Westinghouse Air Brake Technologies Corporation
Q3 2016 Earnings Call Transcript

Published: 25 Oct 2016

[Operator:]

Good day and welcome to the Wabtec Third Quarter 2016 Earnings Release Conference Call. Please note this event is being recorded. I would now like to turn the conference over to Mr. Tim Wesley, Vice President of Investor Relations. Mr. Wesley, the floor is yours, sir.

[Timothy R. Wesley:]

Thanks, Mike. Good morning everybody. Welcome to our third quarter 2015 earnings call. Let me introduce the others here in the room with me, Al Neupaver, Executive Chairman; Ray Betler; President and CEO; our CFO, Pat Dugan; and John Mastalerz, our Corporate Controller. We will first make our prepared remarks, then we will take your questions. And, of course, during the call, we will make forward-looking statements. So, we ask that you please review today's press release for the appropriate disclaimers. Al?

[Albert J. Neupaver:]

Thanks, Tim. Good morning, everyone. In market conditions that continue to be very challenging, we had a good operating performance in the third quarter, with an EPS of $0.91. Excluding $0.03 per share of expenses related to our pending acquisition of Faiveley Transport, EPS would have been $0.94. Despite a revenue drop of 17%, we recorded an operating margin of 17.8%. Excluding those Faiveley costs, our margin would have been 18.3%. This performance resulted mainly from our cost-cutting actions and improved profitability in the Transit Group. As we've said before, we believe our diversified business model combined with an aggressive approach to reducing costs gives us the ability to manage through these cycles better than most. Full-year earnings per share are now expected to be between $4.00 to $4.04, which is at the lower end of our previous guidance. Revenues are now expected to be down about 12% for the year. This guidance does not include costs for any further restructuring activity or expenses related to our pending acquisition of Faiveley Transport. Clearly, we are operating in a challenging environment which means we have to focus on controlling what we can, being disciplined when it comes to costs and being focused on generating cash to invest in growth opportunities. The Faiveley update. We continue to make progress on our planned acquisition of Faiveley Transport, a leading global provider of value-added integrated systems and services for the railway industry, with annual sales of about $1.2 billion. We expect to complete the purchase of Faiveley family stake in November, subject to receiving final regulatory approvals. After that, we begin a tender offer for the remaining public shares. Given the lengthy regulatory process, we had to extend the deadline in the purchase agreements and also modified the terms slightly. The family now has the option of taking between 25% to 45% of their consideration in cash, with the rest in Wabtec common stock. Based on that option, the family could take between 4.8 million and 6.3 million shares in common stock. Faiveley's remaining public shareholders can elect to take 100% of their consideration in cash or a portion in Wabtec common shares, capped at the same percentage chosen by the family. Unlike in the original deal, no Wabtec preferred shares will be issued. So, the deal in our capital structure has been simplified. The modified deal reflects the reality that the economics have changed over the last 18 months, so we took a balanced approach in coming to these terms. Faiveley has the most compelling strategic rationale of any acquisition that we've ever completed. Our assessment has been reinforced as the process evolved over the last 18 months. Faiveley's most recent full year results included sales growth of about 5% and improved operating margin and a record backlog. The company has a rich tradition of innovation and excellence in the rail industry, with products such as doors, pantographs and HVAC equipment. This also gives us a chance to recombine the original WABCO Rail Brake divisions. As a result, we will be one of the world's largest public rail equipment companies, with total revenues of more than $4 billion in a worldwide freight rail and passenger transit industry. The combination further diversifies our business model, it extends our product and service capabilities, and enhances our technology and innovation initiatives, and expands our relationship with blue chip global customers. We will benefit from a complementary geographic presence, products and engineering activities. Finally, we expect to drive long-term annual synergies of at least €40 million to be achieved through enhanced revenue growth, supply chain efficiencies, operational efficiencies and cost savings, and by leveraging our SG&A capabilities. Ray, can you take it over and talk about our current market and growth opportunities?

[Raymond T. Betler:]

