Westinghouse Air Brake Technologies Corporation

Good morning and welcome to the Wabtec Corporation first quarter 2020 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 touchtone phone. 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, Vice President of Investor Relations. Please go ahead.

Thank you. Good morning, everyone, and welcome to Wabtec's first quarter 2020 earnings call. With us today are President and CEO Raphael Santana, CFO Pat Dugan, and Senior VP of Finance John Mastelers. Today's slide presentation, along with our earnings release and financial disclosures, were posted on our website earlier today and can be accessed on the Investor Relations tab on WabtecCorp.com. Some statements we're making 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 the disclosures in our earnings release and presentation. We will also discuss non-GAAP financial metrics and encourage you to read our disclosures and reconciliation tables carefully as you consider these metrics. Before we begin, I'd like to extend wishes of health and safety to everyone on the line as we continue all to manage through this COVID-19 pandemic. And now, I will turn the call over to Rafael.

Thanks, Christine, and good morning, everyone. We appreciate you joining us today. We had a solid first quarter that was only possible due to the perseverance of our employees working in conjunction with customers, suppliers, and key stakeholders. These are unprecedented times that have forced us all to flex and adapt. And for that, I want to sincerely thank our WABTAC team members in our factories and in the few supporting our customers, as well as all of those working remotely for all that they're doing to deliver in the face of incredible change. The COVID-19 crisis reiterates the appreciation for the work our team members do every day, supporting essential rail services that are critical to overcome this crisis. Their work around the world has allowed our sites to remain largely operational, although we have some facilities down in places including China, India, and Europe. As a company operating in the midst of this pandemic, there's some key essential priorities I'd like to highlight to you. So please turn to slide three. First, we are committed to protecting the health and safety of our workforce, and we're taking significant efforts across our plants and sites. In many cases, we're going above and beyond the CDC's recommendations or any local government requirements. These actions include daily temperature checks at many of our facilities, limiting plant floor activity by rotating schedules, removing non-critical staff from the factory floor, restricting access to work areas, enhanced social distancing, deep cleanings, and increased disinfection efforts among other activities. Second, we're focused on maintaining our operational capabilities. Roughly eight weeks ago, we assembled a COVID response team comprised of global business and functional leaders. They meet daily to assess and respond to the extraordinary challenges at hand and implement contingency plans across our operations and supply chain. They assess government mandates as well as any impacts to our business in real time. and take decisive action to ensure WAPTAC is proactively positioned to manage through today's extraordinary challenges. As I shared earlier, we have an incredible responsibility to help keep people and product moving during this crisis. During the quarter, we began to feel increasing impact of the COVID-19 disruption across our supply chain, as well as our operations and our customers' operations. Throughout the pandemic, over 80% of our 160 plus global manufacturing sites have largely remained operational. Those that experienced disruption were primarily due to the customer shutdowns, supply chain disruptions, or government mandated lockdowns. This includes countries like China, which had several sites impacted in February, but they were all back in operations by mid-March. We had operations in countries like France, Italy, and Spain, which were required to close for several weeks in the first and second quarters. And they're mostly all back up and running now. And it also included countries like India. However, in those regions that were on lockdown, all WAPTEC service locations, few service technicians, and warehouses remained in operations to support transportation's essential infrastructure as required by the governments. In the United States, rail and passenger transportation has been squarely recognized as critical to essential operations. As such, all of our major manufacturing sites and services and parts locations across Pennsylvania and Texas and most other locations have remained open and operational throughout the pandemic. Third, we are focused on cash and preserving the balance sheet by working to reduce capex by more than 40% versus our prior guidance of $200 million. In addition, we're quickly aligning working capital for the volume environment and targeting improved cash flow conversion. Overall, our financial position continues to be strong. At the end of the first quarter, liquidity was about $1.2 billion. And we recently took additional measures to further enhance liquidity by adding a new undrawn $600 million credit facility after the end of the quarter. Fourth point, prior to the onset of the pandemic, we were laser focused on reducing costs and delivering on our synergy targets ahead of schedule. For example, Since a year ago, during a period of top-line revenue growth, the company reduced headcount, including contingent workers, by more than 1,500 people and had begun to consolidate operations, reducing our footprint by 6% and removing over a million square feet across our operations. We're on plan to reduce our operational footprint by another 9% in 2020. We also have captured significant sourcing savings from the merger. We've discontinued several shared services contracts with GE, and we've continued to drive lean across our operations to enable more cost-effective and efficient throughput. We saw the results of those actions realized in the first quarter, and while we anticipate a change in the volume assumptions for near-term synergies, we have a pipeline of actions and we remain committed to deliver our synergy targets for the year. Today, given the rapidly evolving situation and uncertainty regarding the duration and severity of the COVID crisis, we have withdrawn our previously issued annual guidance. We will continue to take the necessary measures to control what we can to protect the long-term viability of the company, continue to invest in key technologies and capabilities, and deliver shareholder value for the long term. And you're seeing that focus along with the strength of this franchise and our experienced managed team in our first quarter results. As noted on slide four, in the midst of a challenging market that included operational and supply chain disruptions in China, India, and Europe, we delivered a solid operational quarter. Sales were 1.9 billion with an adjusted EBIT margin of 15.7%, driven by strong execution against cost and synergy goals. These yielded 97 cents in adjusted earnings per share, a testament to the team's execution in the midst of a challenging market. Included in our results, we estimate over 5 cents of earnings per share loss due to the impacts of COVID-19, primarily in China and Europe during the quarter. Cash used for operations was $82 million. However, this was in line with seasonality and the one-time outflows due to previously announced restructuring, litigation, and transactional charges. Our multi-year backlog of about $22 billion continues to provide visibility across both freight and transit. And as we continue to help support our customers during these times, we are adjusting timing and specifications on some deliveries as needed and remain confident in our backlog. Looking across our freight and transit segments, we saw several dynamic market conditions throughout the quarter, many of which we related to the COVID-19 crisis. In the freight sector, North American carload volumes were down about 5% in the first quarter, and intermodal was down over 8%. This was largely driven by weak global macro conditions. Carload volumes have harder deteriorated in the second quarter as the crisis has accelerated its impact on the global economy and supply chains. This will have a near-term impact on demand for services and components, which will improve as freight recovers. At this point, it is very difficult to predict where car loads will settle for the year, given the direct dependency on restarting the economy. In terms of the North American rail car fields, all builders in North America have taken steps to slow production lines in 2020. And industry forecasts now indicate that rail car bills for the year will be less than 30,000 cars. As you're aware, some of these conditions were present pre-COVID and the collapse of the global oil market. But we had already been taking actions to adjust capacity as outlined in our investor conference in early March. To be even more proactive, we are taking additional actions to align all of our operations for the new realities we face. Reflecting on the quarter, despite of the challenging global freight segment dynamics, there were some bright spots. Our digital electronic sales were up double digits versus the prior year. This gives us further confidence that the business can grow in average faster than the overall freight segment. Our modernization deliveries showed good momentum which were up on a pro forma basis versus last year, along with steady international locomotive deliveries, which helped offset North America locomotive and freight car build declines as expected. Transitioning to the transit sector, the COVID-19 crisis and global shelter in place orders have had a direct impact on passenger transportation and near term service levels in some markets. This disruption to services and the impacts on our customers' operations will have a corresponding near-term impact on our OE and aftermarket sales. However, as I shared earlier, most of our transit manufacturing facilities remain operational. Overall, we believe the long-term market drivers remain strong, including the need for sustainable transit solutions and projected growth in both ridership and urbanization. And as buyer restrictions ease, we will see infrastructure spend also recover. I'd also add that we delivered strong margin improvements across the transit segment in the first quarter. While sales were down 7%, adjusted income from operations was up 14% due to improved mix and early absence of actions to drive margin rate improvement. Finally, as noted earlier, across both the freight and transit sectors, we have strong multi-year backlog. This helps provide stability and visibility to evolving environment demand. With that, I'll turn things over to Pat to provide more color on the first quarter.

