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Edited Transcript of ARII earnings conference call or presentation 2-May-17 2:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 American Railcar Industries Inc Earnings Call

ST. CHARLES May 3, 2017 (Thomson StreetEvents) -- Edited Transcript of American Railcar Industries Inc earnings conference call or presentation Tuesday, May 2, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jeffrey S. Hollister

American Railcar Industries, Inc. - CEO and President

* Luke M. Williams

American Railcar Industries, Inc. - CFO, SVP and Treasurer

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Conference Call Participants

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* Justin Trennon Long

Stephens Inc., Research Division - Research Analyst

* Matthew Youssef Elkott

Cowen and Company, LLC, Research Division - VP

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the American Railcar Industries First Quarter 2017 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would like to introduce your host for today's conference, Mr. Luke Williams, Senior Vice President and CFO. Sir, you may begin.

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Luke M. Williams, American Railcar Industries, Inc. - CFO, SVP and Treasurer [2]

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Thank you, Amanda. Good morning. I would like to welcome you to the American Railcar Industries First Quarter 2017 Earnings Conference Call. I am Luke Williams, our Chief Financial Officer, and I would like to thank you for joining us this morning. For those who are interested, a replay of this call will also be available on our website, americanrailcar.com, shortly after this call ends. Joining me this morning is Jeff Hollister, our President and Chief Executive Officer.

Our call today will include comments about the railcar industry, our operations and financial results. Following these remarks, we will have a question-and-answer session. This conference call will include forward-looking statements, including statements as to estimates, expectations, intentions and predictions of future financial performance based on currently available information. Participants are directed to our SEC filings and press releases for a description of certain business issues and risks, a change in any one of which could cause our 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 statements made during the call.

EBITDA and adjusted EBITDA are non-GAAP financial measures we will discuss today that are reconciled to net earnings in our press release that was issued this morning. The press release is available through the Investor Relations page of our website as well as a supplemental information presentation.

Now, it's my pleasure to introduce Jeff Hollister.

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Jeffrey S. Hollister, American Railcar Industries, Inc. - CEO and President [3]

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Thank you, Luke. Good morning. Thanks to everyone for joining us this morning. The FTR rail equipment outlook for North American railcar markets is currently forecasting deliveries near 43,000 cars in 2017. The industry backlog at March 31, 2017, was 60,471 railcars, and approximately 87% of the backlog is for hopper and tank railcars, our primary products. The industry reported that 4,814 railcars were ordered on a gross basis and 10,042 railcars were delivered during the first quarter of 2017, producing a book-to-bill ratio of approximately 0.5:1. Although the FTR rail outlook increased some from their last report, the industry continues to face challenges as both the tank and hopper railcar markets have softened as demand has shifted to lower volumes and more specialized railcars, and there is fierce competition for a limited number of orders for standard railcar types. While inquiries for various types of hopper railcars remain steady, consistent with the past several quarters, the tank railcar market continues to be impacted more heavily than most other markets, resulting in lower levels of tank car inquiries.

Even with industry orders at low levels, we were able to secure orders in both the tank and covered hopper car markets this past quarter, with 874 new railcars ordered or approximately 18% of the total industry's orders. ARI's book-to-bill ratio for the quarter was 0.76:1. This book-to-bill ratio in orders for the quarter do not reflect a reduction of 250 railcars from our previous backlog. These cars were removed from our backlog, as we negotiated with a customer to lease used railcars rather than new railcars. The used railcars were coming off lease from another customer and this arrangement created a win-win situation to keep our lease fleet as fully utilized as possible and meet the immediate needs of this customer. We have taken additional new-car orders in the current quarter and continue to work with key customers on additional opportunities and inquiries for new car deliveries later this year and into 2018.

As of March 31, 2017, we had a backlog of 3,286 railcars, 1,199 of which we expect will go to our lease fleet. Our continued commitment to strategically partner with customers to grow our lease fleet across a wide range of diversified railcar types resulted in the first quarter of 2017 having a heavier mix of railcars per lease as a percentage of total shipments which was 52% compared to our historical trend from the previous 5 years of 29%. Our lease fleet is now approaching 12,000 railcars. While these shipments and orders for railcars on long-term leases are not immediately recognized as profit on the income statement, they do help us in the short term to maintain a steady level of production during the manufacturing period and in the long term by providing a steady stream of future cash flows.

As we continue to support the industry with complete railcar solutions over the full lifecycle of the railcar, we have remained focused on enhancing our ability to adapt to market trends through our knowledgeable management team and core group of skilled employees. Our efforts to expand our repair network and grow our lease fleet will help us weather the current market conditions and remain competitive.

