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Wabtec (NYSE:WAB)

Q3 2008 Earnings Call

October 22, 2008 10:00 am ET

Executives

Timothy Wesley - Vice President, Investor Relations

Albert Neupaver - CEO and President

Alvaro Garcia-Tunon - CFO and Sr. VP.

Patrick Dugan - VP of Finance and Corporate Controller

Analysts

Wendy Caplan – Wachovia Securities

Jim Lucas - Janney Montgomery Scott

Kristine Kubacki - Avondale Partners

Scott Blumenthal - Emerald Advisors

John Barnes - BB&T Capital Markets

Joe Box - KeyBanc

Greg Holter - Great Lakes Review

Dennis Salvo - Jodocus Capital

Operator

Hello, this is the Chorus Hall Operator and welcome to the Wabtec Corporation third quarter 2008 earnings release conference call. (Operator Instructions) I would like to turn the conference over to Mr. Tim Wesley, Vice President, Investor Relations. Mr. Wesley, you may begin.

Tim Wesley

Thanks Denise. Good morning, everybody and welcome to our third quarter earnings conference call today. I’ll introduce the rest of the Wabtec team who are here. Our President and CEO, Al Neupaver, our CFO Alvaro Garcia-Tunon, and our Corporate controller Pat Dugan.

We of course, will make some prepared remarks and then we will be happy to take your questions. And we will make some forward-looking statements during the call, so we ask that you please review today’s press release for the appropriate disclaimers.

And with that, let me turn it over to Al Neupaver, our President and CEO. Al.

Al Neupaver

Thanks Tim. Good morning everyone. What I’d like to cover is a review of the third quarter results and our current market conditions and then talk a little bit more than I normally talk about the progress on our strategic growth initiatives. We’ve had quite a bit of change in the landscape here strategically over the last few months. And then Alvaro will cover the financials in a lot more detail.

The company performed well in the third quarter. We had very strong sales increase of 12% to a record 396 million. Our earnings per share in the third quarter was a record, it was $0.68. That was 24% higher than a year ago quarter. Our backlog remained over $1 billion, even with record sales for the tenth quarter in a row.

Based on our performance and the outlook for the rest of the year, we’ve increased our 2008 guidance. We have our sales growth coming in between 13 and 15%. Of that increase, only 25% is coming from acquisitions. We have our earnings per share between $2.66 and $2.70. It was about $2.65.

Keep in mind, that this performance is being achieved in a weak U.S. freight car market. This shows the strength of our diversified business model, that our strategic initiatives are paying off, and that we continue to drive margins higher through the Wabtec performance system.

Let’s take a look at these markets. The freight rail market. Freight traffic year-to-date, ton-miles are actually up about 0.8%. But overall car loadings are flat to slightly down. Commodities such as coal, chemicals, and grain are up, with most of the other categories lower, including intermodal. Obviously, rail traffic is driven by the overall economy and there definitely seems to be increasing evidence of a global economy that’s slowing.

As expected, railcar deliveries will be down this year, but still at a good level. Most industry analysts are still expecting deliveries low to mid 50,000 this year.

Our third quarter numbers are not released yet, but our internal data suggests that orders were about between 7,000 and 9,000. And deliveries were between 14,000 and 16,000, which would put the backlog in the low 50,000’s.

The locomotive market remains still strong and that is driven primarily by international markets. Overall, we are concerned like everyone else about the economy. And we have contingency plans that are in place.

As far as the transit market, there is slightly a different story. We continue to see a strong transit market driven by federal funding and passenger ridership. The federal transit spending is up 6% to a record $10.3 billion.

Current spending bill runs through September 2009. Congress will wait until a new president takes office next year before beginning any serious discussions about future funding levels.

Ridership continues to increase across the U.S. In the second quarter it was up 5.2%, setting records in many cities. High fuel costs and environmental concerns about emissions should continue to drive growth and new investment.

We also have the international transit markets, which were much larger than U.S. Market and our share is quite low, so we expect good growth in those markets as we go forward.

Now, let’s switch gears a little bit and talk for a minute about some recent U. S. legislation that will have an impact on the rail industry and on Wabtec. Last week, President Bush signed into law the rail safety enhancement act of 2008, known as the rail safety bill.

This legislation has several important features of interest to Wabtec. It addresses positive train control and ECP (electronic controlled pneumatic braking). The bill requires all Class 1 railroads and intercity passenger and commuter railroads to implement a positive train control system by December 31, 2015 on mainline track where intercity passenger railroads and commuter railroads operate and where any hazardous material is being transported. It also provides grants of $250 million over the next five years for new safety related technologies, such as our positive train control and ECP products.

It also funded Amtrak. It authorized Amtrak capital grants and operating grants that totaled over $13 billion over the next five years. It also has other provisions that are designed to improve safety related to work hours, grade crossings, and bridges. We expect the bill to have a positive impact on some of our strategic growth initiatives.

The momentum is clearly building for two of our technologies, positive train control and ECP. Let’s talk about positive train control first. Based on the requirements of the new safety bill, we estimate that 60% of the track mileage, 75% of all the road locomotives, and all commuter locomotives, will require positive train control.

We currently have the only FRA approved system in use today, and we are working with the railroads to establish joint operating standards, so Wabtec is a clear leader in the field. Although it’s premature to talk about specific numbers and a time frame for the roll our, we believe the train control has the potential to provide Wabtec revenues of 200 to 400 million over the next five to seven years.

Electronic controlled pneumatic. We have two pilot trains running in the U.S. this year, with good results. As a result, last week the FRA issued a permanent rule change that allows trains using electronic controlled pneumatic braking to travel 3,500 miles without stopping to check the brakes. The rule previous was that every train without them, and it’s still in existence, would have to stop between 1,000 to 1,500 miles. Quite a advantage for the operating trains.