Thanks, Raphael. Turning to slide five, you can see that we had a good operating quarter despite an increasingly challenging environment. Sales for the first quarter were $1.9 billion, which reflects a 21% increase versus the prior year. Increased year-over-year sales were mainly due to the merger of GE Transportation, along with higher digital electronics and services sales, offset somewhat by decreased revenues in freight equipment, components, and transit, as well as a negative impact due to foreign exchange. For the quarter, operating income was $217 million, and adjusted operating income was $303 million, up 30% year over year, mainly driven by higher freight sales and good performance in digital electronics, the realization of synergies, as well as a better mix of sales and better operational performance in transit. Although there are limitations on visibility into the full effect of the pandemic, we estimated the COVID-19 impact on our customers, suppliers, and operations during the quarter negatively impacted our operating income by approximately $15 million, or five cents in earnings per share. For the quarter, adjusted operating income excluded pre-tax expenses of $86 million, of which $69 million was for non-cash amortization and $17 million of transaction restructuring costs. Please see Appendix B of our press release for the reconciliation of these details. Now, looking at some of the detailed line items, SG&A was $243 million. including $16 million of the restructuring and transaction expenses I just discussed. Engineering expenses increased to $49 million, due mainly to the addition of GE transportation. And amortization expenses were $69 million. But remember, starting this year, we are excluding amortization expense, which is all non-cash from our adjusted operating income. For 2020, we still expect non-cash amortization expense to be about $280 million. Other expense was $15 million versus $8 million of expense a year ago. The variance year over year was due to severe fluctuations in the FX rates late in the quarter, most notably from the Mexican peso and the Brazilian RIAI. Income tax expense was $38 million. Adjusted income tax expense was $63 million for an adjusted effective tax rate of about 25%. We expect the tax rate for the full year to still be about 26%. In the first quarter, we had GAAP earnings per diluted share of 58 cents and adjusted earnings per diluted share of 97 cents. The details that bridge GAAP earnings per share to adjusted earnings per share of 97 cents can be found attached to our press release. As of March 31st, our multi-year backlog was roughly $22 billion, and our rolling 12-month backlog, which is a subset of the multi-year backlog, was $5.6 billion. Our backlog continues to provide visibility across both freight and transit. Now let's take a look at the segment results on slide six. Across the freight segment, sales increased to $1.3 billion in the first quarter. This increase was due to the GE transportation merger, which added $506 million. Organic sales decreased $108 million, primarily due to lower sales of freight car components due to the decrease in car bills, along with lower sales in freight equipment due to the timing of deliveries. Segment operating income was $162 million, and adjusted operating income was $241 million for an adjusted margin of 18.5%. I'd like to note that the margin in the prior year quarter benefited from the timing of deliveries after the close of the GED merger. Finally, freight segment backlog was $18 billion. Across the transit segment, sales decreased to $629 million, driven by disruptions stemming from the COVID-19 virus. Organic sales declined $34 million versus the prior year, but were also impacted by FX, which reduced sales by an additional $18 million. Segment operating income was $69 million for an operating margin of 10.9%. The adjusted operating margin for the segment was 11.9%. an improvement of 220 basis points year over year. This improvement is evidence of some early success in the plans and actions the transit team outlined at our investor day in March. Now let's turn to the balance sheet and cash flow on slide seven. We entered the year with a very different expectation of what has ultimately transpired. And while the pandemic presents uncertainty and many challenges, Labtech is essential to a recovery, and we are confident that our solid financial position and ability to generate strong cash flow will enable us to emerge stronger. From a cash flow perspective, the quarter played out about as expected. Our cash flow from operations was a negative $82 million in the quarter. We had about $80 million of one-time impact due to prior year restructuring, litigation, and transaction charges which we had identified in our last earnings call. Our leverage at the end of the first quarter was about 2.6 times, flat with year end. Our total liquidity at the end of the first quarter was 1.2 billion, down from about 1.6 billion at the end of the fourth quarter. This $1.2 billion does not reflect the new $600,364,000,000 credit facility that we entered into as part of our liquidity planning subsequent to the quarter end, which further strengthened our liquidity position. We have also stress-tested our balance sheet under a variety of scenarios and expect to remain in compliance with all of our covenants. In terms of the working capital items I typically review, they are the following. As of March 31st, receivables were $1.2 billion and inventories were $1.8 billion. Payables were $1.1 billion, all roughly consistent with the end of the fourth quarter. Our unbilled receivables were $523 million, which were more than offset by customer deposits of $603 million. Now turning to slide eight, I'll describe some of the actions we are taking to further strengthen our financial position. First, we are lowering our costs across the business. We are swiftly aligning our operating costs with volume realities while remaining focused on achieving our synergy targets. We are taking further actions to lower our fixed costs by driving down SG&A, eliminating discretionary spend, suspending merit increases, implementing a hiring freeze since January 1, along with other actions. Considering our cost structure, about 85% of our cost of sales are variable, and within SG&A, about 15% of our costs are variable or semi-variable in the short term. We expect the incremental cost actions we are taking to drive down SG&A. Second, we are aggressively managing cash and looking to further strengthen our balance sheet. We expect improved cash flow conversion as we reduce our working capital levels in line with the volume environment. We are also reprioritizing some of our 2020 spend to essential and critical items. We've evaluated expenditures that can be paused or canceled, and we are targeting to reduce CapEx by more than 40% versus our prior guidance of $200 million of capital spend. In terms of capital allocation, our approach remains consistent with what we've said at our investor day, and we will continue to smartly invest in our people and the business. We certainly recognize the current uncertainties of the macro environment, but believe our framework allows us to be flexible and make discretionary adjustments as necessary. We, like many companies, are focused on our business and balance sheet. We are targeting to reduce the debt levels and to increase liquidity We did recently announce our dividend, payable on May 22nd, but for the short term, we've paused our share repurchase program. Keep in mind, we have no major debt maturities due until mid-June of 2021 and remain confident in our ability to access the markets given our financial profile. We are already taking steps to identify solutions to retire or refinance debt well ahead of maturities. including the opportunities from government stimulus programs and other long-term forms of issuances. With that, let's move to slide nine, and I will turn the call back over to Raphael.