Sure. Thanks, Al. Want to talk first about freight rail. Freight markets continue to be very challenging. We don't see much, if any, improvement in the short term. In NAFTA, freight rail traffic is down almost 7% in the first nine months of the year. Increases in almost all commodities in intermodal have been seen and traffic comparisons may start to get easier later in this year. But that doesn't mean actual traffic will improve, so we will continue to monitor the trends very closely. As a result of traffic decline, we lowered our NAFTA assumptions for freight cars and locomotives to about 60,000 and locomotives about 900. Along with the decrease in traffic, these factors represent a headwind of about $200 million in revenues compared to the year 2015. Freight traffic in some of our global markets is also a challenge, especially in heavy haul mining countries. Some of these headwinds could represent secular changes in our markets and some may be recessionary. Either way, we have reacted and will continue to react to these changes. Despite the current challenges, we believe the freight car market around the world will continue to grow over time, which is why we continue to increase our global footprint and our product offerings beyond our traditional NAFTA market. Let's talk about transit. Our transit markets remain stable, both in U.S. and abroad. Ridership is up slightly in the U.S., in the UK and down slightly in Canada. This year, we're expecting North American transit car deliveries to be slightly upward, bus deliveries about the same as last year. Transit funding in the U.S. is projected to grow again next year, thanks to federal government's multiyear transportation bill, which includes funding for positive train control. Due in part to this increased funding, we are seeing increased bidding activity for new projects that we expect will turn into orders over the next several years. Reflecting some of this activity, our transit backlog has been near record high with active projects in the U.S. and internationally. The financial performance of our Transit segment has also been good this year, with increasing sales and profitability. In part, this performance has been driven by ongoing margin improvements at Fandstan using principles of the Wabtec Performance System. Of course, we are applying these same principles in the integration of Faiveley. As for the overall transit market, remember, just as the freight market, we are focused on global growth and increasing our product offerings because international markets are much larger than NAFTA, and our international efforts will be strengthened through the Faiveley portfolio, their products and their capabilities. Let's turn to PTC and signaling. PTC and signaling remains an important part of our long-term growth opportunities, although it's part of the reason why our Freight revenues are down this year. As you know, our customers are working hard to implement PTC, but decreases in freight rail traffic have caused the railroads to reduce their CapEx budgets for both infrastructure spend and rolling stock. In addition, the deadline extension to at least 2018 has resulted in their spending plans. As a result of these factors, we're seeing lower revenues from PTC-related equipment and PTC services, mainly in the Freight Group. We expect a decrease of about 25% for the year. Long term, we expect PTC and spending will be a growth business for Wabtec, and we continue to invest in building the aftermarket for products and services. We have signed a couple maintenance agreements for service and we are working on many more. In addition to these multiyear agreements, we continue to work with our customers to develop additional features to the base PTC system and we're exploring international opportunities. Cost reductions. Before I discuss our growth initiative, I'd like to talk about our cost reduction programs, which have enabled us to maintain good margin performance despite a significant drop in sales. In this case, we have taken the following actions to control our costs. We have reduced total plant employment by more than 10% since the beginning of the year, with another 3% reduction in third quarter this year alone. We will continue to adjust our head count as necessary going forward. We made further cuts in discretionary spending at both corporate and our individual business units, and we've stepped up our efforts in the WPS, Wabtec Performance System area, which includes lean, supply management and quality initiatives. Due in part to these and other initiatives, our Transit Group profitability has improved this year, and we're driving further improvement over time. We continue to focus on growth and cash generation. Year-to-date, we have generated $247 million of cash flow from operations compared to net income of $267 million, which is pretty good performance, and we will continue our focus in the fourth quarter. Our priorities for allocating free cash have not changed, to fund internal growth programs, including product development and CapEx; to fund acquisitions, we've had ample opportunities to deploy capital in this area; to return money to shareholders through a combination of dividends and stock buybacks. At our annual meeting in May, we increased our dividend for the sixth straight year, and we have about $138 million left on our $350 million buyback authorization. We remain focused on increasing free cash flow by managing costs, driving down working capital and controlling capital expenditures. And our growth strategies remain the same, global and market expansion, aftermarket expansion, new products and technologies and acquisitions. So, let's talk about our progress in some of these areas. In the area of growth, global and market expansion. For this quarter, sales outside the U.S. were $366 million. In China, we received current collector orders for third rail current collectors from Wuhan Metro. We've received orders for brake components for freight cars and turnkeys, and we've received projects and are working to support those projects in India and South Africa associated with locomotives. Those projects will continue to ramp up further this year and next. In the aftermarket expansion area, aftermarket sales for the quarter were $380 million. We were selected for transit overhaul projects in the UK, and as I mentioned, we've signed a couple of maintenance and service agreements in the area of train control. And on new products, we have many internal development projects under way. A new plant in China for intercoolers for the power generation market, next-generation sintered pad production for high-speed rail, and bogie brake equipment for South African market. In the area of acquisitions, our pipeline continues to be active, and we're pleased with the opportunities we're reviewing. During the third quarter, we announced the acquisition of the Gerken Group, a leading manufacturer of specialty carbon and graphite products for rail and other industrial applications. The company has annual sales of about US$40 million and is part of our Transit Group. Gerken was founded 80 years ago, manufactures a variety of carbon brushes and strips, graphite and related products used in the railway traction area in power generation and other industrial markets. The company's sales are primarily in the aftermarket and are primarily outside of North America. Gerken's range of specialty products expands our capabilities with existing customers into new markets. It will be a good strategic fit with other Wabtec businesses such as Fandstan, Fulmer and our friction businesses. Pat, can you talk about some of the financial details for the third quarter?

