Trinity Industries, Inc.

Good day and welcome to the Trinity Industries Third Quarter Results Conference Call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask a question. To ask a question, you may press star, then one on your touchtone phone. To withdraw your question, please press star, then two. Please note, this event is being recorded. Before we get started, let me remind you that today's conference call contains forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995 and includes statements as to estimates, expectations, intentions, and predictions of future financial performance. Statements that are not historical facts are forward-looking. Participants are directed to Trinity's Form 10-K and other SEC filings for a description of certain of the business issues and risk, a change in any of which could cause actual results or outcomes to differ materially from those expressed in the forward-looking statement. I would now like to turn the conference over to Leigh Ann Mann, Vice President of Investor Relations. Please go ahead.

Thank you, Eileen. Good morning, everyone. We appreciate you joining us for the company's third quarter 2021 financial results conference call. Our prepared remarks will include comments from Gene Savage, Trinity's Chief Executive Officer and President, and Eric Marchetto, the company's Chief Financial Officer. It will hold a Q&A session following the prepared remarks from our leaders. During the call today, we will reference slides highlighting key points of discussion, as well as certain non-GAAP financial metrics. The reconciliations of the non-GAAP metrics to comparable GAAP measures are provided in the appendix of our supplemental slides. The supplemental materials are accessible on our IR website at www.tren.net. These slides can be found under the events and presentations portion of the website, along with the third quarter earnings conference call event link. It is now my pleasure to turn the call over to Jean.

