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OPERATOR: Good day, ladies and gentlemen, and welcome to the Fourth
Quarter 2006 American Railcar Industries Earnings Conference Call. My
name is [Karissa], and I will be your coordinator for today.
[OPERATOR INSTRUCTIONS]
I would now like to turn the presentation over to your host for
today's conference Mr. James Unger, President and CEO American
Railcar Industries. Please proceed.
JAMES UNGER, PRESIDENT AND CEO, AMERICAN RAILCAR INDUSTRIES, INC.:
Good morning. I would like to welcome all of those on the call as
well as our audio webcast listeners today. For all of those who are
interested, a replay of this broadcast will also be available on our
Web site, americanrailcar.com, beginning shortly after this call
ends.
I am Jim Unger, the Chief Executive Officer of American Railcar, and
with me this morning is Jim Cowan, our Chief Operating Officer, and
Bill Benac, our Chief Financial Officer.
We will open the call today with a brief prepared statement related
to the Company's 2006 financial results. After that we will make a
few comments to update you on the progress on our capital program and
other events occurring at ARI. Following these remarks, we will open
the conference for your questions.
Bill, would you begin the conference with a review of the financial
results for the quarter?
BILL BENAC, SVP, CFO, TREASURER, AMERICAN RAILCAR INDUSTRIES, INC.:
Sure. Thank you, Jim. I am pleased to present our 2006 financial
results. Before we get started, let me remind everyone that today's
call contains forward-looking statements, including statements as to
estimates, expectations, intentions and predictions of future
financial performance.
Participants are directed to American Railcar Industries SEC filings
for a description of certain of the business issues and risks, a
change in any one of which could cause actual results or outcomes to
differ materially from those expressed in the forward-looking
statements. Also please note that the Company does not undertake any
obligation to update any forward-looking statement made during the
call.
The fourth quarter was another solid quarter for ARI in terms of both
revenue and earnings. Revenues were $165 million for the quarter and
essentially the same as the prior year. Deliveries of tank railcars
in the quarter were very strong, with 547 railcars delivered compared
to 414 in the same quarter of 2005.
Tank railcar shipments were higher due to a product mix of primarily
ethanol railcars, which require less time to build than the more
complex railcars delivered in the fourth quarter of 2005. In
addition, the tank railcar manufacturing plant efficiency for the
quarter was excellent.
The fourth quarter was the first full quarter of production since the
repairs to the damage from the April 2, 2006 tornado were completed.
Shipments of covered hopper railcars totaled 1,140 in the quarter,
which was down 23% from the same quarter of 2005.
The decline in shipments was due to a change in product mix to
include larger and more complicated railcars, including some
stainless steel railcars, all of which require more time to build
than the railcars that were produced in the same quarter of 2005,
which included a significant number of smaller cement railcars. Total
railcar deliveries in the fourth quarter totaled 1,687 railcars as
compared to 1,895 cars delivered in the same period of 2005.
For the year, revenues were $646 million, $38 million higher than
2005. Railcar shipments for the year totaled 6,947 railcars, 72 more
than in 2005. This is significant when you consider that we lost
production of approximately 815 tank railcars and their associated
revenues during the four months that the tank railcar plant was under
repair for the tornado damage. For the year, we shipped 5,625 covered
hopper railcars, one intermodal railcar, and 1,321 tank railcars.
Net earnings attributable to common shareholders for the quarter were
$6.1 million or $0.29 per diluted share. For the same quarter of
2005, we reported a net loss attributable to common shareholders of
$1.8 million or $0.16 per diluted share. The 2005 earnings were
reduced by a one-time pension settlement expense of $6.8 million
after tax.
Net earnings attributable to common shareholders for the full year
2006 were $34.6 million or $1.67 per diluted share compared to $1.5
million or $0.14 per diluted share for 2005.
Preferred dividends which reduced net earnings available to common
shareholders were $600,000 in 2006 and $13.3 million for 2005. All of
the Company's preferred stock and substantially all of its debt were
retired in the first quarter of 2006 in connection with the Company's
January 2006 Initial Public Offering.
The 2006 results also included a $2.7 million after-tax gain on the
involuntary asset conversion resulting from the tornado at our tank
railcar factory, and the 2005 results included the one-time pension
expense I mentioned earlier that related to the separation of benefit
plans that occurred during December 2005.
