Trinity Industries Inc Q3 FY2021 Earnings Call

Good day, and welcome to the Trinity Industries Third Quarter Results Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. Before we get started, let me remind you that today's conference call contains forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995 and includes statements as to estimates, expectations, intentions, and predictions of future financial performance. Statements that are not historical facts are forward-looking. Participants are directed to Trinity's Form 10-K and other SEC filings for a description of certain of the business issues and risks, a change in any of which could cause actual results or outcomes to differ materially from those expressed in the forward-looking statements. I would now like to turn the conference over to Leigh Anne Mann, Vice President of Investor Relations. Please go ahead.

Thank you, Eily. Good morning, everyone. We appreciate you joining us for the company's third quarter 2021 financial results conference call. Our prepared remarks will include comments from Jean Savage, Trinity's Chief Executive Officer and President; and Eric Marchetto, the company's Chief Financial Officer. We will hold a Q&A session following the prepared remarks from our leaders. During the call today, we will reference slides highlighting key points of discussion as well as certain non-GAAP financial metrics. The reconciliations of the non-GAAP metrics to comparable GAAP measures are provided in the appendix of our supplemental slides. The supplemental materials are accessible on our IR website. These slides can be found under the Events and Presentations portion of the website, along with the third quarter earnings conference call link. It is now my pleasure to turn the call over to Jean.