[Patrick D. Dugan:]

Sure. Thanks, Ray. Sales for the third quarter were about $676 million, which is about 17% lower than last year's quarter. This decrease was mostly due to the difficult market conditions in our Freight segment. Freight sales did decrease 29%. That is made up of lower organic sales from PTC, from the freight OE and aftermarket and other areas. That amounts to about $156 million decline. It's also affected by negative FX, about $2 million, but it's offset somewhat by acquisitions, which contributed $13 million of sales. Our Transit segment sales increased 4%. Organic sales grew by about $26 million, acquisitions a small, about $2 million, but that was affected by negative impact of FX, about $16 million. So, for the full year, we expect our Transit segment sales to grow and Freight to be down, mainly due to reduced revenues from train control-related equipment and services, lower than expected rail traffic volumes and lower industry deliveries of new freight cars and locomotives. Our operating income for the quarter was $120 million, which is about 17.8% of sales. Our SG&A for the third quarter was about $71 million, which is $11 million lower than the year-ago quarter, mostly due to our cost reduction plans, lower costs due to our lower sales and some lower expenses for benefits and compensation. I also want to mention that included in the results for operating income is about $3.2 million of expenses related to the pending Faiveley acquisition, so our adjusted operating margin is 18.3%. Our engineering expense was only down slightly mostly due to absorption of engineering costs against projects. Our interest expense was $6 million, which is higher than the year-ago quarter, mostly due to our higher debt balance. There's some financing for the Faiveley acquisition that's reflected in that interest expense. Other expense/income, we had income of about $1.2 million in the quarter, mainly from non-cash, foreign currency translations. In the year-ago quarter, we had expense of about $2.9 million for the same reasons. Looking at our effective tax rate for the quarter, it was 28.5% versus 31.5% in the year-ago quarter. This reduction is primarily related to the profit mix of domestic versus international business. And as that mix has shifted to jurisdictions with lower tax rates, this results in an overall improvement in our tax expense. For this same reason, we are now assuming an effective tax rate of about 30% for the year compared to our initial assumption of about 32%. I just want to remind everybody that that's an annual forecast and quarters will vary due to any change in our annual estimated effective tax rate and the timing of any discrete items. EPS for the quarter, earnings per diluted share, were $0.91. And excluding the $0.03 per diluted share for the Faiveley-related expenses I mentioned earlier, we would have had EPS of about $0.94. As a reminder, through the first nine months of the year, our GAAP EPS was $2.92 and excluding about $0.12 per diluted share for the Faiveley-related expenses, we would have had EPS of about $3.04. Looking at our balance sheet, it remains strong and it provides the financial capacity and flexibility to invest in our growth opportunities. We have an investment grade credit rating and our goal is to continue to maintain that. Our working capital at September 30 included trade and unbilled receivables were about $624 million. Inventories were about $496 million and our payables were about $277 million. Cash on hand at September 30 was $250 million, and it's mostly held outside the U.S. It was $303 million at June 30. These balances do not include the $210 million we're currently holding in escrow related to the Faiveley transaction. During the quarter, just something to point out, during the quarter, we repurchased about 1.1 million shares of our common stock for about $78 million or about $71.5 per share. And I'll remind you, we have another $138 million remaining under our current authorization for stock buybacks. Our debt at September 30 was $820 million compared to $744 million at June 30. We generated $247 million in cash from operations for the first nine months of the year, which we think is a pretty good performance. For the year, we continue to expect to generate more cash from operations and net income. That is always our goal. Earlier this year, just something I want to point out, we signed a new bank agreement that includes a $1.2 billion revolving credit facility and a $400 million term loan. These new agreements provide most of the financing that we're going to need for the Faiveley acquisition and also provide capital for the continued investment of our growth initiatives, including any other acquisitions. So, just a couple items for your models. Our depreciation for the quarter was $11 million versus last year's quarter of $11 million. Amortization was $5.3 million versus $5.5 million a year ago. And our CapEx for the quarter was $12.6 million compared to $12.2 million a year ago. And we expect for the full year that our CapEx would be right around $50 million. Backlog information. At September 30, our multiyear backlog was $1.93 billion, which is slightly lower than the end of the second quarter. Transit consisted of about $1.4 billion and Freight was $537 million. Our rolling 12-month backlog, which is a subset of the multiyear backlog, was about $1.2 billion, also slightly down from the second quarter; Transit, $750 million, and Freight was about $420 million of that 12-month backlog. The total backlog figures do not include about $150 million of pending orders and contract options. We do not include them or count them in the backlog until the customer exercises those and makes those commitments. And with that, I'll turn it back over to Al.

[Albert J. Neupaver:]

Thanks a lot, Pat. Once again, we had a good operating performance in the third quarter, and we're pleased with our margin performance. We continue to face challenging market conditions. So, we updated our financial guidance for the year of EPS now expected to be between $4.00 and $4.04, and revenue is expected to be down about 12%. In this environment, we will stay focused on what we can control, managing our cost and generating cash. We are pleased with our strategic progress and the long-term growth opportunities we see, especially with the expected closing of the Faiveley Transport acquisition. With that, we'll be happy to answer your questions.

[Operator:]

Thank you, sir. We will now begin the question-and-answer session. The first question we have comes from Kristine Kubacki of CLSA. Please go ahead.

[Kristine Kubacki:]

Hey. Good morning.

[Albert J. Neupaver:]

Good morning and welcome back.

[Raymond T. Betler:]

Hi.