Adjusted EBITDA for the fourth quarter of 2006 was $13.9 million
compared to $13.5 million for the same period in 2005. These numbers
have been adjusted to exclude stock-based compensation of $1.5
million in '06 and a one-time $10.9 million pension expense pre-tax
in 2005.
Adjusted EBITDA for the year was $70.3 million, 57% higher than 2005.
This improvement resulted from an increase in railcar deliveries,
margin improvement, and business interruption and insurance
compensation for the period that our plant was under repair.
These numbers have been adjusted to exclude stock-based compensation
expense of $8.1 million, the $4.3 million gain related to the
involuntary conversion of storm assets, and a one-time $10.9 million
expense for pensions in 2005.
Adjusted EBITDA and EBITDA are non-GAAP financial measures that are
reconciled to our net earnings in our press release, which was issued
earlier this morning. The press release is also available through the
Investor Relations page of our Web site.
At this time, let me turn the meeting over to Jim Cowan, our Chief
Operating Officer to comment about the status of our plant
operations. Jim?
JIM COWAN, EVP AND COO, AMERICAN RAILCAR INDUSTRIES, INC.: Thanks,
Bill. I would like to begin my comments by congratulating all of our
employees for making 2006 another record year for ARI. The team
executed on many planned opportunities to improve the business,
including our acquisition of Custom Steel, our parts expansion in
Paragould and our capacity expansion in Marmaduke, to name a few.
Perhaps our greatest opportunity was unplanned, as we were forced to
recover from a devastating tornado that destroyed the first third of
our facility in Marmaduke. It is incredible to think that our
employees and contractors were able to return the plant back in
production in a mere 18 weeks.
Today, we are excited to have Marmaduke back in operation and both of
our railcar assembly plants producing at capacity. Production of tank
railcars in Marmaduke was a record in the fourth quarter.
We shipped 447 tank railcars or 32% more in the same quarter of the
prior year. I think this performance demonstrates that the impact of
the tornado is behind us and has only strengthened our resolve to be
the best in the industry.
The good news is that, as a result of rebuilding the plant, we now
have a significant portion of our plant operating with new equipment.
In addition to recovering from the tornado, we have also completed an
expansion that has added capacity of 1,000 railcars per year to the
operation. The additional capacity started to come on stream in early
January, and we are proud to announce, has recently reached fully
capacity.
As Bill previously mentioned, fourth quarter shipments from our
Paragould hopper railcar facility were lower than the fourth quarter
of 2005, which included a significant number of smaller cement
railcars. This decrease can be attributed primarily to the mix of
products shipped during the quarter. We produce several high-quality
stainless steel cars, which require a line change and significant
set-up and training time. We also build pressurized railcars on one
of our three production tracks for most of the quarter.
These specialized cars are more complex than a standard hopper car
and are produced at a slower production rate. We believe this
reinforces our ability to maintain extremely flexible in product mix
by shifting from one product to another all while maintaining our
margins. In addition, we invested time and training to focus our
production teams on implementing lean manufacturing principles. We
expect this investment of time to pay dividends in the near future.
Our railcar services business had a good year in 2006, up 12% from
2005. Gross profit was up 7%. Throughout the year, the work content
was very high for repair services, which allowed us to be very
efficient at our facilities.
As the average age of the domestic railcar fleet continues to
increase, repair volumes for ARI's repair plants have been strong and
we continue to see both the leasing companies and shippers investing
in maintenance and improvements for their railcars.
We are pleased with our manufacturing and repair plant operations for
the year. We still see a number of opportunities, where we can
improve our plant operations and will be working hard on these to
make these improvements in 2007.
At this time, let me turn the meeting back to Jim Unger, our CEO, to
make a few comments on our capital plan and other events at ARI.
JAMES UNGER: Thank you, Jim. We had a great year in spite of the
storm related lost production in Marmaduke. A new earnings record was
achieved for the year, driven by strong covered hopper railcar
shipments, margin improvements and insurance compensation for lost
profits at Marmaduke.
We are very pleased with the results that our employees and
management have delivered, and we would like to thank our loyal
customers for their patience while we rebuilt our tank railcar
facility.
Our railcar backlog remained strong and it, on December 31, 2006, was
16,816 railcars. The increase in our backlog in 2006 was driven
primarily by large orders and option exercises from three major
customers totaling 6,400 railcars. To support this strong demand, we
continue to invest aggressively in the Company.
