美國西屋制動公司 (WAB) 2004 Q2 法說會逐字稿

Welcome to Wabtec's second earnings results conference call. [Caller Instructions] 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.

Thank you very much, Terry, and welcome to our second quarter conference call, Alvaro Garcia-Tunon, our CFO, has joined us on the call as is Tim Wesley, our Vice President of Investor Relations.

Before we talk about the quarter I wanted to comment on the very sad news that we announced yesterday. Greg Davies, our former president and CEO passed away at his home on Wednesday after battling a brain tumor for several months. His fight was courageous and it was inspirational. I can assure you that Greg's legacy at Wabtec will live on. His management team is in place and working hard to improve the business. You may not know this, but Greg was the guy that originally came up with the name of Wabtec. When we merged with [indiscernible] Power Industries in 1999, but that wasn't his only contribution. Other contributions were very far reaching and strategic. He took the company to the next level of lean thinking , initiated a product development system for the company and he really led us in the early 2000 through this year through the worse downturn in the rail supply industry in the last twenty years. We will miss Greg deeply as both a friend and a colleague.

In honor of celebrating Greg's life, Wabtec has established a fund in his name through the University of Pittsburgh Cancer Institute. This fund will support brain tumor research and physician education. There's been very little progress made in the last 30 years in combating this type of brain tumor and we think that this type of research will be very effective. To that end Wabtec and its board of directors are making a donation combined of $300,000 to this fund. And we will also match donations by our employees to this fund dollar for dollar. Our goal ultimately is to raise $1.5 million to [indiscernible] for this research. If you want more information about the funds or would like to make a donation, contact [Tim Wesley]. He has all that information. That being said let's get into the quarter.

As you know I'll point out the forward-looking statements disclaimers that are in the press release. I will then make some opening remarks and turn it over to Alvaro who will talk about the numbers.

Clearly we had a good quarter. We stepped it up to a new level over the first quarter of this year. We are very pleased with this performance. We had EPS of 20 cents in this quarter versus 13 cents a year ago. Our EBITDA was 23.5 million versus 17.5 million last year. Our cash generation was particularly strong at 37 million. Alvaro will talk about these more in detail--about the numbers. The key point however is that we had a strong quarter.

But it is really just the type of performance we need in each quarter going forward to meet our commitment to investors in 2004, which is to earn about 70 cents per diluted share which will be 35% higher than 2003.

There are challenges. On the macro side the economy is strong, but we are challenged by currency exchange rates, particularly between the Canadian and U.S dollar, raw material prices, particularly steel, and, of course, the ongoing insurance costs and other issues that come up in doing business today in the world of regulations.

On the industry side, there are challenges. We see continued and do want to see continued growth in rail traffic in [indiscernible] deliveries but the after market is still not as revised as we would like to see it although we are starting to see some improvement.

Of course then we have internal challenges. We made progress and we talked about it first quarter, having some operational issues and we made a lot of progress in dealing with those. We said we would have about a 4-cent impact from these sub par operations and we cut that impact in half in the second quarter. We are really on track for the recovery that we see in terms of these operational problems . We still have a long way to go to improve margins to where they have been traditionally in these units. On the other hand we feel very confident about the progress we've made thus far and our management is team is working on it. Let's talk about freight car original equipment market.

Freight car market continues to be stronger than we anticipated. We anticipate, however, about 40,000 cars delivered this year. The second quarter's numbers haven't been released yet but we believe they were around 20,000. It's a very strong number which improved the backlog substantially. However, deliveries in the second quarter were 10,000, about the same as the first quarter. So we are flat on actual deliveries. The reasons for that is we've done some scale up of the car builders and the capacity constraints they have in steel and in castings to get there. So the outlook is very good. We just haven't seen the impact as of this date. But that bodes well really if not for the second half and it may not be in the second half but does bode well as we go into 2005.

Locomotive OEM. We have a much better view of the locomotive order book, and it has been gaining strength. Looks like it will come in around 1200 units for the year, slightly higher than we originally had estimated. As you know there are new tiers emissions requirements starting next year. So the locomotive, those ordering locomotives are trying to get their orders in early and that's why we've had a strong year. So we had felt that there would be a downturn in locomotive delivery in 2005. However, what's becoming more apparent is that the railroads are power short and the lease fleets that are out there are operating at very high utilization rates.

This in fact would cause us to feel that locomotives could be stronger next year than we originally anticipatedly. Before we said there'd be seven to 800 locomotives next year. We now thing it will be stronger than that. We just don't have the exact visibility to be able to say how close it might come to this year's performance. We will stand by with the second quarter and give you better information on that.

Great after market. Freight after market is driven by how hard equipment is operated in the field. Rail traffic continues to be very strong. Carloadings were up 5% in the second quarter. Intermodal deliveries were up 12%. These are very high growth numbers. It really is the strongest sustained [indiscernible] growth we've seen in the last six years. As this traffic continues to grow the railroads are running their equipment harder and it needs more maintenance more down the road. It also means it's tougher for them to get the cars and the locomotives in to do the maintenance. On the other hand it has to be done. We think that this business is starting to pick up and we are seeing some modest pick up, not yet at full volume.

