FreightCar America, Inc. (RAIL) Q4 2020 Earnings Call Transcript

Greetings, and welcome to FreightCar America's Fourth Quarter and Full Year Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note this conference is being recorded. I would now like to turn the conference over to your host, Lisa Fortuna of Investor Relations. You may begin.

Thank you and welcome. Joining me today are Jim Meyer, President and Chief Executive Officer; Terry Rogers, Chief Financial Officer; and Matt Tonn, Chief Commercial Officer. I'd like to remind everyone that the statements made during this conference call relating to the company's expected future performance, future business prospects or future events or plans may include forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Participants are directed to FreightCar America's 2020 Form 10-K for a description of certain business risks, some of which may be outside of the control of the company that may cause actual results to materially differ from those expressed in the forward-looking statements. We expressly disclaim any duty to provide updates to our forward-looking statements, whether as a result of new information, future events or otherwise. During today's call, there will also be a discussion of some items that do not conform to U.S. Generally Accepted Accounting Principles or GAAP. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures are included in the press release issued this morning. Our 2020 Form 10-K and earnings release for the fourth quarter of 2020 are posted on the company's website at www.freightcaramerica.com. With that, let me now turn the call over to Jim for his opening remarks.

Thank you, Lisa. Good morning and thank you all for joining us today. 2020 was a truly unique year. It was highly challenging on so many different levels, but it was also a great year in terms of what was accomplished. 2020 set the table for our future. In the midst of both the deep industry downturn and a once-in-a-century pandemic, the FreightCar America team finished the most challenging aspects of the business transformation and essentially finished remaking the company. We are excited to share our progress today and to share some of the reasons why we believe in the potential of the new company. I will also introduce you to our new Chief Financial Officer, Terry Rogers. So, let's get started. I am happy to report that we successfully completed our exit from Shoals. Everything went according to plan. Given the operational challenges associated with closing down a 2-plus million square foot facility as it continued to produce, that is saying quite a lot. We had no appreciable cost overruns. We completed our last car build with quality, and we returned the facility back over to the retirement systems of Alabama, the facility owner on the last day of February as originally planned. One final time, I want to thank our Shoals employees for their dedication to the last day, and we wish all of them the very best for the future. Our new team at Castaños started building cars in July and started shipping to customers in November. Today, Castaños has produced three different car types on time, all while meeting or exceeding customer expectations for quality. If we take a step back and consider where we were just three and a half years ago, we were a company with two legacy cost-disadvantaged facilities, plus the extremely large facility in Muscle Shoals. Our fixed costs and our variable costs were uncompetitive. We needed to produce 6,000 to 7,000 units per year to be profitable. We were not in a position to survive, much less win. In fact, we could see when under the condition of a resurgence and the need for coal cars. Fast-forward to today, and we are now a streamlined manufacturing organization that controls the newest purpose-built facility in North America. That facility is appropriately sized for the moment and has the flexibility to scale when we need it to. We have removed in excess of $25 million per year in fixed costs as compared to 2019. We have improved our variable cost, and we believe we are ready to lead the industry in terms of quality. In fact, we will have reduced our breakeven production levels by two-thirds compared to the old FreightCar America, and that is after we finished scaling the Castaños plant. It is fair to say that the heaviest of the heavy lifting of our transformation is now complete, and we are ready to fulfill our vision to become the most cost-effective, highest quality producer in the industry and that we can now start to shift some of our focus towards growth. At this very moment, we are a two production line company with the capacity to produce approximately 2,000 railcars per year, depending on the mix and number of changeovers. We will scale this new business with the upcycle that we believe is going to come. As a reminder, the Castaños' footprint currently consists of two assembly lines, a much larger paint shop, one designed to accommodate future expansion, and a wheel axle shop. We currently receive the majority of our fabrications from Fasemex, which was our joint venture partner prior to acquiring their stake. We have hired a very experienced team at the facility that is more than qualified to run a future larger operation. The performance of this workforce is, in our opinion, amongst the best in the industry, and the results already attest to that fact. Related to all of this, our Board just approved the construction of our own fabrication shop. This will allow us to make the large majority of our fabrications in-house starting within 12 months, which will bring additional capability and efficiencies. We will gauge the market and sales inquiry levels to time the construction of additional assembly lines and capacity. On a more onerous topic, we must find ways to mitigate the very substantial cost pressure associated with steel prices, which have doubled over the past 12 months and are currently near all-time highs. Between these increases and continued pressure on pricing driven by the industry downturn and overcapacity that still remains, margins will be under pressure for the short-term. The improving news, as Matt will discuss, is that order activity is starting to increase. And now that we are wholly in Mexico with a smaller size, we have the ability to be modestly selective on the business we pursue. As we continue to build the company around the new footprint in Castaños and start to focus on growth, we are highly encouraged by the feedback we have received from customers who have toured the new facility. They are impressed with the efficient and scalable size of the facility, the highly trained and experienced workforce we have assembled, and the absolutely positive morale and culture of the people. We are increasingly encouraged by the number of new sales increases since the start of the year as well. Our delivery guidance for the year is a range of 1,400 to 1,600 railcars, which is approximately two times our deliveries for 2020. While this delivery guidance is below the roughly 2,000 railcars we have noted as our new breakeven level, it is aligned with where the industry is right now. To conclude, we closed the door on Shoals and completed the physical part of the transformation of FreightCar America. 2021 is about building momentum and support for expansion and profitable growth as we move forward. We believe the new flexibility of our business will allow us to ride out the last stage of our industry's downturn and significantly capitalize on its next phase of expansion. With that brief overview, it is my pleasure to introduce you to Terry Rogers, our new CFO. Terry is a true finance professional with nearly 40 years of experience, that includes having held the CFO positions at Roadrunner Transportation Systems, Heico, and Ryerson. We are very fortunate to have him on the team.

