OVERVIEW
Wabtec is one of the world's largest providers of locomotives, value-added, technology-based equipment, systems, and services for the global freight rail and passenger transit industries. Our products are found on virtually allU.S. locomotives, freight cars and passenger transit vehicles, as well as in more than 100 countries throughout the world. Our products enhance safety, improve productivity and efficiency and reduce maintenance costs for customers, and many of our core products and services are essential in the safe and efficient operation of freight rail and passenger transit vehicles.Wabtec is a global company with operations in over 50 countries. In 2019, net sales of aftermarket parts and services represented about 55% of total net sales, while 60% of the Company's net sales came from customers outside theU.S. Management Review and Future OutlookWabtec's long-term financial goals are to generate cash flow from operations in excess of net income, maintain a strong credit profile while minimizing our overall cost of capital, increase margins through strict attention to cost controls and implementation of the Wabtec Excellence Program, and increase revenues through a focused growth strategy, including product innovation and new technologies, global and market expansion, aftermarket products and services, and acquisitions. In addition, Management evaluates the Company's current operational performance through measures such as quality and on-time delivery. The Company primarily serves the worldwide freight and transit rail industries. As such, our operating results are largely dependent on the level of activity, financial condition and capital spending plans of railroads and passenger transit agencies around the world, and transportation equipment manufacturers who serve those markets. Many factors influence these industries, including general economic conditions; traffic volumes, as measured by freight carloadings and passenger ridership; government spending on public transportation; and investment in new technologies. In general, trends such as increasing urbanization, a focus on sustainability and environmental awareness, an aging equipment fleet, and growth in global trade are expected to drive continued investment in freight and transit rail. The Company monitors a variety of factors and statistics to gauge market activity. Freight rail markets around the world are driven primarily by overall economic conditions and activity, while Transit markets are driven primarily by government funding and passenger ridership. Changes in these market drivers can cause fluctuations in demand forWabtec's products and services. According to the 2018 bi-annual edition of a market study by UNIFE, theAssociation of the European Rail Industry , the accessible global market for railway products and services was more than$100 billion and was expected to grow at a compounded annual growth rate of 2.6% through 2023. The three largest geographic markets, which represented about 80% of the total accessible market, wereEurope ,North America andAsia Pacific . UNIFE projected above-average growth rates inNorth America ,Latin America and Africa/Middle East , withAsia Pacific andEurope growing at about the industry average. UNIFE said trends such as urbanization and increasing mobility, deregulation, investments in new technologies, energy and environmental issues, and increasing government support continue to drive investment. The largest product segments of the market were rolling stock, services and infrastructure, which represent almost 90% of the accessible market. UNIFE projected spending on turnkey management projects and infrastructure to grow at above-average rates. UNIFE estimated that the global installed base of diesel and electric locomotives was about 114,800 units, with about 33% inAsia Pacific , about 26% inNorth America and about 18% inRussia -CIS (Commonwealth of Independent States).Wabtec estimates that about 2,900 new locomotives were delivered worldwide in 2019. UNIFE estimated the global installed base of freight cars was about 5.1 million, with about 33% inNorth America , about 26% inAsia Pacific and about 24% inRussia -CIS.Wabtec estimates that about 174,000 new freight cars were delivered worldwide in 2019. UNIFE estimated the global installed base of passenger transit vehicles to be about 600,000 units, with about 45% inAsia Pacific , about 33% inEurope and about 12% inRussia -CIS.Wabtec estimates that about 35,000 new passenger transit vehicles were ordered worldwide in 2019. InEurope , the majority of the rail system serves the passenger transit market, which is expected to continue growing as energy and environmental policies encourage continued investment in public mass transit and modal shift from car to rail. According to UNIFE,France ,Germany and theUnited Kingdom were the largest Western European transit markets, representing almost two-thirds of industry spending in theEuropean Union . UNIFE projected the accessible Western European rail market to grow at about 2.3% annually, led by investments in new rolling stock inFrance andGermany . About 75% of freight traffic inEurope is hauled by truck, while rail accounts for about 20%. The largest freight markets inEurope areGermany ,Poland and theUnited Kingdom . In recent years, theEuropean Commission has adopted a series of measures designed to increase the efficiency of the European rail network by standardizing operating rules and certification requirements. UNIFE believes that adoption of these measures should have a positive effect on ridership and investment in public transportation over time. 25 -------------------------------------------------------------------------------- InNorth America , railroads carry about 40% of intercity freight, as measured by ton-miles, which is more than any other mode of transportation. Through direct ownership and operating partnerships,U.S. railroads are part of an integrated network that includes railroads inCanada andMexico , forming what is regarded as the world's most-efficient and lowest-cost freight rail service. There are more than 500 railroads operating inNorth America , with the largest railroads, referred to as "Class I," accounting for more than 90% of the industry's revenues. The railroads carry a wide variety of commodities and goods, including coal, metals, minerals, chemicals, grain, and petroleum. These commodities represent about 50% of total rail carloadings, with intermodal carloads accounting for the rest. Railroads operate in a competitive environment, especially with the trucking industry, and are always seeking ways to improve safety, cost and reliability. New technologies offered byWabtec and others in the industry can provide some of these benefits. Demand for our freight related products and services inNorth America is driven by a number of factors, including rail traffic, and production of new locomotives and new freight cars. In theU.S. , the passenger transit industry is dependent largely on funding from federal, state and local governments, and from fare box revenues. Demand for North American passenger transit products is driven by a number of factors, including government funding, deliveries of new subway cars and buses, and ridership. TheU.S. federal government provides money to local transit authorities, primarily to fund the purchase of new equipment and infrastructure for their transit systems. Growth in theAsia Pacific market has been driven mainly by the continued urbanization ofChina andIndia , and by investments in freight rail rolling stock and infrastructure inAustralia to serve its mining and natural resources markets.India is making significant investments in rolling stock and infrastructure to modernize its rail system; for example, the country has awarded a 1,000-unit locomotive order to GE Transportation. Other key geographic markets include Russia-CIS andAfrica-Middle East . With about 1.2 million freight cars and about 20,000 locomotives, Russia-CIS is among the largest freight rail markets in the world, and it's expected to invest in both freight and transit rolling stock. PRASA, thePassenger Rail Agency of South Africa , is expected to continue to invest in new transit cars and new locomotives. According to UNIFE, emerging markets were expected to grow at above-average rates as global trade led to increased freight volumes and urbanization led to increased demand for efficient