American Railcar Industries, Inc. (ARII) CEO John O'Bryan on Q2 2018 Results - Earnings Call Transcript

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About: American Railcar Industries, Inc. (ARII)
by: SA Transcripts

American Railcar Industries, Inc. (NASDAQ:ARII) Q2 2018 Earnings Conference Call August 1, 2018 10:00 AM ET

Executives

Luke Williams – Senior Vice President and Chief Financial Officer

John O'Bryan – President and Chief Executive Officer

Analysts

Matt Elkott – Cowen and Company

Justin Long – Stephens

Willard Milby – Seaport Global

Operator

Good morning. My name is James, and I will be conference operator today. At this time I would like to welcome everyone to the Q2 2018 Railcar Industries Inc. Earnings Conference Call. [Operator Instructions] All lines have been placed on mute to prevent any background noise. And after the speakers' remarks there will be a question-and-answer session. [Operator Instructions] Thank you. As an advisement, this call is being recorded.

I would now like to turn the call over to Senior Vice President, CFO and Treasurer, Luke Williams. Mr. Williams, the floor is yours.

Luke Williams

Thank you, James. Good morning. I would like to welcome you to the American Railcar Industries second quarter 2018 conference call. I am Luke Williams, our Chief Financial Officer, and I would like to thank you for joining us this morning. For those who are interested, a replay of this call will also be available on our Web site, americanrailcar.com, shortly after this call ends. Joining me this morning is John O'Bryan, our President and Chief Executive Officer.

Our call today will include comments about the railcar industry, our operations, and financial results. Following these remarks, we will have a question-and-answer session.

This conference call will include forward-looking statements, including statements as to estimates, expectations, intentions, and predictions of future financial performance based on currently available information. Participants are directed to our SEC filings and press releases for a description of certain business issues and risks, a change in any one of which could cause our actual results or outcomes to differ materially from those expressed in the forward-looking statements.

Also, please note that the company does not undertake any obligation to update any forward-looking statements made during the call. EBITDA and adjusted EBITDA are non-GAAP financial measures we will discuss today that are reconciled to net earnings in our press release that was issued this morning. The press release is available through the Investor Relations page of our Web site, as is the supplemental information presentation.

Now, it's my pleasure to introduce John O'Bryan.

John O'Bryan

Thank you, Luke, and good morning. Thanks for joining us today. The North American rail market has shown signs of recovery, including car loads growth driven by a wide array of commodity types and a decline in railcars in storage over the first-half of 2018.

The industry reported quarterly orders of 23,000, which represents its highest point since the fourth quarter of 2014. With certain industry orders placed during the quarter being large orders for long-term needs, the pricing environment remains competitive to meet customers' needs.

During the second quarter of 2018, we received orders of 1,176 railcars, and delivered 933 railcars, or a book-to-bill of approximately 1.3 to 1. Our orders were for direct sale and lease for a variety of hopper and tank railcars. This order activity has increased our backlog to 3,387 railcars at quarter-end. We expect approximately 31% of that to go to our lease fleet.

As we announced this morning, we entered into a long-term supply agreement with GATX, to supply them railcars over a five-year period beginning in 2019. We are excited to partner with GATX, a global leader in railcar leasing space within the next several years to meet their needs. In the long-term we remain focused on setting production levels consistent with industry demand, strategically investing in our lease fleet and managing our costs. With the large portion of our recent orders scheduled for delivery in 2019 and beyond, we expect our overall shipments for 2018 to come in below 2017 levels.

I now turn it back to Luke for a discussion of second quarter financial results.

Luke Williams

Thank you, John. Second quarter 2018 consolidated revenues were $147 million, up 34% versus $109 million for the same period in 2017. This increase was primarily driven by increases in our manufacturing segment with higher railcar shipments for direct sale along with slight increases in revenue in the railcar leasing and railcar services segment.

Consolidated earnings from operations for the second quarter of 2018 were $17 million, down 22% compared to $22 million for the same period of 2017. Our consolidated operating margins were 12% for the second quarter of 2018, compared to 20% for the same period of 2017. These decreases were primarily driven by slightly lower earnings from operation in each of our operating segments and a $3.6 million impairment loss recorded on certain of our leased railcars.

Consolidated manufacturing revenue were $89 million for the second quarter of 2018, compared to $55 million for the same period in 2017. This increase was primarily driven by increased railcar shipments for direct sale for both hopper and tank railcars, partially offset by lower selling prices due to mix of hopper and tank railcars shipped you 2018, compared to 2017, and more competitive pricing prevalent in the current railcar market. We shipped 914 railcars for direct sale and 19 railcars for lease during the second quarter of 2018. This was compared to shipments of 531 railcars for direct sale and 545 railcars for lease during the second quarter of 2017. Railcars built for our lease fleet represented 2% of our total railcar shipments during the second quarter of 2018, compared to 51% for the same period in 2017. Consolidated manufacturing revenues exclude estimated revenues related to railcars build for our lease fleet of $2 million for the second quarter of 2018, compared to $55 million for the same period in 2017.

