FreightCar America, Inc. (RAIL) Earnings Call Transcript & Summary

Good morning. Welcome to FreightCar America's special investors call regarding its business repositioning. [Operator Instructions] Please note that this conference is being recorded. An audio replay of the conference will be available on the company's website within a few hours after this call. I would now like to turn the call over to Joe Caminiti, Investor Relations.

Thank you, and welcome. Joining me today are Jim Meyer, President and Chief Executive Officer; Chris Eppel, Chief Financial Officer; and Matt Tonn, Chief Commercial Officer. I want to highlight that we'll be using a PowerPoint to guide today's discussion that was posted to the Investor Relations portion of our website about 30 minutes ago. You can find that link on both the IR homepage and the Presentations section under our News & Events section. Please turn to Slide 2 of that PowerPoint, and I'll highlight our safe harbor statement. I'd like to remind everyone that 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 2019 Form 10-K and its second quarter 2020 Form 10-Q for a description of certain business risks, some of which may be outside 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. Our 2019 Form 10-K and earnings release and Form 10-Q for the second quarter of 2020 are posted to the company's website at www.freightcaramerica.com. With that, let me now turn the call over to Jim for a few opening remarks.

Thank you, Joe, and thank you, everyone, for joining us on such short notice. Today is a very important day in the history of our company. We are announcing new and substantially more aggressive steps to change the competitive position of FreightCar America, and we are pleased to be able to outline this in full detail for you this morning. Slide 3 summarizes today's agenda. I will first provide an overview of our vision for the company and where we are in our prior and much discussed efforts. Chris will then walk you through a review of the 2 transactions that we are announcing today and then will provide a review of our history and new competitive profile. I will then end by highlighting the steps we need to take to complete this work in 2020, and I will also provide a summary of our new investment value proposition, which is obviously critical for everyone on this call to understand. Please turn to Slide 4. Our vision has been to become the lowest cost, highest quality player in our industry since our work began roughly 3 years ago. Quality, price and on-time delivery are what matter most to our customers. We have also always believed that we had a business and legacy that should drive sustainable growth once we achieve that low cost, high quality position. However, that work has been hampered by 3 things: an uncompetitive manufacturing footprint that includes a key facility that has been too large for who we are today; a downturn in our industry's demand cycle that has further exposed this mismatch; and most recently, the COVID-19 pandemic. Today, we are unveiling additional steps to put those issues behind us, and we are going to walk you through the results of what has been an incredible amount of hard work by our team over the last half year plus. Using the core tenets of our vision, let's start with how we plan to become the lowest cost producer in our industry. As you know, we have significantly consolidated our domestically based manufacturing footprint since I took the leadership position at FreightCar America. We sold our Danville facility in mid-2018. We closed Roanoke at the end of 2019. And roughly 1 month ago, we announced our plans to close the Shoals manufacturing plant in Alabama by early 2021. These were not easy decisions as we have high-quality people and friends in each of these plants who not only did great work, but in the case of Shoals, were aggressively implementing lean manufacturing principles that were helping to drive stronger productivity and cost disciplines. However, with the onset of the pandemic, which intensified our industry's ongoing downturn, more aggressive and proactive action is needed in order to both allow us to achieve our goals and, frankly speaking, to ensure our future in view of these external factors. Thus, we are excited today to share that we have completed the purchase of our partners' interest in our joint venture in Castaños, Mexico. We now have 100% ownership of this important operation. Our competitors have been in Mexico for years, and thus, this is a strategic option that's been on our radar for some time. Our timetable, however, was significantly accelerated by the events of this year. We are fully repositioning because we need to be smaller right now and we need full ownership if we are going to put our full business in Mexico. This step makes us rightsized, and it allows us to be competitive across the entire spectrum of car types. Through this consolidation of our manufacturing from Shoals to Mexico, we will reduce our fixed costs by an additional $20 million per year or $25 million per year from the start of 2020, which results from both the closures of Shoals and our facility in Roanoke, Virginia. We will also achieve significant labor and variable cost savings that we will outline for you in a few minutes. We expect to reduce our breakeven by over 2/3, from 6,000 railcars per year when I started to below 2,000 railcars per year when these last steps are completed. The cost structure created by this final step puts us in a realm where it becomes much harder to be hurt in a downturn, and yet, we have also done it in a manner that allows us to quickly