mass-transportation systems. As this growth occurs,Wabtec expects to have additional opportunities to provide products and services in these markets. In its study, UNIFE also said it expected increased investment in digital tools for data and asset management, and in rail control technologies, both of which would improve efficiency in the global rail industry. UNIFE said data-driven asset management tools have the potential to reduce equipment maintenance costs and improve asset utilization, while rail control technologies have been focused on increasing track capacity, improving operational efficiency and ensuring safer railway traffic.Wabtec offers products and services to help customers make ongoing investments in these initiatives. In 2020 and beyond, general global economic and market conditions will have an impact on our sales and operations. To the extent that these factors cause instability of capital markets, shortages of raw materials or component parts, longer sales cycles, deferral or delay of customer orders or an inability to market our products effectively, our business and results of operations could be materially adversely affected. In addition, we face risks associated with our four-point growth strategy including the level of investment that customers are willing to make in new technologies developed by the industry and the Company, and risks inherent in global expansion. When necessary, we will modify our financial and operating strategies to reflect changes in market conditions and risks. MERGER OF WABTEC WITH GE TRANSPORTATIONWabtec , General Electric Company ("GE"), GE Transportation, aWabtec company formerly known asTransportation System Holdings Inc. ("SpinCo"), which was a newly formed wholly owned subsidiary ofGE , andWabtec US Rail Holdings, Inc. ("Merger Sub"), which was a newly formed wholly owned subsidiary of the Company, entered into the Original Merger Agreement onMay 20, 2018 , andGE ,SpinCo ,Wabtec andWabtec US Rail, Inc. ("Direct Sale Purchaser") entered into the Original Separation Agreement onMay 20, 2018 , which together provided for the combination ofWabtec and GE Transportation. The Original Merger Agreement and Original Separation Agreement were subsequently amended onJanuary 25, 2019 and the Merger was completed onFebruary 25, 2019 . As part of the Merger, certain assets of GE Transportation, including the equity interests of certain pre-Transaction subsidiaries ofGE that compose part ofGE Transportation, were sold to Direct Sale Purchaser for a cash payment of$2.875 billion , and Direct Sale Purchaser assumed certain liabilities ofGE Transportation in connection with this purchase (the "Direct Sale"). Thereafter,GE transferred theSpinCo business toSpinCo and its subsidiaries (to the extent not already held bySpinCo and its subsidiaries), andSpinCo issued toGE shares of SpinCo Class A preferred stock, SpinCo Class B preferred stock, SpinCo Class C preferred stock and additional shares ofSpinCo common stock. Following this issuance of additionalSpinCo common stock toGE , and immediately prior to the Distribution (as defined below),GE owned 8,700,000,000 shares ofSpinCo common stock, 15,000 shares of SpinCo Class A preferred stock, 10,000 shares ofSpinCo Class B preferred stock and one share of SpinCo Class C preferred stock, which constituted all of the outstanding stock ofSpinCo . 26 -------------------------------------------------------------------------------- Following the Direct Sale,GE distributed the distribution shares ofSpinCo in a spin-off transaction to its stockholder (the "Distribution"). Immediately after the Distribution, Merger Sub merged with and intoSpinCo (the "Merger"), whereby the separate corporate existence of Merger Sub ceased andSpinCo continued as the surviving company and a wholly owned subsidiary ofWabtec (except with respect to shares of SpinCo Class A preferred stock held byGE ). In the Merger, subject to adjustment in accordance with the Merger Agreement, each share ofSpinCo common stock converted into the right to receive a number of shares ofWabtec common stock based on the common stock exchange ratio set forth in the Merger Agreement and the share of SpinCo Class C preferred stock was converted into the right to receive (a) 10,000 shares ofWabtec convertible preferred stock and (b) a number of shares ofWabtec common stock equal to 9.9% of the fully-diluted pro formaWabtec shares. Immediately prior to the Merger,Wabtec paid$10.0 million in cash toGE in exchange for all of the shares ofSpinCo Class B preferred stock. Upon consummation of the Merger,Wabtec issued 46,763,975 shares of common stock to the holders ofGE common stock, 19,018,207 shares of common stock toGE and 10,000 shares of preferred stock toGE and made a cash payment toGE of$2.885 billion . As a result and calculated based onWabtec's outstanding common stock on a fully-diluted, as-converted and as-exercised basis, as ofFebruary 25, 2019 , approximately 49.2% of the outstanding shares ofWabtec common stock was held collectively byGE and holders ofGE common stock (with 9.9% held byGE directly in shares ofWabtec common stock and 15% underlying the shares ofWabtec convertible preferred stock held byGE ) and approximately 50.8% of the outstanding shares ofWabtec common stock held by pre-Merger Wabtec stockholders, in each case calculated on a fully-diluted, as-converted and as-exercised basis. Following the Merger,GE also retained 15,000 shares of SpinCo Class A non-voting preferred stock, andWabtec held 10,000 shares of SpinCo Class B non-voting preferred stock. After the Merger,SpinCo , which isWabtec's wholly owned subsidiary (except with respect to shares of SpinCo Class A preferred stock held byGE ), and Direct Sale Purchaser, which also isWabtec's wholly owned subsidiary, together own and operate the post-transaction GE Transportation. All shares of the Company's common stock, including those issued in the Merger, are listed on the NYSE under the Company's current trading symbol "WAB." On the date of the Distribution,GE andSpinCo , directly or through subsidiaries entered into additional agreements relating to, among other things, intellectual property, employee matters, tax matters, research and development and transition services. OnMay 6, 2019 ,GE completed the sale of approximately 8,780 shares ofWabtec's Series A Preferred stock which converted upon the sale to 25,300,000 shares ofWabtec's common stock. OnAugust 9, 2019 ,GE completed a sale of the remaining shares of Series A Preferred Stock outstanding which converted to approximately 3,515,500 shares of common stock, as well as 16,969,656 shares of common stock owned directly byGE . Finally, onSeptember 12, 2019 ,GE completed a sale of all of its remaining shares of common stock ofWabtec , approximately 2,048,515 shares. In conjunction with these secondary offerings, the Company waived the requirements under the shareholders agreement forGE to maintain certain ownership levels ofWabtec's stock following the closing date of the Merger. The Company did not receive any proceeds from the sale of any of these shares. Total future consideration to be paid byWabtec toGE includes a fixed payment of$470.0 million , which is directly related to the timing of tax benefits expected to be realized byWabtec as a result of the acquisition ofGE Transportation. This payment is considered contingent consideration because the timing of cash payments toGE is directly related to the future timing of tax benefits received by the Company as a result of the acquisition ofGE Transportation. The estimated total value of the consideration to be paid byWabtec in the acquisition transaction is approximately$10.3 billion , including the cash paid for the Direct Sales Assets, equity transferred forSpinCo , contingent consideration, assumed debt and net of cash acquired. The estimated consideration is based on the Company's closing share price of$73.36 onFebruary 22, 2019 and the preliminary fair value of the contingent consideration. The value of the preliminary purchase price consideration could change when the Company has completed the detailed valuation of the contingent consideration and other necessary calculations. 27 -------------------------------------------------------------------------------- RESULTS OF OPERATIONS Consolidated Results 2019 COMPARED TO 2018
The following table shows our Consolidated Statements of Operations for the years indicated.
