美國西屋制動公司 (WAB) 2008 Q3 法說會逐字稿

This is the [Coris] call operator and welcome to the Wabtec Corporation third quarter 2008 earnings release 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) For information, this conference is being recorded.

I would like to turn the conference over to Mr. Tim Wesley, Vice President, Investor Relations. You may begin.

Thanks, Denise, and good morning everybody and welcome to our third quarter earnings conference call today. I'll introduce the rest of the Wabtec team who are here -- our President and CEO, Al Neupaver; our CFO, Alvaro Garcia-Tunon; and our Corporate Controller, Pat Dugan. We will of course make some prepared remarks and then we'll be happy to take your questions. And we will make some forward-looking statements during the call, so we ask that you please review today's press release for the appropriate disclaimers. With that, let me turn it over to Al Neupaver, our President and CEO. Al?

Thanks, Tim. Good morning, everyone. What I'd like to cover is a review of the third quarter results and our current market conditions and then talk a little bit more than I normally talk about the progress on our strategic growth initiatives. We've had quite a bit of change in the landscape here strategically over the last few months. And then Alvaro will cover the financials in a lot more detail.

The company performed well in the third quarter. We had very strong sales increase of 12% to a record $396 million. Our earnings per share in the third quarter was a record -- it was $0.68. That was 24% higher than a year ago quarter. Our backlog remained over $1 billion even with the record sales for the tenth quarter in a row. Based on our performance and the outlook for the rest of the year, we've increased our 2008 guidance. We have our sales growth coming in between 13% and 15%. Of that increase, only 25% is coming from acquisitions. We have our earnings per share between $2.66 and $2.70. It was about $2.65. Keep in mind that this performance is being achieved in a weak US freight car market. This shows the strength of our diversified business model, that our strategic initiatives are paying off, and that we continue to drive margins higher through the Wabtec performance system.

Let's take a look at these markets. The freight rail market -- freight traffic year-to-date ton miles are actually up about 0.8%, but overall carloadings are flat to slightly down. Commodities such as coal, chemicals, and grain are up, with most of the other categories lower including intermodal. Obviously, rail traffic is driven by the overall economy and there definitely seems to be increasing evidence of a global economy is slowing. As expected, railcar deliveries will be down this year, but still at a good level. Most industry analysts are still expecting deliveries low to mid 50,000 this year. Our third quarter numbers are not released yet, but our internal data suggests that orders were about between 7,000 and 9,000 and deliveries were between 14,000 and 16,000, which would put the backlog in the low 50,000. The locomotive market remains still strong and that is driven primarily by international markets. Overall, we are concerned like everyone else about the economy and we have contingency plans that are in place.

As far as the transit market, there's slightly a different story. We continue to see a strong transit market, driven by federal funding and passenger ridership. Federal transit spending is up 6% to a record $10.3 billion. Current spending bill runs through September 2009. Congress will wait until a new President takes office next year before beginning any serious discussions about future funding levels. Ridership continues to increase across the US. In the second quarter, it was up 5.2%, setting records in many cities. High fuel costs and environmental concerns about emissions should continue to drive growth and new investment. We also have the international transit markets, which were much larger than the US market and our share is quite low, so we expect good growth in those markets as we go forward.

Now, let's switch gears a little bit and talk to your a minute about some recent US legislation that will have an impact on the rail industry and our Wabtec. Last week, President Bush signed into law the Rail Safety Enhancement Act of 2008, known as the Rail Safety Bill. This legislation has several important features of interest to Wabtec. It addresses positive train control and ECP, electronic control pneumatic braking. The pill requires all class 1 railroads and intercity passenger and commuter railroads to implement a positive train control system by December 31st, 2015 on mainline track where intercity passenger railroads and commuter railroads operate and where any hazardous material is being transported. It also provides grants of $250 million over the next five years for new safety related technologies, such as our positive train control and ECP product. It also funded Amtrak. It authorized Amtrak capital grants and operating grants that totaled over $13 billion over the next five years. It also has other provisions that are designed to improve safety related to work hours, grade crossings, and bridges.

We expect the bill to have a positive impact on some of our strategic growth initiatives. The momentum is clearly building for two of our technologies, positive train control and ECP. Let's talk about positive train control first. Based on the requirements of the new safety bill, we estimate that 60% of the track mileage, 75% of all the road locomotives, and all commuter locomotives will require positive train control. We currently have the only FRA approved system in use today, and we were working with the railroads to establish joint operating standards, so Wabtec is a clear leader in the field. Although it's premature to talk about specific numbers and a timeframe for the roll-out, we believe that train control has the potential to provide Wabtec revenues of $200 million to $400 million over the next five to seven years.

