Westinghouse Air Brake Technologies Corporation (WAB) Q1 2018 Earnings Report, Transcript and Summary

Good morning, and welcome to the Wabtec First Quarter 2018 Earnings Release Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Tim Wesley, Vice President of Investor Relations. Please go ahead.

Hi, Steven. Hello everybody and welcome to our first quarter 2018 earnings call. Let me introduce the others who are here with me in beautiful downtown Wilma Dain, Ray Betler, our President and CEO; Pat Dugan, our CFO; Stéphane Rambaud-Measson, our COO; and our Corporate Controller, John Mastalerz. We say a welcome to Stéphane, who’s joining us on the call for the first time. As usual, we will make our prepared remarks and then we will take your questions. We will make forward-looking statements during the call, so we ask that you review today’s press release for the appropriate disclaimers. And just before I hand it off to Ray, a quick reminder. Our investor conference, investor day is coming up on May 7th in Ney York. If you would like to attend the RSVP deadline is this Friday. So if you need more details, please get in touch with me. Ray, go ahead.

Thank you, Tim. Good morning everyone. It’s good to talk to you today. After a year of transition in 2017, we’re off to a solid start here for the first quarter of 2018. And as expected, we’re seeing improvements in some of our core markets. We slightly exceeded our expectations for the quarter and affirmed our guidance for the year, which we hope will prove to be conservative. We saw year-on-year revenue growth in both of our segments for the second quarter in a row. Our backlog grew again and remains at a record high. A couple months ago on our fourth quarter call, we told you that our company was stronger and better positioned than it was a year ago. And we’re pleased to start demonstrating that with our performance in Q1. We expect to build on these first quarter accomplishments throughout 2018 based on our record in growing backlog, the improvements we’re seeing in our Freight aftermarket, our Wabtec Excellence Program, which gives us the ability to generate cash and continued to increase margins over time. So with that I am going to turn it over to Pat to go through the first quarter numbers.

Okay, thanks, Ray, and good morning to everybody. The sales for first quarter were about $1 billion, $1.06 billion for the quarter. When you look at our segments, our Transit segment sales increased 19% to $677 million. That increase was due to a favorable FX impact of about $64 million, organic growth of about $32 million and from acquisitions – full quarter acquisitions of about $12 million. This is the second quarter in a row where we have seen organic sales growth which demonstrates that our backlog, our record backlog is starting to kick in. Our freight sales increased 9% to $380 million and that’s the second year-on-year increase in a row. This increase was due to sales from our acquisitions about $24 million, some impacts from FX of about $6 million and an organic growth of about $2 million. The sales were the highest level for freight in almost two years and the backlog for freight increased 15% and is now at the highest level in two years. Freight aftermarket sales showed a year-on-year growth for the third quarter in a row, all these are positive indicators. Looking at the income statement for the quarter, our operating income was $131 million or about 12.4% of sales. As we mentioned in our press release this morning, this included restructuring and integration expenses of about $1 million for ongoing cost cutting actions. Going forward, our 2018 operating margin target is about 13.5% with improvement expected throughout the year as we work our way through some of the lower margin – some of our lower margin contracts we talked about last year. Our SG&A for the quarter was about $147 million. The increase was mainly due to changes in foreign currency exchange rates and our full quarter impact of our acquisitions and we expected to be about $140 million to $145 million per quarter going forward. Our amortization expense was up mainly due to those acquisitions and we expect a similar quarterly run rate for amortization expenses for the rest of this year. Taking a look at our segment operating income for Transit. Our operating income increased 39% to $68 million for an operating margin of 10.1%. Just to remind you in the year ago, we did have restructuring and integration expenses in this segment of about $7 million for an adjusted operating margin of about 9.7%. So even after adjusting for those expenses, we did – we generated some margin improvement compared to the year ago quarter. In freight, our operating income was about $70 million, down 2%, 200 basis points for an operating margin of 18.3%. This included some planned investment and cost and strategic growth initiatives in our electronics business and other areas and the prior year comparison is also impacted by some sales mix. For the full year of 2018, we expect our operating margin improvement for both segments during the year compared to last year. These improvements will come through better project