While our customers decide if they want to purchase or lease a railcar from us, as John mentioned, we remain disciplined in evaluating investments in our lease fleet. This approach includes seeking strategic lease opportunities where we can partner with the customer and/or provide our manufacturing facilities an order that will help operational efficiency.

Consolidated management segment earnings from operations were $2 million for the second quarter of 2018, down 15% from the same period of 2017. Operating margin from our manufacturing segment was 2.5% for the second quarter of 2018, compared to 4.6% to the same period in 2017. These decreases were primarily due to more competitive pricing and higher costs associated with lower production volume. These earnings from operations excluded $1 million in estimate profits on railcars build for our lease fleet for the second quarter of 2018, and $5 million for the same period of 2017. The estimated profits on railcars build for our lease fleet are eliminated in consolidation.

Our railcar leasing revenues for the second quarter of 2018 were $35 million, up 3% from the same period in 2017. Our lease fleet has grown to 13,341 railcars at June 30, 2018 from 12,414 railcars at June 30, 2017. Although we continue to strategically grow our lease fleet, we are continuing to experience suppressed weighted average lease rates for new railcars for lease and certain railcars up for lease renewal or reassignment. As of June 30, 2018, our lease fleet utilization was approximately 96%. We are actively working with customers with upcoming expiring leases to renew the lease or find a reassignment opportunity with another customer.

Railcar leasing segment earnings from operations on a consolidated basis in the second quarter of 2018 were $17 million compared to $22 million for the same period in 2017. This decrease was due primarily to a $3.6 million impairment loss recorded on certain of the company's leased railcars as well as increased maintenance cost and lower lease rates. Without the impact of the impairment loss, railcar leasing earnings from operations on a consolidated basis would have been $21 million for the second quarter of 2018. The impairment loss was driven by working with the customer on a strategic opportunity to meet their needs and sell them some of our used tank railcars that were previously in crude oil service within our lease fleet portfolio. This opportunity provides us a good outlet for these railcars. For further discussion of this impairment loss, please see the disclosures in our 10-Q that will be filed later today.

Our consolidated railcar services revenues for the second quarter of 2018 were $22 million, up 10% compared to the same period of 2017. This increase was primarily due to revenue generated from retrofit projects partially offset by lower demand for traditional repair services.

Railcar services earnings from operations on a consolidated basis were $2.6 million or an operating margin of 12% for the second quarter of 2018, compared to $3 million or an operating margin of 15% for the same period in 2017. This decrease in margin was primarily due to an unfavorable mix of work for traditional repair services as well as costs incurred as we ramp up activity on retrofit projects.

Consolidated selling, general and administrative expenses increased approximately 700,000 in the second quarter of 2018, compared to the same period of 2017, due primarily to increased competition cost relating to additional personnel hired in 2017 to increase our sales and marketing team and other supporting group in connection with transitioning our lease fleet management in-house. We also experienced an increase in share-based compensation expense driven by fluctuations in our stock price, partially offset by decreased legal expenses. As a reminder, the increase competition cost are being offset by savings resulting from no longer paying a management fee to our former affiliate, American Railcar Leasing, to manage our lease fleet, which was recorded as cost of revenues in our railcar leasing segment.

Earnings from our joint ventures were $500,000 for the second quarter of 2018, a decrease of approximately $300,000 compared to the same period of 2017. This decrease was primarily due to lower demand at our Axis joint venture.

Net earnings for the second quarter of 2018 were $9 million or $0.48 per share compared to $11 million or $0.57 per share for the same period in 2017. This decrease was driven largely by the impairment loss recorded on certain of our leased railcars which had a negative impact of $0.13 per share and a decrease in earnings from operations as discussed earlier, partially offset by lower income tax expense as a result of the Tax Cuts and Jobs Act enacted in December 2017, decreasing the Federal tax rates from 35% to 21%.

EBITDA adjusted to exclude share-based compensation expense, other income related to short-term investments and impairment losses recorded on certain leased railcars was $37 million for the second quarter of 2018, representing an increase of 1% compared to the same period in 2017. The increase resulted primarily from an increase in railcar shipments for direct sale partially offset by lower earnings from operations.