Electronic controlled pneumatic. We have two pilot trains running in the US this year with good results. As a result, last week the FRA issued a permanent rule change that allows trains using electronic controlled pneumatic braking to travel 3,500 miles without stopping to check the brakes. The rule previous was that every train without them -- and it's still in existence -- would have to stop between 1,000 to 1,500 miles. Quite an advantage for the operating train. We believe this new rule will give railroads the incentive to begin implementing ECP at a faster pace than they otherwise would have. Again, it's premature to discuss specific numbers, but we feel that ECP could actually be a bigger market opportunity than train control, although it would be spread over a longer period of time.

We also had quite a bit of activity on the acquisition front. Late in June we acquired POLI Corporation, a brake component supplier that gives us the ability to expand in Europe, both in the freight and transit market. The integration of that particular acquisition is going well. In September, we signed an agreement to acquire Standard Car Truck for about $300 million. Standard Car Truck is a leading manufacturer of freight car and locomotive components with sales of about $225 million. Some of their key products are freight car truck components such as springs, wedges, wear plates, side frames, bolsters, brake beams, and some locomotive components. This acquisition is very strategic for us. It eventually leads to our ability to provide a complete railcar undercarriage. Their Barber truck design is used worldwide and is the North American market leader. Our combined knowledge of in train braking forces and design capabilities gives us a unique opportunity to advance the stabilization technology for the industry. Improved stabilization means less damage to the cargo, to the railcar components, and to the track.

In addition to these two acquisitions, our pipeline is flowing. But we continue to be very selective and disciplined in our approach. I'll now turn it over to Alvaro.

Thanks, Al, and good morning everyone. Like we said earlier, we thought we had a solid quarter. Highlights would include continued strong sales like Al mentioned earlier and earnings growth as well as operating margin improvement, which is as you well know is something we've been targeting. The backlog continues to be strong in spite of the record sales, and as Al talked about, acquisitions and new products, we're making very good progress in executing our strategic plan.

To be a little bit more specific and to get to the numbers, sales were about 12% higher than last year and hit a record quarterly high of $396 million. One of the things that we're very pleased about is about 80% of the sales increase was organic. It did not come from acquisitions. POLI contributed about $8 million of sales during the quarter. The transit group in particular led the way in the strong sales performance with increases due to several factors including friction products in Europe, transit car components in North America, and again, the acquisition of POLI. Freight group, which we expected to be slightly down this year was actually slightly higher than the year-ago quarter, which again we're pleased with as we've been able to offset the lower demand in freight car, in OE freight car, with growth in other areas such as heat exchangers for the power generation market and international sales in general.

Margins as you well know -- you continue to be focused on margins, we continue to be focused on margins and we're again pleased to report that for the quarter margins increased to about 13% -- operating margins increased to about 13.2% versus 12.9% last year. As a percentage of sales, operating expenses were slightly lower at 13.9% versus 14.1%. And that does include -- operating expenses includes about $1 million of what we call -- what's called purchase price adjustment, which are short-term paper write-offs of acquisition costs. Again, to make it clear, SG&A includes about $1 million of what we call PPA, and there's also about another $2 million in cost of sales. And I think we've discussed this in prior calls, but to refresh everyone's memory, this is basically when you make an acquisition now, what the accountants make you do is write up all the inventory to net realizable value. So you have to recover all that inventory right away basically without a profit. And they also make you write up the backlog right away to net realizable value and you have to amortize the value of that right off the bat.

The effective tax rate, it helped us a little bit this quarter. We benefited from a lower than normal tax rate of 34.2%, which added about $0.02 to our EPS. This was due to releasing a valuation reserve from prior tax years. Normally we extend our taxes. When you do, the statutes expire in the third quarter and that's when you recognize the valuation reserves that you no longer need.

Working capital compared to June 30th, receivables increased by about $15 million, but $9 million of this was due to POLI and the balance was due to increased sales. Receivables balance right now is about $298.7 million. Inventories were higher by about $27 million, but again, $18 million of this was due to POLI. The inventory balance is about $223.4 million and this is one area that we continue to work on. We think as a lean company we should be doing better on inventory. Some of the payables increased by about $12 million which offset some of the higher asset totals and right now payables are about $154.8 million.