scale when the demand environment improves. As we look to our next goal, which is to become the highest quality competitor in our industry, the steps we are announcing today also support this. First, we now fully control the newest purpose-built manufacturing facility in North America, and this facility was specifically designed for our company. It is not too big, it is not too small. It is low cost by design. It is flexible in terms of its ability to scale up, and it readily accommodates all car types that we are likely to produce. Our partners in Castaños, the Gil family and Fasemex, have assembled a best-in-class leadership team, many of whom helped build and run 2 of our competitors' greenfield plants in Mexico in the past. The Gils have also attracted a highly experienced and cost-competitive workforce to the plant who are coming as close as it gets to executing a turnkey start-up for us. Thus, we have all the means we need now to truly lead this industry over the long term in terms of product quality. It may take some time to get there, but we believe we have the right platform and talent now to make that a reality. And that brings me to our third goal, which is to drive sustainable growth, which we know will equate to sustainable value for our stockholders. Becoming one of the lowest cost and highest quality players in our industry should put us in a position to win market share and grow, but we also will need a balance sheet able to facilitate that growth and to ride out whatever remains of our industry's down cycle and the COVID pandemic. We must not only come out of this but we must be prepared to properly leverage the impending up cycle when it starts. Last, I'm thrilled to introduce a new financial partner today, as we have agreed to recapitalize our business through a new $40 million secured term loan from an affiliate of Pacific Investment Management Company, LLC. This cash infusion, the funding of which is subject to certain conditions, will be used to create financial flexibility, complete the next build-out phase at the Castaños facility and fund new products. One of the benefits of that plant is that we can expand it from the 2 lines that exist today to 4 lines or more as we start to see our industry rebound, and we can do this without changes to the base property or the paint shop. But we will need additional capital to fund that expansion and to fund the working capital needs that we will have to build inventory and support our customers and our growth plans appropriately. This new capital has both a debt and an equity component attached to it, and I can assure you that we have been highly diligent in considering every option at our disposal. As I said, we spent significant time considering all of our options, and we believe this was not only the best solution, but a great solution that balances out some equity dilution with the prospect of owning a company that has a much stronger competitive position and growth profile. Please turn to Slide 5, and I'll take a few minutes to remind you how we got here. As many of you know, FreightCar America has been in business for over a century and has a legacy reputation as the premier manufacturer of coal cars. In the 2010s through 2017-plus, we diversified our portfolio to reduce our reliance on the coal industry as it was clearly in secular decline. With a history of engineering leadership in our industry, these new railcar designs were either fully competitive or simply best in class, but our domestically focused manufacturing footprint made our costs uncompetitive compared to most of our competitors. So within my first month as CEO of the company, I announced our Back to Basics operational excellence program, and we began aggressively implementing those work streams across our plants in early 2018. This included the footprint rationalization plan I previously discussed and the implementation of numerous lean manufacturing principles and supply chain strategies. This program was successful, and by late 2019, we had taken out over $7,000 of variable cost per railcar. This helped us lower our breakeven levels from 6,000 railcars per year to approximately 4,000 railcars per year. However, this progress wasn't enough, and we knew we still have work to do. That's obvious as you look at the financial results in the charts at the bottom of this page, in particular our gross margin trajectory. We also knew that there were many railcar types that our customers wanted us to build where we remain uncompetitive, and thus, we decided to invest in the joint venture in Mexico with our new partners to address labor costs and also to shut down our legacy Roanoke, Virginia facility. We entered 2020 with a decent balance sheet and the potential to become much more efficient and cost competitive, but the pandemic obviously changed the world very significantly and quickly in March of this year. I want to be clear that given the impact that the pandemic has had on our industry, in particular the elongation of downturn that we are currently still in the middle of, change is mandatory for us. We cannot afford to let our balance sheet deteriorate further while simultaneously, we also cannot afford to stop investing in our future. We need to take control of our fate, and we need to accelerate our plans for change. We must complete this plan and believe that it is the right strategy and essential to bring value and success for all our stakeholders. With that, I will pass the call to Chris to talk through the details of these 2 transactions and kick off a deeper dive into what FreightCar America will become as we look forward. Chris?

