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Edited Transcript of RAIL earnings conference call or presentation 31-Oct-19 3:00pm GMT

Q3 2019 FreightCar America Inc Earnings Call

CHICAGO Nov 2, 2019 (Thomson StreetEvents) -- Edited Transcript of FreightCar America Inc earnings conference call or presentation Thursday, October 31, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher J. Eppel

FreightCar America, Inc. - VP of Finance, CFO & Treasurer

* James R. Meyer

FreightCar America, Inc. - President, CEO & Director

* Michael Cieslak

FreightCar America, Inc. - Head of Financial Planning & Analysis and IR

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Conference Call Participants

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* Justin Trennon Long

Stephens Inc., Research Division - MD

* Matthew Stevenson Brooklier

The Buckingham Research Group Incorporated - 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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Welcome to the FreightCar America's Third Quarter 2019 Earnings Conference Call and Webcast. (Operator Instructions) Please note, this conference is being recorded. An audio replay of the conference call will be available from roughly 1 p.m. Eastern Time today until 11:59 p.m. Eastern Time on December 1, 2019. To access the replay, please dial 1 (800) 475-6701. The replay passcode is 473325. An audio replay of the call will be available on the company's website within 2 days following this earnings call.

I would now like to turn the call over to Mike Cieslak, Head of the FP&A and Investor Relations at FreightCar America. Please go ahead.

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Michael Cieslak, FreightCar America, Inc. - Head of Financial Planning & Analysis and IR [2]

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Thank you, and welcome. Joining me today are Jim Meyer, President and Chief Executive Officer; and Chris Eppel, Chief Financial 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 under the Private Securities Litigation Reform Act of 1995. Participants are directed to FreightCar America's 2018 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. Our 2018 Form 10-K and earnings release for the third quarter of 2019 are posted on the company's website at www.freightcaramerica.com.

With that, let me now turn the call over to Jim for a few opening remarks. Jim?

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James R. Meyer, FreightCar America, Inc. - President, CEO & Director [3]

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Thank you, Mike. Good morning, and thank you for joining us today. When we entered 2019, we discussed with you our goal of having a substantial amount of our Back to Basics work completed by the end of this year. We have largely achieved this goal, and this is where I will start our discussion today. Shoals is running well, and we are finally able to claim our ability to realize the potential of this world-class facility. Now, in addition to the great physical facility, we have the talent, the processes and the experience of building many thousands of cars under our belt.

With respect to the 3 key operational drivers that distinguish any plant, safety, quality and productivity, our safety is world class with only a single OSHA recordable incident year-to-date. Our quality is meeting or exceeding industry standards, and we continue to invest in our people, processes and plant facilities such as additional welding and painting robotics with the goal of becoming the highest quality producer in the industry.

Productivity also continues to improve. And as a direct result of those same investments plus our new and redesigned products and tooling, we are now more than halfway through our first order of an important and newly reengineered and retooled car type. And our productivity or hours of direct labor to produce a unit is now on a run rate target approximately 30% lower than when we were building this product in 2017 and 2018. But more important than the numbers is what our customers are saying about the consistency and overall quality and workmanship coming off the lines in Shoals. It is both very positive and an affirmation of where we stand in the industry as a manufacturer.

Moving to our cost reduction progress. The Roanoke wind-down is on track and going very well. As a reminder, closing Roanoke is expected to save $5 million per year in fixed cost starting as soon as we exit the facility in the first quarter of next year. This is in addition to the $7 million per year we will save on our new Shoals lease agreement, which begins in January 2022. Our Shoals facility is more than ready to absorb the Roanoke operations. And I would like to once again acknowledge the commitment and work ethic of our Roanoke employees to do what they have always done, which is to produce top-quality cars even as they build out the final order.

So to state the economics once more, we expect our fixed manufacturing cost will improve by $5 million per year starting at the end of the first quarter of 2020. And then we realize another $7 million of cash savings per year starting with the first quarter of 2022.