Cash at the end of the quarter -- still have a substantial amount of financial flexibility. We had about $186 million in cash, and that includes the fact that we paid about $82 million for POLI. Cash from operations was about $47 million for the quarter. So that reflects a strong balance.

Al discussed the Standard Car and Truck acquisition, and in connection with that we decided to obtain a new bank credit facility for $500 million. We were fortunate in the timing that we predated I guess the worst of the financial turmoil by about two to three weeks. We received all the necessary bank commitments and we expect to close on that shortly when we close Standard Car and Truck. We think post closing, between the cash that we have on hand right now and the new bank credit facility, we'll have a substantial amount of flexibility and dry powder to do whatever is necessary going forward.

One question that we recently had a Board meeting and this was at the top of the agenda and I'm sure it's at the top of your agenda as well. We'll periodically conduct risk management analysis, and given the recent turmoil in the financial markets we thought it would be a good idea to visit this with you briefly. What we've done is we reviewed areas such as insurance coverage -- obviously the financial institutions, the insurance companies have seen a lot of turmoil. Cash deposits -- we want to make sure our cash is safe. Our currency exposure, the dollar is moving pretty dramatically all over the place, interest rates are moving dramatically all over the place. Our pension accounts for the defined benefit plans, receivables, issues with suppliers -- and right now hopefully without being too optimistic, looking at it through the proper filters, we haven't really identified any meaningful exposures in this area, but this is obviously something that we'll continue to monitor.

A few miscellaneous items which we always cover at the end and give you the numbers -- depreciation for the period was $5.9 million versus $6.5 million last year. Amortization was $1.7 million this year, versus $1 million last year. CapEx was $4.6 million in line with our normal numbers versus $4.5 million last year. And then backlog -- another positive indicator for the future we believe is that the backlog has remained over $1 billion, which we really didn't hit until this year. The rolling 12-month backlog -- which again is the backlog that we expect to execute over the next 12 months, so three months this year, nine months next year -- totaled about $627 million versus $690 million last year.

In freight, the backlog actually increased slightly, which is a good sign for the freight market, even though the freight backlog is not a terribly meaningful number, but the freight backlog was $191 million out of that $627 million and $178 million last year, so it increased by about $13 million. Transit was down from about $512 million last year to $436 million this year. Part of the reason for that is that because of a change order in one of our locomotive orders, we actually shifted some of the backlog from the executable within the next 12 months to executable after 12 months. One of our customers made a significant change to a locomotive and it's going to take us longer to execute it and that was about $20 million. So about $20 million of that transit backlog just shifted from one category to the next.

The multi-year catalog, which is in essence what we execute after 12 months, and including the 12-month number, just to make that clear -- so the total backlog including what's executable in the 12 months is $1.15 billion, versus $1.16 billion at 6/30/08. Basically it doesn't get more stable than that. Freight was basically the same, $224 million versus $221 million, and transit was $922 million versus $940 million. So again, transit in total executable say within the next two to three years was pretty much the same. You may have some questions on that. We'll be pleased to address it during the Q&A. With that, I'll turn it back to Al.

Thanks, Alvaro. Once again, we've had a strong performance with a $0.68 quarter, record sales, and a strong backlog. The transit market remains strong and our strategic initiatives are working, which gives us the confidence to increase our sales and earnings guidance, although we are concerned about the worldwide economy outlook. The diversity of our business model is really the key to our success. We have a freight market, we have a transit market. We've got 50% of our businesses in aftermarket. We have about 40% of our business outside of the US. This particular business model is serving us well. And the basis of everything we do, the foundation on which we build on, is the Wabtec performance system and this is what provides the established culture of lean manufacturing and continuous improvement. We have an experienced and dedicated management team. And with that, we'd be happy to answer your questions.

(OPERATOR INSTRUCTIONS) Our first question is from Wendy Caplan from Wachovia. You may go ahead, please.

Thanks. Good morning.

Good morning, Wendy.

Good morning.

I've been getting a lot of questions so I'm guessing you're getting a lot of questions about transit spending, given some issues with various states, cities, et cetera. Can you comment on that, whether you're feeling anything yet or whether it's something we should worry about?

Let me -- in order to answer that question, it's a fairly complex question and it's a complex issue. I think understand the situation, you have to understand the basis of the funding. When the transit authorities get funding from the government, whether it be federal, local, or state, there's two different pockets it goes into. One of the pockets is called the operating funds and the other one is the capital funds. The typical products that we actually supply and are in our long-term backlog are the capital funding portion of it.