[Kristine Kubacki:]

Thank you. Just a question about the aftermarket. You talked about it not – at least I inferred from your comments about it – it not getting a whole lot better. But we've seen carloading growth sequentially kind of tick up. Are you seeing any trends that would suggest that it sounds like some of the lessors are pushing cars out and we're seeing utilization tick up. So, are you seeing any sequential trends that would give us hope that things have bottomed on the aftermarket side?

[Albert J. Neupaver:]

I think that if you looked at traditional aftermarket, I think you're probably correct, Kristine. I think that the volumes kind of have bottomed out and you're seeing some improvement. But I remind you that the PTC sales that we had were in the aftermarket, which kind of caused us a little variation there for us. And those particular aftermarket sales are off. I think for the quarter, we're down to like $55 million in absolute PTC sales, and if you look at year-to-date, that puts us at around $200 million. Our forecast for the year, we talked about PTC and related signaling business being off about 25%. So, I think that's why we're seeing a little more pressure on the aftermarket than you would expect from the statistics that we all see.

[Kristine Kubacki:]

Okay. And going forward then, I mean, as we're looking at the deadline coming in 2018, do you expect then that we'll see the reacceleration in PTC activity as we move into 2017?

[Albert J. Neupaver:]

Yeah. I think as we go into 2017 and 2018, we expect that the spending will increase in that area. Give you an idea what work needs to be done, the last report we saw, it said only 30-some percent – 34% of the freight locomotives were fully equipped. In the Transit, it's less than that, like 29%. Training is only 40%. Radio and tires and signals are a higher percentage, but there's still a lot of work to be done. The spend so far is about $6 billion and the Class 1s had expected to spend near $10 billion. So, there's still a lot of work to be done. And as that work continues, we expect our revenues to come back. In transit, there's even less work than accomplished. It's only about one-third of spend they estimate to be at $3.5 billion. So, I think a lot of people took a look at – had the chance to reassess their deployment of their capital and where and what needed to be done. And I think that, all in all, we should see that grow as we go forward. I think it will be a positive thing for us in 2017 and 2018.

[Kristine Kubacki:]

I appreciate the color. Thank you.

[Albert J. Neupaver:]

Thank you.

[Operator:]

Next, we have Saree Boroditsky of Deutsche Bank.

[Saree Boroditsky:]

Hi. Thank you. So just following up on the aftermarket question, could you provide color on aftermarket, excluding positive train control, and just how that revenue should trail trade volumes?

[Albert J. Neupaver:]

I don't have that in my – I don't have it available right now. We could get that for you. Maybe, Ray, do you have...

[Raymond T. Betler:]

So, just to talk about it in terms of scope and services. So outside of train control area, our aftermarket obviously addresses the services business which, as Kristine pointed out, looks like maybe it bottomed out and is starting to come up with rail traffic in some areas, like grain picking up. But heavy haul commodities, like coal and things like that, we don't expect to recover, at least not significantly. That's a big aftermarket revenue generator for us. So, it's a mixed bag in the traditional service area as a result of traffic. We do have overhaul business in the aftermarket area. Some overhauls might have been canceled or delayed, and we're starting to see some come back now in the market for bid. So, I think, in 2017 and 2018, there may be some after haul opportunities associated with locomotives that we'll be able to hopefully bid and capture. That type of business is also mixed in our aftermarket area. Obviously, friction is a big area for us. We're not seeing a lot of improvement in the friction area at this time. So, it's really a mixed bag.

[Albert J. Neupaver:]

Yeah. In absolute numbers, I do have the numbers. If you look at PTC, I think it went down close to $30 million quarter-on-quarter, and the aftermarket went down $50 million. So, that would give you a little bit of the idea of the absolute numbers.

[Saree Boroditsky:]

Thank you. That's really helpful. And then, just one more. It seemed like a lot of your underlying assumptions didn't change on your outlook. So, could you provide us some color on what really drove your lower guidance?

[Albert J. Neupaver:]

The lower guidance, I think if you take a look at what we actually had in the second quarter as far as performance, and then we took a look at what we think we could do in the fourth quarter, obviously we're going to have an improvement in the fourth quarter. There is seasonality in the third quarter that I think a lot of people really didn't account for. And when you look at our guidance, the things that I think are causing us concerns is obviously the freight car build continues to decline, as does the locomotive from our original assumptions. We're still unable to really predict when the PTC spending will be reversed. And that's been the hardest thing for us to try to estimate going forward is what that spend is going to be in that particular area. We've also continued to have FX headwind that we're working toward. And I think that we have stated and we just discussed that volume has somewhat leveled off. But you add all those factors together and you realize it's a very challenging marketplace, at least for the next quarter.

[Saree Boroditsky:]

Okay. Thanks. That's helpful. Thanks for answering my questions. I'll get back in queue.

[Albert J. Neupaver:]

Okay.

[Operator:]

Next, we have Scott Group of Wolfe Research.

[Scott H. Group:]

Hey. Thanks. Morning, guys.

[Albert J. Neupaver:]

Good morning, Scott.