Thanks, Jim. On Slide 6, we highlighted the key components of the 2 transactions we're announcing today. First, let's talk to the details of our joint venture purchase agreement as we completed the acquisition of all outstanding interest in the former JV in Castaños, Mexico. Our JV partner, the Gil family, sold us their 50% interest in the operation in exchange for just under 2.26 million shares of common stock in FreightCar America and $173,000 of cash. That equals 17% of the outstanding common shares prior to the issuance and will be 14.6% of the total shares post issuance of the JV-related shares. We're excited to welcome the Gils as stockholders, and in consideration for their position in the company, we've agreed to add Jesus Gil to our Board of Directors later this month. Jesus has been heading up our operation in Castaños and will become our Vice President of Operations, overseeing the continuous start-up and ongoing operations at the Mexico facility. Jesus has approximately 30 years of railcar manufacturing experience in Mexico, and he was previously part of successful greenfield start-ups and managed operations for 2 of our largest competitors. We're excited for the continued contributions we know he'll make, both being a leader in FreightCar and also as a Board member. Now let's walk through the details of our new senior term loan. As Jim mentioned, we obtained $40 million secured term with an affiliate of Pacific Investment Management Company, LLC, with funding subject to satisfaction of certain conditions. The loan will have a 5-year maturity that is priced at interest rate of LIBOR plus 12.5%. If we have -- it will have a first lien on all the assets of the company except for U.S. receivables and U.S. inventory and then a second lien on those working capital assets. The financing also includes a warrant that will offer the lender the opportunity at a future date to purchase equity that represents up to 23% of the company's common stock at that time at a strike price of $0.01 per share. The company requires a vote of shareholders to approve the issuance of the stock and the exercise of the warrants after, which the lender will fund the term loan and will add its own voting member and 1 nonvoting Board observer. In summary, if we assume that the new term loan was closing today after the JV shares, the total dilution of the current shareholders would be approximately 35%. I want to reinforce what Jim said earlier, we do not take the dilution of the shareholders lightly. We've examined numerous paths to reposition this business for a stronger performance and growth, and we believe this was far and away the best path for all our shareholders. It will provide us with the ability to transform our manufacturing footprint, position our balance sheet for the current industry downturn and support our growth profile in the coming years. The dilution that comes with this transaction is associated with owning a new FreightCar America that has lower liquidity risk and a much improved forward trajectory versus one with limited ability to restructure its operations while dealing with a declining liquidity that governs our competitive position. Based on our analysis, we believe the new term loan is the right decision. With that, let's take a step back and walk through what FreightCar is today and what it will become when we complete this work. Please turn to Slide 7. FreightCar America is a premier railcar manufacturer and aftermarket parts supplier in North America. We're almost 120 years old. We were founded in 1901 and are headquartered in Chicago. 12 decades of industry know-how provides us with deep railcar engineering and design experience and over 160,000 of FreightCar America railcars serviced today. That's roughly 10% of the fleet in North America. Our customer base is blue chip, and many of our relationships have decades or more tenures. Furthermore, based on the fact that we focus on manufacturing and have deemphasized our leasing business, we are in a position to not compete with our midsized leasing customers. This is a unique position within the industry. Slide 8 provides the specifics of our new plant in Mexico in more detail. As you know, we have already invested alongside our partners to build out the first and second lines at Castaños. We are leasing the facility from our JV partners, and currently, it has 312,000 square feet of manufacturing space. As we enter into the second phase of the build-out, post the successful closing of this funding, we plan to add a third and fourth line that increases the manufacturing space to 492,000 square feet as the business supports. This plant will benefit from direct railway access and proximity to many of our key suppliers, which are some of the many low-cost attributes of this plant. Furthermore, through the footprint rationalization actions in 2019 and 2020, we remove almost $25 million of fixed costs annually. As Jim mentioned, we've already hired a highly skilled and cost-competitive workforce that, according to our projections, will allow us to save approximately 60% of our labor cost compared to our prior domestically based footprint. This facility offers a clear path towards our goal of becoming the industry leader in both cost and quality. On Page 9 is the critical takeaways from today's discussions. This shows how significantly we have and will be able to change our breakeven position through the team's hard work over the past few years. Our Back to Basics strategy cuts our breakeven 33% to 4,000 railcars per year, and now Castaños will cut that improved breakeven level by more than half to under 2,000 railcars per year. I will end my prepared remarks on Slide 10, where we highlight our key go-forward product focus. As Jim mentioned, we diversified our product portfolio in 2017, and then we further redesigned many of those with the Back to Basics mentality in late 2018 and early 2019. Those newer builds -- those newer designs built in our Mexican facility will immediately be more cost competitive against our peers who've been in that region for a long time now. I'll now turn the call back to Jim for a few closing remarks. Jim?

