美國西屋制動公司 (WAB) 2004 Q3 法說會逐字稿

Hello and welcome to the Wabtec Corporation third quarter earnings results conference call. [Operator Instructions]. Hearing 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, you may now begin.

Thank you, Jennifer. Joining me on the call is Alvaro Garcia-Tunon, CFO and Tim Wesley, our Vice President Investor Relations. I want to welcome everybody to our third quarter conference call. I call your attention to the forward-looking statement disclaimers and the press release and I'll make the opening remarks and then I'll turn it over to Alvaro.

Relative to the third quarter we thought we had very decent performance in a quarter that sometimes a little seasonal for us with the customer plant shut downs and essentially the summer break period. We had earnings per share of 20 cents, which was 13 cents a year ago.

This quarter included a favorable income tax benefits and some non-manufacturing expense items, puts and takes if you will. Alvaro will talk in more detail about these numbers in a few minutes.

The key point, Alvaro, is that we remain on track to meet our commitment to investors for 2004. And that commitment is to earn about 70 cents per dividend share, which would be 35% higher than 2003. We're going to do this despite the headlines (ph) we've faced all year because of higher raw materials costs and unfavorable foreign exchange rates.

Third quarter orders have been very strong this year and continue that way in the third quarter. It now looks as if in (inaudible) with the order rate that the delivery rate is ramping up and that's a good sign for us.

Third quarter orders were 20,315 units the highest since mid 1988 deliveries were 11,790, which was 17% higher than the second quarter and the highest since late 2000. With that order rate and delivery rate the backlog grew and now stands at 61,052 units, which is the highest since late 1988.

Our question is not really if demand is there, but whether the industry can meet the demand due to shortages of steel and (inaudible). Certainly over the second quarter that seems to be improving, but it is still an issue going forward. (inaudible) sales provides an orderly growth in terms of ramping up.

Locomotive OEM. There is no real change in locomotives, which is about 1,200 units this year. It's still too soon is that next year that it should be a pretty good year also. Because most of the railroads are still power short and weak (ph) fleets are operating with high utilization rates.

These factors are continuing to have a positive impact on demand. Funny about the freight after market -- world traffic continues to be strong. Power loading in the quarter were up 1% and intermodal is up 9%. Intermodal is still just going gang busters.

Strongest the same period of traffic growth in six years is the quarter. As traffic continues to grow railroads are laying their equipment harder and that means more maintenance spending down below.

We believe that that scenario is starting to play out based on our continued pick up as some of our after market businesses so we've seen some signs this is starting to turn.

In terms of transit, there's not much new to report, although the after market is picking up and that's a good sign. And again we've been waiting there as we have been in the freight market for that to happen.

As you all know, the next big item to watch for in transit is the R-160 New York City contract, which is 1,700 or so cars.

Doesn't ramp up really until late 2005 and really gets rolling in 2006. It would be a $250 million contracts. There are components over a four to five year period. However there is always, as in any business situation, challenges.

Certainly, on the macro side, the economy remains strong, but as I mentioned, we are still challenged by exchange rates, particularly from the Canadian dollar and raw material prices, steel and aluminum as well as you know general insurance costs and of course accounting charges in preparing for 404 or Sarbanes-Oxley compliance.

The industry -- we want to see if this continued growth in rail traffic and a ramp up of OEM (inaudible) car deliveries -- we are still looking through absorb that, and continue to roll out and we are also looking to see the after market finally showing up and picking up, but it is still way below prior peaks.

Internally the challenge are to continue to make progress in resolving operational issues that have affected us this year and affected our gross margins. We are going to improve them and we're taking actions to do so. And that's really evidenced by the 42% reduction -- we took it our way Wabtec railway and electronics unit -- which better side of the business to its current volume.

We took that charge in the second quarter. In general we are focusing on further actions like this to continue to focus on our margins and deals with some of these price and cost increases that we've been having to deal with and we have very specific plans for that, that we will talk about it as in next quarters and forward. With that, I'll turn this over to Alvaro to take us through the numbers.

Great. Good afternoon everybody and thank you Bill. What I'll do is I'll go through the income statement numbers as we normally do and I'll actually emphasize a couple of the items that affected this quarter, which I am sure everybody has questions about. Hopefully we can answer a few of these as we go forward. Starting with the revenue, sales were 21% higher than the prior year quarter, obviously evidence of the favorable climate that we are in that Bill mentioned during his part of the discussion.

