美國西屋制動公司 (WAB) 2005 Q2 法說會逐字稿

Hello, and welcome to the Wabtec Corporation second quarter 2005 earnings results conference call. As a reminder, all participants will be in a listen only mode. There will be an opportunity for you to ask questions at the end of today's presentation. [OPERATOR INSTRUCTIONS]

At this time, I would like to turn this conference over to Bill Kassling, Chairman of the Board, President, and CEO. Mr. Kassling, please begin.

Thank you very much. Welcome everybody on the call. I will make some initial comments. Alvaro Garcia-Tunon our CFO is also on the call, and he will speak after me. Tim Wesley will not speak but is on the call, our Vice President of Investor Relations. At the end, we will take your questions. I will caution every body to look at our forward-looking statement disclaimer in the press release. Let us get started.

Clearly, we have stepped it up to a new level in this quarter and we are very pleased with that performance. Our gross margin improved over the first quarter by 1.4% to 24.9%. Our earnings per share was $0.32 versus $0.20 a year ago. A 60% increase in earnings on just a 31% sales increase. Our EBITDA was 32.7 million versus 23.5 million. Alvaro is going to talk more in details about the numbers, but it clearly indicates we are doing well.

The key point is we had a strong quarter and it’s the type of performance that we will need the rest of the year to meet our commitments to investors for 2005. Which is to earn about $1.10 per diluted share or about a 55% increase over '04.

The freight market, as I will mention in a minute, is coming in stronger than we anticipated. We are not raising our guidance at this time because we still are only half way through the year. We have plans for some key internal initiatives, including restructuring actions in the second half that will take place. First, I am going to cover the state of freight and transit markets. I am going to update you on our progress on locomotive modules in contract with EMD. I will update you on growth initiative, and also restructure.

First of all, let us talk about freight car OEM. As I just mentioned, the freight car market is looking stronger than we anticipated earlier in the year. Second quarter deliveries were 17,914, up 14% from the first quarter. Second quarter orders were 19,130, up 9% from the first quarter. As a result of the strong order rate, the backlog of cars to be built was 60,544 at the end of the quarter, an increase over the first quarter. It has been about that level for the past four quarters. It reflects good demand and good stability in the industry. The bottom line of all these numbers is that it is now clear that the full year delivery number for 2005 will probably be, at least, 60,000 units. We are responding well for that level of demand.

As far as the locomotive OEM, at this point of the year we have very good visibility on locomotive order books, which has been gaining strength also. It now looks like we will probably come in around 1,200 units this year, a little higher than we had originally estimated. It is also clear that most of the railroads are [powershift], and lease fleets are at high utilization rates. We expect these factors to have a positive impact on locomotive demand, well into next year as well.

In terms of the freight aftermarket, looking at freight traffic, freight traffic continues to grow. Year-to-date car loadings were up 2% over last year and Intermodals up 6%. These growth rates are a little lower than earlier in the year, but keep in mind we are now comparing this to some pretty strong numbers in the prior year. In other words - growth is good and it continues, no matter how strong.

As traffic continues to grow the railroads are running their equipment harder and that has meant more spending on maintenance and repairs. With the aftermarket representing about 2/3 of our freight group, that’s another positive for Wabtec.

We will give you an update on the EMD contract that we talked about at the end of the first quarter. We said that we have a contract to produce locomotive modules for EMD. These are locomotive cabs, including electronics, air brake controls and radiators. Components coming from various Wabtec subsidiaries with final assembly at our motor-power locomotive plant in Boise. This is a strategic contract for us because we are increasing our locomotive component content substantially and building OE market sharing. Which will help to increase our aftermarket in the future. As you know, and as we have talked about, we absorbed some startup costs on this contract in the first quarter. We were determined to reduce those costs in the second quarter. And we were successful in doing that. While I don't want to be specific at this time, because we are having a sensitive discussion with our customer, I can tell you that we now expect this contract to be profitable in the second half and the reminder of the project. That is good news.

In terms of transit, transit continues to perform at about the level we expected. And some of these units gear up for the R160 contract to hit next year. Just to refresh your memory on the 160 order, our contracts represent about $250 million dollars worth of revenue, including options. The real ramp up will come next year and it should run for four or five years after that. As you know, we are providing the brakes, the doors, the couplers, current collectors and event recorders for this project.

