美國西屋制動公司 (WAB) 2006 Q2 法說會逐字稿

Hello and welcome to the Wabtec Corporation second quarter 2006 earnings results conference call. [OPERATOR INSTRUCTIONS]. At this time I would like to turn over the call to Tim Wesley. Mr. Wesley?

Thank you. Good afternoon, everyone and welcome to our call. I'd like to introduce the rest of the Wabtec team who are on the call. Chairman Bill Kassling, President and CEO Al Neupaver, and our CFO, Alvaro Garcia-Tunon. As usual, we will have some prepared remarks and then we'll be happy to take your questions. During the call of course we will be making some forward-looking statements so we ask that you please review today's press release for the appropriate disclaimers. With that I'll turn the call over to Al Neupaver, our President and CEO. Al?

Okay, thanks, Tim. Good afternoon. It's been quite an interesting morning to say the least. We have been really surprised by the negative reaction to our earnings release. From the beginning of this year, we have said that earnings growth would be driven by margin improvement. We've done an excellent job of improving our margins.

As we all know, freight markets are stable at a high level, transit shipments are slightly off, as we anticipated, compared to last year. With transit orders very strong and the reason for our $1 billion backlog, these orders should drive growth into 2007 and beyond. We're positioning the Company to take advantage of this opportunity. What I'd like to do is go through some details about the performance about the market and our restructuring plan and then turn it over to Alvaro for some numbers.

We had a strong performance in the second quarter. Earnings per share of $0.43 versus $0.32 the year before. That's a 34% increase. Despite slightly lower sales. Income from operations were up 35% to almost $36 million. That's a 13.6% operating profit. We had strong margin improvement again which shows that our efforts to drive down costs are having a meaningful impact. Our gross margins were 29.3% and that's 4% greater than a year ago. In all, we had a strong second quarter which gives us confidence in our full year earnings per share guidance of about $1.60.

Rail traffic continues to be strong, especially the intermodal traffic. Revenue ton miles are up almost 3% year-to-date, intermodal is up 6% year-to-date, railroad profitability is good and we're heading into the peak season right now. Locomotive build for OEM is still tracking to 1,200 units. freight car and market continues to be strong, even better than we anticipated. Second quarter orders came in about 18,000 and that's down from the very high 36,000 in the first quarter, but still one of the better quarters in past several years. Deliveries topped 19,000, highest since early 1999, and the backlog is holding steady at about 86,000 units, another good number.

The transit market, as I said, is strong. Some of the key market drivers in the transit area are federal funding and passenger ridership, both indicators are very positive. Federal spending was passed last year and includes annual increase of about 8% per year and we're seeing that money put to use right now. Ridership was up by more than 4% in the first quarter. With all modes of transportation showing increases in widespread regional growth. Obviously, due in part by higher fuel costs for commuters.

To give you some examples, in heavy transit, for example, Los Angeles saw a 16% increase, [path] in New York up 12%, commuter rail 11% up in Dallas, 8% New Haven. Bus Ridership is also up 18% in Philadelphia, 10% in Memphis. Our transit business should begin to grow as deliveries on some of our recent contract awards begin to accelerate over the next few quarters. We also booked some strong new contracts in the second quarter, primarily in transit.

We signed a ten year, $140 million contract to overhaul bogeys for HSBC Rail, our [leasor] in the UK. This provides a solid base for our UK unit as well as a growth platform. Union Pacific railroad signed up for our ETMS pilot, Electronic Train Management System. We're installing the equipment now and should begin the pilot by the end of the year. Combined with BNSF pilot that's going on and has been going on for a number of years, error free, this means we now have the two largest railroads in North America testing our train control system. Our unit added so its already strong backlog with three locomotive contracts. $21 million contract to build 16 clean vehicle switcher locomotives for Pacific Harbor Lanes, which provides switching services to the ports in Long Beach and LA. Deliveries, will be in 2007.

We're also selected to build commuter locomotives for a group of transit authorities in Utah, California, Massachusetts, and Minnesota. This is a multi-city contract. Under these contracts we'll deliver 22 units in '07 & 08 for a value of about $60 million. And we have options for 45 additional units of $120 million over the next five years. And then just last week we announced an $8 million order for New Jersey transit to rebuild five switcher locomotives in 2007.

Last quarter we shared our vision for Wabtec into the future and that is to double the size of the Company within five years of the average double digit earnings per share growth through the business cycle. Today, we're in the middle of our strategic planning process which is giving us the first opportunity to start laying the groundwork for achieving this vision. Our strategy for growth is based on our rigorous application of principles of the Wabtec performance system that generates sufficient cash to invest in the four key areas: Global and market expansion, after market products and services, new products and technologies and acquisitions. We are very active in each of these areas and we expect them all to contribute to our growth.

