美國西屋制動公司 (WAB) 2004 Q1 法說會逐字稿

Hello, and welcome to the Wabtech Corporation First Quarter Earnings Results Conference Call.

As a reminder, all participants will be in a listen only mode.

There will be an opportunity for you to ask questions later in today's presentation. If you should need assistance during a conference, please signal an operator by pressing star, then zero on your touch-tone phone. This conference is being recorded.

If you have any objections, please let us know by pressing star, then zero now. Bearing no objections, I would like to turn the conference over to William Kassling, Chairman of the Board, and Alvaro Garcia-Tunon, Senior Vice President and CFO.

Mr. Kassling, please go ahead.

Thanks Ed, and welcome to our earnings conference call. In addition to Alvaro, who is on the call today, Tim Wesley, our Vice President of Investor Relations is also here in attendance.

Now obviously, Greg Davies, our CEO, is not on the call today, and as you all know, we announced that he was going to have surgery for a tumor. And he has had that surgery and he has begun treatment, and we have about a 10-week process here to go through.

And so, he, by the way, has had a lot of folks, a number of you on this call included express thoughts and condolences to him in terms of getting well quickly. And I can tell you, having talked to him, he is very appreciative of those thoughts and comments.

However, when Greg left, before he left, he put into place a very strong organization. That organization is in place, doing business every day, and I am the guy who backs him up.

So we really have not lost anything, and we are moving ahead, executing our plan and direction as we would have as if we were here.

And that's a testament to a guy who does a guy who does a good job leading an organization, if he can leave that kind of structure in place while he's off doing this very important work of getting well.

Now there are some forward-looking statements and disclaimers in the press release, which I'd call your attention to. I'm going to make a few remarks, turn this over to Alvaro, and then Alvaro will turn it back over to me for a finish, and then we will entertain the questions. Let's go right into our first quarter results.

Certainly, we feel this has been a slow start to the year with earnings per share of 11 cents versus 13 cents a year ago, and EBITDA, which is essentially flat, around $17 million. And Alvaro is going to take you through the individual support for what we did in the first quarter in a moment.

But the key point here is that even though our earnings were lower than a year ago quarter, we still feel very good, on track to meet our goal for the year, which our guidance was to earn about 70 cents per diluted share, 35% higher than were in 2003.

Essentially, if you look behind these numbers that I'm going to talk about and that Alvaro will talk about, you'll see that while the market for rail cars and rail equipment is significantly improving in North America, based upon growth in their business, we haven't seen in this first quarter any of that uplift. It's just that the actual car build in the first quarter was essentially the same as the fourth quarter. So it isn't flat.

And we see, therefore, this ramp-up in the industry occurring later in the year and in subsequent quarters. So we've not really seen it, yet. Now, despite that, and within our business, we had some challenges. And in fact, we have general industry challenges, the general economy, exchange rates, particularly the U.S. dollar relative to other currencies like the Canadian dollar that has an impact on us.

We all know that raw material prices, particularly steel has escalated, and it has a major impact on us as we were a major buyer scrap steel for our foundry. It was the basic rail bodies that we produce in abundance. And also other costs that effect SG&A like insurance costs are up year over year.

And I'm sure you've heard this story and other companies told as well. Also in our industry, we have not really yet seen a pickup in the aftermarket, despite an improvement in the traffic, although, certainly as equipment is run harder, that should come.

And we have not seen a pickup in OEM deliveries. As I just said because essentially, the market has been capacity constrained by various types of components, which we think will be de-bottlenecked as time goes on. It's just the way things are.

And then of course, we had some internal challenges, which Alvaro will talk about. But we feel very good about how we will achieve margin improvements in subsequent quarters. And we will in fact feel very good about making our commitments for the year.

Now let's talk about the various elements that effect our business. The first is freight car original equipment market. The freight car market is going to be stronger than we anticipated.

We have forecast about 36,000 cars this year, and now we're edging that estimate to 41,000. And as I say, it didn't happen in the first quarter. The orders in the first quarter are going to be about 18,000, which is very strong.

And the backlog is up to over 40,000. And we know that's a very good backlog to where we've been in recent years.

So that the growth is yet to come, and as a component supplier, that will be yet to come for us. In terms of locomotive, the locomotive order book is firmed up, and we're holding to our original forecast of more than 1,000 units.

And we're starting to hear some discussions in the industry, and you can read it all to about power shortages at some of the railroads, which could buy us these numbers upward.

But at this point in time, the build is what it is, and we don't see any incremental orders on top of that at this point, despite the fact that there are perhaps some power shortages developing. Now the freight aftermarket, their traffic has been strong, and I'll just run through a little bit of this data.