[Scott H. Group:]

Hey, morning. So, just wanted to follow up on that last point, Al. So, if I'm doing the math right on PTC down call it 25% for the year, I think that implies like that fourth quarter PTC sales go almost double to like $95 million from the $55 million in the third quarter. Am I doing that math right? And if that's right, what's driving that big sequential uptick?

[Albert J. Neupaver:]

Yeah. The 25% is PTC plus related signaling, okay. It's not just PTC, all right. So, if you look, yeah, I think that's the big difference. So we do expect some signaling business to pick up in the fourth quarter. There are some projects that should allow us to pick up business there. As far as the PTC revenue itself, I don't think we're anticipating there's going to be any major change. It's really going to be in the signaling and the related equipment.

[Scott H. Group:]

And how big is the signaling business right now, ex-PTC?

[Albert J. Neupaver:]

It's about, the signaling business adds close to $100 million in revenue.

[Scott H. Group:]

Okay. Okay.

[Albert J. Neupaver:]

And so, that's why we started talking about it. It's become a major portion of our business and will continue to grow. And a lot of the things that are involved with that is signaling design that's related to PTC. There is also related projects in transit. You also see a lot of work in that particular, where train control, design, systems and implementation and construction. Those are some of the auxiliary businesses that we were able to acquire over the last couple years that really adds to our total signaling business.

[Scott H. Group:]

Okay. That makes sense. And then, just on the Faiveley deal, you mentioned that you had to change the structure because, I don't know if you said the economics have changed or something has changed. Can you just give a little color on what's changed and why the move from preferred to common stock in the split of cash versus stock?

[Albert J. Neupaver:]

Okay. Let's start at the top. I mean, the original deal was set to expire later this week. So, we elected to put in place in an extension that allows us a little additional time to complete some various pre-closing requirements. As we said in the release, right now, we expect the acquisition to close in November. The deal that we struck reflects the reality of the economics of the original transaction have changed, and with the Faiveley family receiving less value due to the decrease in our stock price. So, we negotiated the original deal. And in the modified deal, we addressed as many issues as we can that come up over a long period of time. I mean, this has been 18 months since we struck the deal. And one of the things that was important to us is to simplify the mechanics of the transaction by eliminating the preferred stock, and therefore a preferred dividend. What we've tried to do, and I think we said this in the text, was we tried to get a fair, balanced approach to what the deal was and what the deal is. And I think if you look at decreasing stock and the FX changes, there was probably $60 million to $70 million difference in the actual purchase price, and we negotiated something that we feel is fair for the Faiveley as well as the Wabtec team and simplified the deal as best we can. And it was about a 50-50 type approach on the actual value numbers.

[Scott H. Group:]

Okay. That makes sense. And just last thing on...

[Albert J. Neupaver:]

Go ahead. I'm sorry.

[Scott H. Group:]

Yeah. Last thing on the Faiveley deal. So, can you just walk us through the mechanics of, if the Faiveley, the family – the 51% of the deal closes in November, how do we put that into our models for the fourth quarter, and are you assuming – what's kind of the amount of revenue and earnings you're assuming in the fourth quarter guidance? And maybe just, I know it's a long question, but anything, any color you can give us on amortization costs and integration costs.

[Albert J. Neupaver:]

We could tell you there's nothing in the guidance related to the Faiveley cost or revenue or profit. We will not be able to give you total color until about five days in advance, and that's when they have to notify us what percentage they want between the 25% and 45% cash. At that point, when we do close, our intent is to have a conference call and we would, at that point, try to provide color for the rest of the quarter, and some future-looking reviews. We won't provide guidance of 2017, but we'll definitely give you some directional stuff.

[Scott H. Group:]

Makes sense. Okay. Thank you, guys.

[Albert J. Neupaver:]

Okay.

[Operator:]

Next, we have Allison Poliniak of Wells Fargo.

[Allison A. Poliniak-Cusic:]

Hi, guys. Good morning.

[Albert J. Neupaver:]

Good morning.

[Raymond T. Betler:]

Allison.

[Allison A. Poliniak-Cusic:]

Could you guys talk a little bit about your potential visibility for positive train control? Just trying to get a sense of when you guys would have your conversations with your customers, talking about 2017 plans, I would have to imagine visibility there is a little longer than a traditional aftermarket product.

[Albert J. Neupaver:]

It's hard to predict right now for us. The visibility is not very good, and that's one of the reasons why we've really struggled the last two quarters in trying to get a forecast out there. Projects keep getting pushed out, whether they're transit PTC-related projects or just the spend by the Class 1s. We know what needs done to complete the implementation. We also know what other enhancements we're going to be able to provide. We do have good visibility on the technical support and MSAs. As Ray said, the service agreements, we have a couple of them signed, and we're working on some others that will give us a lot more certainty on what the forecast and our revenue is. But right now, it has been difficult. I think that it should clear up later in the year, early next year, and we should have a pretty good estimate going forward. But right now, it's hard to predict quarter-to-quarter because of project delays and the spending is just not being done in this particular area.