Thanks, Jim. I'm excited to be here and have enjoyed my first few months leading our financial organization. We have assembled a strong team within the financial group to support FreightCar's anticipated return to growth and profitability. Regarding our financial results, consolidated revenues for the fourth quarter of 2020 were $60.6 million, compared to $25.2 million in the third quarter of 2020. This represents a 35% increase from the fourth quarter of 2019, which had revenues of $44.9 million. In the fourth quarter of 2020, we delivered 477 railcars, up from 163 in the third quarter of 2020 and 439 in the fourth quarter of 2019. As we mentioned during our third quarter 2020 results, we updated our delivery guidance for the year and are happy to report that we met our target of 751 deliveries, despite the operational challenges posed by the pandemic and our manufacturing transition from Shoals to Castaños. Our gross profit improved significantly in the fourth quarter to $5.5 million, compared to a loss of $8.1 million in the same quarter of 2019. This marks the first quarter we achieved positive gross profit since June 2019 and only our second quarter of positive gross margin in the last three and a half years. SG&A for the fourth quarter amounted to $8.7 million, up from $7.59 million in the fourth quarter of 2019, primarily due to retention payments linked to the Shoals shutdown and bonuses relating to successful financings. We expect SG&A expenses, excluding restructuring costs in the first quarter, to be about $7 million per quarter in 2021. The consolidated operating loss for the fourth quarter of 2020 was $9.2 million, compared to a loss of $9 million in the fourth quarter of 2019. This operating loss included $19 million in impairment charges related to lease railcars, partially offset by $12.9 million in non-cash restructuring gains, mainly from terminating the lease at the Shoals manufacturing facility in the fourth quarter of 2020. The operating loss in the fourth quarter of 2019 also included a $2 million charge from the sale of 100 railcars previously in the lease fleet, a $6.6 million non-cash gain from terminating a post-retirement benefits plan, and a net $2 million restructuring gain largely linked to a $2.4 million non-cash gain related to our Roanoke, Virginia facility. Now, let’s take a moment to discuss the implications of the warrant we issued last year as part of our recent financing, as it will affect our financial statements going forward. This liability will be marked to fair market value each quarter, impacting our net income and earnings per share calculations. Last quarter, the loss on the change in fair market value of the warrant liability was $3.7 million, representing a non-cash item that reflects the increase in our stock price since the warrant issuance in November 2020. Due to changes in the warrant liability and other non-operating, non-cash, or non-recurring impacts, we have provided investors with a calculation of our adjusted EBITDA results. We believe this additional information adds a meaningful metric alongside GAAP financial measures for evaluating our operational and financial performance. The EBITDA loss for the fourth quarter was $11.6 million compared to a loss of $5.9 million in the fourth quarter of 2019. Interest expense in the fourth quarter of 2020 was $1.5 million, compared to $0.2 million in the fourth quarter of 2019, reflecting the closure of new debt agreements. Moving forward, we anticipate that interest expense will remain above recent historical levels because of these new debt agreements. EBITDA is generally affected by the same significant non-operating adjustments I mentioned earlier that impacted our consolidated operating loss, in addition to the non-cash loss on the change in fair market value of the warrant liability. Adjusted EBITDA for the fourth quarter of 2020 was a positive $1.7 million when adjusted for previously discussed items and other non-cash or non-recurring items. Looking at the balance sheet, we ended the quarter and the year with cash and cash equivalents, including restricted cash and certificates of deposit, totaling $54.2 million compared to $70 million at the end of 2019. This total cash includes $40 million from new secured term loan proceeds completed in November 2020, which will support our strategy as we largely complete our transition to Castaños. As of December 31, 2020, inventories rose to $38.8 million from $25.1 million a year earlier, resulting from higher levels needed to support the transition from the Shoals facility to our manufacturing operation in Castaños, Mexico. We anticipate cash balances will decrease in the first quarter as we complete the transition to Castaños, close the Shoals facility in February, and build working capital to meet second-quarter production targets. Capital expenditures for the entire year of 2020 were $9.8 million, notably higher than the $5.6 million in 2019, mainly due to the transition to our Mexico facility and production ramp-up during the fourth quarter. Given our smaller footprint, we expect our capital expenditures to decrease in 2021, currently forecasted to be between $2 million and $3 million. Once again, I'm thrilled to be leading the FreightCar finance function. Jim and the team have done an exceptional job transitioning to Castaños, and I have inherited a great staff. I believe we have a significant opportunity to create long-term value, and we are at an exciting inflection point in our history.