We believe this new rule will give railroads the incentive to begin implementing ECP at a faster pace than they otherwise would have. Again, it’s premature to discuss specific numbers, but we feel that ECP could actually be a bigger market opportunity than train control, although, it would be spread over a longer period of time.

We also have had quite a bit of activity on the acquisition front. Late in June we acquired Foley Corporation, a brake component supplier that gives us the ability to expand in Europe, open the freight and transit market. The integration of that particular acquisition is going well.

In September, we signed an agreement to acquire Standard Car Truck for about $300 million. Standard Car Truck is a leading manufacturer of freight car and locomotive components, with sales of about 225 million. Some of their key products are freight car truck components such as springs, wedges, wear plates, side frames, bolsters, break beams, and some locomotive components.

This acquisition is very strategic for us. It eventually leads to our ability to provide a complete railcar undercarriage. Their barber truck design is used worldwide and is the North American market leader.

Our combined knowledge of in train braking forces and design capabilities gives us a unique opportunity to advance the stabilization technology for the industry. Improved stabilization means less damage to the cargo, to the railcar components, and to the track.

In addition to these two acquisitions, our pipeline is flowing but, we continue to be very selective and disciplined in our approach. I’ll now turn it over to Alvaro.

Alvaro Garcia-Tunon

Thanks Al, and good morning everyone. Like we said earlier, we thought we had a solid quarter. Highlights would include continued strong sales like Al mentioned earlier and earnings growth, as well as operating margin improvement, which is as you well know something that we have been targeting.

The backlog continues to be strong and pilot in spite of the record sales. And as Al talked about, acquisitions and new products, we’re making very good progress in executing our strategic plan.

To be a little bit more specific and to get to the numbers, sales were about 12% higher than last year and hit a record quarterly high of 396 million. One of the things that we’re very pleased about is that about 80% of the sales increase was organic. It did not come from acquisitions. Foley contributed about 8 million of sales during the quarter.

The transit group in particular led the way in the strong sales performance, with increases due to several factors, including friction products in Europe, transit car components in North America, and again the acquisition of Foley.

Freight group, which we expected to be slightly down this year, was actually slightly higher than the year ago quarter, which again, we’re pleased with, as we have been able to offset the lower demand in freight car and OE freight car with growth in other areas, such as heat exchangers for power generation, market for the power generation market, and international sales in general.

Margins as you well know, you continue to be focused on margins. We continue to be focused on margins. And we are again pleased to report that for the quarter margins increased about to about 13%. Operating margins increased to about 13.2% versus 12.9% last year.

As a percentage of sales, operating expenses were slightly lower at 13.9 versus 14.1 and that does include operating expenses includes about a million of what we call…What’s called purchase price adjustment which is short-term paper write offs of acquisition costs.

Again, to make it clear, SG&A includes about a million of what we call PPA. And there’s also about another 2 million in costs of sales. And I think we’ve discussed this in prior calls, but to refresh everyone’s memory, this is basically when you make an acquisition now, what the accountants make you do is write up all the inventory to net realizable value, so you have to recover all that inventory right away, basically without a process and they also make you write up the backlog right away to that realizable value and you have to amortize the value of that right off the bat.

The effective tax rate, it helped us a little bit this quarter. We benefitted from a lower than normal tax rate of 34.2%, which added about $0.02 to our EPS. This was due to releasing valuation reserve from prior tax years. Normally we extend our taxes when you do the statutes expire in the third quarter and that’s when you recognize the valuation reserve that you no longer need.

Working capital compared to June 30. Receivables increased by about 15 million, but nine of this was due to Foley and the balance was due to increased sales. The receivable’s balance right now is about 298.7 million.

Inventories were higher by about 27 million, but again, 18 million of this was due to Foley. The inventory balance was about 223.4 and this is one area that we continue to work on. We think it’s a lean company. We should be doing better on inventory.

Payables increased. Some of the payables increased by about 12 million, which offset some of the higher asset totals and right now payables are about 154.8.

Cash at the end of the quarter. Still have a substantial amount of financial flexibility. We had about 186 million in cash and that includes the fact that we paid about 82 million for Foley. Cash from operations was about 47 million for the quarter, so that reflects a strong balance.

I’ll discuss the Standard Car and Truck acquisition. And in connection with that, we decided to obtain a new bank credit facility for 500 million. We were fortunate in the timing that we predated I guess the worst of the financial turmoil by about two to three weeks. We have received all the necessary bank commitments and we expect to close on that shortly when we close Standard Car and Truck.

We think post-closing, between the cash that we have on hand right now and the new bank credit facility, we’ll have a substantial amount of flexibility in dry powder to whatever is necessary going forward.

One question that we recently had a board meeting and this was at the top of the agenda and I am sure it is at the top of your agenda as well. We’ll periodically conduct a risk management analysis. And given the recent turmoil in the financial markets, we thought it would be a good idea to revisit this with you briefly.

What we’ve done is we’ve reviewed areas such as insurance coverage. Obviously, the financial institutions and the insurance companies have seen a lot of turmoil. Cash deposits, we want to make sure our cash is safe.

Currency exposure,, the dollar is moving pretty dramatically all over the place. Interest rates are moving dramatically all over the place. Our pension accounts for the defined benefit plans, receivables, issues with suppliers and right now hopefully without being too optimistic, they are looking at it to the proper filters, we haven’t really identified any meaningful exposures in these area, but this is obviously cramping and we’ll continue to monitor.

A few miscellaneous items, which we always cover at the end and give you the numbers, depreciation for the period was $5.9 million versus $6.5 million last year. Amortization was $1.7 million this year versus $1 million last year. CapEx was $4.6 million in line with our normal numbers versus $4.5 million last year.

And then backlog, another positive indicator for the future, we believe that the backlog, which remained over a billion, which we really didn’t hit at of this year. The rolling 12-month backlog, which again is the backlog that we expect to execute over the next 12 months, so three months this year, nine months next year, total about $627 million versus $690 million last year.