With respect to material cost reduction, we have previously stated and updated you on our 2019 goal to realize $2,000 to $3,000 of saving per railcar on a run rate basis. We remain on track to achieve these new savings by year-end. Cost reduction and lean manufacturing are becoming a key part of who we now are as a company, and we will continue to take out significant cost over the foreseeable future.

Our product portfolio work continues to progress and align itself with where we know the market will be. Without going into specific car types, in our recent calls, we have discussed 4 product categories key to our future. One is now in production, along with the productivity gains mentioned; a second, which also has an important first order and will enter production at the end of Q1 2020; and then 2 more products, which will be ready for mid-2020 production.

When I joined FreightCar America in August of 2017, we were competitive in roughly 1/3 of the North American non-tank car market. In another few quarters, we will be competitive on approximately 2/3 of the non-tank car market. And then with the recently announced JV in Mexico, we will have the ability to fill the remainder of this gap.

One structural issue we have not yet addressed is labor cost. Again, we have made tremendous strides in lowering our material and fixed cost. And we have also made tremendous strides at improving our labor productivity. Managing labor rates, however, is also imperative to compete in this industry, and certain car types are simply infeasible to produce profitably from the U.S. This is the motivation behind our recently announced joint venture.

As most of you may know, we announced the formation of a joint venture with Fasemex in September to manufacture railcars in Castaños, Mexico. Over the course of more than a year, we were able to find the right partner and then work together to create the right business structure. This partnership gives us access to extremely skilled railcar workers in a variety of car types starting on day 1. It also gives us an existing fabrication source, Fasemex, a proven supplier to the industry.

And finally, the partnership provides us with the right person to head up this new operation, the same person who helped the industry's 2 largest competitors establish and then lead their operations in the region. Having a footprint in Mexico has always been a planned and critical component of our Back to Basics strategy. We knew it would be very difficult to compete in certain car types without a footprint in Mexico. Our biggest competitors are already there. And for the same reasons, it is critical that we also bring some of our future operations to Mexico.

The manufacturing facility is under construction, and we expect to start a slow ramp-up of production in mid-2020. When complete, the JV will consist of 2 production lines with about 2,000 units per year of total capacity. This is the final step for us to become profitable in car types that we otherwise wouldn't be if these were produced in the U.S.

In terms of the basic structure and capital outlay for the partnership, FreightCar and Fasemex will share profits and losses of the JV 50-50. And we are committing $25 million to the JV through a combination of assets and cash loan. We anticipate providing between $5 million and $7 million in the fourth quarter, which will be used to fund initial working capital and asset needs.

As a manufacturer, we are thrilled by the prospects of having the newest purpose-built railcar factories in both the U.S. and Mexico. The culmination of this work covers almost everything we have been targeting in Back to Basics. In 2018, we put the plan in motion by taking full control of our Shoals facility, investing in our workforce and removing more than $3,000 of cost per railcar. In 2019, we laid out the final phase, which will soon come to completion. So the next logical question becomes: Where are the results?

It is well known by those who follow our industry that we are currently in a business downturn. For much of the past year, most car types, except for tanks and plastic pellets, have been down and in many car types, down significantly. As to specifics, the decline in loadings for U.S. railroads widened to 5.6% year-over-year in the third quarter and continues to widen this quarter. Total railcars and storage has increased in 11 of the last 12 months, and railcar lease rates continue to trend downwards.

As of quarter end, over 350,000 cars or approximately 22% of the total fleet are in storage. Per the Rail Supply Institute, versus Q3 last year, Q3 2019 industry orders are down 71%, and Q3 2019 industry backlog is down 21%. On a year-to-date basis, orders are down 54%. The reasons talked about for the slowdown include the impact of spring and fall weather on the grain market, tariffs on intermodal traffic, general concerns regarding the future strength of the economy and precision scheduled railroading. Regardless of the reasons, we all know this to be a cyclical and an essential needs business, therefore, it will come back.