Thank you, Leanne, and welcome to Trinity. Good morning, everyone. Trinity had another strong quarter on a consolidated basis, and continues to make great strides to optimize returns, highlighted by our newly formed joint venture with WACRA and our new $250 million share repurchase plan, both of which Eric and I will talk about later. Overall, we remain very confident in our ability to execute and hit the targets we shared with you at our investor day a year ago. Let me summarize some key things from our third quarter. At the industry level, fundamentals continue to improve broadly but unevenly. While industrial production levels have ebbed and flowed with supply chain disruption, overall industrial production is approaching pre-pandemic levels, and strong North American economic growth is forecasted over the next few years. With these macroeconomic trends, rail carload volumes are rising from last year's lows, At the same time, the population of rail cars in stores is falling, with elevated scrapping levels and relatively slower train speeds. From our vantage point, the improving rail car demand recovery will continue into 2022, which is very supportive for fundamentals in both of our rail-focused business lines. Let's look at the impact of these trends on our consolidated results. highlighted on slide four. In the third quarter, Trinity generated revenue of $504 million, up 10% from a year ago. Our GAAP EPS was $0.33 compared to an adjusted EPS of $0.29. We'll detail both businesses in a few minutes, but I think it's important to note the strength of our diversified platform. While our rail products group results may vary from quarter to quarter based on our specific orders delivered, Trinity drove solid and consistent cash flow growth in the third quarter. Cash flow from operations totaled $93 million, and free cash flow, or excess cash after all investments and dividends, was $157 million. Eric will go into more detail, but the important takeaway here is that our model can drive significant value creation through stable cash flow and a return of capital to shareholders. In summary, we remain pleased with our execution against our returns optimization initiatives and are equally excited to see continued strength in the industry fundamentals that underpin our future results. Let's turn to slide five, and we can review the rail car market as a whole. First, rail car loads and traffic continue to improve. The industry car loads are now roughly 6.5% above 2020 year-to-date, and we're moving closer to pre-pandemic levels last seen in 2019. Rail cars and storage declined 6% compared to a quarter ago, aided by continued scrapping activity and continued deployment of vital assets in key markets. like boxcars, gondolas, hoppers, and tank cars. Relative to the modest increase in carload levels, slower train speeds are also helping to drive railcar demand, as the average railcar in North America is getting fewer turns. Against that backdrop, Trinity's fundamental key performance indicators are improving as well. Our utilization improved from last quarter to 95%. And the future lease rate differential, which we call the FLRD, turned positive and now stands at 1.4% compared to a negative 20.9% just a year ago. Demand for new rail cars has been exciting as well. In the quarter, with the quarters for 2,530 new rail cars, up 27% compared to a year ago. As we noted last quarter, we believe stronger underlying leasing dynamics and higher car pricing should continue to positively impact our results. And new deliveries will likely trend in line with replacement levels in 2022 and 2023. To be clear, the trend may not be linear each quarter, as our rail product segment results prove. That said, we remain very encouraged by the industry dynamics in place today. On slide six, let's turn to Trinity's segment results for the quarter. In our leasing business, revenue increased slightly compared to last quarter based on a combination of fleet growth, higher utilization rates, and increased servicer fees. Revenue growth in the quarter was also partially offset by lower average lease rates as we cycle through legacy renewals. To contextualize that impact, it's important to note that the four indicators for lease rates are positive. Specifically, our renewal rates in the quarter were 7% higher than expiration. And our view on overall lease rate trends remains positive, as evidenced by the trend in the FLRD I mentioned earlier. Our margins in leasing and management services were also strong, up 340 basis points compared to a quarter ago. Our leasing business benefited from higher servicer fees in the quarter, partially offset by fleet operating costs. We also had modestly higher depreciation driven by our successful sustainable conversion program, which I'll detail later in my remarks. Recall from our commentary earlier this year that we expect these expenses required to position the lease fleet for increasing demand will be a headwind to the leasing segment margin for the year. That said, we believe the headwind in the short term is a good problem to have. given the value being created by rising demand and the resulting long-term returns to Trinity. Now, looking at our results in the Rural Products Group, margin improvement progress year-to-date was offset by labor shortages and turnover, as well as supply chain disruption. Specifically, Operating margins in the rail products group for the quarter was a negative 0.9% compared to 1.2% last quarter. The path of the recovery in this segment will likely be less linear given quarter-to-quarter dynamics like delivery mix, supply chain disruption, and labor shortages. That said, we remain confident based on two main indicators for the business. The first, is that demand for railcars continues to rise as evidenced by utilization, lease rates, and orders in the quarter. The second key indicator is railcar values. While higher input costs like steel can serve as a near-term headwind to our deliveries, we remain very confident that higher costs will drive higher railcar values and ultimately margins as older orders work through our pipeline. Lastly, it's important to note that while this quarter was challenged, Trinity continues to make significant progress on our expense optimization initiative and the rail products group. I'll move to slide seven with an update on our returns optimization initiatives. We were busy and made some great progress over the quarter. Beginning with our balance sheet, Trinity and Wafra, an institutional investor, announced a joint venture partnership that targets $1 billion of diversified rail car asset sales over the next three years. The joint venture is a significant step in our commitment to optimize Trinity's balance sheet and drive ROE. Trinity also renewed our commitment to return capital to shareholders. with a new $250 million share repurchase authorization. In our view, shareholders benefit both from the strong free cash flow that Trinity's portfolio generates, and also as we optimize our balance sheet to help drive better returns on equity for the overall enterprise. Touching on our enterprise cost reduction efforts, Trinity disposed of three properties in the quarter for a total of $8 million in proceeds and $3 million of gains on asset disposal. In manufacturing, we continue to drive meaningful improvements as our lien initiatives and other cost programs have reduced the break-even cost of producing a railcar. Turning to our lease fleet optimization, Clearly, the Walker portfolio sale was a key event, driving $325 million in proceeds. Similar to last quarter, we were also busy on the investment side as we spent $112 million in leasing capex to add to and improve our lease fleet during the quarter. Looking at the fourth quarter, we would expect the pace to slow as we onboard and optimize for the actions taken year to date. The key takeaway here is that fleet returns have improved both from MIPS and the accretive reinvestment of sale proceeds. In addition to portfolio transactions, Trinity closed on a small $4 million secondary market acquisition. In the third quarter, our fleet improved as we doubled the volume of sustainable conversions of tank cars, which totaled 242 compared to 119 last quarter. Through the end of the third quarter, we have received orders for over 1,400 sustainable conversions, which includes a mix of tank and freight cars comprised of internal and external orders. These sustainable conversions allow us to pivot our fleet by converting or upgrading existing rail cars to better meet the challenging demands of the market and to improve the yield of our fleet. This is an important piece to our fleet optimization effort. Lastly, to update on our new products and services, we are on pace with a number of initiatives. For trend sites, We now have reached our 2021 goal for customers paying subscription fees for the service. Additionally, new product development will hit our full goal for 2021. In conclusion, Trinity remains very confident in the three-year plan we outlined at our Investor Day last fall. And we still have a number of ongoing initiatives to continue to enhance returns especially as rail car fundamentals continue to improve into 2022 and beyond. Before I hand the call over to Eric, I'd like to take a moment to discuss our focus on sustainability. Trinity is committed to being a market leader in promoting and enhancing the sustainable environmental benefits of rail transportation. We believe a more sustainable transportation system starts with a shift from highway to rail, as rail reduces emissions to move one ton of freight 75% as compared to on highway. It leads to less congestion and less wear on our critical infrastructure. To promote this transition, we prioritize product and service ideas, which enable shippers to improve the efficiency of their supply chain, moving more freight with fewer rail cars and fewer car loads. We've discussed a few of our new products that fulfill this forward-thinking, more sustainable vision, including our newest grain car and trend sites. Trading has also put great focus in leveraging existing assets to meet new demand through our sustainable conversion program. This eliminates the need to produce an entirely new railcar in certain markets. Earlier this year, we introduced the railcar leasing industry's first green financing framework, and as of quarter end, Approximately $4.3 billion of our rail car related debt meets this designation. At our facility, we've implemented a number of different programs to reduce emissions, limit water use, and recycle waste. In meeting our purpose to deliver goods for the good of all, we strive to reduce our environmental impact and increase our positive impact on people. With that, let me hand the call over to Eric for more detail on our results.