For the year ended December 31, In millions 2019 2018 Percent Change Net sales Sales of goods$ 6,907.9 $ 4,178.0 65.3 % Sales of services 1,292.1 185.5 596.5 % Total net sales 8,200.0 4,363.5 87.9 % Cost of sales Cost of goods (5,128.4) (2,973.5) 72.5 % Cost of services (793.6) (156.1) 408.4 % Total cost of sales (5,922.0) (3,129.6) 89.2 % Gross profit 2,278.0 1,233.9 84.6 % Selling, general and administrative expenses (1,166.6) (633.2) 84.2 % Engineering expenses (209.9) (87.5) 139.9 % Amortization expense (238.4) (39.8) 499.0 % Total operating expenses (1,614.9) (760.5) 112.3 % Income from operations 663.1 473.4 40.1 % Other income and expenses Interest expense, net (219.1) (112.2) 95.3 % Other income, net 2.8 6.4 (56.3) % Income from operations before income taxes 446.8 367.6 21.5 % Income tax expense (120.3) (75.9) 58.5 % Net income 326.5 291.7 11.9 % Less: Net loss attributable to noncontrolling interest 0.2 3.2 (93.8) % Net income attributable to Wabtec shareholders$ 326.7 $ 294.9 10.8 % Segment change The Company has two reportable segments-the Freight Segment and the Transit Segment. Initiatives to integrate GE Transportation operations intoWabtec including recent restructuring programs announced in late 2019 resulted in changes to the Company's organizational structure and the financial reporting utilized by the Company's chief operating decision maker to assess performance and allocate resources; as a result, certain asset groups were reorganized from the Freight Segment to the Transit Segment and vice versa. The change in the Company's reportable segments was effective in the fourth quarter of 2019 and is reflected below in 2019 and through the retrospective revision of 2018 and 2017 segment information. The Company believes these changes better present management's new view of the business. The following table shows the major components of the change in net sales in 2019 from 2018: Freight Transit In millions Segment Segment Total 2018 Net Sales$ 1,766.4 $ 2,597.1 $ 4,363.5 Acquisitions 3,840.7 22.8 3,863.5 Foreign Exchange (17.7) (136.7) (154.4) Organic (148.0) 275.4 127.4 2019 Net Sales$ 5,441.4 $ 2,758.6 $ 8,200.0 Net sales Net sales increased by$3.8 billion , or 87.9%, to$8.2 billion in 2019 from$4.4 billion in 2018. The increase is primarily due to net sales from acquisitions of$3.9 billion , mainly the acquisition of GE Transportation.GE Transportation contributed$3.8 billion of net sales in the year, primarily from locomotive equipment products and services. Additionally, Transit Segment net sales increased$162 million due to increased original equipment project deliveries for HVAC, door, and brake and coupler systems and higher aftermarket deliveries for brake and coupler spare parts and door systems. These increases were partially offset by an organic decrease of$148 million in the Freight Segment, primarily in Components due to a lower carbuild in 2019 and in Electronics due to lower PTC hardware demand. Unfavorable changes in foreign currency exchange rates reduced net sales by$154 million . 28 -------------------------------------------------------------------------------- Cost of sales Cost of sales increased by$2.8 billion to$5.9 billion in 2019 compared to$3.1 billion in 2018. The increase is primarily due to$2.8 billion of incremental costs from acquisitions, mainly GE Transportation. In 2019 cost of sales as a percentage of net sales was 72.2% compared to 71.7% in 2018. Cost of sales in 2019 includes$185 million of non-recurring costs related to purchase price accounting for the step-up of inventory of GE Transportation on the date of acquisition, and$38 million of restructuring charges related to certain plant consolidations. Cost of sales in 2018 included$18 million of restructuring costs, primarily in the Transit Segment. Excluding these non-recurring costs, cost of sales as a percentage of net sales was 69.5% in 2019 and 71.3% in 2018, representing a 1.8% improvement. The margin improvement can be attributed to the overall product mix, shifting away from lower margin Transit sales to higher margin Freight sales. Operating expenses Total operating expenses increased 112.3% to 19.7% of net sales in 2019 compared to 17.4% in 2018. Selling, general, and administrative expenses increased$533 million , or 84.2%, primarily due to$369 million of incremental expense from acquisitions, mainly GE Transportation, and$230 million of incrementalGE Transportation transaction and restructuring costs, as well as certain litigation costs. In the prior year, selling, general, and administrative expenses included$58 million of costs related to the GE Transportation transaction, restructuring costs related to the exit of certain operations and headcount reductions across the company and costs related to a goods and service tax law change inIndia . Engineering expense increased$122 million and amortization expense increased$199 million due to incremental expense from the acquisition of GE Transportation. Interest expense, net Interest expense, net, increased$107 million in 2019 attributable to higher overall debt balances related to the acquisition of GE Transportation. Income taxes The effective income tax rate was 26.9% and 20.6% in 2019 and 2018, respectively. The increase in the effective tax rate in 2019 is primarily the result of non-deductible transaction related expenses incurred as a result of the acquisition of GE Transportation, a higher earnings mix in higher tax jurisdictions, increased estimated liabilities resulting from the provision of the 2017 Tax Cuts and Jobs Act (the "Tax Act") as well as a benefit from the completion of the accounting for the income tax effects of the Tax Act recorded in 2018. 29 -------------------------------------------------------------------------------- Freight Segment The following table shows our Consolidated Statements of Operations for our Freight Segment: For the year ended December 31, In millions 2019 2018 Percent Change Net sales: Sales of goods$ 4,186.5 $ 1,616.3 159.0 % Sales of services 1,254.9 150.1 736.0 % Total net sales 5,441.4 1,766.4 208.1 % Cost of sales: Cost of goods (3,096.5) (1,072.9) 188.6 % Cost of services (763.5) (126.9) 501.7 % Total cost of sales (3,860.0) (1,199.8) 221.7 % Gross profit 1,581.4 566.6 179.1 % Operating Expenses (938.5) (232.3) 304.0 % Income from operations ($) 642.9 334.3 92.3 % Income from operations (%) 11.8 % 18.9 % The following table shows the major components of the change in net sales for the Freight Segment in 2019 from 2018: In millions 2018 Net Sales$ 1,766.4 Acquisitions 3,840.7 Changes in Sales by Product Line: Components (87.2) Electronics/Digital (70.1) Services 9.3 Foreign Exchange (17.7) 2019 Net Sales$ 5,441.4 Net sales Freight Segment net sales increased by$3.7 billion , or 208.1%, to$5.4 billion , due to the acquisition of GE Transportation which contributed$3.8 billion of net sales in the year, primarily from locomotive equipment products and services. This increase was partially offset by lower net sales in Components due to a lower freight carbuild in 2019 and certain restructuring and plant consolidation efforts, and inDigital Electronics due to lower PTC hardware demand. Unfavorable foreign currency exchange rate changes decreased net sales by$18 million . Cost of sales Freight Segment cost of sales increased by$2.7 billion to$3.9 billion in 2019. The increase is primarily due to$2.8 billion of incremental cost of sales and services from the acquisition of GE Transportation. In 2019, total cost of sales as a percentage of total net sales was 70.9% compared to 67.9% in 2018. Total cost of sales in 2019 includes$185 million of non-recurring costs related to purchase price accounting for the step-up of the inventory of GE Transportation on the date of acquisition and$34 million of restructuring costs related to integrating our combined business. Excluding these non-recurring costs, total cost of sales as a percentage of net sales was 66.9%, 1.0% lower than 2018. This decrease can be attributed to a higher mix of freight services sales offset by a decrease in the higher margin sales fromDigital Electronics . Operating expenses Freight Segment operating expenses increased$706 million , or 304.0%, in 2019 and increased to 17.2% of net sales. Selling, general, and administrative expenses increased$397 million due to$368 million in incremental expense from the acquisition of GE Transportation and$33 million for transaction and restructuring costs related to the GE Transportation transaction. Engineering expense increased$116 million and amortization expense increased$200 million , both due to the acquisition of GE Transportation. 30 -------------------------------------------------------------------------------- Transit Segment The following table shows our Consolidated Statements of Operations for our Transit Segment: For the year ended December 31, In millions 2019 2018 Percent Change Net sales$ 2,758.6 $ 2,597.1 6.2 % Cost of sales (2,062.0) (1,929.8) 6.9 % Gross profit 696.6 667.3 4.4 % Operating Expenses (482.2) (474.8) 1.6 % Income from operations ($) 214.4 192.5 11.4 % Income from operations (%) 7.8 % 7.4 % The following table shows the major components of the change in net sales for the Transit Segment in 2019 from 2018: In millions 2018 Net Sales$ 2,597.1 Acquisitions 22.8 Changes in Sales by Product Line: OEM 141.3 Aftermarket 134.1 Foreign Exchange (136.7) 2019 Net Sales$ 2,758.6 Net sales Transit Segment net sales increased by$162 million , or 6.2%, primarily due to increased original equipment project deliveries for HVAC, door, and brake and coupler systems and higher aftermarket deliveries for brake and coupler spare parts and door systems. Unfavorable foreign currency exchange rate changes decreased net sales by$137 million . Cost of sales Transit Segment cost of sales increased by$132 million to$2.1 billion in 2019. In 2019, cost of sales as a percentage of net sales was 74.7% compared to 74.3% in 2018. Total cost of sales includes$5 million of restructuring charges primarily related to severance and plant consolidations while total cost of sales in 2018 included$16 million of restructuring costs. Excluding these costs, total cost of sales as a percentage of net sales was 74.6% in 2019 and 73.7% in 2018. This increase can be attributed to an unfavorable product mix consisting of lower margin overhaul contracts and less original equipment and aftermarket brake and coupler systems. Operating expenses Transit Segment operating expenses increased$7 million to$482 million , or 1.6% in 2019 and decreased 80 basis points to 17.5% of net sales. Operating expenses includes$13 million for restructuring costs in the current year, compared to$26 million in the prior year. The decrease as a percentage of net sales can be attributed to the effect of prior year restructuring plans and headcount reductions in the current year. 31 -------------------------------------------------------------------------------- 2018 COMPARED TO 2017
