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

Greetings. Welcome to the FreightCar America strategic update conference call. [Operator Instructions] Please note, this conference is being recorded. I will now 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 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 in 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. The press release for this call is posted on the company's website at freightcaramerica.com. With that, I'd like to turn the call over to Jim for his opening comments.

Thank you, Lisa. Good morning, and thank you all for making time to join us today. Since we will be well into March by the time we discuss our fourth quarter and full year 2021 results, we decided it was appropriate to hold this call today to talk about the state and direction of the company, share our recent progress and to provide additional transparency as we start the New Year. For all practical purposes, 2021 marked the end of the old company and the birth of the newly transformed company. And while the new company is currently relatively small and with much growth still in front of it, it is a fundamentally much healthier company. 2022 will be the first full year where we are manufacturing 100% of our railcars in Castaños, Mexico. It will also be the first year for which our operations and results will not be obscured by restructuring activities. As such, we believe that our performance this year will provide more clarity on the full potential of the business. Before we get into what the future may hold, I think it would be helpful to provide a brief synopsis of where we came from. The company's more recent history through 2021 included mixed results and underlying challenges. It included periods of strong profitability, driven by either demand surges for FreightCar America's historical products or other shorter-lived dynamics in the marketplace. However, in spite of still having some very profitable years, the company needed to change in order to stay relevant for the long term. Our reality, starting about 5 years ago was that our footprint and cost structure no longer match market demand resulting in the significant financial losses we experienced. This led us to embark on our Back to Basics initiatives in late 2017 to rightsize the company while also further diversifying our product range. During this period, we shed our 2 legacy coal car manufacturing facilities in Danville, Illinois and Roanoke, Virginia and began an aggressive cost reduction program. We attacked fixed cost, variable overhead costs, raw material costs, essentially all costs with the exception of labor rates, which were largely dictated by U.S. market conditions. However, as the benefits of this work began to come to fruition, industry demand for new railcars in general, weakened sharply followed by the global pandemic. Although painful, these external events forced us to take the very difficult but necessary step to further resize and move our manufacturing operations to Mexico and to exit the Muscle Shoals, Alabama factory, which had become too large and too expensive to operate. That period is now behind us. We are through the long, complicated restructuring, and now we are entering a period that we expect to be marked by growth and profitability. Castaños, Mexico is where all our railcars will be produced this year and every year forward for as long as we foresee. Compared to the past, this change takes our cost structure to a much better level for a fixed cost, variable overhead costs and this time, labor as well. We decided our Castaños for a multitude of reasons. Castaños is a railcar building town and in the heart of the industry. The area has a large and well-trained talent pool, steep supply base and rail shipping infrastructure for exporting our products to the United States. I will now describe the new FreightCar America in physical terms. We have 3 locations: a corporate office in Chicago with approximately 30 employees, including some who work remotely; our parts business and a technical center in Richland, Pennsylvania, with about 20 employees, including our industry-respected engineering team. And then finally, our new manufacturing center in Castaños, Mexico with approximately 950 employees currently. Today, Castaños consists of 2 production lines, a wheel and axle shop and a paint shop and is designed to produce approximately 2,500 railcars per year. As you heard us state in the past, our footprint is capable of expansion without disruptions to existing production and was conceived to achieve breakeven adjusted EBITDA at approximately 2,000 railcars per year under normal business conditions. Before we get into our priorities and outlook for 2022, let me briefly review our 2021 successes, and how we progressed against our goals this past year. While we continue to face higher steel prices, a highly competitive pricing environment and other challenges related to the pandemic and tight supply chain, when we report fourth quarter earnings, we expect our fifth consecutive quarter of positive gross margin, our third consecutive quarter of positive manufacturing operating income and our first quarter of positive adjusted EBITDA since opening Castaños. It is important to recognize the significantly improved cost structure of our business. The transition of our manufacturing footprint at Castaños translated to approximately $20 million in annual fixed cost savings in 2021 versus the prior U.S.-based footprint, and even after the as-currently-planned build-out of the facility, which I will describe shortly, the annual fixed cost savings are expected to remain above $17 million. Additionally, we lowered our labor cost per unit by 60% on average in 2021 compared to the previous U.S.-based footprint. Turning to cash and liquidity. At year-end, our total cash position was $26.2 million. Including the new deferred draw loan, which closed at the end of December, we had over $40 million of liquidity as we closed out 2021. This liquidity position provides us with flexibility to support our increasing working capital needs as we prepare for the continued strengthening of the industry, manage through the current period of supply chain disruptions and uncertainties and expand our manufacturing footprint, which I will discuss shortly. Also, as our business results improve, we will look to begin the process of restructuring and strengthening our capital structure. We appreciate the confidence our current financial partners had in providing the funding we needed to undertake the business transformation and ensure sufficient liquidity to see it through. But as our results improve, we expect to look at ways to lower our long-term cost of capital. Also, we remain on track to receive a majority of our Mexican value-added tax or VAT receivable in 2022, which was $31.1 million at year-end. Before continuing into 2022, I would like to turn the call over to Matt for his comments from a sales and marketing perspective. Matt?

