Westinghouse Air Brake Technologies Corporation
Q4 2016 Earnings Call Transcript

Published: 21 Feb 2017

[Operator:]

Good day and welcome to the Wabtec fourth quarter 2016 earnings conference call. All participants will be in listen-only mode. 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.

[Timothy R. Wesley:]

Thank you, Nicole. Good morning, everybody. Welcome to our 2016 fourth quarter earnings call. Let me introduce the other Wabtec team members who are here with me, Al Neupaver, our Executive Chairman; our President and CEO, Ray Betler; Pat Dugan, our CFO; and our Corporate Controller, John Mastalerz. We'll have our prepared remarks, and then of course be happy to take your questions. Certainly, during the call we will make some forward-looking statements, and we just ask that you review today's press release for the appropriate disclaimers. Al, go ahead.

[Albert J. Neupaver:]

Thank you, Tim. Good morning, everyone. As you know, 2016 was a very challenging year for Wabtec due to the recession in the freight rail market and sluggish conditions in many other industrial markets. In this environment, we are focused on controlling what we can and on investing in growth opportunities. With that in mind, 2016 was also a year of tremendous accomplishments for Wabtec. I think we'll look back on it as the year that we took steps to position our company for a new era of growth and performance. So let's talk about those accomplishments. Financially, although we did not meet all of our 2016 targets, we did compile some of the best results in our history and generated significantly more cash from operations than net income. Operationally, we reacted aggressively to our challenges by cutting cost. Strategically, we acquired majority ownership of Faiveley Transport, which has strengthened our diversified business model, expanded our global footprint, and added new products and technologies to our portfolio. Before I turn it over to Ray, I'd like to say a few words about the integration of Faiveley and what it means to our company. As most of you know, we have been interested in acquiring Faiveley for many years, and we were finally able to come to an agreement in mid-2015. Throughout 2016, we spent countless hours dealing with regulators in the U.S. and Europe, and we received the necessarily approvals to move forward in the fourth quarter. On December 1, just 12 weeks ago, we announced the purchase of Faiveley's family stake. And in late December, we began a tender offer for the remaining public shares. That process is ongoing, and we hope to achieve our goal of at least 95% ownership in the first quarter of this year. There is no doubt that Faiveley represents the most strategic acquisition we've made to date, and we're very excited about the growth opportunities we can pursue together. Faiveley's strong position in the global transit market provides increased diversity of our revenue base across markets, across product lines, across geographies to offset the cyclicality of the U.S. and global freight markets. The company has a particularly strong platform of product and service capabilities in Europe and Asia-Pacific, both of which are much larger markets than the U.S. Thanks in part to its geographic diversity, Faiveley generated organic sales growth of about 5% in 2016. Faiveley strengthens our innovation and technology initiatives and brings products that Wabtec has not been able to offer such as high-speed brake for door and door systems and HVAC equipment. The company also brings a strong and experienced management team to complement our existing organization. Over half of Faiveley's revenues are project-based and backlog-driven, which provides long-term stability and visibility. And finally, we believe the combination of Wabtec and Faiveley will result in significant synergies to drive our growth synergies and cost improvements. We estimate synergies of about $15 million to $20 million in 2017, and we expect long-term annual synergies of at least $50 million to be achieved by year three through revenue growth, supply chain efficiencies, operational excellence and cost savings, and by leveraging our engineering and administrative capabilities. Here are just a few examples of synergies we're working on. Sourcing, combined we have spend of more than $2 billion annually, which gives us leverage with suppliers. By optimizing our product portfolio and new product development, where we offer similar products, we will select the best that each company has to offer in each geographic market and we'll eliminate redundant product development costs. From an internal supply standpoint, Wabtec currently manufactures some products such as rubber and castings that Faiveley purchased from outside suppliers. Now they will be buying from Wabtec. Facility consolidations, there are numerous opportunities for manufacturing and office consolidations. For example, Faiveley's existing Indian plant will be used to meet localization requirements for contracts that Wabtec has won, which means we do not have to invest in a new plant there, a savings of more than $5 million in capital. In all, we're tracking more than 100 synergy projects and seeing positive interaction and cultural integration among the teams. So once again, just 12 weeks into the integration process, we're pleased with the progress so far and excited with the long-term opportunities and benefits we expect to achieve. I'd like to now turn over the presentation to Ray.