Car loadings were up over 3% in the first quarter, and the rate of growth increased in each month of the quarter. Intermodal is up over 7% in the first quarter, and this is the strongest sustained period of traffic growth in the last six years.

So the logic will tell you that if traffic continues to grow, the railroads are running their equipment harder, that means more maintenance spending down the road. We believe this scenario is on the horizon, but we aren't yet seeing a meaningful pickup of aftermarket spending.

On the transit side of our business, the original equipment markets that had given us a good backlog of work for this year, particularly in our Royal Door business, some of these margins are lower than our historic margins, and we've got to work to improve them. And that had an impact on the first quarter. So, we have to deal with that, and will.

We have another bit of good news. We've signed the final piece of the R-160 New York City contract for the order, and that's going to represent about $250 million of future business, including all the options. And that is going to start in late 2005, with revenue spread over the ensuing four years. So, we're building a good base in our transit business, which will sustain us for many years to come.

In terms of the transit aftermarket, again, note that there's no change here. It's still weak, and the reason is slightly different. There are continued budget constraints at Transit Authorities, which has, in fact, affected that.

In terms of additional company news beyond the R-160, we have signed a number of other new agreements. The more significant ones are a $19 million contract to provide our UBX brake linkage, which is a unitized brake linkage, to Union tank car.

And that type of our contract demonstrates two of our growth strategies - introducing new products and moving higher up the tier in terms of being an OEM supplier, to be a tier one system supplier.

On top of that, we completed a new $175 million revolving credit facility, which gives us flexibility. And as we have been deleveraging for the last several years, it gives us more flexibility to pursue whatever growth might be out there, which we find attractive. Now I'll turn it over to Alvaro for more details.

Great. Thanks, Bill, and good morning, everyone. I'll now review the financial results in more detail.

Sales were 11% higher than the prior year quarter, while about $16, $17 million lower than the fourth quarter of last year. Again, most of these comparisons will be to the first quarter of last year. Freight group sales increased by 9% compared to that quarter, mainly due to higher sales of freight car components in North America and higher sales of electronic components in the United Kingdom. Transit group's sales also increased by about 16%, mainly due to higher sales of rail door assemblies, and we're not seeing much change in the [inaudible].

For the period, gross profit decreased to 25.2% from 26.7% last year. Obviously, we're not happy with that. Various factors caused this decrease. A couple were expected cost increases, higher manufacturing costs due to increased deal prices and the negative impact of foreign exchange on our Canadian operations, which was still significant on the quarter-to-quarter comparison.

We also had some inefficiencies, higher than planned inefficiencies, in closing and relocating an electronics plant from Canada to the U.S. And finally, we had some cost issues in rampup of low margin door contracts in our transit divisions, and I'll give you a few more details on all these factors going forward here.

Like almost every industrial company, we're feeling the impact of higher steel prices this year. We've estimated that about 6% to 8% of our annual cost of sales number, about 6% to 8% is steel content. It's not a huge number, but the increase in steel prices is costing us about a penny of earnings in each quarter.

To mitigate it, we are trying to pass on steel surcharges to customers. The price increases have been announced. We are negotiating with customers, and we are having some success with that. So, hopefully that will be reduced as we go forward.

In addition to steel costs, we continue to face higher costs in our Canadian operations due to foreign exchange issues, which we've talked about before. The U.S. dollar versus the Canadian dollar flattened later in '03. So, as we go forward, the comparisons won't be as high and we have hedges in place to take care of any increases in the Canadian dollar from where they are right now. But again, we are hurting the comparison to the prior year when they were lower.

We closed an electronic plant in Canada that we had acquired as part of a motor power transaction in the second half of last year and we moved those operations to our U.S. plant in Maryland. Those moving costs have already been accounted for. Those moving costs were accounted for last year, but we are facing some unanticipated integration issues, which cost us a couple of pennies of earnings in the first quarter.

The one thing I can assure you is, we have a very strong team of people working on these issues right now and we'll get them fixed as soon as possible. But that did impact the results of operations in the first quarter.

And then another reason for the decreased margins, the last reason that we've identified, is our rail door operations in Montreal, which are part of the transit group. There we're also seeing some highly anticipated costs in the rampup of some door contracts. Similar to electronics, we have a strong team of people working on this issue and we're confident we'll see improvements in the coming month.

We estimate that these costs in Canada probably cost us, again, the same magnitude as the electronics issue, about a couple of pennies in the quarter.

