Westinghouse Air Brake Technologies Corporation

Good morning. Welcome to the Web Tech Corp third quarter 2019 earnings conference call. All participants will be in listen only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Christine Kubacki, the VP of Investor Relations. Please go ahead.

Thank you, Debbie. Good morning, everyone, and welcome to WAB Tech's third quarter earnings call. With us today are President and CEO Rafael Santana, CFO Pat Dugan, and Corporate Controller John Mastelers. Before we start, I would like to point out a change to today's call. Based on feedback we received from you and our desire to drive continuous improvement, we will be sharing a slide presentation to support our discussion today during today's call. This presentation, along with our earnings release and financial disclosures, were posted on our website earlier today and can be accessed on our Investor Relations tab on wabtechcorp.com. As such, some statements we're making today are forward-looking and based on our best view of the world and our business today. For more detailed risks, uncertainties, and assumptions relating to our forward-looking statements, please see disclosures in our earnings release and presentations. We will also discuss non-GAAP financial metrics and encourage you to read our disclosures and reconciliation tables carefully as you consider these metrics. And now, I will turn over the call to Rafael.

Thanks, Christine, and good morning, everyone. Thanks for joining us. Today I'll share some thoughts on our third quarter performance and strategic priorities for the remainder of the year. Then Pat will cover the quarter in greater detail, as well as an overview of both our freight and transit segments and overall market dynamics. As you can see on slide three of the presentation, our third quarter results were on track and were well positioned to deliver the continuous strong performance with sales of over $2 billion due to strength in our service businesses, continued growth in our international markets, as well as the transit segments. Our aftermarket offerings continue to be a stable and profitable part of our portfolio as well as a key differentiator as we partner with customers over the life cycle of their equipment. This includes our successful modernization program, which closed a significant milestone, which was a first-of-a-kind international mods order in the third quarter. We have also seen growth in transits after market sales, which contributed to the overall transit sales growth year over year. In line with our goal to drive continued margin expansions, we saw improvement in our adjusted consolidated margin as a result of higher freight mix in aftermarket, along with early traction on our synergy and cost actions. We will continue to take action on improved project execution, and we remain laser focused on the prioritization of resources and prudent capital allocation. Cost reductions and synergy actions stemming from the WOTAC and GE transportation merger are also ahead of plan. This is the result of several actions, including a reduction of direct and indirect spend, efforts to consolidate over a million square feet across of our facility footprint, and the discontinuation of several shared service contracts with GE ahead of schedule. I'm encouraged by what we have accomplished so far, and we remain confident that we will deliver a total of $250 million in synergies before 2022. Finally, we continue to deliver strong cash generation in excess of $120 million for the quarter. This was largely driven by higher financial performance. Strong cash execution will allow us to drive increased shareholder value while reducing our debt. and creating the flexibility needed to fund organic growth, acquisition, stock buybacks, and dividends. Based on our third quarter performance and current backlog and our assessment of key markets, we are affirming our cash flow from operations guidance for the full year of approximately $900 million, and we're narrowing our adjusted EPS guidance to the higher end of the range to between $415 and $420. With that, I'll turn it over to Bats, who will provide you a deeper dive into the financials. Thanks, Rafael.