The following table summarizes the results of operations for the period:
For the year ended December 31, In millions 2018 2017 Percent Change Net sales Sales of goods$ 4,178.0 $ 3,685.6 13.4 % Sales of services 185.5 196.1 (5.4) % Total net sales 4,363.5 3,881.7 12.4 % Cost of sales Cost of goods (2,973.5) (2,667.8) 11.5 % Cost of services (156.1) (148.6) 5.0 % Total cost of sales (3,129.6) (2,816.4) 11.1 % Gross profit 1,233.9 1,065.3 15.8 % Selling, general and administrative expenses (633.2) (512.5) 23.6 % Engineering expenses (87.5) (95.2) (8.1) % Amortization expense (39.8) (36.5) 9.0 % Total operating expenses (760.5) (644.2) 18.1 % Income from operations 473.4 421.1 12.4 % Other income and expenses Interest expense, net (112.2) (77.9) 44.0 % Other income, net 6.4 8.9 (28.1) % Income from operations before income taxes 367.6 352.1 4.4 % Income tax expense (75.9) (89.8) (15.5) % Net income 291.7 262.3 11.2 % Less: Net loss attributable to noncontrolling interest 3.2 - 100.0 % Net income attributable to Wabtec shareholders$ 294.9 $ 262.3 12.4 % The following table shows the major components of the change in net sales in 2018 from 2017: In millions Freight Transit Total 2017 Net Sales$ 1,538.6 $ 2,343.1 $ 3,881.7 Acquisitions 50.9 83.8 134.7 Foreign Exchange (1.5) 63.7 62.2 Organic 178.4 106.5 284.9 2018 Net Sales$ 1,766.4 $ 2,597.1 $ 4,363.5 Net sales Net sales increased by$482 million to$4.4 billion in 2018 from$3.9 billion in 2017. The increase is primarily due to an organic increase of$113 million from higher demand for freight rail components, an increase of$76 million for train control and signaling products, and an increase of$124 million due to transit original equipment and aftermarket brake and coupler products, partially offset by lower door and HVAC sales. Additionally, sales from acquisitions increased net sales by$135 million , and favorable foreign exchange increased net sales$62 million . Cost of sales Cost of sales increased by$313.2 million to$3.1 billion in 2018 compared to$2.8 billion in 2017. In 2018, cost of sales as a percentage of net sales was 71.7% compared to 72.5% in 2017. Cost of sales in 2018 includes$18 million of restructuring costs, primarily in the Transit Segment. Cost of sales in 2017 includes$45 million of project adjustments on certain projects and$12 million of restructuring and integration costs related to recent acquisitions, all of which were primarily in the Transit Segment. Excluding the restructuring costs and contract adjustments in both years, cost of sales increased 0.2% as a percentage of net sales. 32 -------------------------------------------------------------------------------- Operating Expenses Total operating expenses as a percentage of net sales increased 0.8% to 17.4% in 2018 compared to 16.6% in 2017. Selling, general, and administrative expenses increased$121 million , or 23.5%, primarily due to$21 million of costs related to the GE Transportation transaction,$20 million of restructuring costs related to the exit of certain operations and headcount reductions across the company,$7 million of costs related to a goods and service tax law change inIndia ,$15 million of increased employee benefit costs and$18 million in incremental expense from acquisitions. Changes in foreign currency rates increased selling, general, and administrative expenses by$14 million and organic sales volume increases contributed to the remainder of the change. In 2017, selling, general, and administrative expenses included$30 million ofFaiveley Transport transaction and restructuring costs. Engineering expense decreased by$8 million , or 8.1%, primarily due to timing of research and development expenses. Amortization expense increased$3 million due to amortization of intangibles associated with acquisitions. Interest expense, net Overall interest expense, net, increased$34 million in 2018 because of interest expense associated with the GE Transportation transaction of$29 million . In addition, net interest expense in the prior year included a$2 million benefit related to the prepayment of debt assumed in theFaiveley Transport acquisition. Income taxes The effective income tax rate was 20.6% and 25.5% in 2018 and 2017, respectively. OnDecember 22, 2017 , theU.S. government enacted comprehensive tax legislation commonly referred to as the Tax Act. TheU.S. tax reform bill lowered the Federal statutory tax rate from 35% to 21% beginningJanuary 1, 2018 . The decrease in the effective tax for the twelve months endedDecember 31, 2018 is the result of higher earnings mix in lower tax jurisdictions as well as a benefit from the completion of the accounting for the income tax effects of the Tax Act and the adjustment to the provisional amounts previously recorded in accordance withSEC Staff Accounting Bulletin No. 118 which was partially offset by the reversal of non-recurring tax benefits recorded in the twelve months endedDecember 31, 2018 . 33 --------------------------------------------------------------------------------
Freight Segment The following table shows our Consolidated Statements of Operations for our Freight Segment for the periods indicated.
For the year ended December 31, In millions 2018 2017 Percent Change Net sales: Sales of goods$ 1,616.3 $ 1,378.2 17.3 % Sales of services 150.1 160.4 (6.4) % Total net sales 1,766.4 1,538.6 14.8 % Cost of sales: Cost of goods (1,072.9) (952.2) 12.7 % Cost of services (126.9) (119.1) 6.5 % Total cost of sales (1,199.8) (1,071.3) 12.0 % Gross profit 566.6 467.3 21.2 % Operating Expenses (232.3) (195.6) 18.8 % Income from operations ($) 334.3 271.7 23.0 % Income from operations (%) 18.9 % 17.7 % The following table shows the major components of the change in net sales for the Freight Segment in 2018 from 2017: In millions 2017 Net Sales$ 1,538.6 Acquisitions 50.9 Changes inNet Sales by Product Line: Components 112.7 Digital Electronics 75.7 Services (10.0) Foreign Exchange (1.5) 2018 Net Sales$ 1,766.4 Net sales Freight Segment net sales increased by$228 million , or 14.8%, primarily due to an organic increase of$113 million from higher demand for freight rail components and an increase of$76 million for train control and signaling products. Acquisitions increased net sales by$51 million . Cost of sales Freight Segment cost of sales decreased 1.7% as a percentage of net sales to 67.9% in 2018 compared to 69.6% in 2017. The decrease is primarily related to a favorable product mix which saw an increase in net sales for train control and signaling products and services and freight car products due to an increase in freight cars built which have a higher margin. Additionally, there were$11 million of project adjustments and restructuring costs in 2017, which did not recur in 2018. Operating expenses Freight Segment operating expenses increased$37 million , or 18.8%, in 2018. The increase is primarily attributable to increased sales and marketing expenses attributable to the increased sales volumes and, increased employee benefit costs, and$11 million of incremental operating expenses from prior year acquisitions. 34 -------------------------------------------------------------------------------- Transit Segment The following table shows our Consolidated Statements of Operations for our Transit Segment: For the year ended December 31, In millions 2018 2017 Percent Change Net sales$ 2,597.1 $ 2,343.1 10.8 % Cost of sales (1,929.8) (1,745.1) 10.6 % Gross profit 667.3 598.0 11.6 % Operating Expenses (474.8) (420.8) 12.8 % Income from operations ($) 192.5 177.2 8.6 % Income from operations (%) 7.4 % 7.6 % The following table shows the major components of the change in net sales for the Transit Segment in 2018 from 2017: In millions 2017 Net Sales$ 2,343.1 Acquisitions 83.8 Changes inNet Sales by Product Line: OEM 61.4 Aftermarket 45.1 Foreign Exchange 63.7 2018 Net Sales$ 2,597.1 Net sales Transit Segment net sales increased by$254 million , or 10.8%, primarily due to$84 million from sales related to acquisitions, a$61 million increase primarily for original equipment brake products, and favorable foreign exchange of$64 million . Cost of sales Transit Segment cost of sales decreased 0.2% as a percentage of net sales to 74.3% in 2018 compared to 74.5% in 2017. Cost of sales in 2018 includes$16 million of restructuring costs primarily related to the downsizing of operations in theU.K. and consolidation of certain operations in theU.S. andChina . Cost of sales in 2017 includes$38 million of project adjustments on certain contracts primarily related to material and warranty cost and$7 million of restructuring and integration costs related to recent acquisitions. Excluding the restructuring costs and contract adjustments in both years, Transit Segment cost of sales increased 1.1% as a percentage of net sales. This increase is a result of additional costs on projects primarily in theU.K. Operating expenses Transit Segment operating expenses increased$54 million , or 12.8%, in 2018 and increased 30 basis points to 18.3% of net sales. Operating expense included$18 million and$20 million of restructuring and integration charges in 2018 and 2017, respectively. The 2018 restructuring charges related to the exit of certain operations and headcount reductions and the 2017 restructuring charges related to Faiveley Transportation integration costs. Additionally, in 2018, operating expenses includes$7 million of costs related to a goods and service tax law change inIndia . Excluding restructuring and integration costs in both years and the impact of the goods and service tax law change in 2018, Transit operating expenses increased$49 million . This increase is primarily due to increased sales volumes, increased employee benefit costs of$10 million , and$11 million of incremental operating expenses from acquisitions. In addition, changes in foreign currency rates increased operating expenses by$16 million . 