Let's talk about transit. The OEM has a good backlog of work for this year although some of it is at lower than normal margins. We are doing a lot of preliminary engineering work which affects it obviously in the early stages. As you know we talked about the R160 contract for New York City and it represents about $250 million of future revenue to us including the options. However, that won't start until late '05 and revenues there will be spread evenly over the in two and four years. On the transit after market we've seen some pick up in certain product lines but it does remain below historical levels and transit authorities are facing budget constraints. That really concludes my initial remarks. I will come back on for questions and answers. Let me turn it over to Alvaro to talk about the numbers. Alvaro?

Thanks very much, Bill. As Bill stated we made a lot of progress during the quarter but we still feel we have some room for improvement. On the revenue side I think the results were very favorable.

Sales in total were 18% higher than the prior year quarter. Break group sales increased by about 14 percent, mainly due to higher sales of freight car and locomotive components in North America, and Transit Group sales increased 30% albeit from a lower base, mainly due to higher sales in the after market.

Going down the income statement, we were obviously disappointed in our gross margin performance. And one of the things I'm going to try and establish in this phone call is to try and pinpoint as much as we can the reasons for that and be as transparent as we can. But gross margin decreased to 25.5% from 27.2% last year.

There were really about three primary reasons for that: FX, foreign exchange on our Canadian operations. On a comparison basis continues to hurt us. We have the Canadian dollar hedged for the rest of the year but you only do that so far in advance in comparison to the prior year. FX does hurt us.

We were also impacted by factors we discussed in the first quarter. Operating factors that we discussed in the first quarter, primarily inefficiencies from relocating an electronics plant from Canada to the U.S. and ramp up of low margin door contracts in transit.

Finally steel costs continues to have an impact on our operation, especially on a year to year comparison. In terms of numbers, and these numbers are difficult to estimate with 100% certainty because basically you are trying to estimate Canadian dollar costs incurred, when they were incurred, the translation rate, et cetera, et cetera. But in general we think that the exchange rate in Canada hurt our operation by about 1.5 million during the quarter.

I believe during the last phone call we said that the operating issues, the operating issues from relocating the electronics plants and low margin door contracts impacted us by about $3 million and we expected that impact to be cut in half in the second quarter. While it's still a negative impact I am pleased to announce that at least we did meet our internal target and that number has been halved, so we think the negative impact on a year to year basis from those operations is about 1.5 million. Last phone call we said we expected by the end of the year to return those to a neutral position and we are still on track to that.

And steel, steel is a difficult number to estimate because, one, it's hard to gauge how much of a price increase is from steel and how much may be due to other factors with the value-added in the costs that you purchase. But I think the number that we said before and we think this number is in the ballpark about six to 8% of our cost of sales is steel.

If you take a look at the manufacturing indices, the cost of scrap steel has gone up about 60% year to year. When you factor in, obviously when we get a price increase from our suppliers we resist it; we are trying to pass along price increase to our customers. We've had some success there but we haven't been successful across the board. Our best estimate now is the increase in steel cost resulted in a negative impact on a quarter to quarter comparison of about 1 million to 1.5 million.

Once you factor in those three items which I think are three principal items affecting margins in the quarter, you will see that we were actually above last year's margins. But again in actual dollars we are below. So we will continue to work hard. We think we should get improved margins with our operating leverage as orders increase and we are going to keep working on it to try and improve it.

On the other items in the income statement, operating expenses were pretty stable. Lower amortization expense offset higher insurance and medical premiums which I think were not isolated in this instance. I think that's an issue for everybody. Interest expense, stable. Higher than last year because we replaced some variable rate short term debt with fixed rate debt at attractive long long-term interest rates. And we believe that combined with our new bank revolver signed in January will give us an appropriate capital structure from which to grow.

Other expenses decreased by 1.4 million, and these primarily due to reduced foreign exchange loss in the other line and what happens is these are the paper FX losses. The counter treatment dictates that you put the operating effects losses, which really relate to dollars spent, in the gross margin line. These relate to BS items and translation of BS items which really don't have a cash effect. In my mind they don't have an economic effect, but you do recognize them for accounting purposes. We put that in the other line. We hedge the economic ones. We do not hedge the noneconomic ones.

Income tax is about the same as last year. We accrued both years at 36.5%.

Cash, we were very pleased with our performance. In the first quarter we weren't pleased and we said we were going to strive and do better and at least we are pleased to say we did do better. We had cash generation of about 37 million during the quarter, about 29 million of that came from operations. The rest were from nonoperating sources. As a result our cash balances are very healthy 95 million at June 30, '04, compared to 70 million at the beginning of the year. So generated about $25 million worth of cash during the year. That should meet our target for the year of cash generation.

Compared to the first quarter levels we held receivables, essentially flat and managed to do reduce inventories by about $4 million. We think that's a very good performance considering that sales were about 18 million higher in the second quarter than they were in the first quarter. Our total debt right now is 95 million net of cash compared to 132 million at March 31, '04. That's 26% of total capital now versus 34% of total capital March 31, '04.