Moving forward, below the gross profit line, operating expenses increased 9% from last year. This was due mainly to [inaudible] inflation, as well as, I think, what every other industrial company is experiencing, higher medical and insurance costs. I think the run rate that you're seeing right now for SG&A is a reasonable run rate going forward, and I think it's consistent with what we said in our last call at the end of the fourth quarter.

Interest expense was about $600,000 higher than last year, and this is due to the senior notes we issued in the summer of '03, in August of '03, I believe. These notes replaced variable rate, short-term debt. At the time we issued the note all our debt was variable rate, all of it was short-term, and we wanted to take advantage of an attractive long-term interest rate market at the time.

That, we believe, combined with our new bank revolver signed in January of this year, gives us an appropriate capital structure from which to grow a significant amount of financial flexibility.

Income tax expense, no changes there. That was accrued at about 36.5%, which was the same as a year ago.

Turning now from the income statement to cash, our cash balance at March 31 was $58 million, and this compares to $70 million at the end of last year, so a decrease there in cash. Basically the main uses of cash were inventorying receivables. Sales, as I mentioned earlier, decreased from the end of '03 to the end of this quarter and you would expect to see those balances to be lower.

However, we had a very strong March and so we weren't able to obtain the benefit of that decrease in receivables because of the strong sales results in March. Additionally, inventories increased by over $6 million, and that's something that we really need to work on and will be spending some time on this quarter. We have a plan in place to basically bring them back down to '03 year-end levels by the end of the second quarter, which should help our cash balance.

Net cash was $132 million or 34% of total capital at March 31, compared to $120 million at year-end '03 and the increase, as I mentioned, is primarily due to higher receivables in inventory. Our goal is always to generate more free cash than net income, so we have more work to do to overcome this deficit in the first quarter, but we're confident we'll get there.

Tax generation continues to be a hallmark of Wabtec operations and we see significant emphasis. Depreciation, just to give you some basic numbers, which we always get questions on, depreciation was $5.5 million, versus $4.7 million last year.

Increase is due to a few factors, nothing very significant. One is FX, the depreciation expense at our subsidiaries go up as the dollar weakens and their currency strengthens. We also had some capital expenditures in corporate for computers and software where we didn't have significant ones in the past, and there's been some depreciation associated with that, as well as the depreciation with normal capital ex and cap ex increases. Amortization down slightly from last year. We had some intangible assets whose life expired and the amortization went down, nothing too significant there. And cap ex for the quarter was $4.2 million versus $2.9 million last year, well within the depreciation range and well within our targets and goals for the year.

In terms of backlog, again, we get questions on backlog, so we're happy to disclose it, although we're not really a backlog-driven business and it's not that significant. But overall, as a company, we have $310 million in backlog at the end of this quarter, as opposed to $263 million at the end of the year. So, 12/31 we had $263. So, obviously the increase is always welcome.

In the freight group, backlog was $148 million versus $112 million at year-end, and in transit the backlog was $163 million versus $151 million at year-end. As we look at all our units, the backlog increase was, for the most part, across the board. There's really nothing specific in one unit that would [inaudible]. And with that, I'll turn it over to Bill to summarize, real quickly, where we are and then we'll have Q&A. Thank you.

Thanks, Alvaro. Just once again, you look at where we are and where we've come over the last few years. The company has deleveraged and, self-significantly has provided ourselves a good position as we go forward and look at the growth opportunities that are coming to us, in terms of improved market.

And we've weathered this significant downturn in our business quite well and, in that process, become a healthier company. So, while the quarter was a little bit slow, the good news is, we still expect to hit our earnings target of about $.70 for the year. And that's a significant increase over the prior year, and we obviously see the market getting better as we go forward, based upon the industry indicators of rail traffic and the original equipment order rate.

But the real growth spurt for us is yet to come in the ensuing quarter. Thank you very much. Now we're going to entertain questions and we will bring back Ed. Hold on just a second.

Sir, are we ready for questions?

Yes, we are.

[OPERATOR INSTRUCTIONS].

Our first question comes from Mike Peasley of BB&T.

Good morning, guys. Actually this is Tom Albrecht here. Mike is on a shared line, as well. I wanted to just chat about a couple of different things. Alvaro, you talked about the unanticipated integration issues that cost about $.02 in the move of the electronics plant from Canada to Maryland. Can you elaborate exactly what? Like you said, the moving costs were in the second half of last year.

Right. The moving costs were in the second half of last year, so this isn't the moving costs. If you may recall, last year we mentioned we had some one-time costs, and one of those one-time costs was relating to moving this facility. These are really issues arising in the production of the product that was transferred.

There have just been normal, not normal, they were unanticipated like I said, but, in essence, higher than anticipated production costs and there's been some rebuild involved. The quality isn't what we would expect when it was manufactured, so we basically had to redo some of the products that came in, as well as some of the costs were higher than we had originally estimated.