[Raymond T. Betler:]

Thanks, Al. I'd like to mention one more reason for our excitement. Two weeks ago, we held our first annual leadership conference for the new Wabtec. We brought together the top business leaders in our company. About half the participants this year were from Faiveley. It was very gratifying to see the two executive teams come together and focus on our conference theme, Stronger as One. I think we're off to a really good start. Our business leaders shared ideas for new products. They shared best practices and disciplines, such as quality and Lean. We discussed new acquisition targets and we explored cultural differences and ways to overcome them. We have no illusions. This integration will be complex, but we're committed to exceeding our synergy targets and to making Wabtec a stronger company for all of our shareholders. With that, let's talk about the current state of our business in our markets. So first we'll focus on fourth quarter 2016. During the fourth quarter, we not only purchased the majority ownership of Faiveley, but we started the tender offer process and began the integration of two other recent acquisitions, Workhorse Rail and the Gerken Group. We completed also a $750 million senior notes offering, and we continued to manage through a challenging downturn in the freight market. Overall, our financial performance in Q4 did not live up to our expectations, with sales of $760 million and adjusted EPS of $0.81. There were several factors that affected our performance. Sales were about $20 million lower than we expected and product mix was unfavorable. For example, revenues from train control and signaling did not meet our sales targets. We added sales of about $100 million from Faiveley, which were dilutive to operating margins. Integration costs and activities related to Faiveley were significant and they did create distractions throughout our organization. As usual, we also booked some year-end adjustments, none of which were significant individually. On the positive side, we did generate strong cash from operations of $202 million and our backlog increased 10% compared to the third quarter, even excluding the Faiveley backlog of $1.9 billion. Throughout 2016, our management team responded to difficult market conditions with aggressive actions to reduce our costs. These actions enabled us to maintain good adjusted margin performance for the year within 100 basis points of 2015 despite an 11% drop in sales. We reduced total plant employment by more than 10% during the year and we continue to adjust that as necessary going forward. We made further cuts in discretionary spending at corporate and across all business units when we stepped up our efforts associated with the Wabtec excellence program which includes lean, supply chain initiatives and quality initiatives. Let's move to 2017 guidance. Today we issued our guidance for the first time. For the year, we expect revenues to be about $4.1 billion with earnings per diluted share between $3.95 and $4.15. Excluding restructuring and transaction charges and non-controlling interest related to the Faiveley acquisition, the midpoint of the EPS range represents growth of about 6% to 7% compared to 2016 adjusted results. Due to the ramp up of projects already in the backlog, and the timing of synergies from the Faiveley acquisition, we expect our adjusted EPS in the first quarter of 2017 to be similar to the adjusted EPS in the fourth quarter of 2016. And we expect the second half of the year to be stronger than the first half. Accretion from Faiveley will increase during the year as projects and synergies kick in. Other assumptions include the following. Revenue growth for the year will come from our Transit Group with the Freight Group expected to be down slightly. Faiveley will be accretive but its financial impact will be reduced by expenses for additional interest and a higher share count along with purchase price accounting charges. We're assuming foreign exchange headwinds of about $65 million at current rates. Our tax rate is expected to be about 29.5% for the year. We're assuming diluted shares outstanding of about $95 million for EPS calculation purposes. But our goals for 2016 are straightforward, to meet our financial plan, to rightsize our business, and remain disciplined when it comes to controlling cost, to generate cash to invest in growth opportunities while strengthening our balance sheet, and to ensure a smooth and effective integration process with Faiveley to capture the synergies and the growth that we expect. As in the past, we strive to control what we can. So, let's talk about the freight rail market. In NAFTA, freight rail traffic was down about 5% in 2016. In the first few weeks of this year the numbers are slightly better with traffic up about 2% on average. We're are not seeing yet any benefits from this as customer inventories of aftermarket parts remained lower than normal levels and equipment storage rates remain high. If rail traffic continues to improve. We do expect to see benefits in our aftermarket business later in this cycle, perhaps in the second quarter or third quarter. Our 2017 freight assumptions include the following. Railroad CapEx, which declined about 15% in 2016, is expected to be about the same in 2017. Locomotives will be down about 6% worldwide and about 30% in NAFTA. Freight car builds will be down about 10% worldwide and about 30% in NAFTA. Combined, that represents a headwind of about $120 million in revenues. We have opportunities to offset these headwinds because our growth strategies and diversified business model allow us to focus on the aftermarket in the U.S. on international projects in places such as India, on acquisitions that we've completed in 2016 which will add incremental revenue of about $100 million. Those acquisitions include Graham-White, Unitrac, Pride Bodies and Workhorse. We also remain focused on increasing our global footprint and our product offering beyond our traditional NAFTA aftermarket because about 75% of our installed base for locomotives and freight cars are outside of the U.S. Our transit markets remain stable both in the U.S. and abroad with good bidding activity overall. Reflecting this activity, our transit backlog is at a record high for legacy Wabtec business and Faiveley's backlog is near record high. Over the next several years, the strongest growth is expected to be in Western Europe, Germany, France, UK and Asia-Pacific, specifically India and Australia while talk of infrastructure-focused spending in the U.S. would also provide additional opportunities. Current projects include brake stores and HVAC equipment for high-speed trains in Germany; brakes, auxiliary power supply, HVAC, couplers, pantographs for regional and commuter trains in Belgium; brake stores, electronics for the regional network trains in France. And we're bidding on significant future projects such as subsystem and component business, maintenance for commuter trains in Sydney, Australia, as well as subsystems in commuter component projects for the New York City acquisition, which is forthcoming. In addition to sales growth, we are focused on improving our margins in transit, both in the legacy Wabtec business and the Faiveley business. Many of the synergy projects that Al mentioned involve plans that we believe will drive significant margin improvements and we're committed to delivering on those plans. We continue to focus on growth and cash generation. In 2016, we generated $449 million of cash from operations, which gives us ample capacity for investment. Our priorities for allocating free cash have not changed, while we continue to strengthen our balance sheet. First, we would fund internal growth programs including product development and CapEx. Second, we would focus on acquisitions where we have ample opportunity to deploy capital. And third, we would return money to shareholders through a combination of dividends and stock buybacks. In May, we announced a dividend increase for the sixth consecutive year, and during 2016, we purchased 3,046,408 shares of our common stock for about $212 million or about $69.63 per share. We have about $138 million remaining under our current share repurchase authorization. We remain focused on increasing free cash flow by managing our costs, by driving working capital down, and by controlling capital expenditures. Our growth strategies remain the same. They are global and international market expansion, aftermarket expansion, new product development and technologies, and acquisitions. So, let's talk about each of these strategies. On the global expansion side, for the quarter, sales outside the U.S. were $450 million or 59% of our total. We're particularly excited about growth opportunities in India, where we have orders for brake systems and event recorders for locomotives, and Faiveley has several orders for doors, brakes, and air conditioning equipment for various transit projects and bidding activity there continues to be strong. In France, after years of flat or declining volume, the bidding activity is very strong, including the largest commuter project ever in Europe for RER regional fleet, which includes 240 high capacity trains. Aftermarket expansion sales there for the quarter were $433 million or 57% of our total. Gerken, one of the 2016 acquisition companies, recently won two multi-year contracts to supply its aftermarket carbon products in China and in Germany. And, then, on the new product side, we introduced several new products last year. We built a new plant in China to build intercoolers for the power generation market. We introduced the new generation of sintered brake pads for high-speed rail. We developed bogie-mounted brakes specifically for the South African market and Faiveley has a new NeoFlexx brake disc which they've introduced to the market. Moving to train control and signaling, control and signaling remains an important part of our long-term growth opportunities. Although, it's part of the reason why our freight revenues were down in 2016. As you know, our customers were working hard to implement PTC but decreases in freight rail traffic caused the railroads to reduce their CapEx budgets for both infrastructure and rolling stock. In addition, the deadline extension to at least 2018, resulted in changes in their spending plans. The result of all that are the revenues from train control and signaling decreased 30% in 2016 to about $350 million. We expect that to be flat to slightly up in 2017. Long term, we expect PTC and signaling will be a growth business for Wabtec based on the following opportunities. Multi-year of maintenance and service agreements, which includes software and product enhancements, international project opportunities and continued growth in signaling through organic investment and acquisitions. In 2016, we acquired a small but very strategic signaling company in the UK to allow us to focus on growth in that market. We're beginning to see evidence that our long term strategy is working. We've signed several maintenance and service agreements related to train control, including the 10-year contract in Brazil to provide a variety of train control and signaling services. On the acquisition side, our pipeline continues to be active and we're pleased with the opportunities we're reviewing. In addition of Faiveley, during the fourth quarter, we acquired Workhorse Rail, which is a supplier of engineered freight components, mainly for the aftermarket. The company has annual sales of about $35 million. Workhorse supplies freight car couplers, knuckles and related parts for a variety of Class I railroad and freight car options. Workhorse offers a variety of product designs and sells primarily in the North American market, that brings an excellent reputation and strong engineering capabilities in new products to our portfolio. In addition, we believe Wabtec's geographical presence in aftermarket footprint, will provide new opportunities to expand Workhorse Rail's customer base in North America and around the world. So with that, I'd like to ask Pat to talk a bit about some of the financial details.