The Federal Transportation Funding Bill continues to be extended while Congress debates the final package. If it doesn't get passed by the end of this month, then it won't happen until after Labor Day. We'll see this creating some pent-up demand because of municipalities that delayed some projects as a result.

I want to comment on Acela, which I know is a hot topic for a lot of folks. I am sure you have been reading about this situation with Amtrak's High Speed Acela trains, which is now starting to return to service after being pulled in April due to a brake disk problem. In response to inquiries we received about this, we can only say what we said at the end of the first quarter and that is we did not design or supply the braking system for the Acela cars. We did provide and machine approximately one-third of the brake disks for the cars and we are assisting Amtrak in its evaluation as Amtrak as requested. Wabtec does not believe it has any material liability with respect to its work and because this is a subject to litigation that's all I can really say at the present time. For those of you who are interested however, there was a story in the Wall Street Journal on July 12th of this year that captured many of the details and I would direct you to go back and look at that July 12th, Wall Street Journal article for more information.

In terms of the strategic growth initiatives, let's talk about them. First of all, international sales growth. In the second quarter, our non-NAFTA sales grew twice as fast as NAFTA sales and that is not including the CoFren acquisition. Our Wabtec rail unit in the UK was just awarded a $15 million contract to rebuild passenger and transit cars and this is a follow on to a previous contract. Sales of our braking equipment remain strong due to the demand for iron ore and coal exports from Australia, Brazil, Columbia and Venezuela. Our international sales growth is doing very well.

In terms of aftermarket sales growth, we have seen very solid growth in aftermarket. More than 20% higher than a year ago quarter. In addition to responding to increasing demand for components, we are growing the service business with new capabilities and expansion of existing programs such as car repair [indiscernible].

Now let me talk about new products, another strategic initiative for the company. These new products continue—we continue to make progress on these as well. One of the most exciting opportunities is our Electronic Train Management System, or ETMS. It's a pilot project we have going with the Burlington Northern Sante Fe. The BNSF has equipped 15 locomotives along 135-mile corridor in Illinois with computer software and hardware to monitor and manage train movements, inform train crews about work areas or speed limits and initiate braking if for any reason the engineer fails to respond. It offers both safety and productivity benefits to the railroads.

This pilot is going very well. BNSF has made about 1200 error free runs thus far. We expect those tests will be completed by later this year and I think it can pave the way for a major production order from the BNSF or other railroads. But we are very excited about this product initiative.

Let me talk about our use of lean manufacturing principals to continue to improve our margins, productivity and efficiency. We are really attacking this now in three – on three fronts. First of all, strategic pricing, secondly, sourcing and thirdly, our traditional lean tools to improve productivity. In this strong market, we have been able to sustain some price increases. Our sourcing programs are well underway and are really starting to roll out and will ramp up in the second half. We are using the souring programs in combination with other lean tools to restructure underperforming operations and increase our margins and in fact, as you see, in the first quarter and second quarter we have had improved margins, which says we are on the road toward this ultimate goal.

Let me talk--a part of this of course comes under the heading of restructuring. And I want to talk about that for a little bit. As I mentioned earlier, the freight car market is stronger this year than we anticipated and that is positive for us. In this rising market we are maintaining our focus on customer service and we want to make sure we maintain and control our capacity levels so that our plans to restructure certain operations do not impact our customers. So, our restructuring really is something we don't have much to report on this quarter but we are implementing it in a pace that is true for Wabtec and our customers in this rising market. Certainly not off the table, it is a work in progress.

We took some actions earlier this year by consolidating two UK facilities and moving a ball valve product line from Canada to the US. When we have a motor report on this in succeeding quarters we will talk to you. Currently we continue to evaluate various alternatives.

Now with that said, let's talk about the numbers and Alvaro, would you like to do that?