35 -------------------------------------------------------------------------------- Liquidity and Capital Resources Liquidity is provided by operating cash flow and borrowings under the Company's unsecured credit facility with a consortium of commercial banks. The following is a summary of selected cash flow information and other relevant data: For the year ended December 31, In millions 2019 2018
2017
Cash provided by (used for): Operating activities$ 1,015.5 $ 314.7 $ 188.8 Investing activities (3,177.8) (147.3) (1,033.5) Financing activities: Proceeds from debt 3,982.4 3,480.7 1,216.7 Payments of debt (3,423.6) (1,454.0) (1,269.5) Cash dividends (81.7) (46.3) (42.2) Operating activities. Cash provided by operations in 2019 was$1,016 million compared with$315 million in 2018. In comparison to 2018, cash provided by operations increased due to favorable working capital performance and higher net income of$35 million . The major components of the increase in cash provided by operations were as follows: a favorable change in inventories of$365 million which is attributable to improved controls over inventory management directed at reducing inventory levels and the liquidation of acquired inventory related to the acquisition of GE Transportation, improved performance on the collection of accounts receivable of$48 million , a favorable change in non-cash items of$228 million related primarily to increased depreciation and amortization as a result of the acquisition of GE Transportation, and a favorable change in other assets and liabilities of$259 million primarily due to the timing of payments related to accrued expenses. These favorable changes in working capital were offset by an unfavorable change in accounts payable of$193 million due to the timing of payments to suppliers. Cash provided by operations in 2018 was$315 million compared with$189 million in 2017. In comparison to 2017, cash provided by operations increased due to favorable working capital performance and higher net income of$29 million . The major components of the increase in cash provided by operations were as follows: a favorable change in accounts payable of$141 million due to the timing of payments to suppliers, a favorable change in taxes of$22 million due to the revaluation of deferred taxes caused by the Tax Act and the timing of income tax payments, and a favorable change in accrued liabilities and customer deposits of$51 million due to an increase in customer advances during 2018. These favorable changes in working capital were offset by an unfavorable change in inventory of$100 million due to efforts to ramp up production in anticipation of stronger product demand in 2019. Investing activities. In 2019, 2018 and 2017, cash used in investing activities was$3,178 million ,$147 million and$1,034 million , respectively. The major components of the cash outflow in 2019 was$2,996 million in net cash paid for primarily the GE Transportation acquisition and planned additions to property, plant, and equipment of$185 million for continued investments in our facilities and manufacturing processes. This compares to$93 million for property, plant, and equipment additions and$51 million in net cash paid for acquisitions in 2018. In 2017,$90 million of cash was used to purchase property, plant, and equipment and net cash paid for acquisitions was$945 million , primarily related to the acquisition ofFaiveley Transport . Financing activities. In 2019, cash provided by financing activities was$462 million , which included net proceeds from debt of$559 million and$82 million of dividend payments. In 2018, cash provided by financing activities was$1,978 million , which included net proceeds from debt of$2,027 million and dividend payments of$46 million . In 2017, cash used for financing activities was$97 million , which included net repayments of debt of$53 million and dividend payments of$42 million . 36 -------------------------------------------------------------------------------- The following table shows outstanding indebtedness atDecember 31, 2019 and 2018: December 31, In millions 2019 2018 Senior Credit Facility:
231.5 -
Floating Senior Notes, due 2021, net of unamortized debt
issuance costs of
498.0 496.8 4.375% Senior Notes, due 2023, net of unamortized discount and debt issuance costs of$0.9 and$1.2 249.1 248.8
4.15% Senior Notes, due 2024, net of unamortized debt
issuance costs of
744.3 743.0
4.70% Senior Notes, due 2028, net of unamortized debt
issuance costs of
1,240.8 1,239.7
3.45% Senior Notes, due 2026, net of unamortized debt
issuance costs of
748.5 748.3 Other Borrowings 32.4 42.2 Total 4,429.3 3,856.9 Less - current portion 95.7 64.1 Long-term portion$ 4,333.6 $ 3,792.8 Senior Notes OnSeptember 14, 2018 in order to fund the GE Acquisition and related fees and expenses, we issued a total of$2.5 billion in aggregate principal amount of unsecured senior notes (in two separate series of fixed rate unsecured senior notes "Senior Notes" and one series of floating rate unsecured senior notes "Floating Senior Notes"). We collectively refer to the Floating Senior Notes and the Senior Notes as the "Notes." Upon issuance, the Notes were reflected on our Consolidated Balance Sheets net of discount of$2.9 million and net of the capitalized debt issuance costs, including commissions and offering expenses of$18.0 million , both of which will be amortized in interest expense through the respective maturity dates of each series of unsecured senior notes using the effective interest method. The Floating Senior Notes bear interest at a floating rate equal to the three-month LIBOR rate plus 1.05% per year; the Senior Notes due 2024 bear interest at 4.15% per year; and the Senior Notes due 2028 bear interest at 4.70% per year. The interest rate payable on the Notes will be subject to adjustment based on certain rating events. Interest on the Senior Notes is payable semi-annually in arrears onMarch 15th andSeptember 15th of each year, commencing onMarch 15, 2019 . Interest on the Floating Senior Notes is payable quarterly in arrears onDecember 15 ,March 15 ,June 15 , andSeptember 15 of each year, commencing onDecember 15, 2018 . The U.K Financial Conduct Authority (the "FCA"), which regulates LIBOR, has announced that theFCA will no longer persuade nor compel banks to submit rates for the calculation of LIBOR after 2021, and the continuation of LIBOR cannot be guaranteed after 2021. The indenture for the Floating Senior Notes provides that upon a permanent discontinuation of LIBOR while the Floating Senior Notes remain outstanding, an alternative reference rate will be used subject to adjustments consistent with industry-accepted practice for such alternative reference rate. The issuance was comprised of the following three series of notes: Senior Notes (in Discount Net Price Issuance millions) Par Value at Issuance at Issuance Cost Net Proceeds Floating Senior Notes due 2021$ 500.0 $ -$ 500.0 $ 3.5 $ 496.5 4.15% Senior Notes due 2024 750.0 1.5 748.5 7.4 741.1 4.70 Senior Notes due 2028 1,250.0 1.4 1,248.6 10.6 1,238.0 Total$ 2,500.0 $ 2.9 $ 2,497.1 $ 21.5 $ 2,475.6 Consistent with the Company's existing senior notes, the newly issued Notes are senior unsecured obligations of the Company and rank pari passu with all existing and future senior debt and senior to all existing and future subordinated indebtedness of the Company. The indentures under which the Notes were issued contain covenants and restrictions which limit among other things, the following: the incurrence of indebtedness, payment of dividends and certain distributions, sales of assets, change in control, mergers and consolidations and the incurrence of liens. But the covenants do not require the Company to maintain any financial ratios or specified levels of net worth or liquidity. The Company may redeem each series of the Notes 37 -------------------------------------------------------------------------------- at any time in whole or from time to time in part in accordance with the provisions of the indentured, under which such series of Notes was issued. Upon the occurrence of a change of control repurchase event with respect to the Notes, each holder of the Notes has the right to require the Company to purchase that holder's Notes at a price equal to 101% of the principal amount thereof, plus accrued and unpaid interest, unless the Company has exercised its option to redeem all the Notes. OnFebruary 12, 2019 , the rating assigned by Moody's was decreased to Ba1. Accordingly, pursuant to the respective terms of the Senior Notes issued onSeptember 14, 2018 , the interest rate increased by 0.25%. The interest rate increase took effect from the next interest period followingFebruary 12, 2019 . The Company is in compliance