Those are the two issues that I think we can work on. We're working on reducing the costs. We're working on improving the quality of the production cycle, and we expect definite improvements as we go forward.

Do you think that will be a factor in Q2 as well?

I think it will be a factor, but it will probably be a reduced factor.

Tom, our view is, we have people all over this and it will be a diminishing factor.

So, it really sounds like it is related to the quality, possibly some warranty issues, like you said, maybe redoing some product, as well.

It really wouldn't be a warranty issue because we're catching it before it goes out the door. We inspect them and so, obviously, we don't want it to get out the door. We don't want to have it be a warranty issue. We want to catch it beforehand. But we are spending more than we had originally planned in correcting some of these issues.

This is going to be fine. This is not something that is out of control.

Yes, and I don't mean to overly dwell on one location, but would it be related to the quality of the machines or just the training processes for the people?

It's a learning process.

OK. And then compare or contrast that with Montreal and the door. Is that mostly higher costs or also training and learning costs, etc.?

I would say it's a combination of both. Sometimes you make an estimate in performing a contract and the estimate proves to be low, and that's been the case there. The FX situation because, obviously, the Canadian dollar getting stronger, that hasn't helped either. One of the alternatives that we're pursuing right now is increased sourcing in the U.S. where the goods are cheaper now than the Canadian good, and we're pursuing that very actively.

So, it's really a question of some costs being higher than originally anticipated, as well as a little bit of a learning curve issue. And we're working on both of those similar to where we are in electronics. And we would expect improvements as we speak.

We're all over this one and we would expect its impact to diminish in ensuing quarters.

Right. And I guess, I just want to make sure. You said one thing that was a little bit interesting a second ago, Alvaro, where you might have mispriced it, so even if you fix some of the quality issues, is this going to be a contract that is going to be under water just because of pricing?

No, it won't be under water.

Roughly how big is the door contract, either in units or dollars?

It's a small percentage of what we do in the transit area, so it's not something that is going to be anything major to our earnings going forward. We take a variety of OE contracts. Some have better margins, some do not.

Right.

When they do not, our position is, we've got to find sourcing and improve our costs and design. All these projects are, many times, designed from scratch almost. So, we have a lot of opportunity to impact on these costs.

Sometimes you have to meet a competitive price and you want to keep the basic backlog in place and you want to keep as level production as you can.

OK. And then I think last quarter, Alvaro, you provided an estimated negative impact to the gross profit margin from the foreign currency. Today I think you've only described that it was negative, but you didn't...

Right.

How much was the impact, do you think?

I would say the first quarter of this year to the first quarter of last year, the negative impact was probably about a couple of cents per share. And see, what happened is, the dollar continued to weaken through all of '03, so on a comparison basis you're going to see that continue, but it's going to be decreasing as we go forward because they reached the current levels second to third quarter of '03.

Right now we basically have the exposure for the rest of the year hedged so we really won't be effected by any changes in the U.S. dollar versus the Canadian dollar either way. But in comparison with last year, you have a degradation of about $.02 a share.

OK. I'm just trying to do the math.

No, I know exactly what you're asking.

So, the gross profit margin, 'cause that's a pretax element, I'm not normally hung up on all these little things, but I just want to make sure I've got it straight.

Yes. You're asking for the gross dollar amount?

Either that or the gross profit margin impact.

The gross dollar amount would be somewhere, let's say, between $1,250,000 and $1.5 million. It's kind of, you're making an estimate to a certain extent on the cost, but it's somewhere in that range.

OK. Now, let me step back on more of the fun, big picture stuff for a moment. I was pleased to see that you did up your own forecast on rail cars. I was surprised that you didn't have more explicit comments on the locomotive trend. What we're hearing in the marketplace is pretty real that this might be a 1200 or 1300-unit locomotive year instead of 1,000. What are your latest thoughts on the locomotive market?

Well, we thought there would be more than 1,000, but that's very welcome news, if, indeed, true. I think we are a little cautious about these things from the point of view of how quickly can the builders ramp up, both GE and EMD (ph) but again, we've heard the same things you've heard regarding power shortage, and that would bode well for the future.

Whatever doesn't happen in '04, we hope carries over to '05.

Yes, I hear you, and this is a cycle story, not just an '04.

Hopefully the under [inaudible] are fundamentally sound and the railroads execute this upturn and, to our knowledge, most are, which says that this could be a sustainable, longer-term trend where shares might shift between trucks and rail.

Right. And then just two last quick ones, and then I'll turn it over.