Freight group sales increased mainly due to higher sales of freight cars and locomotive components in North America and transit group sales increased mainly due to higher sales in the after market.

Gross margins for the quarter was about 24.6% compared to 26% last year. The main factors affecting gross margins in a comparison were steel costs, which I think everybody is familiar with the rapid increase there and when you analyze it, they've gone up about a 100% year to year and we estimate that affected us in the quarter compared to last year by about 2.2 million and the weakening dollar in comparison to the strengthening Canadian dollar, which last year during this quarter was at about 72 cents and this year for the quarter had a weight average of about 77%, and we estimate with that hurt us to about a $1 million.

If you compare the two, once you take these factors into account, the gross margin would have been about 26.7%, which was better than last year. Again, last year was about 26%, but not as much as we'd like. Therefore we are going to continue to work on these issues, give pricing and cost reductions to improve margins.

Another factor that affected us and also is included in the calculation of going from 24.6 to 26.7% was a $1 million reserve for future environmental moderate costs at our Boise, Idaho site. This is not a new issue and I want to emphasize that it actually goes back to the MPI base and it's not for clean up.

It does not show a deteriorating situation. It's just a recognition that we needed to set up a reserve for future monitoring costs over the next 15 years, which we didn't have there previously and again, once -- all those items were in cost of sales and once you adjust for those, you come up with the 26.7 that I referred to earlier. As Bill mentioned, moving on now to, no I'm sorry, it's gross margin we did take action to improve our margins going forward.

Bill mentioned the reduction and force we have in electronics in our WRE unit, which I will cover in more detail in a minute and we will continue to evaluate other action plans to improve our cost position in the near term.

Turning now to SG&A, we had a significant on the face of the income statement, we had a significant increase in SG&A, most of which was due to 4.3 million of non-operating charges. About 3.3 million of the 4.3 million was due to unfavorable litigation ruling and a suit filed against us by GE.

I think we've discussed the suit before in prior calls; it's been disclosed in our financial statements. We believe that the liability was not going to be significant. In the suit GE alleged that we violated a license agreement when we sold certain electronic braking equipment in Australia. We disagreed, but during the quarter the Judge was partially in GE's favor. There were about three issues, we won one, but we lost two.

We intend to appeal but basically, the accounting regulations make us book the amount of judgment in right now and we went ahead and did that.

The balance of the one time non-operating charges, most of it was due to restructuring plan in our electronics unit, which I mentioned earlier. This basically covered the cost of 13% reduction in head count, the size of the electronic business in accordance with current volumes and we will assure continued profitability. Let me elaborate a little bit on the restructuring there because I think we've talked about electronics unit quite a bit in the past.

Historically, we have always tried to be quick on the trigger in adjusting our cost to reflect market conditions. As I think we have mentioned, we have been frustrated to a certain extent by slow acceptance of some of our newer electronic products. We debated internally for quite some time, and we decided then, rather than wait any further, to take this action now.

We still expect the electronic business to pick up as we go forward starting next year, and then more in 2006.

Yes, just to cut in a minute, Alvaro. I was traveling this week, and spent two days at a major railroad, where we talked extensively about these products. These products are meant to improve our productivity by giving them better control of knowing where equipment and work crews are on the system.

We have a very full and good product line to serve this market. And we have been kind of waiting for this thing to roll out and we think it will improve railroad productivity; I can tell you that the pilot efforts unwind, at which we are part of it, with this major railroad, are going very well.

It's just that they are a little behind in terms of approving them out and it is slower than expected. We have -- others still believe in these products, we think these products will ultimately help improve railroad productivity, and therefore help us sell equipment down the road.

So we are sticking with it, but we are also very prudent to say that when it is time to get your business size right for sustained profitability, we are going to have our general managers do that and that's what happened in that quarter.

So electronics is still a work in progress, but we feel optimistic and we just sized it right to make sure it's profitable going forward. Sorry Alvaro.