[Patrick D. Dugan:]

Okay. Thank you, Ray. So, everybody, I'm going to go through our normal review, but also spend a little bit of time on the adjustments just to help everybody with their math and their models and understanding what actually was recorded in the fourth quarter and for the full year. So sales for the fourth quarter were $760 million. And when you compare this to a year ago quarter, that includes a negative effect of about $22 million from changes in foreign exchange rates. If you exclude that FX impact, sales would have been about 6% lower than the last year's quarter. And this decrease can be attributed to the difficult market conditions in our Freight segment. Our consolidated sales figure included about $100 million from revenue with a dilutive impact on EPS, including lower margins and higher interest costs. When you look at our segments, from a year ago, the freight sales decreased about 32%. That's mostly due to lower organic sales mainly from PTC, from freight OE, and aftermarket, about a $174 million impact. Negative FX, which is about $3 million, which in those two items more than offset the positive impact of acquisitions, which would have added about $17 million of revenue. Our Transit segment sales increased 26%. The acquisition of Faiveley and others contributed about $120 million of revenue to the segment. That more than offset lower organic sales of about $14 million and negative FX of about $19 million. Operating income for the quarter was $63 million, and this included the following

[Raymond T. Betler:]

Thanks, Pat. So to summarize, as Al said at the beginning of our call, we had to deal with some very difficult and challenging conditions in our freight and industrial markets in 2016. But we stayed focused on controlling what we can, while investing in growth opportunities. We still face some of these challenges in 2017 and we'll continue to attack our costs aggressively, while driving our growth opportunities. We expect to get back on track as a growth company here this year in 2017, based on current market conditions and our existing strong backlog of projects. We're pleased with the Faiveley acquisition and the progress we're making on integration and synergy planning. We're confident that our diversified business model and balanced growth strategies will enable us to respond to both long term opportunities as well as short term challenges. And with that, we'll be happy to answer any of your questions.