You obviously made some favorable comments about the direction of sales. Do you have any thoughts on the magnitue that you think it might be above the 750 million?

It's tough to tell right now, Tom, and I'll tell you why, because you're seeing the anecdotal evidence of increased sales. You're hearing that there is a power shortage. You're hearing that they're going to get more cars. You can read it in the Journal, various stories about the railroads, but we're not seeing that translated into orders yet. So all the trends are positive and we're very optimistic, but we're not seeing it translate into orders yet.

I think our original guidance was for sales around somewhere 750. Obviously, that's where we are right now, if you analyze this quarter. You're roughly in line with that. And because of everything we're hearing, you would expect it to be higher than that. If I had to make an estimate right now, I'd say it'd be somewhere between 750, 800, somewhere in that range, and that gives us, obviously, additional confidence in reaffirming guidance for the rest of the year, but we're not in a position yet to think - give you a number.

Yes, no. That's fine.

To give you a better estimate than that, I guess.

Yes, I just wanted to hear you think out loud more than anything.

That's exactly what I was doing.

We do that all day around here, actually. And then, lastly, on the still, Bill or Alvaro, obviously you're not as directly impacted as the rail car makers in that, but you kind of mentioned two things, price increases and surcharges. I just want to make sure I understand this.

With surcharges, I don't see why you would necessarily need to negotiate anything, whereas I would think that increasing the price, core price of your good, you would, that you're selling.

Can you help me through the dynamics there?

Yes, let me help you, Tom. Would you like to go on the road? (inaudible) because it shouldn't be a problem.

I'll take the Cliff Notes version there.

Well, let me comment. It is actually a combination of pricing and surcharges, and we've taken an approach relative to the type of unit and the content in the unit as to whether it's one or the other or both.

And I would say the car builders are pricing along the increase that they feel (ph). And so we have a shot at making the surcharges, and/or the pricing, hold. And of course in an increasing market, you've got a little opportunity there, too. So we are reasonably optimistic that for the first time in some years that we will be successful.

OK. And so then the other half is an outright price increase.

Yes. I'd say it's a combination.

OK.

I mean, in other words, in some cases, it's strictly a surcharge. In other cases, it's price increase, and in other cases it's both. Surcharges will fluctuate with the change in the commodity index in question, but price increases, as you know, are more permanent.

Right. OK. And I think that's - I mean, the magnitude is what ...

Let me just say, because on behalf of our customers we try to give a great value proposition to our customers, but in many of our product lines, the pricing hasn't changed in five to 10 years.

Right.

So we have been continuing to really deliver value to our customers and maintain our margins, which means that we've done a very good job of taking our cost down.

OK.

So that doesn't involve (inaudible), though.

Ideal surcharge is what, 4% to 5%, or am I just totally ...

The surcharges themselves have been done on an index. Basically, we try to do it - demonstrate the logic as much as possible, obviously, to get a buy in from the customer.

Yes.

And what we try and do is estimate the amount of steel in each product we sell and then basically take into account the price that it was at more normal times and basically where it is right now and estimate the difference. The price - the surcharge varies with product, obviously, depending on the content of the steel, but in general what we've been requesting has been in the 2% to 5% range.

OK. Thanks, guys, for the additional clarification on all those things.

And thank you.

Thank you. Our next question comes from Gary Yablon (ph) of Impala.

Hi, gentlemen. How are you?

Hello.

Going back to the locomotive side of the house for a second, what - could you refresh me on building capacity? What does it take to ramp up and what's your sense on what industry capacity has peaked at in the past? Is next peak similar to last peak and that kind of thing?

The prior peak was 1,500 units built. And a majority of those would have come out of GE in the prior cycle. Then it's drop-off from that level. We have some unique EPA conditions requirements that would be winning (ph), and so that - I think there's an EPA deadline for a different phase in emissions that is at the end of this year, and we thought that would pull some locomotives into this year. But it's a question of the ability of people to ramp up.

And I think that it will take a bit of work, because there are some steel casting shortages out there. That affects rail cars. It will affect the locomotive builders. There are going to be some isolated issues that may not allow what might be a desire to buy more really to - greater (ph) this year.

So we're comfortable somewhere slightly over 1,100.

What's your guess on shares between GE and GM?

In recent years, it's been 60% GE, 40% EMD (ph). And I don't see any reasons that we would change that rough ratio at this point.

OK, fair enough.

Jump over to the financial side of the house and maybe talk a little bit about capital structure and whatnot. If we assume the world gets - even gets modestly better and you guys do a good job and all, you'll probably be in an overcapitalized position. Let's just say the end of '05 or so.

That would be a strange occurrence for us.

Yes, nice problems.

