Wabtec 2017 Q3 Form 10-Q Summary
Business context and reporting period
Westinghouse Air Brake Technologies Corporation (Wabtec) supplies technology-based products and services to global freight and passenger rail markets. This unaudited report covers the quarter and nine months ended September 30, 2017; comparisons are with the same periods in 2016. About 65% of nine-month revenue came from outside the United States.
Results include Faiveley Transport, acquired in stages beginning in November 2016 and fully owned by March 2017. Faiveley contributed $294.4 million of Q3 revenue and $851.8 million for the nine-month period.
Financial performance and liquidity
- Q3 revenue: $957.9 million, up 41.8%. Acquisitions added $330.6 million; lower freight-market demand partly offset the increase.
- Q3 earnings: Operating income was $102.0 million, down 15.1%; net income attributable to Wabtec shareholders was $67.4 million, down 18.2%. Diluted EPS was $0.70 versus $0.91.
- Q3 margins: Gross margin was 26.4% versus 31.4%; operating margin was 10.6% versus 17.8%. Management cited acquired-business mix, lower freight demand, and $20.4 million of project adjustments on existing contracts.
- Nine-month results: Revenue was $2.806 billion, up 29.2%; operating income was $330.6 million, down 16.4%; shareholder net income was $213.3 million, down 20.1%; diluted EPS was $2.22 versus $2.92. Gross margin was 28.4% versus 32.5%, and operating margin was 11.8% versus 18.2%.
- Segments: Q3 Freight revenue fell 6.0% to $340.2 million, while Transit revenue rose 97.0% to $617.7 million, mainly because of acquisitions. For the first nine months, Freight revenue declined 14.0% to $1.033 billion and Transit revenue increased 82.9% to $1.773 billion.
- Cash flow: Nine-month operating cash flow was $26.5 million, versus $246.9 million a year earlier. Investing used $149.8 million, including $114.2 million for acquisitions and $60.3 million for capital expenditures; financing used $70.0 million. Cash declined $170.4 million to $228.1 million.
- Balance sheet and liquidity: Current assets were $2.277 billion and current liabilities $1.465 billion. Total debt was $1.874 billion, including $49.7 million current; cash was $228.1 million. The revolving facility had approximately $686.7 million of available capacity, net of letters of credit, subject to covenants.
- Other metrics: Nine-month dividends were $0.32 per share. The warranty reserve was $148.8 million, up from $94.1 million at year-end 2016. The effective tax rate was 15.7% for Q3 and 23.4% year to date, including a $9.5 million favorable deferred-tax benefit in Q3.
Material changes versus the prior comparable period
- Acquisitions, led by Faiveley, drove revenue growth, while organic freight demand weakened. Management attributed declines to lower demand for freight original-equipment products and the completion of a large locomotive-rebuild contract in 2016.
- Profitability fell despite higher sales. Cost of sales as a share of revenue rose to 73.6% in Q3 from 68.6%; SG&A and amortization also increased, substantially reflecting acquired operations and integration costs.
- Interest expense rose to $17.9 million in Q3 from $6.1 million and to $51.0 million for nine months from $15.9 million, primarily because of higher debt and interest rates following the Faiveley acquisition.
- Operating cash flow weakened sharply, which management attributed to lower net income and unfavorable working-capital movements, including supplier-payment timing, higher inventory, and other assets and liabilities.
- Foreign-currency translation contributed $278.0 million of nine-month other comprehensive income before tax, versus a loss in the prior-year period.
Outlook, management commentary, risks, and unusual items
- The filing provides no specific Wabtec earnings or revenue guidance. Management described long-term priorities of growth, margin improvement, cost control, and cash generation, and noted that results depend on rail activity, customer capital spending, government transit funding, and economic conditions.
- Management cited industry estimates of about 3,200 new locomotives and 97,000 new freight cars worldwide in 2017, compared with approximately 3,400 and 108,000, respectively, in 2016. These are market estimates, not company guidance.
- Existing-contract project adjustments totaled $20.4 million in Q3: $5.5 million in Freight and $14.9 million in Transit. The filing also reports $6.0 million of restructuring and integration costs year to date.
- A subsidiary, Xorail, faces allegations concerning wireless grade crossings and project delivery for Denver’s Eagle P3 project. Denver Transit alleged $36.8 million of damages through July 31, 2017, continuing to accrue; no claim had been filed. The FRA granted five-year approval for the modified system, but PUC approval remained pending. Wabtec disputed the allegations and stated it did not believe it had liability.
- Other risks include rail-market weakness, customer order delays or cancellations, acquisition integration, contract performance, foreign exchange and interest rates, raw-material and supply constraints, and litigation. The filing reported no material change to previously disclosed risk factors.
- Wabtec reported compliance with debt covenants. Its revolving credit agreement sets a minimum interest coverage ratio of 3.0 and maximum debt-to-EBITDA ratio of 3.25. Disclosure controls were considered effective, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much revenue and earnings growth is organic versus attributable to Faiveley and other acquisitions, and whether acquired operations can improve margins.
- Whether the freight-market declines and weaker operating cash flow persist, and how working capital and inventory convert to cash.
- Progress on existing-contract adjustments, warranty claims and reserves, and the remaining integration and restructuring costs.
- Debt levels, interest expense, covenant headroom, and available revolver capacity as operating cash generation develops.
- Developments in the Denver Eagle P3 dispute, including PUC approval status and any asserted or filed damages claim.
- Completion of Faiveley purchase-accounting estimates, which the filing describes as preliminary and subject to potentially material adjustment.