Absolutely, thank you Bill. I will review the numbers and then we will turn it over to Q&A. As Bill mentioned earlier, we are in a very strong sales market right now and the numbers reflect that. Our sales were 31% higher than the prior year quarter and 10% higher than the first quarter of ‘05 and we believe a comparison of the first quarter of ‘05 is particularly encouraging. In essence, on the incremental sales, if you do the numbers, we brought down about 33% to the operating income line and about 35% to EBITDA, which we believe illustrates our favorable operating leverage. Sales in the freight group were particularly strong. Sales increased there 43%, again, compared to last year, mainly due to higher sales of freight car locomotive components in North America, the CoFren acquisition, and the locomotive modules contract with EMD, that Bill referred to earlier.

The transit group sales were stable. They were about up 2% year over year. In terms of gross margin, we’re still not where we need to be and we realize that, but at least we are showing progress. You can see that first with the incremental numbers that I talked about before and improvement in the overall gross margin line as well.

Gross margin is 24.9% in this quarter versus 23.5% in the first quarter of this year. So again, we are up almost a point and a half, down from 25.5% in the year ago quarter, but we expect that to improve as the situation with the locomotive modules contract improves. As Bill mentioned earlier, we’re now expecting the contract to be profitable in the second half of the year, but we did incur a loss in this quarter.

Operating expenses were 18% higher compared to last year, due mainly to the acquisition of CoFren and higher sales. As a percentage of SG&A, however, they are going down. They are 11.6% versus 12.4% a year ago, again, illustrating the favorable operating leverage that we get with approved sales.

Interest expense net decreased compared to last year by about 2.2 million in line with expectations. This reflected a lower debt level and higher interest income. We net our interest income against our interest expenses. And income tax expenses are very stable. In this quarter we accrued income taxes at 36.4% versus 36.5% a year ago.

Turning to the balance sheet now, cash and securities. Our cash balances increased by almost 30 million since the end of the first quarter. This reflects strong cash generation by our operations of about 12 million as well as cash from stock options exercised during the quarter.

Working capital compared to first quarter levels, receivables and payables increased by roughly the same amount, which is a balance, which we think, is favorable. As a lean company, we put a lot of emphasis on increasing inventory and we continue to emphasize that, but at least any increases right now are offset by increases in payables. Inventory was up by about 10 million due to the strong sales increase, but again, that scenario that we are going to concentrate on at least keeping it level, if not bringing it down.

Debt, net of cash and securities, which I think everyone here is familiar that's how we record debt balances, is 53.4 million or 13% of total capital compared to 82 million, 20% of total capital on March 31, 2005. And this really almost begs the question, which we get frequently, is what are we going to do with our cash? Obviously, it is a good problem to have and we want to ponder the possibilities and we do that constantly. As we said in the past, one of the possible uses of cash is for acquisitions and that continues to be something that we look at. We haven’t set any firm deadlines for making acquisitions, because that is when we believe we make mistakes, but we do have opportunities and we will be exploring them over time. What we are really looking for are acquisitions that would reduce the impact of a North American freight cycle, give us sales opportunities in new markets, hopefully both here and abroad, be accretive and generate returns above our cost of capital. We will be disciplined in this process and highly selective.

Turning here to the end of the financial review, depreciation was 5.6 million in current quarter versus 5.4 million last year. Amortization, 1.1 million this year versus about 750,000 last year. The increased amortization was due to some intangibles relating to CoFren. CapEx pretty stable at about 5.5 million this year versus 4.2 million last year.

The backlog, and again we don’t like to emphasize backlog too much because with the exception of the transit division, it’s not that critical to the other components of the company, but it was steady. The overall backlog was steady at 407 million versus 412 million on March 31. In the freight group, current backlog was at 243 million versus 259 million on March 31. The decrease is primarily due to international units. Domestic unit backlog actually went up slightly. So again, a relatively stable backlog. Transit, again, stable at 164 million versus 153 million on March 31.

And that is pretty much the review, the financial review, and I’ll turn it back over to Bill for a quick summary and then we can do question and answers.

Thanks Alvaro. Once again, our second quarter performance was strong. It’s the kind of performance we need to have through the rest of the year to achieve our 2005 goal of earnings per share of about $1.10. We are making progress on resolving our margin issues. We still have plenty of hard work to do. Industry demand is strong. It looks like things will stay that way for a good while. So, with that, we will be happy to entertain your questions. Let me call Brock back to entertain your questions. Hold on.