Before I turn this over to Alvaro, I'd like to say a few words about our restructuring plan that we announced today. The reason for the plan is that we are always looking for ways to improve our profitability and efficiency, a fundamental principle of lean manufacturing. Do in part to the strong Canadian dollar, our manufacturing costs in Canada have risen significantly. Last year, we began to analyze ways to reduce those costs, which resulted in the plan we presented for Board approval last week.

As part of the plan, we're downsizing two of our operations in Canada, Stony Creek and Wallaceburg. By moving some of the production to lower cost Wabtec facilities and by outsourcing other components entirely. To accomplish this, we will record restructuring charges of about $11 million. These charges will be taken in the second half of 2006 and first half of 2007. These charges are mainly non-cash and are mainly for pension-related items and fixed asset write downs. We expect to achieve a pay back of less than one year on cash restructuring expenses which will be about $3 million.

Alvaro? Why don't you cover the numbers.

Okay. Good afternoon, everybody. Thank you, Al. And as Al said, we thought that this was a very strong quarter for the Company in spite of the market reaction today with earnings per share up about 34%. Sales were $261 million in the second quarter, about the same as the first quarter, but a little below the year ago quarter which was $266 million.

The quarter -- I think it's important to analyze that very slight sales drop. The quarter to quarter sales drop was $4.4 million; however, it's important to note that sales of a discontinued unprofitable locomotive part line and a marginally profitable UK HVAC contract dropped by $11.7 million, almost $12 million quarter to quarter. If you exclude those two items from the comparison, sales increased by about $7.3 million or 3% from the same period last year, and our decreased reliance on these product lines is one of the reasons our margin improvement that was one of the main reasons for our margin improvement.

So again, this was something that we saw coming and if you do it on what we see as a more profitable apples-to-apples basis, sales increased by about 3%. The same calculation on a year-to-date basis yields a sales increase of about 8%.

Going by segments, Freight Group sales were flat but at the continued high level which we've been seeing for quite a while, while Transit Group sales were slightly lower due to decreased sales of our UK unit which I referenced before.

As you look at the groups -- at the transit and Freight Groups, keep in mind that we've made some slight revisions in our segment reporting this year because two of the units have seen their market shift from freight to transit, and we're re classifying those sales accordingly. We've classified this year that that way and we've also gone back and reclassified prior years. If you want anymore details on this for your modeling purposes, please feel free to call Tim Wesley because he's volunteered to provide you the additional information that you may need.

Gross margins as Al mentioned again before, we think was a very strong performance. It was gross margins were 29.3% for this quarter versus 24.9% the year ago, and 28.6% in the first quarter, so even just quarter to quarter we had an improvement of 70 basis points. The improvement was, as we've talked about before, we reversed a loss from this locomotive modules contract last year to a profit position this year. Mix has been good, and obviously, our continuing efforts to lower costs through strategic sourcing and lean manufacturing play a key part in the improvement in margins.

Operating expenses stayed pretty much flat at slightly more than 41 million on the year to year basis, after taking into account stock based compensation expense which we started to recognize this year under FAS 123 R. That was about 1.5 million this quarter. Operating margins which for us are an even more important number than gross margins were 13.6% after the quarter, up from 9.9 % last year and 12.4% in the first quarter. We'll continue to try and improve that margin as we go forward with the transit contract. Interest expense was only 423,000 this quarter versus 2.2 million in the year ago quarter due to higher interest income and our increasing cash balances. In other expense not much happened there was the 1.6 million versus about 700,000 last year due primarily to some paper foreign exchange losses.

Income tax expense relatively stable. We accrued a 35% this quarter a little bit lower than our normal 36, 36.5% rate which was in effect last year. Cash continues, cash generation which has always been a hallmark of our operations continues to be very strong. We have about $238, almost $240 million of cash at June 30 compared to about $141 million at the end of the year last year, at December 31, 05. Some of this came from stock options. About $86 million in the first two quarters came from operations which is obviously a very strong number. A large component of that came from certain prepayments on these long term contracts, and we'll see the effects of that reverse as we go forward.

Debt continues at $150 million per the bonds that are outstanding. Nothing changed in the debt position. One question we always get during these calls and so I'll address it now is future uses of cash. As we've discussed before, our preference is to use our cash to grow our business through investments to produce organic growth as well as acquisitions. We really don't have a set timetable but we're seeing an increased flow of opportunities and we're looking forward or we're looking into them aggressively. In addition, especially frankly in light of today's reaction, we're exploring other uses for our cash including stock repurchases which we'll seriously consider.

Cash flow items, the miscellaneous list we always try and include, depreciation for the quarter was $5.2 million versus $5.8 million last year. Amortization was about $860,000 this quarter versus $1.1 million last year. CapEx was about $5.6 million this quarter versus $6 million last year. For the year, CapEx should be pretty much what we've said all along, somewhere between 22, 24, $25 million versus our depreciation amortization of about $27 million.