Thank you, Jean, and good morning, everyone. I will begin on slide eight with a summary of the quarter. Overall, as Jean said, Trinity continues to benefit from both the steady improvement in railcar demand and our strategic initiatives. Starting with the income statement, Third quarter consolidated revenue totaled $504 million, up nearly 10% compared to a year ago. This was driven by higher external deliveries in our rail products group, as well as continued improvement in leasing fundamentals in the highway business. Adjusted earnings per share of 29 cents grew both sequentially from 15 cents and year over year from 17 cents, driven by a combination of better fundamentals, gains on lease portfolio sales, and our share repurchase activity. Our third quarter results were negatively impacted by accelerated depreciation associated with our sustainable railcar conversion program. Our adjusted EPS number excludes a four cent benefit from insurance recoveries related to the tornado damage at our Carter's Road facility. As discussed, our joint venture portfolio sale positively impacted our third quarter earnings, with a gain of $33 million on our $325 million transaction. In this joint venture, WAPRA owns 90% of the equity, and Trinity owns the remaining 10%. Similar to the improvement in lease fundamentals, our new RIV transaction is another example of the broadening market for leased railcar assets. Looking forward to next quarter, we expect our consolidated fourth quarter margins to be relatively consistent with our third quarter results before the impact of lease portfolio sales. Turning to the cash flow statement, Year-to-date cash flow from operations totaled $428 million. Cash flow from operations in the third quarter was $93 million, which includes the collection of $41 million of our tax receivable. Our remaining tax receivable is $192 million, which is not included in our full year cash flow guidance. Last quarter, we got into full year cash flow from operations of $600 million to $650 million. Given the higher cost of inventory, as well as working capital changes we plan to implement, we are reducing our target. Our revised guidance is a range of $450 to $475 million. This is intentional, as we are focused on strategic sourcing to mitigate inflationary pressures and protect against supply chain constraints. as we increase the pace of deliveries. In the quarter, we had a net reduction in investment for leasing of approximately $204 million, consisting of $112 million of lease fleet investments, more than offset by lease portfolio sales. Year-to-date proceeds from lease portfolio sales exceeded the investment on our lease fleet by $41 million. Trinity's net lease weight investment for the full year is now expected to be between $40 million and $70 million as we continue to make disciplined investments at a track of returns that support our lease optimization initiative. Manufacturing CapEx for a quarter was $4 million, which brings our year-to-date manufacturing CapEx to $22 million. Our manufacturing CapEx for the full year is now projected to be between $30 million and $40 million. Total free cash flow after investments and dividends was $157 million in the third quarter, which brings year-to-date total to $516 million. As Gene noted, the strength of our platform continues to drive these cash flows and allows Trinity to drive value to shareholders through the return of capital. Year-to-date, Trinity has returned nearly half a billion dollars to shareholders, with $69 million in dividends and $405 million in share repurchases, which represents approximately 17% of our market capitalization. If we turn to slide nine, let's review our capitalization. Trinity continues to have a very strong financial position, highlighted by quarter in liquidity of $1.1 billion, even after the return of capital I just discussed. This liquidity provides flexibility, as we plan to generate additional shareholder value through disciplined, returns-focused capital allocation. Our strategy to drive returns over asset growth remains unchanged, but we expect to make investments in our lease fleet for growth, especially in markets where we can meet increasing demand and we remain committed to the return of capital. As you can see from our actions to date, our strong cash flow affords us the ability to do both. This quarter, we completed our previous $250 million share repurchase program and launched a new $250 million authorization that runs through 2022. We continue to optimize our balance sheet and improve our return on equity, which is a key focus of our long-term strategy. In closing, we are progressing well against our strategic plan. We are proud that Trinity continues to execute against our goals. While Trinity is not immune to the challenges of the current operating environment, our financial position showcases the resilience of our platform and the ability to deliver returns through the cycle. As the market recovers, we will demonstrate the power of our platform to generate attractive, risk-adjusted returns. Eileen, you may now take us to questions for our participants.