At FreightCar America, over the last 24 months, our backlog has been heavily impacted by a combination of our incomplete product offering, our cost structure, which led us to not pursue certain business, which is especially true this year, and the soft market just described. Our order backlog as of September 30, 2019, consisted of 1,704 railcars with an estimated total sales value of approximately $188 million. While our backlog is up compared to the 1,121 railcars at the end of the second quarter, it has significantly fallen over the last few years.

Our Back to Basics work, including the Mexico footprint that will come online next year, addresses all but the industry weakness. We must finish the job and be fully ready to take advantage of the next up cycle. And please note that we will take the steps necessary to ensure sufficient liquidity as we wait out this difficult market and that we have a number of options to consider should this downturn persist, as Chris will speak to you shortly.

Looking ahead to the remainder of 2019. Our full year delivery guidance remains at 2,200 to 2,500 railcars and consists entirely of sold production slots.

On one final note, we are pleased to formally welcome Matt Tonn to our team as Chief Commercial Officer. Matt is an extremely accomplished sales and business development executive with more than 25 years of experience in the railcar industry. He spent the last 11 years in senior sales, marketing and business development roles at Wabtec. This is not only a testament to our ability to attract Tier 1 talent but also how proven industry leaders see the potential of FreightCar and want to be part of our future success.

With that said, Chris, can you please walk us through the financial results for the third quarter?

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Christopher J. Eppel, FreightCar America, Inc. - VP of Finance, CFO & Treasurer [4]

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Thanks, Jim. Before we discuss the financial performance, I wanted to review an accounting-related matter in the quarter. In line with normal GAAP practices, the company completed its annual goodwill impairment testing during the quarter. Due to our most recent financial results and the current condition of the new freight car market, the company recorded a noncash goodwill impairment charge of $21.5 million in the quarter. This represents the entire amount of goodwill on the company's balance sheet. This charge had -- this charge has no impact on liquidity or our cash position. Furthermore, the charge will not impact our ability to generate cash flow or influence ongoing operations.

Turning to the financial results. Consolidated revenues for the third quarter 2019 totaled $40.7 million compared to $79 million in the third quarter of last year due to factors already discussed by Jim. Based on the 47% decline in deliveries from the third quarter of last year, our gross margin fell to a negative $5.4 million compared to a negative $3.8 million in the third quarter of last year. Despite our volume decline, the corresponding loss and the corresponding loss of operating leverage, the company benefited from the progress of its material cost reduction efforts. As a reminder, the Roanoke facility will end production in the fourth quarter, and we expect all costs associated with this facility to cease during Q1 of 2020. In terms of 2019 targeted cost savings, approximately $1,200 of new cost reduction per railcar achieved during this year was recognized in the P&L for the quarter.

SG&A for the quarter totaled $7.8 million, up from the $5.4 million in the third quarter of 2018. The increase in SG&A as compared to the prior year was primarily related to the timing in certain compensation expenses year-over-year and project-based legal expense as compared to the prior year. This increase is not a trend, and we expect SG&A costs to be down sequentially and year-over-year in coming quarters. We also note the company will terminate the post-retire medical benefit it provided for certain employees effective January 1, 2020. This policy change will generate approximately a $6.3 million gain in the fourth quarter in addition to ongoing cash savings of approximately $400,000 per year going forward.

Consolidated operating loss for the third quarter of 2019 was $36.3 million, largely attributed to the aforementioned goodwill impairment. Excluding that impairment and the $1.5 million of restructuring charges related to Roanoke, our operating loss was $13.2 million as compared to a loss of $8.7 million in the third quarter of 2018.