The steady stream of revenues generated from our lease fleet and Railcar Services business served to partially offset softness in the market for new railcars. It is this commitment and the hard work of our employees that has helped lead our leasing segment to a quarter of over $33 million for revenues and Railcar's Services segment to a quarter of over $20 million for revenues while supporting key customers with necessary maintenance and repairs and availability of railcars as needed.

I'll now turn it back to Luke for a discussion of the first quarter financial results.

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Luke M. Williams, American Railcar Industries, Inc. - CFO, SVP and Treasurer [4]

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Thanks, Jeff. First quarter consolidated revenues were $115 million, down 35% versus $176 million for the same period in 2016. This decrease was due to decreased revenues in the manufacturing segment, partially offset by increased revenues in the railcar leasing and railcar services segments.

Consolidated manufacturing revenues were $61 million for the first quarter of 2017 compared to $124 million for the same period in 2016. This decrease was driven by fewer railcar shipments for direct sale as our mix of shipments was heavily weighted towards building our lease fleet. We shipped 549 railcars for direct sale and 602 railcars for lease during the first quarter of 2017. This was compared to 1,130 railcars for direct sale and 200 railcars for lease during the first quarter of 2016. Railcar shipments for lease represent 52% of our total railcar shipments in the first quarter of 2017 compared to 15% during the same period of 2016. During the first quarter of 2017, we continued to produce a large mix of specialty hopper and tank railcars, and our shipments saw a heavier mix of hopper railcars compared to the same period in 2016. Due to the heavier mix of hopper railcars in 2017 and more competitive pricing due to the softened railcar markets for both tanks and hoppers, average selling prices decreased during the first quarter of 2017.

Consolidated manufacturing revenues exclude estimated revenues related to railcars built for our lease fleet of $60 million for the first quarter of 2017 compared to $24 million for the same period in 2016, reflecting a higher mix of railcars shipped for lease. As a reminder, due to the flexibility of our integrated business model, it is at the customer's discretion whether to directly purchase or lease railcars from us. Also, please note, because revenues and earnings related to leased railcars are recognized over the life of the lease, our future quarterly results will vary depending on the mix of lease versus direct sale of railcars that we ship during a given period. Our railcar leasing revenues for the first quarter of 2017 were $34 million compared to $33 million in the same period of 2016. Our lease fleet has grown to 11,869 railcars at March 31, 2017, compared to 10,556 railcars as of March 31, 2016.

Although we continue to strategically grow our lease fleet, we are experiencing a slight decline in weighted average lease rates compared to the same period in 2016, given the current industry trends. Our lease fleet continues to be utilized at over 99%. We continue to actively work with customers with leases expiring during 2017, to renew the railcars under lease with the current customer or reassign the railcars to another customer.

Our consolidated railcar services revenues for the first quarter of 2017 were $20 million, up 2.5% compared to the same period of 2016. Revenue increased due to an increase in customer demand for our mobile repair services and repair projects performed at our tank railcar manufacturing facility in 2017, partially offset by an unfavorable mix of repair work in the current quarter at some of our other repair facilities.

Consolidated earnings from operations for the first quarter of 2017 were $22 million, down 46% compared to $41 million for the same period in 2016. Our consolidated operating margins were 19% for the first quarter of 2017 compared to 23% for the same period in 2016. These decreases were primarily driven by lower earnings from operations in our manufacturing and railcar services segments combined with slightly lower earnings from operations from the railcar leasing segment.

Consolidated earnings from operations for our manufacturing segment were $3 million and 5% of sales for the first quarter of 2017 compared to $19 million and 15% of sales for the same period in 2016. These decreases were due to fewer overall railcar shipments for direct sale, as previously mentioned, higher costs associated with the lower production volumes and more competitive pricing on both hopper and tank railcars. These earnings from operations excluded $6 million in estimated profits on railcars built for our lease fleet for the first quarter of 2017 and $3 million for the same period in 2016. The estimated profits on railcars built for our lease fleet are eliminated in consolidation.

Earnings from operations for the railcar leasing segment were $21 million for the first quarter of 2017 compared to $23 million in the same period of 2016. This decrease was due to an increase in maintenance costs associated with the company's lease fleet and a slight decline in weighted average lease rates on certain renewals compared to 2016. While our relatively young lease fleet continues to yield relatively low maintenance expenses, we expect to see slightly higher maintenance expenses in the coming years as cars come off lease and may be reassigned to other customers. While the utilization of our lease fleet remains strong, we are not impervious to the declining lease rates experienced by much of the industry as a result of the softness in the overall market. On the upside, the expiration dates of our operating leases for railcars in our lease fleet are spread over the next several years, which helps mitigate the risks of renewing leases at lower rates or any inability we may experience in renewing leases or re-leasing these railcars. As of March 31, 2017, we have approximately 11% of our lease fleet up for renewal through the end of 2017. We are actively working with customers on these renewals, and have already been successful at renewing or reassigning almost 600 lease railcars thus far in 2017.