In freight, the backlog actually increased slightly, which is a good sign for the freight market even though the freight backlog is not a terribly meaningful number, but the freight backlog was 191 out of that 627 and a 178 last year, so an increase by about $13 million.

Transit was down from about 512 last year to 436 this year. Part of the reason for that is that because of a change order in one of our locomotive orders. We actually shifted some of the backlog from executable within the next 12 months to executable after 12 months.

One of our customers made a significant change in locomotive, and it’s going to take us longer to execute it, at that was about $20 million, so about $20 million of that transit backlog just shifted from one category to next.

The multi-year catalog, which in essence is what we execute after 12 months and including the 12 month number just to make that clear, so the total backlog including what’s executable in 12 months is 1.15 billion versus 1.16 billion at 6-30-08. So basically, doesn’t get much more stable than that.

Freight was basically the same, 224 million versus 221 million and transit was 922 versus 940. So again transit in total executable, they would in the next two to three years was pretty much the same.

You may have some questions on that we’ll be pleased to address it during the Q&A. And with that I’ll turn you back to Al.

Albert Neupaver

Thanks Alvaro. Once again we’ve had a strong performance with the $0.68 quarter, record sales and a strong backlog. The transit market remains strong and our strategic initiatives are working, which gives us the confidence to increase our sales and earnings guidance, although we are concern about the worldwide economy outlook.

The diversity of our business model is really the key to our success. We have a freight market, we have a transit market. We’ve got 50% of our businesses in aftermarket. We have about 40% of our business outside of the U.S.

This particular business model is serving us well. In the basis of everything we do the foundation of which we build on is the Wabtec performance system and this is what provides the established culture of lean manufacturing and continuous improvement.

We have an experience and dedicated management team and with that we’ll be happy to answer your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question is from Wendy Caplan from Wachovia. You may go ahead please.

Wendy Caplan – Wachovia Securities

Thanks, good morning.

Alvaro Garcia-Tunon

Good morning Wendy.

Albert Neupaver

Good morning.

Wendy Caplan – Wachovia Securities

I’ve been getting a lot of questions so I’m guessing you’re getting a lot of questions about transit’s expanding given some issues with various states, cities, and etcetera. Can you comment on that whether you’re feeling anything yet or whether it’s something we should worry about?

Albert Neupaver

Let me…In order to answer that question, it’s a fairly complex question and it’s a complex issue. I think to understand the situation you have to understand the basis of the funding. When the transit authorities get funding from the government whether it be federal, local or state, there’s two different pocket that goes into.

One of the pocket is called the operating funds and the other is the capital fund. The typical products that we actually supply and in our long term backlog are the capital funding portion of it, and how these transit authorities get funding for this particular two areas, in the operating fund, about 48% to 50% of that have to come from direct generation being the toll gate in order to -- so it have the direct relationship to the ridership.

And one of the problems with that obviously is ridership’s goes up and if most of the funding really comes from directly generated, without raising the price and fares, what they have seen is increased cost related to obviously their labor cost, but more importantly in some of their fuel and energy cost that they have.

So they’re really getting stretched. In the operating funds about 20% comes from local, about 20 comes from state and only seven comes from the federal government. Now that’s the kind of news that you’re reading about when you talked about these trends in authorities being pressed. That’s really the operating fund that’s being -- there’s struggling with.

When you look at the capital funding directly generated is only about 25% while the state supports about 13, local 15 I think, and federal is over 40%. Some of the programs are really funded 80% federally from matching funds. So, that particular funding is in place and that’s what’s in our backlog.

The ability to move between these two funds is very, very difficult. So, the concern that we would have going forward, the real question is what happens to this federal funding when the current safety, I mean the current funding expires and that’s called the safety lieu with some $52 billion, but it does expire and it had increased spending each year, in September of ’09.

Now if the current safety bill is any indication of how the politicians feel about future funding, we’re in pretty good shape, because if you’ll look at what they’ve given Amtrak, and authorized in that safety bill. I mean, Amtrak, it’s been a bad all year-on-year and actually they left it out of the total transit bill. And the fact that they’re authorizing over $13 billion over the next five years is a positive indication for mass transit.

But until we get a new president in place, there are obviously -- there’s a period of time. But most of our long term contracts looks can be on that period of time and by not approving a new program, all it means is that the current amount will not increase, but that amount will be available for the transit area.

I hope that answered your question. It’s exceptionally a long answer.

Wendy Caplan - Wachovia Securities

But was, so it was extremely helpful and I’m sure not just for me but for others as well. I was somewhat surprise Al about, and you can comment about sales mix. I guess I thought that I had expected a bigger change in terms of increase for transit versus freight. I was somewhat surprise to see that switch that transit was up so much on a sales basis. And can you comment on the mix of aftermarket and OEM within those two segments please.

Albert Neupaver

Sure. On the mix, what we -- Wendy’s referring to, if you look at the third quarter of last year and even second quarter in L.A., freight was about 51% of our revenue and transit was about 49. This particular quarter, we had the freight was 46% and transit was 54%.

So, we really saw a large increase in the transit area as a percentage of sales. I think that we do get swings quarter to quarter especially as we ship a lot of these transit orders are large orders and sometimes there’ll be a, you know, a lot more sales in one given quarter compared to the next to the previous one.

I think the thing that we’re extremely pleased about is that we were actually able to hold in quarter-on-quarter on our freight business, which really is -- it’s really is a statement against a diversified business model when you look at things like having the ability to take advantage of the opportunity in transit in doing this particular quarter, yet holding our own in the freight area. It really is the fact that we are very diversified.

The other thing that’s amazing you asked about the aftermarket. Aftermarket was actually down quarter on quarter, in this particular quarter we only have 43% of our business was in the aftermarket area. And we would have, you know, typically not seeing that. We’ve actually have seen the more on average as you know it, it’s basically of around 50%, when you look at year to date and compared to the previous year.

