Business context and reporting period
Westinghouse Air Brake Technologies Corporation (Wabtec) filed this Form 10-K for the fiscal year ended December 31, 2016. It supplies technology, equipment and services to global freight and transit rail markets through its Freight and Transit segments. Results include Faiveley Transport only from its November 30, 2016 acquisition date.
Wabtec acquired a controlling interest in Faiveley Transport, a major transit-rail supplier, and reported 78% ownership after a further tender offer closed on February 3, 2017. The company also completed several smaller acquisitions. Aftermarket parts and services represented about 59% of 2016 sales; customers outside the U.S. accounted for about 54%.
Financial performance and position
| Metric | 2016 | 2015 |
|---|---|---|
| Net sales | $2.931 billion | $3.308 billion |
| Gross profit / margin | $924.2 million / 31.5% | $1.048 billion / 31.7% |
| Operating income / margin | $458.4 million / 15.6% | $607.6 million / 18.4% |
| Net income attributable to Wabtec shareholders | $304.9 million | $398.6 million |
| Diluted earnings per share | $3.34 | $4.10 |
| Cash from operating activities | $449.3 million | $448.3 million |
| Cash and cash equivalents at year-end | $398.5 million | $226.2 million |
| Total debt at year-end | $1.893 billion | $692.2 million |
Investing activities used $775.1 million, including $183.1 million of net cash paid for acquisitions and $50.2 million of capital expenditures. Financing activities provided $524.2 million. Year-end current assets were $2.868 billion and current liabilities $1.447 billion; however, $744.7 million of current assets was escrowed for the Faiveley tender offer. Available borrowing capacity under the credit facility was about $783.7 million, subject to covenants.
Freight segment sales fell 24.9% to $1.543 billion and operating income was $344.5 million. Transit sales rose 10.8% to $1.388 billion, with operating income of $171.4 million. The reported Transit increase includes the acquisition and foreign-exchange effects; Faiveley contributed $110.8 million of revenue and $0.6 million of operating income during its 31 days in Wabtec’s 2016 results.
Material changes versus prior period
- Consolidated sales fell 11.4%, operating income declined 24.6%, and shareholder net income fell 23.5% year over year. Diluted EPS decreased from $4.10 to $3.34.
- Lower freight demand was the primary operating headwind: North American carloadings declined 4.5%, locomotive deliveries 20%, and freight-car deliveries 27%. Freight original-equipment and train-control sales weakened, and a large locomotive rebuild contract concluded.
- Acquisitions added $189.2 million to 2016 sales, while unfavorable foreign exchange reduced sales by $71.1 million. Freight sales declined despite acquisition contributions.
- Operating expenses increased to 15.9% of sales from 13.4%, including $38.9 million of Faiveley acquisition-related costs and $5.4 million of restructuring costs. Net interest expense increased $25.7 million, reflecting higher debt and $14.9 million of refinancing costs.
- Debt increased substantially to fund acquisitions. Wabtec issued $750 million of 3.45% senior notes due 2026 and entered a $1.2 billion revolving facility plus a $400 million delayed-draw term loan.
- Unaudited fourth-quarter sales were $760.0 million versus $832.8 million in 2015; operating income was $62.8 million versus $151.2 million, and shareholder net income was $37.8 million versus $101.8 million.
Outlook, commentary, risks and unusual items
Management’s stated priorities are cash generation, margin improvement through the Wabtec Excellence Program, product innovation, international expansion, aftermarket growth and disciplined acquisitions. It did not provide specific company-wide revenue or earnings guidance in the supplied filing text. Management expected 2017 global locomotive deliveries of about 3,200 versus 3,400 in 2016, and freight-car deliveries of about 97,000 versus 108,000; it also expected North American locomotive and freight-car deliveries to be lower than in 2016. These are market estimates, not earnings guidance.
- Management cited a global accessible rail market above $100 billion, with UNIFE projecting approximately 3.2% annual growth through 2021. This is an industry forecast, not a Wabtec forecast.
- Key risks include rail-market cyclicality and weaker freight activity; customer order deferrals or cancellations; government funding and ridership trends affecting transit; foreign-exchange and interest-rate exposure; integration and synergy execution; labor negotiations; and supply, product-warranty and long-term contract risks.
- Wabtec reported $345 million of 2016 train-control and signaling revenue, including Positive Train Control. The U.S. PTC compliance deadline was December 31, 2018, with possible extensions for qualifying railroads; timing changes could affect revenue.
- Siemens sued Wabtec in 2016 alleging infringement of patents related to PTC technology. Wabtec disputes the claims and is defending the case. Asbestos claims remain pending; management said the ultimate liability cannot be estimated, while believing resolution would not materially affect the company overall.
- Acquisition accounting for Faiveley and several smaller businesses remained preliminary. Management excluded those acquired businesses from its 2016 internal-control assessment; the external auditor likewise excluded them. The auditor issued an unqualified opinion on Wabtec’s financial statements and assessed the company’s controls as effective within that stated scope.
- Goodwill and other intangible assets rose materially with acquisitions. No impairment was recorded in 2016, but goodwill valuations depend on forecasts and assumptions. The filing also identifies contract estimates, pensions, warranties and taxes as areas of significant judgment.
Most important facts for investors to verify
- Whether Faiveley’s remaining tender offer is completed, and whether the anticipated acquisition benefits and integration savings materialize.
- Whether weak freight volumes and lower equipment deliveries persist, and how they affect Freight sales, margins and backlog conversion.
- Debt repayment, covenant headroom, interest-rate exposure and the availability of cash held in escrow for the acquisition.
- Progress toward the PTC deadline and the outcome or potential financial effect of Siemens’ patent litigation.
- Whether the $3.98 billion year-end backlog converts to revenue: contracts may be delayed, adjusted or canceled, and much aftermarket business is not recorded in backlog.
- Changes in warranty and loss-contract provisions, acquired goodwill valuations, and the company’s internal-control integration of recently acquired businesses.