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Edited Transcript of RAIL earnings conference call or presentation 2-Nov-17 3:00pm GMT

Thomson Reuters StreetEvents

Q3 2017 FreightCar America Inc Earnings Call

CHICAGO Nov 7, 2017 (Thomson StreetEvents) -- Edited Transcript of FreightCar America Inc earnings conference call or presentation Thursday, November 2, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* James R. Meyer

FreightCar America, Inc. - President, CEO & Director

* Matthew S. Kohnke

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

* Theodore W. Baun

FreightCar America, Inc. - Chief Commercial Officer

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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

* Michael W. Gallo

CL King & Associates, Inc., Research Division - MD & Director of Research

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Presentation

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Operator [1]

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Welcome to FreightCar America's Third Quarter 2017 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 1:00 p.m. Eastern Time today until 11:59 p.m. Eastern Time on December 2, 2017. To access the replay, please dial (800) 475-6701. The replay passcode is 432281. 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 Matt Kohnke, Chief Financial Officer of FreightCar America.

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Matthew S. Kohnke, FreightCar America, Inc. - CFO, VP of Finance and Treasurer [2]

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Thank you, and welcome to FreightCar America's Third Quarter 2017 Earnings Conference Call and Webcast. Joining me today are Jim Meyer, President and Chief Executive Officer; and Ted Baun, Chief Commercial Officer.

I'd like to remind everyone that statements made during this conference call relating to the company's expected future performance, future business prospects or future events or plans may include forward-looking statements as defined under the Private Securities Litigation Reform Act of 1995. Participants are directed to FreightCar America's 2016 Form 10-K for a description of certain business risks, some of which may be outside the control of the company that may cause actual results to materially differ from those expressed in the forward-looking statements. We expressly disclaim any duty to provide those -- to provide updates to our forward-looking statements, whether as a result of new information, future events or otherwise. We will also make references to adjusted operating income and adjusted operating loss, which are not measures in accordance with GAAP. For a reconciliation of adjusted operating income and loss to operating income and loss, the most directly comparable GAAP measures, please see the supplemental disclosure attached to the earnings release. Our 2016 Form 10-K and earnings release for the third quarter of 2017 are posted on the company's website at www.freightcaramerica.com. 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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Thanks, Matt. Good morning, everyone, I'm happy to be with you today, and while this is my second earnings call at FreightCar America, it is my first review where I have more than just a few days of being on the job under my belt.

Since starting 3 months ago, I spent a lot of time in our plant speaking with our employees and meeting with our customers and business partners, all done in order to learn the business. My assessment today is largely unchanged from when I first came in and first spoke with you. FreightCar America is a company with a proud 116-year history and a company with great potential.

We have successfully repositioned ourselves from a coal car producer to a diversified railcar manufacturer, we are running our business debt-free and with a considerable cash position, and we have transformed our footprint from our origins in Johnstown, Pennsylvania to now include the purpose-built and state-of-the-art facility in Shoals, Alabama. However, as our results indicate, we also have serious issues that must get fixed. Aside from the market conditions, which Ted will discuss shortly, the primary drag on our business is our cost of goods sold, beginning with now 4-year long startup of our Shoals operation, which simply put, we have not gotten right.

While we continue to deliver cars out of that facility that meet our customer's expectations, the cost of doing so is far too high. Shoals remains a significant operational undertaking, but now through the events that brought me here, we are developing the right plans to finish the job and realize the potential that has eluded us to this point.

In addition to the work still to be completed in Shoals, my early assessment is that we have tremendous opportunity to take out material cost and better optimize our supply chain. Like many businesses of our type and size, we are much better at buying than we are at sourcing, we are much better at engineering for function than we are at optimizing for both function and cost, and we have historically, not focused nearly enough attention on designing parts with the assembly process in mind.

The entire suite of topics evolving strategic sourcing, value engineering and design for manufacturing awaits us. One of my goals is for FreightCar America to become very good at each of these disciplines. I have put these disciplines in place and watched it at work in other companies, and I'm confident about its ability to positively impact margins.

With respect to our decision to suspend the dividend, we are mindful of our current performance, the current state of the marketplace and our desire to maintain a strong cash position as we start to evaluate new opportunities that enhance profitability and shareholder value.

While nominal in value, the suspension of the dividend provides us with a degree of even greater flexibility.

Finally, and in addition to what has already been discussed, we have idled our Danville plant, while our Roanoke facility continues to perform well.

All in all, we have everything required, the products, the manufacturing footprint, the financial strength and now, I believe the know-how to finish the jobs at Shoals and build a great and complete foundation for FreightCar America while we wait out the current industry slump.