performance, a better mix as we complete our lower margin contracts and the benefits of our restructuring and cost reduction programs. Just as a quick update on our integration and our synergy plans. In 2017, we generated about $30 million of synergies compared to our target of about $15 million to $20 million. In 2018, we expect to achieve an additional $15 million, and we are on track to achieve that in the first quarter. Our total target for the first three years is at least $15 million, so we’re ahead of that pace and expect that to continue. I’ll, talk a little bit more about the income statement. I want to talk about interest expense and the other income and expense. I just want to remind everybody that companies have changed the way, we account for our pension expense and how that impacts interest and other income and expense. Previously, pension expense was captured entirely in our cost of sales, but the new method is to split these into three categories of service costs, interest costs and our return on investment into different line items on the income statement. Now, only service costs are captured in the cost of sales, interest costs are recorded in the interest expense lines and the return on investment is recorded in other income and expense. There is no change to the bottom line at all, it doesn’t change our historical EBIT margins materially, but we do have to revise the interest expense and other income line items for the last year, which is why those 2017 Q1 numbers in our press release today are different from the ones we reported a year ago. The effect of this is that we reclass about $2.5 million of pension expense, which increased both interest expense and other income. Interest expense was $20 million for Q1 2018 and going forward, we expect interest expense to be roughly the same, although we are focused on generating cash to reduce debt, and then of course of interest expense on that debt. Other income and expense – other income was $2.6 million compared to $4.8 million in the prior year quarter and the decrease was due to a smaller FX gain that we had last year. Income tax and our effective rate for the quarter was about 23% in line with our guidance, and our 2018 full year assumption remains at about 23.5%. I’ll just remind everybody that that’s an annual estimate and any individual quarter can vary due to the timing of any discrete items. Our GAAP earnings per diluted share were $0.92 compared to $0.77 in the year-ago quarter. The 2017 first quarter included restructuring and transaction expenses, tax adjustments, and non-controlling interest adjustment from the Faiveley Transport acquisition, and the combination of which reduced earnings per diluted share by a net of $0.07. So our adjusted comparable number for the 2017 Q1 was $0.84 compared to our $0.92 in Q1 of 2018. If we take a look at our balance sheet, it remains strong, providing the financial capacity and flexibly that we need to invest in our growth opportunities. We have an investment grade rating and credit rating, and our goal is to maintain it. Our cash from operations, we generated $24 million compared to a use of cash of $26 million in the year-ago quarter. So, we improved about $50 million quarter-over-quarter. This is the third quarter in a row that we have improved our cash generation compared to the prior-year quarter, and we expect our cash generation to improve during the rest of this year, and to finish 2018 with more cash from operations than net income. At March 31, we’re talking about working capital, at March 31, our receivables were $886 million, inventories were $829 million and payables were $608 million. In addition, we had unbilled receivables of $383 million, which were offset by customer deposits of about $378 million. Cash on hand at March 31 was $250 million, mostly held outside the U.S. and our debt at March 31, we had a total debt of about $1.92 billion and net debt of about $1.67 billion, which gives us a net debt-to-EBITDA of about three times. Just a couple of miscellaneous items for everybody. Our depreciation expense for the quarter was $18 million compared to $16 million in last year’s quarter, and for the full year of 2018, we expect it to be about $75 million. Amortization expense for the quarter was $10.4 million compared to $9 million in last year’s quarter. For the full year of 2018, we expect it to be about $41 million. And our CapEx for the quarter was $18 million compared to $19 million a year ago and we expect or forecast to spend about $100 million in 2018 in capital expenditures. Turning to backlog, we had another good quarter, generating new orders, as you can see, the numbers we reported in the press release. At March 31, our multiyear backlog was a record $4.9 billion, a 7% increase from year-end, and our book-to-bill in the first quarter was 1.28, of the increase of about – of the increase, about 40% was due to changes in FX rate. Our rolling 12-month backlog, which is a subset of the multiyear backlog, was at a record $2.5 billion, a 7% increase compared to the end of the year, which again, is another positive sign for this year. So with that, I’ll turn it back over to Ray.