with the restrictions and covenants in the indenture under which the Notes were issued and expects that these restrictions and covenants will not be any type of limiting factor in executing our operating activities. Term Loan Agreement OnJune 8, 2018 , the Company arranged (i) a$350.0 million term loan with proceeds used to refinance existing loans (the "Refinancing Term Loan"), and (ii) a new$400.0 million delayed draw term loan in order to fund theGE Acquisition and related fees and expenses (the "Delayed Draw Term Loan"). The Company collectively refers to the Refinance Term Loans and the Delayed Draw Term Loans as the "Term Loans." Consistent with our other debt securities, the Term Loan Agreement includes covenants that, among other things, limit our liens and the liens of certain of our consolidated subsidiaries. In addition, it requires us to maintain the same financial maintenance covenants as discussed below. Loans under the Term Loan bear interest at a variable rate based on, at the Company's option, either the ABR rate or the LIBOR rate (each as defined in the Term Loan Agreement) plus an applicable margin that is determined based on our credit ratings or the Company's ratio of total debt (less unrestricted cash up to$300.0 million ) to EBITDA ("Leverage Ratio"). As ofDecember 31, 2019 , the applicable margin was 0.375% for base rate loans and 1.375% for Eurodollar rate loans. Senior Credit Facility OnJune 8, 2018 , the Company entered into a credit agreement (the "Senior Credit Facility"), which replaced the Company's then-existing "2016 Refinancing Credit Agreement." The Senior Credit Facility is with a syndicate of lenders and provides for borrowings consisting of (i) term loans denominated in euros andU.S. dollars; and (ii) a multi-currency revolving loan facility, providing for an equivalent inU.S. dollars of up to$1,200.0 million in multi-currency revolving loans (inclusive of swingline loans of up to$75.0 million and letters of credit of up to$450.0 million ). The multi-currency revolving loan facility will mature onJune 8, 2023 , and the Term Loans will mature onJune 8, 2021 . Subject to any mandatory or optional prepayments, the Term Loans are required to be repaid on a quarterly basis in an amount equal to 2.5% of the principal amount drawn, with the final payment due at maturity. The following table presents availability under our credit facilities: (in millions) Multi-currency revolving loan facility Maximum Availability$ 1,200.0 Outstanding Borrowings 232.0 LC Under Credit Agreement 31.0 Current Availability$ 938.0 Under the Senior Credit Facility, we can elect to receive advances bearing interest based on either the ABR rate or the LIBOR rate (each as defined in the Credit Agreement) plus an applicable margin that is determined based on our credit ratings or the Company's Leverage Ratio. As ofDecember 31, 2019 , the applicable margin was 0.375% for base rate advances and 1.375% for LIBOR rate advances. The Company also pays fees related to the Senior Credit Facility. The largest of these fees is a commitment fee on the unused portion of the multi-currency revolving loan facility of 0.10% to 0.30% per annum (currently 0.15% per annum), depending on our credit ratings or Leverage Ratio. None of the fees were material to interest expense. The obligations under the Senior Credit Facility are guaranteed byWabtec and each ofWabtec's wholly owned subsidiaries (collectively, the "Subsidiary Guarantors"). In addition, the Senior Credit Facility contains a number of customary affirmative and negative covenants. In addition to other and customary covenants, the Senior Credit Facility and the Term Loan each require that we maintain the financial covenants listed below as of the end of each fiscal quarter for the period of four fiscal quarters then ended. The Company was in compliance with all of our covenants in the Credit Agreement and the Term Loans as ofDecember 31, 2019 . 38 --------------------------------------------------------------------------------
Interest Coverage Ratio 1 3.0x Leverage Ratio 2 3.25x 1. The interest coverage ratio is defined as EBITDA, as defined in the Credit Agreement and Term Loan Agreement, to net interest expense for the four quarters then ended. 2. The leverage ratio is defined as net debt as of the last day of such fiscal quarter to EBITDA, as defined in the Amendment Credit Agreement and Term Loan Agreement, for the four quarters then ended. The 2018 Senior Credit Facility contains an uncommitted accordion feature allowing the Company to request the establishment, in an aggregate amount not to exceed$600.0 million , of incremental borrowing commitments under the Revolving Credit Facility or of incremental term loan commitment. TheFCA , which regulates LIBOR, has announced that theFCA will no longer persuade nor compel banks to submit rates for the calculation of LIBOR after 2021, and the continuation of LIBOR cannot be guaranteed after 2021. The Senior Credit Agreement provides that upon a permanent discontinuation of LIBOR, an alternate rate of interest will be established by the administrative agent and the Company giving due consideration to then prevailing U.S. market convention. AtDecember 31, 2019 , the weighted average interest rate on the Company's variable rate debt was 3.08%. Cash PoolingWabtec aggregates the Company's domestic cash position on a daily basis. Outsidethe United States , the Company uses cash pooling arrangements with banks to help manage our liquidity requirements. In these pooling arrangements,Wabtec subsidiaries "Participants" agree with a single bank that the cash balances of any of the pool Participants with the bank will be subject to a full right of set-off against amounts other Participants owe the bank, and the bank provides for overdrafts as long as the net balance for all Participants does not exceed an agreed-upon level. Typically, each Participant pays interest on outstanding overdrafts and receives interest on cash balances. The Company's Consolidated Balance Sheets reflect cash, net of bank overdrafts, under all pooling arrangements. 39 -------------------------------------------------------------------------------- Contractual Obligations and Off-Balance Sheet ArrangementsThe Company is obligated to make future payments under various contracts such as debt agreements, lease agreements and has certain contingent commitments such as debt guarantees. The Company has grouped these contractual obligations and off-balance sheet arrangements into operating activities, financing activities, and investing activities in the same manner as they are classified in the Statement of Consolidated Cash Flows to provide a better understanding of the nature of the obligations and arrangements and to provide a basis for comparison to historical information. The table below provides a summary of contractual obligations and off-balance sheet arrangements as ofDecember 31, 2019 : Less than 1 - 3 3 - 5 More than In millions Total 1 year years years 5 years Operating activities: Purchase obligations (1)$ 387.3 $ 68.4
303.2 53.9 83.4 62.7 103.2 Pension benefit payments (3) 206.5 19.2 39.6 41.4 106.3 Postretirement benefit payments (4) 9.4 1.1 2.1 2.0 4.2 Financing activities: Interest payments (5) 945.2 171.9 290.8 222.1 260.4 Long-term debt (6) 4,429.3 95.7 1,109.8 1,234.5 1,989.3 Dividends to shareholders (7) 92.0 92.0 - - -
Other:
Standby letters of credit (8) 714.0 183.5 112.5 152.9 265.1 Total$ 7,086.9 $ 685.7 $ 1,732.0 $ 1,933.0 $ 2,736.2 (1)Purchase obligations represent non-cancelable contractual obligations atDecember 31, 2019 . In addition, the Company had$1.5 billion of open purchase orders for which the related goods or services had not been received. Although open purchase orders are considered enforceable and legally binding, their terms generally allow us the option to cancel, reschedule and adjust our requirements based on our business needs prior to the delivery of goods or performance of services. (2)Future minimum payments for operating leases are disclosed by year in Note 15 of the "Notes to Consolidated Financial Statements" included in Part IV, Item 15 of this report. (3)Annual payments to participants are expected to continue into the foreseeable future at the amounts or ranges noted. Pension benefit payments are based on actuarial estimates using current assumptions for discount rates, expected return on long-term assets and rate of compensation increases. The Company expects to contribute about$10.9 million to pension plan investments in 2020. See further disclosure in Note 10 of the "Notes to Consolidated Financial Statements" included in Part IV, Item 15 of this report. (4)Annual payments to participants are expected to continue into the foreseeable future at the amounts or ranges noted. Postretirement payments are based on actuarial estimates using current assumptions for discount rates and health care costs. (5)Interest payments are payable March, June, September and December of each year at a rate based on contractual terms of Floating Senior Notes due 2021. Interest payments are payable May and September of each year at 4.15% of$750 million Senior Notes due 2024. Interest payments are payable March and September of each year at 4.7% of$1,250 million Senior Note due 2028. Interest payments are payable May and November of each year at 3.45% of$750 million Senior Notes due in 2026. Interest payments are payable February and August of each year at 4.375% of$250 million Senior Notes due in 2023. Interest payments for the Revolving Credit Facility and Other Borrowings are based on contractual terms and the Company's current interest rates. (6)Scheduled principal repayments of outstanding loan balances are disclosed in Note 9 of the "Notes to Consolidated Financial Statements" included in Part IV, Item 15 of this report. (7)Shareholder dividends are subject to approval by the Company's Board of Directors, currently at an annual rate of approximately$92.0 million . (8)The$714.0 million of standby letters of credit is comprised of outstanding letters of credit for performance and bid bond purposes, which expire in various dates through 2034. Amounts include interest payments based on contractual terms and the Company's current interest rate. The above table does not reflect uncertain tax positions of$17.2 million , the timing of which are uncertain. Refer to Note 11 of the "Notes to Consolidated Financial Statements" for additional information on uncertain tax positions. 