And how these transit authorities get funding for these particular two areas -- in the operating fund it's about 48% to 50% of that has to come from direct generation, being the toll gate in order to -- so it has a direct relationship to the ridership. And one of the problems with that, obviously, as ridership goes up and if most of the funding really comes from directly generated, without raising the price and the fares, what they have seen is increased costs related to obviously their labor costs, but more importantly, some of their fuel and energy costs that they have. So they're really getting stretched. And the operating funds, 20% comes from local, about 20% comes from state and only 7% comes from the federal government.

Now, that's the kind of news that you're reading about when you talk about these transit authorities being pressed. That's really the operating fund that's being -- they're struggling with. When you look at the capital funding, directly generated is only about 25% where the state supports about 13%, local 15% I think, and federal is over 40%. Some of the programs are really funded 80% federally for matching funds. So that particular funding is in place and that's what's in our backlog. The ability to move between these two funds is very, very difficult.

So the concern that we would have going forward and the real question is what happens to this federal funding when the current safety -- I mean the current funding expires and that's called the safety lieu, it's worth some $52 billion -- but it does expire, and had increased spending each year, in September of '09. Now, if the current safety bill is any indication of how the politicians feel about future funding, we're in pretty good shape. Because if you look at what they've give Amtrak and authorized in that safety bill, I mean, Amtrak, it's been a battle year on year and actually they left it out of the total transit bill. And the fact that they're authorizing over $13 billion over the next five years is a positive indication for mass transit. But until we get a new President in place, there's a period of time. But most of our long-term contracts will extend beyond that period of time, and by not approving a new program, all it means is that the current amount will not increase, but that amount will be available for the transit area. I hope that answers your question. That was definitely a long answer.

Well, it was, but it was extremely helpful and I'm sure not just for me but for others as well. I was somewhat surprised, Al, about -- and can you comment about sales mix? I guess I thought that -- I had expected a bigger change in terms of increase for transit versus freight and was somewhat surprised to see that switch, that the transit was up so much on a sales basis. And can you comment on the mix of aftermarket and OEM within those two segments, please?

Sure. On the mix, what we -- what Wendy is referring to, if you look at third quarter last year and even second quarter in '08, freight was about 51% of our revenue and transit was about 49%. This particular quarter, we had the freight was 46% and transit was 54%. So we really saw a large increase in the transit area as a percentage of sales. I think that we do get swings quarter-to-quarter, especially as we ship -- a lot of these transit orders are large orders and sometimes there will be a lot more sales in one given quarter compared to the next or the previous one. I think the thing that we're extremely pleased about is that we were actually able to hold in quarter on quarter on our freight business, which really is -- it really is a statement against our diversified business model, when you look at things like having the ability to take advantage of the opportunities in transit during this particular quarter, yet holding our own in the freight area, and it really is the fact that we are very diversified.

The other thing that's amazing, you asked about the aftermarket. Aftermarket was actually down quarter on quarter, and this particular quarter we only had 43% of our business was in the aftermarket area. And we would have -- typically not seen that, we'd actually have seen more on average. As you know, it's basically around 50% when you look at year-to-date and compared to the previous year. So these mixes will change but the key to what we like to really stay focused on in our strategic approach is to stay diversified as we can and not be reliable on, say, railcar builds. As you know, railcar builds comprises less than 20% of our total revenues.

Al, thank you. But that switch in aftermarket, that's related to the strength in transit in the quarter?

I believe, yes. I think it has a lot to do, exactly, Wendy.

Like, Wendy, for example, transit -- and again, R160 in here in the states for New York City is gearing up and a few of the other transit areas as new locomotives are gearing up as well. So transit was about 60% OE. So definitely the reliance on transit is going to shift those ratios a little bit.

Thanks a lot.

Thank you.

Next question is from Jim Lucas from Janney Montgomery Scott. You may go ahead, please.

Thanks, good morning.

Good morning, Jim.

Couple of housekeeping questions first. You gave us the organic. What impact did FX have on the top line this quarter?

Give me one second here. This quarter, compared to, say, the second quarter of '08, which I think is probably the most relevant, you actually -- the dollar's gotten stronger, so that hurts revenues to a certain extent. So revenues actually dropped by about $4 million compared to Q2 of -- I'm sorry. I was comparing it to last year. To Q2 of '08 was $7.8 million. Compared to last year, it was about $4.2 million.