Thanks Pat. As I mentioned previously, we affirmed our guidance for the year based on our first quarter performance and our outlook for the rest of the year. We expect full year revenues of about $4.1 billion, with adjusted earnings per diluted share of about $3.80, excluding restructuring and integration charges compared to 2017. This would represent revenue growth of about 6%, and adjusted EPS growth of about 11%. Given that we slightly exceeded our first quarter expectations, we hope the guidance proves to be conservative. We expect to generate cash from operations in excess of net income for the year. Our key assumptions include the following: revenue growth in both segments; our consolidated operating margin target for the year is about 13.5%; as Pat mentioned, we should see improvements starting the year through better project performance, the completion of longer margin contracts and get the benefit of restructuring and cost reduction programs; our tax rate is expected to be about 23.5% for the year, and we’re assuming diluted shares outstanding of about 96 million for EPS calculation purposes. Our goals in 2018 are straightforward: to meet our financial plan, to generate cash, to invest in growth opportunities while strengthening our balance sheet and to capture the additional synergies and growth we expect through the Faiveley acquisition. We continue to focus on cash generation to fund growth. Our priorities for allocating free cash remain the same, although we expect to reduce debt throughout the year. Those priorities already fund internal growth products, including product development, innovation and CapEx, to fund acquisitions where we have ample opportunities to deploy capital, to return money to the shareholders through a combination of dividends and stock buybacks. We remain focused on increasing free cash flow by managing costs, driving down working capital and controlling capital expenditures. Our corporate strategic growth strategies also remain the same. We expect to achieve growth through new product development, innovation and new technologies, to invest in aligned market expansion and global expansion, to invest in aftermarket and service expansion and to invest in acquisitions. Before I ask Stéphane to discuss the Transit and Freight markets, I’d like to talk briefly about PTC. Obviously, this will continue to be a topic of great interest as we get closer to the deadline at the end of 2018. In Q1, our revenues in this area were $91 million, and we’re comfortable with our estimate of about [indiscernible] growth which would be about $350 million. During Q1, we booked about $75 million of new train control contracts to provide equipment and project management and aftermarket services for various customers. Also this year, our aftermarket revenues are starting to kick in from master service agreements with our Freight and Transit customers. As you know, we’ve said that this would generate annual revenues between $50 million and $100 million. We’re already in this range, which represents a strong foundation for our ongoing revenue. In addition, as we are focused on helping customers meet their deadlines in the near term, we are also investing to ensure that we capture the long-term growth opportunities from this installed base. For example, our largest single investment in new product development is designed to help us maintain our leadership position in North American market PTC. And to leverage our PTC installed base for the future follow-on opportunities, and enhancements and added functionality. Stéphane, can you know discuss the Transit and Freight segments, please? Stéphane Rambaud-Measson: Thanks Ray. And I am pleased to discuss [indiscernible] groups and their performance. Our Transit business is now a true global player. . Overtime, there should mean more visibility and stability, better growth opportunities, both organic and through acquisitions, and improve margins as we benefit from increased scale and market share and the rest of market revenues increase. Currently, the state of the Transit market worldwide is strong, with investment in public transportation growing. We are seeing growth opportunities, for example, in India and Europe, especially Germany and France. India is a market where we expect to benefit real-time from good volume from repeat orders on standard products. And in U.S., we are participating in all the major new vehicle projects. Our position within the market is also strengthening. During 2017, our backlog increased about 20% as we moved orders in all major markets, in all our major product categories and in all of our major customers. During the first quarter, our backlog increased again, this time by 5%. The project includes supplying components and system for new cars in the Middle East, in Southeast Asia and in Europe, and during the first quarter, we’ve also add organic growth of about 6%, and some of the backlog is starting to kick in. You have to remember that these OEM orders typically lead to long-term aftermarket contracts, which drive product revenues and good profitability for about 30 to 40 years. Let me give you a quick update on new product development in Transit. We have a number of growing and environmentally-friendly products in the pipeline. It includes low energy consumption HVAC systems, the compact and lower-weight doors mechanism, compact by electronics and light-weight break disc for commuters and high-speed trains. Now let’s move on to our freight rail business, which is also showing improvements. In NAFTA, freight rail Transit is about 2.5% year-to-date. And while we still see a lot of [indiscernible], these numbers continue to come down. For example, the product locomotives are down about 10% since the end of last year. Around the world, freight market conditions are mixed, with growth in some areas offset by service demands and orders. We can mention India is a bright spot, with a significant increase in new freight car position this year. Throughout 2017, we saw the models pick up in operating aftermarket revenues, but that output is improving. We continue to see more inquiries for component servicing and retail, and eventually locomotive and all projects. Our freight backlog is now at its highest level in two years, and as Pat mentioned, our first quarter revenues showed a year-on-year increase for the first time in two years, which are positive indicators. We are also seeing some improvement in our non-rail businesses, particularly the heat exchanger products, which has been driven by higher oil and gas prices. As a reminder, our 2018 freight assumptions include the following: annual CapEx, which declined about 10% in 2017, is expected to be flat or slightly up in 2018; new locomotives, we see a slight increase worldwide, down in NAFTA, but it’s looking like 2018, we will grow; for new freight cars, NAFTA should be flat to slightly up. Adding now in our Transit business, we are also investing in new products in Freight, whether it is data analytics, electronic Transit sales or train control automation, leading to more computers, we have an extensive pipeline of innovation. Finally, let’s review the two acquisitions we made in the first quarter. We acquired Annax, a market-leading supplier of public address and passenger information systems for transit vehicles and stations; and Lynxrail, a manufacturer of vision-based wayside inspection systems for the rail industry, combined the annual sales of about US$60 million. Annax is a partner in Germany, and provides a wide range of products and solutions, including communication systems, intercoms, audio technologies and displays, throughout all main jobs in those platform and market segments. Annax continues offering the innovative and added value solutions and processes, which are Wi-Fi, passenger accounting, smart window technology. Annax strategically allows registering the required product for Transit in those markets. And the leading-edge solutions complements well and more than Wabtec’s product portfolio. Lynxrail is a partner in Australia, the first product that leverage sophisticated most innovative technologies and dominance to assess components and provide real-time accessible analysis to the customer. This technology complements the condition of the products supplied by a Wabtec unit, Track IQ, which specializes in wayside condition monitoring equipment and data management systems. The combination of Lynxrail and Track IQ creates a new opportunity for Wabtec to become one of the largest supplier of wayside condition monitoring technology worldwide. Ray?