We will now begin the question and answer session. To ask a question, you may press star, then 1 on your touchtone phone. If you are using a speakerphone, please pick up the handset before pressing the keys. To withdraw your question, please press star, then two. Our first question today comes from Matt Elkoff with Cowan.

Good morning. Thanks for taking my question. Gee and Eric, Canadian National said that the one thing they're most enthusiastic about is the green energy car loads related to Alberta's growth in the hydrogen energy project. They said that the potential is, peak of the crude by rail but only much more sustainable. Is that something that presents an opportunity for you guys?

Yes. Matt, thank you for the question and We have looked at hydrogen and continue to look at the different types of fuels that may be able to be transferred by rail. It's on the radar. We're doing some development on that. And we'll continue and hope that overall that the government approves the movement by rail for the hydrogen.

Okay. And if such an approval is granted, you know, how much lead time should be expected before you guys have an appropriate car for that?

It would really depend on we have a design that would fit fairly well. So, it would come down to the testing that would be required by the different governments or countries to put that on rail.

Got it. And just one more question on the guardrail business. Is the improvement in anticipation of the infrastructure bill And can you just talk broadly about how exposed to infrastructure bill this business is and maybe address some of the remaining small litigation risk on the state level?

Sure. I'll start out with saying that the highway business team did a great job. They had the best third quarter ever in the history of our highway business this past quarter. The business is improving because of the input cost a lot, so we're able to pass that on, along with the freight costs. So you see that in the revenue. When you're looking at the infrastructure bill, will it have an impact? Yes, but it's most likely at least six months to 12 months out. The bill has to be passed. They have to get the funding. programs or the construction approved, and then they normally buy the guardrail portion later in the cycle, so closer to when they're ready to start that construction. So, that would happen. On litigation, you've seen smaller changes in our releases. On what's going on there, we are seeing less new litigation come in. It's been dropping over the last few years. and we expect that trend to continue. And I think, Matt, did I get everything you were asking, or did you have a follow-up?

I believe so. I know it was a three-part question, but I would imagine on the demand front related to the infrastructure bill, even if there's a six- to 12-month lag before it's reflected in the business, I would imagine that the confidence will increase immediately after the passage of the bill, and that could lead to some at least inquiry activity. Is that reasonable?

I think it is. I think people may pre-start some projects or they may go ahead with some, but we'll have to wait and see when it gets passed and what confidence it puts out there.

Okay. And when you guys went off ARCOSA, a few years ago, you understandably kept the guardrail business as the only non-railcar business because of the litigation at the time, which is largely out of the way now. Would you be open to divesting this business for the right valuation, especially that now it's an infrastructure play and it might be in high demand?

Well, Matt, I have said in the past that we believe the long-term best owner for that business would not be Trinity as we focus more on the rail industry. But we would have to get into the right dynamics, the right situation for us to be able to sell that. So it is on the table, and we have talked about that prior.

Thank you very much, June.

Thank you.

Our next question comes from Allison Poliniak with Wells Fargo.