Thank you, Leigh Anne, and welcome to Trinity. Good morning, everyone. Trinity had another strong quarter on a consolidated basis and continues to make great strides to optimize returns, highlighted by our newly formed joint venture with Wafra and our new $250 million share repurchase plan, both of which Eric and I will talk about later. Overall, we remain very confident in our ability to execute and hit the targets we shared with you at our Investor Day a year ago. Let me summarize some key themes from our third quarter. At the industry level, fundamentals continue to improve broadly but unevenly. While industrial production levels have ebbed and flowed with supply chain disruptions, overall industrial production is approaching pre-pandemic levels, and strong North American economic growth is forecasted over the next few years. With these macroeconomic trends, rail carload volumes are rising from last year's lows. At the same time, the population of railcars in storage is just falling with elevated scrapping levels and relatively slower train speeds. From our vantage point, the improving railcar demand recovery will continue into 2022, which is very supportive of fundamentals in both of our rail-focused business lines. Let's look at the impact of these trends on our consolidated results, highlighted on Slide 4. In the third quarter, Trinity generated revenue of $504 million, up 10% from a year ago. Our GAAP EPS was $0.33 compared to an adjusted EPS of $0.29. We'll detail both businesses in a few minutes, but I think it's important to note the strength of our diversified platform. While our Rail Products Group results may vary from quarter to quarter based on our specific orders delivered, Trinity drove solid and consistent cash flow growth in the third quarter. Cash flow from operations totaled $93 million, and free cash flow or excess cash after all investments and dividends was $157 million. Eric will go into more detail, but the important takeaway here is that our model can drive significant value creation through stable cash flow and a return of capital to shareholders. In summary, we remain pleased with our execution against our returns optimization initiatives and are equally excited to see continued strength in the industry fundamentals that underpin our future results. Let's turn to Slide 5 and review the railcar market as a whole. First, rail carloads and traffic continue to improve. The industry carloads are now roughly 6.5% above 2020 year-to-date, and we're moving closer to pre-pandemic levels last seen in 2019. Railcars in storage declined 6% compared to a quarter ago, aided by continued scrapping activity and continued deployment of idle assets in key markets like boxcars, gondolas, hoppers, and tank cars. Relative to the modest increase in carload levels, slower train speeds are also helping to drive railcar demand as the average railcar in North America is getting fewer terms. Against that backdrop, Trinity's fundamental key performance indicators are improving as well. Our utilization improved from last quarter to 95%, and the future lease rate differential, which we call the FLRD, turned positive and now stands at 1.4% compared to a negative 20.9% just a year ago. Demand for new railcars has been exciting as well. In the quarter, we took orders for 2,530 new railcars, up 27% compared to a year ago. As we noted last quarter, we believe stronger underlying leasing dynamics and higher car pricing should continue to positively impact our results, and new deliveries will likely trend in line with replacement levels in 2022 and 2023. To be clear, the trend may not be linear each quarter as our Rail Products segment results prove. That said, we remain very encouraged by the industry dynamics in place today. On Slide 6, let's turn to Trinity segment results for the quarter. In our Leasing business, revenue improved slightly compared to last quarter based on a combination of fleet growth, higher utilization rates, and increased service fees. Revenue growth in the quarter was also partially offset by lower average lease rates as we cycle through legacy renewals. To contextualize that impact, it's important to note that the forward indicators for lease rates are positive. Specifically, our renewal rates in the quarter were 7% higher than expiration. And our view on the overall lease rate trend remains positive as evidenced by the trend in the FLRD I mentioned earlier. Our margins in Leasing and Management Services were also strong, up 340 basis points compared to a quarter ago. Our Leasing business benefited from higher service fees in the quarter, partially offset by fleet operating costs. We also had modestly higher depreciation driven by our successful sustainable conversion program, which I'll detail later in my remarks. Recall from our commentary earlier this year that we expect these expenses required to position the lease fleet for increasing demand will be a headwind to the Leasing segment margin for the year. That said, we believe the headwind in the short term is a good problem to have, given the value being created by rising demand and the resulting long-term returns to Trinity. Now looking at our results in the Rail Products Group. Margin improvement progress year-to-date was offset by labor shortages and turnover, as well as supply chain disruptions. Specifically, operating margins in the Rail Products Group for the quarter were a negative 0.9%, compared to 1.2% last quarter. The path of the recovery in this segment will likely be less linear given quarter-to-quarter dynamics like delivery mix, supply chain disruption, and labor shortages. That said, we remain confident based on two main indicators for the business. The first is that the demand for railcars continues to rise as evidenced by utilization, lease rates, and orders in the quarter. The second key indicator is railcar values. While higher input costs like steel can serve as a near-term headwind to our deliveries, we remain very confident that higher costs will drive higher railcar values and ultimately margins as older orders work through our pipeline. Lastly, it's important to note that while this quarter was challenged, Trinity continues to make significant progress on our expense optimization initiatives in the Rail Products Group. I'll move to Slide 7 with an update on returns optimization initiatives. We were busy and made some great progress over the quarter. Beginning with our balance sheet, Trinity and Wafra, an institutional investor, announced a joint venture partnership that targets $1 billion of diversified railcar asset sales over the next three years. The joint venture is a significant step in our commitment to optimize Trinity's balance sheet and drive ROE. Trinity also renewed our commitment to return capital to shareholders with a new $250 million share repurchase authorization. In our view, shareholders benefit both from the strong free cash flow that Trinity's portfolio generates and also as we optimize our balance sheet to help drive better returns on equity for the overall enterprise. Touching on our enterprise cost reduction efforts, Trinity disposed of three properties in the quarter for a total of $8 million in proceeds and $3 million of gains on asset disposal. In manufacturing, we continue to drive meaningful improvements as our lean initiatives and other cost programs have reduced the breakeven cost of producing a railcar. Turning to our lease fleet optimization. Clearly, the Wafra portfolio sale was a key event, driving $325 million in proceeds. Similar to last quarter, we were also busy on the investment side as we spent $112 million in leasing CapEx to add to and improve our lease fleet during the quarter. Looking at the fourth quarter, we would expect the pace to slow as we onboard and optimize for the actions taken year-to-date. The key takeaway here is that fleet returns have improved both from mix and the accretive reinvestment of sale proceeds. In addition to portfolio transactions, Trinity closed on a small $4 million secondary market acquisition. In the third quarter, our fleet improved as we doubled the volume of sustainable conversions of tank cars, which totaled 242 compared to 119 last quarter. Through the end of the third quarter, we have received orders for over 1,400 sustainable conversions, which include a mix of tank and freight cars, comprised of internal and external orders. These sustainable conversions allow us to pivot our fleet by converting or upgrading existing railcars to better meet the challenging demand of the market and to improve the yield of our fleet. This is an important piece of our fleet optimization effort. Lastly, to update on our new products and services, we are on pace with a number of initiatives. For Trinsight, we now have reached our 2021 goals for customers paying subscription fees for the service. Additionally, new product development will hit our full goal for 2021. In conclusion, Trinity remains very confident in the three-year plan we outlined at our day last fall. And we still have a number of ongoing initiatives to continue to enhance returns especially as railcar fundamentals continue to improve into 2022 and beyond. Before I hand the call over to Eric, I'd like to take a moment to discuss our focus on sustainability. Trinity is committed to being a market leader in promoting and enhancing the sustainable environmental benefits of rail transportation. We believe a more sustainable transportation system starts with a shift from highway to rail, as rail reduces emissions to move one ton of freight by 75% as compared to on-highway and leads to less congestion and less wear on our critical infrastructure. To promote this transition, we prioritize product and service ideas, which enable shippers to improve the efficiency of their supply chains, moving more freight with fewer railcars and fewer carloads. We've discussed a few of our new products that fulfill this forward-thinking, more sustainable vision, including our newest train car and Trinsight. Trinity has also put great focus in leveraging existing assets to meet new demand through our sustainable conversion program. This eliminates the need to produce entirely new railcars in certain markets. Earlier this year, we introduced the railcar leasing industry's first green financing framework. And as of quarter end, approximately $4.3 billion of our railcar-related debt meets this designation. At our facilities, we've implemented a number of different programs to reduce emissions, limit water use, and recycle waste. In meeting our purpose to deliver goods for the good of all, we strive to reduce our environmental impact and increase our positive impact on people. With that, let me hand the call over to Eric for more detail on our results.