Well, no, exactly.

But my question is, nice problems, but problems nonetheless. And how do you balance that with growing the business, capital intensive, but yet you're going to be generating a fair bit of excess cash. Tell me what's that going to do for the shareholder, and how do you get from A to B.

OK, and Gary, we have discussed this in the past in general, and we're welcome to reaffirm what we've discussed in the past. We think that there'll be opportunities that will present themselves to us, attractive opportunities, coming out of this downturn to make acquisitions and to make investments.

And one of the things we're trying to do with our capital structure is really allow us the flexibility to take advantage of these opportunities as they occur in the future.

Obviously, as I mentioned during the narrative, interest expense increased slightly, but again, we felt we had a lot of exposure to the short-term variable debt and we wanted to take advantage of the nice capital environment and at the same time solidify our capital structure going forward.

So you're absolutely right. We think our capital structure gives us a significant amount of flexibility. We won't be capital constrained, and we'll be able to take advantage of some of these opportunities as they occur.

Now, we intend to be highly selective. We're working for certain characteristics in let's say an acquisition. We want something that makes us less dependent on the cyclical North American trade market. We want something that not only has cost saving opportunities, which we're very good at realizing, but we want something that also will give us top-line benefits as well. We want something, hopefully, that will diversify us outside of NAFTA, outside of the U.S. and again be less cyclical and present opportunities abroad.

So there is a number of characteristics that we're looking for, and again, we're going to be patient and we're going to be selective and get the right ones.

Well, let me ask you, one thing you didn't discuss is how you weighed buying in your shares. I mean, if the stars line up well for you over the course of the next two years, as you sit here today, some analysts out there might argue that your stock's attractive. How do you weigh that against what you just talked about?

Well, we would weigh that. It's one of the uses of capital that you have. I think what is interesting about us is that in the last - in the middle of this significant downturn, we were producing in the last several years at least $1.00 a share in free cash flow.

We've done that for three or four years in a row, despite a major downturn in our markets. And the trick for us is to make sure that we don't turn off this cash in less time (ph) and that we continue to produce the cash, and I think we will. And when you produce cash like that and you get the capital structure in a reasonable position, you have a whole range of choices, and we will take those choices from the point of view of producing value to the shareholder, because that's what we're about.

And I have this (inaudible) common view of that, since I have quite a bit of stock in the company. So we're going to be very much focused on enterprise value.

Excellent. OK. Thanks for your time.

Thank you.

Thank you. Our next question comes from Stuart Hosansky (ph) of Vanguard.

Yes, good after - I'm sorry, good morning. This is Stuart Hosansky (ph) of Vanguard. A couple of questions. Just one or two might be clarifications. With the kind of special unexpected charges that you had in the first quarter, did I understand right that there is going to be some additional costs in the second quarter of maybe one or two cents a share?

I think so, if I had to guess, and right now this is similar to the last question where I was kind of thinking out loud a little bit. But if I had to provide an estimate, I would say we could probably cut each of those in half the second quarter and hopefully eliminate them by the third, but there will be some residual effect I think for (inaudible).

These - there will some carryover, but we believe - and in fact seeing the trend rate of improvement that would have these diminish at about those ratios, yes. Probably half as much in the second, and then not very much in the third.

And the third - I'm sorry, and the steel costs you expect to be about one cent a share going out through the entire year.

Yes, that's the effect, and again, we're trying to dampen those with price increases, and we're getting mixed results, but hopefully that will improve as well. But that's - gross, that's the effect.

OK, and the new credit agreement that you have in place, what's the term of that agreement?

It's five years.

OK, and that was just put in place in February, or ...

Right, it was really a renewal of the prior agreement was going to expire in November of this. And obviously we didn't want to get too close to the deadline, so we basically renewed it actually at a lesser amount than we had before. Before it was in the 225, 225 million, and we renewed it at 175.

OK, and I do see what the covenants are in there, but can you talk a little bit about what your target internal ratios are? As the prior caller - prior questioner asked about, the use of your free cash flow and all? Can you talk a little bit about what your kind of target level of maybe debt to total cap, et cetera, might be?

Debt to total cap is one that we keep an eye on, probably the one certainly that's in our bank agreement, and one that we tend to focus quite a bit is what I call the coverage ratio, debt to EBITDA. Right now we're about - it depends whether you take cash into account or not, and it depends what point in time you're measuring it, but we're about 2.5 or lower.