Okay. And tax rate, we've got the seasonal true-up I guess for lack of a better term, but given you've got 40% of revenues now international and we happen to be the second highest tax rate in the world. What -- can you talk about potential for that tax rate to come down further going forward?

Sure. Actually, that's a question we ask ourselves continually and we do have various initiatives underway to try and get it. Mostly focused on foreign operations. One of the things we're trying to do is consider the use of a European supply company where we actually set something up centralized in a low tax country to basically recognize and trap revenue there and get it taxed in a low tax country. When we do acquisitions in Europe, we also try and use various holding companies where you can trap other income, again, in low tax countries.

A couple of specific ways you can do this. When you talk about taxes, you obviously want to talk generalities, rather than too specific. But one thing you can do for example is move -- appraise all your intellectual property, move it all into a low tax country, and then pay royalties into that low tax country and get your royalty expense in the high tax country. That's one area that we can do it. You can do the same thing with finance, basically lend money from low tax countries to high tax countries. Transfer pricing, you have to be very careful. But again, you can improve your transfer pricing. So probably the chief area that we're looking to reduce our taxes would be in the foreign areas, primarily, in Europe. In the US, you're somewhat limited, but going forward we'll be looking at ways there as well.

Okay. And Al, you touched on working capital earlier and you look, working capital as a percentage of sales, 23.5% in the third quarter, which is up sequentially as well as year-over-year. Not necessarily a bad number, but continuous improvement at the heart. Could you talk about what is going on within working capital specifically and any areas of near-term opportunity there?

There is obviously plenty of opportunity and we're never satisfied -- with our lean culture, continuous improvement in that area is really a complete corporate focus. But our business is a slightly different business than other businesses, when you get into analyzing working capital, because of the nature of our large contracts and the way that we account for them. We get a lot of advanced payment. So we have to really -- we use two metrics when we really judge our ability. One is simple working capital, and then we do a GAAP working capital because we get a lot of that payment upfront, okay, and we go out and we have to buy inventory and there's certain other aspects related to it. So we do track both numbers and we continue to try to show improvement quarter on quarter, year on year. I think that the POLI acquisition -- obviously I think Alvaro pointed out the amount of that working capital gain came -- I think of the $30 million, $21 million of it came from POLI, although we did have a little bit of favorable impact from FX, if you look at the spot rates period to period. So I think there's a tremendous amount of opportunity and we're going to stay focused on that.

Okay.

To give you an example, Jim, and again, I think I said it during the remarks, but I'll emphasize it again. But we think inventory is an area we can do better in and we continue to emphasize it. From at least last year, I'm not sure I have the number in front of me from the last quarter, but since last year we have an increase of customer prepayments of about $30 million. So while some of the working capital balances have been going up, also the customer deposits have been going up. And when you look at it, I think it makes sense to look at it both because a lot of these customers deposits allow us to purchase the inventory and basically finance the unbilled receivables that arise from a long-term contract.

I think if you look at it on a GAAP basis, our inventories are down into the low teens. Is that correct, Pat?

Yes.

Okay. And final question from a -- for a number that won't be disclosed until the Q, but if you look at the spread of margins between freight and transit, given that transit has now become a larger percentage of the overall business and you did experience margin expansion the quarter, what is the gap now between freight and transit?

Since -- I'll give you a history.

Okay.

Okay? If you had third quarter '07, right, and this was all in the public information, it was about 6% spread in the third quarter. If you look for --

Third quarter last year.

Third quarter last year. And if you -- second quarter would be history and that was only a spread of about --

5%.

Almost 5%. 4.9%. So what we've done is -- that's with holding basically the freight margins pretty constant across that timeframe. We've been able to increase our transit margin, which has really been a focus. Working capital and margins in transit has really been two key initiatives that we worked very hard at and we've been able to do it and we will continue that into the future.

Okay.

And again, Jim, I recognize your question because you basically are trying to model it and you're trying to figure out where all these things are going. But for us, the key number where we evaluate ourselves on is really the consolidated operating margin number. That's the one that we want to continue to grow and obviously, whatever means we use to get there. But the key I think is the corporate number.

Fair enough. Thanks a lot, guys.

Thank you.

Our next question is from Kristine Kubacki from Avondale Partners. You may go ahead, please.

Good morning, gentlemen.

Good morning, Kristine.