No, no. Thanks Bill. Returning now, I think we just finished covering SG&A, we'll turn to engineering expense. Engineering expense was 8% higher, but in line with the second quarter of this year. If you recall, in the year ago quarter we capitalized certain non-recurring design engineering costs with the new R-160 contract, the transit contract for New York City that Bill mentioned during the introduction.

So last year's quarter was a bit lower than normal but this year's -- this quarter's run rate is what I think you expect going forward.

Interest expenses has been true all year with higher than last year, but in line with what we've been experiencing this year and that's because we issued some notes in August '03, these notes with a fixed rate replace variable rate bank debt with a -- at an attractive long term interest rates.

Other expense, really nothing there to talk about much, no real change. Income tax expense, obviously that is a big number, which I am sure has drawn a lot of attention as you review our results.

We booked a favorable benefit of 4.9 million, following a successful resolution of certain outstanding tax issues from prior years. During the quarter the IRS completed an audit of our 1997 though 2001 tax returns for five years. And as a result, we determined that we had some reserves that we no longer needed. We tend to be conservative on our tax accounting because we don't want any unpleasant surprises down the road and while on the face of it, the amount looks large, it was for five years and I think that tends to make it look a little bit more reasonable.

Working capital, compared to second quarter levels it was up about two million, which is really good considering where we are -- not a significant change. Debt net of cash was 93 million or 25% of our capital compared to 120 million or 33% of total capital at December 31, '03. Cumulatively we've reduced debt by about 27 million this year and we are on target to meet our objective to generate more free cash than net income each year.

One of the questions we get while we are talking about cash is future uses of cash. At this point, acquisitions are at the top of our list. And I think we've discussed this before as we are on the road and during our quarterly calls. But in regards to acquisitions we are being very disciplined and highly selective.

Two examples just to illustrate our approach, both of which transpired during the quarter I think are illustrative. SAB, some of you, I am sure most of you are familiar with SAB or WABCO, which is our former sister company in Europe.

SAB was auctioned off. The owners conducted an auction. It hasn't closed yet, but right now it looks like the winner is going to be a French company that is active in the rail called Faiveley .

For us this was a very big transaction because the purchase price would've been about 400 in U.S. dollars. And we wanted, I'm sorry, 400 million U.S. dollars and we want to be very careful and cautious in approaching this transaction.

For us it was a marvelous fit. We knew the business well. It was something we were very interested in. But as we looked at it and examined it in detail we saw that the synergies would be while attainable, would take a lot of time and a lot of effort and obtaining the synergies would be critical to making the transaction successful.

Once the price succeeded our limit we decided just to back off and see what happened. And right now what happens is it looks like it will close to Faiveley. But again, you never know how these things work and then maybe some way we can cooperate with them in the future.

Another example where we were successful in making the acquisition, which we signed an agreement for the acquisition of a friction company called Rutgers in Italy that hasn't closed yet, but we have signed a tentative agreement. We expect it to close in the fourth quarter. Rutgers, is I think, a very good example of our acquisition philosophy.

It was purchased at a reasonable multiple. It immediately filled the need that we've been trying to fill for quite some time. And we expect that to be our beach head in Europe for continuting successful Rutgers as well as introducing new products.

We've set no real timetable for making future acquisitions. Typically we will have a few in the pipeline. But we really don't discuss it until we have a definitive agreement. But we do have opportunities and we will be exploring them over time.

Just to go over a few miscellaneous items and give you a few numbers that were frequently asked. Depreciation for the quarter was 5.9 million versus 5.4 million last year. Amortization was 771, 000 versus 1.1 million last year. And Capex in line with our projections was about 4.7 million this year versus 4.3 million last year. Our backlog overall, total corporate backlog was 353 million versus 328 million in June 30 so in the prior quarter, up 8%.

Again we're reflecting a favorable industry climate. Freight, there is a freight backlog. The backlog in our freight segment was a 193 million versus 160 million at June 30. Up 21% the largest quarterly increase in quite a long time. And in transit, though, the backlog was slightly down a 160 million versus 168 million in June 30, down 5% not a very unusual number.

With that I'll turn it back over to Will for a quick summary and then we will do Q&A.

Thank you, Alvaro. Mostly in our third quarter performance is OK. It pus us in line to achieve our 2004 growth and earnings per share of about 70 cents per share. Industry demand is strong and looks like things it will stay that way for the foreseeable future certainly through 2005.