Thank you, Jean, and good morning, everyone. I will begin on Slide 8 with a summary of the quarter. Overall, as Jean said, Trinity continues to benefit from both the steady improvement in railcar demand and our strategic initiatives. Starting with the income statement, third quarter consolidated revenue totaled $504 million, up nearly 10% compared to a year ago. This was driven by higher external deliveries in our Rail Products Group, as well as continued improvement in leasing fundamentals in the highway business. Adjusted earnings per share of $0.29 grew both sequentially from $0.15 and year-over-year from $0.17, driven by a combination of better fundamentals, gains on lease portfolio sales, and our share repurchase activity. Our third quarter results were negatively impacted by accelerated depreciation associated with our sustainable railcar conversion program. Our adjusted EPS number excludes a $0.04 benefit from insurance recoveries related to the tornado damage at our Cartersville facility. As discussed, our joint venture portfolio sale positively impacted our third quarter earnings with a gain of $33 million on our $325 million transaction. In this joint venture, Wafra owns 90% of the equity, and Trinity owns the remaining 10%. Similar to the improvement in lease fundamentals, our new RIV transaction is another example of the broadening market for leased railcar assets. Looking forward to next quarter, we expect our consolidated fourth quarter margins to be relatively consistent with our third-quarter results before the impact of lease portfolio sales. Turning to the cash flow statement, year-to-date cash flow from operations totaled $428 million. Cash flow from operations in the third quarter was $93 million, which includes the collection of $41 million of our tax receivable. Our remaining tax receivable is $192 million, which is not included in our full-year cash flow guidance. Last quarter, we guided to full-year cash flow from operations of $600 million to $650 million. Given the higher cost of inventory as well as working capital changes we plan to implement, we are reducing our target. Our revised guidance is a range of $450 million to $475 million. This is intentional as we are focused on strategic sourcing to mitigate inflationary pressures and protect against supply chain constraints as we increase the pace of deliveries. In the quarter, we had a net reduction in investment for leasing of approximately $204 million, consisting of $112 million of lease fleet investments, more than offset by lease portfolio sales. Year-to-date proceeds from lease portfolio sales exceeded the investment in our lease fleet by $41 million. Trinity's net lease fleet investment for the full year is now expected to be between $40 million and $70 million as we continue to make disciplined investments at attractive returns that support our lease optimization initiative. Manufacturing CapEx for the quarter was $4 million, which brings our year-to-date manufacturing CapEx to $22 million. Our manufacturing CapEx for the full year is now projected to be between $30 million and $40 million. Total free cash flow after investments and dividends was $157 million in the third quarter, which brings year-to-date total to $516 million. As Jean noted, the strength of our platform continues to drive these cash flows and allows Trinity to drive value to shareholders through the return of capital. Year-to-date, Trinity has returned nearly $0.5 billion to shareholders, with $69 million in dividends and $405 million in share repurchases, which represents approximately 17% of our market capitalization. If we turn to Slide 9, let's review our capitalization. Trinity continues to have a very strong financial position, highlighted by quarter-end liquidity of $1.1 billion, even after the return of capital I just discussed. This liquidity provides flexibility as we plan to generate additional shareholder value through disciplined returns-focused capital allocation. Our strategy to drive returns over asset growth remains unchanged. While we expect to make investments in our lease fleet for growth, especially in markets where we can meet increasing demand, we remain committed to the return of capital. As you can see from our actions to date, our strong cash flow affords us the ability to do both. This quarter, we completed our previous $250 million share repurchase program and launched a new $250 million authorization that runs through 2022. We continue to optimize our balance sheet and improve our return on equity, which is a key focus of our long-term strategy. In closing, we are progressing well against our strategic plan. We are proud that Trinity continues to execute against our goals. While Trinity is not immune to the challenges of the current operating environment, our financial position showcases the resilience of our platform and the ability to deliver returns through the cycle. As the market recovers, we will demonstrate the power of our platform to generate attractive risk-adjusted returns. Eily, you may now take us to questions from our participants.