I have a question regarding -- you guys have a better idea now, the railroads are coming out talking about what they're going to spend on positive train control. And from your end, in terms of also thinking about how many locomotives you're thinking about. From your end, though, what are you thinking about in terms of your rampup in terms of what you guys are going to need in terms of capacity, number of people, and how do you think about that into '09 and possibly going forward from there and green field if that's an option?

As we see the demands increase for positive train control, we think that our current capacity from a manufacturing standpoint is adequate. I think the areas that we would focus on to make sure that these projects move forward properly is project management type of resources, so we have the technology. It's out there. It's been approved by the FRA, the product safety plan's been approved. It really is a project management in getting this. We're also -- we've already for the last year been working on the next generation of vital ETMS systems. So those things are in place. I don't see a big amount of resources or any brick and mortar really required for these demands.

Do you get the sense that from your railroad counterparts that they're going to start developing and start getting to work right away on these types of things, or are they going to wait for looking for a funding source to push them, maybe more of a 2011 timeframe or do you think they need to get going right away?

I think we're seeing a tremendous amount of activity and rightly so. They -- if you look at some of the press releases that the Class 1 railroads have made, they've already agreed on developing an interoperability standards by the four Class 1s. We've been part of those meetings. I think in all cases, and everyone's been working on this, this is not something that has been shelfed. The class ones, the NSF started their program in 2004. We started talking to the UP and Norfolk Southern probably 18 months ago developing a program and we've been working on and CSX actually has the basic framework of our system. That's been installed since the early 2000s. So it's a matter of upgrading some of that framework. So no, they're not idly standing by, but it is going to take time to do. Again, it's a program management thing that needs rolled out and it's a very complex situation because the interoperability, not only between the railroads but you're talking about all commuter locomotives -- so you've got all these transit authorities who are going to also need to be upgraded in order to meet this 2015 deadline.

Okay. And then to switch gears real quick, I just -- you haven't really talked a whole lot about the international business and how you see that progressing, and we've heard of some infrastructure projects obviously with the financial meltdown being stalled or delayed. Is that impacting your international business in any way, and could you give us an update on China as well?

Okay. That's about four questions in there, I think, Kristine. But I'll try remember what they all were. First of all, internationally, we have a lot of activity going on. When you talk about China -- I'll touch on that and I'll come back to it. Their demand, they're slowing down, they're going from 10% to 9% growth anticipated, so their demand for commodities are still there. So on the freight side of things, you have a lot of activity going on in the mining countries that we've talked about before. And that continues.

From the transit side, we play a very small part in the transit markets in Europe and Asia and with the acquisition of POLI, now that we have the product in the development, we just recently attended a trade show in Germany called [Intertrans]. Tremendous amount of interest in our technology and our capabilities and we expect the fact that we have such a small part to offer growth opportunities for us. Back to China, we've been working on some joint venture arrangements. They're progressing well. We still see that market as a very attractive market for us. It is a good growth area. We hope to be able to make some announcements about closing those arrangements before year-end.

Okay. Very good. Thank you. Great quarter, guys.

Thank you.

Our next question is from Scott Blumenthal from Emerald Advisers -- you may go ahead, please.

Good morning, gentlemen.

Good morning, Scott.

Alvaro, did you give an inventory turns number in your commentary?

I did not give an inventory turns number. Typically, the inventory balance is -- the turns number doesn't change that much. Typically, company-wide it's about 6. I think Pat's going to check my math real quick. But I think it tends to be around 6 times. And it really doesn't vary that much. The balances will go up and down but because the sales volume is large enough --

It is an individual metric that we do use for divisions.

It's by unit.

Every unit has a turns metric that we track monthly.

Okay. And Alvaro, could you comment maybe on what type of a benefit, if any, you expect from these precipitous drops in commodity costs, especially being a large consumer of steel and I guess to a little bit lesser extent, copper? Sure. It's gotten to the point -- I'm going to give -- Al, I think gave a relatively long-winded answer, I'd say long, not long-winded, excuse me, to a brief question --

Thanks.

It's actually a a two edged sword in a couple respects. One, we've actually gotten our surcharge mechanism. While they don't cover 100% of the cost of the material increases, they were helping to offset a large, large portion of the cost. So to a certain extent we were pretty well covered by commodity price increases. So what you'll see is a decrease in obviously the cost and you'll also see a decrease in the surcharges. That may cause a slight improvement in margins and really a slight benefit to us going forward and which will be welcome, but it wouldn't be that significant because, again, we were pretty well covered with surcharges. The other effect is really the price of oil. I think the rail industry -- the price of oil got too high and it didn't benefit anyone. But to a certain extent it was oil going up, it helped passenger transit because more people would ride transit, and it helped the freight because they have automatic surcharges to pass on increases in the cost of oil. So with the cost of oil going down, obviously that's going to help our cost picture. But long-term, it may make -- have an effect on the rail, although that's very difficult to tell. So I think short-term, the decrease in the price of oil should have a favorable effect on the operations. And those are the two major commodities.