Earnings from operations from our railcar services segment decreased $1 million compared to the first quarter of 2016. This decrease was primarily due to an unfavorable change in the mix of work at some of our repair facilities causing inefficiencies, partially offset by an increase in demand for our mobile repair services.

Selling, general and administrative expenses were $9 million for the first quarter of 2017 compared to $8 million in the same period of 2016, primarily due to increased bad debt expense, compensation cost and depreciation. Interest expense was 6% lower in the first quarter of 2017 compared to the same period in 2016 due to a lower average debt balance during 2017, as amounts drawn on our revolving credit facility were repaid during the first quarter of 2016.

Net earnings for the first quarter of 2017 were $11 million or $0.55 per share compared to $23 million or $1.16 per share for the first quarter of 2016. This decrease was driven by the lower earnings from operations referenced earlier, combined with lower earnings from our joint ventures. Earnings from our joint ventures declined largely as a result of certain ramp down costs experienced as a result of the idling of production at our Ohio Castings joint venture facility and lower production at our Axis joint venture in 2017 in line with expected industry demand.

Adjusted EBITDA, which excludes share-based compensation and other income related to short-term investment activity, was $36 million for the first quarter of 2017. This was 33% lower than the $54 million for the first quarter of 2016. This decrease resulted primarily from decreased earnings from operations as previously discussed.

Our earnings contributed to positive cash flow from operations of $42 million during the first quarter of 2017 and we ended the quarter with net working capital of $206 million, including $151 million of cash and cash equivalents. As of March 31, 2017, we had $570 million of debt outstanding under our January 2015 lease fleet financing facility.

Our strong balance sheet combined with the $200 million available to borrow under our revolving credit facility provides us with the ability to continue to find opportunities to strategically grow as we make future investments to further enhance our business model. We also have additional unencumbered railcars available to further leverage our lease fleet, as we continue to expand that segment of our business.

We continue to return value to our shareholders through the payment of quarterly cash dividends. On April 28, our Board of Directors declared a 19th consecutive quarterly cash dividend. This $0.40 per share dividend to ARII shareholders of record as of June 16, 2017, will be paid on June 29, 2017. During the first quarter of 2017, we did not repurchase any shares of our common stock. Board authorization for approximately $164 million remains available for further share repurchases as we continue to evaluate the market and our share value.

At this time, I'd like to turn it back to Jeff for some further comments.

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Jeffrey S. Hollister, American Railcar Industries, Inc. - CEO and President [5]

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Thanks, Luke. Even though the North American railcar industry is facing challenging times with low order and inquiry levels, we believe our family of product offerings of quality hopper and tank railcars, that serve a variety of commodities and customers, sets us apart from our competition. We continue to work with customers on active opportunities to fill our production availability later in 2017. Even at the lower production levels we are currently facing, our skilled and flexible workforce is able to efficiently produce high-quality hopper and tank railcars at competitive prices.

One of our key strategies has been and continues to be the vertical integration and flexibility within our business and our supply chain, as we continue to benefit from our component manufacturing facilities and our joint ventures. Based on the current low levels in the railcar industry, as Luke previously mentioned, the partners recently decided to idle our Ohio Castings joint venture production in January 2017. We expect that this joint venture will remain idle through at least the end of 2017, subject to revaluation based on changes in future demand expectations. Although we strive to be as profitable as possible in these joint ventures, one of the key reasons for these partnerships as well as our ARI component plans is the assurance of consistent high-quality compliments when we need them and the ability to control our inventory levels and cost. By working with our partners and our key vendors, including our other joint venture Axis, we have confidence that we can acquire an adequate supply of key railcar components at competitive prices for not only this year but also for years to come.

As previously announced, the sale of our current lease fleet manager, American Railcar Leasing, or ARL, is expected to close during the second quarter of 2017. With this sale, we have the opportunity to further enhance our capabilities by transitioning the management of our railcar leasing business in-house to ARI. Transition plans and efforts have been underway over the past several months. We continue to believe our integrated business model lends itself to a solid foundation of knowledge that we intend to leverage as we transition to internally manage our own railcar leasing business.