Our first question today comes from Matt Elkott with Cowen.

Jean, Eric, Canadian National said that the one thing that they're most enthusiastic about is the green energy carloads related to Alberta's growth in the hydrogen energy projects. They said that the potential is the peak of the crude by rail, but only much more sustainable. Is that something that presents an opportunity for you guys?

Yes, Matt, thank you for the question. And we have looked at hydrogen and continue to look at the different types of fuels that may be able to be transferred by rail. It's on the radar. We're doing some development on that, and we'll continue and hope that overall, the government approves the movement by rail for the hydrogen.

Okay. And if such an approval is granted, how much lead time should we expect before you guys have an appropriate car for that?

It would really depend on our design, which fits fairly well. The key factor will be the testing required by the various governments or countries to allow that on rail.

Got it. And just one more question on the guardrail business. Is the improvement in anticipation of the infrastructure bill? And can you just talk broadly about how exposed to the infrastructure bill this business is? And maybe address some of the remaining small litigation risk on the state level.

Sure. The highway business team performed exceptionally well, achieving the best third quarter in the history of our highway operations. The business is progressing due to significant input cost management, which we are able to pass on, along with freight costs, contributing to higher revenue. Regarding the infrastructure bill, yes, it will have an impact, but it is likely to be at least 6 to 12 months away. The bill needs to be passed, and the programs or construction must be approved before they typically purchase guardrails later in the cycle, closer to when construction begins. Concerning litigation, we have noticed minor changes in our updates, with a decline in new cases over the past few years, and we anticipate this trend to continue. Matt, did I cover everything you needed? Or do you have a follow-up?

I understand it was a 3-part question, but regarding the demand related to the infrastructure bill, even with a 6- to 12-month delay before it impacts the business, I expect that confidence will rise immediately after the bill is passed, which could result in increased inquiry activity. Is that reasonable?

I think it is. I think people may prestart some projects or they may go ahead with some, but we'll have to wait and see when it gets passed and what confidence it puts out there.

Our next question comes from Allison Poliniak with Wells Fargo.

Just want to turn to the input cost inflation that you kind of called out for manufacturing. I guess, one, is it steel or is it actually the components that you're seeing the most inflation? And I guess, you had mentioned some older contracts. Is there a way to think about how that evolves where some of these input inflation starts to get rolled into the contracts going forward in terms of deliveries? Any color there?

Yes, Allison, this is Eric. In the quarter, the impact was likely more related to steel and surcharges than to specialty components. Additionally, industrial gases like oxygen and nitrogen were disrupted as they were redirected for hospital use due to COVID, which certainly affected operations. On the specialty side, there may be some downward pressure on specialty components in the future. Regarding the backlog, as Jean mentioned, it won’t be a straightforward linear progression. We will need to address some older contracts, whether they are fixed price or escalatable, which were agreed upon during a time of less favorable demand compared to now.

Got it. Just a broader question. Jean, you mentioned feeling comfortable with deliveries reaching that replacement level. One concern we're hearing often is that the railroads aren't operating as efficiently as expected due to certain network challenges, which might not necessarily add capacity to the situation, but could potentially cause some demand to revert. Can you provide any insights on your thinking regarding this? Or is your comfort with the replacement level based on limited impacts from some items returning to storage?