Thanks, Chris. And please turn to Slide 11. I know some of you are likely questioning why we believe a plan that will dilute stockholders is justified, and I want to address that question directly. We have executed an aggressive plan to reduce our manufacturing footprint, control costs and build best-in-class productivity, yet we have continued to see negative gross margins and over a 70% reduction in net cash position over 2 years -- in our cash position over 2 years. With the changes we made to our manufacturing footprint and the improving productivity we're seeing at Shoals as well as the 50% ownership we had in Castaños, we entered 2020 with some potential. However, the elongation of the downturn in our industry required additional and much more aggressive steps. Our historical approach of hoarding cash and controlling costs in the down cycles only to moderately, at best, participate in the up cycles is not sustainable. And clearly, it hasn't created the kind of stockholder value we would have liked. We must be ready to participate in the next up cycle, which we know will come given the backbone that our industry provides for numerous parts of the economy. Now is the time for change. Now is the time to invest in your future. Now is the time to reposition this business with a more flexible and cost-effective approach to success in the future. Please turn to Slide 12 where we have highlighted our go-forward sources and uses of capital. First, we ended the third quarter with $33.9 million as of September 30. We announced recently that we had replaced our historical asset-based credit facility or ABL with a new $20 million program with the Siena Lending Group. While the amount of that facility is lower than the previous facility it replaced, it has the flexibility we need to execute this new strategy. And we'll look to augment it in the future and as needed as we ramp up production in Mexico. And last, we have arranged a new term loan of $40 million with the Pacific Investment Management Company, LLC. This gives us potential available liquidity or capital of roughly $90 million if the term loan closed today. So let's talk about our expected cash outflows. First, we still have closing costs associated with both the finalization of our plants at Shoals and the transaction cost of these announcements today. We will invest in Castaños further, and we'll look to add the next 2 production lines at Castaños as demand in our industry returns and the up cycle initiates. As we start to win our fair share commercially and fill up production in Mexico, we will have significant working capital costs associated with building inventory, and we have future products that we would like to invest in to expand our portfolio even further. We estimate that we have at least $40 million in capital needs for all these items, and they alone would stretch our balance sheet fairly thin if everything went perfectly. However, we are still in the middle of the pandemic and our industry is still in the throes of its downturn. Proper risk management requires us to make sure that we can ride out these near-term challenges, invest in our business prudently and flexibly and exit in a position of strength. Please turn to Slide 13, and I'll review the last steps we need to complete in 2020 to finalize this process. First, our team at Shoals needs to complete the customer orders we have there. I want to thank that team again for their dedication and professionalism as they are fulfilling our commitment to our customers as they always have. Next, our American association of railroad inspections at Castaños are complete, and we expect to receive our official certification paperwork soon. The Castaños team is building railcars and will complete its first production run by the end of this year. We'll look to launch line 2 at the plant in the near term as well. Next, we've already started hosting live and virtual customer meetings at Castaños and have received great feedback so far. We will hold a virtual Special Meeting of Stockholders in late November and vote to approve the common stock issue under the warrant that we've announced today. You should see further details on that and the preliminary proxy statement fairly soon. And once that is complete, we will have welcomed 2 new partners to our Board of Directors. I'll close on Slide 14, where we have highlighted our new investment thesis. FreightCar America is over a century old, has a large installed base of railcars in the market today and it has always been a key component of an industry that is fundamental to industrial commerce in the U.S. We have deep product engineering talent across multiple car types which support many of the high barriers to entry in our industry. Our customers are commercially invested in our success as they want other credible options to our larger competitors in this highly concentrated industry. In particular, we are uniquely positioned to support our leasing customers as we are primarily focused on manufacturing and thus are not directly competing with them like our larger competitors are. The steps we have taken over the last several weeks will significantly change our competitive position and allow us to finally leverage those key strengths I just mentioned. We will own the newest purpose-built manufacturing facility in North America, which is appropriately rightsized for our current market conditions but has the ability to scale as demand improves. We will have one of the lowest breakeven points, if not the lowest, in the industry at under 2,000 railcars per year. We will remain intently focused on achieving our goals to become the lowest cost and highest quality producer in railcars. We will have a significantly enhanced profitability and free cash flow profile, all of which will help us leverage the next up cycle in our industry and expand our share in the future. I look forward to sharing this new journey with all of you. That concludes our prepared remarks. And I'll now turn the call back to the operator.