Long term, I would say that we're very comfortable operating in that range, somewhere between 2.5 to three. If we do an acquisition, depending on the size, it may go higher. We've discussed that with credit rating agencies. We acknowledged it ourselves, but our goal would be if it does go higher with an acquisition, to get it back somewhere in the range of 2.5 to three as soon as practically possible. Interest coverage is another thing we look at. Right now, I think we're at about five or six or something like that. We're at a very high number. Debt to cap right now, net of cash, I think we're about a third.

Somewhere 50 to 50 debt to cap is another ratio that we probably - somewhere in that range we're comfortable in.

OK, and just to make sure, when you were talking about the 2.5 times, that was debt to EBITDA, right?

Yes.

Right, and I guess one final thing, and just a clarification for me, in the credit agreement talks about a maximum I guess, surety bonds, et cetera, of $200 million.

Correct, yes.

This seems like an awfully high level. Can you please talk a little about why you need such a high amount, and do you get those via the bank lines through letters of credit? Are those through surety bonds, what the sources of those are?

Sure. They are surety bonds and we get them through the normal bonding company. And, you know, we get them through the normal bonding company. And the reason it is probably a little higher than you would expect, but particularly at our Motive Power unit in Boise, they do have a requirement for a significant amount of bonding. I'll give you an example. We had a contract with Metra that was in the $80 million range. Metra's in Chicago. That's the commuter authority in Chicago, to build locomotives for Metra, and that required an $80 million bond. So just one contract accounted for almost half the capacity that we have there.

And so we want to make sure that we retain additional flexibility in that area, and we don't use up the whole $200 million, but we do require a significant amount.

And that $80 million bond was not because you were given an $80 million deposit.

No, it was just - it was a performance bond, and municipalities, when you deal with municipalities, they almost 100% of the time they require a bond. Motive Power, our sub in Boise, deals directly with the municipalities. So everything that they build for a municipality requires a bond. Our transit division typically is a subcontractor, so they don't necessarily need a bond, because the prime contractor, the Kawasakis, (inaudible) and Bombardiers of the world are the ones providing the bonds to the municipalities. But invariably, they'll put on bonds.

And the prime did not require you to put up a bond?

It depends. It goes on a case by case basis. Sometimes they give us an advance, and if they give us an advance, then they may require either a bond or an LC or a corporate guarantee, and that's negotiated on a case by case basis.

What about the New York City contract? What is your expectations on that?

What happened there is they have given us a cash advance and in essence we use an LC to basically secure that, with a declining balance as we work off the cash advance by doing the NRE, the amount of recurring engineering on the project

And would those cash advances be in your general cash account?

Yes, they would.

And one final question. You mentioned that GE, GM, the split in the locomotives was about 60-40, and I'm just not sure of the answer to this. Do you deal with both companies, or are you primarily with General Electric.

Well, we deal with both. We have good relationships with both.

And do you provide about the same amount of material to both?

It can vary on the order, but like for like content doesn't vary that much on the ...

OK, great. Thanks very much.

Thank you, our next question comes from Gene Oniche (ph) of Metropolitan West.

Good morning, gentlemen. How are you?

Good morning.

I was wondering if you could break out the ...

Could you speak up, just a little bit?

Sure. Can you hear me now?

Yes.

Can you please break out the 150 basis point decline in gross margin between the three components, the manufacturing cost, foreign exchange and then the inefficiencies?

I'd have to go back and redo my math in terms of trying to put it in percentages, but again, I think we said that FX was about two cents, and I think I said that was about $1.250 million to $1.5 million in cost, so if you could save me some calculations and do the percentages, I'd appreciate it. Steel's about a penny, and a penny's roughly about $700,000 of increased costs.

Thanks.

Sure.

Thank you. Our next question comes from Greg Macosko of Lord Abbott.

Yes, thank you. Could you talk a little bit about the New York City contract? What - could you give us an idea of your expectations for gross margin on that contract, particularly relative to the rest of the business?

Sure. Typically, our transit businesses would carry a - particularly OE deliveries on our transit business would carry a lower gross margin than either the aftermarket business or the freight (inaudible) business. We talked about that for years.

When the size of the contract and the competitiveness of the contract goes up and it becomes more attractive, those margins are pressured even further. In the case of New York City, obviously one of the biggest contracts, and of the prior contract for New York City, which was the R142 (ph) contract, it was a very competitive strategic business, just as the R160 (ph) is, but we were very successful in improving our costs as we went through the (inaudible) and delivery of the products that we delivered. And so that's the same process we're involved in right now.

So the answer is, tough business, very competitive, but we have historically made money in this business, and we expect to make money in the current contract.

But would you expect it to be better than the R142 (ph)?

I expect it to be as good as the R142 (ph).

And you mentioned sort of the uncertainty with regard to looking at the 700, more than 150 million this year. However, the order growth seemed quite strong on a sequential basis. Was this totally as expected?