By taking these various points into account, the past successes, the current challenges and the tremendous potential for improvement, you have the reasons as to why I'm so excited to be here and why I'm so optimistic about our future. I'll now turn the discussion over to Ted.

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Theodore W. Baun, FreightCar America, Inc. - Chief Commercial Officer [4]

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Thank you, Jim. Deliveries for the third quarter of 2017 totaled 829 railcars compared to 1,214 railcars delivered in the same quarter of 2016 and 1,096 railcars delivered in the second quarter of 2017. We received orders of 920 railcars in the third quarter of 2017, of which, 650 were leased railcars. Comparatively, we received orders for 620 railcars in the third quarter of 2017 and orders of 1,520 railcars in the second quarter of 2017.

Our order backlog at September 30, 2017, was 3,317 railcars with an estimated total sales value of approximately $291 million compared to 3,226 railcars at the end of the second quarter. Our current backlog consists of 2,542 railcars to be manufactured for direct sale, while the balance of units are leased railcars.

Based on current production and delivery schedules, we have increased our full-year delivery guidance by 300 units, and now expect to deliver between 4,600 and 4,800 railcars for the full year of 2017, including approximately 150 railcars to be delivered under lease and 53 rebuilt railcars.

Industry-wide, non-tank car orders totaled 7,175 for the third quarter of 2017. This figure, while higher than many of the recent quarters, still remains somewhat below average over a longer time frame. On the demand-side, we continue to see positive data with respect to railroad traffic levels driven by intermodal container, coal and stone, sand and gravel loadings all up from prior year levels. We are also cautiously optimistic about the level of inquiries we're receiving. However, on the supply side, it remains a challenging market environment, when considering the excess supply of railcars embedded in the industry backlog as well as a high number of certain existing railcar types in storage.

That said, when taken together, assessing the likelihood that the customers will act on their needs remains in question. The sales team remains highly focused on marketing our newer products, sustaining our deeper relationships with our customers and turning the aforementioned inquiries into orders.

Now I would like to turn the call over to Matt to address our third quarter financial results.

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Matthew S. Kohnke, FreightCar America, Inc. - CFO, VP of Finance and Treasurer [5]

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Thank you, Ted. Consolidated revenues were $72 million in the third quarter of 2017, compared to $113.5 million in the third quarter of 2016, and $118.7 million in the second quarter of 2017. Consolidated operating loss for the third quarter of 2017 was $18.6 million, which included a $2.9 million contingency charge related to our ongoing patent litigation, $1.2 million in severance and other expenses related to the change in our Chief Executive Officer position and $59,000 of charges incurred with our previously announced cost-reduction plans.

Consolidated operating loss for the third quarter of 2016 was $52,000. Consolidated operating loss for the second quarter of 2017 was $944,000, which included restructuring and impairment charges of $30 -- $396,000 --$369,000, excuse me, relating to the cost-reduction program. Excluding these cost, adjusted operating loss for the third quarter of 2017 was $14.5 million compared to an adjusted operating loss for the third -- for the second quarter of 2017 of $575,000. The results on a sequential basis are unfavorably affected by production and efficiencies across various orders, pricing pressure and an unfavorable sales mix, as well as a loss of operating leverage on lower deliveries in the third quarter of 2017.

Selling, general and administrative expenses for the third quarter of 2017 were $10.7 million compared to $8 million in the third quarter of 2016 and $5.9 million in the second quarter of 2017. The increase on a sequential basis was primarily attributable to the aforementioned unusual charges incurred in the third quarter of 2017.

Turning to our balance sheet. Our financial position remains strong with no outstanding debt and $127.3 million in cash, cash equivalents, marketable securities, restricted cash and restricted certificates of deposit at September 30, 2017. While our third quarter 2017 operating cash outflow was driven by our core operating results, we still have generated positive operating cash flow of approximately $31 million year-to-date in 2017, largely driven by a reduction in our net working capital levels as well as the receipt of a federal tax refund.

Looking forward, based upon our existing production and delivery schedules, we expect to generate modest operating cash flow in the fourth quarter of 2017. Capital spending for the third quarter of 2017 was approximately $170,000. For the full year of 2017, we expect capital expenditures to be approximately $1 million. At this point, I will turn the call over to Jim for concluding remarks.