Again to anticipate some of the questions that we are likely to get asked is I think everybody wants to know, what are you going to do with all your cash. For us it's a very good problem to have. We can remember two and three years ago when the question was posed slightly differently. So for us it's a good problem to have. One of the possible uses of cash is for acquisition and that continues to be something we've looked at. We get asked about this and our answer consistently is it is our policy that we set no timetable for making acquisitions because then we believe that's when you make mistakes. We do have opportunities. We are exploring them continuously and our goals in this arena are to look for acquisitions that would reduce, the impact of the North American freight cycle, give us sales opportunities in new markets and be accretive immediately. We will be disciplined in how we select it, I can assure you of that.

Just to go over a few miscellaneous items that again we get some questions on. Depreciation during the quarter was 5.4 million versus 5.1 million last year.

Amortization was 745,000, versus 1 million last year.

And Capex continues to be in line with our budget by 4.3 million during the quarter versus 2.6 million last year.

In terms of backlog, our total corporate backlog is 328 million, versus 311 million at March 31, up 5%. The freight backlog, 160 million, versus 148 million at March 31, up 8 percent, transit, 168 million, versus 162 million at March 31, up 4%.

Again, 55% of our revenues come from the after markets. So after market numbers reason critical to us but certainly just seeing an across the board increase is encouraging. With that I will turn it back over to Bill so he can summarize then we will take Q&A. Thank you.

Thank you, Alvaro. Just to summarize, our second quarter performance is strong but it is the kind of performance well need to have through the rest of the year to achieve our 70 cent objective. We are making good progress in resolving our margin issues, particularly in this problem operation. Our industry demands looks strong and it looks like things will stay that way and that bodes well particularly for 2005. And as always we are highly focused on cash. We are extremely pleased with the substantial cash generation we had in the second quarter but I can assure you our operating people are not going to slack off as we go into the balance of the year. So with that, Terry, would you like to come back on and with will entertain questions.

[Caller Instructions] Our first question is from Art Hatfield. Go ahead, Mr. Hatfield.

Good morning. A couple things guys. First of all I want to offer up condolences on your loss. We thought a lot of Greg here and we understand your loss. First of all, Alvaro, the numbers you gave on the margin situation, I kind of just came up with a quick number that it was about a 200 basis point impact to the gross margin. Is that kind of a fair calculation?

I think so, Art. We did the same calculation here obviously and the way I did it is once you take into account those factors you are slightly above where we would have been last year. Last year we were 27.2. This year we are 27.4, something like that. to be honest we are not happy with that. we are going to try to continue to improve it but in terms of your question, yes, I think.

Fair enough. With that said, are you expecting to see sequential improvement in that gross margin as you move throughout the rest of this year?

Again, you know you have to be careful in terms of giving guidance these days but I can assure you that our operators will hear a lot about margins, that our operating emphasis will be on improving margins. We will be disappointed if we didn't.

Okay. Great. One other question, I hate to do this to you but I am going to try to ask you to project again.

I can always say no, that's okay. Give me your best shot.

That's right. And I can always take no for an answer so don't feel bad. Earlier in the year I think you guys when you were giving your guidance for EPS you also were saying that you felt that sales for the year,were roughly and correct me if I'm wrong about $750 million. It's kind of looking like that's going to be pushing closer to the 800 million level. Is that fair to say? And I think a lot of that reason for the uptick, obviously the freight is doing a little bit better but from my perspective and what I was modeling, transit seems to be doing a lot better than what I was looking for. Any thoughts on that? And where you kind of think that gross sales can fallout for the year?

Sure. I think initially we came out at the beginning of the year saying 750. And again I could be off on this, and correct me if I'm wrong, I think in the last conference call we said we thought the margins were getting stronger and we thought we would be in excess of 750, probably somewhere between 750 and 800. I think if you annualize our results YTD you will see we are still within that framework and I would leave it at that.

Thanks, guys.

Thank you, Art. Thanks for your kind thoughts, thank you.

Thanks for your comments on Greg. Good guy.

He was.

Our next question is from [Scott Hawning.] Go ahead, please.

Any idea just in the locomotive increased magnitude for next year? Just any general thoughts? You were thinking seven, 800. Are you thinking significantly higher from that or maybe a couple hundred?

Well, it's going to be 1200 this year and we were thinking seven, 800. I think it's somewhere between those two numbers.

Okay.

Just to bring you right around 1,000. We don't have the visibility to be absolutely certain.

Great. Thanks.

We get our numbers from the manufacturers and what they are saying, they are seeing an improved picture but the orders haven't been booked so we really don't want to really make an adjustment to the forecast until we can get the booked orders from the manufacturers.

Great. Thank you.

Our next question is from [Dottie McConoughay].

Hi, it's [Dottie McConoughay] from Westfield. I wanted to put my thoughts in for Greg Davis and his family and company as well. But my question is regarding your outlook of 70 cents. Are there any issues on mix or anything else I'm overlooking that would cause you to see earning in the second half to be lower than your initial projections? I guess given this quarter, is there any reason for your initial projections to hold?

Well, what we did, Dottie, just to recap the first six months a little bit the first quarter was off. We weren't happy with the results and we tried to explain the reasons why. The second quarter is much better but we are still seeing some challenges. But we think we can make the 70. So we are not going down wards. We are not going upwards either, with revenues going up we tends to be a little bit conservative but we certainly have some challenges to face. You are seeing a lot of orders but you are not seeing the production that you anticipate with that. So right now we are comfortable forming the 70s as we did in the press release and we are not going up or down.