Sure, Allison. So when you look at the number of cars getting scrapped per year, remember, we have scrapped around 50,000 in the last two years. We're on pace to do that and maybe a little bit more this year. And the car types that are getting scrapped, many of those have high demand right now. So they're going to need those replacement cars if it's boxcars or grain cars or others. So our confidence in what we laid out there for demand for the industry for the next couple of years, 40,000 to 50,000, is really based off replacing the cars that are being scrapped right now. So it's not a large increase overall in demand.

Our next question comes from Gordon Johnson with GLJ Research.

This is James Bardowski in for Gordon. So I guess the first one is it relates to the new JV. Was that for about 2,000 railcars, give or take?

No, it's about 3,600 railcars. There will be more detail in our Q, and there is also an 8-K that we filed in August with a lot of those details. It was around 3,600 railcars, and the proceeds were $325 million. I want to mention that this joint venture really demonstrates our platform. It addresses many of our initiatives, aligning with our efforts to optimize our lease fleet and balance sheet.

Right. Okay. That's helpful. Clearly, that affects your utilization rate as well as your loan-to-value ratio. Is that fair to say? And secondly, without that sale, what would the utilization rate have been?

It would have a slight impact on the utilization rate by lowering it a bit. The 3,600 railcars we sold were all utilized, so selling 3% of the portfolio at full utilization does decrease the overall rate a little. I haven't calculated the exact impact, but it's something you could figure out. Regarding the loan-to-value ratio, the proceeds of $325 million included some railcars that were unencumbered and some that were from our debt facilities, so there are various factors to consider. Ultimately, our leverage for the wholly owned fleet increased slightly this quarter to about 63%.

Yes. So that is within your earlier range that you previously guided. Is there any change in terms of your strategy right now in terms of capital allocation?

Sure, James. Yes, you're correct. The target we set was 60% to 65%, and we are currently at the midpoint of that range. This range remains our near and midterm target. We haven't made any changes, but we do have the flexibility to adjust it if needed. As of now, that range is still applicable.

Okay. Great. And then just a couple more. I'll try to speak through them. But you mentioned that you were going to focus on accelerating deliveries. Can you just let us know how much your backlog you anticipate shipping this year?

So I think we talked about getting cars ready for delivery. So they could go in, in the market quicker. But market activity remains strong. And for the year, I don't know that we came out with what percentage.

It's in the quarterly report how much of our backlog is set to deliver this year. It’s approximately 32%, with 31.8% representing the portion of our delivery for 2021 in terms of new rail delivery in dollars.

I'll wrap this up with a final question since it is quite a complex one. I apologize for that. Considering the rising costs we are experiencing, can you clarify how much of the increase in lease rates today is due to improving conditions versus simply the lessors passing on higher costs?

So when you're looking at the rate changes that we're seeing, a lot of that has to do with supply and demand. In the markets where you have fewer cars available, we're absolutely seeing the rate increase. I mentioned that we had a 7% in the quarter increase on the renewal rate versus the expiring rate and that our forward-looking FLRD was positive. So that means looking at the cars that will be coming off of lease or expiring, we're expecting to see an increase overall in those rates. So it's still a positive trend for us.

Our next question comes from George Sellers with Stephens Inc.

So I guess my first question, you talked about railcar valuations increasing. And I'm just curious, so I know pricing varies by car type, but could you talk about the percentage increase you've generally seen in new railcars? And then how much of that is a function of higher commodity prices versus more just core pricing trends?

So George, the mix of car types and the amount of steel are important factors. We've noted that with input costs doubling and tripling compared to pre-pandemic levels, core prices have generally increased by 20% to 30%. A significant portion of that increase is attributed to steel and input costs. Additionally, it likely varies based on the starting margins. Overall, margins have improved in the last few quarters.

Okay. That's helpful. And then you talked about the backlog, but could you say how much of the current backlog is going to be delivered to the lease fleet in the fourth quarter?

I didn’t address that, but I will look into the Q. Please give me a moment, and I’ll find that information. 34% of our deliveries are connected to the leasing company in the fourth quarter.

Remember, in the past, we've told you that typically, the railroads and the third-party lessors will come in and buy new cars first, that's still occurring right now. We're getting some secondary market or in-shippers buying. But the majority are still railroads first and then third-party lessors.

Our next question comes from Bascome Majors with Susquehanna.