Backlog, which for us with the transit contracts is becoming a more important number. Without options, we reached a backlog of just over $1 billion – a billion 14 million which is a new record high for Wabtec. If you include options you add about $350 million to that number. The number without backlogs compares to about 975 million at the end of the first quarter this year, March 31, '06. This backlog is about 70% higher than a year ago and 4% higher than the first quarter.

And with that I think that pretty much covers the numbers. I'll give it back over to Al for a quick summary and then your questions.

Thanks, Alvaro. Although disappointed with the reaction to our earnings release, we are completely focused on running our business and really excited about our future. We have a new vision for Wabtec and are working on a strategy to get us there. Our balance sheet and cash flow are strong. Our end markets look strong for the next several years. Wabtec performance system provides an established culture of lean manufacturing. As you can see the results of that in the cash generation as well as the margin improvement. We have an experienced and dedicated Management team and with that, we would be happy to answer any of the questions you might have.

Thank you. [OPERATOR INSTRUCTIONS].And the first question comes from Art Hatfield at Morgan Keegan.

Afternoon, guys. A few questions, Al. On the restructuring, you mentioned speaking to Canada the issue of the currency. The moves that you're making just aren't currency related. You're going to see other real cost benefits from moving to a lower cost environment; is that correct?

Exactly, Art. There's no question about it. When we look to move, we're not only moving product just to get it away from the currency but also we're going to the lowest cost platform. Our approach is that we're able to manufacture these products at multiple sites and we can generate that capability, and we will produce now and into the future at the lowest cost platform.

In addition to that, we look for opportunities to deintegrate some of our manufacturing. These are components or even multiple components that we could outsource at a much lower cost than we could to manufacture at any of our platforms so it's not just the exchange rate, you're exactly right, Art.

Great. Talking about growth a little bit, Al, you mentioned that the strategic goal is to double the size of the Company in five years. That would imply roughly about 15% top line growth going forward and obviously, the reaction to your stock today was due to the fact that people are concerned that there isn't any growth for your Company right now. Could you address that a little bit and maybe mention how you get there and what the mix you're going to need to make between organic and acquisition growth, to double the size of the Company in five years.

Okay. First of all, I want you to know when we put together the vision, we were very conscious about why we put the vision together and the reason was not so much for the absolute number as to change the culture. The culture at Wabtec over the last number of years, since it basically went public was to try to grow the business but more concern on cash generation and pay down of the debt. They've done a tremendous job. We've done a great job in doing that. We've got a real strong lean manufacturing operation as I said based on the margins, but we have to change that culture to growth and one way to do that is set that vision there.

Now, that growth, as we're going through our strategic planning process, which we're doing with every division right now, we're about 50% complete and it's amazing just when you ask that question how do you grow your business to these people, we come up with a lot of opportunities and we're generating that model right now. I think that the way I see it is that we could probably get about probably less than half of our growth organically. I think the other half is probably going to have to be acquisitions and as you know, we're formally setting up a structured program for that.

So not only have we tried to put structure in our strategic planning process which will lead to a more accurate budget process, but also structured to trying to find acquisitions, strategic acquisitions in the future. But we will need both to fulfill that vision.

Well, Alvaro alluded to that a little bit that you're seeing a lot of opportunities in that regard and that's increased recently, if I understood him correctly. What's driving that? Is that a result that people seeing their business slowdown and they would like to cash out before we go through another dip in the freight transportation business?

Well obviously, we're in a cyclic business. There's no question about it. Now whether we're going to see those deep cycle downturns, we just don't feel that's the case. One of the things that you see right now is there is a -- there's some capacity constraints on some supply of components but also you're seeing constraint by the people that are making the order which is a positive for this industry.

Instead of just trying to order rail cars and locomotives to solve the problem, they're trying to do it with efficiencies with having discipline in their purchases and that's the part we play strong in. We're one of the few companies in the world that could help improve the efficiency, the safety, and reliability of the railroads and I think that it's a positive thing that we don't see this wild buying that we've seen in the past.

Now, all that said, is there a lot of opportunities? I think that back when the market really crashed a few years ago there was a lot of private equity and a lot of money put into the business and obviously when the markets are at a high level, it's time to assess that. Whether they continue to own it or sell it, and I think that's what you're seeing, exactly.

One last question, Al, and I'll let you go. Obviously --

Are you sure I can go, Art? I mean I have to stay for other questions.

Right! I know you like to focus on operating margins, Al, but I'm so glued in on gross profit I'm going to ask you the gross profit margin question.

We could answer either one.

I appreciate that. 29.3%. That's the best that we've seen in a long time. Can you address the potential sustainability of that and kind of what the opportunity -- obviously with your announcement of the restructuring today and the savings that will accrue from that, I would get the sense that you as a Company hope that you have more upside to the margins that you're seeing today.