As you can see from our press release this morning, we discussed both GAAP and adjusted numbers, so we encourage you to review the reconciliations that have been provided. We continued solid momentum into the second half of the year and delivered a strong operating performance in the third quarter. We updated today our guidance for sales. adjusted income from operations, adjusted EBITDA, adjusted EPS, and affirmed GAAP cash flow from operations, further illustrating that our business is performing well. So turning to page four of our slide deck, sales for the third quarter were $2 billion. Adjusted sales were about $2.1 billion, which includes the effects of accounting policy harmonization. Increased sales year over year were mainly due to the merger of GE Transportation, and increased revenues in transit, offset somewhat by foreign exchange impact, as well as lower sales for rail car components and electronics. For the quarter, operating income was $169 million, and adjusted operating income was $317 million, driven by favorable OEM X. seasonality in locomotive services, and the timing of the policy harmonization. Adjusted operating income included $63 million for non-cash policy harmonization, consistent with our estimates in our original guidance at the close of the GE transportation merger. But adjusted operating income excluded pre-tax expenses of $85 million. Detailed as follows, $69 million for transaction, restructuring, and litigation costs. $16 million for one-time non-cash purchase price accounting charges. Again, please see our reconciliation table for the details. In addition to these expenses, the company also had pre-tax expenses of $71 million or $0.28 in earnings per share for non-cash recurring purchase price accounting charges. They were not added back to the adjusted income from operations. So looking at some of the other detailed line items, SG&A was 292 million, including 40 million of the 85 million in expenses I just discussed. We expect the adjusted run rate number for SG&A to be about 250 million per quarter going forward. Engineering expenses increased to 59 million due to mainly the addition of GE transportation. And our amortization expense was 80 million Going forward, we expect the amortization expense to be about $70 million per quarter. Looking at our net interest expense for the quarter was $58 million and was higher due to our debt balances. Our adjusted net interest expense was $54 million. Going forward, we expect interest expense to be about $55 million per quarter. Just remember that as a priority and a focus, we are intent on generating cash to reduce our debt and our interest expense. Income tax expense was $23 million, and excluding the tax benefit from the transaction cost of the transportation merger, adjusted income tax expense was $67 million for an adjusted effective tax rate of about 25%. Our third quarter EPS, we had gap earnings per diluted share of 48 cents and adjusted to earnings per diluted share of $1.03. So to reconcile the third quarter earnings per share, you can see the details in our press release, but just to recap, we have gap EPS of 48 cents. You add back transaction restructuring and litigation costs of 28 cents. You include the policy harmonization, which adds 25 cents. add back the one-time non-cash PPA of $0.06, and then reduce tax expense or adjust for tax expense for non-deductible transaction costs of $0.04, we end up with an adjusted EPS excluding these items of $1.03. And to remind, the company also had after-tax expense of $0.28 per diluted share for non-cash recurring purchase price accounting charges, which we've not added back to the adjusted EPS. It's included in the GAAP numbers. EBITDA, which we define as income from operations plus depreciation and amortization, was $292 million, and adjusted EBITDA was $440 million. Adjusted EBITDA included $63 million of policy harmonization but excluded the pre-tax expense of $85 million, which we previously discussed. Depreciation was $43 million versus $18 million a year ago quarter. The increase was due to the GE transportation merger. And for the full year of 2019, we expect depreciation to be about $155 million. Amortization expense was $80 million compared to $10 million in last year's quarter. The increase was also due to the merger. For the full year of 2019, we expect amortization expense to be about 245 million. At September 30th, our multi-year backlog was 22 billion, and our rolling 12-month backlog, which is a subset of the multi-year backlog, was 5.7 billion. Just to note, the impact of foreign exchange on our total backlog number from last quarter was roughly $200 million. Turning to our segments, I'd like to discuss the market conditions and outlook along with the segment results in more detail. In the freight segment, our business performed well despite challenging conditions in North America. North American carload volumes were down about 4% in the third quarter and are down about 3% year-to-date versus last year, driven largely by uncertain macro conditions that have led to a drop in intermodal traffic, and declines in critical commodities like coal and agriculture. We continue to expect carload volumes to be down mid-single digits versus last year and forecast the railcar bill to be in the low 50s for the full year. These assumptions are included in our guidance for the full year. Precision scheduled railroading, or PSR, is having some effect on new LOCO orders, but continues to be offset by our modernization program and aftermarket service book. We continue to work closely with all the Class 1s to understand their current fleet strategies and remain confident that our business model as a technology leader and critical digital and service provider is very much aligned with driving efficiency and productivity for our customers. Across our international installed base, we continue to see strong opportunities for growth, including regions like India, where we will be delivering over 100 locomotives this year as part of our 1,000 locomotive contract, and are testing the 6,000 horsepower locomotive that is expected to enter revenue service soon. Across the freight segment, adjusted sales increased to 1.3 billion in the third quarter. The increase was due to the GE transportation merger again, adding about $1 billion in sales. Organic sales decreased $45 million, primarily due to lower sales of freight car components and electronics. The segment operating income was $148 million, and adjusted operating income was $256 million for an adjusted margin of 19%. It is important to note that aftermarket services historically peak in the third quarter for the railroads as they prepare for winter. Therefore, the fourth quarter is usually a lower seasonal quarter for aftermarket services, which presents a mix in headwind for the segment. We have baked this into our fourth quarter assumptions. Finally, the segment backlog fell slightly from last quarter to $18 billion. due to timing of locomotive and modernization orders. Looking in the transit sector, we continue to see steady growth in ridership and urbanization. Aging fleets across Europe and the U.S. need to be upgraded, presenting unique opportunities for growth. And increased growth in infrastructure spending and emerging economies like India is driving tremendous growth opportunities for our business. Across our segment portfolio, We have firm multi-year backlog that will contribute to our growth. Transit segment sales increased 3% to $706 million, driven by growth in OE sales. The increase was due to strong organic growth of about $44 million, acquisitions which contributed about $2 million, which more than offset the negative impact of foreign exchange, which cost $26 million. This is the eighth quarter in a row we've seen organic sales growth, which shows that our near-record backlog continues to drive multi-year top-line visibility. Segment operating income was $56 million for an operating margin of 7.9%. Excluding about $11 million in restructuring costs, the adjusted operating margin for the segment was 9.4%, an improvement of about 20 basis points from last year. We know, we recognize that we must do better in segment margins, and the team is focused on driving margin improvement with prudent project selection, improved project execution, and cost reductions. With these efforts underway, we remain confident that our transit segment margins will improve over the company's strategic planning period. Excluding the impact of foreign currency, overall transit backlog is down slightly, but still stands at near record highs. So let's now turn to the balance sheet and our cash flow on page five of the presentation. We generated cash from operations of about $124 million, mainly due to the higher financial results. It is worth noting that in the quarter, we had about $40 million of cash outflows related to transaction costs. included in the results from cash from operations, so included in the cash from operations. Working capital at September 30th had receivables of about $1.7 billion, inventories were about $2 billion, and payables were $1.1 billion. We expect improvement in our working capital performance going into the fourth quarter. Just to note, our receivables included unbilled receivables of $460 million, which were more than offset by customer deposits of $671 million. At September 30th, we had $587 million in cash and cash equivalents, mostly held outside the U.S. Our total debt was about $4.7 billion in net debt to adjusted EBITDA of about three times. Our debt and cash levels at the end of the quarter were impacted by the timing of cash received late in the quarter and the timing of our debt payments. However, by year end, we are still targeting a net debt to adjusted EBITDA to be about 2.5 times. Our capital expenditure in the quarter was $51 million compared to $25 million a year ago. The increase was due mainly to the merger. And we expect to spend about $200 million in 2019. Overall, our balance sheet continues to provide the financial capacity and flexibility to invest in our growth opportunities. And our goal is to be an investment-grade credit rating company. Now let's shift to the 2019 guidance for a minute, as illustrated on slide six, and I will turn the call back over to Raphael.