[Operator Instructions] Our first question comes from the line of Matt Elkott with Cowen.

I had sort of a macro type question. We're seeing some positive signs in the rail industry. Rail traffic decline is decelerating, railcar utilization improving for 3 consecutive quarters. I wonder if you can share some of your thoughts on what you think the next railcar industry expansion will be driven by and how much of that may be related to the kind of fundamental shift in the way people live their lives now, switching from a travel and service economy to more of a product economy. Is that part of what's helping the intermodal recovery? And is intermodal going to be a big part of the next expansion? Any thoughts on that front would be helpful.

Matt, this is Jim Meyer. Our -- Matt Tonn, our Chief Commercial Officer, is here with us, and I'll ask him to provide his insights on what's going on in the marketplace.

Matt, yes, you're spot on. We're seeing some increased traffic on the intermodal side. That's positive growth. I think we're really at a point of near pre-COVID levels in terms of traffic, and we're seeing pockets elsewhere. I think the return on the rail side in demand is really driven by the same issues we've seen from the past, which is car storage numbers starting to dwindle. We're starting to see quarter -- last 2 quarters, we've seen a drop in railcar storage numbers, which is a positive. Traffic increase is another big aspect of it. And I think lease rates for freight cars, we need to see some stabilization and increases in that marketplace. I think when we see those things occurring in the market, it's when you'll really start to see a change in railcar demand and start in terms of an uptick of new orders.

Got it. Well, one of your customers, I guess, just reported, and noted a flat to slightly up lease rates on an absolute spot basis in the third quarter. So that was one of their remarks. And can you remind us your intermodal equipment customers, what's the makeup of that? How much of that is lessors? And how much of that is rail in the form of the rail partnership? And how much of it could be shippers?

Yes. Matt, this is Chris Eppel. I know -- we appreciate your question, but we're not -- we haven't been giving out our specific customer-by-customer amounts and positions. But I think it's safe to say that for the folks that buy that product, we have a great offering, and we participate in those bids and that opportunity to pick up additional units going forward.

Okay. And just one last question for me. And sorry if I missed this on the call, but when can we expect to get some more specificity from you guys as far as targets? And it doesn't have to be an EPS target, but any form of guidance as you restructure the business and implement all these changes?

Yes. Matt, it's -- I understand the question. So I think the big guidance that we have come out with is that we're at -- once we complete these actions and heading into next year, we're at a significantly different breakeven point, which I think is a very clear overview of the potential of the company going forward as normal. In our year-end, we will be giving some guidance on a limited basis. And we'll -- as we see a better ability to predict and lay out that, we'll kind of use that to decide how much is reasonable to give out during our year-end. But as a reminder, our third quarter call is November 9, and we will not be giving any 2021 guidance at that point. But that would obviously be reassessed as part of our year-end announcement.

Got it. And so do you think -- standing where you are now, do you think that -- and given what's happening in the market and if it continues at a gradual pace, do you think that breakeven on an EBITDA basis is achievable in 2021? And net profitability, is that plausible for 2022?

Matt, this is Jim again. We're not in a position or wanting to give guidance at this time. So we're not going to answer that directly. What I would do though is just -- I would like to just go back to your question about intermodal for just a second and just remind you and everyone else that in the 2018, 2019 time frame, our intermodal well car was one of our focused products that we substantially redesigned and retooled and built at the Shoals and built it well under good economics. And now that we're moving that product with everything else on to the Mexico cost structure, that should put us in all the more competitive standing. So to your earlier question, we'll feel very good about our ability to participate in that piece of the business.

Ladies and gentlemen, that's all the time we've allotted for the call today. I'll now turn the floor back to Mr. Meyer for any closing comments.

Thank you again for your time today and your continued support. It's an exciting day, and all of us as stockholders have an important vote to approve to solidify our path forward. We believe strongly that the strategy we have unveiled today is the right one, and we look forward to seeing what the new FreightCar America will do with its new highly improved competitive position. Thank you again for your support, and have a great day.

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