Thanks, Terry. As Jim mentioned, the railcar industry continues to navigate the challenges of the lowest freight car demand cycle seen since 2009. In the fourth quarter of 2020, we booked orders for 90 railcars and 490 railcars for the year compared to 385 and 2,227 for the fourth quarter and full year 2019, respectively. Although order activity was relatively quiet, we were encouraged by the number and substance of new car inquiries throughout the fourth quarter of 2020, as well as continued improvements in key market indicators that ultimately drive demand for new railcars. Year-over-year rail traffic growth seen in the second half of 2020 is a positive sign to the beginnings of an economic recovery. Although bringing in intermodal car loadings outpaced all other commodity groups, we expect to see improvement in the industrial economy and associated car loadings. Reductions in railcar fleet storage numbers down five consecutive months in the second half of 2020, and continued this trend in the early part of 2021. We do expect the increased scrap steel pricing to support sequential reductions in stored cars throughout 2021. We are encouraged by the strong level of new car order inquiries in the last 90 days, along with improved customer sentiment, as well as a reduction in reported COVID cases and increased vaccinations. Like other railcar builders we are anxious to fill our factories. However, we are also careful that we close orders that are acceptable to us and satisfy our financial targets. We do anticipate an aggressive market pricing environment in 2021, and the two-times increase in steel costs in the last year has created additional headwinds. Thankfully, our smaller footprint, as it currently sits, positions us to be more selective on orders. Our 2021 delivery guidance of between 1,400 and 1,600 railcars, while double what we achieved in 2020, is still well below our historic average. As I mentioned, industry inquiry levels do support expected increases in order activity, which we anticipate being heavily weighted in the second half of 2021. This makes sense given that we are at a low point and anticipating the recovery. The bigger unknown is not whether there will be a recovery of substance but instead when it will start in earnest and whether it will become gradual or steeper in nature. As Jim already noted, we are already seeing early benefits of the transition to the new Castaños facility and believe our competitive position will improve along with market dynamics. The efficient footprint of Castaños not only leads itself to deliver our broad product portfolio, but is designed with the flexibility to change car types more quickly and run efficiently at lower volumes than what is generally supported by the other manufacturers. Further, as the industry leader of railcar conversions, we will continue targeted investments in this space, including infrastructure, capabilities to Castaños, and expansion of our offerings, leveraging both our engineering and manufacturing expertise. For our customers, we have surplus fleets or cars that no longer provide solid leads or revenue returns. FreightCar America provides a solution to upgrade underutilized rail assets into the latest car designs that generate new revenue opportunities for them. In closing, I wanted to share with you some of the customer reactions we have received since production commenced at Castaños. When COVID travel restrictions were lingering, we have taken the opportunity to hold a number of virtual events that show customers how their freight cars are manufactured from fabrications and sub-assemblies to painting and lighting and final quality inspection. Using the latest virtual meeting technology and video, these virtual face-to-face plant tours and sample car events provide a firsthand look at the entire build process. Feedback on the in-person and virtual visits has been overwhelmingly positive, with a top customer stating in our sample car reviews was one of the most professional and thorough ever within any builder. This is just one anecdote of the type of responses we were getting on Castaños and supports our purpose-built approach to customers.