In the spring and even in the summer, you had talked about how you were really well positioned on manufacturing labor, being an employer of choice in East Texas and the regions you're in, in Mexico. It does seem like that has become more challenging. Can you unpack to us kind of what changed in the last 3 months? And maybe give us a little bit of visibility into regionally or functionally where you're having the most challenge with labor and how feel that's trending as we get deeper into the fourth quarter?

Sure, Bas. This is Jean. I'll take that. So we were very fortunate during the beginning of the pandemic not to have the supply chain and labor issues. And as we've gotten further in, it was just this past quarter that we started to see some things. Some of it, we think, is transitory and that's going to be some of the gases that Eric already talked about, where there was a short-term disruption in supply. And then we had some valves. As far as the labor, in Mexico, it's still very strong, very low turnover, very low shortages. But in the U.S., just like I think every other company who has labor is experiencing some of the higher turnover as people are leaving for other jobs or even retiring and taking themselves out of the marketplace. So that came in, again, more the third quarter for us. And it's something that we'll continue to work on, like everyone else, making sure that we're positioning ourselves in the best place to respond to the needs of the market.

Have your pain points in the U.S. started to stabilize? Do they feel like they're getting worse? Just curious where that stands versus the surprise you started to feel in the quarter.

So the beginning of the quarter, it was a little less. It went up and it's pretty much stabilized from there. So it's, again, just getting now the resources in place to be able to make sure we continue to meet all the demand.

It was encouraging to see your future lease rate differential show a positive inflection for what seems to be the first time in your reporting. Can you share what that looks like on the ground? Are we reaching a point where the price increases in new cars, which you mentioned earlier, are leading to a quicker change that we often see during upcycles, where lease rates can rise rapidly? Are we at that point yet? Are we approaching it? Do you have any insights on the supply-demand dynamic and how new car price inflation might affect lease rates next year?

I'll start on that and then turn it over to Eric. Now remember that our fleet does expire at different times. So about 17% to 20% of the fleet expires each year. So when you're looking at the change of that lease rate, it is over many years to work through all of them. We mentioned the 7% increase on renewal rates versus expiring for the quarter, but the overall average lease rate for the quarter still had some headwinds. So it's still down a little bit. So I think it will take time to work all the way through, but we are encouraged. We've seen the renewals go up. And in the markets where the supply-demand metric is more towards needing more supply, you'll see that move quicker than some of the other areas. I don't know, Eric, would add?

Yes, Bascome, I would just add to Jean's comments that it does change car type by car type, but in absolute terms, newer railcar prices which lead to higher new car lease rates will cause existing car rates to allow existing car rates to come up as you price them. But then also, we've seen steady for 15 months railcars coming out of storage; it is that metric. So the fleet continues to get tighter, both from attrition and from increased railcar loadings. So both those things increase railcar loadings or needing more railcars to move the same freight. So all of those factors are tailwinds to demand for existing assets and new assets and should lead to opportunities to improve pricing. I think that's one of the benefits of our platform is as a large manufacturer, as a large lease company with our maintenance operations, we see the market, and we generally are able to see these points of inflection quickly and respond accordingly.

To wrap up that discussion, I apologize if this was already mentioned in the prepared remarks; I was on other calls. Is there a way to consider the incremental current renewal rate and how it's trending quarter-over-quarter or month-over-month? Any insights into the sequential improvement would be appreciated, with the understanding that renewals occur slowly and the overall average lease rate of the portfolio changes gradually.

Sure, Bas. I mean the market activity has absolutely been increasing. And so sequentially increasing, very, very strong for us as far as renewal rates or assignment rates that go into that. And then we are still seeing a lot of activities for quotes for new cars. And we see orders continuing to come through on that.

Our final question today comes from Steve Barger with KeyBanc Capital Markets.

Can you quantify the labor and supply chain issues in the Rail Group? I'm just trying to get a sense for how much of the operating loss was that versus volume and mix?

All three of them play a role in the results that we had going through. So when you're looking at supply chain, the inefficiencies that come in from not having gases to be able to do the work you need to do or another example of the valve that you need to put on play into the fact that you can't get the work done at the time that you wanted to. Then you also have the fact that you either have turnover or labor shortages to be able to do that work. So when you put all those together, it absolutely has an impact. We've not gone through to say, is that 25%, 30%? But when you combine all of them, I think you're going to hear most industries or industrials talking about that impact for the quarter.