[Allison A. Poliniak-Cusic:]

Understood. And then on the Freight side, Ray, you highlighted the U.S. and some of your traditional global markets being challenged, and it's likely that they're probably going to be challenged for some time, but you also mentioned some opportunities. Can you maybe give us some color on other global opportunities in freight that could serve as an offset to this?

[Raymond T. Betler:]

Again, it's a mixed bag, Allison. In some countries, there's good opportunities, like India as you know, we won a large order for freight locomotives in India. We're in the process of localizing that work. We're investing in facilities there and we're building our resources and project team there. So, that's a very positive market for us. We're seeing some improvement in Australia. We still are delivering locomotive and freight industry equipment in South Africa. Brazil is slow but we do have an order for new bogie brake mounted equipment in Brazil. In Russia, they've announced that they want to retire all freight vehicles that are 30 years old or more, which is a positive sign for us. So, it's not – I wouldn't call it robust, the international opportunities, but there are some positive international opportunities that we're engaged in.

[Allison A. Poliniak-Cusic:]

Great. Thanks so much.

[Raymond T. Betler:]

Thank you.

[Operator:]

Jason Rodgers, Great Lakes Review.

[Jason A. Rodgers:]

Hello, guys.

[Albert J. Neupaver:]

Hey.

[Jason A. Rodgers:]

If you could provide your expectations for the Transit side of things to meet your guidance in the fourth quarter, just in terms of projects?

[Raymond T. Betler:]

So on the Transit side, we have a record backlog in Transit, Jason. And on the Transit side, we've won major order in North America this year. We continue to pick up small orders around the world. We have very strong business in Fandstan, that's power collection, mainly. We're getting ready to bid on the next two large orders in the North American market, the largest of which will be the next order in New York City. So, on the transit side, it's very positive. We just won a large overhaul order, another one in the UK. We have a very good market share in the UK Transit side, on the overhaul business. So, both on the OEM, in the overhaul side, transit's a very positive trend for us.

[Jason A. Rodgers:]

And just one more follow-up on PTC. What would be the penalty for railroads not meeting the PTC deadline? Because I noticed a few railroads aren't expected to have that implemented until 2020?

[Raymond T. Betler:]

Yeah. I think as far as the penalties, they haven't been explicitly defined by the government. I mean, if you – there was a deadline in 2015 and the penalties from that were an extension to 2018. So, I can't predict what the government position will be when that time comes. But what I can tell you is that our customers are working hard to implement. I recently visited UP. I'm heavily engaged with all of our Class 1 railroads, and they're working hard on the implementation, as Al said, they have cut back significantly their CapEx. They're trying to balance their pros and cons in terms of expenditures and value, just like we are in a tough market.

[Jason A. Rodgers:]

And then finally, I wonder if you could just talk about the performance in the quarter outside of the rail markets.

[Raymond T. Betler:]

So, again, it's a mixed bag, Jason. The oil and gas hasn't improved, as you know, but we do have some other business. We have business associated with power generation and power distribution. We're building a plant in China, we spoke about that before, to deliver new equipment in the power generation area, that's thermal equipment. We have a nice array of business in areas like porch for railing systems, festoon systems with Fandstan. We have some commodity business that generates from things like our rubber business. So, it's again, I would say, it's not robust and there are certainly pressures on the oil and gas side that haven't recovered, but we do have some positive movement in the industrial side.

[Jason A. Rodgers:]

Thank you.

[Albert J. Neupaver:]

Thank you.

[Operator:]

Next is Justin Long of Stephens.

[Justin Long:]

Thanks and good morning, guys.

[Albert J. Neupaver:]

Good morning, Justin.

[Justin Long:]

Wanted to ask another one on Faiveley. Given the revised terms for the deal, have your expectations for accretion changed materially? And secondly, do you have an updated expectation for what pro forma leverage will look like after the deal?

[Albert J. Neupaver:]

Okay. I'll take the first one and Pat could take the second one. As we said in the text, as we've gone through this process over the 18th month, we've been nothing but happy with what we're seeing. We're very pleased with their progress and we're excited about the opportunities and, hopefully, we could provide a lot more color about that when we have our call after the close.

[Patrick D. Dugan:]

Okay.

[Justin Long:]

Fair enough.

[Patrick D. Dugan:]

So in terms of – sorry.

[Justin Long:]

Yeah. Go ahead on the leverage.

[Patrick D. Dugan:]

Right. So we modeled this a couple different ways. I mean, the Faiveley family – read the press release there – has some options and can elect a range of cash versus stock. So, if you just assume the most conservative view, that they take the most cash that they can, we'll have a leverage ratio that will be approaching 3 times, which is a little bit higher than what we had originally said, but well within a comfort range that I think makes sense, especially considering the aggressive and important deleveraging program that we'll have as we get the companies combined, drive the results of the two companies and generate cash.

[Justin Long:]

Okay. Great. That's helpful. And then, you mentioned a couple of times that you've won some maintenance agreements for PTC. And I was wondering if you could provide any more color on that in terms of the size and/or length of these deals, and any clarity on when we could start seeing a revenue contribution from those agreements.