40 -------------------------------------------------------------------------------- Obligations for operating activities. The Company has entered into$387.3 million of material long-term non-cancelable materials and supply purchase obligations. Operating leases represent multi-year obligations for rental of facilities and equipment. Estimated pension funding and post-retirement benefit payments are based on actuarial estimates using current assumptions for discount rates, expected return on long-term assets, rate of compensation increases and health care cost trend rates. Benefits paid for pension obligations were$16.0 million and$17.0 million in 2019 and 2018, respectively. Benefits paid for post-retirement plans were$0.9 million and$1.0 million in 2019 and in 2018, respectively. Obligations for financing activities. Cash requirements for financing activities consist primarily of long-term debt repayments, interest payments and dividend payments to shareholders. The Company has historically paid quarterly dividends to shareholders, subject to quarterly approval by our Board of Directors, currently at a rate of approximately$92.0 million annually. The Company arranges for performance bonds to be issued by third party insurance companies to support certain long term customer contracts. AtDecember 31, 2019 , the initial value of performance bonds issued on the Company's behalf is about$619 million . Forward Looking Statements We believe that all statements other than statements of historical facts included in this report, including certain statements under "Business" and "Management's Discussion and Analysis of Financial Condition and Results of Operations," may constitute forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events. Although we believe that our assumptions made in connection with the forward-looking statements are reasonable, we cannot assure that our assumptions and expectations are correct. These forward-looking statements are subject to various risks, uncertainties and assumptions about us, including, among other things: Economic and industry conditions •prolonged unfavorable economic and industry conditions in the markets served by us, includingNorth America ,South America ,Europe ,Australia ,Asia andSouth Africa ; •decline in demand for freight cars, locomotives, passenger transit cars, buses and related products and services; •reliance on major original equipment manufacturer customers; •original equipment manufacturers' program delays; •demand for services in the freight and passenger rail industry; •demand for our products and services; •orders either being delayed, canceled, not returning to historical levels, or reduced or any combination of the foregoing; •consolidations in the rail industry; •continued outsourcing by our customers; •industry demand for faster and more efficient braking equipment; •fluctuations in interest rates and foreign currency exchange rates; or •availability of credit; Operating factors •supply disruptions including but not limited to disease outbreak, fires, earthquakes, explosions, floods, tornadoes, hurricanes or weather conditions; •technical difficulties; •changes in operating conditions and costs; •increases in raw material costs; •successful introduction of new products; •performance under material long-term contracts; •labor relations; 41 -------------------------------------------------------------------------------- •the outcome of our existing or any future legal proceedings, including litigation involving our principal customers and any litigation with respect to environmental matters, asbestos-related matters, pension liabilities, warranties, product liabilities, competition and anti-trust matters or intellectual property claims; •completion and integration of acquisitions, including the acquisition ofGE Transportation; or •the development and use of new technology; Competitive factors •the actions of competitors; or •the outcome of negotiations with partners, suppliers, customers or others; Political/governmental factors •political stability in relevant areas of the world; •future regulation/deregulation of our customers and/or the rail industry; •levels of governmental funding on transit projects, including for some of our customers; •political developments and laws and regulations, including those related to Positive Train Control; or •federal and state income tax legislation; and •the outcome of negotiations with governments. Statements in this 10-K apply only as of the date on which such statements are made, and we undertake no obligation to update any statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. Critical Accounting Estimates The preparation of the financial statements in accordance with generally accepted accounting principles requires Management to make judgments, estimates and assumptions regarding uncertainties that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Areas of uncertainty that require judgments, estimates and assumptions include the accounting for allowance for doubtful accounts, inventories, the testing of goodwill and other intangibles for impairment, warranty reserves, pensions and other postretirement benefits, stock based compensation and tax matters. Management uses historical experience and all available information to make these judgments and estimates, and actual results will inevitably differ from those estimates and assumptions that are used to prepare the Company's financial statements at any given time. Despite these inherent limitations, Management believes that Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) and the financial statements and related footnotes provide a meaningful and fair perspective of the Company. A discussion of the judgments and uncertainties associated with accounting for derivatives and environmental matters can be found in Notes 2 and 18, respectively, in the "Notes to Consolidated Financial Statements" included in Part IV, Item 15 of this report. A summary of the Company's significant accounting policies is included in Note 2 in the "Notes to Consolidated Financial Statements" included in Part IV, Item 15 of this report and is incorporated by reference herein. Management believes that the application of these policies on a consistent basis enables the Company to provide the users of the financial statements with useful and reliable information about the Company's operating results and financial condition. Accounts Receivable and Allowance for Doubtful Accounts: DescriptionThe Company provides an allowance for doubtful accounts to cover anticipated losses on uncollectible accounts receivable. Judgments and Uncertainties The allowance for doubtful accounts receivable reflects our best estimate of probable losses inherent in our receivable portfolio determined on the basis of historical experience, specific allowances for known troubled accounts and other currently available evidence. Effect if Actual Results Differ From Assumptions If our estimates regarding the collectability of troubled accounts, and/or our actual losses within our receivable portfolio exceed our historical experience, we may be exposed to the expense of increasing our allowance for doubtful accounts. Inventories: Description Inventories are stated at the lower of cost or market and are reviewed to ensure that an adequate provision is recognized for excess, slow moving and obsolete inventories. 42 -------------------------------------------------------------------------------- Judgments and Uncertainties Cost is determined under the first-in, first-out (FIFO) method. Inventory costs include material, labor and overhead. The Company compares inventory components to prior year sales history and current backlog and anticipated future requirements. To the extent that inventory parts exceed estimated usage and demand, a reserve is recognized to reduce the carrying value of inventory. Also, specific reserves are established for known inventory obsolescence. Effect if Actual Results Differ From Assumptions If the market value of our products were to decrease due to changing market conditions, the Company could be at risk of incurring write-downs to adjust inventory value to a market value lower than stated cost. If our estimates regarding sales and backlog requirements are inaccurate, we may be exposed to the expense of increasing our reserves for slow moving and obsolete inventory. Business Combinations: DescriptionThe Company accounts for business acquisitions in accordance with ASC 805, Business Combinations which requires the purchase price of the acquired business to be allocated to tangible and intangible assets acquired and liabilities assumed based on the respective fair values. The amount of purchase price which is in excess of the fair values of assets acquired and liabilities assumed is recognized as goodwill. Judgments and Uncertainties Discounted cash flow models are used to estimate the fair values of acquired contract backlog, customer relationships, intellectual property intangibles, and below-market customer contract liabilities. The significant assumptions used to estimate the value of the intangible assets and off-market customer contract liabilities included revenue growth rates, projected profit margins, discount