Thanks, Stéphane. I’ll conclude my prepared remarks by talking about our long-term growth opportunities. As you know, we completed our first strategic plan as an integrated company last year, and our five-year plan meets our long-term financial goals to average double-digit growth in revenues and earnings to the business cycle, while improving margins. To achieve these goals, we have growth initiatives in each of our major product lines, consistent with our four growth strategies. Five years from now, we expect to be a stronger, more global, more balanced, more profitable company. So just to reiterate some of my comments in the beginning of the call, we are off to a solid start in the first quarter of 2018. We slightly exceeded our guidance for the quarter and affirmed our guidance for the year, which we hope will prove to be conservative. We saw year-on-year revenue growth in both of our segments for the second quarter in a row. Our backlog grew again and remains at a record high. We expect to build on these first quarter accomplishments throughout 2018 based on our record in growing backlog, the improvements we’re seeing in our Freight aftermarket, our Wabtec Excellence Program, which gives us the ability to generate cash and continued to increase margins over time, we believe this is going to be a good year. With that, we will be happy to answer your questions. I’ll turn it over to Tim.

Okay. Steven, if you want to pull for questions, go ahead.

We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Sam Eisner with Goldman Sachs.

Yeah. Good morning, guys.

Good morning, Sam.

Good morning, Sam.

Can you maybe talk a bit about some of the investments that you’re making in Freight? You called out increased investments in strategic growth initiatives, curious how much of that has been a drag on first quarter performance, how much do we expect for the year, presumably that’s embedded in your 13.5% margin target for the whole company? How long do you expect it will last, just an overall view of what these investments are, how big they are, how long they’re going to last? Thanks.

Okay. Thanks. Yeah. We’ve talked off and on about the investments in the Freight market throughout last year and I’m happy to continue to do it. As you recall last year, last year, we invested in heat exchanger for the energy business, energy market, although in China, it was through our heat exchange business this year. We talked about last year and started this year our investment in our facility in Turkey to expand our presence in Turkey overall, but significantly to focus our Freight activities in Turkey. Turkey’s a large market. East Europe, it’s a large market. We have a facility in Macedonia, which we continue to upgrade, which will complement the facility in Turkey. One of the things that we did is with the unit track business which is one of our main infrastructure businesses. When we acquired that company, it had two new separate locations, and while they were a sort of a short distance apart, there were still two separate locations. They did not offer really efficient production capabilities. And so we invested in a brand-new facility. It’s in the same geographical location but a couple miles from the existing businesses and we’ve consolidated everything in one location, it’s all under roof, one of the two facilities that we acquired was, it’s close to the environment, which you can imagine in Tennessee, it’s a tough way to work in the summer. So we’ve completed that investment and won’t be able to improve our product offerings and productivity for infrastructure products. And we mentioned several times, the investments we continue to make in electronics, which are significant.

Understood. Is there any way to put a number behind what these investments should be the expectation for a drag on profitability, the return profile that you expect on this any kind of financial details would be greatly appreciated?

Yeah. Class A number has gone. So let me hand…

Sam, I guess we don’t want to carve out a whole lot of the data on the specific investment programs. I can tell you that all these investments are definitely in our guidance. I would say that you kind of look at our overall spending for R&D and other operating type expenses in these developments are somewhat consistent with what we’ve spent in prior years. You can clearly see a little bit of additional CapEx versus a normal year in our numbers, but what really –what really comes to light and it becomes visible as you can see it impacting our segment operating percentage from time-to-time based on the timing of those expenses and how they’re going to hit. We always look at these initiatives and expect to have them pay for themselves, and a fairly short or not even within the year.

Understood. And maybe just sticking with Freight, you guys historically have given expectations for rail traffic growth, locomotive deliveries, railcar deliveries, any update that you guys have on those specific figures now according to the year and seemingly, Freight data is maybe, a bit better-than-expected when you guys first gave guidance?

So, I think that’s our feeling Sam, and we’re pretty encouraged by the improvement that we’ve seen in Freight and on the locomotive side, you know that there was an order lag for 200 cars earlier in the year. And that order was not expected to come that early. Certainly in 2018, we are aware of other orders that were in discussion in the industry. Freight car build is definitely tracking ahead of plan. cars and storage are coming down pretty dramatically, both on the locomotive side and the Freight car side, there is about a 10% improvement for instance since the end of December on the locomotive side and for railcars, about 50% since mid-year and last year. So I think, all in all, the market is headed in the right direction. We’re picking up business in the aftermarket and are encouraged by the OEM opportunities.

If I can just sneak one more in on the PTC, I know you’re guiding 5% up year-on-year, 3.54% for 2018. Just looking out to 2019, I know you don’t have guidance out there, but presumably, a lot of investors are focused on what happens post the deadline. Any way for investors to kind of think about, is there a hole, is there not a hole, do you anticipate having the mark of revenue growth from $50 million to $100 million. Is there any kind of broader comments that you can give on 2019, post the deadline?

So maybe, let me talk about the deadline for a minute. So people really can put it in context. So deadline for the end of 2018, it’s a mandate that people need to have their equipment completely installed and basically, beyond their test mode to qualify the equipment. Some people won’t be able to go into PTC operation across their entire network. Some people will need to extend to leverage the opportunity to extend from 2019 to 2020. Those extensions will be based on a specific case-by-case submittals, they have to be approved from the FRA. We’re meeting with the FRA on a regular basis to make sure that everybody is on the same wavelength in terms of information, and to optimize the rollout. So the fact of the matter is the market’s not going away. There is going to be business in 2018, 2019 and 2020 and as that PTC business continues, we’re going to build on that business to the enhancements we’ve talked about operational improvement, opportunities and two new product developments that ultimately for our product roadmap leads to autonomous operation.

Got it. I’ll hop back in queue. Thanks.

Thanks, Sam. Operator Our next question comes from Matt Elkott with Cowen. Please go ahead.