We, our Wabtec performance system is a great system and I've been able to visit all but about three plants now, and I could tell you that not all of them are as lean as we would like, and there is opportunity for improvement, continuous improvement and that's part of the system. Matter of fact as you know, we have a tremendous amount of backlog for our Boise operation in the locomotive area.

Our plan is to take every general manager, including the executive office, out to Boise and do a [Kaisan] for a week in September and what we're going to look at is how do we improve that process. And it's going to be, I think there's room for improvement there and other places, and we're going to continue that. So we think that it's important that that's a never ending challenge that we have.

Having that said, I think it's important to realize that as this transit market becomes a greater percentage, the margins in transit are lower than they are in the freight markets, and that will have a negative impact. But we're working hard now to prepare the Company for that transit market to try to get those margins up higher and the contribution as we get that sales volume, and that's probably one of the main focuses we've had in the last quarter and will have in the next two quarters.

Great. Thanks. I'll let somebody go after you!

Thanks!

Thank you. The next question comes from John Barnes at BB&T Capital Markets.

Good afternoon, guys.

Hi, John.

Real quick, just I guess on your, on the use of cash, first of all you talked about that you're seeing more opportunities there. Can you just shed some color on that in terms of are you looking at one or two things a week or are you looking at half a dozen a week? Just what kind of opportunities are out there and I guess more importantly, are those opportunities still on the value add-type type goods or products in this market or are you looking at going downstream at all?

It's not more than a handful a week, I could tell you that. There are some opportunities that we are seeing, John, and those opportunities we really are trying to do our best to be as disciplined and thorough as we can in understanding those opportunities and we're going to be aggressive but yet we're going to do what's right for Wabtec in the long term.

Opportunities are there. If we expect the number to grow, we would have to start looking at what we would call adjacency, something maybe a little further from the core of what we do. There's a lot of risk with going too far and we're well aware of that so we've got a very structured approach to acquisitions that we formalized and we're going to follow through with that program and I'm sure that the results will happen. It just may not happen as quick as I would like.

Okay. If I was looking at the available cash on your balance sheet and your cash flow that you're looking to generate the remainder of this year, understanding the Board's desire to grow the business and kind of the mandate you all have been given to go out and find these acquisition opportunities, you made the statement that you would look at your repurchase here given the pressure the stock is under. What percentage of your cash or your cash flow would you be willing to put to use there? I mean, is it as great as half or would it be a much smaller piece and trying to keep as much dropout as possible?

I'm going to let Alvaro answer that.

Yeah, and one of the factors that we're looking at and we're not ready to talk specific numbers, but I think we can answer it in general, John, is we do have bonds are outstanding and they do contain limitations on what you can go do for a stock repurchase, so that's going to be one of the key considerations.

The other key consideration is how we see our cash flow developing and our potential uses of those cash. Probably the former is going to play a bigger part in the decision-making process than the latter and we have to evaluate that obviously if we were to do something we got to get Board approval so it's not anything that's going to be imminent but it's something that we're seriously going to consider.

Can you remind us what those limitations are on the bonds?

I'd rather not get into that right now. I just don't want to set a number right now.

Okay. And then lastly, I'm not trying to pry, yes I am, I'm trying to pry it out of you! I'll just fess up! If we look in the back half of this year, okay you got a $1 billion backlog. My guess is a fair amount of that is going to hit in the next 12-18 months.

We've said all along we felt like your top line would really accelerate in '07 & 08 as a lot of these contracts began to come to fruition as the options were exercised. But so we don't end up in a similar situation where there's published numbers that suggest that you guys actually had a shortfall versus expectations on the top line. Should we be looking for similar results the balance of this year?

I know the R160 contract doesn't kick in probably until the fourth quarter. So you're still saying high level in the freight car area. We've kind of got these issues versus a year ago that we've grandfathered, so going forward, should we see some stability in this number kind of at these levels we saw in this quarter?

Yes. As we look at the second half, we feel that the freight markets are going to stay at the high stable rate they're at. One thing about the transit market, it takes an awful long time once you have the order before you start shipping, and that delay is some of what you see in our second half. I think that what you saw in the first half is probably close to what we expect to see from a volume standpoint in the second half.

I think that these transit, the couple of orders with the locomotive should start kicking in early '07, maybe a little of it in '06, and we also see some seasonality on revenues each year, in the third quarter and I think a lot of companies do see that. So we would expect revenues in the third quarter to not actually go down and that's traditionally what I've seen spending in the last ten years or so.

Okay. So you don't expect revenue to decline in the third quarter?

No, we do. We think revenue will come down.

Okay.