I think you will take a little time for the orders to be [flowing] through the system. We went through a significant downturn down severe downturn and that capacity went away, at least it's reduced. Now it's ramping up but they are finding that certain components, steel and castings are creating shortages. That's why we had a flat freight car delivery from first quarter to second quarter despite the orders.

Our next question is from [Stuart Hazanzki]. Go ahead, please.

Good morning. I would like to extend my condolences as well. I had a particular question on your cash level and your expectations for use of that. I understand that you said you would use it for primarily acquisitions when the time comes. Can you talk a little bit about your targets if any for your capital structure, what type of leverage targets you have? Right now you are fairly low leveraged. Is that something that you intend to continue or are you willing to lever up the at the right opportunity?

Yeah, I'd be happy to do that, Stuart. Actually we are in a little bit of a strange position for Wabtec and we are going to stay where we are. We would basically be investment grade. We are not sure we know how to handle that situation.

But in terms of our goals, here's what we've said. We think debt is a good source of capital. It's an inexpensive source of capital and it's one that we want to use judiciously but in proper amounts. On a going forward basis, on a permanent basis, probably the key parameter that we use is debt to EBITDA. And we would feel comfortable somewhere in the two to 2.5 range right now.

If you annualize our debt to EBITDA for the quarter, and take our debt net of cash we are almost right now at the one to one level which is actually lower than would be ideal for us, we feel. If we do an acquisition, we probably would go higher than the two to 2.5. I would anticipate that we would go somewhere to three, 3.5, even a little higher if we had to.

I don't want to set any limits, with the goal that we would get back to basically our sweet spot where we feel comfortable of two to 2.5 as quickly as possible after that acquisition.

And on the, your comfort level, two to 2.5, is that on a gross or net basis?

That would be, that would be debt net of cash if that's the gross versus net you're asking about.

Right.

Debt net of cash.

Right. So you could really lever out without any concern at all about another $100 million or so?

I think that would be accurate.

Very good. Thank you.

Okay, Stuart.

Our next question is from Mike Peasley. Go ahead, please.

Hey, Bill, Alvaro, Tim, good morning. We wanted to pass on our condolences as well. We are all going to miss Greg. That's for sure.

Ditto here. Thanks very much.

Real quick, Alvaro. Let me ask you a little bit about SG&A. You see revenues go up, 16, $18 million sequentially. And I understand the leverage as a percent of revenue it can come down certainly there's operating leverage there. But even on an absolute basis it's down dollar for dollar sequentially. Is there something else in there? Is this sort of a sustainable trends? Just kind of give us some flavor on what happened with SG&A in Q2.

I think SG&A to be honest, Mike, was pretty steady in Q2. There are always going to be some factors that affect SG&A. Medical insurance costs, that's a zig zag kind of number, it can be up one, it can be up one quarter, down another quarter depending on your experience and you have to make accruals based on that experience.

So if your experience is a little favorable one quarter your accrual is going to be better. If it's worse as it was actually for us the second quarter, it can be a little worse. It can get impacted by a number of factors. I think right now our run rate, within a reasonable limit is pretty much consistent with the first quarter. And I think the run rate that you see really for the first six months is something that you can use for modeling purposes for the second half of the year as well.

SG&A is something we look at continuously. We try, we are never happy with it. We are looking at the numbers always to see where we can make reductions and I would anticipate it would be relatively steady for the rest of the year. I don't see a whole lot that will affect it.

Let me ask you another question. If you were to break out the employment level versus, like administrative versus what's on the plant floor, has that changed a lot over the last year or so?

We are both looking at each other and shaking our heads. Not really, no. If you are asking is there any leverage there we wouldn't anticipate a big SG&A increase even if volumes grow up.

In fact I think we will look very hard at whether there's some improvement possibilities. I think that's, I think that's what Alvaro is saying. We are constantly looking at these things as we go through evaluations and see what layers and levels we have and try to adjust to be as lean as we possibly can.

That's fair. Then transit had a nice sequential jump in revenues. I think, Alvaro, you mentioned at the beginning that after market kind of picked up in the quarter. Is that sort of a blip? Is that an ongoing trend? Maybe some of it's the transit door contract that's sort of ramping up?

No, the transit you know, the new R160 revenues haven't started to ramp up from that yet so that wouldn't be the in, I think, the states are still pinched but they reason as pinched as they were before. And so I think it's something that in terms of orders booked you can see the transit backlog is up a little bit and that's from those sources. I think it's not the R. 160, I don't think it's a blip. I think it's more of a steady effect.

I think we were very low in the last couple years because of budget concerns so just inevitably has to come back up.

But the transit door contract I was referring to, weren't you working on one now that you had some trouble.

Yeah, we said that we had some transit rail door contracts that were substandard and we are working those, they are in our backlog but we are working those from the point of view of cost reduction and internal productivity. And we have said we made progress on those and we have. We have new management there. We have new operating management in place. And they are making progress.

Now, we get these guys come in and tell us about what they are doing quite often. So we feel that we are very much on the right path here. But it's, it's a process and it's going to take time.

Last question, just kind of looking back historically, Q3 tends to be a little more seasonally weaker. Is that the case this year? I know things are ramping up and you are seeing a lot more demand sequentially. Does Q3 tends to be a little more seasonally weaker?