Thanks, Pat. Based on our third quarter performance, our current backlog, and our assessment of conditions in our key markets, Our guidance for adjusted sales is about 8.2 billion, adjusted EBITDA of about 1.6 billion, adjusted income from operations of about 1.2 billion, and adjusted earnings for diluted share to between 415 to 420. And we maintained our gap cash from operation guidance to be about 900 million. I also want to emphasize that we expect to see a normal positive seasonality in the cash flow generation in the fourth quarter. Despite some uncertainty on the end markets, we continue to focus on controlling what we can, and that's by delivering and executing on our commitments for 2019. It's about accelerating our cost actions and synergies into the year end. The adjusted guidance includes the add-back related to non-cash accounting policy harmonization, but excludes estimated expenses, for the G transportation merger for transactional restructuring and litigation costs as well as one-time purchase price accounting charges. Excluding these expenses, our adjusted operating margin target for the full year is about 14% and our adjusted effective tax rate for the full year is expected to be about 24%. I'd also like to point out that our adjusted guidance includes after-tax expenses of about $0.88 per diluted share for non-cash recurring purchase price accounting charges. In other words, we're not adding that back to our adjusted EPS guidance. And as we model for next year, any add-backs from policy harmonization won't be repeated either. We plan to host our analyst day in the first quarter of 2020. We're locking down the specifics for that event, and we will share you more details when they're available. So as you plan, as in as you heard throughout the morning, and you see on page seven, WAPTEC has had a solid performance in the third quarter. Growth in our aftermarket and services revenues demonstrate the importance of our significant install base. across really both freight and transit and the resilience of our portfolio. Cost reductions and synergies stemming from the WTAC and GE transportation merger are on target, and we fully expect to deliver a total of 250 million in synergies before 2022. Second, we are delivering strong, which continues to place the company in a position of strength and we are poised to deliver significant shareholder value while reducing our debt and creating the flexibility needed to fund future organic and inorganic growth. We remain confident on our cash flow guidance for the full year of approximately 900 million, and we're updating GAAP EPS guidance to be between 205 and 210, and we're narrowing our adjusted EPS guidance to the high end of the range between 415 and 420. In addition, our significant install base across the freight and transit market along with our globally diverse business model provides a strong foundation for long-term growth. Finally, we continue to make solid progress on our integration efforts. Together, we have a strong team committed to perform. We're building a culture really focused on execution and accountability, and we're seeing that execution in our results. With that, I hope you have a better chance for what we're seeing across the company, our strengths, our challenges, and our strategy for moving forward. Now we're happy to take any questions you may have. Operator?

