not willing to that’s fine.

Mark J. Rittenbaum

I see. I don’t have that handy. The revolving notes that are anything, in this same range as they currently are today, and it might have gone down slightly. But it’s not materially different.

Jim Laventhol – Laventhol and Company

Okay. And just on a sort of following up on that, would you guys be willing, you’re talking about this change in the covenants to your various borrowing facilities that will give you more flexibility. It sounds like that’s pending. Would you be willing to put out a press release or in some way make it public knowledge when those covenants are changed?

Mark J. Rittenbaum

Yes. And it could happen, we expect it to happen very shortly. We’ll be happy to put that out.

Jim Laventhol – Laventhol and Company

That’ll be really helpful. Thanks a lot guys. I really like what you’re doing in terms of transforming the company.

Operator

Our next question is from Steve Barger with Keybanc. Your line is open.

Joe Radigan – Keybanc Capital Markets

Hi. This is actually Joe Radigan (sic) in for Steve today.

In terms of inventories, what was the makeup of the increase this quarter? Is that raw materials or work in progress or finished product? Can you kind of clarify that?

Mark J. Rittenbaum

If you give me a minute I’ll get to that question. Part of it is raw materials. The breakout of inventories is about $150 million of raw materials and about $90 million of work in process. That would be in the inventory line on the balance sheet.

Joe Radigan – Keybanc Capital Markets

Okay. Great. Thanks. And then you may have touched on this, can you talk about lease rates? Are you seeing any significant degradation in lease rate pricing?

Mark J. Rittenbaum

Lease rates, lease rates on new rail cars remains a very competitive environment. Last quarter we commented that in some cases it was unprecedented low rates. So new rail car environment very competitive. There’s been some degradation on the used equipment side, just as new rail cars provide the umbrella on lease rates. But not nearly what we’re seeing on the new rail car side. The used car side has been fairly stable.

Joe Radigan – Keybanc Capital Markets

That’s all I have. Everything else has been addressed. Thanks, guys.

Operator

Our next question is from Joe Ciampi with Southpaw Asset Management. Your line is open now.

Joseph Ciampi – Southpaw Asset Management

Hi. Thanks. Good morning. You briefly touched on it in the comments, but I was wondering if you could talk a little more about traffic trends and maybe demand transit in some of the key rail car types that you’re seeing. Are you seeing any signs of strength in any particular car types?

Mark J. Rittenbaum

We continue to think that the tank car business will have legs on it. We also believe that there are isolated opportunities in covered hoppers. We see continuing weakness in forest product cars, with exception to some very specific car types. There are stronger fundamentals in the commodities that the cheaper dollar have made attractive for export. There’s some traffic changes having to do even with intermodal cars. So it’s really a mixed bag. But you can look at the published loading statistics and see.

The difficulty in looking at the demand side, though, is that when demand falls velocity improves on the railroads. They’ve really been fine tuning their velocity to improve their efficiency. That normally happens in a down turn anyway, so you need fewer cars to carry the same amount of traffic. That causes storage. When you look at the supply side and you look at the storage statistics it really muddies up an easy interpretation of what’s going on out there.

As the railroads, as other are, are scrapping older cars and this will work itself off. But we estimate that, and there’s just a very large overhang in many car types out there that the railroads could deploy. It’s just not a very positive environment right now on the combined demand and supply side.

Joseph Ciampi – Southpaw Asset Management

Okay. And then just quickly, this is somewhat related to J. B.’s question. You guys talked about the refurb and parts division. Margins were favourably impacted by increases in scrap steel prices. Would you guys be able to give us an idea of how much that accounted for in the quarter?

William A. Furman

We don’t break out the margins by various parts of the business or by scrap versus non-scrap.

Joseph Ciampi – Southpaw Asset Management

Okay. Thank you.

Operator

Thank you. Our next question is from Ryan Keeley with Keeley Asset Management. Your line is open.

Ryan Keeley – Keeley Asset Management

Yes. Hi. Good morning. I have a question on the 1,000 cars still that you can’t forecast the cost for. Is that the same order as the 900? With the $5.3 million accrue?