So, these mixes will change, but the key -- what we like to really stay focus on in our strategic approach is to stay diversified as we can and not be reliable on say real car deals as you know, real car deals still comprises less than 20% of our total revenues.

Wendy Caplan - Wachovia Securities

Thank you, but that’s switch in aftermarket, that’s related to the strength in transit in the quarter?

Albert Neupaver

I believe, yes. I think it has it has a lot to do exactly Wendy.

Alvaro Garcia-Tunon

Not like, Wendy for example, transit and again our 160 in here and the state for New York city is gearing up and few of the other transit areas as the new locomotive are gearing up as well. So transit was about 60% OE. So, definitely the reliance on transit is going to shift those ratios a little bit.

Wendy Caplan - Wachovia Securities

Thanks a lot.

Albert Neupaver

Thank you.

Operator

Our next question is from Jim Lucas from Janney Montgomery Scott. You may go ahead please.

Jim Lucas - Janney Montgomery Scott

Thanks, good morning, gents.

Albert Neupaver

Good morning, Jim.

Alvaro Garcia-Tunon

Good morning, Jim.

Jim Lucas - Janney Montgomery Scott

A couple of housekeeping questions first. You gave us the organic, what impact did FX have on the top line this quarter?

Alvaro Garcia-Tunon

Give me on second here. This quarter compared to the second quarter of ’08, which I think’s probably the most relevant, the dollar’s gotten stronger, so that hurts revenues to a certain extent, so revenues actually dropped by about four million compared to Q2 of -- I’m sorry I was comparing it to last year, to Q2 of ’08 was 7.8 compared to last year, it was about 4.2.

Jim Lucas - Janney Montgomery Scott

Okay and tax rate, we got the seasonal true-up, I guess, for lack of a better term. But, given you’ve got 40% of revenues now international and we happen to be the second-highest tax rate in the world, can you talk about potential for that tax rate to come down further going forward?

Alvaro Garcia-Tunon

Sure. Actually, that’s a question we ask ourselves continually and we do have various initiatives underway to try and get it, mostly focused on foreign operations. One of the things we’re trying to do is consider the use of a European supply company, where we actually set something up, centralized in a low-tax country to basically recognize and trap revenue there and get a tax in a low-tax country.

When we do acquisitions in Europe, we also try to use various holding companies where you can trap other income again in low tax countries. A couple of specific ways you can do this, when you talk about taxes, you obviously want to talk generalities rather than too specific, but one thing you can do, for example is appraise all your intellectual property, move it all into a low-tax country and then pay royalties into that low-tax country and get your royalty expense in high-tax countries. That’s one area that we can do it.

You can do the same thing with finance; basically lend money from low-tax countries to high-tax countries. Transfer pricing, you have to be very careful, but, again you can improve your transfer pricing. So, probably the chief area that we’re looking to reduce our taxes would be in the foreign areas, primarily in Europe. In the U.S. you’re somewhat limited, but going forward, we’ll be looking at ways there as well.

Jim Lucas - Janney Montgomery Scott

Okay and Al, you touched on working capital earlier and you look working capitals, percent of sales, 23.5% the third quarter, which is up sequentially as well as year-over-year, not necessarily a bad number, but continuous improvement at the heart, could you talk about what is going on with them working capitals specifically and any areas of near-term opportunity there?

Albert Neupaver

There’s obviously plenty of opportunity and we’re never satisfied with our lean culture. It continues to improve in that area is really a complete corporate focus, but our business is a slightly different business than other businesses when you get into analyzing working capital because of the nature of our large contracts and the way that we account for them. We get a lot of advance payments, so we have to, really, we use two metrics when we really judge our ability.

One is simple working capital and then we do a GAAP working capital because we get a lot of that payment upfront and we go out and we have to buy inventory and there’s certain other aspects related to it, so we do track both numbers and we continue to try to show improvement quarter on quarter, year on year.

I think that the POLI acquisition, obviously -- I think Alvaro pointed out the amount of that working capital gain came, I think, of the 30 million, 21 million of it came from POLI, although we did have a little bit of favorable impact from FX, if you look at the spot rates period to period.

So, I think there’s a tremendous amount of opportunity. We’re going to stay focused on that.

Jim Lucas - Janney Montgomery Scott

Okay.

Alvaro Garcia-Tunon

Just to give you an example, Jim and, again, I think I kind of said it during the remarks, but I’ll emphasize it again. We think inventory’s an area we can do better in and we continue to emphasize it, but from last year -- I’m not sure I have the number for me from the last quarter, but since last year, we have an increase in customer prepayments of about 30 million.

So, while some of the working capital balances have been going up, also the customer deposits have been going up and when you look at it, I think it makes sense to look at them both because a lot of these customer deposits allow us to purchase the inventory and basically, finance the unbilled receivables that arise from a long-term contract.

Albert Neupaver

And I think if you look at it on a GAAP basis, our inventories are down into the low teens. Is that correct, Pat?

Patrick Dugan

Right.

Jim Lucas - Janney Montgomery Scott

Okay and final question for a number that won’t be disclosed until the queue, but if you look at the spread of margins between freight and transit, given that transit has now become a larger percentage of the overall business and you did experience margin expansion in the quarter, what is the gap now between freight and transit?

Albert Neupaver

I’ll give you a history.

Jim Lucas - Janney Montgomery Scott

Okay.

Albert Neupaver

Okay. If you had third quarter ’07, right and this was all in the public information, it was about 6% spread in the third quarter. If you look for --

Alvaro Garcia-Tunon

Third quarter last year, just --

Albert Neupaver

Third quarter last year, and if you -- second quarter would be history and that was only a spread of about almost --

Alvaro Garcia-Tunon

Five.

Albert Neupaver

Five percent, 4.9%. So, what we’ve done is -- and that’s withholding, basically the freight margins pretty constant across that time frame, we’ve been able to increase our transit margin, which has really been a focus. Working capital and margins in transit have really been two key initiatives that we work very hard at and we’ve been able to do it and we continue that into the future.