[Operator:]

Thank you. Our first question comes from Justin Long of Stephens. Please go ahead.

[Justin Long:]

Thanks and good morning.

[Raymond T. Betler:]

Hi, Justin.

[Justin Long:]

So, hi, how are you? So looking back on 2016, obviously, results missed expectations and I totally understand it's been a tough demand environment to battle. But especially with the month of December being so far below expectations, could you just comment on your visibility and confidence in the outlook for 2017 and as you do that I'm also curious if you've changed your methodology in terms of forecasting the business based on what we saw last year?

[Raymond T. Betler:]

The methodology has not changed. We have a very detailed bottoms-up methodology that we use for forecasting and we're basically analyzing that on a week-by-week basis to make sure that we have as a good visibility as possible, Justin. I think the Q4 results were disappointing. We had issues that that we had to address some on our contracts. We had a few contracts where we had to take contract adjustments and the freight business did not recover. The electronics business did not recover. We didn't expect it to. But we were trying to negotiate some MSAs that we were hopeful would develop revenue opportunities sooner than they did. So it was a host of issues that resulted in the shortfall. I think on lot of those issues were one one-time unique issues that we addressed and we think that the forecast for 2017 and the guidance is solid.

[Justin Long:]

Okay, great. And maybe to build on that a little bit looking at the 2017 guidance, could you talk about what you're assuming for organic growth in the Freight segment and also what's you are assuming for organic growth in the Transit segment?

[Raymond T. Betler:]

And, so, we're expecting overall, as I said, about 6% – 7% Freight. We expect to be basically flat to slightly down. We will monitor very, very closely obviously, the aftermarket opportunity. Our opportunity in Freight to a large extent it's going to be dictated by how fast we start to derive benefits from traffic. If traffic continues to pick up then, again Q2 – Q3 we should start to see some of the benefits from that. We know that on the OEM side that car builds are going to be down. We do anticipate some growth opportunities on the international side, but overall, we expect traffic to be down. Transit organic growth about 5% over the year is what we anticipate and if you analyze the backlog in Transit both on Wabtec and the legacy Faiveley side, it's again, basically, a record high and we continue to pick up new orders. The project – the good thing about the project business is it is pretty predictable and we anticipate improvements in revenue throughout the year.

[Justin Long:]

Okay, that's really helpful. And I guess, lastly, when you look at the business, just on an organic perspective, what are you assuming for the change in operating margins in 2017? Do you think, knowing the environment you just described from a top line perspective, margins will improve?

[Patrick D. Dugan:]

Justin, this is Pat. So I think what you're going to see, just due to the way the year should progress that we'll get to about a 15% operating margin by the end of the year. That is in line with what we discussed earlier. Clearly, the overall margin is impacted by the higher mix of Transit sales from Faiveley acquisition. So there's going to be a steady improvement in margin throughout the year. We expect to execute on the synergies and the other integration plans and so we'll also see benefits from that too.

[Albert J. Neupaver:]

I might add that the one thing that you might ask, you look at December and we had a pretty good view. I just want to point out that because of the antitrust reasons, we really did not have a good view of the Faiveley business and how it would roll out during 2017. We assumed a lot about an equal business across, but the way they did a lot of completion on some projects in the fourth quarter, and our Faiveley business will really start out slow during the beginning of the year, and these projects will start kicking in as the year goes on. And they're in the backlog, they're planned, and a lot of these projects you do percentage completion type accounting, so we have good visibility on this. This is not like our Freight business, which is a component business that you have much better equalized sales, but you don't have the visibility as much as we do, and that's really the strength of this diversified business model and the strength of the Faiveley acquisition. And as Pat points out, these synergies, they will build up as the year does and that's one of the reasons, we said we'll start out slow and be stronger in the second half of the year.

[Justin Long:]

That's helpful, Al. Lastly, Pat, I just want to clarify on the operating margin comment, you said around 15% all-in, but would you be willing to share what the year-over-year change is or what you expect in terms of the organic margin profile of the business?

[Patrick D. Dugan:]

Yeah, I think I would rather – let's just stick with the kind of the overall group, the combined margin and because the organic growth, I mean the organic margin, I don't see that really changing but I think we need to do a little more in analysis to make sure that we have that for you.

[Justin Long:]

Okay. Fair enough. Thanks for your time today.

[Operator:]

Our next question comes from Sam Eisner of Goldman Sachs. Please go ahead.