We will now begin the question and answer session. To ask a question, you may press star, then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then 2. At this time, we will pause momentarily to assemble our roster. The first question comes from Justin Long with Stevens. Please go ahead.

Thanks, and good morning. Good morning. So maybe I'll start with a question on the North American freight aftermarket business. Is there anything you can give us that could help us size up that business today? And as we think about the recent underperformance we've seen in rail volumes, maybe you could speak to how that business has performed in light of that and what you're kind of baking into the guidance or your thoughts going forward.

Okay. Just a couple of thoughts here. Number one, we're certainly feeling the impact of both car loads being down over 3% in the year. Also, the elements of locomotive parkings. What I'm happy to say is we've seen strength in our business in both transactional parts, multi-year service agreements, especially in international markets where our locomotive fleets continue to grow. And not to mention our mods program. which I think you heard me talk about our first order internationally, which continues to provide the significant opportunities moving forward. We like the portfolio we have, and in North America, especially when you think of our digital and electronics portfolio, we feel like we have strong products to help our customers be more efficient, win on fuel efficiency, And I think we're progressing on that.

Okay, great. And then on synergies, it was good to hear the update there. I'm assuming that you're seeing that number ramp over the course of this year, but could you maybe share what you're assuming for synergies in the fourth quarter, and if there's any initial thoughts around 2020 and the step-up we could see next year, that would be helpful.

Yeah, so Justin, this is Pat. We're still on our guidance of net synergies of about $20 million being realized for the full year of 2019. There's a lot of activity that's ongoing related to the cost to achieve those synergies and how they're impacting us. We're very confident that that $20 million net will be realized in the in the current year, and we're taking steps to, in some instances, to take the extra effort to see that we can accelerate those synergies into going into next year. We're not going to give a lot of guidance at this time about the synergy plan, but we did say that we feel very confident of the 250 before 2022, and we'll continue to update people as we get into more more 2020 guidance in our investor days.

Okay. But from a high level, would it be fair to say in 2020 you'll see the biggest kind of year-over-year step up over the course of the four-year implementation of the synergies?

Yes, Justin. If anything, since I've started, I feel even more confident about our ability to drive improvement in our margins and We are seeing an acceleration on synergies, and we do expect that to go into 2020. I think you've seen a number of planned consolidations that we've announced. In addition to that, we're certainly making the necessary adjustments for the business as we face new realities.

Okay, great. I'll leave it at that. Thanks for the time. Thank you.

The next question comes from Allison Polanek with Wells Fargo. Please go ahead.

Hi, guys. Good morning. Good morning. First, I want to talk on transit. You know, margins have sort of been in the sub-10% range since going back to last year. Labtech was historically able to get it, you know, well above that. You know, is there something structural that you're seeing? I understand there's been some challenges there that you guys wouldn't be able to get back to that range at some point.

So, Allison, a couple points. Number one, back to the comment I made it before. If anything, I'm really confident about our ability to drive margin improvements. And I've got to break that into two fronts. I think on the transit side, Lillian and the team, he has added some new leadership, including a new CFO. They're being a lot more selective in terms of the quality of the order intake. And there's really increased accountability in the business. To make sure we continue to drive improvement from the household who has delivered margins. So I think early days, some progress, a long way to go in that business, but we're confident there. On the freight side of the house, I think we are really accelerating a lot of the synergy actions. We're starting to see some of the benefits. Pat mentioned the 20 million of net synergies. We've got it for the year. We expect to exit the year ahead of that and to realize greater synergies into 2020.

So, Allison, I would add to this is that, you know, the transit business is also part of the overall, you know, synergy plan and restructuring. And if you look at the margins kind of on a quarter-over-quarter basis, I feel good that we're showing a positive trend, quarters that are improving, and the momentum going into the fourth quarter and to next year will really start to show the benefits of those actions.

Great. And then you had also mentioned a decline in electronics in the freight side. Any color you can provide there, something unique going on that we should be aware of?

So a couple points. Number one, if you were to look into our sales this year versus last year, and if you were to exclude specifically PTC, you'd see a business that's still slightly growing. One thing with Phil... Really positive and confident is our ability to grow our orders. And so far here today, we're seeing opportunities to consistently do that as we go into 2020. Okay. Thank you.