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James R. Meyer, FreightCar America, Inc. - President, CEO & Director [6]

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Thanks, Matt. While we are clearly disappointed with our third quarter results, we're looking forward and that means we are working to fix our operational issues at Shoals, starting the process of reducing product cost and most importantly, continuing to take care of our customers. Our job is clear and as we take on these actions, it is also our job to maintain a strong balance sheet and to be positioned to act on value-enhancing opportunities as they present themselves. This ends our prepared comments, and we are now ready to address your questions.

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Questions and Answers

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Operator [1]

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And our first question in queue will come from the line of Michael Gallo with CL King.

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Michael W. Gallo, CL King & Associates, Inc., Research Division - MD & Director of Research [2]

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James, I was wondering, if we can just drill in a little bit more on the manufacturing issue. I know this has been on and off at Shoals for the last few years, but can you speak to, kind of, where you are right now in addressing those issues, obviously, you did increase your shipment guidance for the fourth quarter. So you must have some level of comfort that you're going to get some of these issues resolved, but I know you said you're looking forward, but help us with the framework on having implemented these processes and procedures at other companies. How long it's going to take to get things; one, where you want them to be; and two, to acceptable levels relative to what we saw in the third quarter?

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

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Yes. Mike, that's -- it's fair questions. Our issues at the Shoals are complex and they've been with us for a long time to this point. We're confident we know what to do. We're confident that we've now started the right process to effectively address these issues once and for all. But these issues were not created overnight and they will take time to resolve. We've made it harder than it probably needs to be, but at the end of the day, this is about people and process and it's, quite frankly, no harder than that sounds, but we've got a lot of work to do. It's going to start out slow, most likely, that's certainly my experience. And then, as we continue to go along, we'll build momentum and pick up pace. And I think what I'll do is, I'll certainly be able to intend to keep everyone up to date on our progress on subsequent calls and as we go forward, but we've got work to do down there.

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Operator [4]

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And our next question will come from Matthew Brooklier with Buckingham Research.

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

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So wanted to dig just a little bit deeper in terms of some of the challenges you saw at Shoals in the quarter. Could you maybe talk to if a specific car type, if there is a line change over that maybe was part of the problem here? Or is it just a function of lower volume and some of these existing issues that you talk to?

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Matthew S. Kohnke, FreightCar America, Inc. - CFO, VP of Finance and Treasurer [6]

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It's Matt Kohnke. Yes, there is not one car type or issue, in particular, that impacted the results. Our challenges are, as Jim said, are broader in nature impacting multiple orders. The impact of -- on the results in total, you know, related to our gross margin was related to pricing, as I mentioned, that loss operating leverage on the lower railcars being delivered. In particular, there our Roanoke facility was largely idled for the majority of the quarter. And in fact, has started ramping up later in the third quarter for bills coming in the fourth quarter. So the cost of starting that operation back up as well as all the cost associated with it being idled, really impacted us in the quarter. And then lastly, as you mentioned, our Shoals facility -- or Jim mentioned, our Shoals facility is not where it needs to be and that while we're producing product that's meeting our customer expectations as it leaves the facility, it's doing so on a tremendous cost, additional cost to us.

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

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Okay, the Roanoke color in terms of getting that back online that's definitely helpful. Just turning to the suspension of the dividend. If it's such a -- I guess, a smaller payout and considering where you are in terms of your cash and equivalents balance currently, which is really strong, why -- I guess, I'm trying to understand why suspend the dividend at this point in time? Are you anticipating there's going to be a greater use of cash on go-forward basis? And then if that is the case, or you are ramping up your investment maybe you could talk to some of the areas where you feel that's going to drive this potential deployment of incremental capital on a go-forward basis?

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James R. Meyer, FreightCar America, Inc. - President, CEO & Director [8]

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We obviously have a very strong balance sheet. And our job as a management team is multi-fold: fix our operations once and for all; have the flexibility to look at and consider investment opportunities that we believe will increase shareholder value; and maintain our strong balance sheet throughout the process. Given our recent poor performance, the uncertainties within the marketplace and our responsibility to maintain a strong cash position, we suspended the dividend. Albeit as you point out, it's relatively small in value. We believe it was the prudent and responsible decision at this time.

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Matthew Stevenson Brooklier, The Buckingham Research Group Incorporated - Analyst [9]

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Okay. And then, is the thought process that you're going to use a portion of what you have right now to, I guess, it is, but to reinvest in the existing business? And then if you could talk to potential investment outside of what you're doing currently. If there is any way to provide a little bit more color there, I think, that would be helpful.