We are working hard to develop an informal action plans to improve margins. Alvaro and I look forward to reporting those actions to you as they take place. Now with that we'll get Jennifer back and we'll answer any questions you might have. Just hold on a second.

Are you ready for questions?

Yes, Jennifer.

[Operator Instructions]

And our first question comes from Wendy Caplan of Wachovia Securities.

Thanks, good afternoon.

Good afternoon, Wendy.

Bill, it's been a long time since I followed the stock so bear with me here, but I forget what the reason was that we don't do give operating profit information by segment in the quarter. I'm not sure it would not be a good enough reason, but I'd like to -- if you would review it for us.

Well, I am not sure -- then my answer is going to satisfy, we never have given margin information I don't think in our press releases, so it's not something that, you know, we may have started and stopped. We really never have, to be quite honest historically we tend to be very sensitive regarding margins, just because of the nature of our business, the competitive nature of the business, obviously the customer relation.

So we were really need to be, quite honest with you, we really don't give unless we have to. In the queue, we do disclose the information required and we do put in the queue, but we never really have put it in the releases before.

Well, Alvaro, my vote is to put it in the release. It seems like if you're doing it on the queue anyways, it should be ...

(off mic) and the marketing people -- then we will see where we end up.

OK, the question, another question. Bill you referred to some of the restructuring that you did in electronics. Can you identify for us kind of not by name, but kind of by job, what kinds of folks are no longer with electronics, is it a, was it a strictly administrative or did we, I guess I am getting at whether we're stepping down our focus in terms of new products?

Yes, it was primarily overhead and certain engineering functions that we didn't deem necessary given the current volume of business in certain product areas. So since we didn't harm in anyway, we felt the business or its momentum but we sized it right given the current speed of roll-out, let's say a certain, a certain product offering in the speed at which it is bought. Those -- so it's primarily overheads. This is not going to be, this will be a cost reduction.

OK, and we still so that engineers weren't part of that in terms of the focus on new products?

No, we did not lose any focus on new products. There were established -- I am sure there were some engineers that we deemed it not necessary given the level of business we had and you know, for the things they were working on. So we haven't lost any momentum by a long shot. We're in good shape.

OK, and your discussion about the future restructurings that we may see would it be, should it, not I guess, should we be surprised to see some restructuring in Q4 that might like in Q3 penalize results a bit -- would that be -- ?

Wendy, our hope is to do a pay as you go basis but there is always a cost associated with the severance earlier if you move the product line we're moving the product line and we hope to when we talk about our outlook to assist and size those costs within, you know, our commitment. I don't know if that answers your question, but we will have in coming quarters things to talk about in this regard but they have long-term benefits.

Right, but should we expect that they could come as soon as the fourth quarters might?

I believe we will have things to talk about probably every quarter here going forward for several quarters.

OK, I'll let someone else jump on thanks.

All right Wendy.

Our next question comes from Mike Peasley of BB&T Capital Markets.

Hi Mike.

Hey guys, good afternoon.

Hi Mike.

Just back on the electronics restructuring quickly. It's a more product question. You know, you guys had talked about how well the pilots have gone in the past and it sound like it's a great product and I know the railroads are always looking for productivity enhancements. What is it that's pushing it back? Are they more focused on their rolling stock needs spending money elsewhere? What areas are they pushing back?

I think they view it as having significant opportunities. Now I want you to know that the pilots are on specific rollers yet not everybody is doing it but those that are doing these pilots are being closely watched by the industry.

What I think has slowed it down a bit is to be frank about it the regular -- you got to deal with the government and safety issues and all of that and so its just a kind of a bureaucratic process where there would have to be approvals to do certain things and that everybody has to be satisfied that safety is being respected. So I think the attitude among those conducted in pilots are quite good because I was out there talking to him out here just a few days ago.

Its just a little slower because the regulators are involved with a third party that wants to kind of oversee make sure things are right, you get unions that want to have a say in safety. So it's just a little bit of a bureaucracy.

I know one of the benefits would be for the railroads that they may not need as many personnel so to speak on each one of the rails or each one of the locomotives. I mean are you going to get the union pushed back on that or are you feeling that?