We tends to have a little weaker third quarter and it's been this way for 20 years. And the reasons are that the railroad shops shut down. There's a lot of vacations and that's really is what, and, of course, on the transit side, they are down. So that's what causes it. We are working hard to try to be as level loaded as we can and to the extent we can we'll keep the performance as level as we can. But there could be a little bit of this, yes. We just have to see. We are still committed to the 70 cents.

Yup.

That's where we are heading.

Great. Well, it was a great quarter for sure. I appreciate your time on the call.

Okay, Mike.

Thank you, Mike.

Next question is from Tom Albrecht. Go ahead, please.

Hey, guys. Just , sorry about that. A couple of other things. I was looking, Alvaro, and Bill, at the engineering expense line item. Sequentially you dropped about $600,000 yet you talked a lot about that there's a lot of preliminary engineering going on. That statement doesn't seem to reconcile with the experience you just had.

Well, what we do do Mike, and actually we did this, I'm sorry, Tom, I forgot we switched from Mike to Tom, sorry, is we will capitalize the engineering on major transit contracts, both on the break side and the door side. And then it's not a percentage of completion, it's just engineering costs. And we will amortize both costs as we ship the product. So in other words there was a lot of activity going on that may not show up as engineering expense.

What BS item will that be under?

That's actually carried under inventory and that's where we get the question about working capital inventory going up, that's one of the reasons. Part of that is capitalized engineering.

Okay.

As often as possible, Tom, we try to get paid for that engineering

I would hope so.

We do, too.

Now, what about your outlook on the Canadian dollar in the second half of the year? It seems to me that the big appreciation began during the second half of last year. It had been a little more stable here in recent weeks. I haven't paid attention to it the last couple weeks. But shouldn't that be at a point where it is less of a negative impact here in the second half of the year?

Here's, one, I'll be perfectly frank. We actually had a board meeting yesterday and they asked me the same question and I said I don't know what the Canadian dollar is going to do and if I did I would probably be out investing in it. But in all seriousness where we got hurt with the Canadian dollar is in the comparison from year to year which is what everybody is looking at. For the rest of the year we actually have it hedged. Right now the Canadian dollar is at 76. We have it hedged slightly below that in the neighborhood of about 75, or a little shade below. So economically it really changes won't impact it because we have it pretty much hedged in for the rest of the year. But in comparison to last year when it was lower, it does affect us.

Do you have the approximate level it was in Q3 last year? Wasn't it like.

Q3 I think it was starting to rise. I think it was in the low 70s last year.

It started really in the second half.

That's what I recall. So I was thinking we were getting close to a neutral event.

Yeah, we will. Probably by the fourth quarter.

Okay.

But, you know, in terms of forecasting where it is, I mean, if I was betting that I would bet that it would come down. But I've been wrong thus far, so.

Okay. That's a fair answer. Let's go back to acquisitions for a second. I was thinking you were relatively close to making some things happen in Europe on the acquisition front. Can you bring us up to date between North America and Europe where maybe the pool of activity and discussions is hotter?

Tom, one thing we have to do is be very careful what we comment on in acquisitions, and basically what we do say that at any point in time and it was happening two to three years ago we didn't make any because really the market just didn't lead to anything that could be successful. But at any point in time we are probably taking a look at two to three acquisitions. However, in terms of strategy and what we are looking for and comment in terms of specific acquisitions, we really don't like to, so.

Okay. So what's the appetite of sellers, then? Let me ask it that way. I mean, their results are undoubtedly improving, too. What are sellers looking for as they examine potential bigger partners?

I think sellers right now are mixed. I've seen a couple where I think I can say this, we actually put in a preliminary bid on one and we were told that we were way too low and we said, thanks very much, we think we will be in the next one and there are others that I think are more realistic. So at any time expectation can go across the board. But the nice thing for us is that we have much greater visibility as to our own financial results and to the results of the target and that makes for a better environment.

If you recall, Tom, during the last downturn we had four bankruptcies and it has been historically one that cycles quite a bit. So you have to be careful. You can't, you have to be right and you have, you can't over pay. Just to stay in fashion for the moment.

Right. Let me go back for a second to the disruptions at the transit door contract and the electronics plant. You said you cut the disruption impact to about 1.5 million, maybe. Should we cut that in half again in Q3? Or could you give us just your preliminary thoughts there?

Yeah, we have a clear path of quarterly and monthly and even weekly improvements that we are measuring and measuring the operating [indiscernible] against. We are making progress. So our view is we are going to continue to bring these back to the traditional margin levels that Wabtec enjoys in these businesses. It's going to take sometime because you have certain imbedded contractual operations that it takes time to work out.

Sometimes you can make them better but you can't make them as good as you like. The company does fulfill its obligations to its customer. That's how we are viewed as a good and quality long time supplier. So we are working on it. I can say you can trim line a rate of improvement that will continue well into 2005.

Okay. I was just thinking because you said you thought it would be a neutral event in Q4 that, I just want to make sure I didn't hear just a second ago that maybe this would carry into '05.

I said the improvements carry into '05.

Okay.