Hi, good morning. Good morning. Just want to turn to the input cost inflation that you kind of called out for manufacturing. I guess, one, is it steel or is it actually the components that you're seeing the most inflation? And I guess you had mentioned some older contracts. Is there a way to think about how that evolves where some of these input inflation start to get rolled into the contracts going forward in terms of deliveries? Any color there? Yeah.

Yeah, Allison, this is Eric. I would just say, you know, in the quarter, it was more probably steel and surcharge-related than specialty components. But you also had things like industrial gases being interrupted, both oxygen, nitrogen. So all those things, as those gases switched to – were diverted to hospital usage, because of COVID. So that certainly had an impact. I think on the specialty side, there's probably some pressure down the road on specialty components. So you have that. In terms of the backlog and how it works through, as Jean said in her comments, it's probably less than, it's not going to be just linear. There'll be, as we work through some of the older contracts, whether they're fixed price or escalatable, they were taken in times when the main environment was not as good as it is now. And so you'll have that coming through over the next quarter or two.

Got it. Thanks. And then just a bigger question, you know, Gene, you had mentioned your comfort with deliveries sort of reaching that replacement level. You know, one pushback we're getting quite a bit is, you know, obviously rails aren't operating as efficiently as they would hope, you know, just given some of the network challenges that, you know, we're just to some extent not throwing capacity at the situation, but some of these cars, could actually reverse or some of that demand. Any color there in terms of how you're thinking about that, or is it just really comfort with that replacement level kind of moving forward with limited impact from some stuff kind of returning to stores here?

Sure, Allison. So when you look at the number of cars getting scrapped per year, remember we have scrapped around 50,000 the last two years. We're on pace to do that and maybe a little bit more this year. And the car types that are getting scrapped, many of those have high demand right now. So they're going to need those replacement cars, if it's box cars or grain cars or others. So our confidence and what we laid out there for demand for the industry for the next couple years of $40,000 to $50,000 is really based off replacing the cars that are getting scrapped right now. So it's not a large increase overall in demand.

Got it. Understood. Thanks for the time. Thank you.

Our next question comes from Gordon Johnson with GLJ Research.

Hey, guys. This is James Bodowski in for Gordon. Thanks for taking my questions. So I guess the first one relates to the new JV. Was that for about 2,000 rail cars, give or take?

No, it was 35. There's about 3,600 rail cars, and there'll be more detail, obviously, in our queue. There's also an 8K that we filed in August that has a lot of those details as well. It was 3,600 rail cars, and the proceeds were $325 million. And I'll just go ahead and talk about it a little bit. That joint venture, we think, really demonstrates our platform. It solves a lot of the initiatives. It's something that we're doing in line with all the initiatives that we have in terms of optimizing our lease fleet and our balance sheet.

Okay. That's helpful. Clearly, that affects your utilization rate as well as your loan-to-value ratio. Is that fair to say? Yes. Without that sale, what would the utilization rate have been?

Okay. So it would slightly impact utilization rate by making it a little bit lower. The rail cars that we sold, those 3,600 rail cars, were all utilized. So it does reduce the – you're selling 3% of the portfolio and 100% that does make it a little bit lower. But I don't have the – I haven't done the math to tell you what it is offhand, but I think you can do that math. Okay. In terms of among the value, certainly, you know, the proceeds of $325 million, some of those rail cars were unencumbered. Some of those came out of some of our debt facilities. And so, you know, there's a lot of ins and outs. At the end of the day, our leverage for our wholly owned fleet went up slightly in the quarter to about 63%.

Yeah, so that is within your earlier range that you previously guided. Is there any change in terms of your strategy right now in terms of capital allocation?

Sure, James. Yeah, you're right. The target we put out was 60% to 65%, and we are now kind of in the midpoint of that range. That range is still our near and midterm range. We haven't made any change, but we still certainly have flexibility. to change that, but right now that is still our rating.

Okay, great. And then just a couple more. I'll try to speed through them. But you mentioned that you were going to focus on accelerating deliveries. Can you just let us know how much your backlog you anticipate shipping this year?

So I think we talked about getting cars ready for delivery so they could go in – in the markets quicker, but market activity remains strong, and for the year, I don't know that we came out with what percentage.