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Matthew S. Kohnke, FreightCar America, Inc. - CFO, VP of Finance and Treasurer [10]

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Yes, Matthew, it's Matt. So gain, as Jim said, our short-term focus here is -- focus on addressing the operational issues that were based down at the Shoals and fixing them once and for all as well as taking product cost out of the business. We're -- that -- in order to do that it may require some investments that need to be made in order to unlock the full benefits that we see. So again, it provides that flexibility to us as it's needed. In terms of more longer-term strategies, we are developing those that should be pursued, again. Some of them may require to deploy cash, and certainly, we'll let you know as those opportunities arise.

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Operator [11]

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And next question in queue comes from Justin Long with Stephens.

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Justin Trennon Long, Stephens Inc., Research Division - MD [12]

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Maybe to start with a follow-up on Shoals. I was curious, you've given these operational headwinds if you're still committed to that facility. It sounds like the answer is yes, but wanted to confirm that? Or -- and just ask if you've thought about other options, maybe other manufacturing options in North America? And if you're committed to Shoals, is there any kind of ballpark expectation on when we might get back to, kind of, normal operations? Is there a potential for that to occur at some point in 2018? Or is it going to take longer than that?

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James R. Meyer, FreightCar America, Inc. - President, CEO & Director [13]

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Let me just start with, the Shoals is a purpose-built, world-class railcar manufacturing facility. As a company, we've clearly underestimated the startup challenges of such a large facility, and one with a brand-new workforce. It's also true we've not yet come close to realizing the potential of such a facility. We have a lot opportunity down there, and it is certainly our intent to take full advantage of that and to ultimately be rewarded by having this facility as part of our business. And it's -- I think the easiest way to kind of describe where we are in this journey is as everyone on the phone, I'm sure can readily imagine, building and bringing online a 2.2 million-square-foot facility is a very big undertaking. It's hard in the best of circumstances. And to then to do it, where you're also having to bring into the workforce over 1,000 workers and train them in railcar manufacturing, almost all of them have never been up close to a railcar before is a similarly big undertaking. Now we've clearly underestimated what was involved, as I said, we've not gotten it right to this point. But we are now well beyond the stages of having a facility and having a workforce and putting railcars out the door that meet customer expectations. What we're not doing yet is doing it well and doing it efficiently, and obviously, doing it to the point where it's generating profitability for us. This is where we're at in the process. We're well, well past the start point. I don't want anyone to think this is a full restart, it's not. In some respects, the hardest work is behind us, but now we've got to come in and make it all work.

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Justin Trennon Long, Stephens Inc., Research Division - MD [14]

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Okay. And secondly, I wanted to ask about inquiries. I think, you made the comment that you're cautiously optimistic based on what you're seeing in the market today, and there's been a little bit of a pickup. Just curious, where you're seeing that pickup, what car types are driving that? And also wanted to get your opinion on your view of this being an uptick in the market versus just some seasonality into the end of the year or customers trying to take advantage of what's a weaker pricing environment?

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Theodore W. Baun, FreightCar America, Inc. - Chief Commercial Officer [15]

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Justin, it's [Ted]. Yes, as you pointed out the inquiries are higher when we compare them to, say 2016 levels. The team has been busy responding to those inquiries. That being said, you know, there is still some cloudiness in the market. Cars -- a lot of cars are still in storage. And trying to flush that out and to your point, our customers just looking for budgetary pricing or are they looking for more meaningful? We think it's a combination of both. But until we continue to flush those out, it's going to be -- it's a good question, and we'll find out. As far as the car types that we're receiving inquiries on, just broadly across the board, it's the covered hopper cars, it's open top hoppers as well as gondolas. So fairly wide variety of the FreightCar landscape there.

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Justin Trennon Long, Stephens Inc., Research Division - MD [16]

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Okay, great. And lastly, I just wanted to ask about the backlog. And if you look at that number and exclude implied fourth quarter guidance, is the rest of the backlog schedule for delivery in 2018? Or are some of those units beyond that time?

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James R. Meyer, FreightCar America, Inc. - President, CEO & Director [17]

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Yes. The vast majority would be scheduled for 2018.

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Operator [18]

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We'll go to the line of Matt Elkott with Cowen.

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Matthew Youssef Elkott, Cowen and Company, LLC, Research Division - VP [19]

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Staying on the delivery front, with just over 2000 railcars left in your backlog after 4Q and most of it scheduled for 2018 and given the current inquiry and conversation level with customers, are you guys expecting to -- are you targeting to match 2017 deliveries in 2018? Or have you thought about the delivery forecast for 2018 yet?

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Matthew S. Kohnke, FreightCar America, Inc. - CFO, VP of Finance and Treasurer [20]

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It's Matt Kohnke. We have not given guidance yet for our 2018 deliveries.