In other words, but I would say, yes, we will, in terms of the major impacts we are making progress every quarter. From the impact in the first quarter we cut it in half in the second and improve in the third and will improve in the fourth and we will keep it improving through 2005. Then, Tom, just to make a minor clarification I think what we said it will be a negative effect by the ends of the year not necessarily during the fourth quarter. So hopefully obviously we want to minimize it as quickly as possible but again I think that's what we intended to say.

Okay. And then let me go back to steel for a moment. So many companies obviously are facing the same challenge but my somewhat maybe shallow view is that many of them maybe are having a little bit more success in raising prices, maybe it's in other sectors but raising prices.

Why would you be maybe a little bit slower? Is it because your customers are so much bigger than you are and maybe there's a little bit more relative even sized issues in other industries or what?

Well, it is a combination of things. We are in fact doing, trying to carry these prices forward to our customers. In some cases we have historic relationships; a one year agreement in relationships and that sort of thing. It does take time. And there is a lag. That lag hurts us. So we have our people working on it. We have a clear plan to work on it. in our sales and marketing operations. They know what they have to do. But those, you know, it's not the kind of thing where you just automatically do it. If you haven't done it before. So there's a lag.

Right. Did you ,Alvaro, a suggested dollar impact from the steel? I think in the first quarter you suggested it might have hurt by about a penny or so.

Yeah, and here's the way we do the number, Tom. Basically we've estimated, again, it's a rough estimate because it's a tough number to pin down exactly but we estimate that about six to 8% of our cost of sales is raw steel. The problem is you can buy a part from a manufacturer. He has adds a lot of value to it. It's more than just the raw material. And that's why you have to try and guesstimate which part is just the raw material. But it's our best guess so far. That translates to about 10 million a quarter, or 40 million a year.

The indices have indicated at least quarter to quarter published by I think one of them is---the one we use, the American metals manufacturing association or something like that---indicate that, again, scrap has gone up by about 60 to 70% quarter to quarter, second quarter last year to second quarter this year.

And so again, one, they are not trying to pass all that through to us. Two, we tend to be resistant as well as to the extent we can and, three, we are trying to pass this on to our customers and some units are meeting more success with that and others and across the board we are having success but certainly not 100%. And again it's a little bit of an estimate but the numbers as I said based on that we are looking at 1 million to 1.5 million will impact this quarter. To be honest I think it's as close as we can get to.

It's [indiscernible] cents.

I appreciate the working through the drill there. Then I guess lastly, if we go back to the SG&A question for a moment, and if you had to break out the five or six largest buckets of where you make expenditures in the SG&A line, we know about insurance, obviously back office, administration, whatever, can you give us maybe a more clear-cut view on those different buckets?

Yeah, I mean the bigger number by far is salaries. Because basically you have all the salaries that you are not putting in your cost of sales. They will go in SG&A. Apart from engineering, of course, which goes on it's own separate line.

But by far the biggest is salaries. Apart from that the most volatile item and I mentioned during the call, is medical insurance. That's one that we've been trying to maintain a reasonable levels and I tell you it's very difficult. We did a study last year that indicated various ways to reduce costs. We implemented almost all the recommendations. I think to the credit of our labor force I think everybody understood the issue and it was relatively well accepted but costs will go up. Other kinds of insurance.

Casualty insurance, D. and O. Insurance. That has been going up tremendously after 911 and with the downturn of the stock market. That's actually stabilized and while it hasn't gone down to the prior lower rates at least you are not seeing these 200, 300% increases any more.

Also another number that you have in there which you are seeing a dramatic increases on especially on a percentage basis is your Sarbanes-Oxley cost and your audit costs. As a matter of fact we were just talking with our auditors about that last week. And I tell you, Sarbanes has imposed a very, very significant burden on American industry and we are not exempt from that. We are in there with everybody else.

Okay. But that's helpful and I know I said last a second ago but I have one more. I believe in January, Bill, I think that was the timing, you kind of redescribed a new initiative to focus on purchasing. You really hadn't gone after all of the economies of scale, centralized purchasing. Where does that stand? Because I kind of remember being a little surprised that you weren't more advanced given your overall focus on lean manufacturing there.

Yes. I would be happy to respond to that. We have just actually reviewed this yesterday. We have an organizational structure in place. We have people on the ground in China as well as in India who are looking at global sourcing opportunities. And we are making real progress.

We are using these tools to quite frankly help us on some of the problem units that we talked about, the contracts that we talked about. And we are making real progress. It does take sometime to ramp up. And we are looking at it. It was a reasonable impact this year but it will be double that number next year. It reports into our Q. PS function and we have a good number of people out there working on it. so I am pleased with the progress. It has been perhaps a little slow.

When you are a lean company, we tend to feel that work on the thing that you do internally, sometimes you are not, haven't been as aggressive as you could be working with your supply chain. So you could say that maybe we are a little slow out of the chute but we are gaining momentum. That bodes well for the future.

Does that suggest longer term maybe four to six quarters, that there may be some modest facility consolidation within North America?

I would tell you I believe there is a facility consolidation in our future, yes. I think, we look at it, we probably have too many units.

Bill, I know it's tough for you to do this but how do you feel with the timetable I just suggested, the next four, five quarters?

I feel good about that.

Okay.

I think that's a good time horizon, yes. I think we will be taking some action before the end of the year.

Okay. Good. Guys, keep up the good work. Thanks much.