Thanks, Pat. So as you heard throughout today's call, the company performed well and delivered a solid first quarter despite a weakening environment. As we go forward, we remain committed to executing on our strategic plans as communicated during our investor day, and we will continue to carefully assess the markets in which we operate. This includes reducing costs, aggressively managing cash, and enhancing our liquidity position while focusing on what we can control. We'll also lean into the strong long-term fundamentals of this company. This includes our $22 billion multi-year backlog, recurring service revenues, broad aftermarket reach, significant install base, technical capabilities, expansive international footprint, and a proven leadership team with deep industry domain. In addition, we will continue to invest in technologies and capabilities that will advance our competitive advantage and drive the long-term growth. These are the intangible differentiators that will help us successfully manage today's market headwinds over the long term, and will help us emerge as an even stronger and more resilient company. Before I turn the call over questions, I want to personally thank each and every member of the WAPTEC team for all that they're doing. Every day, I hear stories about people jumping to action to ensure we keep our customers operations moving. and critical medical supplies flowing into the hardest-hit communities. But I also hear stories of team members going above and beyond to make a difference in our communities, like our technology team who are using additive technology to produce thousands of face shields for healthcare workers and first responders, or our teams in Tennessee and in the UK who quickly provided radiators for generators at the University of Southern California Hospital and East London's Axel Exhibition Center, which both delivered emergency medical care during the pandemic. These moments, and so many more like them, are the stories that fill me and our team with pride. And these are the stories that demonstrate how we will emerge from this crisis even stronger. With that, I'll turn the call back over to Christine.

Thank you, Rafael. We will now move on to questions. But before we do, out of consideration for others on the call, I would ask that you limit yourself to one question and one follow-up question. If you have additional questions, please rejoin the queue. With that, operator, we are now ready for our first question.