[Raymond T. Betler:]

So, Justin, I would tell you this, the length of the agreements vary three to five years. That's about the timeframe that we're negotiating. The agreements are coming in from the Class 1s, as well as, I think we mentioned MRS in the past. So, we're in a process of negotiating with all the Class 1 railroads. We've closed a couple. I don't want to mention them by name, but we believe that by the end of this year, we'll have closed the ones for North America – or for the U.S. I'm not so sure about the Canadians, but at least for the Class 1s in the U.S.

[Justin Long:]

Okay. Great. And when do you think we can start to see revenue from those deals materialize? Is it a 2017 event?

[Raymond T. Betler:]

We have some revenue already that we're booking and it will accelerate in 2017, yes.

[Justin Long:]

Okay. That's helpful. And then last question was on signaling. I wanted to clarify, I think, Al, you mentioned $100 million in signaling revenue. Was that a number for the third quarter? If not -

[Albert J. Neupaver:]

No. That's an annual number, Justin.

[Justin Long:]

Can you provide maybe what the signaling revenue was or, I guess, you've been providing the train control and signaling revenue number the last few quarters, what that was in the third quarter. And then secondly, any commentary that you can provide around the margin profile of that signaling business relative to PTC? Is it a similar margin or is there a gap between the two?

[Albert J. Neupaver:]

Okay. The PTC sales were about $55 million and the total train control, including the signaling, was about $80 million. So you had about, what is that, $25 million.

[Patrick D. Dugan:]

Yeah. In Q3.

[Albert J. Neupaver:]

Yeah. In Q3. As far as the margin, there's some of the businesses similar to the PTC. When you get into some of the construction business, it's less than the PTC average.

[Justin Long:]

Okay. That's very helpful. I appreciate the time.

[Albert J. Neupaver:]

Thank you.

[Operator:]

Next we have Matt Brooklier of Longbow Research.

[Matt S. Brooklier:]

Hey. Thanks. Good morning. So, wanted to circle back on PTC. Al, you mentioned you guys booked $55 million of total PTC revenue, and $80 million when you include the signaling component. How did that break out between the Freight and Transit divisions?

[Albert J. Neupaver:]

Yeah. Three quarters of it was related to Freight.

[Matt S. Brooklier:]

Okay.

[Albert J. Neupaver:]

And that was only a little bit international, and maybe 5% or so.

[Matt S. Brooklier:]

Okay. And then my other question relates to your guidance. If I look at what's implied for fourth quarter, it seems like it's a pretty sequential, a pretty big sequential step up. Historically, you've seen closer to kind of a low single-digit increase in terms of your earnings cycle. And the implied guidance, if I take the midpoint, is implying something closer to like a 10% increase. You mentioned there's some pickup, maybe, on the signaling side in terms of projects, but what else is moving the needle sequentially? Are there certain projects that start up in fourth quarter? Are you guys doing some incremental things on the cost savings side? I'm just trying to get my arms around that big jump from 3Q to 4Q.

[Raymond T. Betler:]

So, Matt, it's a combination of a lot of incremental things. So, we're continuing to address the cost side for sure, both in discretionary costs area as well as head count. We have a forecasting process in place that we're reviewing our forecast on a weekly basis. We have some improvement on the revenue side that we're anticipating that is obviously going to bring additional EBIT. So, it's a combination of a lot of incremental things. There's no one big step change third to fourth quarter.

[Matt S. Brooklier:]

Okay.

[Albert J. Neupaver:]

And we also, we see a pretty good increase in revenue in the Transit area.

[Matt S. Brooklier:]

Okay.

[Albert J. Neupaver:]

Some of which is PTC project related possibly.

[Matt S. Brooklier:]

And then, what are your expectations for Faiveley deal costs in fourth quarter? I think deal costs been running at about $3 million the past couple of quarters.

[Albert J. Neupaver:]

They're not included. They're not included at all.

[Matt S. Brooklier:]

Okay. They're not included in the guide, but I guess are you able to talk to what the potential magnitude of the costs would be?

[Albert J. Neupaver:]

Well, the only thing is, is when we close in November, there's a lot of expenses related to that, success fees, banker fees, financing fees and everything else. So, we'll have a lot of moving parts when we get to talk to you.

[Matt S. Brooklier:]

Okay. So, it sounds like it's a bigger number than what we saw in 3Q is the message.

[Albert J. Neupaver:]

I don't know. Yeah. If you look at it today and with banker fees and the investment banking fees, yeah, it will be larger.

[Matt S. Brooklier:]

Okay. Appreciate the time.

[Albert J. Neupaver:]

Thank you.

[Operator:]

Next, we have Liam Burke of Wunderlich.

[Liam D. Burke:]

Thank you. Good morning, Ray. Good morning, Al.

[Albert J. Neupaver:]

Good morning.

[Liam D. Burke:]

Ray, with the rough freight market this year, do you see additional opportunities to further consolidate the market or receive better pricing on potential acquisitions?

[Raymond T. Betler:]

There's a lot of small and weak suppliers that are falling out, that's for sure. I don't think we're going to see any major consolidation, though, in the market, Liam.