Thanks, Matt. Our manufacturing transformation is now largely complete, and we have taken control of our own destiny. We have dramatically repositioned our competitive profile and in so doing created a new company, one that is able to win. We certainly have work left to do with building sales momentum now at the top of the list. If 2020 was about getting all the right pieces in the right places, 2021 is about building momentum so that 2022 and beyond will be about leveraging this new company to drive significantly enhanced profitability, free cash flow, and long-term shareholder value. We are looking forward to sharing that journey with all of you and thank you for your continued support. That concludes our prepared remarks. And I'll now turn the call over to the operator for Q&A.

At this time, we will be conducting a question-and-answer session. Our first question is from Justin Long with Stephens. Please proceed with your question.

Thanks. Good morning. And Terry, congrats on the new role. Look forward to working with you going forward.

Thank you.

So, maybe to start with gross margins just because there was such a notable improvement both sequentially and year-over-year. When I looked back to the second half of 2019, a similar level of deliveries, but gross margins were negative 16% this quarter, in 4Q, we were positive 9%. Can you just help us bridge the difference there? I know there have been a lot of cost improvements and operating improvements in the business. But I think it would be helpful to break down the major buckets that we should be thinking about.

It was primarily that we had a very attractive and well-priced order that we were processing through most of the fourth quarter and improved fixed cost structure. And it's just a more efficient management of that order going through, which I think you'll be able to see as we go forward in a more efficient cost structure in Castaños in the future.

Okay. And in terms of gross margins going forward, I know you mentioned the run-up in steel prices maybe causing some near-term pressure. Is there anything else you can share to help us from a modeling standpoint? I'm guessing sequentially gross margins will be down, but do you still expect gross margins to be positive throughout 2021, or back into negative territory?

We want to avoid providing any sort of guidance going forward on the financial in terms of a financial forecast, but certainly we feel we have a more attractive cost structure. As Matt mentioned, we are facing the headwinds of higher steel prices. But we do feel we positioned ourselves to operate at a much more profitable level going forward, but now we don't really want to get into providing specific guidance for 2021.

Okay. And then lastly, you mentioned from an inquiry standpoint that things have picked up year-to-date. Have you received any orders so far in 2021? And maybe just from an inquiry perspective, you could provide a little bit more color to help us understand the magnitude of the pickup you've seen?

Justin, I can't provide specific details about the orders received at this time, but there will be a more detailed update on our next call. I can share that we are observing a broader range of inquiries regarding different car types compared to what we saw last year, which I believe indicates that the industry is starting to improve.

Okay. Thanks. I'll leave it at that. I appreciate the time.

Yeah. Justin, this is Jim. Just to put a little more color maybe on the first of your questions around the gross margin improvement from 2019 to 2020. We benefited from several things, including the fact that part of our production was on the new footprint, and obviously the new footprint is more cost-competitive than the one that we've recently closed in Shoals. But also we were benefiting from several years of material cost reductions, and also the fact that both footprints for the quarter, the old Shoals and the new Castaños, ran reasonably well. And I'd have to say the thrill for us is how quickly the new footprint in Castaños has ramped up towards efficiency. It has far surpassed our own internal expectations. So, in that sense and looking forward, we feel very confident in the future delivery capability of the new footprint.

Great. Thanks Jim. Appreciate those thoughts.

And our next question is from Matt Elkott with Cowen. Please proceed with your question.

Good morning. Thank you. Jim, and possibly Matt, I want to follow up on Justin's question regarding orders. We have seen improvements in utilization over the past several months. The number of cars in storage has decreased by 130,000 units since July. Rail traffic has shown positive trends, although we experienced multiple weather disruptions that impacted our network, potentially affecting rail equipment. Are you surprised that the order activity hasn't increased more significantly? Do you think it's possible we could see a sudden rise in orders over the next couple of quarters due to the changes in utilization?

Yeah. Good morning, Matt. I think you're probably onto something. Without getting into specifics, the level of inquiries that we're seeing, as I mentioned previously, includes a broader number of car types based on the timing we're hearing from customers. I think we're going to see some of that. It takes a while for order processes to go through all of their steps and to go from the inquiry stage to the order stage. But I think, the other piece of it, as you mentioned, is with an increase in traffic, some of the storage numbers, which are turning very positively, all lead to increased activity, not just the inquiry levels, but in order activity. And again, we see a large portion of the order activity falling into the second half of the year. So, your points are valid.