Good morning. Thank you for taking my question. Ray, it sounds like you clearly have increased confidence in the guidance for 2018. Can you talk about the primary areas of the business that give you this increased confidence? Is it mostly Freight aftermarkets or margins or just any more clarity on what seems to give you more confidence in the guidance for 2018 would be appreciated?

Yeah. I think it’s a combination of things. I think the Freight market in general that I just spoke of is certainly one big factor. But also the fact that we spent a lot of time and effort to integrate our business last year, and if we have done a lot of work to baseline of our projects, the backlogs we have in transit and the work that Stephane is doing to improve our overall performance on productivity across our organization, the opportunities that exist through the synergies that we’ve already completed and the ones that are still are not planned. And frankly, our position in the PTC, I mean, it’s a very good position that we’re in, and this is an important year for everyone and because of the closeness of our company with our customers and the regulatory authorities, I believe that that’s going to offer new opportunities for us.

Okay, that's great. Speaking of the Freight aftermarket business, you did have an encouraging increase in the organic portion of Freight sales. You had a decline last quarter. Based on -- do you think based on what you see in the market and based on where we are today in the second quarter, does organic Freight sale growth can continue for the rest of the year?

I can't really speculate on where it's headed, but I feel good about the market right now. We’re in regular touch with Freight car builders, both in terms of their domestic field as well as their international, a lot of these Freight car builders are expanding their operations overseas. And certainly, the aftermarket, you folks know the issues that exist right now, with congestion, sensitivities, each of their Class 1s have been calling to respond to service transportation board and velocities stands. So I think between the need for in terms of overall our performance and the need for equipment, it looks pretty good. So I guess, in turn, what this is, we’re cautiously optimistic about the market going forward.

Got it. And just one final question. I know you guys are always evaluating a pool of different acquisition targets. Can you talk about the acquisition candidates that you’re evaluating at this point? Are they more Freight companies or channel companies or sizes, any color would be appreciated?

Yes. So when we do our strategic plans, each of our business leaders identify candidates, and we go through very large potential portfolio acquisition candidates through a funneling process to shortlist candidates. So there’s, at any given time a 12 candidates that will be, in some case, pursuing. So it’s a mix across our total business. There’s good opportunities in every one of our segments, and really, it comes down to which one represents of the best return on investment for us as they compete for our acquisition funding.

Okay, great. Thank you very much.

Thanks, Matt.

Our next question comes from Justin Long with Stephens. Please go ahead.

Thanks and good morning. Maybe to follow-up on that last question. Obviously, there was an article that came out last Friday about the GE transaction and your potential involvement. I know you guys won’t comment on rumors, and I certainly want to respect that. So maybe I can ask a different way. When you think about your buying power for acquisitions, and you look at your leverage ratio today, the integration of Faiveley and other recent deals, is there a limitation on the size of acquisitions that you’d be willing to entertain?

Yes.

Yes. I think, Justin, this is Tim. So in the context of your question and the media reports and everything, we’ve always had our long-standing policy of not speculating on rumors, commenting on rumors or speculation. So I think we’ll stick to that.

But separating – this is Pat, but separating your question about how you let into the question, but to our leverage. We said in our prepared remarks that we intend to remain an investment-grade company, with respect to the leverage ratios, and that is something we consider in all our capital allocation strategies is very important.

Great. And do you think in order to remain investment-grade, you would need to keep leverage ratios about where they are today? Is that the assumption?

I think we talked about our long-term goal and where we wanted our leverage ratios to be. Obviously, there’s a certain amount of deleveraging that is expected in our investment grade rating right now, and that’s – it’s a big part of formulating our cash strategy. And I think that that’s remained consistent and haven’t changed.

Okay. I guess, secondly, going back to some of the margin commentary for this year, you gave guidance for both Freight and Transit margins to improve year-over-year in 2018. But is your view that margins in both segments should improve quarter-to-quarter throughout the year relative to what we saw in the first quarter? I just wanted to get a better sense for how we should think about the cadence?

Yes, just that’s sort of quarterly guidance, isn’t it? I mean really, at the end of the day, if we are executing on our plan and hitting the numbers that we put forward for the full year, really sort of implies that throughout the year, we’re going to have continuous improvement in our margins just as we always built it into our strategic planning and to our budgets year to year. We feel good about our full year guidance and so I think that kind of gives you an indication of how much it evolve.

Okay. And lastly, there’s been a lot of discussion about the Freight aftermarket business, and it’s encouraging to see a pickup there. I wanted to ask about what you’re seeing in the Transit aftermarket business? How should we think about the growth profile of that operation over the remainder of 2018?

Stephane, do you want to take that one?

Thank you, Ray. Actually, it’s a slightly different dynamic than the one of the Freight market for various regions. One of them is our 20 business is absolutely truly global. We primarily and what we’re going to start market for Transit is primarily two components: one is selling stock parts, we truly start after the warranty period and last for 30 to 40 years, in most of the cases we have a relatively captive position as most of our part are safety physical. The second part of our offering is engineering services. We offer to our end customers to reestablish equipment, retail equipment, modernize equipment, over the last time of the trend. We – I mean, it’s relatively difficult to model any service business in the Transit part due to the significant fragmentation of our customer base, the daily global business and the very different nature of the contractual arrangement we have all over the world, that we can’t foresee and it’s one of our strategic targets to continue to increase the volume of our service business for Transit worldwide, and gradually balance services and original equipment.