Mark J. Rittenbaum

No. It is not. There are two separate pieces.

Ryan Keeley – Keeley Asset Management

Okay. And is the reason why you can’t forecast because delivery is not near, so you can’t forecast the steel price at that point?

Mark J. Rittenbaum

No. There are just a number of moving parts still on that and given the number of moving parts on that we have not yet accrued because it’s not yet estimable.

Ryan Keeley – Keeley Asset Management

I see. All right. Just a more general question, then. The barge production, that was the first time I ever heard you guys talk about how much you’ve produced in a quarter. Is that chunky or is that the normalized production?

William A. Furman

We have about, we’re trying to improve that production and at the current production rates we have about a two-year run-rate backlog, unless we can improve the rates. So we’re really pleased about the demand side of that and we’re also pleased that we have been up until now and continue to not take a steel pricing exposure in that market.

Ryan Keeley – Keeley Asset Management

I think that’s great too. But should I look at you produce one-ish barge every quarter? Is that right? Or is there some things that are easier to do, some things that are more difficult?

William A. Furman

Yeah, that’s the right way to look at it. The tonnages of the barges, the size of the barge has a great deal to do with it, but it’s more like one plus barge per quarter as one and a fraction. And depending on the size of the barge. Just to get more changeable, right now the annualized revenue from that segment is about $60 million and it’s a $100 million business. The challenge for us is without going overboard with capital expenditures to try to use the footprint of the Gunderson facility, where that is located, to divert from rail to marine and improve our throughput and we’re hopeful that we can continue to grow that business with modest acquisitions and organic growth as well.

Ryan Keeley – Keeley Asset Management

Okay. So in general you probably have three or four of these in process at any one time? Is that right to think about?

William A. Furman

Yes. Three. Maybe three in the staging, one on the way to be launched. You know, I know you guys have a big presence in the company. You ought to come out and see this tangibly because it’s a fairly impressive operation. We have a very interesting position in the barge building business for Jones Act (sic) work and West. We have a very good niche and the challenge for us is to do more with that niche than even we’re doing. We’ve put some new management on board over there a year and a half ago and these guys are really improving the throughput with lean manufacturing. They’re enhancing the market. They’re working on some technological improvements. And we really believe we can get that to a $100 million a year business. But you really have to see it, to come out to a launch some time if you’d like to. It’s really worth doing. We’ll send you an invitation.

Ryan Keeley – Keeley Asset Management

I appreciate that. Thank you.

Operator

Thank you. Our next question is from Mulan Von Redden (sic) with Happy Capital. Your line is open.

Mulan Von Redden – Happy Capital

Yeah, thanks. My questions have been answered.

Operator

Thank you. Then our next is from Art Hatfield with Morgan Keenan. Your line is open.

Logan Stevens – Morgan Keenan & Company, Inc.

Morning, guys. This is Logan Stevens in for Art. I just have one clarification and one question. Did I hear you correctly that you said that a third of your rail car backlog currently has some fixed price associated with it?

Mark J. Rittenbaum

Yes.

Logan Stevens – Morgan Keenan & Company, Inc.

Okay. So beyond the 900 that you’ve accrued for and the 1,000 cars you’ve talked about there’s another couple thousand cars that have fixed prices but that you are currently still estimating as profitable contracts.

Mark J. Rittenbaum

Correct.

Logan Stevens – Morgan Keenan & Company, Inc.

Okay. And then my question is, now that we’re about six weeks into the end of the quarter can you talk about order activity or inquiry activity since the end of the quarter?

Mark J. Rittenbaum

Order activity since the end of the quarter we don’t break out, but I think the order inquiry activity is consistent with Bill’s overall comments about the market being sluggish.

I’d just like to clarify your earlier question. It’s correct. We have a third of our cars in backlog containing fixed-price contracts. Included in that one-third is the 900 we already accrued for and the 1,000 that we’ve identified. So just to make sure we’re on the same page there.