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Matthew Youssef Elkott, Cowen and Company, LLC, Research Division - VP [21]

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Okay. And then you mentioned the elevated level of inquiries and I don't remember you guys when you gave a breakdown of the types of cars, I don't remember hearing intermodal. If I'm correct, we're seeing volume growth accelerate in intermodal, we're seeing the ELDs are coming up in December, enforcements luckily kick in, in April. Are you seeing an increased level of conversation with customers regarding intermodal equipment?

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Theodore W. Baun, FreightCar America, Inc. - Chief Commercial Officer [22]

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Ted, again. I think there's no question the intermodal is strong right now. It's been strong. It's been a bright spot in the industry. What we're seeing right now is, if you will, they're not -- the inquiries aren't dead, but they're certainly reduced, and I think the folks that invest in intermodal cars are essentially hitting the pause button just for now, just to see, how their fleet is rightsized for what 2018 portends.

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Matthew Youssef Elkott, Cowen and Company, LLC, Research Division - VP [23]

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Got it. And then just one final question, maybe for Jim. Jim, you talked a lot about going forward, adjusting the cost structure at Shoals. I was wondering if there is one big step in mind that you guys are contemplating or is -- are the efforts going to be, basically, just a number of various things that you're going to do at the same time to try to get the cost structure down?

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James R. Meyer, FreightCar America, Inc. - President, CEO & Director [24]

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We have lot of work streams ramping up or to soon be ramped to address different pieces of the cost structure. But with respect specifically, to Shoals, it's about getting more railcars out the door with the scheduled labor. When you're ramped up to produce 10 cars a day and you're only getting, say, 8 out the door, and that's just an example, you're carrying that extra labor burden. So there is the throughput aspect, the efficiency aspect. What I, in the last call, referred to as the hidden cost of flawed execution. This is truly a set of manufacturing and process-driven work streams that we're already at work on. We also have a very big opportunity, in my opinion, on material cost. And we have -- as I said, in my opening comments, it's not atypical of companies of our size. We're good at buying. We're good at keeping materials flowing into the factories on time, but we are not necessarily equipped or focused on strategic sourcing. And we have, I have no doubt, a lot of opportunity on material cost through sourcing arrangement, through negotiation and we have got quite a bit of activity still to get started on that, but we're certainly fairly far along and laying out our plans and foundation to go after it. But at the end of the day, the biggest line item on the P&L is material cost and we've got opportunity there as well.

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Operator [25]

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You have a follow-up question from Michael Gallo, CL King.

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Michael W. Gallo, CL King & Associates, Inc., Research Division - MD & Director of Research [26]

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Just a follow-up question, I guess, for Matt. Matt, were there specific costs that you can call out that hit the gross margin line, be it startup or otherwise, that you don't expect to recur in the fourth quarter?

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Matthew S. Kohnke, FreightCar America, Inc. - CFO, VP of Finance and Treasurer [27]

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Yes, Michael, nothing in particular, other than what I've mentioned earlier, the combination of the lower deliveries and the lack of covering those fixed costs, certainly, had an impact, especially at Roanoke, the production inefficiencies and what we were building down in Shoals and then also the impact of pricing. The combination of those 3 were the key drivers for the results, not anything, in particular, that I would call out.

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Michael W. Gallo, CL King & Associates, Inc., Research Division - MD & Director of Research [28]

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All right. Based on your delivery guidance which, I think, mirrors what you're delivering in the second quarter, perhaps at the high end or even a little bit better than that. Is there anything in the composition of that, that would make you think that the gross profit percentage shouldn't be more in line with the mid-single digits you saw in the second quarter? Or will some of these issues at Shoals that perhaps did or didn't play the second quarter carryover into the fourth quarter?

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Matthew S. Kohnke, FreightCar America, Inc. - CFO, VP of Finance and Treasurer [29]

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Yes, obviously, consistent with the past, we won't comment on overall gross margin guidance, but what we see going forward is the higher deliveries will absorb those fixed costs. The product mix, which was very challenging in the third quarter eases a little bit. And -- but the Shoals operations -- operating inefficiencies as Jim mentioned, those aren't going to go away overnight as well as the pricing pressure, which continues to be up in the marketplace.

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Operator [30]

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And this time we have no further questions in queue.

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

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This concludes today's conference call. Thank you for joining. A replay of this call will be available beginning at 1:00 p.m. Eastern Time today at 1 (800) 475-6701, passcode 432281. See you next quarter.