Okay, great. I’ll leave it at that. Thank you so much for the time.

Thanks, Justin.

Our next question comes from Allison Poliniak with Wells Fargo. Please go ahead.

Hi, guys, good morning. Not to harp on this Freight margin question, but I guess, if I – Pat, if you strip out the investments that you’re making and just look at the base organic margin, are you seeing expansion there? And would you expect wider expansion at least on the base core as you grow with some volatility with the investments? Is that how we should think about it?

Yes. I think you can see that the margins will get to kind of a more typical for the full year. You definitely have an impact of this, have some spending here, and some other costs that are being realized in that segment. But I think to answer your question, the best way to look at it and model this would be the recovery to a more typical Freight margin, which is a little bit higher for the full year. We continue to be focused on these – on the margin for these businesses, and it’s a big part of the overall EBIT expansion that we talk about through the rest of the year. We have programs in place to continue to improve, and I think that you’ll see that as a way to look at it on a full year basis.

Great, thanks. And then just on the Faiveley, synergies coming in pretty quickly. I mean as you dig a little bit more into the two businesses, with that number, do you think at this point you could exceed that number? On the revenue side, are you seeing incremental that maybe you weren’t expecting coming out of it. Any thoughts there?

We talked about in the prepared remarks, which is that we were on our plan that we built into our plan additional savings and synergies that we’re realizing. I think in terms of any kind of topline synergies, you’re really seeing it manifest itself in the backlog improvement that we get quarter-to-quarter. Clearly, the Faiveley integration is a big effort by our management team. We feel really good about it. It’s been successful. Ray talked about it earlier, and we really see that we have a long-term vision of this to continue to evolve and resulting in improved results.

Great. Thanks so much.

Our next question comes from Scott Group with Wolfe Research. Please go ahead.

Thanks. Good morning, guys. So I wanted to try one more on the GE question, I know it’s tough, but is there anything you guys have ever said in the past that suggest that a deal with GE couldn’t or wouldn’t happen because of any sort of strategic or size? Anything you ever communicated in the past? And then maybe can you say what your average content is per locomotive? And maybe, in an ideal world, how high it could go if an OEM used all of your products on you’re their local.

Scott, this is Tim again. I’ll jump in again and say that we’re not going to comment more than anything related to rumors or speculation, so I’m not going to comment on that. As far as content on locomotive, you know, it varies. I think we’ve said that if we get everything, maybe it’s a couple hundred thousand, but we’ve never given an average content level on the max.

Okay. Pat, in the last couple quarters, I think you’ve given some sort of directional guidance on the upcoming quarters’ EPS. I don’t think you said anything this quarter, any color or comments still appropriate to make?

I don’t know that I’ve said anything about quarterly guidance in terms of EPS. But at this point, it’s really kind of – it will be very difficult for me to really break it out by quarter what we think is going to happen. We’re going to stick to a full year guidance in terms of EPS.

Okay. And then on the PTC aftermarket, I think, Ray, you said that you’re already doing 50 million to 100 million of aftermarket this year. Is there any way to say what percent of your customers are already paying aftermarket? I’m just trying to get a sense of if this is already as good as it gets or should there be a lot of growth from here in aftermarket because only half or less than half of customers are paying aftermarket?

Yes. In one way or another we’re servicing all of the customers that we’ve delivered equipment in various ways. One is under MSAs, we’ve mentioned in the past that all the Class 1s are under MSAs. 100 or 200 national customers save a few community rail customers, and we continue to negotiate. There’s many customers, Scott, as you know, that have just recently entered into contracts with the OEM equipment. So those customers probably won’t come under MSA agreements for two to three maybe four years down the road. But we have a pretty significant portfolio now and we’re supporting either under MSAs on going medium, long term MSAs or just more normal aftermarket transactional business, all the customers that we’ve serviced so far. And in that portfolio there is 40 pus customers.

Okay. And then last one real quick. The low margin contracts that you talked about a couple of times back. How much is that impacting full year operating margin.

Yes, we haven’t given that number. I think, you kind of look at it as the adjustments occurred in the fourth quarter, and we called those out, but clearly it creates a very low margin revenue stream that goes into a portion of 2018. So that does affect our operating income a little bit percentage income. Yes, as Tim pointed, it’s reminding me, it’s all being contemplated in our guidance for full year.

Okay. All right. Thank you guys. Appreciate it.

Our next question comes from Matt Brooklier with Buckingham Research. Please go ahead.

Thanks and good morning. The $75 million in new orders that you talked to in the press release for first quarter is that inclusive of Signaling, I’m just want to get to what was, if your positive strength number for first quarter in terms of orders?

It’s just the new orders, so if you include whatever we booked in Train Control. We don’t break it out.

Yes, now the total.

So, Matt, it does PTC and Train Control system projects are in about $75 million, if that’s what you’re asking.

No, I’m just trying to figure out what’s pure PTC and then what’s Signaling? I know you’ve included – you include that in out together. I’m just trying to figure out, of the $75 million, what’s pure PTC orders versus some of that non-key Signaling work that you guys do?