William A. Furman

Mark talked about the moving parts. One of the moving parts, of course, is if you look at our inventory position we’re very concentrated on that and want to manage that as a source of cash. If you look at our inventory position, we’re very concentrated on that and want to manage that as a source of cash. Unfortunately it’s somewhat counterintuitive in this market because if you want to hedge steel pricing the way to hedge it, if you’ve got a fixed price, is to stockpile steel when you can get it. So that’s a way of locking in your profit for fixing a loss if you’ve got a loss position. So our inventories are higher than we would like, but a part of that is in reaction to using inventory as a way of managing this incredibly difficult and unpredictable market for steel pricing and availability.

Logan Stevens – Morgan Keenan & Company, Inc.

Great. Thanks, guys. That’s all I have.

Operator

Our next question is from Todd Maden (sic) with BB&T Capital Markets. Your line is open.

Todd Maden – BB&T Capital Markets

Thank you. Most of my questions have been answered. I just wanted to run through the capex again, if you could. I know you said $160 million of additional borrowing capacity, then you referenced your capex spending. I had $30 million for manufacturing, $10 million for refurbishment, $30 million to $35 million for leasing. Was there another line item in there?

William A. Furman

No, that’s all of it.

Todd Maden – BB&T Capital Markets

Okay. All right. All right. Great. Like I said, everything else was answered. I appreciate it.

William A. Furman

Okay. We have time for perhaps one or two more questions.

Operator

Thank you. Our next question is from Chris Beard with Symphony and your line is open now.

Christopher Beard – Symphony

Thank you, gentlemen. I just want to make sure I got this correct. So of the 17,500 units you have in backlog you said one-third or roughly one-third of those are under fixed-price contracts?

Mark J. Rittenbaum

Correct.

Christopher Beard – Symphony

Okay. So that would put you at about 5,800 total units. Now, is some portion of that fixed-price contracts makeup, is that pertaining to the actual GE contract?

Mark J. Rittenbaum

Yes.

Christopher Beard – Symphony

It is. Okay. Okay. So if you back up 11,900 units of that 17,500 it leaves you with about 5,600, 1,900 of which you said were under fixed-price contracts. So the remaining 3,700, are those all pass through contracts or are there some fixed-price?

Mark J. Rittenbaum

Let’s try this again. About one-third of the rail cars in backlog are fixed-price contracts. We’ve identified about 1,900 of those that we believe there is the potential for loss. Roughly 900 of those we took a $5.3 million hit this quarter for a loss reserve. The other 1,000 we have not yet accrued a loss as it’s not estimable. The remaining cars of those one-third that are in backlog we do not believe that there is a loss to be realized on those rail cars.

Christopher Beard – Symphony

Okay. And then of the remaining, what portion pertains to the GE contract?

Mark J. Rittenbaum

Roughly 11,900, I believe, is the number that relates to the GE contract. That are all pass throughs.

Christopher Beard – Symphony

Oh, 11,900 are all pass throughs?

William A. Furman

Do you want to clarify what you said earlier about GE contract? Because you had a fixed price, you said that you had fixed-price contracts.

Mark J. Rittenbaum

Right. So all the GE contract is a pass through contract. Again, about one-third of the backlog – and GE is about 11,900 cars – and then about one-third of the backlog is fixed-price for which we believe there is loss exposure on 1,900 of the cars. About 900 of which we took a loss contingency this quarter.

Christopher Beard – Symphony

Okay. But there’s additional units that are under fixed-price contract that could be susceptible to losses if steel prices were to increase going forward?

William A. Furman

There is exposure there. We don’t see that loss today.

Christopher Beard – Symphony

Okay. And then the actual mechanism for the actual pass through, do you recover 100% of the actual increase for those contracts that you do have pass through? Or is there some type of lag or percentage leakage in terms of the recovery?

William A. Furman

No, it’s a straight pass through.

Christopher Beard – Symphony

A straight pass through. Okay. Well, that’s all I had. Thank you, gentlemen.

Operator

At this time I’d like to turn the conference back to Greenbrier management.

Mark J. Rittenbaum

Thank you very much for your participation in today’s call. If any of you have any follow on questions we’ll be available to take them directly after the conference call today. I thank you again for your participation. Have a good day.

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Source: The Greenbrier Companies F3Q08 (Qtr End 5/31/08) Earnings Call Transcript
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