Wabtec — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2018. Wabtec supplies equipment, systems, and services to freight and passenger rail markets; about 66% of nine-month revenue came from outside the United States. Dollar amounts below are in millions unless stated otherwise.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net sales | $1,077.8 | $957.9 | $3,245.7 | $2,806.2 |
| Gross profit / margin | $302.0 / 28.0% | $253.2 / 26.4% | $936.9 / 28.9% | $796.9 / 28.4% |
| Operating income / margin | $125.2 / 11.6% | $101.7 / 10.6% | $380.0 / 11.7% | $329.5 / 11.7% |
| Net income attributable to Wabtec shareholders | $87.7 | $67.4 | $260.5 | $213.3 |
| Diluted EPS | $0.91 | $0.70 | $2.70 | $2.22 |
- Growth: Q3 sales increased 12.5%, operating income 23.1%, and attributable net income 30.2% year over year. Nine-month sales rose 15.7%, operating income 15.3%, and attributable net income 22.1%.
- Drivers: Management cited higher demand for train-control and signaling products, transit original-equipment products, brakes, and freight spare parts. Acquisitions added $32.2 million to Q3 sales and $106.4 million to nine-month sales. Foreign exchange reduced Q3 sales by $19.7 million but added $89.7 million over nine months.
- Margins and expenses: Q3 gross margin improved to 28.0%, chiefly from favorable product mix and the absence of $20.4 million of 2017 project adjustments. Nine-month gross margin rose to 28.9%. SG&A increased, including $7.2 million of Q3 and $16.4 million of nine-month costs related to the proposed GE Transportation transaction.
- Taxes: Effective tax rates were 16.2% for Q3 and 17.2% for the first nine months, versus 15.7% and 23.4% in 2017. The nine-month comparison reflects Tax Act-related benefits, earnings mix, and releases of uncertain tax positions.
Cash flow, debt, and liquidity
- Operating cash flow: $38.0 million for the first nine months, versus $26.5 million in 2017, despite net income of $256.8 million. Working-capital outflows included inventory growth and timing of customer receipts; the filing attributes a $125.6 million favorable offset to timing of supplier payments.
- Investing and financing: Investing cash outflow was $104.2 million, including $64.2 million of capital spending and $49.1 million net acquisition spending. Financing provided $1,995.3 million, including proceeds from debt issuance and borrowings, partly offset by $1,466.6 million of debt repayments and $34.7 million of dividends.
- Cash: At September 30, cash and cash equivalents were $411.4 million and restricted cash was $1,724.0 million, for combined cash and restricted cash of $2,135.4 million. Restricted funds were intended to finance the GE Transportation transaction and should not be viewed as freely available liquidity.
- Debt: Total debt was $3,865.1 million, including $3,818.1 million long-term debt, compared with total debt of $1,870.5 million at year-end 2017. The increase reflects transaction financing. Wabtec issued $2.5 billion of senior notes in September: $500 million floating-rate notes due 2021, $750 million 4.15% notes due 2024, and $1.25 billion 4.70% notes due 2028.
- Available capacity and covenants: The company reported about $1,170.3 million of available revolver capacity, net of letters of credit, subject to financial covenants. It reported compliance with debt covenants. Variable-rate debt carried a 3.49% weighted-average rate at quarter-end.
Material developments, outlook, and risks
- Proposed GE Transportation combination: The modified Reverse Morris Trust transaction includes a $2.9 billion cash purchase of certain assets and a stock merger for the remaining business. The filing estimated total consideration at about $12.8 billion using Wabtec’s October 12 share price; actual equity consideration depends on the share price at closing. Management expected closing by early 2019, subject to shareholder, regulatory, and other customary approvals. GE and former GE shareholders would collectively own about 50.1% of the combined company; pre-merger Wabtec shareholders about 49.9%.
- Transaction financing condition: The notes are intended to fund the cash portion. If the transactions have not closed by August 20, 2019, or the agreements are terminated earlier, the notes are subject to mandatory redemption at 101% of principal plus accrued interest.
- Business outlook: The filing provides market estimates, not specific Wabtec earnings or revenue guidance. Management described demand as dependent on rail traffic, customer capital spending, transit funding, and economic conditions. It cited anticipated 2018 global deliveries of about 2,400 locomotives and 175,000 freight cars, and orders for about 34,000 passenger transit vehicles.
- Principal risks: Market and economic weakness, delayed or cancelled customer orders, dependence on major OEM customers and government transit funding, supply disruptions, raw-material costs, foreign exchange and interest rates, execution of long-term contracts, acquisition integration, and transaction approvals or completion.
- Contingencies: Siemens litigation alleges infringement of Positive Train Control patents; trial was scheduled for January 2019, and only one of ten patent-review proceedings had been decided as of October 24, 2018. A separate employee non-compete matter generated putative class actions seeking unspecified damages; the cases were at an early stage. Denver Transit had previously alleged $36.8 million of damages concerning a crossing system, but approvals were obtained, crossings were certified in August 2018, and a subsequent complaint named RTD, not Wabtec’s subsidiary Xorail.
- Other items: Warranty expense was $45.7 million for nine months, up from $33.1 million. The warranty reserve was $154.6 million at quarter-end. Wabtec adopted ASC 606 in 2018; management said the effect was not material. Disclosure controls were judged effective, with no material change in internal control over financial reporting reported for the quarter.
Important facts for investors to verify
- Whether the GE Transportation transaction closes on the stated terms and timeline, and the final share issuance, cash consideration, and financing needs.
- How much of reported cash is restricted for the transaction, and the company’s post-closing debt, leverage, and covenant headroom.
- Whether operating cash flow improves as inventory, receivables, and customer-payment timing normalize.
- Whether sales growth and gross-margin gains persist after excluding acquisition, foreign-exchange, and nonrecurring project effects.
- Developments in the Siemens patent case, employee class actions, and other product, warranty, and contract exposures.