Thank you.

Thank you.

The next question is from Jerry Revich with Goldman Sachs. Please go ahead.

Yes. Hi. Good morning, everyone.

Good morning. Good morning.

I'm wondering if you could talk about the puts and takes around the GE transportation performance in the quarter. It looks like organic growth slowed to about 2% from better growth on a pro forma basis in the first half. Is that just timing of deliveries? And then I'm also wondering if you could just expand on the $63 million increase non-cash policy harmonization point. Just help us understand that better so we can get comfortable with that back and lack of drag in 20. Okay.

Well, let me start here. First, a couple points to take into consideration in the third quarter. What you saw there is when you think of locomotive equipment, freight equipment, that number came down in the third quarter in terms of the shipments, and that's very much tied to timing of projects so expected. At the same time, we saw a pick-up on revenues with regards to the freight services segment, and that's associated with a seasonality that's very much expected as railroads really face into some of the preparation for inclement weather. So those are certainly two elements that have impacted the numbers, but it would have some other variation associated with a policy harmonization patch. Why don't you comment on that?

So the policy harmonization, the majority of that number is really related to revenue recognition policy and really represents a bridge from the legacy business to where we are today. These numbers are very consistent with what we included in our original guidance at the date we closed and even with some of the numbers that were provided in the merger documents and the pro forma and the proxy statements. What it really represents is a business process that GE Transportation used related to their service contracts. where the team would focus on getting more efficient. If you want to use the word lean, lean out some of the maintenance projects to understand what costs need to be incurred or don't need to be incurred, how we could do it more efficiently, how we can apply better productivity, better sourcing, or stagger some of the costs related to the projects in a manner that would that would be beneficial and take a cumulative catch-up adjustment related to those efforts. The way they'll manifest for us on a go-forward basis is better profitability in those projects in the future years. You know, that profitability will be real cash earnings and will show in margin expansion for those particular service contracts in each year as we do our planning. So, again, it's very consistent with what we provided before. The number hasn't changed, hasn't grown. The seasonality matches the underlying business process and in my mind really represents the opportunity going forward in both our profitability and our cash.

Okay. And then the million square foot reduction in combined capacity, can you just talk about where that is relative to the longer term targets? How far along are we in the facility? rationalization phase and what are you folks learning as you head through the process in terms of the positive and any negative surprises as you consolidate the footprint? Thanks.

I think at this point most of the announcements are really being around North America and we expect that to be very much done within the early part of next year. I think there shall continue to be opportunities out there that we'll continue to be working on. I think another element to be mentioned, year to date we've exited 84 office locations that were previously occupied and we're on track to exit close to 100 office locations by year end. So that's very much on track. And we'll continue to look into the elements of driving farther efficiency with the combined portfolios we have.

And I apologize for the part of the question. Any significant variances versus the initial plan as it's being executed, positive or negative? No.

So, no, I'd say, if anything, we're just really working to accelerate some of these elements so we can capture more value earlier. Okay.

Thank you.

The next question is from Matt Elcott with Cowan. Please go ahead.

Good morning. Thank you. Good morning. Rafael, if we see a modest increase one to two percent traffic growth on rail in North America next year off of a very low base this year. What would that mean for your organic freight aftermarket business in North America directionally?

Well, a couple of points here. to stay at this point away from providing specific guidance in 2020. And I'll be careful with speculating on some of those changes translating immediately into the business. Because you do have a number of locomotives that are parked. So there's that element in place. So what I'll tell you is we're seeing a very robust international business. We're growing our fleets internationally. When we look at the elements of transactional parts and multi-year service agreements, we see growth on those two segments, and it's part of really partnering with customers for better outcomes in their fleets, an element of reliability, but also an element of efficiency as they move forward.

Okay. That's helpful.

I mean, given the current environment in North America and the pockets of opportunities internationally, is it plausible that you could grow earnings next year?

Again, I'll not at this point provide specific guidance in 2020, but when we look at the opportunities, there's five lines. especially on the equipment side of the business. I'd say about two-thirds of that's coming from international opportunities. When you think of India, Southeast Asia, those are really part of important growth dynamics for our business. And we're tracking on a number of projects into their next phase. And we feel we have a strong backlog, which really provides us visibility to multi-year. So as I mentioned before, in the last two years, I think we captured a number of multi-year orders, which provide us the visibility to the next couple of years. And we feel strong about that. It's very much the case for both the transit and the freight segment. Got it.