And Steve, we've previously mentioned our order book being more focused on freight cars. However, I wouldn’t categorize that as a shift from the second quarter to the third quarter in terms of mix. The reason we’re highlighting the labor and supply chain issues is because those are the primary factors influencing our performance.

Got you. And Eric, I just want to make sure I understand your comment on what 4Q could look like. If you don't sell more cars into the JV, then plus or minus 4Q, it seems like it's going to look more like 1Q given the loss in the Rail Group. And I think most of your EPS came from the gain on sale this quarter, right?

My comments in the fourth quarter were focused on margins before considering the impact of car sales, specifically regarding margin percentages. When excluding car sales from the revenue we discussed, the margin percentages would appear similar. This is a beneficial way to interpret those numbers. Regarding car sales, we completed $325 million in sales to Wafra in the third quarter. As we mentioned, this is more of a programmatic effort over the next three years, and we do not expect to see significant transactions from Wafra in the fourth quarter.

Okay. How about the first part of next year? Is it…

It's a three-year deal with $1 billion. So you think about it ratably over that time.

Got it. And so if 4Q looks like 3Q for the Rail Group, then the Rail Group is not going to contribute to operating income this year. Do you think 4Q will be a trough for Rail Group margins? Or given recent ASPs for new orders, should we be tempering our expectations for the OEM business for the first part of '22?

Remember, I said it won't be a linear trajectory for the Rail Products Group. So it's really going to depend on the mix and the volume that are going through that. I would expect to see improvement. I'm just saying it may not be linear. And so we do have a lot of the optimization initiatives and lean initiatives that are still going on that occur through the full three-year period that we laid out in Investor Day. And as each of those complete, you'll see different types of improvements flow through our results.

But is it fair to say that given the ASPs that you've taken over the last couple of quarters and the volumes that you expect, that margins are not going to rebound sharply in the first half of '22?

I believe the average selling prices are more indicative of our product mix than our margins. It's important not to draw too many conclusions about margins solely based on average selling prices since they are largely affected by the mix. As I mentioned earlier, the margins on new railcars we are now acquiring are improving due to a better demand environment compared to what we experienced during the peak of the pandemic. As our backlog stabilizes and begins to extend, we generally see margin expansion on the manufacturing side. However, due to various supply chain disruptions and labor issues, we are being careful not to set overly optimistic expectations, as there is a lot of variability in the results. Overall, the demand situation is getting better, which positively influences the pricing environment.

Okay. And last one for me. Can you just talk a little more about the sustainable railcar conversion program? How are you converting them to make them more sustainable?

So as the markets change, we look and see that maybe you have a car type you could put into a different market and have better utilization and higher yield. So we can do some modification work to that, be it rethinking, putting in a different hopper, and things like that to go ahead and reposition that car and improve our overall utilization and improved yield.

Are you doing that on a speculative basis or in response to a customer saying, 'I want a new railcar. I don't want to pay the full railcar price.' And you finding a creative way to say, 'Well, I can do some work to this car and maybe make it suitable for your purposes?'

Great question. And we continue to say that we want to utilize existing railcars first, our existing assets, and that's what we're doing here. Instead of building a new car and having the older assets sitting there, maybe not as utilized, we're making the choice that, when it makes sense financially and from a return standpoint, to convert that car and put it to use in a market that may have either a longer run or a higher need at the time.

Steve, that will depend on the individual owner's perspective. Each fleet owner has their unique considerations. For example, some car types have recently experienced lower utilization rates, particularly small cube covered hoppers, which have become more prevalent as demand and carloadings have shifted. These are relatively new assets, and they fit into that scenario. Each owner will decide based on their circumstances. The same situation applies to tank cars, where some sustainable conversions can be performed, such as retanking. All these factors influence the decision-making process, which is also affected by the railcar's underlying age.

And it goes to the strength of our platform again. We have the capability of doing those conversions in our own maintenance shops. So it does help meet the demand for the customers and provide us a more sustainable product overall.

This concludes our question-and-answer session. I'd like to turn the call back over to Leigh Anne Mann for some closing remarks.

Thank you, Eily. A replay of today's call will be available after 10:30 a.m. Eastern Time through midnight on October 28, 2021. The replay number is (877) 344-7529 with an access code of 10152033. A replay of the webcast will also be available under the Events and Presentations page on our Investor Relations website. We look forward to visiting with you again on our next conference call. Thank you for joining us this morning.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.