Our earnings contributed deposit of cash flow from operations of $51 million during the first six months of 2018, and we ended the quarter with net working capital of $182 million, including $104 million of cash and cash equivalents. As of June 30, 2018, we had $533 million of debt outstanding under our January 2015 lease fleet financing facility. Our strong balance sheet combined with $200 million available to borrow under our revolving credit facility along with additional unencumbered railcars provides us with the flexibility to strategically grow as we make future investments to expand our lease fleet.

At this time I would like to turn it back to John for some additional comments.

John O'Bryan

Thanks, Luke. In our view, the railcar market is continuing the slow improvement that we saw during the first quarter, and we are encouraged by these recent trends. However, current market pricing remains below long-term averages, and we expect to maintain a discipline strategy that optimizes volume, price, and service.

We also seek opportunities to invest in our operations to enhance capabilities and to ensure that our products, services, and operations meet the highest standards of safety and quality. We have managed our lease fleet in-house for over a year. The sales, marketing, and leasing teams are working closely with our customers to understand their needs and deliver creative solutions. The entire ARII team is committed to the journey of continuous improvement and innovation as we focus on aligning people, process, and tools to deliver world-class results in safety, quality, and service.

I would like to thank the ARII team members for their hard work and support in serving our customers, shareholders, and industry partners. Now I will turn the call back over to operator, and we will be happy to take your questions. Operator, would you please explain how our participants can register their questions?

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Matt Elkott from Cowen and Company. Go ahead, please. Your line is open.

Matt Elkott

Good morning. Thanks for taking my questions. My first question is I was wondering guys if your order activity in the quarter would have been different had you not been tied up negotiating the GATX supply agreements, any color on that would be helpful.

John O'Bryan

I think frankly we focus strategically to partner with GATX, and the majority of our sales and marketing team is really focused on serving other customers. I don't think it had a significant impact.

Matt Elkott

Okay. And speaking of the GAXT deal, can you provide us any type of visibility as to the cadence of delivery beginning 2019?

Luke Williams

Hi, Matt. This is Luke. At this point, we are not going to give a lot of cadence. I think you can look at other information that's available, but at this point we are not going to give cadence on deliveries.

Matt Elkott

Fair enough, Luke. On the margin front, now that you have these incremental orders that we are baking to long-term outlook, as you look at 2018 margins basically and you have the GATX deliveries beginning in 2019, would it be fair to assume that there would be margin upside given the incremental deliveries coming in 2019?

Luke Williams

Matt, this is Luke again. On a conceptual basis, I think you are right on there. Obviously it comes down to executing and getting additional orders to put in that incremental volume. So, in theory, yes, you are accurate.

Matt Elkott

Okay.

John O'Bryan

Matt, this is John. My only additional comment would be obviously mix plays a factor in that. I mean, not on all railcar types, and commodities are created equal. So, as the mix dictates a little bit of that as well.

Matt Elkott

Got it. And now with the new tailwinds in -- for tank car demand especially the final liquid tank car deals in 2017, are you seeing any evidence of increased demand for those tank cars, and if so, would it be -- is it fair to assume that we could see some pull-forward from maybe out year deliveries to the second-half of this year and early 2019?

John O'Bryan

Matt, this is John. We have seen elevated inquiry levels that really began in late fourth quarter of 2017, and continue to be strong; we continue to have dialog with a lot of customers around their tank car fleet and strategy. I don't really think we will see a lot of pull-forward for later this year, but we are seeing a lot of activity that really is focused on deliveries in 2019 and beyond. As you know, with the regulations, depending upon the commodity really kind of drives people's thinking as to when they need to upgrade or retrofit their fleet.

Matt Elkott

Got it. Great, thank you very much.

John O'Bryan

Thank you.

Operator

Your next question comes from the line of Justin Long from Stephens. Go ahead please. Your line is open.

Justin Long

Thanks and good morning. So following up on that GATX order that was announced today, is there any color you can provide on the estimated split between tank and hopper cars? And then, also you gave the estimated value for, I guess, this first slug of cars to be about $750 million. Does that mean that the pricing has already been locked in?

Luke Williams

Justin, this is Luke. We are not going to give a split out of tanks versus hoppers just for competitive purposes. And then, to your point on the value that was put in the press release this morning, it is a cost plus contract, so the pricing is escalateable. So that's really just kind of the value as of today.

Justin Long

Okay, that's helpful. And then, on the option for the additional 4,400 cars, is there any color you can provide on the probability of that option being exercised and what some of the inputs around that are, and on pricing on that piece, is that something that has already been decided? Is it also a cost plus arrangement or is that something that will be decided down the line?

John O'Bryan

Justin, this is John. For competitive reasons frankly both for ourselves and for our partner, we are really not going to make too many comments there. There is a variety of different factors associated with the option contract. Obviously our intention is to serve the needs of our strategic partner, and really I think the market conditions will define to what level the options are exercised over time.