Yes, I think in the pilots we are talking about, which are train control kinds of things and early warnings, you know, for other trains in the area work groups in the area that you know, the attitude amongst those that have been working on these is good, but everybody worries about whether -- how they're cutting costs and total employment so not only d the individuals like it, but there are worries about total employment.

I don't think it is a it's going to ultimately stop this I think it will go forward and as Alvaro said, his business place is threatened by the attitudes.

All right and then just move onto after market real quickly. Alvaro if you could break that down, you know, maybe you want to talk about it on a consolidated basis maybe you can talk about it on a segment specific basis, but year/year how much is your aftermarket business, maybe in terms of revenues, as a percent and how has that accelerated over the last couple of quarters?

Mike, to be honest, I don't really have an exact number so I'm going to give it to you almost anecdotally by feel. Transit has -- we're seeing a stronger transit aftermarket than we have in the past.

Last year, it was really hurt by really a shortage in local spending and in local revenues. And we've translated to less spending. This year, particularly in the order rate, the order rate has been quite good. We haven't realized all those orders yet but the order rate actually this year has been quite good. So you're seeing a rebounding in that.

In terms of the freight aftermarket, probably you're not seeing quite as strong a rebound yet, but what you will see going forward we think is -- are stronger numbers as traffic increases. In other words, the railroads are still very cognizant of expense controls. But basically with the higher traffic that they're handling, it's going to start picking up. So again, freight -- while I can't give you exact numbers, we have -- it's been getting better but again more in terms of what we expect in the future rather than results today.

Mike, we have, on the freight side, I would say it feels to me like, as Alvaro said, that the volume hasn't picked up yet but I would also say that we have some initiatives that move us out of the traditional pneumatics arena into electronic repairing service. And while we have not booked our reserves I see a good momentum on the part of our guys having success in bringing some of that electronic maintenance out of the scope of what railroads do into us providing it.

See, basically Michael, the way we report internally is we report by P&L center, not by OE versus aftermarket. Now periodically we'll take a look at those numbers just to establish estimates which we share with the street but on a regular basis internally, we really don't report that way. That's what makes giving an accurate number kind of difficult right now.

Well let me ask another way. Say your revenue through the first, I don't know, 9 months is up 16 to 18%, would you say 90% of that growth is related to OEM and 10% of aftermarket -- I mean could you even break it down like that?

Could be tough. I don't know.

OK.

I just can't give you ...

What we might do ...

I don't want to give you the wrong answer.

What we might do is go through that -- do that analysis and maybe have a way to report on it on a more periodic basis. I think we can do that with a little preparation. Not -- its not that difficult. It's just that we don't have it right in front of me but OE has definitely picked up.

Yes.

But I'd say we've also had some pickup in the aftermarket.

OK. Well, I tell you what, let me turn it over to some body else. I might follow up in a second. I appreciate your time.

Certainly.

Our next question comes from Art Hatfield at Morgan Keegan.

Afternoon, guys.

Hi, Art.

I want to touch on this issue with gross margins a little bit and I think we've talked a lot about what you can do on the cost side. But what do you see in -- with regards to pricing? If you get better pricing going forward that's obviously one way you can help improve margins.

Are you -- throughout this year, you've seen steel prices go up and your customers obviously know that you have that issue. But now you're starting to see your order books pick up and I would think that in that environment you should start to see a little bit of pricing power. Where are you with regards to that?

We haven't talked about it. I'll talk about it in a couple of ways. First, from the point of view of our customers, in this case, the car builders. The car builders have said going forward that they will take twice the time of delivery and they are also enforcing steel price surcharges in fact. And the railroads are imposing fuel price surcharges.

So, they are collecting on this pricing relative to these escalated costs. In our case, we have had some longer term contracts, which take a while to work their way through. We have also announced some lower price increases, that should take effect, fairly meaningfully in -- starting in '05 in our Freight side.

We also have talked about it and have implemented steel and aluminum price surcharges. And they have been spottedly, we've been -- by a customer a little bit hard to get it and it's taken time. That being said all of what you said is true.

As the mark tidies up and as volumes pick up, the atmosphere for pushing in steel will improve. And we are dedicated getting that done. We actually have reorganization -- small reorganization here recently that would, I think, focuses more on the cost side as well as on the pricing side. And so, we're hopeful although, again, I'd like to see it start to come into the gross margin line as opposed to just talking about what we think we're going to do.