rates, royalty rates, customer attrition rates, revenue obsolescence rates and market participant profit margins. These significant assumptions are forward-looking and could be affected by future economic and market conditions. Effect if Actual Results Differ From Assumptions Different assumptions may result in materially different values for assets acquired and liabilities assumed, which may impact the Company's financial position and future results of operations.Goodwill and Indefinite-Lived Intangibles: DescriptionGoodwill and indefinite-lived intangibles are required to be tested for impairment at least annually. The Company performs its annual impairment test during the fourth quarter and more frequently when indicators of impairment are present. The Company reviews goodwill for impairment at the reporting unit level. The evaluation of impairment involves comparing the current fair value of the business to the recorded value (including goodwill). Judgments and Uncertainties A number of significant assumptions and estimates are involved in the application of the impairment test, including the identification of macroeconomic conditions, industry and market considerations, cost factors, overall financial performance,Wabtec specific events and share price trends and making the assessment on whether each relevant factor will impact the impairment test positively or negatively and the magnitude of any such amount. Effect if Actual Results Differ From Assumptions Management considers historical experience and all available information at the time the fair values of its reporting units are estimated. However, actual amounts realized may differ from those used to evaluate the impairment of goodwill. If actual results are not consistent with our assumptions and judgments used in estimating future cash flows and asset fair values, we may be exposed to impairment losses that could be material to our results of operations. For example, based on the quantitative analysis performed as ofOctober 1, 2019 , a decline in the terminal growth rate by 50 basis points would decrease fair market value by$794 million , or an increase in the weighted-average cost of capital by 100 basis points would result in a decrease in fair market value by$2,168 million . Even with such changes the fair value of the reporting units would be greater than their net book values. See Note 2 in the "Notes to Consolidated Financial Statements" included in Part IV, Item 15 of this report for additional discussion regarding impairment testing. Warranty Reserves: DescriptionThe Company provides warranty reserves to cover expected costs from repairing or replacing products with durability, quality or workmanship issues occurring during established warranty periods. Judgments and Uncertainties In general, reserves are provided for as a percentage of sales, based on historical experience. In addition, specific reserves are established for known warranty issues and their estimable losses. Effect if Actual Results Differ From Assumptions If actual results are not consistent with the assumptions and judgments used to calculate our warranty liability, the Company may be exposed to the expense of increasing our reserves for warranty expense. Stock-based Compensation: DescriptionThe Company has issued incentive stock units to eligible employees that vest upon attainment of certain cumulative three-year performance goals. The program is structured as a rolling three-year plan; each year starts a new three-year performance cycle with the most recently completed cycle being 2017-2019. No incentive stock units will vest for performance below the three-year cumulative threshold. The Company utilizes an economic profit measure for this performance 43 -------------------------------------------------------------------------------- goal. Economic profit is a measure of the extent to which the Company produces financial results in excess of its cost of capital. Based on the Company's achievement of the threshold and three-year cumulative performance, the stock units vested can range from 0% to 200% of the shares granted. Judgments and Uncertainties Significant judgments and estimates are used in determining the estimated three-year performance, which is then used to estimate the total shares expected to vest over the three year vesting cycle and corresponding expense based on the grant date fair value of the award. When determining the estimated three-year performance, the Company utilizes a combination of historical actual results, budgeted results and forecasts. In the initial grant year of a performance cycle, the Company estimates the three-year performance at 100%. As actual performance results for a cycle begin to accumulate and the Company completes its budgeting and forecasting cycles the performance estimates are updated. These judgments and estimates are reviewed and updated on a quarterly basis. Effect if Actual Results Differ From Assumptions If assumptions used in determining the estimated three-year performance change significantly, stock-based compensation expense related to the unvested incentive stock awards can fluctuate materially from period to period. For example, a 10% decrease or increase in the estimated vesting percentage for incentive stock awards would decrease or increase stock-based compensation expense by approximately$1.5 million . Income Taxes: DescriptionWabtec records an estimated liability or benefit for income and other taxes based on what it determines will likely be paid in various tax jurisdictions in which it operates in accordance with ASC 740-10 Accounting for Income Taxes and Accounting for Uncertainty in Income Taxes. Judgments and Uncertainties The estimate of our tax obligations are uncertain because Management must use judgment to estimate the exposures associated with our various filing positions, as well as realization of our deferred tax assets. ASC 740-10 establishes a recognition and measurement threshold to determine the amount of tax benefit that should be recognized related to uncertain tax positions. Effect if Actual Results Differ From Assumptions Management uses its best judgment in the determination of these amounts. However, the liabilities ultimately realized and paid are dependent on various matters including the resolution of the tax audits in the various affected tax jurisdictions and may differ from the amounts recorded. An adjustment to the estimated liability would be recorded through income in the period in which it becomes probable that the amount of the actual liability differs from the recorded amount. A deferred tax valuation allowance is provided when it is more likely than not that some portion or all of the deferred tax assets will not be realized. Revenue Recognition: Description Revenue is recognized in accordance with ASC 606 "Revenue from Contracts with Customers." The Company recognizes revenues on long-term customer agreements involving the design and production of highly engineered products that require revenue to be recognized over time because these products have no alternative use without significant economic loss and the agreements contain an enforceable right to payment including a reasonable profit margin from the customer in the event of contract termination. Generally, the Company uses an input method for determining the amount of revenue, cost and gross margin to recognize over time for these customer agreements. The input methods used for these agreements include costs of material and labor, both of which give an accurate representation of the progress made toward complete satisfaction of a particular performance obligation. Judgments and Uncertainties Accounting for long-term customer agreements involves a judgmental process of estimating the total sales and costs for each contract, which results in the development of estimated profit margin percentages. Contract estimates related to long-term projects are based on various assumptions to project the outcome of future events that could span several years. These assumptions include cost of materials; labor availability and productivity; complexity of the work to be performed; and the performance of suppliers, customers and subcontracts that may be associated with the contract. Factors that influence these estimates include inflationary trends, technical and schedule risk, internal and subcontractor performance trends, business volume assumptions, asset utilization, and anticipated labor agreements. Generally, pricing is defined in our contracts but may contain include an estimate of variable consideration when required by the terms of the individual customer contract. Types of variable consideration that the Company typically has include volume discounts, prompt payment discounts, liquidating damages, and performance bonuses. Effect if Actual Results Differ From Assumptions Should market conditions and customer demands dictate changes to our standard shipping terms, the Company may be impacted by longer than typical revenue recognition cycles. The development of expected contract costs and contract profit margin percentages involves procedures and personnel in all areas that provide financial or production information on the status of contracts. Due to the significance of judgment in the estimation process, it is likely that materially different revenue amounts could be recorded if we used different assumptions or if the underlying circumstances were to change. Changes in underlying assumptions/estimates, supplier performance, or circumstances may 44
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adversely or positively affect financial performance in future periods. Some of our contracts are expected to be completed in a loss position. Provisions are made currently for estimated losses on uncompleted contracts.
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