Based on the third quarter seasonality. And this is something, John, that happens annually at Wabtec. What happens is a number of our customers will actually close down for a period of time during the summer to consolidate everyone's vacation and if you take a look at our sales for the last few years, you're going to see a recurring pattern. It's nothing dramatic. It's nothing to get alarmed about but there is some seasonality to our sales and there's traditionally been a dip in the third quarter.

Very good.

In other words you take into account the seasonality, the accounts will be stable I guess is what we're trying to say. I'm not doing a very good job of it!

Well, I just want to make sure. I mean you're not -- you don't feel like okay, let's just for whatever reason, there was a shortfall; okay? Whether or not we got too aggressive which I'll be willing to take the blame, what I guess I'm trying to get at is you are not seeing a deceleration in either the order pipeline and that's why the backlog continues to get better, nor are you seeing potential cancellations of products, nor are you seeing deceleration because of I don't know, economic slowdown or something like that.

I just want to understand that you expect freight car or freight, the freight markets to stay at this high level, transit is always going to have some variability in it because of timing and that kind of thing, but regardless, even incorporating the seasonality in the third quarter there's some stability in the back half at kind of the levels we saw in the first half?

Yes. We're seeing same thing that's consistent with everything else in the market as far as the rail car and locomotive builds which we see as continuing to be strong. We don't have any other --

Yeah, John, and we thought particularly the second quarter freight car order rate what was particularly strong, I mean you followed on a quarter where they ordered 38,000 plus freight cars which was just I don't know, but like a 25 year old record on just very record high and we expect that after a quarter like that to see something just sequentially lower and yet the number came in at 18,000 plus which we thought was very strong.

And deliveries, were up. Business is good.

Okay. Very good, guys. Thanks for your time.

Thank you, John.

Thank you. And the next question comes from Jim Lucas of Janney Montgomery Scott.

Thanks. Afternoon, guys.

Hi, Jim.

A couple of different questions. Not to beat a dead horse but following up on the last what I guess the theme du Jour on some of the freight trends that we do seem to see more lumpiness beginning to emerge in that market, and have you been able to discern any trends based upon the pretty wide swing from what we saw in the first or second quarter. Do we indeed see a trend beginning to emerge here or can you give us a little bit of color about what you're seeing and define stable? I mean is stable 3%, 6%? We're just trying to look for a little bit of granularity in the outside world.

We really don't see any what you're saying there, Jim. Again, I think that a thing that's very positive, I think we're seeing constraint on the part of the people that are making orders so they just don't solve problems by adding inventory on an already congested system.

So I think that it's pretty positive right now and I think that going into this peek season, they're trying to solve the problems the right way, through efficiency and velocity, not through just putting more rail cars and locomotives on the tracks. They are building more tracks and I think all of that is positive. We just don't see that lumpiness that you referred to.

Okay, well I mean, we on the outside world only have a few data points from which we can extrapolate from, and the numbers would suggest otherwise.

No, I understand.

So I mean anecdotally is one thing but then numbers are numbers.

Right.

So all right, we will not beat that horse anymore. Switching gears, on the restructuring side, is this, should this be all that we expect or are there other big shoes that could potentially drop, bigger actions that you can take going forward that maybe you've got earmarked that you're doing this incrementally?

Yeah, we had a continuous improvement which we'll continue on but we don't anticipate any big other shoes to drop. We have, we've been continually trying to restructure this business and it got to the point where it became necessary that we had to recognize these pension liabilities and the asset write-offs and it became necessary to announce it because there's no intent to bring those people back at those operations. And we will continue to look at ways to produce our product at the lowest cost platform or source it or whatever, to lower our cost basis. We're going to maintain that continuous improvement culture into the future, but there's no gigantic shoe that we would need to drop in order to do that.

Well to take that one step further, we're seeing the right sizing of two facilities, but are there any -- do you think that you have too many facilities in the system?

I think there's opportunities that you always need to look at and we do that in our strategic planning process. I think that that again is -- you need to continually look at why certain facility exists and is there a better way to do it and we will continue that but we don't anticipate any of -- I don't know of any of those things that would be a large ticket item that would require this similar type of restructuring charge.

Okay. Fair enough. And then on the acquisition side, two different questions related there. First, from a people standpoint, both from a Corporate Development filling the pipeline doing the due diligence. Any update you can provide there about do you have the staff that you need or do you need to add additional Human Resource standpoint? And then from a criteria standpoint, whether it be multiples return on capital criteria, any additional color you can give us on what your criteria is and does it differ on core acquisitions versus potential adjacencies?

First of all from a Resource standpoint, we plan to create a corporate development department here in the executive office and we're still on our search which means that we've got about six or seven individuals just at the executive level and our general managers and others out there engaged in trying to do some overtime and work in that area and we hope to fill that position soon. As far as acquisitions, I think that some guidelines we try to use is to have a very disciplined structured approach. We see companies that are close to our core or adjacent to our markets. We focus on acquisitions that will add to Wabtec differentiation in the marketplace and hopefully try to dampen that business cycle that we operate under.