The other thing we're seeing, Scott, is that as you look at the supply chain, our suppliers are not the people actually mining the ore, so they're very reluctant to try to pass this on. So there is a battle out there as these commodities do drive down, and we're fighting very hard to get the advantage that Alvaro talked about.

Jim asked the question about working capital. I was wondering how much of a benefit such a thing would be to you in that respect.

Yes, see, working capital, while we do not talk about hedging before, right now we have a natural hedge in that as the dollar, say for example, strengthens, our cost centers in Canada become cheaper. But our foreign operations, the profits are a little bit less. And they tend to offset each other and we watch that every quarter. And so far it's been true. I mean, it could be $0.5 million one way or the other, but you're always going to get that when you have about 40% international sales like we do and the cost centers. What FX is going to have, if the dollar strengthens, obviously's going to have a decreased effect on sales because the centers in Canada are cost centers, rather than revenue centers. But bottom line, so far they've been having a relatively neutral effect. And as the dollar strengthens, then our working capital benefits. As it weakens, it denigrates. And Pat also did a quick calculation and it's pretty -- our total inventory turns are pretty much what I thought. On a year-to-date basis they're about 6 turns, year-to-date. I'm sorry, third quarter. It's a little less because POLI, the addition of POLI and a few other factors. And one last point on the FX, is the impact on commodities.

One last point on FX is the impact on commodities. One thing we're looking at now, we were exploring just the other day is actually the dollar strengthened significantly against the Euro, which may make buying commodities from other sources like in Europe more attractive. And we're continually looking at that to make sure we have the cheaper source.

Okay. Great point. Can you talk about also -- it appears as though the backlog has really hung in there nicely. I guess you're giving us a net backlog number. Have you seen any cancellations at all in there?

No, we haven't seen any cancellations. Our backlog's hanging up -- division, division, there's some little swings. But if you look, 55% of our backlog flows out in the next 12 months, 20% of our total backlog is still freight. 30% of our backlog is international. And we've really been tracking all those, so no indications up to this point.

Okay. Terrific. Thank you.

Thank you.

Our next question is from John Barnes from BB&T Capital Markets. You may go ahead, please.

Good morning, guys.

Good morning, John.

Going back to positive train control, ETMS, I just want clarification in terms of what guidance you've given in terms of -- you said $200 million to $400 million over a five-year period. Is that $200 million to $400 million a year over a five-year period or is that the total amount you -- of revenue you expect to generate over five years?

That's total amount over the five years. I'm glad you asked that so there's no confusion.

Okay. Now, when I've talked to the railroads, visited one recently, they've put a price tag on this system much higher than that -- much, much higher than that, and I'm kind of curious. Two questions. Number one, why would their price tag be so much different from what you're forecasting? And then secondly, given that the impetus behind this bill has been accidents between freight and commuter rails and that type of thing and it seems like that's where the focus is, does the number of users of ETMS go up significantly if the commuter rails are also forced into some positive train control?

Okay. Good questions, John. First of all, the commuter rails will have to have positive train controls. So they will have to be able to interoperate with the freight lines. So yes, the number of users, the number -- and that's why the time period here is really going to be a challenge, to have all those systems on, just from a project management standpoint -- not from the fact of the product or the technology, because the technology is already proven and has been proven and approved. But back to your question on why they put a different price tag on, if you look at -- you have to understand that the total implementation of this really has a lot of other factors involved. What we're supplying is basically the system that goes on the locomotive that communicates with other areas and it has to communicate with the wayside. It communicates with the back office or the dispatch system and there is also the communication system that is used in it. That total price tag, people have estimated close to $2 billion when it's all done. Of that $2 billion, about 35% of it is related to the positive train control system that we would supply, so it's a much smaller number that's available. And there will be other players in this market as we go forward and that's all factored in there.

Okay.