Jim Lucas - Janney Montgomery Scott

Okay.

Alvaro Garcia-Tunon

And, again, Jim, I recognize your question because you basically are trying to model and you’re trying to figure out where all these things are going, but for us, the key number where we evaluate ourselves on is with a consolidated operating margin number. That’s the one that we want to continue to grow and, obviously, whichever means we use to get there, but the key, I think, is the corporate number.

Jim Lucas - Janney Montgomery Scott

Okay, fair enough. Thanks a lot, guys.

Albert Neupaver

Thank you.

Operator

Our next question is from Kristine Kubacki, from Avondale Partners. You may go ahead, please.

Kristine Kubacki - Avondale Partners

Good morning, gentlemen.

Alvaro Garcia-Tunon

Good morning.

Albert Neupaver

Good morning, Kristine.

Kristine Kubacki - Avondale Partners

I have a question regarding -- you guys have a better idea now, the railroads are kind of coming out and taking about what they’re going to spend on positive train control and from your end, in terms of also thinking about how many locomotives we’re talking about -- from your end, though, what are you thinking about in terms of your ramp up, in terms of what you guys are going to need in terms of capacity, number of people and how do you think about that into ’09 and possibly going forward from there in Greenfield, if that’s an option?

Albert Neupaver

As we see the demands increase for positive train control, we think that our current capacity from a manufacturing standpoint is adequate. I think the areas that we would focus on to make sure that these projects move forward properly is project management type of resources. So, we have the technology. It’s out there. It’s been approved by the FRA. The product safety plan’s been approved. It really is a project management in getting this.

We’ve already, for the last year, been working on the next generation of vital ETMS system, so those things are in place. I don’t see a big amount of resources or any brick and mortar really required for these demands.

Kristine Kubacki - Avondale Partners

Do you get the sense that from you railroad counterparts that they’re going to start developing and start getting to work right away on these types of things or are they going to wait for looking for kind of a funding source, maybe, to push them, so maybe it’ll even boom more of a 2011 kind of time frame or do you think you they need to get going right away?

Albert Neupaver

I think we’re seeing a tremendous amount of activity and rightly so. If you look at some of the press releases that the Class 1 railroads have made, they’ve already agreed on developing interoperatability standards by the four Class 1's. We’ve been part of those meetings. I think in all cases, and everyone’s been working on this, this is not something that has been shelved.

The Class 1's -- ENSF started their program in 2004. We started talking to the UP and Norfolk Southern probably 18 months ago, developing a program and we’ve been working on and CSX, actually, has the basic framework of our system. That’s been installed since the early 2000’s. So, it’s a matter of upgrading some of that framework.

So, no they’re not idly standing by, I see, but it is going to take time to do. Again, it’s program management thing that needs rolled out and it’s a very complex situation because the interoperatability, not only between the railroads, but you’re talking about all commuter locomotives. So, you got all these transit authorities that are going to also need to be upgraded in order to meet this 2015 deadline.

Kristine Kubacki - Avondale Partners

Okay and then to switch gears, real quick. You haven’t really talked a whole lot about the international business and how you see that progressing. We’ve heard of some infrastructure projects, obviously, with the financial meltdown, being stalled or delayed. Is that impacting your international business in any way and could you give us an update on China as well?

Albert Neupaver

Okay. That’s about four questions in there, I think, Kristine, but I’ll try to remember what they all were. First of all, internationally, we have a lot of activity going on. When you talk about China, I’ll touch on that and then I’ll come back to it.

They’re slowing down. They’re going from 10% to 9% growth anticipated, so their demand for commodities are still there. So, on the freight side of things, you have a lot of activity going on in the mining countries that we’ve talked about before and that continues.

From the transit side, we play a very small part in the transit markets in Europe and Asia and with the acquisition of POLI, now that we have the product and the development, we just recently attended a trade show in Germany called Intertrans, tremendous amount of interest in our technology and our capabilities and we expect the fact that we have such a small part to offer growth opportunities for us.

Back to China, we’ve been working on some joint venture arrangements. They’re progressing well. We still see that market as a very attractive market for us. It is a good growth area. We hope to be able to make some announcements about closing those arrangements before year-end.

Kristine Kubacki - Avondale Partners

Okay, very good. Thank you, great quarter guys.

Patrick D. Dugan

Thank you.

Operator

Our next question is from Scott Blumenthal from Emerald Advisors. You may go ahead please.

Scott Blumenthal - Emerald Advisors

Good morning gentlemen.

Patrick D. Dugan

Morning Scott.

Scott Blumenthal - Emerald Advisors

Alvaro did you give an inventory turns number in your commentary?

Alvaro Garcia-Tunon

I did not give an inventory turns number. Typically the inventory balance, the turns number doesn’t change that much. Typically company-wide it’s about six. I think Pat’s going to check my math real quick, but I think it tends to be around six times. And it really doesn’t vary that much. The balances will go up and down but because the sales volume is large enough --

Patrick D. Dugan

It is an individual metric that we do use for divisions.

Alvaro Garcia-Tunon

We use it by unit.

Patrick D. Dugan

Every unit has a turns metric that we track monthly.

Scott Blumenthal - Emerald Advisors

Okay, and Alvaro could you comment maybe on what type of a benefit if any you expect from these precipitous drops in commodity costs, especially being a large consumer of steel and, I guess, to a little bit lesser extent copper.

Alvaro Garcia-Tunon

Sure, it’s gotten to the point -- Al, I think, gave a relatively long-winded answer, not long, let’s say long, not long-winded. Excuse me, to a brief question let me do the same.

It’s actually to ensure in a couple respects. One, we’ve actually gotten our surcharge mechanism, while they don’t cover 100% of the cost of material increases; they were helping to off-set a large, large portion of the cost.