We're going to explore international opportunities. We really like to get to 50% international. Right now we're only about 36%. We're going to apply a disciplined financial criteria and we'll look for businesses that are going to add economic profit, accretion, and positive and sustainable impact on our economic future.

So those are kind of the guidelines. We've set kind of an arbitrary goal for what we think is an optimum debt level would be two to 2.5 times our EBITDA so we have the criteria. Actually, we actually put together a very formal structured acquisition strategy that we presented to the Board and got approval on the approach just last week. So we're working hard at it. A lot of people working overtime now, and as I said before, we're going to stay in there and we'll make progress and it will just take some time to do it.

All right so it sounds as if for now, somewhat fuzzy targets there, the benefit of the doubt that the structure is in place but in terms of hard targets of X percent return on capital just not prepared to share at this time. Is that a fair --

They aren't fuzzy.

Well, in terms of communicating to the outside world. I know they aren't fuzzy internally but what you're willing to share?

You know our nature here. We don't share anything more than we have to; right?

You want us to tell how much we're willing to pay, Jim? You working for buyers or you working for sellers out there!

I'm the focus is on return on capital here.

Oh, okay! We're very much, well we're very much in line with that focus.

All right we will be, you know, Management is ultimately what gets the premium valuation in the market.

There you go. Okay.

Thank you.

We agree completely with that approach. I appreciate the question.

Thank you. And your next question comes from Wendy Caplan at Wachovia Securities.

Hi.

Hi, Wendy.

Hi, Wendy.

Hi. Just to be succinct about this, could you answer the question how fundamentals at the Company changed?

Fundamentals -- no, I think the Company is fundamentally the same Company and I think that there's not been any major change.

Okay. And the margin, the gross margin of 30%, it has been a long time. In fact almost seven years since we saw something as good as we saw this quarter. Quite frankly, I didn't expect it so soon.

Can you tell us whether there was anything that contributed to that margin that was unusual or one-time or should we continue to see that kind of margin, and you'd been, part of that question as well, you'd been talking about a 30% gross margin goal for awhile. Does that mean that we're there and we don't have any future goals or would we be looking at other goals as well? Higher goals as well?

We're definitely have not achieved what we, any goal that we would stop working more to, Wendy, without a doubt. So we're going to continue to strive to do a lot better on the gross margin. We are very proud of the progress that we've made and it's not one issue. There's a number of issues. One thing that this group did last year was they had a terrible contract. The SD89 contract and they got out of that contract and that's been a part of the improvement, but also part of the improvement is a lot of little things. It's not one thing.

Our outsourcing, our global sourcing efforts have been fantastic. Some of the things that are related to a Project Green or whatever our announcement here in the restructuring, some of these actions have really already taken place, and it became necessary to recognize the tension in other liabilities, so if you look at just lean manufacturing applications, being able to get surcharges on the material increases that we've had, it's not one item. It's all these little items that have added up to making this a much better Company and it's the same approach that we'll use in the future, and that is that we will continue to drive for continuous improvement in all of these areas.

So do we have a new gross margin goal now that we've just about hit the old one?

I'd like to wait and see 'til we're through our strategic planning and budgeting process and maybe we could share that with you.

Okay. That's fair, and finally, I'm not sure I understood the backlog explanation Alvaro. Could you tell us what the 12 month backlog is and give us a sense of what portion is freight versus transit, please?

Sure. The total amount and this is before options, is a little bit over $1 million, Wendy. A billion, sorry, big difference! It's about $1.014 billion. Out of that, approximately 45% is due for delivery in the next 12 months and 55% is greater than 12 months and in terms of divisions, transit is about 85% of that total and freight is about 15% of that total. That help?

That does. Thank you very much.

Sure.

Thank you. And the next question comes from Lawrence Casse from M Partners.

Hi. Now forgive me. Could you just briefly repeat the explanation that was given as to on an apples-to-apples basis the top line revenue were up about 3%?

Yes, let me go back and get those numbers. What happened is last year we had two product areas that in essence, we de-emphasized. One was the locomotive modules contract that Al referred to which we de-emphasized deliberately because we were losing money on it. So we cut back on what we were producing and the second one was a contract in the UK for production of HVAC units.

I'm trying to get back to my notes here. Those generated sales of about $11.7 million. I'm sorry. The drop in those two numbers was $11.7 million quarter to quarter. So in essence, if you drop $11.7 million in sales quarter to quarter and then do the comparison, you're at about 3% increased quarter to quarter.

Okay, so were those operations that have gone into discontinued operations?

No. They wouldn't be discontinued but de-emphasized. In other words, I'll give you an example. In a locomotive modules contract we were producing two products, one of them at a severe loss and the other one at a modest loss. The one at the modest loss we managed to restructure so that it now is profitable and the one that had the severe loss we're discontinuing it and we're not selling it anymore.

