Westinghouse Air Brake Technologies Corporation (WAB) Earnings Call Transcript & Summary

All right. Afternoon, everyone. This is Scott Group, transport analyst here at Wolfe Research. We're kicking off the freight side of the conference. Really happy to be starting with Wabtec. We've got Pat Dugan, the CFO. Pat, thanks for joining us on the webcam. Appreciate it. Appreciate you being here. Any -- before we get into Q&A, any sort of opening comments you want to make? And then, just a reminder, anyone -- everyone. I've got questions, and we've got about half an hour here, but if you have any questions, definitely feel free to type them in, and I'll make sure anything that's worth asking that you type in, we'll get to that. And if not, I've got plenty of questions myself. But Pat, any opening comments that you want to make?

Sure. So Scott, thanks for inviting me. Thanks for hosting us. I'm sorry, we're meeting from remote locations, but I think everyone understands that we want everybody to stay well and healthy and that everybody and your family and everyone you work with are staying well and healthy. So just as a little bit of introduction for those who don't know me, my name is Pat Dugan. I've been the CFO for Wabtec Corporation for almost -- for 6 years. I've been with the company for almost 17 years, believe it or not. So I've seen a lot of change, a company that has grown from kind of a humble start to where we are today. I've seen a lot of economic cycles, freight cycles, lived through the credit crisis. And they've been challenging times, but this is unique, as we all know. But I really believe that we're much well -- better positioned than ever to navigate through all the things we're going through and emerge even stronger. When you look at where we are, we're a much more diverse, much more global organization, We have an installed base that's global across our Freight and Transit segments. But just as importantly, we have -- that installed base gives us significant recurring Service revenues, gives us a lot of technical capabilities, a lot of intellectual property that gives us strength in our businesses. And we have a very sizable backlog, about $22 billion of backlog that gives us both visibility into where we are today and in the future, but also confidence in where we're heading. The macro is challenging. We did withdraw our earnings guidance with our first quarter earnings release a couple of weeks ago. We are very much focused on making sure that with the volume disruption that our company and other companies like us are seeing, that we're focusing on what we can control, which is our cost, defending our margin and making sure that we maintain our profitability percentage as a goal into the rest of the year. We've been very aggressive about cutting costs, making sure we deliver on our synergy plans. And of course, focus on cash. So those are, I think, some highlights, I think, that are helpful to kind of set up the questions. But Scott, maybe you could lead on and then if anybody has any other questions, I'm happy to answer them.

Okay, great. And there's already a couple that have been submitted, but I'll start with a few. I'm going to ask everybody this first question, maybe just to give any kind of revenue or directional revenue update that you can share with us for the second quarter and maybe start thinking about trends in April versus what you've seen in May. Are you seeing signs of any kind of revenue pickup so far in May? Do you think that volumes -- or maybe from your perspective, do you think that sales at this point have bottomed yet?

Yes. So I think it's a question that was asked in the earnings call, and I'm -- and I just want to make sure that, hopefully, I address it to everybody's satisfaction. It's a little hard for us to -- it's a little tricky for us to kind of take the first month of a quarter and extrapolate it over the full quarter. We're not a Class I where you have -- you can kind of measure the number of trains that are running. We're not an airline where you can look at number of seats. What we look at is we look at our backlog and our order intake. We look for -- especially, the order intake is specific to our aftermarket business. And so if there are short-cycle opportunities, we see purchase orders that we can build and deliver within the quarter. And we see a lot of strength, and we have a lot of confidence in what's happening there. Our backlog was all -- from the OE side was always there. And other than some of the similar things we saw in Q1 where we have supply chain disruption or customers that aren't ready for deliveries or our plants, which were, for the most part, deemed essential businesses and not shut down, weren't at full capacity because of workforce disruption or absenteeism, I think that we've continued to see that the backlog is proving to be strong, that we have confidence in the full year in 2020. Our customers are talking to us about timing. That's a reality. And we're seeing order intake being strong for our aftermarket side. So we did withdraw our guidance. I mean it was part of the uncertainty of where we are with kind of a very unique event in the history of our industry. But I don't want that to be confused with us being not confident about where we are right now and where we are going to be for the full year.

So maybe just a follow-up there. And, again, just directionally, so it sounds like you're saying that the most -- the shortest cycle part of your business will be order intake on aftermarket. Can you just talk, again, directionally, are you seeing that trend? Have you seen that trend, that order intake, deteriorate? And then are you seeing any signs of that order intake start to recover yet?