Justin Long

Okay, fair enough. And then I guess lastly, in terms of just pricing in the market today, you mentioned the market remains competitive, but at the same time you are kind of optimistic that we are starting to see signs of recovery and that's reflected in industry orders. Could you just comment on what industry railcar pricing did from your perspective on a sequential basis from first quarter to second quarter stripping out some of the noise that I'm guessing we are seeing with tariffs steel prices?

John O'Bryan

Sure. As you know, the railcars really are made up of a lot of different micro markets. At a high-level, I would say that most of the car types in the covered hopper space were fairly steady. We saw a little bit of improvement in a few market segments. On the tank car side, Matt asked as well, we have seen elevated levels of tank car demand, and interest in future opportunities. So I would say the pricing in that area has improved. So again, it's a little bit commodity-specific. I think if you look at the more traditional chemical markets, I think the pricing is approaching more long-term levels. If you look at some of the markets that have had excess equipment like crude, it's still matter of how does that market balance out.

Justin Long

Okay, that's very helpful. I will leave it that. I appreciate the time.

John O'Bryan

Thanks, Justin.

Luke Williams

Thanks, Justin.

Operator

[Operator Instructions] Your next question comes from the line of Willard Milby from Seaport Global. Go ahead please. Your line is open.

Willard Milby

Hey, good morning gentlemen. If I could focus on deliveries in the lease fleet, I think you talked about 31% of the current backlog testing for lease. Should we expect that the -- I guess, the lease fleet deliveries to step-up here in the second-half to that 30-ish level?

Luke Williams

Will, this is Luke. Thanks for the question. Yes, I think it will hit actually higher than 50% of deliveries over the second-half of the year. So, little bit higher that 30% that's indicated in the backlog.

Willard Milby

Okay. And speaking of deliveries, should we expect I guess continued sequential improvement as we move through the remainder of the here? We had a step-up for the 120 cars, so deliveries between one and two, should we kind of expect that cadence to continue throughout the remainder of the year? And same question maybe on margin, I know mix was an impact here, looking at the gross margin manufacturing for Q2. Is there a chance that subsides in the last two quarters of the year? And just any kind of color you might have on that?

Luke Williams

Sure. So the delivery cadence, we are actually expecting to take a little step backward in Q3. In Q3, our products come in close to Q1 levels. And then, a little bit of an uptick in the fourth quarter. And then as John alluded to, overall deliveries for the year will come in lower than where we were in 2017.

On the margin side, it's coming in at 6% on the gross profit for the manufacturing segment specifically. I think we will see close to that, if not a little bit down Q3-Q4 as we kind of work through some mix and changeover and work through a few orders for delivery in the back-half of the year.

Willard Milby

All right. Fair enough. And if I could go back to lease fleet, when you are talking with customers for renewal right now, are you seeing your renewal success rate kind of increase given the current floppiness in the tank car markets? Is it easier to renew cars with customers right now, is that -- maybe about the same that you saw last quarter, can you talk a little bit about those conversations that you are having with customers and what you are seeing in that market?

John O'Bryan

Sure. Will, this is John. We are seeing customers with more interest in renewing assets. We are also seeing an uptick in reassignment of other types of assets. So we had a pretty high success rate working with our customers. Again, our focus here both from an investment side and part of why you saw our lease fleet fees down a little is we try to be very disciplined, we're going to grow our lease fleet, but we are going to do it in a smart way. And kind of the same thing is true on the renewals and reassignments. We try to work with our customers to align with their fleet strategy, but also get to a place where we think it's a fair transaction for both sides for the long-term.

Willard Milby

And is that something where you think -- maybe leasing gross margin can step-up, because maybe that's a little bit easier, maybe not having to -- had expenses related to refreshing cars with new customers or do we think this kind of maybe call it low 60% gross margin of leasing is a good place to be for the remainder of the year and looking out?

John O'Bryan

Yes, I think it's a good place to be overall. I mean we are still working through some of the idle cars that we have. As we mentioned our utilization is 96%, so obviously incurring some costs related to those, and we are hoping we will get those back on lease, but yes, I think low 60s, high 50s is a good range.

Willard Milby

All right, that's it from me. Thanks for the time.

John O'Bryan

Thanks, Will.

Luke Williams

Thank you.

Operator

And with that, I would like to turn the call back over to John O'Bryan for some closing remarks.

John O'Bryan

That concludes our conference call this morning. Thank you to everyone who has participated. We look forward to talking to you in the next quarter. Have a great day.

Operator

This concludes today's conference call. You may now disconnect.