I would say that the actual order rate for freight cars was higher than we would have expected, although we know the business is steadily getting better, and we know that all the economics favoring car builds are there because there were surplus cars that were out there in the 2000, 2001, 2002 timeframe. We think most of that surplus has been worked off or been put back into service, so now we're on the demand side of this equation. And so you tend to get an upsurge. And then if the car builders, the buyers of our freight cars, anticipate possible shortages or possible constraints on delivery, they kind of pile those orders in.

So it sort of gets aggressive. And so I see this happen quite a bit, and then I think that's what's happening now. The reason we will be cautious about the uplift in our revenues is the question of how quickly the industry's fill up. We went through this terrible downturn and we had at least four bankruptcies in terms of suppliers to the industry, and capacity has been mothballed, and it takes time for all those things to be corrected.

In our own case, we feel very confident about our ability to meet the needs of the marketplace.

Would you talk about the content per new freight car. Kind of what is it - what was it, say, last year in '02, and what are your expectations for this year?

In general, obviously, the content for rail car can vary. The two principal factors that affect it are share, and the second one is how many products you put on that, because we don't just sell brakes. We sell a variety of products. The number that we've provided over the years, which tends to be relatively stable within the range, is that for every freight car, for every freight car delivered, we have about $2,500 to $3,000 worth of content. That's market share adjusted.

In other words, because market share is going to go up and down, that's one of the reasons that you have a range. But for every freight car delivered, on average, we'd have something like that.

However, if I adjust that for share, are we talking - you have roughly 50 percent share, so it would be ...

No, no, no, no. He's already adjusted. If you take 10,000 cars built and it would be $2.5 to $3 million of content for Wabtec, and that's adjusted for share already.

I see. And your share, then?

Well, our share is the two suppliers and almost every product that we produce. And the more they want to serve it, you're going to get only (ph) half the market.

So that's your - that has been typically the case in the past.

It has varied, but it varies around that main (ph).

OK. And then the same question with regard to the locomotive areas.

Our content there is ...

Our content there is - again, it's market-share adjusted, and this can vary higher. It has a little more, I guess, variation because it depends on electronics and electronics, if we get it, finances a significant amount of content. And if we don't, it can vary. But in general, market share adjusted, it's in the $40,000 to $60,000 range.

And is that - has that been rising?

We expect it to increase not so much this year, but in the coming years, because of new products and what we call tier one offerings where we try to combine various products into really a subsystem for the manufacturer. So you won't see it so much this year, but hopefully in the coming years, we will provide guidance on that as we go forward.

OK, and then finally, if you would, could you talk about your ventures and participation in India and China?

Yes. We have - we sell both in India and in China, and we have production facilities in both India and in China for very specific components, but we view that as a large and - and largely in many ways, untapped market. I think they need a rail infrastructure, and historically it's been underinvested in, and they have tremendous logistical needs now, particularly China, and we are very much a part of the process ongoing there.

Now, they have historically - particularly China has been a bureaucracy. The minister of railroads has been one of the biggest (inaudible), well, it's clearly a bureaucracy in the People's Republic of China, but we see some evidence that these opportunities are going to get greater.

How much, roughly, would your revenue in those, in China and India, be?

Right now it's - I would say about $20 to $25 million in total revenue between those two countries. Part of it directly ...

Our overall outside of North America is about 20%.

It's about 20%, so we're sort of talking about $150 million or so outside of North America. And I'd say about 20 to 25 of that either through imports or through direct operations in those two countries is ...

This is - if you're not familiar at all with our history, we really began as a public company as a primarily North American producer, although we have had contacts around the world in the rail industry, both transit and freight, and we have worked quite diligently over the past 10 years, going on now 10 years, to improve that. And we have done a pretty good job to raise it to about 20% of our total sales.

We anticipate in the future - it's one of our growth initiatives, to have that ratio improve.

I thought the China venture was a joint - China was a joint venture, or is that 100% owned?

It's a joint venture, but we have the majority.

So the $20 to $25 million is 100% of the revenue,.

That's correct. That would be what we consolidate on.

That's not - but some of that sells from outside of the People's Republic of China into China. We're selling certain electronic products and other technology products to the Chinese. So these encompass all of what we do, not just the joint venture.

And also India as well. That includes India where our operating is 100% owned.

OK, thank you.

You're welcome.

Thank you. Gentlemen, currently at this time, there are no further questions.

Well, OK. Ed, thank you very much and I thank everybody for joining us, and we'll look forward to meeting you 90 days from now.

Thanks, everybody.

Thank you. The conference has now ended. You may disconnect your lines.