Thank you, Tom.

Our next question is from Greg [indiscernible] . One moment, please.

Thank you. This is Greg, yes, thank. Hi, just to pass on my condolences regarding Greg as well.

Thank you.

Could you talk about the revenue per freight car? It was up 14 percent, the revenue in the freight area, but on a locomotive and car basis have you increased the content? Can you give some color on that?

Content, well, essentially the actual freight car deliveries was flat for the quarter over quarter.

But up second quarter last year

I would say, I wouldn't say there's been a dramatic change in content between the two quarters.

And the same on locomotive?

I would say the same on locomotive. I think in the future there will be some change on content as we implement some programs. But those will occur in 2005.

Okay. And it looks as if you've made progress on inventory. You talked about it last quarter. How much more to go there?

A lot. We believe that we can really fundamentally improve our inventory turn around and we I think would say in the last year all of us were a little disappointed in our performance . So it was pleasing to see in the second quarter that we really got it going a bit. But we are by no means finished.

Okay. And with regard to non-North America, how was that and is there anything you can talk about China a little bit?

I would say that we were making real progress on our international sales and non-North American sales. We are projecting about 20% of our total revenue coming this year from outside North America. Ten years ago that was nonexistent. As I look at the international activity, not specifically China but the international activity, we have opportunities to fit our product line, I think our international people are really doing nice job in gaining momentum. It's a good incremental business for us. It's going out and taking advantage of existing product lines worldwide and so we are confident that momentum will continue. In terms of China we have a venture there which is the buff-door venture. And in terms of being local and producing it for the Chinese market we've got a long way told to go. But there are contacts and there are opportunities.

And we also have established a joint venture with our Japanese licensees and we are, actively exploring, you have to be careful in China which projects you go after but selected projects where we think we can be profitable, where we can get the price we want and we are optimistic that our opportunities there will be increasing shortly.

And then.

Next year.

And then finally with regard to Boise, I know you were looking at improvement in operation and other thing there. Can you talk a little bit about that operation, that locomotive situation?

Boise is a really a very nice asset to the company. The only issue that it's ever had is its variability of volume year over year. And it needs a certain base load of business to be stable. There, Boise is going to be fine this year. It has an Amtrak that we just put in there. But it's really to help out the plans that we had in place for Boise this year. Eventually I think down a little bit year over year but it's still doing adequately.

Our objective with Boise is to find a very stable base load. By that we are looking to move up to tier in having a bigger content of what goes on in locomotive. By doing some of the infrastructure work, modular designing modular car design, or other types of packages. We are making real progress in that regard. We've spent money. We've spent money to work with locomotive builders on this and we've spent cash and this is the opportunity about to break out for us. In 2005 will be helpful. To our overall performance. In Boise we think can be a very, have a very stable base load, be consistent year after year and then on an incremental basis be a real plus to the company.

Okay. Thank you very much.

Sure, Greg.

Our next question is from [Steven McBoyle].

Yes, thank you, can you talk a little bit about pricing both within the rail side and I was led to believe that New York air break was raising pricing. Just curious what your strategy may be there and what you are doing. Secondly, with respect to the locomotive side of the business, to the extent that you have obviously a more sustainable higher level of demand there, is that at incrementally higher prices and margin levels as well?

Okay. During the downturn from 2000 through to last year, the whole industry suffered price erosion. And only as demands is firm is there an opportunity perhaps to have pricing improve. We are pleased to hear that a competitor has raised price. I would think that that's something that's needed in this industry. And I think with these increases in steel costs it's imperative.

Also we are hopeful that our locomotive customers, of course, want us to keep prices stable going forward and we do our best to support them by becoming a leaner and a more productive company. But there are times and there are circumstances where prices have to go up. And we always look at it and we are working it.

Having said that, is pricing on the rail side increasing for you above and beyond the component cost increases you are seeing?

I think I answered that question from the point of view of the lag we are experiencing. You have contractual obligations and it takes awhile for inflationary costs to be filtered through in terms of pricing to your customers. But over time we will, I think, be able to do some things that will improve our pricing. It has taken, I would say, performance YTD we are probably not achieving what we'd like to achievement but going forward I think increasingly quarter by quarter I think we will.

Great. And then next question, with the earlier comment with respect to content opportunities in 2005 you alluded to a number of programs.

Yes.

I'm presuming that the unit tank car program but if you can just allude on what opportunity that may exist ahead of you in '05 on the content front.

Well, certainly the unit tank arrangement is an improvement in overall content and we are aware, we are working on a number of things to get there. But this is--we're really not in a position to per barrel too talkative about it at this point.

And on the rail side, I would be interested in your perspective on the industry dynamics in terms of what you are hearing from the manufacturers, in terms of steel allocation and castings? Is this an issue that's increase single becoming less of an issue as the year goes on?

I will tell you, Steve, my experience is when there is demands the capacity will change to fulfill the demand. So I would suggest that the casting and steel shortages will not go on forever. So the industry is struggling now at this point to pick up its volume closer with the but over time they are going to finds away to do it.

And interested in seeing the industry backlog, I guess at a four-year all time high. Is there a bias for higher deliveries in the second half? Again in perspective to your guidance, I believe it is predicated on a 41 car delivery.