In 2006, we invested almost $36 million in new capital for buildings
and equipment to expand capacity and improve efficiencies. An
additional $9 million of insurance payments were invested in new
buildings and equipment to rebuild the Marmaduke plant. We also
invested $17 million in the acquisition of Custom Steel. In total,
this was a $62 million commitment to the growth of this business.
As a result of acquiring Custom Steel on March 31, 2006 and opening a
new fabrication facility at Paragould during the third quarter of
2006, we are continuing to realign the production of parts at our
plants to optimize the production efficiencies.
With a modest investment, our parts plants have the capacity to
produce additional parts to support increased volume. We have
identified a number of parts that we expect to in-source to these
plants during 2007 and 2008. We expect the in-sourcing of these
components to increase our profitability.
We also have a new facility under construction to finish axles and
mount wheels at our Paragould, Arkansas facility. We expect this
plant to lower our cost through production and freight cost
reductions and reduce inventory levels of finished wheel sets.
In 2007, we will continue to invest in the Company by constructing a
tank head production facility at our Marmaduke, Arkansas tank railcar
facility. This facility will provide us with significant cost savings
as it allows us to produce tank heads instead of purchasing them from
an outside vendor. We expect additional freight savings from
producing at our plant as well. We expect the tank head facility to
be operational in mid-2008.
As you may recall, we announced that we plan to build a new flexible
railcar manufacturing plant adjacent to our tank railcar
manufacturing plant in Marmaduke, Arkansas. The new plant will be
capable of producing tank, covered hopper and intermodal railcars.
We expect the plant to have initial capacity to produce 2,500 tank
railcars annually. I am pleased to report that the construction for
that plant is underway and we expect the plant to be completed by the
end of 2007. Production at this new plant is expected to begin in
early 2008.
We believe that our accomplishments in 2006 were significant and very
important for the future of our Company, but just as important are
the plans that we have for the next several years. Because of the
focus and execution by our employees, we were able to deliver record
revenues and earnings and complete over $62 million of new
investments in our facilities.
We see a strong market for our products and services and have a solid
backlog to support our future expansion plans. But, most important,
we have a capable management team to deliver on our plans.
We will now take a few of your questions. Operator, would you please
explain to our guests how they can register their questions?
OPERATOR: [OPERATOR INSTRUCTIONS] And your first question comes from
the line of Peter Nesvold of Bear Stearns. Please proceed.
PETER NESVOLD, ANALYST, BEAR STEARNS: Good morning guys.
JAMES UNGER: Hi, Peter.
PETER NESVOLD: I hope the weather is a little better where you guys
are than where we are right now in New York. Let's talk a little bit
about this mix in 3Q, because covered hopper mix -- I'm sorry, in 4Q,
it was an issue in 3Q also.
And so, what I'm trying to understand is, is the 4Q production for
covered hoppers, is that the appropriate run rate to use going
forward, or was there some kind of disruption moving towards
stainless steel cars that might have thrown this quarter off.
JAMES UNGER: I think, Peter, going forward, you won't see the mix we
experienced in fourth quarter. However, a lot of the mix is based
upon the demands our customers have and the type of cars that they
want. Our multi-year contracts provide some flexibility with our
customers to order the whole variety of hopper cars that we produce.
We are looking at, in the first quarter of '07, a different mix. We
will be producing more cement and [drain] cars at Paragould versus
the stainless steel cars and the pressure differential cars that were
produced at Paragould in the fourth quarter of '06, which run at a
significantly lower production level. Although they are very high
quality and high margin cars, you just don't get the volume up.
PETER NESVOLD: Okay, so maybe -- all right, I mean, cement -- I mean,
when I hear that, I think big numbers, but I'm not going to expect
maybe 1,650 that you were tracking at 2Q, but maybe something closer
to 3Q, where it was about 1,300?
JAMES UNGER: Yes, I would say that would be a good assumption.
PETER NESVOLD: Okay, okay. Now, if we talk a little about the
services gross margins, because it was down about 500 basis points
sequentially, it's flat year-over-year, but you saw a nice little
bump there in 3Q, and I'm curious why that didn't stick, as you went
into 4Q?
JAMES UNGER: Well, you've got to look at what occurred in 3Q. We had
a high production facility, paint and lining facility in Goodrich,
Texas. But in third quarter, we converted that from repair to support
production volumes and it ran at very high volumes, very high
profitability.
So, you will see your 3Q margins exceeding your first, second quarter
margins. So, the margins we achieved in fourth quarter are more in
line with the overall averages we get in those services businesses.
PETER NESVOLD: Okay, so sort of a 20% type gross margin going forward
is what we should expect in services?