We will now begin the question and answer session. To ask a question, please press star then one on your touchtone phone. If you're using a speaker phone, please pick up the handset before pressing the keys. To withdraw your question, please press star then two. Our first question comes from Allison Politiak with Wells Fargo.

Hi, guys. Good morning.

Good morning, Allison.

Raphael, you had talked about your European and Asian sites, you know, from a web tech perspective coming back online. But could you maybe talk about how the recovery is playing out in those regions on the demand side? You know, I suspect there's a little bit of a lag there.

Sure. I think a couple of comments there, Allison. Number one, I think as of today, of our 162 manufacturing sites, we only have two that are still closed. And they've got, I'm going to call specific plans to be open within the next 10 days. So I think that's encouraging to see from that perspective. Of course, I mean, as sites resume, I think we're dealing with a lot of government restrictions still, so that's to be observed. And we're staying very much aligned with our customers to understand how that pace of recovery will take place. And I think, if you're with all the most of our customers, they would describe as volumes really bottoming between what I call the month of April and May. and starting to really see recovery through the end of the second quarter and through the second half of the year. So I think that's probably the best description of how we're seeing recovery ahead of us. But we do expect a significant impact in the second quarter based on the bottoming of that volume.

I understand. And then that 15 million profit impact of the quarter from the closures, is there any way to help us understand what percent went to freight versus transit there?

Hey, Allison, I would say that the majority of it was in the transit area. The impact was really kind of disruption to our operations and the ability to maybe complete and ship and recognize revenue on orders or, you know, both from a supply chain or inflow of components, but as well our own operations and having the people there and get things completed and things out the door. So the majority of that was in Europe and Asia.

Great. Thanks so much. I'll pass it along.

Thank you.

Our next question comes from Justin Long with Stevens.

Thanks and good morning. Good morning. Good morning, Justin. Good morning. Maybe to start with the balance sheet, Pat, you mentioned you've stress tested the balance sheet and expect to stay in compliance with your covenants. Is there any color you can provide on the EBITDA downside scenarios that you're modeling as you think through that? And if possible, maybe talk about the range of free cash flow outcomes in 2020 as you think about the different scenarios that you're assessing.

Yeah, Justin, you know, thanks for the question. It's a little bit of guidance and kind of wrapped in there, but yeah, What we've done is, just as a reminder, our covenant ratios are about, for this quarter and the next, at a three-and-a-half times, and then it reduces to three-and-a-quarter debt to EBITDA on kind of a bank basis for calculating those covenants. We've done a variety of scenarios. We've looked at percentage drops of... kind of like a most likely a deeper case. We've looked at changes within quarters where one quarter is more drastically affected than others. And as we've come out of those views, our covenants, we are staying within those. We feel like our cash conversion is aligned with what we gave in terms of guidance in the investor day. a 90% cash conversion that will most likely improve because of working capital management. And so all those things have really given us the opportunity to see strong and we're confident in our strong cash performance and meeting our covenants.

Okay. That's helpful. And then secondly, just because things are changing so rapidly here, I was wondering if you could provide any update on the quarter-to-date trends you're seeing in the business, just maybe from a revenue perspective. And also, you know, I think everybody's looking back to the last recession as a proxy. Obviously, the business has changed a lot with acquisitions. Is there a way to think back and, I guess, look at the pro forma business and what the aftermarket business did in the last recession on an organic basis, as we think about kind of a downside scenario for the aftermarket?

So Justin, let me maybe start here. Number one, I think just with regards to cash flow conversion, we see an opportunity here to increase that conversion from the 90% above that we've gotten in our investor relations. So just keep that in mind. The second piece here is, as we look into the first quarter, I think as you think about aftermarkets, and I'll break it down here on the freight side, it grew 8% against performance. So I think we've seen at least a couple of bright spots in the business. And the server assist is certainly one of them. Digital electronics is another one. I think we've talked quite a bit before about the fact that we've got internationally fleets are growing. I think we see, especially across customers, there's some that are being less impacted, especially if you're more dependent on agriculture or specific single commodities versus dependence on what are called global trade or general cargo, intramodal.

I think that's playing differently across different geographies we serve. Of course, there's different end markets, too. For that context, I think we see mining potentially less impacted than the overall freight.

markets. So we remain confident in terms of the long term view for some of these segments. We do again expect really based on discussions we've had with our customers to see bottoming of volume between here the months of April and May timeframe with recovering starting to happen in the later part of this quarter and through the second half of the year. Pat,

Yeah, I would just – it's a difficult comparison to previous crisis. I mean, not everything is the same. This is unlike anything that any of us have ever seen in our lifetime. I just keep coming back to the, you know, the strength of our aftermarket and service business, which, you know, will be disrupted, as Raphael talked about, but but is obviously critical to any kind of recovery and part of the essential businesses that still operate and in some cases operate with some strength. So we feel good about the business, the core business, the base business, and the cash flow that it'll generate.

The last thing I'd add there, Justin, is just we're confident about our backlog. We're staying very close with customers And through that process, of course, there's impact in terms of shipments based on some of the impact we've had and our customers have had through the second quarter. But I think the backlog gives us a strong confidence about the long-term views and the fundamentals of the business.

Thanks. And, Pat, on the quarter-to-date part of that question, is there anything you can share on how the business has trended from a revenue perspective or just looking at aftermarket?