I believe we are beginning to see some changes in the metrics, particularly in leasing, as it appears that major lessors experienced around 5% sequential rate improvements over the last few quarters. However, manufacturing order activity has notably fallen behind. In fact, the fourth quarter may have been the weakest of the year in terms of orders. Do you think the political and COVID-related uncertainties from late last year influenced people's decisions to hold off on manufacturing orders and instead opt for short-term leases?

Well, I think it's safe to say that there were some pretty aggressive lease rates available out there across a broad number of car types and fleets available. So, those typically are going to get consumed first. To your point on customer sentiment, no doubt that COVID, the overall economy and uncertainty associated with the election and COVID vaccinations and the overall health of the economy and consumer spending, et cetera, had an impact on some of that decision-making. We're seeing where that is beginning to ease, and that customer sentiment is definitely improved. So, if we compare Q4 to now, we'll talk more about it in our first quarter earnings call, but definitely sentiment has improved, and we've seen a significant change over the course of the last 90 days.

Matt, this is Jim. I want to add that at FreightCar America, we have been focused on restructuring the business. It’s easy to overlook that we are still experiencing a once in a century pandemic with global chaos. When you factor that in with the existing railcar industry recession, we must rely on key indicators like railcars and storage, which are showing improvement every month along with general economic indicators. Like everyone else, we anticipate a recovery; it's not a question of if but rather the nature of that recovery. Will it be sudden and strong, or will it take a more gradual approach? We wish we had the answer. A quick recovery would be great, but if it's gradual, we believe our new structure and footprint will allow us to manage through it. For us, the key focus is determining when to expand our assembly lines. Being smaller is advantageous while the industry is still adjusting, but we want to be ready for the rebound. Therefore, our attention is currently on planning for additional capacity in our new setup.

Jim, you are operating as a different kind of company at many levels right now. Can you discuss your sales efforts? Has your outreach been less effective? Are you targeting a different type of customer or focusing on a different kind of railcar? I'm curious if all the changes you've made have led to a shift in your customer profile.

I'm going to start with a couple of ideas, but then I'll let Matt add more. When considering the two biggest competitors and the smaller companies, there’s a significant opportunity in the market in between. From a broad perspective, we see a favorable position for ourselves in that space. As we mentioned earlier, we don't intend to be a major player in the leasing aspect of the business. We view ourselves as a dedicated manufacturer, which allows us to collaborate effectively with leasing companies. There's a natural synergy there in terms of partnerships and customer relationships. Regarding order sizes, we recognize we're a small company, and it's essential for us to excel at model changeovers and maintain our efficiency in engineering, an area we are well-known for. Our ability to adapt to customer needs is paramount. We've been talking about purpose-built solutions, allowing us to operate with smaller quantities on our new footprint. For instance, we started receiving materials in Castaños in July, four months before AAR certification, began production in August, gained certification in October, and started deliveries in November, yielding positive gross profit for the quarter. Up to now, we've completed three model changeovers. Our focus is on engineering to meet customer needs efficiently. We've invested significantly in flexible tooling to enhance our changeover processes, which allows us to reduce time since we perform partial rather than complete physical changeovers. With our experienced team in Castaños, we can execute these changeovers even faster and more cost-effectively. I hope that clarifies your question. Matt, would you like to add anything?

I think Jim covered all the key items. I’d like to emphasize our strong position in the marketplace, supported by customer feedback indicating that we provide a better value compared to some competitors. We aim to collaborate with our leasing partners rather than compete for lease opportunities. Regarding our purpose-built facility in Castaños, we have the manufacturing and volume flexibility that serves us well with various customers, leasing companies, and shippers. We can execute smaller production runs efficiently and adapt with minimal disruptions to our capacity. We engage with multiple customers, and I believe our capability to serve them purposefully distinguishes us from many competitors.

Got it. Thanks so much for the insights, guys. Appreciate it. And Terry, congratulations on the new role.

Thank you. Look forward to meeting you.

Thank you again for your time today. We're truly excited about the future of the business. Our transformation is now largely complete, and we are beginning the process to pivot to growth as we continue to build momentum in 2021. Have a great day and thank you very much.

This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.