Gentlemen, are we ready to take some questions?

Yes

[OPERATOR INSTRUCTIONS]

Our first question today comes from Wendy Caplan of Wachovia Securities.

Good morning. I’m a little confused Bill. You raised your freight car delivery estimate. You expect profits in second half on the locomotive modules, and you presumably should get better operating leverage, given the volume, lower interest expense, yet you didn’t raise your view of the full year. Should we expect--and you were--when you talked about restructuring, you seemed to imply that you didn’t want to cause an issue for production in the plant. How should we be thinking about your sticking with the about 1.10 guidance for the year? Should we view that as conservative?

Well, we always like to be conservative and we always like to, then, be successful, but you look at the first half earnings multiplied by two, we’re going to have to have a bigger second half than we did the first half in order to get the 1.10. We want to be prudent.

In terms of--I think you’re correct that because of the uplift in the market, we want to make sure that we have capacity. And so, while restructuring hasn’t been set aside, we are looking at making sure we have good deliveries to our customers as we implement this, so we’re going to be fine in that regard. I think all the things you said are relative to the good news about what we’re doing and how we’re making progress is there.

Okay, so we’ll take that as a yes, we’re being conservative answer. The transit shipments in the second half of the year, have we given up, sort of thinking that there could be some that come in to the fourth quarter for the 160 project or is that still being viewed as an ‘06 event?

Well, it’s going to be an ‘06 event. Typically, I know that the delivery plans were to have it start to ramp up in late ‘05. Quite frankly, all these things get delayed by three to six months, so we are just assuming that that’s going to be an ‘06 event.

Okay, and finally, could you talk about the cost to the gross margin of the locomotive module contract? How much in basis points did it cost us in the quarter?

Well, we said very purposefully that we are in a very delicate customer negotiation and so we have not really cited that specifically. You know that the number we cited in the first quarter was 4.1 million; we said we would improve on it in the second. We have done that, and we have also said that we would anticipate that we could break even or be profitable in the second half and we think that’s absolutely on. I’d rather focus on next quarter, to be frank. That’s where it’s no longer is a drain.

Okay, thanks very much Bill.

Our next question comes from John Barnes of BB&T Capital Markets.

Going back to Wendy’s question on the gross margin on the locomotive module contract, why the negotiation? I mean, is there some element of the contract, the initial contract that proved to be a little bit more cumbersome on the cost side that needs to be renegotiated?

Yes, well basically, again, obviously there were losses in the start up which we disclosed—we discussed last quarter, and we are actually improving, as the learning curve moves down, we’re actually improving the performance there, but there are other issues that we are talking to our customer about relating to the contract, and again as Bill mentioned, you don’t like to discuss these in a public forum. These are for discussion between them and ourselves and we’d rather focus on where it’s going, which we think in the next quarter, with all the improvements that we’ve managed to put in place, we think it will be profitable. That’s our current expectations.

Okay, the initial contract, was it a cost plus deal or not.

It was fixed price.

Fixed price, okay. In terms of, and last question, I don’t mean to beat a dead horse but have you made enough improvements that the customer is satisfied that maybe we see a larger unit order coming from them or maybe an extension on the contract as part of this?

We feel very good about the term of the contract and we know that as the locomotive outlook improves, there will be possible increased demand from the customer. Again, this is all part of negotiation, how many per day and what’s the cost. So, we’re doing real well on this. I think we’ve made progress. I think we’re very confident about the second half.

Okay. On the freight car side, can you give us an idea, in terms of the demand, is it fairly broad-based across car types or have you seen any weakness or any abnormal strength in any car type on the freight car side?

No, it’s really across the board, it’s clear that Intermodal has been very strong and coal has been strong because of commodity demand, but it really is across the board.

Okay. On the transit side, I just moved out of Connecticut where I took Metro North every day for 5 years. Connecticut just announced a flush for state tax receipts right now. They finally pulled the trigger and increased their spending on the transportation budget, bringing on new cars into Metro North; I’m talking in the magnitude of $300 million. Have you seen, given the outlook for state tax receipts and the better budgets on the state level, are you seeing additional orders over what some of the legislation would allow, are you seeing an up tick in demand there?