[Samuel H. Eisner:]

Yeah, good morning, everyone. So just on the PTC asset here, PTC was down and PTC and signaling, I believe was down about a $150 million year-over-year based on that 30% decline. Can you talk about which buckets between signaling and kind of core onboard electronic PTC, how much of those were each declining? And then is there any change in the mix expectations for your flat guidance for 2017?

[Raymond T. Betler:]

So Sam, on PTC, PTC hardware was down because capital spend was down. So we anticipate that this year the Class Is will buy after remainder of the PTC hardware. On the signaling side, we had one of the reasons we missed Q4, we had a pretty significant drop. It was actually a delay, a cancellation, but it's anticipated to come back in 2017. A delay in one of the major projects. It is associated with PTC, but we were doing signaling construction on that project. So it was for us, the scope was signaling category. So about $250 million of PTC last year out of the $350 million total train control and signaling was the revenue mix. So the signaling really was pretty constant at about $100 million 2015 to 2016 and the drop was in the PTC part of it.

[Samuel H. Eisner:]

Got it. That's helpful there. And then where you called out these contracts adjustments and, certainly, it was a decent size headwind this quarter, is there a way to get a final point on what specifically these contract adjustments are? Are there cost overruns that are going on? Are you taking lower margins on longer term contracts because I don't know there are issues with it? I just wonder to have a better understanding of where these are being impacted, which segment, what specifically, any kind of greater details that you can give us on that would be great.

[Raymond T. Betler:]

Yeah. The contracts were really associated with the overall delivery performance problems, Sam. They're very different – there were three contracts that were in different industries and different geographical markets, but for the most part they were associated with cost overruns unit due to supplier problems in two cases and basically late deliveries and all that.

[Samuel H. Eisner:]

Got it. Maybe just one last one. Are there any – you guys called out the synergies for 2017, but are there any additional cost saving actions that we need to be mindful of> I think this year there was pretty significant cost savings. So is there anything else that we should be mindful of entering next year in order to get to you roughly a 15% EBIT margins for the full year?

[Raymond T. Betler:]

We're going to continue the initiatives that we had last year. So, we'll continue to try to proactively as much as possible adjust our discretionary spending. So that includes all our expense items, travel and the like head count things like that as well as the synergy programs. So the synergy programs are very explicit. We have over 100 DTL programs with people responsible to deliver on those programs. We managed those on a day-to-day basis, but we have a unconsolidated meeting on a monthly basis. So, we have very good tracking mechanisms visibility and our focus is to accelerate those as much as possible, look for additional opportunities to add to that portfolio and to deliver on the ones we've already defined. And they're across the board, across the world, across every business. Every business unit leader, every functional leader has a target with specific projects associated with their responsibility.

[Samuel H. Eisner:]

And, Ray, just to follow up on that, is there any number that you can put behind the 2016 cost saving on the discretionary items? Thanks and I'll hop back in queue.

[Raymond T. Betler:]

I'll let Pat chime in.

[Patrick D. Dugan:]

I've got to say that that's a little – we get that question a bit. I think the reality is that until we got to the fourth quarter and we had done a very good job of maintaining a margin with dropping revenue, and so those cost-saving initiatives in 2016 really are reflected in that improved margin. There was no one specific program initiative. All we did was we were constantly focused on identifying variable costs related to the volume change, but also being mindful of taking fixed cost out that would allow us to maintain that margin. So going forward, as Ray said, the real focus is on these synergies and integration opportunities we have, and we'll continue to do the same thing with the changes in volume.

[Operator:]

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

[Ivan Yi:]

Good morning. This is Ivan Yi on for Scott Group. Thanks for the time. Going to your...

[Patrick D. Dugan:]

Hi, Ivan.

[Ivan Yi:]

Hey, good morning. Can you provide a little bit more detail on your updated guidance? You lowered your revenues by about $100 million from $4.2 billion to $4.1 million (sic) [billion]. Can you put that into which bucket is that in, what product lines, what segments? Is that all freight? And then a similar question on the earnings guidance, where that's also been lowered from your original preliminary guidance in December as well. Are you seeing higher expenses in certain cost bucket? A little more color would be great.

[Raymond T. Betler:]

Okay. As far as the revenue job, that's associated with a host of things. It's associated with the Freight market certainly, but also things like FX and other cost-related items. As far as the second part of the question, can you repeat It?

[Ivan Yi:]

Yes. Just similarly, are you seeing higher expenses in certain areas that prompted you to lower your earnings guidance from your preliminary projections in...

[Raymond T. Betler:]

No, we're focused, as we said, on reducing expenses, driving down our overall SG&A and our costs and continuing to improve our margins. It's really about all against reduced revenues that we're trying to fight.

[Ivan Yi:]

Got you, okay. Secondly, can you describe the current acquisition pipeline both in the U.S. and internationally? Are certain markets a little more active than others? And I just want to get a sense of what you're seeing out there in the marketplace.

[Raymond T. Betler:]

We have still a very healthy pipeline. The pipeline is strong both in North America and internationally. One of the benefits of the Faiveley acquisition is they obviously have their own acquisition candidates. So we're now including those in our overall portfolios as we consider prioritizing acquisitions. So we have both international as well as domestic and Freight as well as Transit.