Right. Steel's been an issue all year long. Are you seeing it easier -- how much easier is it today to try and get surcharges or price increases tacked on than it was say six months ago?

Well if you go to the -- you go to the brink and you see if you can get there. And we made some announcements in April. We reviewed where we are here in the third quarter. Not much was happening and so we're back at it again. I think ultimately we'll end up being successful in getting these things through because our customers are essentially playing the same game with their customers.

Sure, well yes exactly. And it seems like they were somewhat reluctant to pass up those on ...

They're having the same problems we are. I think the railroads are getting their surcharges pretty well through but I think car builders are still -- they've got their own set of backlogs and it takes them a while to get this price at time of delivery implemented. So, we're all -- this is -- it's just a little lag. It's a lag here.

Do you mind saying what you think or you hope to -- what kind of price increases you hope to institute in '05 or is it too early for that?

I think it's too early to say but we'll focus on it.

OK.

And I think that's -- we're not going to depend on it exclusively. I mean if we just sat back, put our feet on the desk and said "Well all right, let's take care of all of our woes," I think we'd be sadly disappointed.

Absolutely not. No, I agree with that. I just wanted to see where you were at with that because that is one of the important pieces of the puzzle.

We do meet about it quite regularly.

One other thing, switching gears a little bit, and then I'll hang up and just listen to what you guys have to say, but on the acquisition strategy, can you give us a broad perspective of what your strategy is with regards to that?

Is it focused within the rail industry or do you want to diversify from that? And obviously it seems that you have a somewhat geographic diversification strategy with your acquisition of Rutgers. And with that I'll ...

Yes, I'd be happy to talk about -- relative to -- our focus is railroad, railway stock components. That's what we've been doing through the 90s. We constantly talk at the Board level about where we should be broader than that. And the whole concept of being a little bit -- adding some counter-cyclicality. We have stayed with where we are now and that's what we're doing. You are correct that there is significant opportunity outside of North America for selective acquisitions. It's a big world for railway stock components out there and we'd like to be a big part of it.

And in terms of our discipline, it is to have things that can be accretive immediately. We don't want to be in a position of making an acquisition, then implementing a lot of synergies, and have costs associated with those synergies and then for that accretive opportunity out there several quarters. We'd like to make sure that happens right away. So, we will have discipline. I think we feel good about what we did and the discipline as we were in subsidiary WABCO sort of a bid situation that we found ourselves in. I thought that we made the right decision to at this time step back in terms of product.

In terms of diversification internationally, we will be about 20% of our sales outside of North America this year. And we'll be I'm sure close to about 25% next year. So that's grown from really nothing in the early 1990s. So we continue to establish our international (inaudible) and as long as we follow the discipline, we'll continue to do so.

All right. Thanks.

Our next question comes from Vicky Bryan of Aim Investment Management.

Hi. Good afternoon.

Hi.

I am looking at your -- the language that you're using. Did you -- and I apologize if you already said this, but did you break out what is cash and what is debt?

No, typically, the way we disclose it Vicky is we just give debt net of cash because basically what happens most of our debt are in the bonds, which we don't redeem, we don't buy back. So the meaningful number is debt net of cash. And that's what we typically disclose.

The total debt number is ...

Yes.

... total debt ...

The debt numbers are 190 million.

Right. See, that's what I ...

... (inaudible) 190 million. So what you do is you just take the debt net of cash number and you can find out how much cash we've got.

Right.

Right. I'm aware of how to do the exercise. I just I guess I take issue with the idea. It appears to be that you're -- and maybe you're not trying to do this, but it comes across as you're trying to show that you're deleveraging the company and you're not. And you're growing cash, which is good, but you got that senior debt up there you could be paying down with that cash and -- or whatever. But the language in the release makes it look like you're reducing your debt and you're not.

OK. I understand that.

And so that's kind of it. Did you talk about--?

Vicky, we don't mean to mislead anybody ...

Yes. But ...

... But what we're trying to say is we'd, like you said, that we could use the cash to pay that right ...

I think that ...

... (inaudible) up.

... Vicky, that language comes from a period when, in fact, we were using it directly to reduce debt.