Yeah, it's a little preliminary to be talking about the quarter and how we performed in April. I understand the desire to get a little bit of direction there, but it's a bit early. I can say that what we've been doing is focusing on some KPIs, looking at, again, our confidence and our backlog and how that's evolving. and looking at our kind of cash performance on a daily, weekly basis. And so far, we feel that that performance kind of supports all the comments about our confidence and strength in the overall view of backlog and cash flow.

Okay. Fair enough. I appreciate the time. Thank you.

Our next question comes from Chris Weatherby with Citi.

Hey, thanks for the morning, guys. All right. Maybe just drilling down a little bit on the cash flow and working capital, it sounds like there's some, you know, I think some efforts as the year goes on to maybe improve the working capital sort of dynamics. Can you talk a little bit about sort of the first quarter and sort of dynamics within working capital and then how that may sort of improve as you move forward through the rest of 2020?

Yeah, so we talked about the impact of those one-time items that really did impact our first quarter. We had about $80 million worth of cash outflow, which are working capital items, but that cash outflow related to prior year reserves and accruals that were paid in the first quarter. They were restructuring, transaction-related. They were litigation-related. So that $80 million did impact Q1. you look at the rest of kind of the working capital performance in Q1, you do have a seasonality there. We have these outflows that happen in Q1 specific to some comp and benefit type things, incentive-related reserves, and then you also have a very good performance in Q4 that – that probably impacted our Q1 a little bit. And what you'll see throughout the year is that our working capital, we anticipate kind of the normal performance where it becomes a source of cash throughout the rest of the year. And then you layer into it the impact of a business that, you know, we've talked about the disruption that's occurring related to the virus and in our operations and revenue, and you would anticipate that working capital would become a bit of a source of cash over the course of the rest of the year. So we feel like that working capital performance for the remaining quarters will help us drive our cash conversion up for the remainder of the year.

Okay, that's helpful. I appreciate that, Collin. And then just maybe thinking bigger picture about the transit outlook and maybe how we can think about, you know, sort of government budgets, you know, just sort of potential longer-term changes post-COVID-19. You know, are there any sort of beginnings of thoughts around how this business might look and sort of the shape or trajectory of this business might look in sort of a three- to five-year window? I know it's early on in this process, and we're still sort of learning about it, but I'm kind of curious, maybe, Rafael, your thoughts around how this business might evolve over time, if it will be sort of impacted.

I think what I'll say is the short term, I mean, certainly ridership has been impacted. But as we look at really the restarting of economies, I mean, and if you look at some of the transit systems and implementation of what I'll call safe distancing, it's going to demand more trains, more investments. So we're certainly looked at as – I think a positive for the transit segment. So I think we continue to see a demand there and it's certainly part of also a commitment of continuing to, I think, moving things in a better way. So I think we're bullish there. And I'll just take the opportunity to also mention, as we think about some of the dynamics on the freight side, I think we also see, I think, potentially some opportunities playing out of this. which would include elements of, I think, some of our end markets really valuing a lot more reliability in terms of their supply chains. And there could be an element special for North America in terms of nearshoring or onshoring some of the supply chains. So those are probably, I think, a couple things that we could see out of this that would certainly drive volumes and trends up for the end markets we serve.

Got it. Great. Thanks very much for the time. I appreciate it.

Our next question comes from Matt Elcott with Talon.

Good morning. Thank you. So a lot of these North American freight railroads talked about, I think they still want to do locomotive modernization. Some may actually use a downtime to to do more, but they're also, like everybody else, cutting capital expenditures. You know, where we stand now, Rafael, how does that impact the outlook for modernization this year? Are we looking at fewer modernizations or in line or off?

I think at this point, we see a continuous commitment to the modernization programs. It's a big part of how you drive efficiency and productivity into the customer's operations. And I'll probably add to that some of the elements of our digital electronics business as well. So we're seeing a commitment there. And I think there's continued opportunity to play that also internationally. And I think we're currently discussing a few opportunities to drive upgrades internationally as well and continue to grow from the opportunity I highlighted at the end of last year.

But it's too soon to say whether modernization revenue would be, directionally how it would look relative to your expectations a few months ago.

I'd say, I mean, we're confident about the backlog, and I'd say we've walked into this year with that backlog fundamentally secured, and it was the same with regards to new locomotives, which was expected to be down. I do want to remind you that for the first quarter, and we had mentioned that before, we expected both new locomotive shipments and modernizations to be lower, so there was even pre-code veg, but I think we remain confident about dynamics of demand for mods in the business.

Just one more question. If you can just talk broadly about the impact of lower oil prices on the different part of your business.

Okay. So if you think about lower oil prices, I think as far as the freight market goes, it really calls for about 7% of what up on North America railroads transport. That's totally where we would see most of that impact. I'd say less than a third of that 7% is really tied to any variation of what I call a price of oil per se. So it's less about that. And I think the one area to watch out is some of the energy markets that we serve with our products, and that's an area that we'll continue to watch. I think as we really follow with customers here on how they're seeing volume ahead, I mean, we're very much committed to make sure we're taking the necessary cost actions to adjust the different parts of the business to face these new realities.

Great, thank you very much.

Thanks.

Our next question comes from Jerry Ravitch with Goldman Sachs.