And then just one final quick question on guidance this year. So this whole year we've seen rail traffic declines become more and more pronounced. PSR implementation going according to plan, if not better, actually helped by the weak traffic. Meanwhile, you guys for two consecutive quarters have either maintained or slightly improved your guidance for the full year. So can you help us understand how you were able to maintain or slightly improve your guidance in the face of a worsening environment, did you maybe start off with an especially conservative guidance or, you know, just trying to kind of bridge that gap between what's happening with the environment and the fact that your guidance has remained intact?

I'll start first. I mean, I think there's an element of controlling what we can, and we've been really strong on taking the necessary actions to adjust our business proactively to new realities. I think there's an element of the synergies and the framework we've laid out earlier on, and we're certainly taking advantage of that in terms of accelerating this. We feel very strong about the install base we have and the ability to really partner with customers and support outcomes. Our international fleet continues to grow and we're seeing some of those numbers coming through in terms of our transactional parts, in terms of our multi-year service agreements. And I wouldn't underestimate just the strength of the portfolio in terms of not just the elements of international, but when we look at just diversity of the portfolio to better navigate cycles than we've ever had before.

Great. Thank you very much.

Thank you. The next question is from Scott Group with Wolf Research. Please go ahead.

Hey, thanks. Morning, guys. Good morning. I want to start on the gross margins, 34% in the quarter. I don't know if we've ever been there before. Can you just talk about what's driving that and how sustainable it is, how you think about gross margin going forward?

Yeah. Clearly, the quarter has got some benefits from the mix of sales. You have a higher mix of aftermarket sales, especially in the freight area. And coupled with the policy harmonization, I think it really just lends itself to a really good margin performance here. So that mix is the biggest impact.

To the extent we think that OE pressures continue, do you think that 34% gross margin is sustainable?

No, I think when you kind of take a step back, you really need to look at that full year view of sales mix. We're going to probably for the full year get back to our more historic mix of about 40%, 45% OE, 60% to 55% on the aftermarket side. That's kind of our traditional mix of sales for a full year period. And when you have that kind of traditional mix, you're going to end up with margins that are pretty consistent with our guidance. I just think that our third quarter just ends up being overweighted to aftermarket. The OE side of our business for Q3, especially in freight, is somewhere around 30%.

Okay. Now, I get you don't want to talk about 2020 yet, but maybe can you just help us with some of the accounting puts and takes that we should be thinking about for both from an earnings standpoint and a cash flow standpoint? And then have you guys made any decisions in terms of guidance next year if it's going to be adjusted earnings or cash earnings guidance, just any visibility?

Yeah. Yeah. No. I mean, we've obviously... We've been going through our IR strategy and talking about how we cast and describe the business to you and to others. We're going to move to more of a cash EPS kind of viewpoint. Obviously, there's a lot of pluses and minuses in the results. It's a little bit noisy. We really want to try and simplify it by going to a cash EPS goal. And then also take these accounting harmonization type things and really step back from them because we're going to be on a policy. We're going to have an approach and that is combined and consistent across the company. And we'll just include all those kind of aspects of accounting into our guidance. So think of it as including all the accounting harmonization type things and adding back for the non-cash kind of expenses that have occurred as part of the transaction.

So what are the specific sort of puts and takes for next year from a cash flow standpoint?

So when you mean puts and takes for cash flow, I mean, I think that you're going to end up I don't want to get into, you know, we agree that we don't want to talk too much about 2020 yet, but I think that you're really, you know, kind of describing if you look at the full year impact of these things, not including the policy harmonization, but not including the impact of the recurring PPA. I think those are the kind of aspects of modeling that we should consider. Okay.

Thank you.

Yeah. Thank you.

The next question comes from Chris Weatherby with Citigroup. Please go ahead.

Hi, guys. James Wannigan on for Chris. I wanted to ask about the relationship between rail volumes and freight revenue. Should we expect your revenue to improve lockstep when rail volumes improve, or should there be a lag in between it? And also, if rail volumes continue to decelerate, should we expect your revenue growth to decelerate as well?

I think there's a correlation, but there's certainly going to be an element of a lag, especially when you take into consideration the number of parts, assets that are currently out there. That's, of course, a little bit different if you think just about our services business, which will fill that in a more direct way.

Got it. I also wanted to ask about the locomotive backlog. Could you give us an update there? I think last quarter was 1,900 locomotives and 800 mods. What would that be now, and what's the international mix? Trying to get an understanding of how it's changing and just translations and things like that.

So from that number, I would say, from that combined number, the counts have come down right around 3%, and that's where we stand it. And you've got about very much, say, 50% of that backlog. I should say two-thirds of that pipeline tied to international and about a third tied to North America.