Right and kind of that's been decided. And what is your CAPEX number for this quarter?

For this quarter, it was 4.7 if I remember right. Yes, it is 4.7. We've said for the years that we expect CAPEX to be in the range of about 20. And I think we're still on target for that.

OK, good. And how much of that was maintenance?

I think most of our CAPEX is really maintenance, given the structure of our business. And really our lean philosophy, a large chunk of that is maintenance. Some of it is for new but I would say a large chunk of that is maintenance.

Very good. Thank you, sir.

We also have our -- demand significant pay back for in the gap where we stand.

What kind of ROI do you look at for your CAPEX?

We say, if you got a one year pay back, you can just mail it in.

OK.

We don't like anything over three years. I can tell you that.

OK, very good. Well thank you.

All right.

Thank you.

Our next question comes from Thom Albrecht with BB&T.

Guys, my questions have been answered. Thank you.

OK, Thom.

And our next question comes from Wendy Caplan of Wachovia Securities.

Thanks. I just had another growth margin question. I was looking back in my models and realizing that at the prior peak you posted a 29/30% growth margin. With the activities that you're now involved with in terms of some of the restructuring and getting some of the overhead out, should we expect that at the next peak, that we could get to, perhaps even exceed, that level. Is that reasonable to assume?

I think we've been very clear to say that we want to -- we'd like to see a three in front of that gross margin number.

OK, so you're suggesting that it could be better than 30%?

We're working on it.

OK.

And I'd like to -- again, the proof is in the doing not promising but that would be a good objective. That will be a good objective for our management team.

OK, thanks folks.

Our next question comes from Greg Macosko of Lord Abbett.

Yes, thank you. Just to understand, the non-manufacturing cost that you mentioned in the releases, was that the engineering or restructuring or what were those?

Yes, Greg, this is Alvaro. The non-manufacturing costs were really, if I could in two sections, again, to make that clear for everybody, in the cost of sales we had a million relating to the environmental issue at our plant in Boise. Below the line SG&A, we had 4.2 million, about three of that 4.2 related to the judgment in the GE law suit. A large portion of the balance related to the restructuring at GE and those and other minor charges.

Restructuring (inaudible).

(inaudible). Getting my acronyms mixed up here. Thanks, Bill (ph); WRA.

And then the electronics restructuring et cetera, that is the Canadian plant that was moved to Maryland, is that right or--?

We did have a -- we did have a Canadian electronics plant that we moved to Maryland last year. And we expended approximately, if memory serves me right, about a million dollars of that, that we just float through as you normally would. This was actually a further restructuring of that unit whereby we basically reduced the workforce by 13%.

And that -- and so, all of the electronics work is done in that Maryland plant at this point?

There is another plant in Cedar Rapids that's not a manufacturing facility. It's mostly an R&D facility, mostly an engineering facility. So there's actually two facilities. Then we have a small repair center still in Canada. So technically we still have three. I'd say most of the work is being done out of Maryland, certainly all the manufacturing is being done out of Maryland.

And the reduction occurred both in Cedar Rapids and in Maryland, whereby majority of the reduction came out of the Maryland operation.

OK. And then with regard to steel, are we still seeing -- are you still seeing steel prices coming through. In other words, you're expecting additional increases in your costs of steel in the current quarter.

Well, what we did is -- because we knew the question would arise, we actually surveyed our units and tried to come as close to a number as we could for the effect of steel during the quarter. And the effect of the surcharges to us -- in other words will the higher cost pass along on to us, we're about 2.2 million.

From the second to the third quarter, if you look at the appropriate indices you'll see that steel prices rose by about 20%. And on a year-to-year basis they've increased by about 100%. So the increase has been quite dramatic. Where it's going to stop, we don't know. We thought at the end of the last quarter, that there was a little bit of easing off and we thought that the pressure had -- starting to level off somewhat. But really during the third quarter, it's started up again.

And how do you feel at the end of the third quarter?

Well, I can tell you what we wish or what we're hoping for.

I know what you wish.

It's little bit like FX with the softening U.S. dollar. You're hoping that it's leveled off because you think geez can it get much higher. But you really have to take a wait and see attitude.

But have you locked in steel prices relative to contracts that you have for the quarter? I mean are you looking at it in that way?