JAMES UNGER: Yes, I would say that would be fair.
PETER NESVOLD: Okay. Just moving down the income statement here,
SG&A, we saw another tick up, I mean we saw a tickup there in
fourth quarter sequentially. What was driving that, was it a result
of the capacity expansion that you recently did?
BILL BENAC: Well, the absolute number is also a function of the
growth of the Company. We, over the last -- I guess it's three years,
our revenues were up 220% I think the number is. We've kept our staff
very lean, our SG&A percent of sales is probably right down at
the bottom of what our competitor or comparable companies look like.
So, we've added some additional staff, we've added some additional
people to support the growth of the business; engineering,
production, sales, right across the board.
PETER NESVOLD: And if may I, I know the numbers are a little skewed
because 2Q and 3Q, you have the tornado, so it threw up some of the
numbers. But, you are up 30% from where you were in the first quarter
'06, and revenue is not up 30%.
So, I mean, is something happening here that maybe you were kind of
understaffed historically or maybe you are staffing up in
anticipation of some kind of growth going forward, but the SG&A,
looks like it's growing faster than the revenue currently?
JAMES UNGER: Okay, did you account for the 815 tank cars that were
missed due to the tornado?
PETER NESVOLD: Well, that's what I'm just looking at 1Q '06 versus 4Q
'06 because the tornado, I think was, first week of April. So, 1Q '06
should be a pretty clean number.
BILL BENAC: What numbers are you looking at, Peter? The numbers I am
looking at, we had $5.145 million in 1Q and $5.191 million in Q4.
PETER NESVOLD: Okay. I think, okay, we are including a second line in
there. Okay, that might be our mistake. I will double check on that
and follow up with you offline.
BILL BENAC: Yes, and we can talk further about it if you would like,
but the overall SG&A level increased modestly from Q1 to Q4. I
will tell you that we expect to see that line go up as we move
through 2007. We are adding to staff.
We have taken a real hard look at some of the support services we are
getting right now, IT and some of the other things and we are going
to be adding some additional expenses in there in '07. But it was
pretty flat throughout '06.
PETER NESVOLD: I think you right. It's stock-based compensation that
we are including in that line. That's my mistake.
BILL BENAC: Okay.
PETER NESVOLD: Two other quick questions. Can you talk about the high
yield offering? It's pretty big. I mean, 250 I believe is the number
that was discussed yesterday. And I am curious, number one, use of
proceeds because I believe the tank car plant that you were talking
about is only $26 million of capital, and number two, why high yield
and not bank debt?
JAMES UNGER: Okay. Peter, much as I would like to talk about it, we
can't talk about it. It's a private offering; our lawyers have told
us we cannot discuss it.
PETER NESVOLD: Okay.
JAMES UNGER: In the 8-K, you can read it, or I would be happy to talk
about our capital plans as we disclosed in our 10-K.
JIM COWAN: You will see in the 10-K we filed last night, there is a
little bit more description in there about what the capital plan is
going to look like in '07. It is going to be up from '08 and we have
not only some specific projects we announced to you this morning,
that we are going to do this tank head press in addition some other
things. But there are also, we are looking at various strategic
things we might be pursuing this year.
BILL BENAC: Identifiable projects we listed is approximately $80
million in '07, but there are some non-identifiable that will come to
fruition.
PETER NESVOLD: Got you. Last question, what was the value of the
backlog at fourth quarter?
BILL BENAC: $1.3 billion?
JIM COWAN: Yes. I don't have the number right here with me. I think
it's a $1.3 billion. Peter, I'll have to check that number.
PETER NESVOLD: Okay. Thank you for the time.
JAMES UNGER: Sure.
OPERATOR: Your next question comes from the line of Jason Feldman of
UBS. Please proceed.
JASON FELDMAN, ANALYST, UBS: Good morning. Back to the gross margins
for the manufacturing side, how much does the mix influence the gross
margins separately from revenue? I mean, compared to the first
quarter kind of the last clean quarter that we had before the
tornado, the manufacturing gross margins were down substantially?
BILL BENAC: It could affect it 50 basis points even less, yes, maybe
1% depending on the volume. There is a big volume variance there,
Jason.
JASON FELDMAN: Right. So, it's a combination of both operating
leverage and just potentially lower margin products?
BILL BENAC: That's correct.
JASON FELDMAN: Okay. So, those were -- there was nothing else unusual
perhaps with the expansion plans at Marmaduke that was expensed there
or was there anything else strange that we should be aware of?