Thank you.

Thank you.

The next question comes from Steve Barger with KeyBank Capital Markets. Please go ahead.

Hey, good morning. Good morning, Steve. You affirm the operating cash flow of $900 million, which includes the $100 million of merger expense. As we think about organic growth trends next year and synergies and working cap initiatives, should we think about that as a target to achieve for next year or more of a floor to build on?

That sounds like 2020 guidance to me, but, yeah. You know, I think the cash flow – I think the cash flow – Our view continues to be strong. I think we talked a lot about some of the headwinds were reality for the company as we combined. I think with all cases, our target, our expectation is that it could do better. That 900 is with the type of EBITDA profile that we provided in previous communications would indicate that we have a real opportunity to improve upon it.

Got it. Okay. Just going back to your comment a few minutes ago about looking to more of a cash EPS outlook, you have $0.88 of non-cash amortization on the income statement right now. In that framework, you'd be adding that back and trying to get people to think about earnings profile in that context?

Right. I think so. I think it would be very useful, and I think it goes well with the EBTA profile of the company, and that's the plan. So we're going to go forward in terms of 2020 guidance and describing the business and include that in the numbers.

Right. So a nice step up from that. As we think about the impact of integration synergy and the transit projects you mentioned in the prepared remarks, do you expect to drive more margin expansion from freight or transit next year?

We're certainly driving margin expansion on both segments. I think we're coming from certainly a low base on the transit side, so we do expect A broader set of opportunities there, but it goes for both segments.

Yeah, okay. And just one last one. When do the cash outflows from the transaction roll off? Are we about done with that or will we be done at calendar 20?

Yeah, so in terms of transaction costs, I think we should be pretty close to having most of those paid here in the third quarter. You know, we still have some restructuring costs that will, you know, will incur some cash, some non-cash. You know, we'll be updating on those type of things and also cash to achiever synergies will be baked into the guidance. But, you know, I think that the vast majority of specific transaction costs like, you know, fees and professional fees and banker fees, things like that have been taken care of. Great.

Thanks for the time.

Thank you.

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

Hey, thanks, and good morning. Good morning. What drove the restructuring charge of transit in the border?

So, you know, as part of the consolidation of the border, of some of the operating facilities. You know, we talked about the consolidation of about a million square feet of operating facilities. That did have some impact on our transit businesses. The costs incurred on moving some of that work, it really is transaction costs that, or structure costs rather, that we included in the add back.

Okay, so related to the merger integration process of what's going on.

Absolutely. I mean, we have facilities that, you know, do both. Yeah, exactly. They do both transit and freight work. And as we consolidate them, there's impacts to both sides of the segments.

Okay, got it. Good to hear. And then I'm going to ask about GE, you know, a little bit differently. Rafael, as we look at the business now, what percentage of revenue, you know, is being derived from North America and then, you know, what percentage of revenue is being derived from, you know, your international businesses?

I think we continue to see international with the opportunity to be more than 50% of our business and as we look into I'll call the pipeline for growth, especially going to Lenny. That wants to be a more robust pipeline in terms of the orders case.

Okay, so the more tailwinds and headwinds, you know, let's say 55, 60% of the business at GE going forward, the balance is North America, and it's pretty clear that, you know, we have more headwinds than tailwinds in that business right now.

Yeah, it's softer from a North America perspective versus internationally.

Okay. And then you've talked to, you know, the modernizations of locomotives. It sounds like it's a growth business. I think you've quantified it loosely as, you know, you're going to be doing a couple hundred of those units Is there any way to maybe give a little bit more color in terms of the magnitude of modernizations, and is that going to be a tailwind as we look to 2020?

I think we have the opportunity to make that a continuous tailwind for us. I think we spoke about the opportunity of the modernizing install days, and I think the order we got in the third quarter internationally is really the first one. And we certainly have a large install base internationally to build from. So I think we've done that for North America. It's an opportunity moving forward.

Okay, great. Appreciate the time.

Thank you.

The next question comes from Terry Boroditsky with Jefferies. Please go ahead. Hello?

Hi. Hi, good morning.

Good morning. Yeah, last Corey talked about strength in your mining business. Can you update us on what you're seeing in the mining industrial business to date and maybe expectations going forward?

When I think of the mining business, I think we're continuing to see a robust, I'll call services, options for upgrades. There's certainly a lot of changes on that market right now. And there could be elements of softness as you go into 2020, but I wouldn't be saying more than that.