It's in the queue in terms of how much of our backlog is delivering this year, and it's about 32%, 31.8% is what will be in the queue for what percentage of our delivery that we'll deliver in 2021. That's of our new route for our delivery.

Got it. And I'll cut it off here as a final question, since it is a very loaded question. I do apologize for that. But given the rising costs that we are seeing, is there any way you could decipher how much of the upward pressure you're seeing in lease rates today is a factor of improving conditions versus simply the lessors passing on the higher costs? And with that, I'll say thank you, Gene and Eric, very much.

Keep it up. Yeah, thanks. So when you're looking at the rate changes that we're seeing, a lot of that has to do with supply and demand. In the markets where you have fewer cars available, we're absolutely seeing the rate increase. I mentioned that we had a 7% in the quarter increase on the renewal rate versus the expiring rate. and that our forward-looking SLRD was positive. So that means looking at the cars that will be coming off of lease or expiring, we're expecting to see an increase overall in those rates. So it's still a positive trend for us.

Okay. Wonderful. Thank you very much again, guys. Thanks, James.

Our next question comes from George Sellers with Stevens, Inc.

Hey, good morning. Morning. Hey, George. So I guess my first question, you talked about rail car valuations increasing, and I'm just curious, so I know pricing varies by car type, but could you talk about the percentage increase you've generally seen in new rail cars, and then how much of that is a function of higher commodity prices versus more just core pricing trends?

So, George, you know, obviously mix and car types matter and the amount of steel matters. We've talked on, you know, when you have some of the input costs that have doubled and tripled over the last, really from a pre-pandemic level, that has translated into car prices being anywhere from 20% to 30% higher. And, you know, how much of that is steel and input costs? A lot of it is steel and input costs, and it depends on There is a margin component to it, and it probably depends on where you're starting from. So margins have improved over the last couple of quarters. But I would say much more of the increase is related to just the inflationary pressures on new rail cars. And that just ties into, you know, as an owner of 105,000 existing rail cars, those 105,000 rail cars benefit greatly. from the higher input costs on the 2,000, 2,500 cars that we delivered this quarter. And so that's really where we get into where we see rail car valuations getting impacted is those new rail car prices give the existing rail cars more room to run both in terms of lease rates and in terms of valuations from a depreciated replacement value level. So that's really where we get excited about the future with the lease fleet.

Okay, that's helpful. And then you talked about the backlog, but could you say how much of the current backlog is going to be delivered to the lease fleet in the fourth quarter?

I did not get into that, but I've got to look at that queue. I may have to give me a minute and I'll come back and find that one. Okay, that's... 34% of our deliveries are related to the leasing company. Gotcha.

Yeah. Okay, that's helpful.

Remember in the past, we've told you that typically the railroads and the third-party lessors will come in and buy new cars first. That's still occurring right now. We're getting some secondary market or... and shippers buying, but the majority are still railroads first and then third-party lessors.

Okay. That's really helpful. I'll leave it there. Thank you all for the time.

Thanks, George. Thank you.

Our next question comes from Vascom Majors with Susquehanna.

Yeah, thanks. Good morning, and thanks for taking my questions. In the spring and even into summer, you had talked about how you were really well-positioned on manufacturing labor, being an employer of choice in East Texas and the regions you're in in Mexico, it does seem like that has become more challenging. Can you unpack to us kind of what changed in the last three months and maybe give us a little bit of visibility into regionally or functionally we are having the most challenge with labor and and how you feel that's trending as we get deeper into the fourth quarter. Thank you.

Sure, Baskin. This is Jane. I'll take that. So we were very fortunate during the beginning of the pandemic not to have the supply chain and labor issues. And as we've gotten further in, it was just this past quarter that we started to see some things. Some of it we think is transitory, and that's going to be some of the gases that Eric already talked about. where there was a short-term disruption in supply. And then we had some valves. As far as the labor, in Mexico, it's still very strong, very low turnover, very low shortages. But in the U.S., just like I think every other company who has labor is experiencing some of the higher turnover as people are leaving for other jobs or even retiring. and taking themselves out of the marketplace. So that came in, again, more of the third quarter for us. And it's something that we'll continue to work on, like everyone else, making sure that we're positioning ourselves in the best place to respond to the needs of the market.