I think, as a loyal commuter, you ought to write and get an increase and better transportation from suburban Connecticut and I would tell you, you are riding on Wabtec brakes, so hopefully it works this morning for you anyway. But we – we don't – this is the kind of thing that puts the wind at the back of state spending and it could conceivably over time have an impact. Certainly state and federal governments love to spend money on mass transit and particularly on rail mass transit, so it’s conceivable that that kind of positive influx of tax revenues could spill over.

Okay and lastly, you mentioned one of the areas of growth for your company on the service side, can you give us just a feel for how big a percentage of revenue this could ultimately be? I mean, are we beginning to hit the top end of what you think service can be, or could we double or triple the number from where we are today?

Our total number, as I recall, is about 55% company wide of aftermarket. If you went back to the early 90s, I’m sure that number was at not more than 20%. So we have clearly moved up scale in terms of doing what our customer used to do, doing that for our customer and doing it more efficiently and giving them better up time. So there is still – it’s happened – there has been a lot of sourcing by railroads and we get more and more of that opportunity, there is still some to go there. Railroads have not been able to outsource everything that they may like to.

On the transit side it's even a little slower, and our aftermarket revenues in transit are lower. The kind of acquisitions we look at favorably are those that are aftermarket because they are less cyclical, and so all of that’s combined to say that we moved this dial on aftermarket up to above 50% and I think we have an opportunity to continue to improve our mix of total sales in aftermarket for some years to come.

Okay, very good. Congratulations on the quarter.

[OPERATORS INSTRUCTIONS] Your next question comes from Greg Macosko of Lord Abbett.

Would you talk about more, give us a little bit more background on CoFren and how that’s going?

Sure. CoFren we closed on that at the end of January. It is operating at the budgetary numbers we expected it to operate at which was to be accretive immediately. We have a number of initiatives geared for CoFren for some restructuring and also for new product introductions. Those have not happened yet, but on an on-going basis the business is accretive.

Okay, and you talk about synergies, as well, can you expand on that a little more?

It’s very interesting that this friction business now for us is a worldwide business and with CoFren we picked up a bigger emphasis on the transit friction side. We have also picked up some additional product lines. We see these as – we get the whole worldwide friction group together periodically and we talk about product development initiatives that we are each working on and we take away great ideas for product development and innovation from these sessions. So this is just at the early stages of this and this friction business is, of course, it is an ongoing aftermarket—it's our highest volume after market spare parts and so we are going to continue as a workhorse to be in place.

By improving and innovating new products for the customer, that is better performance or things that we don’t — we have a brake shoe for instance that helps to improve imperfections in wheels, giving longer wheel life. These are the kinds of things that the customers get the benefits from and therefore is willing to pay for. So we’re very excited about the friction business and its ultimate opportunity for us.

You – I think you said that aftermarket was 55% of revenue?

That’s correct.

And have you a longer-term goal or expectation for that?

Our corporate strategic initiative was to grow that business over the next 3 years in the 8 to 9% range. Which should be generally higher than the long-term trend in OE so we would improve that percentage.

If you wouldn’t mind could you go back through the backlog numbers, I missed some of those [multiple speakers] in transit.

Yeah, I would happy to if you could give me one second here. Overall the corporate backlog, the total backlog was 407 at the end of this quarter versus 412 at the end of March 31 of this year. The freight--total freight backlog at the end of this quarter was 243 versus 259 again at March 31 and the decrease was due to backlog of international units. The domestic backlog actually increased slightly. And transit was at 164 versus 153 million at March 31.

Do you expect anything more on the transit backlog? Is there anything out there that you are working on that’s hanging fire?

We’re always working on it, the transit market, to be quite honest, the OE market works slowly. It inches a long. There are always a variety of orders out there, however that we are working on. I mean there’s nothing imminent that we expect to break, but there are a number of orders that we are breaking on – that we’re working on sorry.

We have another question from Wendy Caplan of Wachovia Securities.