So to a certain extent, we were pretty well covered by a commodity price increase. So what you’ll see is a decrease in obviously the cost and you’ll also see a decrease of the surcharge. That may cause a slight improvement in margins and really a slight benefit to us going forward, which would be welcome, but it wouldn’t be that significant because, again, we were pretty well covered with surcharges.

The other effect is really the price of oil. I think the rail industry, the price of oil got to high and it didn’t benefit anyone. But to a certain extent, with oil going up, it helped passenger transit because more people would ride transit and it helped the freights because they have automatic surcharges to pass on increases in the cost of oil.

So with the cost of oil going down, obviously that’s going to help our cost picture, but long-term it may have an effect on rail although that’s very difficult to tell. So I think short-term, the decrease in the price of oil should have a favorable effect on the operation. And those are the two major commodities, I think.

Patrick D. Dugan

The other thing we’re seeing, Scott, is that as you look at the supply chain, our suppliers are not the people actually mining the ore, so they are very reluctant to try to pass this on. So there is a battle out there as these commodities do drive down and we’re fighting very hard to get the advantage that Alvaro talked about.

Scott Blumenthal - Emerald Advisors

Well Tim asked the question about working capital and I was wondering how much of a benefit such a thing would be to in that respect.

Alvaro Garcia-Tunon

Yes, see working capital, and I’ve talked about hedging before. Right now we have a natural hedge in that as the dollar, say for example, strengthens, our cost centers in Canada become cheaper, but our foreign operations, the profits are a little bit less and they tend to offset each other and we watch that every quarter. And so far it’s been true. I mean it could be half-a-million bucks one way or the other, but you’re always going to get that when you have about 40% of international sales like we do in the cost centers.

What FX it is going to have if the dollar strengthens, obviously it’s going to have a decreased effect on sales because the centers in Canada are cost centers rather than revenue centers. But bottom line so far they’ve been having a relatively neutral effect, and as the dollar strengthens, then our working capital benefits as a weakness. It (inaudible).

And Pat also did a quick calculation and our total inventory turns are pretty much what I thought on a year-to-date basis. They’re about 6% -- I’m sorry six turns year-to-date. I’m sorry, third quarter it’s a little less because the addition of POLI and a few other factors.

And one last point on the FX is the impact on commodities. One thing we’re looking at now, we were exploring that the other day, is actually as the dollar strengthens significantly against the Euro, which may make buying commodities from other sources, like in Europe, more attractive. And we’re continually looking at that to make sure we have the cheapest source.

Scott Blumenthal - Emerald Advisors

Okay, great point. Can you talk about also it appears as though the backlog has really hung in there nicely. I guess you’re giving us a net backlog number. Have you seen any cancellations at all in there?

Patrick D. Dugan

No, we haven’t seen any cancellations. Our backlog’s hanging up. Division, division there’s some little swings, but if you look, 55% of our backlog flows out in the next 12 months. Twenty percent of our total backlog is still freight. Thirty percent of our backlog is international and we’ve really been tracking all those, so no indications up to this point.

Scott Blumenthal - Emerald Advisors

Okay, terrific. Thank you.

Patrick D. Dugan

Thank you, Scott.

Operator

Our next question is from John Barnes from BBT Capital Markets. You may go ahead please.

John Barnes - BB&T Capital Markets

Hi, good morning guys.

Albert Neupaver

Good morning John.

John Barnes - BB&T Capital Markets

Going back to positive train control, ETMS, I just want clarification in terms what kinds of guidance you’ve given in terms of you said 200 to 400 million over a five year period. Is that 200 to 400 million a year over a five year period or is that the total amount of revenue you expect to generate over five years?

Albert Neupaver

That’s the total amount over the five years. I’m glad you asked that so there’s no confusion.

John Barnes - BB&T Capital Markets

Okay, now when I’ve talked to the railroads, visited one recently, they’ve put a price tag on the system much higher than that, much, much higher than that. And I’m kind of curious. Two questions, number one, why would their price tag be so much different from what you’re forecasting?

And then secondly, given that the impetus behind this bill has been accidents between freight and commuter rails and that type of thing and it seems like that’s where the focus is. Does the number of users of ETMS go up significantly if the commuter rails are also forced into some kind of positive train control?

Patrick D. Dugan

Okay, good questions John. First of all, the commuter rails will have to have positive train control so they will have to be able to interoperate with the freight line. So yes, the number of users, and that’s why the time period here is really going to be a challenge to have all those systems on just from a project management standpoint, not just from the fact that the product or the technology because the technology is already proven and has been proven and approved.

But back to your question on why they put a different price tag on, if you look, you have to understand that the total implementation of this really has a lot of other factors involved. What we’re supplying is basically the system that goes on the locomotive that communicates with other areas and it has to communicate with the wayside.

It communicates with the back office or the dispatch system and there is also the communications system that is used in it. That total price tag, people have estimated close to $2 billion when it’s all done. Of that $2 billion, about 35% of it is related to the positive train control system that we would supply. So it’s a much smaller number that’s available and there’ll be other players in this market as we go forward and that’s all factored in there.

John Barnes - BB&T Capital Markets

Okay.

Patrick D. Dugan

But they’ll spend just as much on the wayside meaning what they have to do is set up some type of communication on those switches that are actually communicating with that onboard computer. You have an onboard computer that communicates with GPS.

It communicates with where all these switches and signals are. It communicates with the dispatch system, which is the main office. And it takes all that information. There’s a number of other companies that would be involved in some of that product, especially related to the wayside or the switch gear. Okay?

John Barnes - BB&T Capital Markets

Okay, once it’s installed, what’s the recurring revenue stream once the recurring revenue’s in place? Well obviously there has to be a maintenance factor associated with this product and also system upgrades as we proceed.

Patrick D. Dugan

We also, as I mentioned, are working on the next system, which would really get into doing some of the safety critical functions. Today the system that it’s employing to prove is the safety overlay system that only acts if the engineer of the locomotive violates one of the limits, whether it’s a speed limit, authority limits, going into a work zone, so it would shut the train down.