Have your pain points in the U.S. started to stabilize? Do they feel like they're getting worse, just curious where that stands versus the surprise you started to feel in the quarter.

So the beginning of the quarter is a little less. It went up and it's pretty much stabilized from there. So it's, again, just I was getting now the resources in place to be able to make sure we continue to meet all the demands.

You know, thank you. And, you know, again, You gave your future lease rate differential, and it was encouraging to see that inflect positively for, I think, the first time since you've been reporting that metric. Correct. Can you give a sense of what that feels like on the ground? I mean, are we approaching a point where this price escalation in new cars, which you talked about on a previous question – is creating that faster inflection that you tend to see in up cycles where lease rates can move very quickly. Are we there yet? Are we getting there? Is that in your sight? Just any thoughts on the supply-demand dynamic tied into new car price inflation and what that means for lease rates in the next year?

I'll start on that and then turn it over to Eric. Now, remember that our fleet – does expire at different times. So about 17% to 20% of the fleet expires each year. So when you're looking at the change of that lease rate, it is over many years to work through all of them. We mentioned the 7% increase on renewal rates versus expiring for the quarter, but the overall average lease rate for the quarter still had some headwinds, so it's still down a little bit. So I think it will take time to work all the way through, but we are encouraged with seeing the renewals go up. And in the markets where the supply-demand metric is more toward needing more supply, you'll see that move quicker than some of the other areas. Eric, would you add?

Yeah, Baskin, I would just add to Gene's comments that, you know, it does change car tax by car tax, but, you know, in absolute terms, newer rail car prices, which lead to higher new car lease rates, will cause existing car rates to allow existing car rates to come up as you price them. But then also, we've seen, you know, studies for 15 months, rail cars coming out of the storage. It's that metric. So the fleet continues to get tighter, both from attrition rates, and from increased rail car loading. So both those things, increased rail car loadings or needing more rail cars to move the same freight. So all of those factors are, you know, tailwinds to demand for existing assets and new assets and should lead to opportunities to improve pricing. You know, I think that's one of the benefits of our platform is as a large manufacturer, as a large lease company, with our maintenance operations, we see the market and we generally are able to see these points of inflection quickly and respond accordingly.

Thank you for that. And maybe to just put a period on that discussion, and I apologize if you mentioned this in prepared remarks, I was hopping calls, but is there a way to think about, I mean, I know spot is not the right word, but kind of an incremental current renewal rate and and how that's trending quarter over quarter or month over month, just any sense of the sequential improvement you're seeing with the caveat that we understand that the renewals happen slowly and, you know, the overall average lease rate with the portfolio takes a while to move. Thank you.

Sure, Beth. I mean, the market activity has absolutely been increasing, and so sequentially increasing, very, very strong growth. For us, as far as renewal rates or assignment rates that go into that, and then we are still seeing a lot of activities for quotes for new cars, and we see orders continuing to come through on that.

Thank you. Thank you.

Our final question today comes from Steve Barger with KeyBank Capital Markets.

Thanks. Good morning. Can you quantify the labor and supply chain issues in the rail group? I'm just trying to get a sense for how much of the operating loss was that versus volume and mix.

All three of them play a role in the results that we had going through. So when you're looking at supply chain, the inefficiencies that come in from not having gases to be able to do the work you need to do, or another example is a valve that you need to put on, play into the fact that you can't get the work done on the time that you wanted to. Then you also have the fact that you either have turnover or labor shortages to be able to do that work. So when you put all those together, It absolutely has an impact. We've not gone through to say, you know, is that 25%, 30%. But when you combine all of them, I think you're going to hear most industries or industrials talking about that impact for the quarter.

And, Steve, we've talked in the previous call about this, our order book being more freight car-centric. Yes. And so, that's there, but I wouldn't call that out as a change from, say, the second quarter to the third quarter in terms of mix. It's, you know, the reason why we're calling out the labor and the supply chain is because those are the biggest drivers.

Gotcha. And, Eric, I just want to make sure I understand your comment on what 4Q could look like. If you don't sell more cars into the JV, then plus or minus 4Q seems like it's going to look more like 1Q, given the loss from the rail group, and And I think most of your EPS came from the gain on sale this quarter, right?