Thank you, Jim, and good morning. As Jim referenced in his opening comments, the heavy lifting part of resizing and retooling our manufacturing footprint is now complete. We have a significantly more cost-efficient operation, veteran manufacturing, quality and support leadership throughout the new operation, and I believe we are positioned to grow. The FreightCar America brand is rock solid, and I'm very excited about our opportunities to leverage the new operation in the marketplace. We have great quality, are able to build the right car types for the market, and we are able to offer our customers products tailored to their specific needs. And now finally, the market is improving. As has been widely reported, demand for new railcars is on the rebound, emerging from the worst railcar demand cycle since the recession of 2009. Railcar scrapping rates, aging fleets and railroads with the capacity to grow are all pointing in the right direction for a strengthening railcar demand cycle. Turning to our inquiry and order activity. We experienced a double-digit year-over-year inquiry levels and booked 1,032 orders in Q4. We believe this speaks to the reputation and confidence that customers are placing in the Castaños team and the new company. We entered this year with a backlog of 2,323 cars and a strong inquiry pipeline that continues to increase. Furthermore, our orders and inquiries are for a broad range of new car types and conversions and with a diverse customer base. Our internal views of the marketplace are consistent with published forecasts, which predict new deliveries of 43,500 railcars this year, an increase of over 48% over '21 and then continue to grow in 2023 and 2024. FreightCar America is gaining traction in the marketplace in spite of near-record raw material costs. We are starting to see indications of steel pricing coming down, and we anticipate that lower raw material costs will further improve order activity. Customer feedback is that many car classes are in short supply. With FreightCar America's extended product offering, ability to execute efficient line changes and additional capacity coming online over the next 12 months, we believe that we are well positioned to grow both on our own and with the benefits of an expanding demand cycle. With that, I'll now turn the call back over to Jim for additional comments as it relates to 2022 and our go-forward expectations for the company.

Thank you, Matt. Now let's review some of our expectations and strategic priorities for 2022 and beyond. First, we expect to deliver between 2,350 and 2,650 railcars this year, an increase of 44% over 2021 at the midpoint. Most importantly, we expect to be profitable on an adjusted EBITDA basis for the full fiscal year 2022. Second, we will continue to expand the new Castaños facility. By the end of the first quarter, we will have more than doubled the size of our wheel and axle shop. And by mid-year, we expect to have our 162,000 square foot fabrication shop online. We have also broken ground on 3 additional production lines. Our goal is to have Line #3 ready to produce before the end of this year. Line #4 by early next year and a fifth line that we will simply keep at the ready. By this time next year, we expect that we will have double capacity to approximately 4,000 to 5,000 units per year on the 4 lines and be producing a large majority of our fabrications in-house. With these completed, we expect the benefit from the scaling effects of more units produced and substantial additional cost savings from producing our fabrications in-house. This is the preview of our goals for 2022. It's really quite simple. We created a new company that we intend to grow profitably. Also, in 2022 and for the foreseeable future, we will continue to focus on differentiating FreightCar America as a best-in-class manufacturer with the ability to flex production specifications and order sizes to meet customer needs. We are determined to be the leader in the industry for quality and customer satisfaction. In closing, FreightCar America is now well positioned for future growth and sustainable long-term profitability. Finally, I would like to thank our loyal customers that stood by us as we undertook the transition to Mexico, and I also want to thank all our employees and our entire team for being such an integral part of what we are creating. I want to acknowledge FreightCar's Board of Directors and management team who are key to the planning, execution and ultimately, the pivot to our new identity. Thank you. and I look forward to sharing more successes with you in future calls. Before we open the line for our analysts to ask questions, I would like to just quickly caution that we are still in the process of closing the books on fiscal 2021, so we will not be in a position to answer any further financial questions about the fourth quarter beyond what we've just presented. But we are happy to take questions around our strategy and prospects for the future. With that, Shamali, please open the lines for Q&A.