In this next system it would actually do some of the switching. It could do some of the safety critical evolutions. So there’s more revenue opportunities potential, one from the maintenance side of things and upkeep and, too, upgrading the system as time goes on.

John Barnes - BB&T Capital Markets

Okay, and then, how many customers do you have ETMS that are actually in a test phase, a deployment phase, or what have you?

Patrick D. Dugan

We’re working indirectly with all the class -- ones and we’ve also been working with a number of the commuter transit authorities as well. So I would say there’s probably 8 to 10 different people that we have an ongoing discussion of the program with.

John Barnes - BB&T Capital Markets

Okay. And then, one question on the backlog. The increase in freight from a rolling 12 month basis is it safe to say the increase was as a result of rolling off last quarter and rolling on the three months at the end that you’re starting to see maybe some of the forward orders a little bit out and that’s why we’re seeing in a bump up in the freight backlog? Or, do you think you actually saw some strength there in terms of orders and that type of thing?

Alvaro Garcia-Tunon

We haven’t read into it that far. We don’t -- when you know that ton-miles is basically -- last quarter we reported ton-miles up 1.8, this quarter .8, you look at car loading's down. I think that this particular trend wasn’t something that we could really put our arms around and get excited about, especially with the railcar builds that we’re anticipating.

John Barnes - BB&T Capital Markets

Okay. Alright, very Good.

Albert Neupaver

We don’t read too much into the freight backlog. I think the good sign is it’s showing that the market’s relatively stable and that’s a good thing. I wouldn’t read too much that it’s increasing or decreasing, but basically that it’s stable, which is a good thing right now.

John Barnes - BB&T Capital Markets

Sure, sure. All right. Thanks for your time guys.

Albert Neupaver

Thank you, John.

Operator

Our next question is from Steve Barger, from KeyBanc. You may go ahead, please.

Joe Box - KeyBanc

Hey, good morning guys. This is actually Joe Box filling in for Steve.

Albert Neupaver

Hey, Joe.

Joe Box - KeyBanc

Given some of your strategic initiatives on the freight side, and excluding the standard acquisition, I’m just wondering if you think you could grow top line in an environment where you’ve got declining rail car builds and potentially lower ton miles from the Class 1’s?

Patrick D. Dugan

Obviously we can’t provide guidance going forward. But, keep in mind our strategic initiative, sir, not one facet. We really feel there’s lots of opportunities for us to expand globally in the freight market. We also look at what we call market expansion. That’s that technology that we have in the freight markets, and look at other market applications with it, current technologies, new markets.

Right today, 10% of our business that is included in the freight is outside of the freight market, actually. We look at new products and new product development. And, really, we’ve been talking about the opportunity here with positive train control and electronic controlled pneumatics, and other things that we’re offering. So, those are opportunities for us.

We’re always looking for acquisitions and we really want to maintain that aftermarket percentage, or even improve on it. So we are pleased with our opportunities and our approach, and it’s a matter of executing toward those.

Joe Box - KeyBanc

Okay, thanks for that. I think you guys did a good job of laying out the opportunity for PTC. The $200 to $400 million dollars that you laid out, is that for an overlay system or is that for a vital system?

Patrick D. Dugan

Basically, it’s to go out with the current overlay system to meet the current demands based on the safety bill. So we may have -- if there’s interest, there may be other opportunities for us and, even if we’re able to look at upgrades, obviously.

Joe Box - KeyBanc

Okay, and my last question’s going to be for Alvaro. You reported $1 million in purchase costs on the SG&A side, and $2 million to cogs in the quarter, can you give us a sense of what that’s going to look like for the POLI acquisition in 4Q?

Alvaro Garcia-Tunon

Yes, in 4Q (inaudible), I think we’re going to have two in total versus three, and then after that it should start to wind down.

Joe Box - KeyBanc

Very good. Thanks, guys.

Patrick D. Dugan

Thank you.

Operator

Our next question is from Greg Holter from Great Lakes Review. You may go ahead, please.

Greg Holter - Great Lakes Review

Good morning guys, and thanks for taking my questions.

Patrick D. Dugan

Our pleasure.

Greg Holter - Great Lakes Review

A couple of clarifications. Alvaro, did you say the cash is $186 million at 930?

Alvaro Garcia-Tunon

Yes, that’s correct.

Greg Holter - Great Lakes Review

Okay, and, looking at your receivables, two questions really there. One is to the quality of those and second is, ex-POLI, it looks like they’re still up about 34%, although I don’t know what the currency impact was, still, probably up 30%. I wondered if you could comment on the increase year-over-year as well as the quality.

Albert Neupaver

Okay, I think, in terms of quality, I touched upon that we conducted this review for our board, for our own internal purposes. And, one of the benefits that we have, for example, in transit we’re dealing with municipalities, we’re dealing with very large, well financed companies and so, for the most part, in transit I think the receivables are in pretty good shape.

Similarly in freight, in freight, you’re dealing with Class 1’s, the car builders are relatively strong, they’re coming off very strong periods. So, in terms of quality of the receivables, we’ve actually looked at them in detail on a unit by unit basis, because, that’s the same question we had, internally and, we think we’re in pretty good shape there and whatever reserves we have, which aren’t very big, we think adequately cover it.

In terms of increases, part of that is POLI, part of that is increased sales, and part of that is, again, these long-term contracts. When you get into a long-term contract, the percentage of completion revenue recognition is different than the billing cycles, so, you could have a buildup in receivables.

What try and do is make our long-term contracts, at worst, cash neutral, and then we take a lot of pains in doing that. And, that’s why when you take a look at receivables, you also have to take a look at your customer deposits, which have gone up by about 32 million since the beginning of the year. It’s really a combination of all those three things.

Greg Holter - Great Lakes Review

Okay, that is very helpful. I don’t know if you provided the amount of debt at 930, as well as the equity balance?