[Ivan Yi:]

Great, thank you so much for your time.

[Raymond T. Betler:]

Thank you.

[Operator:]

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

[Allison A. Poliniak-Cusic:]

Hi, guys. Good morning.

[Raymond T. Betler:]

Hi, Allison.

[Patrick D. Dugan:]

Good morning.

[Allison A. Poliniak-Cusic:]

I just want to go back on the positive train control and signaling comments. I think you mentioned flat to up slightly. Obviously, the biggest headwind was on the PTC side. What's changed? As we go heading towards the 2018 deadline, I would assume that would ramp up. Is there a piece, whether it's system, design or something that's not coming back to where you thought it was? Just help me understand that a little bit.

[Raymond T. Betler:]

I think for 2018, they're going to basically have to catch up in 2017 and 2018, and it has to be more loaded towards 2017 because by the end of 2018, the requirement is basically that all the equipment be installed and ready for commissioning. So there is about 20% – 25% of the hardware that they still have to buy, and we expect that most of that is going to get bought out this year. Relative to the signaling side, a lot of infrastructure work has been completed, but they did pull back significant on the infrastructure. And then on top of that, we have new opportunities that we're booking for commuter lines and other railroads. So there is some pickup in new business associated with new projects as well as the completion associated with the existing PTC procurements.

[Allison A. Poliniak-Cusic:]

Okay. I know the aftermarket piece is a bit new, but it sounds like you're getting some maintenance agreements and so forth in there. Is it tracking where you thought it was, a little bit more, a little bit less, any color there?

[Raymond T. Betler:]

So there were delays a little bit, Allison, honestly again another impact on last year's revenue. We were hoping to negotiate and close those earlier in the year. It was a long, protracted negotiation in most cases. Railroads are very good at what they do and we have most of the Class I's under contract now. So those start off slow, low. And as the PTC implementation continues, they'll ramp up. And the contracts are negotiated basically at the level that we thought they would be. We said 5% to 10% of the hardware OEM equipment level, and that's about where we're going to end up it looks like. We're pretty happy with the way the negotiations went once they were finished.

[Allison A. Poliniak-Cusic:]

Agree. And then just last on Faiveley, are you – => I guess would a low to-mid-single-digit organic growth assumption be the right way to look at it in terms of your visibility for this year for them?

[Raymond T. Betler:]

Overall, we think organic growth, low to mid-single digits is about where we think we'll be.

[Allison A. Poliniak-Cusic:]

Great, thank you.

[Raymond T. Betler:]

Thank you.

[Operator:]

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

[Saree Boroditsky:]

Thank you, good morning. Could you provide some more color on the performance of the industrial business, and then just how you are thinking about that into 2017?

[Raymond T. Betler:]

Sure. On the industrial business, we're not seeing any significant improvements in Industrial. It's pretty much similar to Freight. We're hopeful that that will change, but at this point we're not seeing any significant changes. On the other hand, we do have growth opportunities associated with industrial through the new product development and geographical extension that we talked about. So that intercooler project represents growth. We have businesses like industrial controls businesses in Australia and other places in the world that serve the power distribution and power generation market. So, I think we're forecasting a flat market for industrial similar to what we are at Freight but there are improvement areas that will offset the continued depressed areas that you see in this country.

[Saree Boroditsky:]

Thank you, that's helpful. And then just going back to the guidance, is the implied ramp in earnings, is that just due to Faiveley projects and synergies, or is there anything else that we should be thinking about?

[Raymond T. Betler:]

No, I think it's a total mix of our business. We're going to continue to manage our improved profitability in all of our businesses as we always do. That comes through our focus on cost improvement, on Lean, on reduced cost, support quality as well as the backlog that's associated with and the mix associated with Freight and Transit. Aftermarket business is strong, working to grow the aftermarket business in both of those areas to more OEM business you get in Transit to more aftermarket business, you have a 30 – 40-year life. So it's a mix across the entire business that margin generation.

[Patrick D. Dugan:]

Yes, you are right. I mean, the two things are going to be the major factors is the project phasing that again we did not have the visibility of back in December. And, the second thing is, as we generate the synergies through the year, those are going to be the major contributors, but as Ray points out, these aren't the only two factors and we do have a tremendously diverse business model now that really provides us with the opportunity to deal with large headwinds. Think about the headwinds that we're going to be faced with, just FX and our headwinds from the Freight business in the U.S. both rail car and locomotive. So, I think that really speaks to the strength of our business model.

[Saree Boroditsky:]

Okay, that's very helpful. I'll pass it on. Thank you.

[Raymond T. Betler:]

Okay.

[Operator:]

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

[Jason A. Rodgers:]

Yes. So I wonder if you could discuss what your expectations are for ECP in 2017?

[Raymond T. Betler:]

If you're referring to the regulation, it's being contested. We don't anticipate that issue is going to get resolve, Jason, this year. But I think it's going to continue to be debated and we haven't forecasted any revenue associated with ECP in the U.S.