Again, we don’t break it out. We do give you the revenues for both, we just haven’t break it out the backlog or the contracts for both.

Okay. And then I think I heard more numbers talked to in terms of the revenue that you booked in the quarter. Do you have standalone PTC revenue for the first quarter?

I’ll look for that. So ask your next question, I’ll look for that.

We can take that offline, if maybe. And then just finally, it sounds like, you’re more positive on the aftermarket portion of your business at Freight, you talk to that a couple of times through the conference call and I think part of that has to do with this directional pickup in the locomotive market. Could you maybe talk to your OEM business that the new order side and delivery side of it, if you think that potentially – this pickup in locomotive activity, that sounds like it’s hitting your aftermarket portion of your business? Could it potentially also result in maybe better industry delivery this year and maybe the timing around that, if that’s the case?

Yes, I think the OEM business will come later in the year, Matt. What we’re seeing right now that the OEM business from the improved OEM locomotive orders. On the OEM side for Freight, that business is relatively short-term, three to six months turnaround. So that business is coming now and part of the revenue stream that we are seeing now. But to give you an example, some of the types of businesses, and you have to remember in terms of capital budgets Class 1s have committed to basically hold flat their capital budgets year-on-year. So they’re putting more money into other parts of their systems because they don’t have to spend as much on PTC. Some of that is showing up in rolling stock, some of that is showing up in maintenance away, both of which we get. But on the aftermarket side, there’s customers have setup increased their overhaul programs for overhaul locomotives from one customer, I won’t name the customer, but from one program change from a request of 100 to 200 this year, overhauls, that’s – a lot of that is drop in business. For us, there’s another customer that’s converting DC to AC power for 100 locomotives. These are all business opportunities that are improving conditions over the last year.

Hey, Matt, this is Tim again. So the first quarter revenues for PTC was $59 million, Signaling was $32 million, for a total of $91 million.

Okay. That’s great. That’s all I have. Thanks.

Our next question comes from Saree Boroditsky with Deutsche Bank. Please go ahead.

Good morning, I appreciate on PTC. I was wondering if you can help us understand the breakout of overall revenues this year in Transit and Freight?

Yes, we don’t give the specific breakdown for Train Control and Signaling by the two segments. Historically, a majority of it has been in Freight. That’s been a lengthy shifting, a little bit more – the mix might be shifting a little bit to Transit as some of the project work with Transit agencies, but we don’t give a specific breakout.

Okay. And then just to confirm, I believe I heard previously, debt-to-EBITDA, 2 to 2.5 times to maintain the investment grade. Is that how you’re still thinking about the leverage target?

Yes, I think our long-term view of our leverage is that we should be in that 2 to 2.5 times. Clearly, it’s part of the Faiveley acquisition, where we talked about this with our rating agencies, there was a plan for deleveraging over time, and they’re fully aware of our financial policy and our goal of getting there. We expect to be investment-grade company, and maintaining that investment grade rating, and that leverage ratio is a big part of that long-term building.

Our next question comes from Mike Baudendistel with Stifel. Please go ahead.

Just wanted to ask you, on the components that you’re selling to locomotive manufacturers all over the world, if you view the North American Freight locomotive manufacturers as being competitive with others in other parts of the world that specialize in either transit, locomotives or locomotives for other geographies?

No, Michael, they’re very different. GE is definitely competitive in all Freight applications so markets around the world, they are the same, but they’re not competing for typical European, passenger locomotives, Siemens, Bombardier all some compete for that business. So their core business is really focused on same.

Got it. It makes sense. And just add on to that, are you selling the same or similar components to all of those locomotive OEMs, or are those different product lines that you’re selling to those different segments?

It’s different. You’re familiar with the components that we sell for Freight here, the compressor, the brake systems, electronics, heat exchangers, I’ll let Stephane talk about the European locomotive dealers.

It’s a very, very different than some of the European dealers are supplying locomotives, which are for electrified networks. The technology is not the same standard as in the North America. So they are very different. So the other CD front that we supply actually most of the year (58:49) and in most geographies, majority in Europe or in China.

Our next question comes from Steve Barger with KeyBanc Capital. Please go ahead.

Hey good morning. Nice year-over-year swing in operating cash flow. Can you tell us if we generate positive cash flow and both Freight and Transit this quarter and would you expect growth will be positive in each quarter this year?

Yes. We actually – because the operations are so intertwined, we really don’t kind of break it out in Transit versus Freight. It just would be – first of all, when I said, it would be very difficult to do. I think all in all, we see is a good overall cash flow performance when you look at the prior quarter, it’s typical operations as we come out of the year-end in the first quarter and some other things, the timing of some of how our working capital involves. But our goal for the year is to exceed our net income.

Okay. In just longer-term thinking about free cash flow efficiency, conversion. Is there any structural reason why Wabtec can’t go back to the levels that it used to when prior to the Faiveley acquisition?

I don’t think so. Clearly, last year, with the acquisition, we became more international, more Transit and really created some challenges in the last year’s performance. But what you’ve seen now was three quarters in a row where we continue to improve. We’re very, very – we feel very good about our quarter-over-quarter cash from operations in performance, and we want to see that continue. Our goal remains the same, as I said, we haven’t changed our goal. That’s what we’re planning to do. It’s that of our cash from operations exceeded net income.