Albert Neupaver

Sure, the amount of debt at 930 is, basically, the $150 million of bonds that we’ve had outstanding for quite some time. So, actually, if you take the cash, which the we look at it, and you offset the net debt, were positive 36. We have more cash than we have debt, which is a nice position to be in during these turbulent times.

In terms of shareholder's equity, we don’t look at it that, that much, say, in terms of financing. The strength of our financial position, we tend to look at debt to EBITDA ratios. In our capital structure, we have some capital stock transactions and treasury stock, we have a lot of things going in and out of it, so it’s not, in our mind, as good a measure of liquidity as debt to EBITDA.

But, basically, I think our total shareholder’s equity we’ll be somewhere around 675, 690, 685, somewhere in there. It’s going to vary somewhere between those numbers.

Greg Holter - Great Lakes Review

Okay, that’s perfect. And, I believe you said that the foreign currency had an impact of dropping your sales by four million in the quarter, was that correct?

Albert Neupaver

Yes, because basically, again, bottom line it’s relatively neutral. But, when the dollar strengthens, our revenues from the operations overseas are going to be less, but, we get a benefit from our cost centers in Canada. So, bottom line they tend to wash, but revenues will show a decrease when the dollar strengthens.

Alvaro Garcia-Tunon

It was a decrease when compared to second quarter to third quarter, but, if you compare, the third quarter ’07 to ’08, it was a positive two million.

Greg Holter - Great Lakes Review

Oh, okay. Okay. And, finally, you talked about cash a little bit. Just wondering where that’s held, and if you have any of these instruments that have been getting some of the news lately?

Albert Neupaver

The fortunate thing is that we use to have some of the ABR’s, some of the financial institutions were pushing them, but about six to nine months ago we just decided we just want to keep things liquid. We saw a few of these acquisitions coming down the horizon and we said we don’t want to be in a position where we have cash in an instrument that we can get out for an acquisition, so, we basically put it in very liquid money market accounts.

Now, we’ve actually taken some of the domestic cash and put it in treasury money markets, to make sure the principle value stays constant. The cash of 186, very roughly, I would probably say, about, let’s say, 100 to a little less than that that’s domestic, and the balance is abroad and, what we continue to look at is ways to repatriate that cash without adverse tax consequences.

Jim Lucas asked earlier about our tax strategy, and that’s a key element of our tax strategy. How can we get some of that cash, or utilize it? When we do a POLI, we actually utilize the cash that we have abroad to make that acquisition, rather than domestic cash, which is a good use of it. So, we constantly evaluate ta way to use that cash, but, it’s in short term money market funds or treasury funds.

Greg Holter - Great Lakes Review

Okay, great. Thank you very much.

Albert Neupaver

Thank you.

Operator

Our next question is from Wendy Caplan, from Wachovia. You may go ahead, please.

Wendy Caplan - Wachovia

Hi, I know you want to stop soon because it’s 11:00, but, just a quick clarification. Al, the interoperability issue that you raised with the Class 1’s, and the transit authorities, does that imply that it’s likely that Wabtec would be a single source supplier of this system, since yours is already there and perhaps you license your technology to another? What’s the competitive situation in that market?

Alvaro Garcia-Tunon

Obviously, I think a possibility exists, Wendy. However, I think being realistic, the railroads have always tried to act in a way that would you’d have a couple of suppliers, at least two suppliers and actually, they like two, they don’t like more than two, so, whether we license someone else or not, I don’t know.

When you look at the interoperability, the biggest thing there is for all of them to agree on the communications network that’s required and, I think they’re coming very close there, and that’s where the focus has been. And, we actually are involved in that part of the train control system ourselves.

So, there’s some good opportunity there, where excited. If you look what Wabtec did, I mean, this goes all the way back to an acquisition that was made, it was a strategic acquisition, was made, Rockwell business, it was their train control system.

We had acquired the electronics division down in Germantown, Maryland, and they saw the opportunity for positive train control, which Rockwell was working on. We have actually continued to develop this technology for a lot of years without any funding or even any revenue. So, I think that it’s going to take a lot of effort, on all of our parts, to bring this to commercialization, but, we’re really excited about the opportunity that we have right now.

Wendy Caplan - Wachovia

Thanks so much, Al.

Alvaro Garcia-Tunon

Thank you, Wendy.

Operator

Our next question is from Dennis Salvo from Jodocus Capital. You may go ahead, please.

Dennis Salvo - Jodocus Capital

Thank you for taking my call, and good quarter. As you look out over the acquisition landscape, I was just curious to see if there were any specific targets that you may be looking at, and does the weakened economy maybe present some more opportunity’s than normally? And, secondly, it seems like you do have a good bit of drive power on the balance sheet, what would you be willing to take the (inaudible) issue up in order to maybe do some more acquisitions?

Alvaro Garcia-Tunon

Okay, we’ve stated time and time again, we feel that a debt of 2, 2.5 times our EBITDA would be something that we would consider livable. As far as specific acquisitions, I really can’t comment on that, but I will comment on the fact that we do have -- our pipeline is flowing, we’ve got some opportunities, the landscape has changed.

I think the number of deals, this really hasn’t changed, but the number of deals that are strategic are probably higher than those with private equity, right now. I think you’re also seeing the same credit crunch, money is no longer free, nor is it as available. So, it’s very tight right now.

So, I think all those dynamics play in, and we continue to be very active. And, although active, we will maintain our discipline and only going forward on those strategic acquisitions that meet our criteria. Okay?

Dennis Salvo - Jodocus Capital

Yes, thank you.

Alvaro Garcia-Tunon

Thank you.

Operator

(Operator instructions).

Patrick D. Dugan

Well, with that, we’ve really thank you all for your participation and look forward to talking to you early next year again.

Alvaro Garcia-Tunon

Thank you everyone.

Operator

This concludes today’s Wabtec conference call. Thank you very much for your participation.

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Source: Wabtec Corporation Q3 2008 Earnings Call Transcript

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