Sure. So probably the -- starting with the Freight side. What I would do is kind of point everybody looking at our revenue, our product line revenues, and I can kind of describe where I see the impacts and I think that would help a little bit. On the freight equipment side, that's mostly our new loco builds. Those are loco builds that are a combination of North America loco builds and international, about 2/3 of that revenue is loco build. And you have mining, mining is the big part of the remaining amount of revenue there. Mining is supported by our backlog. Our loco build on the OE side is almost entirely international, also supported by backlog. When I look at our Freight Services business, about 50% of that product line is -- are covered by maintenance agreements, long-term multiyear maintenance agreements that are dependent on the activity of the locos, but very stable and not a lot of variability quarter-to-quarter and year-to-year. And then you have 20% of that product line is modernizations also supported by backlog and the remaining is part sales. Those parts sales are dependent on loco parkings, on activity and so we can kind of see some short-term impact with fewer locos running. But as regions open up, economies open up, the auto industry opens up, we would see locos come back online and part sales recover kind of in hand. The freight car component business is -- got a service element to it, but it's mostly dependent on freight car builds, which are down. When I shift a little bit to Transit, 40% of that business is OE. There's backlog. These are long-cycle projects that have been won and are being executed on years. They were won years ago, and we're executing on them now, a little bit of disruption related to supply chain and customer capacity to accept our products. And then 60% is aftermarket, and that aftermarket business is kind of impacted. It's been -- there are some puts and takes there. There's been some negative impact as the transit authorities have adjusted their capacity with lower ridership. So we've seen some order -- changes in order activity there, but we've also seen some strength because we've had some customers that have used the opportunity to get caught up on some maintenance, some service activity and also make sure that they have adequate inventory on hand for any kind of disruption. So a little bit of pluses and minuses here and there.

Okay. So just so I understand. So it sounds like on the Freight side, the equipment and components are where we should see biggest sort of near-term pressure on sales and electronics and services should hold up relatively better. Do you think -- I mean I know electronics and services were up, sales were up double digits pro forma in first quarter. Do you think that those 2 pieces can remain positive right now on a year-over-year basis?

So Services, again, I think you've got the parts that's covered by backlog, the maintenance agreements and the mods. I think we can see some strength and stability there year-over-year. I think you look at the part sales. You have to recognize that they will be impacted by loco parkings and the basic activity of the Class Is. Digital electronics, which I think you mentioned, that was up year-over-year. That's also covered by our backlog. And as we execute today on a more full year basis, they're -- in our original guidance, we had some assumptions about convertibility of new orders that we were keeping a very tight look at that because it does kind of require our Class Is to make a decision about investing, investing that we think will lead to operating gains for them as part of their kind of overall PSR and cost-out strategies, but they are investments and so there could be some impact there, especially in the second half of the year.

So I want to ask one about Transit. Usually, Transit is the easy one to model, right? It's the steadiest business historically. I'm struggling with how do we think about Transit right now in an environment where ridership is just down so much? Is this having a bigger impact on Transit resales or Transit aftermarket sales? And then how do you guys plan for a world of maybe transit ridership is, I don't know if impaired is the right word, but for a long time, if just people aren't going back on trains, like how does this impact Transit margins, Transit revenue? How do you think about that?

Well, so I think kind of on a bigger Transit kind of view, we -- I think it's a little early to tell exactly what's going to happen. I think that -- I always -- I try to remind everybody that the majority of our revenues in Transit are outside of North America. And so what you're talking about is regions Europe, Asia, places that are very heavily dependent on public transportation. You kind of sit here and say it's hard to imagine that there could be a sizable shift that with the economies opening up, the regions opening up, the cities becoming more active, that the transit -- public transportation just doesn't kind of start to return to kind of typical levels. Does it go all the way back? I don't know. It's hard to say. I think it's going to go with the economy. What our customers -- what our -- the transit authorities are going to need to do is really look at their own operating model to create the confidence that's going to be needed in order to get people back on the trains, back on the buses. And that confidence comes with maybe reconfiguring interiors of vehicles, maybe improving the social distancing within the trains by adding more vehicles, by running more often. All of those things, I think, are going to be on the table and be considered, so that investment, that economic engine of public transportation doesn't get impaired, as you said. And I think that we play a part in all that. We have to help our customers come up with the solutions that they're going to need in order to get back to normal, whatever that looks like in the future. In the meantime, we know that not in Transit but also in Freight that there's going to be volume impacts. We have to take cost actions. We are very aggressively looking to consolidate our manufacturing spaces, reduce our footprint, achieve our synergies early, make sure that our variable costs are being adjusted with the new volume realities and that -- to the extent that we can get additional fixed cost, SG&A and other operating expenses out of the company, we can then maintain -- as a goal, maintain our margins on the lower volume levels.

So just a couple of follow-ups there. So can -- is there a number that you have in terms of the total amount of cost actions that you've taken so far year-to-date?