Moving to the balance sheet. We finished the quarter with cash and cash equivalents of approximately $60 million, a decline from the $71 million at the prior quarter. As we go forward, we have multiple liquidity options available to us and feel confident about our current position. As such, FreightCar had no additional borrowings or asset sales of any type during the quarter. The company maintains an asset-backed lending facility in addition to a separate facility secured by its leased car portfolio. As I mentioned on our prior call, we continue to focus on identifying less productive assets on the balance sheet that we can turn into productive, flexible assets in the future. While we did not take any action in this regard within the quarter, the company has the ability to reallocate its balance sheet towards additional liquidity in the coming quarters if necessary. Examples include, but are not limited to, the utilization of current borrowing facilities, additional monetization of our leased fleet and other assets and additional debt funding opportunities.

Furthermore, outside of our expected initial cash loan of between $5 million and $7 million to the JV, we will make -- that we will make in the fourth quarter, the company's previously announced JV investments are not date-specific and can be managed in line with building an order book for the products produced at that location. The company's only debt remains a $10 million leased fleet loan secured directly by a portion of our lease portfolio. As a reminder, this facility is secured directly against leased assets and no other part of our balance sheet. As such, it's separate from our ABL facility. The company also maintains additional liquidity in this leased fleet on top of the loan.

Finally, capital expenditures for the third quarter totaled $1.2 million. For 2019, we continue to anticipate CapEx figure for the year, excluding the JV, to be roughly $5 million. These expenditures will go towards advancing the design of our new products, bringing those products online and enhancing our Shoals facility with a number of improvements to support those efforts.

In summary, the company remains in a stable cash position with multiple opportunities for additional balance sheet liquidity. This positions us to effectively manage the cyclical reduction we are currently experiencing in industry demand. The work that has been completed on both the fixed cost base and the portfolio expansion position us to be in a cash positive position when industry volumes improve and we launched our enhanced product offerings at a competitive cost base.

With that, I would like to conclude our prepared remarks and turn the call over to the operator for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we will begin with the line of Matt Brooklier with Buckingham Research.

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Matthew Stevenson Brooklier, The Buckingham Research Group Incorporated - Analyst [2]

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Can we talk about the cost savings, the cadence that you talked a little bit about it early in the call, but there's kind of a fair amount of moving parts at this point in time? Maybe talk about the cadence of cost savings moving forward into fourth quarter. And then maybe if you could just kind of summarize the total potential cost savings in 2020, where you think that potentially shakes out.

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Christopher J. Eppel, FreightCar America, Inc. - VP of Finance, CFO & Treasurer [3]

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Sure. I'm going to -- I'll talk to a couple of things specifically that Jim mentioned in his section. This is Chris. First, the Roanoke cost savings that we've talked about of approximately $5 million gets fully embedded into the P&L within the first quarter of 2020. So if you look out next year, you should start seeing parts of that in Q1 and then going forward. The lease cash, the cash impact of the lease reduction is -- starts at the end of '21, effectively the beginning of 2022. That's the $7 million we discussed. The ongoing material cost reductions, obviously, get done sequentially over time, in line with how we've announced. So again, part of that was in the number you saw. Despite the significant decline in sales, you saw a smaller decline in gross margins. So you are seeing some of that now, and you'll see more in the future. And in addition, you'll start seeing sequential SG&A improvement effectively in the next quarter becoming greater as we go off into next year. Jim, would you like to add anything?

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James R. Meyer, FreightCar America, Inc. - President, CEO & Director [4]

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No, I think that covers it.

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Matthew Stevenson Brooklier, The Buckingham Research Group Incorporated - Analyst [5]

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What -- the total potential annual SG&A savings, those could be what in '20?

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Christopher J. Eppel, FreightCar America, Inc. - VP of Finance, CFO & Treasurer [6]

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We're not giving guidance on that right now, but we'll talk more about our guidance in our next call.

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Matthew Stevenson Brooklier, The Buckingham Research Group Incorporated - Analyst [7]

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And then when we look at the backlog, where it stands now, we take into consideration your expected deliveries in fourth quarter, I'm left with, I think, something like 1,200 -- roughly 1,200 units, assuming there's kind of minimal order activity because of, obviously, what's happening in the industry. But could you just talk to the backlog and how much of what you have in the backlog right now is anticipated to deliver in 2020?