We are preparing for this new opportunity by performing testing and training on our systems and actively hiring personnel, including certain former ARL personnel. These efforts will help us to further establish our lease fleet operations when we take over managing our cars in-house. We feel our ability to manufacture our own railcars for lease, gives us the flexibility and competitive advantage to manage and grow our leasing business as opportunities arise to be able to meet customers' needs to transport a variety of commodities in both hopper and tank railcars.

By furthering strengthening our organization through this strategic leasing endeavor and utilizing synergies from our manufacturing and railcar services operations, we will continue to be well positioned to compete in the North American Railcar Leasing market.

With a commitment to be a leading railcar solutions provider and effort to support our customers, we remain optimistic in the growth of our railcar services business. Through our full-service repair network, including our mobile repair operations, we offer the flexibility and capacity to meet both our ARI fleet demands as well as those of our customers over the railcar life cycle. This also helps us to gain valuable insight into our customer's needs. Furthermore, with the additional repair capacity available at our tank railcar manufacturing facility in Marmaduke, Arkansas and at ACF facility in Milton, Pennsylvania, we can perform traditional repair and retrofit services in a more efficient production line setup. The capacity of these facilities will also aid us and our customers in complying with the FRA's revised directive, under which we have began to inspect railcars in 2017.

We continue working with the Federal Railroad Administration and our customers to inspect railcars identified as part of the FRA's revised directive. We now await a hearing date, to be set by the court regarding our efforts to challenge the directive. Throughout this process, we remain focused on the safety and quality of the railcars we manufacture and supporting our customers.

Knowing we're expecting a soft year in 2017, we have scaled back our current capital expenditure plans to focus on supporting necessary maintenance needs and cost-reduction initiatives and continuing to strategically grow our lease fleet. While we continue to see intense competition in a soft railcar market, inquiry activity has been encouraging. As mentioned, our vertically integrated manufacturing along with our dedicated employees has helped us to remain profitable and efficient even in a challenging market.

We are proud of the continued growth of our railcar leasing and railcar services segments. With the help of these segments, we stand ready to support the industry with a complete set of railcar solutions over the full lifecycle of the railcar.

Now we'll turn the call back over to the operator, and we'll be happy to take your questions.

Amanda, would you please explain how our participants can register their questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is from the line of Matt Elkott of Cowen.

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Matthew Youssef Elkott, Cowen and Company, LLC, Research Division - VP [2]

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Speaking of ARL, I was wondering if you guys incurred any transitory cost associated with your work on bringing management in-house in the quarter?

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Luke M. Williams, American Railcar Industries, Inc. - CFO, SVP and Treasurer [3]

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We've had a little bit of work as we started to hire personnel, as we mentioned during the prepared remarks, but all that is really seeding the management team and getting us started, to be able to hit the ground running as soon as the transition happens and the close of the sale takes place during the second quarter.

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Matthew Youssef Elkott, Cowen and Company, LLC, Research Division - VP [4]

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Okay. And then once this -- the whole process is done and you fully transition into in-house management, do you have visibility on, are you -- is the management cost versus the fees that you guys were paying to ARL, do you have any visibility on are you going to be breakeven? Or are you going to be better off, worse off?

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Luke M. Williams, American Railcar Industries, Inc. - CFO, SVP and Treasurer [5]

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So I think, and as we've talked about in prior calls, the management fee and commissions we've paid to ARL over the past several years has ranged from $7 million to $8 million in a given period. We don't anticipate saving a whole lot at this point, at least the first year and maybe even the second year, but we do expect some synergies as we move forward with it but we don't expect immediate savings going -- in this first year here.

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Matthew Youssef Elkott, Cowen and Company, LLC, Research Division - VP [6]

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Got it. And on the production front, do you guys -- do you have any commentary that you can share with us on the rest of the year? Should we expect continued decline of 100, 200 railcars every quarter going forward?

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Jeffrey S. Hollister, American Railcar Industries, Inc. - CEO and President [7]

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Yes, Matt. So this is Jeff. So second quarter should be pretty similar to Q1. We should be able to remain pretty steady with the production rates we were at, at Q1. Just to remind you that the lease percentages was very high for Q1 and that will continue into Q2 as well. And then, in the second half of the year you should see a slight decrease in production rates. We still got a little work to do at our tank car facility later in the year to keep our production rates at the higher level. So there's a chance we could tail off in the second half of the year.

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Matthew Youssef Elkott, Cowen and Company, LLC, Research Division - VP [8]

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Got it. And just one last quick question, I noticed that the backlog that are subject to lease has declined fairly materially from last quarter. I think it was 1,637 -- last quarter's 1,637 units and now it's 1,199. Can you give us a little color on that?