Okay. Just to go back to the same issue that others have raised questions about, let's assume that there was a 3% year-over-year revenue growth, the perception would be that in the time when the industry is going through a cyclical boom, particularly the freight industry, you would see a little stronger top line growth. What is it that the market is missing here?

See, I think that the last year we had a very strong year and this year we're having a very strong year. Again, in response to some of the questions we've been getting today, business is very good. This year, we'll expect a very good freight car production and very good locomotive production but last year we had a very good locomotive and freight car production so what you're seeing is an industry, I think, that the industry itself, especially on the freight side is operating and near capacity and you see that at a reflected in the stable sales level and where you are going to see the growth in the future is going to come from transit which is not operating under similar constraints.

Right. I was going to ask that actually, the freight industry seems to be physically constrained by lack of track and operating at close to 80% capacity. Is that affecting your business?

I believe it is, and they're trying to solve the problem the right way and that is to get more track out there and get more rail out there and improve efficiencies and the effectiveness of the railroads, not just ordering rail cars and locomotives.

Okay. So going back to the gross margin improvements, as you move forward, do you see the gross margin improvements coming from increased manufacturing efficiencies or do you see it coming also from a change in the product mix and things like services and software? In other words, is there more efficiency to be gained?

There's definitely more efficiency to be gained from the manufacturing standpoint. The sourcing standpoint, lean manufacturing principles, but at the same time, as the mix of transit versus freight switches somewhat, right now it's 70 freight, 30 transit, and with this strong backlog in transit, that will switch and transit will become a larger position, and that has a lower margin and that will have impact on that -- on our total margin number.

Okay. So excluding acquisitions going forward let's say over the next year or two, would it be reasonable to expect again excluding acquisitions, top line growth in the mid to single digits and EPS at double digits?

As I said before, right now we're in the middle of a strategic planning process and we're trying to really understand that well. The best deal I have is about half of what we need which would give you in the mid single digit internal growth rate. That would be my estimate at this point and we would like to get through the planning process before we really give you a firm number on that.

Okay, great. Thanks very much.

Thank you.

Thank you. And the next question comes from Matt McGeary at Sentinal.

The restructuring of Canada, have you guys, I know sometimes it's hard to find people there, have you gone through all of the necessary regulatory issues you need to do that restructuring or is that still coming down the pike?

No. We've crossed all the T's and dotted the I's and have worked with the regulatory agencies related to that and the unions.

You also talked about potential, when you were talking about acquisitions, potentially looking into adjacencies, and maybe having to stray outside the core business. Just how far might you think you would go there?

Well, we really want to stay as close as we can to our core business. That, we feel that we're best in doing so. So it's hard to say how far we would waver. I think there's opportunities within the core and very close to the core and those are the things we're going to concentrate on.

And I would like to offer a comment from a potential investor that I know you guys like to keep things close to the vest but it does pay to pay attention to what the Street is thinking. You oughtn't be surprised by the reaction if you miss expectations by as much as you did on the top line. Now whether or not that's fair is another point, but it is what it is.

Yeah, I think it's fair, but what happens is the reality of the situation is that you have to be very careful on how you comment on guidance these days in light of regulation FD and we do. We will follow a lot closely and that severely limits the kind of discussions you can have with individual analysts about their projections.

Yeah, I understand. Okay, great. Thank you.

Thank you. And the next question comes from [Marcelo Desio from Triado Capital.]

Hi, thanks. If you don't have current authorization to buy back stock outstanding how long would it take to get one approved the Board? Thanks.

It's a matter of just a telephone call. Do you have a follow-up? Hello?

Okay, he stepped away from his phone. [OPERATOR INSTRUCTIONS].

We actually have a question from [Lewis Cann with Cann & Company].

Thank you for taking the call gentlemen. Concerning the downsizing of the two Canadian plants, maybe you can indicate what lanes of gross margin improvement you see out of the products that are now being produced at those plants?

Yes. Like I've mentioned before, some of the actions have already been taken but as we indicated in the release, we expect cash savings return on investment in less than a year.

No, that's not my question. My question is: What do you consider to be the potential margin percentage improvement from a product being shifted from Canada to wherever you're shifting them.

You're looking for the absolute margin --

No, range.

It's about, I'll give you an answer but it's not going to be exact. There is a range and it could be from 0.5% to 1.5%.

You're saying from 150 basis points to 200 basis points?

No, I said a 0.5 to 1.5.

0.5% to 1.5.

50-150.

Okay, 150 basis points potential, and what percentage of your revenue is produced at those plants that are going to be downsized? As things stand today, what --

You know, it should have no impact on revenue --

No, no. That's not my question. My question is of your total revenue, approximately what percentage is generated by the two plants that are going to be downsized where the products are going to be shifted?