JIM COWAN: No, there was nothing unusual there. The car mix and the
volume is something that we live with quarter-to-quarter. It's not a
reflection of any long-term trend when you see these unusual mix, as
we consider the fourth quarter to have been pretty unusual in the
first quarter, and we had a comment about this in the press release.
We are getting back to a little bit more normal car mix. We expect
that will probably have a positive effect on revenues and should have
a positive effect on the margins as well.
JASON FELDMAN: Okay.
JAMES UNGER: Mix, we have to live with. That's part of our business.
We run a business that -- with two products, three product segments
with covered hopper and tank. We produce the full variety of those
cars. That's why customers like us. We can deliver on each car type
they want.
JASON FELDMAN: Okay. On order rates, I mean, the fourth quarter, I
mean if you compare to the -- obviously, the third quarter was a
phenomenal quarter for orders. And if you look at 2006 as a whole, it
was very good year, I mean, substantially above your delivery rate.
What are you seeing in the marketplace in terms of near-to-medium
term order outlook, because you are fully booked in '07 and you
certainly got a good chunk of '08 filled? Is that deterring people
from talking to you because the lead times are so long or is there
still lot of interest in '08, '09?
JAMES UNGER: There is a lot of interest in '08 and '09. We purposely
have chosen not to book some orders out in that form. We are waiting
till the quarter progresses. We are talking to some of our major
customers right now, they are talking about orders in '09, and I
suspect by the end of this quarter, we will probably book some of
those orders.
Our ideal backlog, what I would like to see is we should follow
industry. Little over a year, it's nice to have a year-end production
where you can plan for the oncoming budget year, and then you can get
some pricing leverage for the open spaces.
JASON FELDMAN: Okay. What about intermodal specifically? I mean I
know you have some products out there being evaluated.
JAMES UNGER: Yes. We have a product that's been sold actually and
it's still in the test phases. We expect to be able to quote
intermodal orders come late second quarter. The problem we have is a
production facility to produce those cars. We are booked and our
lines are full. So, until we see an opening, we can't deliver
intermodal, but we fully expect to be able to quote intermodal cars
by the end of second quarter of '07.
JASON FELDMAN: Okay. And then last question, in the 10-K after the
capital plan, listing the components to the $80 million, you made
reference to a potential facility possibly with partners for
additional in-sourcing of parts. Can you provide any color on that,
is that just additional, bringing certain components to currently
purchase in-house?
JAMES UNGER: That is correct, and I really -- I don't want to discuss
these projects much further because of competitive reasons.
JASON FELDMAN: Okay. Okay, thank you very much for your time.
OPERATOR: And your next question comes from the line of Paul Bodnar
of Longbow Research. Please proceed.
PAUL BODNAR, ANALYST, LONGBOW RESEARCH: I just want to do a quick
follow-up on the gross margin line. So, going into next year, are you
pretty much saying that should look more like first quarter in '06
kind of like an 11% type run rate there or could mix kind of affect
that negatively or positively?
BILL BENAC: What we have really said, Paul, is that we expect a
rebound on that gross margin line. That would be our estimate.
PAUL BODNAR: So, basically kind of get back to that level or close to
it, for average throughout the year?
BILL BENAC: No, we expect it to rebound somewhat here. We are not
going to give guidance on what the number is.
PAUL BODNAR: And then, secondly, also kind of on the top line growth,
you say you converted about half the backlog in '07, in terms of the
parts business, [you saw] anything externally there and what kind of
contribution would you get from that to revenues?
JIM COWAN: Well, that is part of our manufacturing segment. We have
one plant that's devoted strictly to railcar parts that's not within
our railcar group, our parts plant at Jackson, and about a third of
their sales go to third parties. And that margin on that business is
a little bit higher than it is on the average of the whole railcar
group.
JAMES UNGER: Jim, I might add the capital projects that we have
mentioned and that we disclosed in our 10-K, many of those projects
won't be complete till the end of '07. These are significant projects
that I think long-term will add a lot to the business, but we are not
going to see a lot of benefit in the year '07 till those projects are
substantially complete.
PAUL BODNAR: Okay. And then, I also wanted to follow-up just demand
out there and what the outlook looks like for the tanker cars, in
general I think you have -- ethanol has been driving all this, and
I'm assuming these -- a lot of these plants have ordered for their
outlook and what they can produce in '07, '08 and into '09, if you
kind of get a point there where there is other car types, tanker cars
start to come on or do you still see additional demand based on that
ethanol production rates going up?