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

Congratulations on the announcement this morning. When you guys moved manufacturing to Mexico, you rightsized your manufacturing footprint. And now you're doubling your annual capacity to basically what it was before. And I understand that part of this is because you have an improved cost structure now. But can you talk about some of the other factors such as market demand that gives you the confidence to say we need to double our manufacturing footprint?

Matt, this is Jim. Let me start with a response and then maybe Matt can join in. When we made the move from the U.S. to Mexico, when you take the total potential capacity from the Muscle Shoals and the Roanoke facility, we were safely talking about 10,000-plus units of capacity per year. And so we knew that needed to be rightsized even for a future that included growth. When we did the move and built the factory in Mexico, we built the first 2 production lines with a goal to get those operational and bring the new footprint on in stages. And also, we wanted to be rightsized for what was still squarely in the middle of a railcar industry recession and a pandemic. We always intended to scale that facility, commensurate with how we view ourselves in the marketplace. And the 5,000-ish kind of units makes a lot of sense for how we see ourselves, yet that square -- obviously significantly smaller than the overhead we were carrying to accommodate the neighborhood of 10,000 units. So just to kind of get the numbers squared away, we still -- once we're done with the expansion, are about half of what we were in the recent past, up in the U.S. As it relates to market demands and the activity that Matt is saying, I'll ask Matt to comment on it.

Yes, Matt. I think a couple of things. If you look at the last 3 years of order activity, it's been sub-replacement level. Deliveries have been sub replacement level, and we've had, I think, roughly 2 full years of scrapping rates that were above the replacement level. So I think that, coupled with what we're hearing from customers in terms of demand supports the move for us to have increased capacity. And in addition, it provides us with additional flexibility to have more than 2 lines of capacity.

Got it. That makes sense. Matt, when would you say you guys made that decision to double the manufacturing capacity? Is that something -- I'm sure it's something that you may have been mulling for quite a while. But when did you gain the confidence to say, okay, let's start working on this?

Well, Matt, this is Jim. I'll just take that first. Again, we always conceived of having a -- 4 active production line operation in Mexico. And again, it makes all the sense in the world when we were starting, given the industry backdrop to start as small as made sense and not carry that extra fixed cost when we didn't need to. So we started with the 2, always with the intention and the plan to scale at the 4. In fact, when we built our paint shop, we built our paint shop with capacity to support the 4 lines. In terms of when we sort of saw the tea leaves suggesting we were going to be ready to take on more, we first made the decision to fund the start of the expansion last summer sometime, which I think we've talked about on a couple of calls last year and recognizing that even though we could do it relatively quickly, it still takes time to get a facility up and running and onboard people and train and so forth. And I'll turn it over to Matt here, but certainly, with the level of activity we're seeing in the marketplace. Now the timing for that was very well timed. And our expectation is we're going to look to have that third line producing cars by the end of the year.

Yes. I think just to add, we've talked a couple of quarters now about inquiry level activity and then in Q4 order activity. And what we see is versus '21, for example, order quantity and volume per order is a little bit greater. And as a result, that supports having the additional capacity and additional line space available.

Got it. And Matt, are you guys baking in rail traffic growth this year and next year in your assumptions?

I think the story is a little mixed right now on what rail traffic growth is going to be. I think that the majority of what we're seeing in terms of demand is really tied to some of the earlier comments I had about not keeping up with the replacement rates of cars. I mentioned in my comments that the railroads are poised for growth. They've certainly made some investments. And it appears that the PTC front is impacting their efficiencies and network gains. I think they're ready for growth. It remains to be seen if they can fully execute that. And I'm not certain that we know yet how that will impact demand.

So if rail traffic growth is pretty anemic this year, let's say, 1% or 2%, that would pose a risk to your assumptions because I think that may actually end up being correct assumption like 1% to 2% growth.

Matt, we make our planning assumptions based on sales inquiry activities. So all of our capacity planning, our views on production for the year, is driven less by putting together all the external pieces of data, quite frankly, and more governed by our current sales activities.

Yes. That makes sense. And Jim, I think you guys mentioned you're starting to consider strategic opportunities in the tank car market. Is that still something? Any new thoughts on this?