[Jason A. Rodgers:]

Right. And how about the outlook for raw material cost? Are you seeing any beginnings of increases there?

[Raymond T. Betler:]

So for our raw materials cost, basically, only about 6% of our total spend is associated with raw materials. We have indexes under contracts for each of the raw materials copper, aluminum, steel, et cetera. Some of the raw materials that are going up are offset by raw materials that are going down like rubber, glass, wood. So bottom line is we feel pretty comfortable that we're going to be able to manage any raw material inflation across our business for the year.

[Albert J. Neupaver:]

But most importantly, we had either indices or surcharges with our customers and we also have fixed pricing with our suppliers.

[Raymond T. Betler:]

And where we're renegotiating those contracts to drive both fixed prices down frequently.

[Jason A. Rodgers:]

And can you remind us what percent of your total sales are derived from freight OEM currently?

[Albert J. Neupaver:]

You mean, freight car and locomotive OEM?

[Jason A. Rodgers:]

Correct.

[Albert J. Neupaver:]

Less than 10% of the business is related to new freight cars and locomotives in North America.

[Jason A. Rodgers:]

All right. And then, just final housekeeping question, would you happen to have the shareholders' equity balance in the quarter?

[Patrick D. Dugan:]

Sure. So, the shareholders' equity at the end of the year is $2,976,000,825.

[Jason A. Rodgers:]

Thanks very much.

[Raymond T. Betler:]

Thank you.

[Operator:]

Our next question comes from Matt Brooklier of Longbow Research. Please go ahead.

[Matthew S. Brooklier:]

Hey. Thanks. Good morning. So I had a question around Faiveley synergies. I believe the $15 million to $20 million of synergies you anticipate to capture this year, that's up from your previous expectations. Maybe if you could just talk to what's changed why you believe you're going to be able to capture, roughly I think twice the amount of synergies that you've formally anticipated in 2017?

[Albert J. Neupaver:]

That number really is basically the same and it's a gross number. We still have costs that are associated with that. And as we go through the year, we've already had, I can't tell you how many meetings we've had that's been concentrated on a program. We have a full time individual that's devoted to it. As we develop our synergy program, maybe the next call Ray and Pat could provide a lot more color and visibility on it. But right now, this is the best we have, is a gross number between $15 million and $20 million of synergies. But I think someone I know – I think I'd mentioned that we're tracking over 100 different projects right now.

[Matthew S. Brooklier:]

Okay. So the number hasn't changed, it's just the $15 million to $20 million of growth.

[Albert J. Neupaver:]

No, it's the same.

[Matthew S. Brooklier:]

You're anticipating some there's cost offset that gets you back on to the, I think, it's like a net $8 million to $10 million.

[Albert J. Neupaver:]

Exactly.

[Matthew S. Brooklier:]

Okay, that helps. And then just broadly speaking, of the $50 million of total targeted synergies., could you talk to how much of that is related to cost and maybe how much of it is potentially related to some revenue synergies that you could capture with the combination of the business?

[Albert J. Neupaver:]

I think that's an excellent question because I think long term that's really where the synergy is, is how we capture market share and grow our volume. I mean that's the whole reason, that's really the most profitable way to grow and we're really focused on it. There is some of that in the $50 million, but you have to be realistic about the acquisitions and ability to do that. We first have concentrated and focused on getting the integration, get the teams culturally combined and focused on the right thing. So, that will probably not be something you would expect in 2017, but beyond 2018 and 2019, it should start to grow, and that really is our long-term synergy, the main reason we keep saying this is the most strategic acquisition that Wabtec has ever done.

[Matthew S. Brooklier:]

Okay. So just to clarify, the majority of the $50 million at this point in time are more focused on the cost versus the sales synergy potential?

[Albert J. Neupaver:]

I don't know how you define majority, but yes, most of them (1

[Matthew S. Brooklier:]

I'm just trying to get the confidence level in terms of hitting that number.

[Albert J. Neupaver:]

Yeah.

[Matthew S. Brooklier:]

And then...

[Albert J. Neupaver:]

Yeah. I've always classified them as hard synergies and soft synergies, and typically this revenue is a soft one.

[Matthew S. Brooklier:]

Okay, that's helpful. And then do you – for fourth quarter, do you have the breakout in terms of PTC revenue, how much of it was Freight and how much of it was Transit?

[Albert J. Neupaver:]

75% was freight, roughly.

[Matthew S. Brooklier:]

Okay. And then just lastly, you talked about, well, actually Ray mentioned, I wanted to clarify something that at this point in time, you've already signed the Class I rails into contracts for PTC maintenance and services. Moving forward, is that – did I hear that correctly?

[Raymond T. Betler:]

Yeah. Most of the Class Is are under contract, yes.

[Matthew S. Brooklier:]

Okay. And the expectation is revenue from those contracts are expected to ramp as their systems go live, so probably expecting kind of minimal contribution from those contracts in 2017, is that a fair way to think about it?

[Raymond T. Betler:]

Yes, that's right.