JAMES UNGER: We see a mix right now because of the concentration the
builders have had in ethanol. We see demand for the other car types.
We've kind of shied away some of the other builders and we see
customers wanting for years, your general purpose tank cars. And so,
we see that tank car market being strong in all aspects.
PAUL BODNAR: So, you basically see orders come in for all car types?
JAMES UNGER: Yes.
PAUL BODNAR: Going into '08, '09?
JAMES UNGER: Yes.
PAUL BODNAR: Okay. Thanks a lot guys.
JAMES UNGER: Sure. Thanks, Paul.
OPERATOR: Your next question comes from the line of Robert Lagaipa of
CIBC World Markets. Please proceed.
ROBERT LAGAIPA, ANALYST, CIBC WORLD MARKETS: Hi, good morning.
JAMES UNGER: Hi, Rob? How are you doing?
ROBERT LAGAIPA: Pretty good. Just a few questions, a few follow-ups
actually, one, just with regard to the backlog, can you talk about
the composition of the backlog? I think you have given us some
numbers for the third quarter and I think it was something like
10,000 tank rail cars. Where does it stand as of the fourth quarter
end?
JAMES UNGER: You got about 10,000 tanks and 6,000 to 7,000 hoppers.
BILL BENAC: Tanks -- it's about flat on the tank car side and the
hoppers are down somewhat in the backlog.
ROBERT LAGAIPA: Okay. And then secondly, just with regard to the
production levels moving forward, I think you had mentioned to or
commented relative to an earlier question about -- about 1,300
hoppers in the first quarter. That would imply, I believe that on the
tank railcar side, you are pretty much producing full out on that
expansion. So, should we be expecting something like 750 cars?
The way I am getting there is just, I mean, if we look at your
backlog, I think you had mentioned in your 10-K, 49% of the backlog
and I assume that's with regards to the cars themselves as opposed to
the revenues.
That would imply something like 8,200 units for the year, a little
bit north of that, and then, the 1,300 in the first quarter, you need
at least 750 cars to get to kind of the average unless the
distribution is going to be different. If you could maybe help us out
with that, that will be great.
BILL BENAC: Bob, I am a little confused. It sounded like you were
throwing out hopper car numbers and tank car numbers.
ROBERT LAGAIPA: Yes. Where I am getting to, Bill, is if we look at
your 10-K, you had mentioned that 49% of the backlog is anticipated
to be completed by year-end '07. Now, is that with regard to the cars
or the revenues?
BILL BENAC: Essentially both. Let me just respond because you were
kind of I think tossing out some numbers on both sides. So, let me
respond to both. First of all, the number you mentioned, the 750, was
that the -- your idea of tank cars?
ROBERT LAGAIPA: Yes. Where I am getting to with that, Bill, is if we
take the 49% of the backlog, that gets to roughly 8,200 or so cars
for the year?
BILL BENAC: Right.
ROBERT LAGAIPA: And that would imply about a little north of 2,000 a
quarter.
BILL BENAC: Yes.
ROBERT LAGAIPA: And that's assuming that your production rates are
stable throughout the year. I guess my question is, are they going to
be stable throughout the year or not, or is -- there's going to be a
difference in the distribution?
BILL BENAC: Well, first of all, without getting real specific, you
are certainly directionally correct on the tank car side. Jim
mentioned -- Jim Cowan mentioned in his comments that the plant is
now running capacity including the 1,000 car addition, which really
came up to speed in January. So, we will be producing probably a
considerably a higher number of tank railcars.
On the hopper car side, Jim has talked a lot about what happened
there in the fourth quarter, what our expectations are in the first
quarter. And our customers are in a position where they can specify
exact car types. So, it is going to vary somewhat from
quarter-to-quarter, but directionally, what you said is correct.
JAMES UNGER: Our customers on some of the contracts have got 90 days
to tell us what type of car they want.
ROBERT LAGAIPA: Okay.
JAMES UNGER: So, they could change in the last half of the year.
ROBERT LAGAIPA: Okay. Is there any reason to believe that the
distribution will be different than that, higher or lower in any
particular quarter, based on what you know right now?
BILL BENAC: Different than what? I am sorry.
ROBERT LAGAIPA: Different than what you are expecting in the first
quarter?
BILL BENAC: No. But, as I said, the customers don't specify exactly
what that car is until they get within a certain number of weeks of
the actual production date.