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Christopher J. Eppel, FreightCar America, Inc. - VP of Finance, CFO & Treasurer [8]

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Right now, again, we're not giving 2020 guidance about how much of the backlog specifically for that amount. Obviously, based on our guidance that we have given for the rest of the year, you can anticipate Q4 to be -- from a unit perspective, to be roughly in line with Q3. And again, we'll continue -- we'll give additional guidance on that in our next call as we give guidance on 2020.

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James R. Meyer, FreightCar America, Inc. - President, CEO & Director [9]

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Yes. Matt, this is Jim. I think what I'll just also add as we -- I think we did in the last call, the majority of the backlog is scheduled for 2020, so we'll leave it at that.

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Matthew Stevenson Brooklier, The Buckingham Research Group Incorporated - Analyst [10]

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Fair enough. And then what -- as you look at your backlog, maybe you talk about car types. We recently saw there was a pretty sizable cancellation for small cube covered hoppers bound for the frac sand market. Do you have any of those cars in your backlog as of today? And then maybe just talk to the types of cars -- other types of cars you have in backlog currently?

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James R. Meyer, FreightCar America, Inc. - President, CEO & Director [11]

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Matt, this is Jim. I'll answer both ways. We don't have any sand cars in our backlog. But other than that, we don't give specific guidance or -- on the nature of the mix or car types.

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Operator [12]

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Next, we will go to the line of Justin Long with Stephens.

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

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So I wanted to circle back to the JV in Mexico. I think you mentioned the peak capacity for about 2,000 units, but is there any color you can provide on the car types that you'll be able to build in Mexico? And at what point will you start to be able to take orders for that Mexican facility, if not, already?

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James R. Meyer, FreightCar America, Inc. - President, CEO & Director [14]

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Justin, this is Jim. Let me just give a little clarification on the joint venture. We will bring online one production line next year with a plan to settle out at 2 production lines total. So that sort of gives you a visual on the -- if you will, on the size of it.

As this sort of fits with the overall business, our primary manufacturing platform is and remains Shoals, Alabama. We've invested a lot in it. We're going to continue to invest in it. Our Roanoke facility, as you know, which has been winding down now, all of that product, in fact, transfers to Shoals. What we will be doing specific with the footprint in Mexico when it's ready in 2020 is open up the ability for us to compete in car types we're currently not active in today just because of the nature of the economics of those particular car types. But I'd rather not get into the specifics of what we will build, where and when other than to perhaps reiterate what was stated on a prior call, which is intermodal well cars, which are an important part of the industry and an important part of our future, that's a product that is and will be built in Shoals. And we've also talked about making significant investments -- additional investments in our painting facilities in support of plastic pellet production. And that's also a dedicated product to our Shoals facility. But I won't go any further than that at this time.

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

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Okay. That's helpful. And obviously, there have been a lot of strategic improvements and announcements that you've made here over the last couple of years or so, but do you have any thoughts around the timing of when the business can return to breakeven? And you mentioned the weaker railcar demand environment. Do we need to see an up cycle or a material improvement in the demand environment to get to breakeven? Or do you think with some of the footprint rationalization and cost improvements we've seen that you can get to breakeven even in today's demand environment?

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Christopher J. Eppel, FreightCar America, Inc. - VP of Finance, CFO & Treasurer [16]

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This is Chris. So it's a good question. So as you would expect, we continue to be focused on lowering effectively our breakeven point as a company, and a lot of the footprint reductions and cost reductions and efficiencies that we've been putting in place allows us to get there.