Okay, and I know you guys have moved away from providing too much color on locomotive deliveries, but could you just help us understand, as we think about 2020, it just seems like it's going to be tough comparables on the Class 1 side of the business. Can you offset these with international deliveries?

Sure. I think, number one, as I mentioned before, I think we've got about a third of the pipelines probably associated with North America, two-thirds associated with international opportunities. I think it's very important, the fact that we have multi-year orders that are specially worked in the course of the last couple of years that provides us visibility into the next couple of years for the business. And that's true for both the freight and the transit side of the business.

Okay, and then just one last thing. It's been asked a couple different ways, but on the accounting policy harmonization, you have a $115 million benefit to sales to date. Is that all reversed out in 2020?

Yeah, exactly. So when we get into the guidance next year, we will not be taking any of these as add-backs or adjustments that will be included in our guidance.

But it will be a headwind to sales for next year since they're included in 2019?

Yeah, well, I think the way to think of it is it will be a headwind of sales because the process, the way it was handled in the past was to book these kind of cumulative adjustments for these projects where it will be a benefit or a tailwind will be the fact that it will result in real margin expansion, not nearly as much because it's really kind of within the quarter as incurred in real cash. But it'll be a tailwind as these projects are – we execute on these projects and get the benefits.

No, I appreciate that. I'm just trying to understand from 2019 to 2020, that revenue – okay, perfect. Thank you so much for taking my question. Thank you.

The next question comes from Ken Hexter with Bank of America. Please go ahead.

Great. Good morning, Rafael, Pat, and Christine. Just, I guess, to revisit Scott's questions earlier on the margins, but maybe just to take it to the freight side a little bit more direct, you mentioned that there's some mixed impacts in the third versus fourth quarter, and you expect the margin impact. Can you quantify that, I guess, shift into the fourth quarter, and I guess really looking for what's the margin pullback you're expecting because of that?

Yeah, so I think we talked about where we think the margins will be for the full year, and it'll be roughly the 14% that we talked about. And where's the mix? How is this manifesting itself? We're going to have higher OE deliveries on some projects for LOCOs and other OE projects, and we talked about the fact that the third quarter, especially for Freight local services is probably always the strongest part of our, the strongest season for that time because of just a bit of the timing and how the class ones do their maintenance. So I think between those elements and the guidance, you can kind of get a sense of where the quarter EBIT margin is going to be and where we've included all of those factors, those assumptions. in our four-year guidance.

Okay. And then I guess maybe just a bigger picture thought. You ramped up your freight backlog for the next 12 months, but obviously it also declined long-term. Maybe just your thoughts on kind of your view on the market right now.

I think we continue to look at some robust opportunity internationally. And as we go around the world, I mean, Asia seems to certainly be a brighter spot for us If I talk about Australia, New Zealand or India, we certainly see a good amount of opportunities in Indonesia as well. As far as the transit market goes, the team is working strongly on opportunities in both Europe and North America as well. We're following through a number of the next phases of projects we've done in Africa and I think that's an exciting part of the portfolio where we have the opportunity to offset some of the softness of North America.

And just a last one, if I can, on the UK transit contract, any update on kind of when that fully rolls off and, I guess, ability to kind of end that margin impact over time?

Yeah. I mean, we're largely still on the same schedule that we've talked about before. You know, the margin is, you know, very low, and we have about $25 million of revenue impact every quarter, okay? And so we're still looking at these projects wind up at the end of 2020 with a little bit still, not nearly so much, the $25 million anymore, but a little bit still rolling into the first quarter of 2021. So we see this as, you know, it's a little bit of a margin headwind where, It's part of our plan to burn off this backlog and be more selective on any projects going forward so that we don't have the same situation. I just want to emphasize one thing about the backlog question. I mean, quarter to quarter, we have fluctuations. It's a lumpy business. You win projects, you add them, and so you can have some kind of variability quarter to quarter, and really, to me, We focus on the order intake and kind of a year-over-year view.

Is there any seasonality to that, to kind of timing of wins, or just consistent on the fluctuation side?

No, like I said, it's just about your customers' timing and when they're awarding the projects, and so it can have some impact to the quarter-to-quarter on how you look at the backlog change.

I appreciate it. Thank you.

Thanks.

This concludes our question and answer session. I would like to turn the conference back over to Christine Kubacki for any closing remarks.

Thank you, Debbie. Thank you everyone for your participation today. We look forward to speaking to you next quarter and we'll have more details about our upcoming analyst day early next year. Take care. Thank you.

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