ROBERT LAGAIPA: Right. So, you are going to have some variability?
BILL BENAC: And so, there will be some variability in that, which
doesn't trouble us at all. For the long haul, we have got the
facility in place, it's running well, and we expect long haul to see
some higher production levels.
ROBERT LAGAIPA: Understood. Two follow-ups, one with regard to the
pricing on the cars, and obviously, given the third and fourth
quarter, you were producing a higher level of stainless steel cars,
you are also producing these pressurized cars, which I would imagine
you carry a much higher price. Would that imply that, on a go-forward
basis, at least here in the near-term that the average pricing for a
car should be less?
BILL BENAC: It's not going to be that significantly different. We do
not believe it will be that different.
ROBERT LAGAIPA: Okay. Last question is just with regard to the
in-sourcing of parts. Now, from a manufacturing basis, I understand
that 80, 85% something like that, your cost of goods sold, is related
to materials and parts et cetera.
Exiting 2005 versus 2006 and what you are expecting moving forward,
how much of that number would you -- was in-sourced at the end of
'05, how much of that number was in-sourced as a -- at the end of
'06, and how much of that number can you in-source going forward?
Thanks.
BILL BENAC: Well, conceptually, as we have said for quite a long
period of time, we believe that by having flexible manufacturing
facilities, which are highly scalable in a non-union environment with
relatively low fixed cost, this is a prudent strategy for our Company
to have. So, we are pushing down that line.
But, we have got the several projects that we just mentioned, Jim has
mentioned to you already, which are under construction right now. And
there is a possibility to in-source some further components and we
just don't want to discuss that strategy anymore in a public form, in
any form. We think there is some competitive advantage to what we are
doing and we are going to pursue that.
JAMES UNGER: I can give you just a rough estimate. It's in excess of
10% of our cost that we will be shifting to in-source.
ROBERT LAGAIPA: First versus this past year?
JAMES UNGER: Yes.
ROBERT LAGAIPA: The 10% delta? Okay, terrific. Thanks very much.
OPERATOR: Your next question comes from the line of [Bill Gilchrist
of the Hartford]. Please proceed.
BILL GILCHRIST, ANALYST, HARTFORD: Thanks for taking my question.
Follow-up on the overall demand outlook for tank and hoppers cars,
could you give us some stats on where that industry overall backlog
is right now and the split between tanks and hoppers if you have
those numbers?
BILL BENAC: I think we do actually.
JIM COWAN: There is a published report the ARCI publishes. Let's see.
BILL BENAC: This is estimated production, Jim. The ARCI and the RSI,
all public, a lot of statistics on this, we don't generate our own
statistics on this.
BILL GILCHRIST: Okay.
JIM COWAN: But, we don't have them readily available.
BILL GILCHRIST: I can follow up with you later on that. I guess what
I am really trying to understand here is what do you see as the
growth drivers for both the different, for tanks and hoppers over the
next couple of years? My concern is that you guys are bringing on
this capacity, so obviously, that could be a good thing if the
industry is going to be great; it could be a really bad thing if
things do slow down. So, I just want to get your thoughts there on
the drivers behind kind of --?
JAMES UNGER: The drivers behind tank cars is just the general
chemical industry. It's very strong. They are going to need
replacement cars. There are regulatory changes in process right now
that's going to require replacement of a lot of your older cars. In
addition, the ethanol and energy markets are drivers of the tank car
demand. They also drive the hopper car demand. You drive [distilled
grain] cars that hold the by-product out of ethanol plants as well as
the grains are going to ethanol.
So, we see a strong hopper car demand there, as well as the aging
fleet. The average age is over 19.5 years the car is traveling the
roads out there. Railroads have tremendous pricing power now. And you
look their earnings, their cash flows, extremely strong, first time
we have seen this in over 20 years. So, there is a lot of equity out
there, a lot of money. We feel this is the time you are going to see
rebuilding of these roads.
BILL BENAC: Bill, just a little more color on that. If you are going
to call me offline, I can give you some more sources. I think the RSI
is calculating about an 86,000 railcar backlog at the end of
December. 19% of that is in tank cars and 25% is in covered hopper
cars. Those are the two big sections, the two biggest sections of
that market. And also another statistic to look at, Jim mentioned the
average age of the fleet in the United States is the percentage of
railcars that are in excess of 25 years old.