So my comments in the fourth quarter were around margins before you take the impact of car sales. It was on margin percentages. So when you just take the revenue, we said the margin percentages would look similar when you exclude that. So, you know, I think that's a good way to think about it from those numbers. In terms of car sales, we did $325 million of car sales to WAFRA in the third quarter. As we talk about, that's more of a programmatic over the next three years. I wouldn't expect those large – we're not planning a WAFRA transaction in the fourth quarter.

Okay. How about the first part of next year?

It's a three-year deal with a billion dollars, so you think about it radically over that time.

Got it. And so if 4Q looks like 3Q for the rail group, then the rail group is not going to contribute to operating income this year. Do you think 4Q will be trough for rail group margins or given recent ASPs for new orders – Should we be tempering our expectations for the OEM business for the first part of 22?

Remember I said it won't be a linear trajectory for the rail products group, so it's really going to depend on the mix and the volume that are going through that. I would expect to see improvement. I'm just saying it may not be linear. And so we do have a lot of the optimization initiatives and lean initiatives coming that are still going on that occur through the full three-year period that we laid out in Investor Day. And as each of those complete, you'll see different types of improvements flow through our results.

But is it fair to say that given the ASPs that you've taken over the last couple of quarters and the volumes that you expect, that margins are not going to rebound sharply in the first half of 2022?

I think the ASPs – really reflect more of the mix than the margins. I wouldn't read too much into the ASP from a margin profile standpoint. That's more about the mix. I think I talked about, you know, that the margins on new rail cars that we're taking are improving because it's a better demand environment than what we did back, say, during the height of the pandemic. And so from that standpoint, As backlogs stabilize, as backlogs start to extend, then generally on the manufacturing side, you start to see margins expand as well. With all of these supply chain disruptions and labor, et cetera, we're just being cautious about getting ahead of ourselves in terms of expectations because there's a lot of noise in the results. But Generally speaking, the demand profile is improving, which leads to the pricing environment improving.

Okay, and last one for me. Can you just talk a little more about the sustainable rail car conversion program? How are you converting them to make them more sustainable?

So as the markets change, we look and see that maybe you have a car size you could put into a different market and have better utilization and higher yields. so we can do some modification work to that, be it rethinking, putting a different hopper on, things like that to go ahead and reposition that car and improve overall utilization and improve yield.

Are you doing that on a speculative basis or in response to a customer saying, I want a new rail car, I don't want to pay the full rail car price, and you finding a creative way to say, well, I can do some work to this, and maybe make it suitable for your purposes?

Great question. And we continue to say that we want to utilize existing rail cars first, our existing assets, and that's what we're doing here. Instead of building a new car and having the older assets sitting there maybe not as utilized, we're making the choice to, when it makes sense financially and from a return standpoint, to convert that car and put it to use in a market that may have either a longer run or a higher need at the time.

But you're doing that proactively or in response to customer requests?

It's in response to customer requests. We're not doing anything like that proactively. We either have orders from external customers or we have orders that we need to fill from our lease fleet.

And just last one, how many cars in your fleet or in the total fleet do you think lend themselves to conversion?

Steve, I mean, that's going to be in the eye of the owner, and each fleet owner is going to have different things. When you think about some of the other – some of the car types that were recently – have been softer, we have slower or lower utilization. You can think of the small cube-covered hoppers. where that fleet got ahead of itself as demand changed, as car loadings changed. So those are relatively young assets, and so each owner is going to make a decision. We've made, you know, and the same goes on tank cars, where you've had tank cars. Some of the sustainable conversions are things that you can do, retank tank cars, et cetera, so all of those have an impact. And it depends on the underlying age of the rail car.

And it goes to the strength of our platform again. We have the capability of doing those conversions in our own maintenance shops. So it does help meet the demand for the customers and provide us a more sustainable product overall.

Thanks very much.

Thank you.

Thank you.

This concludes our question and answer session. I'd like to turn the call back over to Leanne Mann for some closing remarks.

Thank you, Riley. A replay of today's call will be available after 10.30 a.m. Eastern Time through midnight on October 28, 2021. The replay number is 877-344-7529 with an access code of 101-52033. A replay of the webcast will also be available under the Events and Presentations page on our Investor Relations website, located at www.trends.net. We look forward to visiting with you again on our next conference call. Thank you for joining us this morning.

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