[Matthew S. Brooklier:]

Okay, that's helpful.

[Raymond T. Betler:]

They'll will ramp up to a steady state this year, Matt.

[Matthew S. Brooklier:]

Okay. And again, just to clarify, 5% to 10% of total revenue on – I guess on the equipment side of things for the class ones, that's a fair way to think about, the total annual maintenance and services to the revenue moving forward?

[Raymond T. Betler:]

So we've said 5% to 10% of our PTC hardware the installed base that is out there.

[Matthew S. Brooklier:]

Okay, thank you for the time.

[Raymond T. Betler:]

Thanks, Matt.

[Operator:]

Our next question is a follow-up question from Sam Eisner of Goldman Sachs. Please go ahead.

[Samuel H. Eisner:]

Hey, sorry. Just a quick question here. Just on organic growth, there were a bunch of numbers that were thrown around. I thought, Pat, you said 6% to 7%, but then you also said flat to down on Freight and up 5% Transit. So, just help me kind of square. What are you guys expecting for organic growth in 2017? If you could put a number on it, that would be great?

[Albert J. Neupaver:]

Yeah. Yeah. I think the confusion is around how much acquisitions play in that, whether you include Faiveley or not. The overall volume is up tremendously but internal growth is low to single-digit growth.

[Samuel H. Eisner:]

All right. That's helpful. Thanks very much.

[Albert J. Neupaver:]

Okay.

[Operator:]

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

[Steve Barger:]

Hi. Thanks. Good morning. I appreciate all the detail...

[Raymond T. Betler:]

Hi, Steve.

[Steve Barger:]

...on the call so far. I just wanted to ask one a little further out. If you do look forward a few years to the point where the integration is well underway and we have say a stable to modestly growing freight market. Do you have a thought on what consolidated operating margin will look like given the new mix?

[Albert J. Neupaver:]

The only thing I would say is, if you take a – if you step back and you take a look at the Faiveley business and we've identified in three years $50 million of synergies, one could easily just add that to their current position and you would have an indication on what their margin might look like. And I think, Pat, the challenge would be the margin question about our base business even under the volume demand to maintain those margins as they have within that percent. I think that long term, we should be able to maintain our high margin business in the traditional Wabtec businesses. So that would give you an idea and that's just looking at it from 20,000 feet.

[Steve Barger:]

Understood. So fair to say as you go towards the end of the decade that you would think there's a couple hundred basis points of improvement from the 15% full year that you're talking about right now. Is that timeframe realistic?

[Raymond T. Betler:]

Yeah. Yeah.

[Steve Barger:]

All right. That's all I had today. Thanks.

[Raymond T. Betler:]

Thanks, Steve.

[Operator:]

Our next question comes from Kristine Kubacki of CLSA. Please go ahead.

[Kristine Kubacki:]

Good morning, guys. A question, a little bit longer term on the acquisition strategy now, it sounded like and I get the complexity of this deal was the largest you've taken on and you made the comment about distraction. It sounds like from a financial capability, it is no problem to continue with the acquisition strategy. But where we're at with Faiveley, do you think that there is still bandwidth within management to continue at pretty aggressive acquisition strategy over the next couple of years given what's on the plate with Faiveley still?

[Raymond T. Betler:]

Yeah. I think Kristine, Faiveley brought a tremendously strong management team with them. Stéphane Rambaud-Measson has done an excellent job pre-acquisition to come to Faiveley to address some performance issues and improvement opportunities and he was well along on a transition put in place a strong management team around him and those folks are a good part of the people that are running the Transit business worldwide today. So they have certainly their own relationship experiences and acquisition candidates that they brought with them and I personally have already participated in three different acquisition visits with folks from a Faiveley legacy, Faiveley executive team. So yeah, they're a fundamental part of our organization now. We look at them as part of us. We don't say they and we anymore. And we have plenty of capacity, probably more capacity than we had before definitely more reach.

[Albert J. Neupaver:]

Yeah. And I'd add to that is, what I'm think, focuses is the integration and the synergy related to the acquisition. And as Ray mentioned in his prepared remarks, he said we're not having delusion that this is going to be a slam dunk easy acquisition. So the question is a very valid one and one that we take serious. And I think that when you look at where we're at in the integration process on this, from my years experience, I think we're kind of where we thought would be. I think the biggest hurdle was still one of cultural integration. And I think we'd be careful in going ahead with a huge one, although we have the capacity. I think you worry about resource allocation. You worry about attention to details. But I don't think we're years away from that. I think we're months away from that point.

[Kristine Kubacki:]

Okay. And that's very helpful. Thank you very much, guys.

[Raymond T. Betler:]

Thank you.

[Operator:]

It seems we have no other questions at this time. So I would like to turn the conference back over to Tim Wesley for any closing remarks.

[Timothy R. Wesley:]

Okay. Thanks for everybody's attention this morning. And we will talk to you in about two months with our first quarter earnings report. Have a great day.

[Raymond T. Betler:]

Thank you.

[Operator:]

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.