Westinghouse Air Brake Technologies Corporation (Wabtec) — Q3 2010 Form 10-Q
Reporting period: Three and nine months ended September 30, 2010. Financial statements are unaudited. Unless stated otherwise, amounts are in millions of U.S. dollars.
Business context
Wabtec supplies technology-based products and services to freight rail and passenger transit markets, operating in 17 countries. About 46% of revenue in the first nine months came from customers outside the U.S. Its reportable segments are Freight Group and Transit Group.
Financial performance
| Metric | Q3 2010 | Q3 2009 | First 9 months 2010 | First 9 months 2009 |
|---|---|---|---|---|
| Net sales | $375.7 | $330.5 | $1,113.8 | $1,042.4 |
| Gross profit | $109.2 | $94.8 | $331.1 | $293.7 |
| Gross margin | 29.1% | 28.7% | 29.7% | 28.2% |
| Operating income | $50.6 | $45.8 | $151.5 | $138.2 |
| Operating margin | 13.5% | 13.8% | 13.6% | 13.3% |
| Net income attributable to Wabtec shareholders | $30.5 | $27.3 | $92.1 | $90.9 |
| Diluted EPS | $0.63 | $0.57 | $1.92 | $1.89 |
| Operating cash flow | Not presented quarterly | Not presented quarterly | $75.2 | $92.8 |
Liquidity and debt: At September 30, cash was $176.8, versus $188.7 at December 31, 2009. Total debt was $409.8, up from $391.8, comprising $150.0 of 6.875% senior notes due 2013, a $137.5 term loan, $122.0 drawn on the revolving facility and $0.3 of capital leases. The company reported $148.4 of available bank borrowing capacity, net of letters of credit, subject to covenants. It was in compliance with its debt covenants.
Cash flow and investment: Nine-month operating cash flow fell $17.6 year over year, with management citing increased working capital, including receivables and inventory. Investing used $103.2, including acquisitions and $12.4 of capital expenditures. Financing provided $13.7; debt proceeds and repayments were $201.4 and $183.3, respectively. Cash declined $11.9 over the period.
Changes versus comparable periods
- Q3 sales rose 13.7% and net income rose 11.9%. Higher Freight Group sales and acquisitions drove growth, partly offset by weaker Transit Group sales.
- For the first nine months, sales increased 6.8%, but net income increased only 1.4%. Higher volume and gross margin were partly offset by increased SG&A and income tax expense.
- Q3 Freight Group sales grew 67.6% to $208.6; Transit Group sales fell 18.9% to $167.1. The Transit decline reflected completed major contracts, project delays and municipal budget constraints.
- SG&A increased 25.4% in Q3 and 20.9% year to date, attributed mainly to acquisitions and incentive compensation. Q3 operating margin declined from 13.8% to 13.5% despite higher sales.
- Q3 diluted EPS was $0.63 versus $0.57; nine-month diluted EPS was $1.92 versus $1.89. The prior-year nine-month tax rate benefited from a $9.7 tax benefit related to tax examinations.
Outlook, commentary and risks
- Management reported U.S. freight rail traffic improving: revenue ton-miles through mid-October were 8% above the prior-year period, and the industry’s new freight-car backlog reached about 19,000 cars in Q3. New locomotive and freight-car deliveries were expected to remain below 2009 levels, although recent order rates had improved.
- Wabtec expected to benefit from deployment of positive train control technology required by 2015 legislation. Management also cited international expansion and acquisitions as growth priorities; no quantified company revenue or earnings guidance was provided.
- Near-term transit demand remained pressured by agency budget constraints and deferred equipment and aftermarket purchases. Management said it would continue cost reductions, including consolidations, workforce reductions and spending cuts.
- Management warned that a weaker global economy could cause order delays, cancellations, longer sales cycles or reduced demand. Other risks include customer and industry conditions, government transit funding, foreign exchange and interest rates, supply and raw-material costs, technology execution, acquisition integration and litigation.
- Interest-rate swaps with $137.0 notional value fixed the rate on a portion of bank debt at 2.23% through maturities ending by December 2012. A 1% rate change on variable-rate debt was estimated to change annual interest expense by $1.2.
- Faiveley-related litigation remained pending. A prior arbitration award required a $3.9 royalty payment; a later complaint by Faiveley entities was being contested, with trial potentially in early 2011 for claims surviving summary judgment. Wabtec said it did not expect material liability. Asbestos claims also remain; management said the ultimate loss could not be estimated but expected resolution not to be material.
- 2010 acquisitions included Xorail, G&B Specialties and Bach-Simpson, alongside investments in China joint ventures. After quarter-end, Wabtec acquired substantially all assets of Swiger Coil Systems on November 5, funded from cash reserves without incremental debt or equity issuance; management said it would not materially affect liquidity or financial position.
Investor verification priorities
- Assess whether Freight Group growth can continue and whether Transit Group sales stabilize amid agency budget pressures and project delays.
- Track working-capital needs and cash conversion, given lower operating cash flow despite higher earnings and increased receivables and inventory.
- Review acquisition integration, purchase-price allocations, goodwill growth and the returns from recent acquisitions and joint ventures.
- Monitor debt levels, available revolver capacity, covenant headroom and refinancing needs ahead of the 2013 facility and note maturities.
- Follow the Faiveley proceedings, asbestos claims and insurance or indemnity coverage; the filing does not quantify a reliable ultimate asbestos loss.
- Verify the pace of positive train control adoption, government transit funding and freight-market recovery against management’s expectations.