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Luke M. Williams, American Railcar Industries, Inc. - CFO, SVP and Treasurer [9]

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So the 2 main factors, as we mentioned earlier, we had 52% of our shipments for lease during the quarter, so that's 602 railcars. And then as Jeff mentioned, we had eliminated 250 cars out of our backlog, where we worked with a customer to give them used cars in exchange for a new railcar to help leverage and keep our lease fleet fully utilized and meet the needs of that customer.

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Operator [10]

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(Operator Instructions) And next question is from the line of Justin Long of Stephens.

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Justin Trennon Long, Stephens Inc., Research Division - Research Analyst [11]

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So maybe to start with a high-level question. You mentioned the competitive nature of the market right now. But I was curious, does the market feel like it got more competitive sequentially in the first quarter? Or have you seen some stabilization in terms of pricing and the competitive dynamics on a sequential basis?

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Jeffrey S. Hollister, American Railcar Industries, Inc. - CEO and President [12]

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I would say we're seeing more inquiries and customers seem to be at a point where they're starting to make decisions to order certain cars and, obviously, the order size is a lot smaller than we've seen historically. But what we're seeing is that, along with our competition, everybody's needing cars to fill production for '17 and early '18. And so it's getting more competitive as far as customers have choices. Depending on the car types, certainly, what I'd call a standard car types, pricing and rates are very aggressive. Where we try to pride ourselves on is the specialty cars that we can build, both on the hopper and tank car side, that the rates are still meeting our acceptable margins. And so that's where we've been able to get several orders here in Q1 and we've actually gotten a few orders here in Q2 as well.

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Justin Trennon Long, Stephens Inc., Research Division - Research Analyst [13]

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Okay. Great. But if you look at the pricing for what you defined as the standard cars, is it worse today than it was at the beginning of the year?

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Jeffrey S. Hollister, American Railcar Industries, Inc. - CEO and President [14]

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It's probably -- it's worse than it was in Q4. But I mean, it's still acceptable, depending on certain car types. I mean it just really varies by car top by car top and which manufacturers can build certain car tops.

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Justin Trennon Long, Stephens Inc., Research Division - Research Analyst [15]

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Got it, that makes sense. And I wanted to ask a second question on your expected -- based on your expected production and mix, how should we be thinking about manufacturing margins over the remainder of the year, do you think we'll see some moderation maybe to the high-single-digit level, just given your commentary that production could start to come down a little bit?

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Luke M. Williams, American Railcar Industries, Inc. - CFO, SVP and Treasurer [16]

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Yes. Justin, this is Luke. We definitely expect to see some pullback on margins as we move forward throughout the year, just based on some of the orders we've taken, a little bit lower margins and lower production volumes that resulting in some higher cost that we can't absorb at those lower production levels. So yes, we see a little bit of pullback happening going forward.

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Justin Trennon Long, Stephens Inc., Research Division - Research Analyst [17]

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Okay. And maybe lastly, you guys have always talked about services margins averaging around 20% over time, but this is now the second quarter where we've been closer to the mid-teens. Could you talk about your confidence, we -- in seeing a bounce back closer to that 20% level, and is that an achievable target as we look at over the rest of the year?

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Jeffrey S. Hollister, American Railcar Industries, Inc. - CEO and President [18]

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Yes, Justin. So a few moving variables here. At the end of the year, obviously, we've ramped up some of our repair plants in '15 and '16. At the end of '16, we saw several customers, whether it'd be budget reasons or timing or whatever pulled back on a lot of our repair projects at the very end of the year. So we scrambled to put other work in its place. When you change the mix at our repair shops, it affects efficiencies and that affects margins overall, and so we started to see that at the end of the year. And then, obviously, starting the new year, we couldn't get the pipeline turned on quick enough either on a lot of this project work. And so, again, probably filled in some of our repair volume with a mix of work that's probably not as profitable as we've seen historically. So we are starting to see an upbeat in the last month or 2 as far as margins, and so we are very hopeful to get back to that 20% level, but it's probably going to be several months before we get back to that level as we try to work through mix issues and the working with some of our customers to get that consistent volume flow into the plants.

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Operator [19]

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At this time, I'm showing no further questions. I'd like to turn the call back over to Mr. Jeff Hollister, President and CEO, for any closing remarks.

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Jeffrey S. Hollister, American Railcar Industries, Inc. - CEO and President [20]

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Thank you, Amanda. Well, that concludes our conference call this morning. Thanks to everyone who participated, and we look forward to talking to you next quarter.

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Operator [21]

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Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everybody, have a great day.