Yes, hi, good morning, everyone, and I'm glad you're all doing well. I'm wondering if you could talk about the opportunities to accelerate the cost reduction targets as a result of the weaker demand environment, anything that you could do to come out, you know, step ahead on the strategic front out of this lower volume environment, and if you could talk about your expectations for synergy savings cadence over the course of this year, given the evolving playbook, that would be helpful.

Let me start, and I'll maybe pass it on to Pat, I think. I'll probably start with just SG&A is down for the first quarter, about 70 base points. Hopefully, you've seen that a lot of these actions were taken in the back of the year. So, if you look at 19, we were actually growing volume above 5%, and we took more than 5% half count down during that time. So, we are committed to take the necessary actions. challenging, tough actions, but necessary to the environment we have. And we're going to continue to do that. We've had announcements in terms of reductions in some of our key sites, and we'll continue to move in that direction. Earlier on, we talked about CAPEX, and we're implementing more than 40% reduction. I want to balance that with the following comment. I think a lot of that CAPEX reduction was tied to projects that we have volume associated with it.

We're either deferring or postponing some of these as we gain better visibility ahead.

I do want to, again, emphasize our commitment to R&D and continue to invest on some key programs that will be differentiators for us, as we highlighted in the investor conference we had.

I think the other element has been really consolidating footprint.

Last year, we did about 6% of footprint consolidation. and that was about a million square feet. We're going to be executing on our 9%, so that's also going to be an element of how we continue to drive costs down. If I think about the synergies per se, we're absolutely committed to the $150 million of synergies for the year. We do recognize there could be an element of impacts associated with volume, but again, I think we're continuing to take farther actions to make sure that we deliver on that. Maybe Todd?

Yeah, I would just add we're trying to be very disciplined about what we measure as synergies versus just adjusting the business for the volume realities. We're doing both at the same time. And so if you, you know, to go back to your kind of original question, is there anything we can do strategically to accelerate the We had already accelerated the synergy plan that we would hit our run rate a little bit earlier. We're going to continue to execute on all of those expectations, all those plans, and they can and will be looked at as maybe done a little bit earlier based on volume, but nothing that we want to really highlight at this point in terms of giving a number or anything plant-specific. All I can tell you is that we are working on everything we can to ensure that we – and we expect to get those synergies, but to do more in terms of additional cost because of the change in the environment.

Expect us to use every labber in the business, and we'll continue to evaluate those and make sure that we exercise those as we look into new realities of that.

Okay. I appreciate the color. And then in terms of services and, you know, electronics specifically, how discretionary are aspects of those product lines in, you know, this type of environment where, you know, volumes are down 20% for your customers? You know, I'm sure they're also targeting OPEX reductions as well. Can you just talk about how critical the services are? Do you expect to continue? to outperform in your services versus freight volumes, just high-level comments there would be great.

Okay. Well, first of all, there's certainly an element of impact there as customers park locomotives, especially in North America, in the light of volume bottoming. I think we've said before, I think we have a younger fleet of fleet of locomotives that's more productive than our competitors locomotives. So I think we're better positioned in terms of being able to navigate through this downturn. And I think a lot of the solutions that we have in the digital electronics, even though, to your point, some of that could be discretionary spending, I think a lot of those play strong in terms of allowing customers to get really lower costs, lowering expenses, and ultimately getting the benefit with relatively short term. And so we continue to expect strength on those product lines.

Yeah, I'm going to just reemphasize what Raphael just said, is that the service side of our business helps our customers drive efficiencies and reduce operating expense. It's really some of the premise of PSR, and you would think that that would continue as we go through the rest of the year.

I appreciate the discussion. Thank you.

Thanks.

Our next question comes from Scott Group with Wolf Research.

Hey, thanks. Morning, guys. Good morning. Can you help us? think about with transit ridership down at least so much in the near term, is that having more of an impact on OE or aftermarket? How do we think about margin mix within transit right now? I know there was a comment in the release about committed to segment margin improvement. Does that apply to both of the segments this year?

Yeah. So I may be a start. I think as we think about transit, I mean, I think we're seeing the end customers continue to be committed to what I'll call the projects, per se. There could be an element of, I'll call, impacts of what I'll call services for the short term, just based on, well, ridership being down. I think, again, we're probably gonna see, and as we talk to customers, I think there's an expectation that the bottom of that has really happened between here, the month of April, and May, and I think ridership is expected to be ramping back up as we go into the later part of the quarter and into the second half of the year. So I think that's one element. I think a lot of the dynamics, what you saw in the quarter, per se, I think that referred to the over five cents we've had of impact on EPS. I think a lot of that came really associated with our inability to ship due to shutdowns. and those were either to our own plants, especially in, I'll probably mention here, India and parts of Europe. And, well, of course, we have customers impacted through that as well. So in some cases, the inability of customers receiving some of these shipments. But, again, I think we have a solid long-term view here for the business, and we're confident about strong fundamentals. Pat? Yes.

Yeah, I think kind of getting to your question about, you know, what do we think about the impact of transit ridership being down, I think, you know, kind of near term you're seeing a little bit of a mix of fewer trains running, but maybe some pent-up demand for some maintenance and services and safety stocks. So, I mean, some of that is definitely occurring. I think the kind of more longer-term impact of the, you know, of – of a quarter or more of the lower ridership is to be seen. And part of the reason why we talk about our top line guidance the way we have is we still have to see how this unfolds. But long term, the areas that we're operating in are heavily dependent and will continue to rely on transit And in some way, it may become opportunistic as everybody kind of figures out what transit looks like in the future.