Year-to-date, we're focusing on -- we're looking at -- I don't think we gave any specifics. We did talk about reducing our manufacturing footprint by about 9% in the year. We've been reducing our head count with the goal of reducing labor costs in the operating lines, kind of real fixed cost reductions as well on top of the impact to our variable costs. We've cut discretionary spending. We've suspended hiring and merit increases and -- of course, looking at all our incentive programs. So all those things are contributing to our cost plan for the year. And of course, we're managing cash. That, to us, is absolutely critical that we make sure that we maintain our liquidity.

Okay. And then just on Transit, just a couple of follow-ups. So we've -- you've historically talked about transit ridership as the driver for Transit, but is that the wrong way to think about it now? Meaning, if the trains are operating, but no one is on them, which maybe is what's happening right now, is that still an okay outcome for you? And then someone just typed in, do you have any sense how much of your Transit business is in urban versus rural areas? And maybe in urban areas, it's just not really possible to switch to driving. And so is there any way -- so those are 2 separate questions.

Yes. I think the conclusion is, and having gone back and I kind of looked at it that way, but just my experience is that the majority of these Transit customers are in urban locations. You're talking about metros, subways, buses and it's -- you can't imagine these big cities like London or Paris or that -- without public transportation. That's kind of my point, is that, that investment has happened. And so now it's really going to be a shift to how do we operate more safely and more healthy for our riders to create that confidence so that people will use them again. Ridership, we've always talked about ridership as kind of a driver, a revenue driver, but it's always kind of directionally correct. You can't say -- it's not like an airline where you would say 80% ridership results in 80% reduction of capacity. You're still going to be -- the systems are going to run their trains, their buses in a -- not in a linear fashion. They're just going to be less crowded. And so I was giving an example on an earlier call, I think I read somewhere that ridership was down 80%, 8-0 percent, in the -- in that particular transit authority. But the actual cars online, their actual capacity was actually only down 20%. So there's an impact to us, and it's meaningful, and it has budget impacts for our customers, but it's not quite as dramatic a change.

Okay. You said a couple of times so far during our conversation about maintaining margins. Is that sort of the expectation? Was that a Transit comment? Or was that a full -- was that a consolidated Wabtec margin comment for 2020?

Sorry, that's for our company. I mean, when I've gone through, as I led off with a couple of these experiences in these years and we wanted -- our goal is just to maintain for the company our EBIT percentage on lower volumes. I mean, we are working to take cost out to make sure that we can defend the margin, so to speak, on a year-over-year basis in a challenging volume situation. So that's how we're operating. That's what we're working our teams towards.

Okay. And I don't think this came up on the first quarter call. When you had your Analyst Day in March and this situation had already started, you guys gave 5-year guidance. I know you pulled down the 2020 guidance, but I'm guessing 5 years, has anything changed with the 5-year guidance? Or at this point, you're still comfortable with that?

No. We've talked about that at a very high level, and we feel very good about that strategic plan. That was a 5-year view. It was a lot of inputs, a lot of thoughts. Things clearly have changed since then. But with the assumption of kind of back -- getting back to normal and maybe with a little bit of a pushout into future periods, we still think that, that 5-year strategic plan holds together very well. We have a lot of confidence in our ability to achieve them. And we liked what we presented at our Investor Day and continue to think that, that's where we are.

Okay. A bunch of questions came in online. So I'm just going to try get through those now. Is there a minimum free cash flow level we can think about for 2020? I know you guys burn cash in the first quarter. Do you expect first quarter free cash flow to be the low point for the year?

Yes.

And I'll just add to that. So working capital was a pretty large drag in the first quarter. Does it turn to a tailwind in the second quarter? Or is that more back half?

Yes, it becomes a tailwind. What -- we had 2 aspects to the first quarter cash flow. One -- and we talked about those in our original 2020 guidance. We had some onetimers related to the transactions, some restructuring costs, some litigation reserves that all get paid in Q1 and a little bit in Q2. $80 million impact in Q1. And we've said we estimated that the total impact for the year would be about $100 million. So that hurt us in Q1. We also have always -- both companies have had a certain seasonality to our cash flow performance, and it's very predictable. Some of it is payment of incentives and retirement plan amounts due in Q1. We have tax estimates, we have interest costs and that always impacts our Q1 cash from operations. We estimate that at about an $80 million impact in Q1. But that then becomes a tailwind. That becomes something that improves as we go through the rest of the year as we kind of replenish those reserves, so to speak. We also always overperform in Q4. If you remember, we were way over our estimates in Q4, and I think that had a little bit of impact in Q1. As we go through the rest of the year, to get to the meat of the question is, we think working capital will become a cash inflow. Lower volumes, you have the opportunity with working capital management to do well in terms of working capital. And we expect our cash conversion to be 90% and greater.