Just a quick one Alvaro, can you give us the core gross number for the quarter that is the revenue excluding CoFren.

The revenue excluding CoFren, yes if you will just give me one second. I think revenue year-to-date for the quarter, I think CoFren revenue Wendy is about 10 to 12, that’s off the top of my head, and I think in the first half of the year it was about 9. So the second CoFren was about 10 and I’m pretty sure it was about 8 to 9 for the first quarter, roughly.

One more question, Bill on ETMS, I don’t think you’ve spoken about it in such detail, in terms of the test from the BN on calls before. Can you tell us whether that is because you have a greater level of confidence that it’s going to be a '06 event or what?

Well I think, we have been pretty effusive about ETMS, but maybe I was just a little more enthusiastic today. But when you go through 1200 error free runs and their goal, I think is, 1500 runs – 1800, so we’re two-thirds of the way through the test. And I just – I know that the Burlington Northern has put out a brochure about this. I know they have talked about it positively to the other railroads and there have done demonstrations for other railroads, so that the word of mouth on this system, it’s a very cost effective system that does improve productivity and safety and I believe it will improve capacity. So we get excited about this because we have been working on it for 8 years and we’ve got some direct evidence and a customer who is enthusiastic.

And are you ready to share the cost per unit on this yet or the price per unit?

Well we will tell that this will be a positive margin business for us. We’re not in this for a wealth transfer but I’ll let Alvaro comment on that.

Yeah, Wendy, I think we’ve said it before, it part of it depends the bells and whistles, it’s almost like an automobile, do you get it fully equipped or do you get the rudimentary system. But in general our estimate would be that would be somewhere between 20-40,000 per unit and obviously it can go on an OE locomotive as well the rail – over the track, locomotive we’re up to is about 20,000. The total I think is about 26,000 and that includes switchers and locomotives that really -- this wouldn’t be appropriate to – but I think it would be appropriate to about 20,000 over-the-track units as well as obviously new locomotives being manufactured.

The likelihood of that being ruled out for the whole fleet certainly initially is slim.

Right.

Where this will be used, this will be used in hopefully in the bottlenecks, the high volume corridor traffic and so it —that’s where it will be used initially, I think that is where the BN would plan to deploy it initially. I will also tell you that the business is not a cash drain to us today --It is definitely paying its own way.

Currently there are no more questions.

Okay, let’s just wait a second and see if anyone thinks of one. If any thinks of one we would be happy to answer it.

We do have a question from Ed Lepermen [ph], First Manhattan.

I cannot let you go here. I noticed in the numbers is that your shares outstanding are up about 4%. Both for the quarter and six months. Notwithstanding, all the usual discussion on use of cash and what you said about acquisitions. Have you not established some type of strategy in terms of buying enough stock back to offset dilution?

Obviously the dilution is coming from the exercise of options.

Right

What we have done and the numbers are easy to do. I mean anybody can do them. You could do them; anybody can do them. What we have done is, and this is an ongoing topic at every board meeting we have and what we do is look at the numbers that we can get right now and we compared stock re-purchase and even though our bonds don’t even have a call provision, just to theoretically accrued (sic) a redemption in the bonds in there and then an acquisition type priced at a reasonable multiple, reasonable to high multiple and the numbers we think we could do much better with an acquisition, like for example a CoFren, which meets our strategic standards and which right now, as Bill indicated, is operating much on budget. So right now we are leaning that way.

Are we irrevocably committed to that? No we are not, we do look at it all the time, but at least at near term most of the time and we will give our best strategy a chance and see if it works before we do anything else.

So that acquisition is better than just offsetting the option dilution?

Yes definitely.

Okay.

Okay, we do have another question from Deforest Henneman, Paradigm Capital.

Hi guys. I was wondering if you could disclose operating margins for the two segments?

Yes, basically what we disclose is we disclose in the Q. We have had this discussion to be honest, a number of times in the past and for competitive reasons we just like to basically, to disclose what we disclosed in the Q and then leave it at that.

[OPERATOR INSTRUCTIONS]

Okay, if there are no further questions we will be back in touch in another 90 days and look forward to continued progress.

The conference has ended; you may now disconnect your lines.