No. We talked about that on at least one, I think, possibly 2 recent earnings calls. It's a process, as I'm sure you appreciate. And -- the first part of the process is getting AAR approvals on designs. And we're squarely in that process actually right now. And we've got 1 design that's approved and 2 more that are under review for approval, which we expect this year. And we'll have more to talk about that in the future. That won't be really a focus -- of a big focus of the business. It certainly won't be driving the business in 2022, but it's very much part of our future. That will be, very much, a part of it.

Okay. No, I understand, and I recognize the commercial opportunities that, that would open up eventually, especially with lessors that want to have access to a diversified fleet with the optionality to switch between car types if I'm thinking along the right lines.

I'm sorry, Matt, was that a question? Or was that your wrap-up comments?

No. Yes, that was a comment. I think I had an audio issue towards the end of that, too. But if I may ask just one more maintenance question. Are there any other line items this year that could have noteworthy moves that we should be aware of?

Line item...

On the income statement.

Terry, do you have...

No, I'm not sure I fully understand the question, Matt. But no, there's nothing that we should stick out differently in terms of what our financial performance will be, certainly.

In fact, we think for all folks following us now that the preponderance of the restructuring is in the rearview mirror, this will be the first sort of -- this will be the cleanest look yet at the new company operating from Mexico.

Our next question comes from the line of Justin Long with Stephens.

I wanted to start by circling back on some of the inquiry commentary. I think I heard the comment that it was -- they were up double digits. I wanted to clarify if that was year-over-year or sequential. And either way, maybe you could just help us understand how the inquiry environment has trended 3Q to 4Q and then maybe into the early part of this year?

Yes. So looking at Q3 and Q4, we saw really significant activity in Q3. Q4 was pretty consistent. And my comments regarding double-digit or year-over-year-based.

Okay. And would you say -- so you said fourth quarter was pretty consistent with the third. Any change kind of year-to-date?

I would say, overall, Justin, we're seeing continued inquiry levels that are consistent with what we saw in Q4. It's clear that customers are recognizing the benefits of perhaps the reduction in raw material costs. And some of the inquiries from Q4 are getting, I would say, much more solid in Q1.

Okay. That's helpful. And I guess following up on that point, I think we're all aware of what steel prices have done, and we're seeing some moderation here recently. Do you think that was a contributing factor to industry orders getting better in the fourth quarter and your order book getting better in the fourth quarter as well? Or is that something that's on the come as we move into 2022?

I think it had somewhat of an impact. I would say that in most cases, where we received orders, these were cars that were definitely in demand. We've seen, in some cases, customers report the inability to get cars in the secondary market. Cars simply aren't available. So this is about an absolute must where they needed the rail assets to support their business model.

Just know that, Justin. I think as your words were 'on the come', I don't think we've really seen that start to ripple through yet, the moderating of steel pricing. So we would anticipate that's going to obviously help the dynamics going forward.

Okay. Looking at the backlog today, it sounds like it's a little over 2,300 units, is all of that scheduled for delivery in 2022?

A good portion of that is for 2022. That's a good way to look at it.

Okay. So just looking at that number and the guidance you provided, I mean, you can basically get close to that low end of the 2022 delivery guidance with the backlog today. So I guess my question is from an order perspective, are you now taking orders for 2023? Is that something that we should be expecting in the next few quarters? Or would you prefer to get a little bit closer to these capacity adds at the end of this year and beginning of next year before securing those orders?

Yes, Justin, we still -- we have production capacity available later part of this year, and we do have flexibility in our production. We have a very efficient operation that allows us to ramp up. And in addition to that, we're adding the line third line. So there's additional capacity. But to answer your specific question on order intake. We are absolutely in discussions on orders for 2023 and beyond.

Sorry, Justin. Sorry, I would just clarify that the guidance we gave today is based on the current order book as well as the 2 available production lines. And if we need to further comment, adjust on that as we get further along in the year, we will do so. We certainly did that in many of the prior quarters.

Okay. And lastly, I guess, thinking about the 2022 guidance to be positive for the full year from an adjusted EBITDA perspective. Is there any color you can provide around the gross margin assumption or SG&A assumption that gets you to that guidance?

I think the only thing I would say right now, Justin, is when we get to where we're reporting our first quarter, I think you'll have -- you'll start to have increasing clarity on what the company does as a 2-line company. And so no, we're not going to give Q1 type guidance now as we're still working the books on Q4, but you'll start to see that for yourself coming up here.