[Liam D. Burke:]

Okay. And on the signaling side, you talked about $100 million in annual revenue. It's a much, much larger market than that. How do you see a ramp-up? Are you going to need acquisitions to supplement your growth, or do you see enough opportunities with your base of business to continue to get where you need to go?

[Raymond T. Betler:]

I think we need to do both organic development and acquisitions. You're talking about a $12 billion market-plus, and the opportunities are pretty broad if you look across a total signaling market worldwide, and are broad in terms of your definition, then you're talking about a $22 billion market across ERTMS, the European train management system, traditional mass transit signaling system, things like that. So, we're trying to locate niche opportunities. We're trying to leverage our capabilities that exist now. For instance, some of that non-PTC related revenue Al talked about is in the control systems area, where we could expand our central control and office products. We could expand our diagnostics. We have a data analytics system called Wabtec-1 that we're putting in place. We are looking at improving the vitality of our systems, so going from non-vital to vital systems. So, there's a lot of areas that we can continue extensions of our existing technology, and then acquire businesses. But you kind of have two choices in the signaling area, either you go big bang and you acquire a billion-dollar signaling organization, it is full-fledged signaling across all market areas; or you do it in small incremental steps. And we kind of are pursuing the latter.

[Liam D. Burke:]

Great. Thank you, Ray.

[Albert J. Neupaver:]

Thank you.

[Operator:]

Steve Barger of KeyBanc Capital Markets.

[Steve Barger:]

Thanks. Good morning.

[Albert J. Neupaver:]

Good morning, Steve.

[Steve Barger:]

Just another 4Q question. Really great performance on the SG&A line in 3Q. Is that a reasonable run rate for 4Q? And how should we think about run rate going into the first part of next year?

[Patrick D. Dugan:]

Yeah. I think in terms of run rate, I think about $75 million would be the right number there. There are definitely some items that are in there that are discrete, that were to our favor, but $70 million to $75 million is probably the right number going forward.

[Steve Barger:]

Okay.

[Albert J. Neupaver:]

Next year, we're going to have to re-base.

[Patrick D. Dugan:]

Yeah, next year, we're going to have to re-baseline with the Faiveley acquisition, but our portion of that, I guess, would be that would be the run rate.

[Steve Barger:]

Yeah. I'm just trying to get a sense for kind of what your stand-alone profitability will be next year or cost level, and then we can talk about Faiveley in November. 2015 operating margin was 18.5%. You'll probably come in around the same level this year, even with a 12% revenue decline. Not trying to get too specific on next year, but if we do look at stand-alone WAB and you assume a continuation of freight declines and an improving transit market, do you think you could maintain that margin with that mix if overall revenue comes down a bit?

[Albert J. Neupaver:]

If you look at what we've been able to do today and the drastic changes, next year, as we see it, there should be some benefits of that restructuring and cost-cutting actions. I think that we've been able to improve. I think Ray mentioned this in his talk, we actually improved our Transit margins nicely throughout the year. And I think by doing that, we've offset the mix effect of a lower-margin business. So, I think that we should be able to continue that trend into the future. And you're right. I mean, there are some negatives that will continue into next year, and that's the car build and possibly the locomotive build. The actual traffic will have a big dependence on what happens with the economy. But I think some of the projects, our strategic plan, execution, there's a lot more positives than negatives.

[Steve Barger:]

Yeah. No, I understand. To your point on the locomotives, do you know what percentage of that fleet is idle right now? And are you more going into storage or coming out at this point?

[Raymond T. Betler:]

I think in terms of storage, it's up around 25%, Steve. As far as in or out, there's some pickup in mainly the area of grain. It's going to be a record year for grain, so there is some pickup there. But I don't think – it's certainly not a dramatic change at this point. We're not seeing any dramatic change. I think it's trending in a positive direction and hopefully we hit the low point in terms of traffic, but it's not dramatic change.

[Steve Barger:]

So, I guess if these general trends kind of continue into the first part of next year, you would – would you think that the 900 build rate is a reasonable number on a go-forward basis?

[Albert J. Neupaver:]

I think if the traffic flattens out, it could be there or a little less. If the traffic continues to drop, then I think you know what direction it will go.

[Raymond T. Betler:]

Yeah. We're hopeful that one of two things will happen if they don't build new, that some of the overhaul projects that were identified and delayed will come back. That's a very positive opportunity and frankly, more of a short-term opportunity than the OEM.

[Steve Barger:]

Right. All right. Thanks for the time.

[Albert J. Neupaver:]

All right. Thank you, Steve.

[Operator:]

Well, at this time, there appears to be no further questions. We'll go ahead and conclude today's question-and-answer session. I will now like to turn the conference back over to Mr. Tim Wesley for any closing remarks. Sir?

[Timothy R. Wesley:]

Thanks, Mike. Thanks, everybody, for joining us. And we hope to talk to you next month after we complete the purchase of the family stake. Have a good day. Bye bye.

[Operator:]

And we thank you, sir, and to the rest of management team also for your time today. Again, the conference call has now concluded. At this time, you may disconnect your lines. Again, we thank you all for participating. Take care and have a great day.