And I think when you reflect on the margin improvements, I think we're continuing to see the quality of the order intake margins continue to improve there. So the orders are coming in. And the other piece is we're seeing operational improvement in the business. That speaks to improvement on time delivery. reduction in cost of quality. Of course, these comments are pre-COVID, and we'll be assessing how COVID will be impacting some of that, but we're committed to the margin improvement on the transit segment.

Okay, and then I want to sort of see if maybe we can get a little bit more color. I understand you won't give us April revenue, and that's fine, but, you know, We're lapping GE. We don't really have any KPIs to track. There's not great sort of comps. Like directionally, is there any sort of color on sort of how to think about revenue right now, down mid-single, down high single, double-digit, strong double, like any sort of directional color just because it's – with you guys, it's particularly tough right now relative to some of the other, you know, companies. Yes.

Yeah, you know, I appreciate the question, Scott. I don't, you know, with kind of pulling the guidance, I think, for the year, I think it's a little bit difficult to put anything out there. You know, April for us is still being kind of accumulated and looked at. We feel good about, as we're measuring where our backlog is and our cash flow performance is, that We feel like it's well within some of the scenarios that we had outlined, but nothing that we really want to talk about publicly right now in terms of guidance.

Okay. Perhaps in the queue, maybe an update on April would be helpful. Okay. Thank you guys very much. Appreciate the time.

Thank you. Our next question comes from Sherry Boroditsky with Jefferies.

Good morning. I think you mentioned mining being less impacted than the overall freight market. Could you talk about what you saw from the industrial business in the quarter and how you're thinking about demand there for the rest of the year?

Okay. I think whether we think about the impact, I think certainly the energy markets is the one that we're probably more concerned about and being back there as we serve some end customers in that regard. We're working very closely with our mining customers. and staying very close with Komatsu here, and I think we continue to see opportunities for the services of that business, and I think we're seeing certainly less of an impact there. Anything else you would add here, Fats?

No, I mean, I think that some of the industrial markets are really tied to oil and gas, or our heat exchange business and some of our turbocharger business. And we've seen some decline in the quarter. We imagine that that decline will be sustained a little bit with the price of oil.

Thanks. That's helpful. And then you talked about continued strength on the freight services side. I was just wondering if you're seeing any of the rails perform more in-house services given the lower volumes?

Could you repeat that again, please?

You talked about continued strength on the freight service side, so I was just wondering, in your conversations, if you've seen any of the rails perform more in-house servicing?

I'd say no, we haven't seen any significant change to that. I think, in fact, we have some opportunities here to help the railroads, potentially driving railways, efficiency through that process. So if you think about mods and some of the elements of things that we do on the services side of the house, so I think that's a continuing opportunity for us. We don't see that as an impact to our revenues right now.

Perfect. Thanks for the call. Our next question comes from Courtney Yakovonis with Morgan Stanley.

Hi, thanks for the question, guys. Can you just comment a little bit on the shutdown in India? Obviously, they make up a large portion of the backlog on the freight side and on the local delivery side. Can you just comment on your ability to kind of catch up by the end of this year or whether we should be thinking about some of those expected shipments getting or deliveries getting pushed into 2021?

So I'd say our sites resumed operations today in India, except for one of them, which I think we have a clear line of sight to starting back up within less than a week. And I think we're going to be watching really closely here. But right now, things seem to be really moving in the right direction. And we would have the ability to catch up soon. for the year. And even as we look at it in the quarter, there has been, I think, a potential some opportunity to partially recover some of the volume loss there in terms of shipments. Does that answer your question?

Yes, that's helpful. And then also, you know, you commented on kind of quantifying the COVID-related drag on the quarters being about $0.05 or $15 million. Can you just comment what exactly you're including into that and how you would break that down between freight and transit?

Yeah. You know, we didn't view it as – when we were talking about this, this is not something we added back. We just highlighted it for – just for, you know, exactly this question. I mean, mostly it's revenue impact to – our operations in India, the ability to get some of our LOCO build finalized. But I'll also point out we have a pretty sizable transit business in India that was also impacted. And again, it's just the timing of shipments and production and shipments in the quarter at the end of the quarter. The rest of the impact is is European operations where shutdowns or partial shutdowns occurred. And, again, maybe things weren't shipped and the revenue recognized or our inputs components from suppliers didn't arrive in time and we weren't able to complete the project. So all of those things kind of added up into the $15 million worth of EBIT impact. We did not have a lot of – we had some, but nothing worth highlighting of, like, cleanup costs or any kind of things like that. We clearly were taking the appropriate steps to protect our employees, to make sure that any kind of cleaning or any kind of disruption that way were viewed, but the five cents that we're talking about here are really revenue disruptions.

Okay, thanks. And then just one more clarification on the 9% footprint consolidation. Was that incremental to your previous plans, or was that kind of what's expected to achieve the synergy targets you guys were planning?

That was within how we would have achieved the synergy targets for the year. So totally tied to the $150 million that we're committed to delivering the year. Okay, great. Thank you, guys.

Thank you.

Our next question comes from Ken Hexter with Bank of America, Merrill Lynch.