Congrats on all the changes.

Our next question comes from the line of Bascome Majors with Susquehanna.

Can you talk a little bit about any progress you've made with larger strategic buyers? And specifically, the kind of leasing companies that tend to pull in multiyear orders have -- have you made traction with those type of customers? Is that something that we could see bear fruit and give you some long-term visibility this year? Just curious on how that relationship stands that you've gotten through the worst of this downturn.

Yes. Good question. So we continue to work with all customers, leasing companies, both small and large and, of course, Class 1s and end user shippers. I would say that our relationships at the larger lessors continue to improve, and we are in talks with various options for longer-term multiyear type builds. One of the things that we bring to the table that I think is a competitive advantage is that, we are not a leasing company. We are a pure-play builder. And for many of our leasing companies, they find that to be a refreshing advantage.

And as you look out longer term, do you see an opportunity to sort of ink that relationship or become associated to create more of a captive manufacturing build model? Or do you think stand-alone is really the long-term right move for FreightCar?

For the foreseeable future, our focus is on being the best manufacturer in the industry. And -- so that's where the focus is for now. And where we go from there, well, to be determined or to be discussed down the road. The only other comment I'd add on to what Matt said around the larger leasing companies. We have a history of doing plenty of business with the larger leasing companies. And so that hasn't changed. And what will certainly make those kinds of discussions easier for us is when we get just a little more production capacity brought online.

Okay. And one labor-related question, I appreciate not wanting to guide forward margins before you've closed the books on the prior quarter. But -- can you talk a little bit broad strokes about the labor environment in Mexico? I know you're co-located or near a couple of other large manufacturers, assuming you draw from some of the same labor pool. How have challenges or opportunities in hiring, both availability and maybe the cost of that labor trended over the last couple of quarters? And what sort of thought process are you baking into your expansion into next year as far as how easy or tough that will be to get the people to drive this growth?

Yes, that's a good question. First of all, we went to Castaños and its neighboring Monclova because, as I said earlier in the prepared remarks, this is the heart of railcar manufacturing. And we took the business to where the skilled labor is, where the infrastructure is, that was very deliberate. And the process of building up our workforce from approximately 0, 18 months ago to just shy of 1,000 today, we feel very good and very confident about the quality of the people we brought on board. As I've said in the last couple of earnings calls, our employees are very well trained. They're very committed to the company. And in spite of the pandemic, we've kept everybody very healthy and are very proud to be a 100% fully vaccinated company, including all our folks down in Mexico. So we're in a really good spot today. We don't see anything fundamentally changing. And we feel good about continued access to quality people as we scale.

I'll close it up with a strategic question here, but -- do you foresee manufacturing consolidation to be something that we encounter in North American railcar over the next 3 to 4 years? Or do you think the stage is pretty much set as is today?

Well, I can't predict the future. We can all look back and look at the very substantial consolidation that's taken place across the manufacturing end of the industry over the last 20, 25 years. Is it done? Is it not done? I couldn't say. Okay. I will leave you with this, and I'm probably stating the obvious here, the -- with the relatively few number of players out there today, the industry is better served by having more players and all of them in healthy condition.

And just my final question. You talked about strategically focusing on reducing your cost of capital as you get through this expansion. Can you talk about what the options for that, that might be on the table and, call it, '23, '24 if the industry continues to grow and your profits continue to grow with it? I don't know if that's debt restructuring, bringing on a financial partner or a strategic partner? Just any thoughts on kind of the scenarios that we could see to accomplish that goal?

This is Terry Rogers. Yes, we would look at pretty much any of those things that you just talked about. But specifically, what we would do is try to lower the cost of the debt that we have now, which was done at pre-transition. So as we continue to work through our growth, we feel that we could refinance to lower cost forms of debt. But there is nothing that isn't on the table in terms of things we would look at to enhance shareholder value. So whatever would make the most sense from a capital structuring standpoint, we would do it as long as it could support our execution of our strategic plan and the growth of the company and our ability to serve our customers.

[Operator Instructions] And it appears that we have reached the end of the question-and-answer session. And I'll turn the call back over to Jim Meyer for closing remarks.

Very quickly, thank you all for joining us today and for following our journey, and we'll talk to you all again in March at the Q4 earnings call. Thanks, and have a great day.

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