So, it's not a smooth replacement cycle. There are some bumps we
believe coming, which are going to drive further replacement of
railcars. In addition to looking at things like loadings and the
drivers behind the ethanol market are so big, if you consider the
30,000 gallon ethanol car.
Looking at how many cars it's going to take per billion gallons, no
matter what number the government comes up with, whether it's the 5
billion additional gallons we expect this year or Mr. Bush's -- 20
billion gallons on top of that number, you multiply that through by
the number of both tank and hopper cars and we believe that ethanol
will be a driver of this business for at least several years to come.
OPERATOR: Your next question comes from the line of Fritz von Carp.
Please proceed.
FRITZ VON CARP, ANALYST, SAGE ASSET MANAGEMENT: [inaudible - audio
gap] in the quarter, in the P&L implications, I am not exactly
clear what you are saying. I understand that you had fewer cars units
because they were bigger and more complicated units to build. I think
I understand that.
But it's not clear to me why that would lead to weak revenues. I
mean, if in fact, these are at least good margin, average margin
cars, and I think we even said that they were better than average
margin one would expect that being more complicated.
But even if there are just at the same margin, I don't understand why
that would drive lower earnings, push fewer cars through I understand
but at bigger dollars. Is it a timing issue that you don't get to
recognize some of those revenues that you ship the cars? And so, you
push some revenue recognition out of the quarter and to the
subsequent quarter. Is that like scenario A or is it scenario B that
these are just lower margin cars?
BILL BENAC: Well, actually it's neither. We certainly don't, in most
cases, we don't drag revenue from one quarter to another. The cars
are shipped essentially when they are completed. Your scenario --
FRITZ VON CARP: Right. But if you complete less cars in the quarter,
but if there were higher margin, but if you don't recognize until you
ship and let's say you just ship, you have some cars that aren't
complete until the beginning of next quarter, that ship next quarter?
BILL BENAC: Right. And I recognize that that this is not a phenomena
that would be significant to the Company. There are always a few cars
that we haven't shipped at the end of the quarter. Generally
speaking, that's not a problem. Your scenario B had to do with lower
margin. That is also not the case.
The dollar margins are higher on those more expensive cars, as you
would expect, and the percent margins are not lower. They may be
comparable, but dollar margins are higher. What really happens is we
are not able to produce as many cars and consequently, the amount of
dollar margin that we are getting off of a given production line on a
given day is lower because the higher margins on the more expensive
cars don't compensate fully for the amount of extra time it takes.
FRITZ VON CARP: But they are not really higher margin cars and it
doesn't sound like, I mean do you use your assets just as intensively
during a 90-day quarter or whatever and have less dollars to show
for?
BILL BENAC: Well, for an individual railcar, it's a more expensive
car with a higher gross margin. The percent of the margin is not
higher generally speaking. And the number of cars that we produce is
sufficiently depressed that the overall total margin for the Company
is not as high. We recognize that.
And it's one of the costs that we incur as a result of being able to
build a wide product selection for our customers, which is an
important feature of why customers like to do business with us.
FRITZ VON CARP: It doesn't seem like -- it seems like you make less
money on the bigger cars though, fully loaded?
JAMES UNGER: No, no, we don't. We make essentially the same or more
margin. But the --
FRITZ VON CARP: But when you load it with the labor, which is the
same per hour, and the overheads and all this, I mean if --
BILL BENAC: I hear what you are saying and we are disagreeing with
you.
FRITZ VON CARP: Okay.
JAMES UNGER: If you look at the sales volume compared to a higher
cost car versus a lower cost car based on production volumes and
multiply times a same margin, you are going to record less income and
revenue.
FRITZ VON CARP: Right. So, okay, so it's a lower return?
JAMES UNGER: Lower return.
BILL BENAC: It's a lower return on that production line that month or
that week.
FRITZ VON CARP: Okay. Thank you.
OPERATOR: [OPERATOR INSTRUCTIONS] There are no further questions at
this time. I'd like to turn the call back over to Jim Unger for
closing remarks.
JAMES UNGER: Thank you. In closing, I would like to thank our
customers, employees and shareholders for a great year, first year of
being a public company. We have tremendous platform for growth in
this Company and have an aggressive plan to accomplish this growth.
We look forward to the challenge and are confident with the hard work
and dedication of our employees, coupled with our strategic business
partnership, customers, and suppliers, we will succeed. Thank you
again.
OPERATOR: Thank you for your participation in today's conference.
This concludes the presentation. You may now disconnect. Good day.
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