Hey, good morning, Pat and Raphael and Christine. On the confidence in the backlog, maybe you could just talk a little bit about this. I just want to see, have you had customers come and have discussions about shifting? Maybe you could talk to us and give us some precedent and prior downturns, how has that committed spending been and is the – Is that tied to production schedules in terms of the backlog? Can they shift delivery times and push that out? I just want to understand how the timeframe works on that backlog as well. Thanks.

Yeah. So I think you bring a great point. I mean, this is not the first downturn we're going through. We will operate and work very closely with customers here, and we're confident about that $22 billion backlog at this point. We're, of course, working with customers as COVID has impacted operations, so there could be a shift. in terms of when some of these projects are shipped, but overall confident about delivering on that backlog.

Yeah, just can you expand a little bit on that, Rock? I have customers come and ask for delays. I just want to understand the commitment on that.

I think the backlog is largely, again, I think we're executing through that backlog. The elements of delay are really associated with some of the dynamics we're seeing in the quarter. A lot of it's due to our, I'll call, own inability to catch up on some of the elements of this delivery just based on delays. the shutdowns we've been subject to, or customers' ability to also be receiving or executing through that. So I think, again, back to my original comment, the confidence on the backlog is there, and we'll always be working with customers proactively on that regard.

But no comment directly on if customers have come and asked for delays or what the negotiations like of that. I think I'm just I don't understand how that.

So, Ken, I mean, I think some of the, you know, we're constantly in conversation with all our backlog and all our customers about timing of deliveries. And so it does have an impact. When we kind of look at the current year, you know, right now, you know, we have a lot of confidence in the current scheduling in terms of manufacturing and delivering. But it will – you do have this kind of constant demand on us and our customers to kind of work on when and how we're going to deliver the backlog. So it's not kind of simple as just saying, well, have they all of a sudden just showed up and asked the question? This is how everything unfolds every year.

Okay. And just on the second part of that, was that tied to your production schedules? Can they shift the delivery times? Is that part of the backlog discussions you had?

I think there's a mix. There's an element of I'll call long-term orders that we're certainly executing through. There could be delays there. I think the area where you could see some variation is really tied to more transactional volumes. associated with potentially fleets that are being parked and maintenance to some extent that's going to be deferred to the fact you're not utilizing equipment. And most of that impact is certainly going to be felt here, I think, in the second quarter based on my earlier comments of bottoming a volume between the months of April and May timeframe. And we do expect that to resume as we go towards the end of this quarter and the second half of the year.

Great. And then my follow-up, on Courtney's question before about the 9% footprint consolidation, maybe just expand on that a bit. Are you doing any structural changes, you know, now that you look at, you know, post-merger and given the downturn in demand, do you see, like yourself, accelerating some of these structural changes? Or are you saying with 150, you're sticking with the target, maybe you've accelerated that plan within that target? but there are no new moves that you're putting within that that are clear now that you've got downturn and can make bigger changes?

So certainly I think volume reductions allow us to potentially look at, I'll call it, accelerating some of these elements. And I think when I go back to our comments of staying committed to deliver on the $150 million of synergies for the year, there's certainly an element of that. And despite of any, I think, volume reductions we're seeing there on the synergy, especially if you think from a sourcing perspective, there could be, I'll call it an impact there. I think we've got areas of opportunity this year to continually to take action on.

All right. Thanks for your time, guys.

Our next question comes from Jeff Case with Dates Capital.

Yeah, I have a question. If I look at the GE business that you purchased, can you talk about the seasonality of that? And it looks like the first quarter from the pro formas you gave last year show that it's typically very seasonally weak in the first quarter. And I'm just wondering, what is it about that business that makes it so seasonal?

Hey, Jeff, I think – The seasonal aspect of this business, and Raphael may add on to this, is the service side. I think our customers have a kind of overweight in the local areas, the service business into the third quarter and not so much in the first and in the fourth. And so that's the real seasonal element about it. But when you kind of look at it over a multi-year period, you do have the impact of projects, which is OE and is driven by customer demands and expectations, their own fleet strategies for new equipment, and then international projects too. So that can kind of create some lumpiness quarter to quarter in terms of revenue recognition. But the true seasonal part, which is the service of North America and international markets, locomotives tends to be very heavily weighted in the Q3 and not so much in Q1.

But am I thinking about it correctly that the GE business, the first quarter, is more seasonally weaker than the legacy web tech business?

I think if you were to look historically, I think there could be elements of weakness in the first quarter, but back to Pat's comment, it's really more tied to time of projects than anything else. And as I look into specifically this quarter, we did have both elements of not just lower shipments on new locomotives, but we also expected lower shipments on the modernization side. And those were even pre-COVID.

So, largely, again, project-driven. And I would add one other element, and I don't know how many periods or what periods you're comparing, but there's, if you go outside of the numbers that we've provided, you have different revenue recognition standards, and that would maybe exaggerate some of the seasonality. But I think that it's fair to say that Q1 is seasonally is lower on the service side. Q3 is a little bit higher. LabSec, on the other hand, which is doing freight car service and maintenance, may be a little bit different, but now it's a much smaller percentage of the total business where that seasonality would be more Q1 and less in Q3. So a lot of things to kind of add and subtract from that.

Okay. Thank you. Thank you.

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

Thank you, Eileen, and thank you, everyone, for participation today. Hope everybody stays safe and healthy. We look forward to speaking to you soon. Goodbye.

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