41,000, right.

Is there a bias for that to be a higher number in the second half?

Well, it is marginally higher if we were, from the first six months, if you annualize it, marginally higher if we were, from the first six months. If you I would say you get a slight uplift in the second half but not much. I just think that prudence says that this capacity constraint, though temporary, will be present with us for the next couple quarters.

But again with an expectation of going into the year with deliveries of 41,000, obviously we are at a two quarter run rate of that. But backlog continues to increasingly get better.

Yeah, our original, I think if you go back and look at the transcripts we originally said 37,000 cars. Last quarter we modified that to 41,000.

Okay.

So we have in fact increased. And the only thing I can tell you is that the actual delivery second quarter to first quarter were flat. So.

Right.

The industry has not achieved the uplift yet.

And I guess what I'm trying to get a sense is your perspective on the constraint issues from my perspective it seems like those are becoming less of an issue through the year. So one ought to expect that deliveries second half over first half ought to be at a higher run rate.

Well, you know, I guess we will see in 90 days whether that's true or not. I hear that there are shortages. But hopefully, I agree with you, actually, that ultimately people will finds away to sell the demands that are put upon them at whatever price levels are acceptable.

That's helpful. And then with respect to the door operations in Montreal, as I understand it the issues there were obviously contractual in nature. You were incurring some higher costs there. Have you had the opportunity to put in place any new sourcing contracts? I think you were looking to the U.S.

Yes, we have. That's part of the solution.

That was put in place this quarter?

We have some that are going in place. We are trying to, exactly. We are trying to finds ways to relieve the cost penalties that can be there from Canadian sourcing. We are looking internationally. But we are doing it commensurate with filling the contracts in our contractual obligations. There are certain components we agreed to provide. We have certain engineering reviews on these contracts. We will not violate contractual agreement with our customers. But within that realm we are looking to reduce costs by servicing.

So looking forward, you feel confident as further contracts come up for renewal you are going to find equal quality contractual arrangements at lower prices?

Ins well, I believe that going forward, yes, not only we will have I think good disciplines in place so that we take, we don't ends up with substandard margins by the contracts that we take. But also in design and sourcing decisions certainly we will continue to reduce our costs. I believe that going forward, yes, not only we will have I think good disciplines in place so that we take, we don't end up with substandard margins by the contracts that we take. But also in design and sourcing decisions certainly we will continue to reduce our costs. Commensurate again with high quality products that function as we have told the customer they would.

Okay. Then just to circle back on the SG&A line of questions, the absolute dollar obviously down sequentially, meaningfully up in the sales quarter. Is that, just so I understand, I know you touched on this, but is that a sustainable absolute dollar amount through the remainder of the year?

Yeah, like I said, I think SG&A is going to vary quarter by quarter due to different castings. It's a pretty sizeable amount in total. But I think if you take the run rate taken in the first six months and project it out for the rest of the year, I don't see anything dramatic in the horizon that would impact that much one way or the other.

One last question. I can't help but circle back to the earlier question with respect to content and some of the program opportunities you may have in place in 2005. I know the strategy has been one where you've wanted to move more from a component solution sale to a sub-system sale. Is there anything more you can allude on that in terms of the opportunity?

Just to say that we have a very active program and I think we are going to have some very good success to report in the future. But when you're working with your customers on these issues you have to respect the process as to how you get there. It's really not possible for me to go into a great deal of detail right now.

I understand. Thank you for taking my questions.

Thank you.

Thank you.

Our next question is from Art Hatfield. Go ahead, please.

One quick follow up. Alvaro, I know you mentioned this but I didn't write it down. What was your cash position at the end of the quarter?

At the end of the quarter I think, Art, it's around 95, 95 million cash on hand.

And that's also 95 million net debt?

Right, yeah.

Slightly over $2 per share.

That's all I needed. Thanks.

Thank you, Art.

Our next question is from Tom Albrecht. Go ahead, please.

Yeah, hey, guys, quick follow up, too. I know Boise is working on ten switcher locomotives for Amtrak. Are they working on building any switcher locomotives for the freight world?

No. There are some other switcher , there's one other switcher contract that , a little bit unique. But, no, just the Amtrak.

What's the last time you actually had switcher orders within the freight world?

There's a good question. Probably.

Probably two or three years ago.

That's kind of what I was thinking.

But we still are, we're the only ones doing it. You want to create a little excitement about that. We would be happy to deliver.

We will go out and make some sales calls this afternoon.

All right. We will give you a commission without increasing SG&A too much if you can do that.

Okay. We will try to make it happen. Then lastly on that SG&A, I appreciate the earlier discussion, Alvaro. Just want to go one step farther. Just ballpark it, but SG&A, salaries are what, half of the total on a typical quarter and medical insurance would be what, 10 percent, or can you kind of help me a little bit more?

To tell you the truth, to be honest I don't know the exact breakdown and I hesitate to give you just a ballpark guess because I could be off. I would rather take a pass and maybe next quarter when we discuss this we will have a better breakdown of that.

Okay. We may follow up with you then in a week or two, so okay. Good. Thank you.

Thank you, Tom.

At this time we have no questions.

Okay. Thank you, Terry, and we will be getting back to you 90 days from now and have a good quarter.

Thanks, everybody