I'll tell you sir, it's very difficult to lock them in.

We use scrap steel in the foundry. It's almost -- I wouldn't say -- it's hard to buy. You need to get it in advance. I can go check that. It's probably appropriate to try to not -- to try to soften the increases but in the end you're going to pay.

OK. With regard to casting, you suggested that supply is easing a little bit. Is it a little better or --?

Yes. The casting supply is non-related to our product lines which are (inaudible) and other steel castings for undercarriages. Apparently it is picking -- doing better a little bit; 70% more cars in the quarter. So there's more of that ability coming.

And that means that your customers are taking deliveries more quickly.

Yes. That means that there is a pick up in our product lines because there's deep bottle-necking occurring in these castings that are preventing car builders from producing cars.

OK. And then finally with regard to locomotives, you talked about 1200 in -- for the deliveries that are expected in '04, is that right?

Yes.

And I know you talked about '05, suggesting that it's maybe going to be a little better than you expected. What is the outlook for '05?

Well we -- there was a -- there's a new tier 2 missions requirement that comes up in '05.

Right.

So the backlogs from locomotives were just full because railroads were trying to get (inaudible) on the lesser missions requirement. And in '05, (inaudible) produced locomotives which can comply. Initially, we thought it would be quite a substantial fall off in '05 because this accelerated approach is in '04. But because of the trailer (ph) shortages we think that that significant fall off won't be there. There might be a 5 to 10% fall off but it wouldn't be more than that. Because we're starting to see the earlier backlog from locomotives still up. And because there's a need for power.

So we're talking something, order of magnitude 1,100?

Yes, I'd say. I mean I don't have a specific number whether it's 1,000 or 1,100 but the order of magnitude is not much of a decline.

So it seems to me that that outlook has incrementally improved since the middle of the summer.

Yes I'd say it has because we started -- that was in the third quarter would be when we started to feel more -- and that's when things firm up about the coming years. So you start to see the harder backlog numbers. And so, yes, it's -- it has been -- it has changed to a more optimistic outlook for '05.

And anything along the same lines for the Freight outlook? I think that you're expecting 61,000 this year. Was that correct?

No, no that's the -- that's the current backlog.

That's the backlog, OK.

The industry I would expect is 42,000 for this year. And it'll be between 45 and 50,000 I expect in '05.

OK, thank you very much.

Sure.

Our next question comes from Steven McBoyle, Lord Abbett.

Yes, thank you. Just a couple clarifying questions. On the steel issue. I think it cost you about a million each or thereabouts Q1/Q2, you spoke to 20% increase in surcharge together with a $2.2 million drag in the quarter. How do I -- how do I make that relationship work?

I'm sorry, Steven, for some reason I didn't get the first half of your question. I heard the 1 million and 1 million but I didn't hear the part before that.

Yes, the steel -- the steel impact for you guys, I thought was a million dollars each Q1, Q2 and ...

I think what we said in the past, I could be wrong, is that steel was roughly a couple of pennies or two cents per share, to be more precise which for us is about a million and a half. And this -- again this quarter, we tried to estimate as exactly as we could and we're right up to 2.2 million. So it's -- again it's very difficult to estimate because what happens is you buy a lot of products that has value added. And so it's difficult to estimate the pure steel content of the products you're buying, but its somewhere in the ballpark around there.

OK great and then on the locomotive side, just to clarify, is there a scenario wherein revenue you could be maintaining '04 revenue in '05, just given incremental content?

Yes, and we've alluded to that in prior conference calls. While we don't have anything specific to announce, we do -- we are improving our positions with certain of the locomotive builders which gives us a high content. And that will give us a real shot at at least maintaining revenue volume despite a 5 to 10% decline in the market, OE market. I'd say it's a very good estimate.

Great. Thank you very much.

Our next question comes from Art Hatfield of Morgan Keegan.

Just one last quick question, Alvaro. How do you -- what kind of inventory accounting method do you use for goods such as steel? Is it a LIFO or a FIFO or a weighted cost average --?

No, we use FIFO.

OK. Thank you.

Gentlemen, at this time we have no further questions.

Well, OK, good. Thank you very much for joining us. And we'll be back with you in 90 days talking about the year.

OK.

Take care.

See you then.