I trying to make a guess, if I can, of the range of dollar margin, gross product, gross profit improvement if I can, of the revenue that's being shifted from Canada to U.S. Or where ever you're going to do it.

The value would be between probably 12-15%.

Of your total revenue?

Right.

That's interesting and are those plants up well producing mostly transit or freight or both?

Predominantly Freight but some transit as well.

Got you. Thank you very much. It's very useful.

Thank you.

Thank you and the next question comes from Lavon von Redden with Hockey Capital.

Thanks for taking the call. A couple of questions. One of which was you started to --

Could you speak up a little bit. We're having trouble hearing.

Sure. Can you hear me now?

As well, we're having trouble with the names here, thank you.

Can you hear me now?

Yeah, thanks.

You started to in response to one of the previous callers comments, you had said that you think that half of what you need to get to the mid single digit growth level and you never finished your sentence. I was wondering what you were driving at when you started to say that. You said you think you have half of what you need.

We're talking about meeting the goal of 15% or trying to double the business on -- in order to double the business you need 15% each year.

Okay. So you're saying that you think you have that currently in hand and acquisitions will get you the rest?

That's what we're trying to develop. That's correct.

I apologize. I didn't quite follow that.

I'm sorry.

Related to acquisitions, obviously you don't want to talk about what exactly you're looking at, but are there any ranges or ideas as to kind of what people are asking for in terms of either EBITDA multiples or whatever for businesses that you are currently thinking about investing in?

I think EBITDA, you are seeing an increased flow of transactions as I alluded to it earlier because basically there's a lot of capital chasing deals and I think that everybody is aware of that and in terms of multiples it can vary widely depending on the product line being offered, on any alternative opportunities it may have, and so just to give an estimate, it can grow from let's say five times EBITDA to over eight. But within that range, it can certainly vary widely.

And one final question relates to the top line issue. Obviously you're saying freight is stable and you expect the transit to kind of kick in. Why wouldn't we see then freight be a larger portion of your backlog or your backlog growing substantially higher than it is currently if transit is 85% of it and freight I think you said was 15.

Right. We just don't have as much visibility. The backlog is very short for the freight business.

Exactly. Most of the freight business comes in on purchase orders and it comes in on a purchase order you ship in 30 days and boom, it's done. A typical transit contract from the day you sign the contract until you complete the order, you probably are talking four to five years, so there's a big difference in backlog numbers between the two. In terms of significance, we don't place that much significance on the freight backlog because again, it's a rapid turnover type of situation whereas a transit backlog is more significant because it has a much longer lead time and a much longer execution time.

Thanks.

Thank you. And the next question comes from Nathan Brown at Waddell & Reed.

Yes, hi. Real quick, from the freight Group perspective, potentials for growth going forward, if there are any, what do you see out there from a new modules standpoint, where are the capacity constraints within the freight car and locomotive market? Is it you guys, and then also I'd like to get kind of what the mix of business from the after market versus OEM --

One constraint --

And where is it going?

One constraint that we're aware of is just wills of themselves, and I think that there's a lot of activity to resolve that, and we see there are opportunities as we go through our strategic planning process for growth in freight and some of the technologies that we continue to develop on an Electronic Train Management Systems and other high-technology products we feel that there is room for growth in the freight markets.

And your comments about that being stable for foreseeable future but at least for the next couple of quarters is predicated on basically no growth in any new technologies and in anything that --

We haven't layered those in. That's correct. We're basically talking about the marketplace.

And then when you think about the mix of the after market versus the OE side can you give us what the break down was and where do you foresee that going in the next couple quarters?

One of our stated growth initiatives is to grow the after market business. Currently, we're at 50% of our business is after market and 15 is OEM and we would like to continue to grow that.

And should we expect that to grow going forward and how should we expect that to flow through the margins?

Obviously, the after market provides, there's two things it provides. Generally better margins and secondarily it dampens that cycle because in the down cycles the after market stays up a lot more resilient than the OEM market, so we would expect that to grow.

If I think that the locomotive and rail car OEs are more or less capacity constraint, what is the perspective for the after market sales growth going forward?

I think that's one of the positive driving forces for the after market in the repair business is that as they utilize their asset to resources more, we do see more businesses and more business available to us there.

To translate that into numbers for us, is that after market is going to grow 2%, after market is going to grow 5%? Help us understand that.

I can't give you a number. If I would, it would be an estimate that I don't have right now. As I said, we're going through a strategic planning process with the business and that trend is positive. I don't have a number for you.

Okay, thanks.

Thank you.

[OPERATOR INSTRUCTIONS].

Okay. If there's no other questions we want to thank you.

Keith, are we clear on the questions?

Oh, yes, I'm sorry. There are no more questions.

Thanks everybody. We'll see you in about another three months.

Thank you.