Got it, thanks. And one more quick one. I’m curious about electronics and signaling orders outside of the North American freight market. As you’re out in the market talking to customers, are you seeing more interest from new projects where you can get involved in project design early on? Or is this more of upgrading existing systems? And I’m just trying to get a sense for what type of customer is seeing in the value and the products, and how that’s evolving?

Yes, so we try to stay pretty close with that customers. I’m trying to understand their business for them and opportunities, certainly we want to get to a point where they have orders in their own order forecast. We’re trying to position ourselves to work with them as a partner, not just as a supplier. So that’s the – in the case of Transit, I mean, we work with customers two, three years ahead of the actual award of the contracts. So there’s long-term ongoing relationship with the freight car builders and the locomotive builders that facilitates that on the freight side also. So yes, we’re involved with our customers early on, and basically trying to work with them more in the partnership to integrate our equipment into their designs and their platforms.

Got it. Thanks.

Thank you.

Our next question comes from Jason Rodgers with Great Lakes Review. Please go ahead.

Yes. Do you expect FX to benefit sales at a similar rate as you saw in the first quarter, looking again to the second quarter and the second half?

Yes, I mean, we don’t unusually forecast FX. But I think if you just kind of look at the FX rates, obviously it’s – to the extent that you see them remain consistent, that’s the kind of impact you’ll see in consolidation.

And wonder if you can talk about, you’re saying the way of raw material price increases? And if your contract surcharges are fully offsetting those increases?

We’re definitely saying an impact, but it’s – so far, it’s been relatively small, minor impact to our earnings. What we do is, we get in with our contracts it the opportunity to reprice or apply an escalation to really offset those impacts to us.

And then finally, the accounts receivable was up year-over-year in sequentially a bit larger-than-normal increase for you. What was the reason for that?

Well, when you just look at the absolute dollars on the balance sheet, you have to factor in the – some of the impact of FX, especially, when you look at prior quarter, but all in all, it’s really related to the higher sales and the timing of how the sales hit in the quarter. So as we’re growing, we’re going to have to see some receivable growth and some inventory growth and some payable growth to offset that.

Okay, thank you.

Thanks, Jason.

Our next question comes from Liam Burke with B. Riley FBR. Please go ahead.

Thank you, good morning Ray.

Hi, Liam.

Ray, could you give us some sense of – both on an opportunity in competitive front how the Transit PTC is rolling out for Wabtec?

So I think, on the commuter side, again, we’re in a soul source position, but what we’ve been able to do is improve our overall product offerings and capability to be able to participate at a turnkey level as a prime or as a sub-deal of prime. So we’re not only able to deliver the onboard PTC, we’re delivering a lot of subsystems and, in some cases, the entire project management and integrated system. So you have places like Greenfields, like TEX Rail as an example, what we’re participating in that position that we’re delivering the overall signaling system. And then separately, we have a contract to deliver to PTC. So we’re, I think, in a pretty good position in that market. There’s not a lot of people that are doing that, but, I think, we have the majority of those share.

And on the pricing side of the profit profile side, is it similar to freight?

Yes. It’s very similar.

Great. Thank you, Ray.

Thank you.

Our next question comes from Jay Van Sciver with Hedgeye. Please go ahead.

Great. Thank you for taking my question. I just wanted to follow-up on the materials cost component, if you could. Does that become at all a headwind in the year, as there’s a lag between the price changes and your cost as you incur them?

Yes. So we study it, and obviously, some more information will come later when we get into Q file. But what we’ve seen is that our material cost as a percentage of sales have not changed, and we’ve also measured the kind of on the outside through our sourcing team and a little bit that is impacting us, it’s definitely immaterial. It’s just not a big number. But what we think and expect to happen is that, similar to other years where we’ve had raising material cost due to commodities, that the programs and the protections that we have in place will continue to operate well. We have – obviously, we can reprice some of our shorter-term orders that come into our backlog in our shorter-term into sense that you when the order and deliver. The pricing can be adjusted to accommodate that. We have surcharge programs in for longer-term agreements with our customers, and finally, we have escalations provisions in our long-term Transit projects. So all these things are in place to protect us from the impact of any kind of commodities like.

Just on SG&A as a percentage of sales there’s little bit higher than we would have expected. How do you think of that cadence throughout the year?

So when we look at our SG&A I think in our prepared remarks, we talked about a run rate of $140 million to $145 million. It’s higher from a quarter a year ago because of acquisition, because of the FX impact on our – especially our European operations, and we definitely have some discrete items that were lower a year ago and some discrete items that came in as especially on the professional fee area related to some cost we incurred in the Tax Reform Act bill that was passed. So all in all, I think, you definitely see a big – an increase compared to 2017 first quarter, both when we look and study it on a run-rate basis, we’re probably in that – we feel very good about that $140 million to $145 million as a go forward.

Thank you.

Sure. This concludes our question-and-answer session. I’d like to turn the conference back over to Tim Wesley for any closing remarks.

Okay. Thanks guys. We will talk to you again at our second quarter. Oh, see you at the Investor Conference. Bye-bye. Thank you.

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.