Now when you look at the portfolio expansion, that effectively allows us to get more cars in a down market. So it's hard to say if it's really the -- the way just to kind of highlight is we think about it as we're producing or creating a cost structure and infrastructure that will get us to profitable at a unit volume consistent to what we've seen in the prior few years. Obviously, for us, it's ahead of where we are today. But we do not view this lowering the breakeven point as a fixed time period thing. We'll continue to make adjustments to the company in line with what we see from an order basis, but the, I mean, long story short, I think the idea is that the company's breakeven point is much lower than it had been several years ago, and we'll continue to lower it.

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

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Makes sense. And lastly, just thinking about the railcar demand environment today, do you have an expectation on how industry railcar orders progress over the next several quarters? Is your assumption that we kind of stay around the 3Q level or we get better or worse? How are you thinking about that?

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James R. Meyer, FreightCar America, Inc. - President, CEO & Director [18]

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Justin, this is Jim. We are students, just like you, of the rail industry data that's put out regularly. That's what we read. That's what we forecast, and that's what we plan our business off of. So I know you're familiar with all of that data, and that's what we use also.

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Operator [19]

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And our last question comes from the line of Matt Elkott with Cowen.

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Matthew Youssef Elkott, Cowen and Company, LLC, Research Division - VP [20]

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To stay on the order front, I think you got 1,050 net orders in the quarter, which is basically the number you had mentioned on July 31 that you got in July. So in the last 3 months, you got -- you didn't get any orders? Or did you get some orders but had some cancelations?

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James R. Meyer, FreightCar America, Inc. - President, CEO & Director [21]

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Matt, this is Jim. The order intake for the quarter was taken in across a couple of different orders, and it was in the first part of the quarter. In time, that let us make mention of it, as you noted, on the last call. We've not taken additional orders since the call. We remain active with our sales funnel, and it's obviously not as healthy as anybody would like it to be in the industry right now. But there is activity out there, and we're doing what we always do, which is work the funnel and work deals.

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Matthew Youssef Elkott, Cowen and Company, LLC, Research Division - VP [22]

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Got it. And...

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James R. Meyer, FreightCar America, Inc. - President, CEO & Director [23]

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I guess the only other thing I'd add to that is, as we have -- we've talked about what the retooling and bringing online the additional car types, we have a lot more types of discussions that we can have today than we did in past quarters.

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Matthew Youssef Elkott, Cowen and Company, LLC, Research Division - VP [24]

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Very helpful. And for Chris, I want to make sure I heard this correctly. The SG&A expense in the fourth quarter should be below 3Q and below 4Q last year's -- last year.

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Christopher J. Eppel, FreightCar America, Inc. - VP of Finance, CFO & Treasurer [25]

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Yes, it should be below 3Q. Obviously, there are other structural things they could have and they could have an impact on that. But as far as what I would call the structural SG&A, it should be, again, coming -- definitely coming down over this quarter and then looking favorable as compared to prior year.

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Matthew Youssef Elkott, Cowen and Company, LLC, Research Division - VP [26]

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Okay. And I missed the first 5 minutes of the call, so sorry if I missed this, but did you say anything about when you would expect your gross margin to be positive again?

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Christopher J. Eppel, FreightCar America, Inc. - VP of Finance, CFO & Treasurer [27]

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We've not given time guidance on that at this point.

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Matthew Youssef Elkott, Cowen and Company, LLC, Research Division - VP [28]

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Okay. And then on the -- the backlog ASP went up significantly in the third quarter. Is that more a function of the orders you received or more of the deliveries you made in the third quarter?

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James R. Meyer, FreightCar America, Inc. - President, CEO & Director [29]

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More -- it's obviously, mathematically -- this is Jim. It's a combination of both, but I'm going to say biased towards orders received.

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Operator [30]

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And there are no further questions.

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James R. Meyer, FreightCar America, Inc. - President, CEO & Director [31]

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Thank you again for your time today and your continued support. I look forward to continuing to update you on our future calls. Have a good day.

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Operator [32]

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Ladies and gentlemen, that does conclude your call for today. Thank you for your participation. You may now disconnect.