Okay. By the way, if anyone is listening to this and has questions asked, please do not email me. I am going to -- I'm definitely going to miss them, if you email me. Please just submit them through GoToWebinar or figure out some way to get someone to submit them. I'm not going to be able to get to them on email. Sorry about that. So question on the -- someone's asking on the backlog. So the $18 billion Freight backlog, how much of that's U.S., how much of that's Service, if you know?

I don't think we've disclosed that anywhere. I would say that the majority of it is Service related. We have these -- as I said earlier, we have these multiyear maintenance agreements that we deliver on and are probably the bulk of the $18 billion.

And so -- and you said the -- I think you said earlier, the OE backlog is almost entirely international on Freight, but you haven't said how big the total OE backlog is within?

No. I think what I was saying is that the revenue in the current year is mostly international loco build on OE and not a lot related to North America.

Okay. And there seems to be a lot of questions just about the backlog. Maybe just last one is people want to know how to think about -- I guess, I'm trying to summarize a few of these into one. Basically, is the backlog at risk of cancellation? What's the process of canceling? Are you seeing any increase in cancellations in the backlog?

What we've seen right now is that we have a lot of confidence in the backlog for the current year. Beyond the current year, what we are -- we haven't seen any, I would say, outright cancellations, but there is sort of a reconfiguring, so to speak, of timing and scope and mix into future periods. And I would -- and I think it's kind of normal. I don't view it as anything that is particularly troublesome. It's just the normal stuff of what our customers are doing as they're adjusting their own plans for spending going forward.

Okay. On the synergies with GE, is it still -- I think there's $230 million of incremental synergies left. What's the right number to think about for this year? And at this point, do you think there's upside to the $230 million?

Yes. So the incremental synergies for 2020 is about $120 million. So that, we feel really good about. We do think -- we have talked on earlier calls that there are some risks because some of the synergies are volume related, they're sourcing synergies. So with lower volume, maybe you don't get the entire buy done within the year and then, therefore, the savings. But it's not -- we don't think it's really significant or material to the -- for the $120 million incremental. We have really good programs in place and we're monitoring them, and we see these benefits coming through in our fixed costs and our other base costs. And so we think that we have great confidence in those. When you get into next year, we -- the original guidance was that we would get to the full $250 million run rate by the end of next year. Again, we feel good about that and are expecting to achieve that.

Okay. Someone's asking, are you benefiting from Germany's push to modernize their transit infrastructure?

Well, sure. I mean there's lots of opportunity there in Germany. Not only are they modernizing it, they're making it more environmentally friendly. They're -- and so that's really -- that's part of our opportunity for Germany and the rest of Europe.

Another one just came in. Transit margins were great in the first quarter despite the revenue decline. How much visibility do you have in Transit margins given the backlog?

So the margin definitely improved quarter-over-quarter. We had some better project execution. We had -- but I also feel like it's the starting point of our -- of all those things that we've been working on for a long time to just get Transit margins up, reducing our cost for quality, better sourcing, better labor utilization. All those things really paid off and improved the margin in the quarter and for the rest of the year. We think that, that's part of our plan, and we talked about that margin expansion over the strategic period. The last thing I would say is that we were also starting to see that we're doing a better job of order intake. That's -- we look at our backlog and our margin in the backlog and we're starting to see that, in total, really improve.

Okay. And then we're sort of out of the half an hour, but I'm going to just try and ask one last one that came in. So what -- do you have a way to put what percentage of the total Freight business is ultimately tied to North America? And then with record numbers of parked locomotives, does that, at some point, put a risk to your aftermarket business, if you could sort of use those parked locomotives for spare parts and things like that? I don't know if that's happening at all, can that happen?

Yes. So I would say -- let's start with the first question. So in terms of North America for Freight, so let me double-check. It's -- we're probably about over 50% of our Freight revenue is outside of the United States, okay? So that's our exposure. I think that's the right number. When I -- as for parked locomotives, that's what we monitor. For us, those parkings are -- affect our Service business, but our Service business is not just parts. So like for them to go cannibalize or tear a part of locomotive and use as spare parts, it's -- it doesn't have that as much impact as just having the loco part. And I think that in prior times of crisis, we've seen that when those Class Is have done that, they've really created more problems than they've saved on not buying parts from us. So I think it's not as much a risk. We want to make sure that when locos are parked, that it's our fleet that stays active, and we support that very heavily and work with our customers to make sure that happens.

Okay. Great. I think we need to wrap it there. Thank you so much, Pat, for doing this. Really appreciate, and glad to see you're doing well.

All right. Same for you and same for everybody else.

Thanks, everyone. So we're going to get going right away with our luncheon -- or, I guess, pretend lunch shipper panel with a bunch of really good freight transport shippers. Thanks, Pat.

Bye.