But they'll spend just as much on the wayside. Meaning what they have to do is set up some type of communication on those switches that are actually communicating with that onboard computer. You have an onboard computer that communicates with GPS. It communicates with where all these signals and switches are. It communicates with the dispatch system which is the main office and it takes all that information. There is a number of other companies that would be involved in some of that product, especially related to the wayside or the switch gear. Okay?

Okay. Once it's installed, what's the recurring revenue stream once the system is in place?

Well, obviously there has to be a maintenance factor associated with this product and also system upgrades as we proceed. We also, as I mentioned, we're working on the next system which would really get into doing some of the safety critical functions. Today, the system that's employed and approved is a safety overlay system that only acts if the engineer of the locomotive violates one of the limits or -- whether it's a speed limit, authority limit, going into a work zone, so it would shut the train down. In this next system, it would actually do some of the switching. It can do some of the safety critical evolution. So there's more revenue opportunities potential, one, from the maintenance side of things and upkeep and two, upgrading the system as time goes on.

Okay. And then how many customers right now do you have for ETMS that are actually either in a test phase, a deployment phase, or what have you?

We're working with probably indirectly with all the Class 1s and we've also been working with a number of the commuter transit authorities as well. So I would say there's probably eight to 10 different people that we have an ongoing discussion or a program with.

Okay. And then one question on the backlog. The increase in freight from a rolling 12 month basis -- is it safe to say the increase was as a result of rolling off last quarter and rolling on the three months at the end, that you're starting to see maybe some of the forward orders a little bit out? And that's why we're seeing a bump-up in the freight backlog? Or do you think you actually saw some strength there in terms of orders and that type of thing?

We haven't read into that far. We don't -- when you know that ton miles is basically -- last quarter we reported ton miles up 1.8%, this quarter 0.8%, you look at carloadings, down, I think that this particular trend wasn't something that we could really put our arms around and get excited about, especially with the railcar builds that we're anticipating.

All right. Very good.

We don't read too much into the freight backlog. I think the good sign is it's showing that the market is relatively stable and that's a good thing. I wouldn't read too much that it's increasing or decreasing, but basically that it's stable, which is a good thing.

All right. Thanks for your time, guys.

Thank you.

Our next question is from Steve Barger from KeyBanc. You may go ahead, please.

Good morning, guys. This is actually Joe Box filling in for Steve.

Hey, Joe.

Given some of your strategic initiatives on the freight side and excluding the Standard acquisition, just wondering if you think you could grow top line in an environment where you've got declining railcar builds and potentially lower ton miles from the Class 1s?

Obviously, we can't provide guidance going forward, but keep in mind our strategic initiatives are not one facet. We really feel there's a lots of opportunities for us to expand globally in the freight market. We also look at what we call market expansion. That's to take that technology that we have in the freight markets and look at other market applications with it. Current technologies, new markets. Right today, 10% of our business that is included in the freight is outside of the freight market, actually. We look at new products and new product development and really we've been talking about the opportunity here with positive train control and electronic controlled pneumatics and other things that we're offering. So those are opportunities for us. We're always looking for acquisitions and we really want to maintain that aftermarket percentage or even improve on it. So we are pleased with our opportunities and our approach and it's a matter of executing toward those.

Okay. Thanks for that. You guys did a good job of laying out the opportunity for PTC. The $200 million to $400 million that you laid out, is that for an overlay system or is that for a vital system?

Basically, it's to go out with the current overlay system to meet the current demands based on the safety bill. So we may have -- if there's interest, there may be other opportunities for us. And even if we're able to look at upgrades, obviously.

Okay. And my last question is going to be for Alvaro. You reported $1 million in purchase cost on the SG&A side and $2 million to COGS in the quarter. Can you give us a sense of what that's going to look like for the POLI acquisition in 4Q?

Yeah, in 4Q I think we're going to have $2 million in total. $2 million in total versus $3 million. And then after that, it should start to wind down.

Very good. Thanks, guys.

Thank you.

Our next question is from Greg Halter from Great Lakes Review. You may go ahead, please.

Good morning, guys and thanks for taking my questions.

Our pleasure.

Couple of clarifications. Alvaro, did you say that cash is $186 million at 9/30?

Yes, that's correct.

Okay. And looking at your receivables, two questions really there. One is to the quality of those and second is ex POLI, looks like they're still up about 34%, although I don't know what the currency impact was, still probably up 30%. Wonder if you could comment on the increase year-over-year as well as the quality?

Okay. I think in terms of the quality, I touched upon that, that we conducted this review for our Board for our own internal purposes. And one of the benefits we have for example in transit, we're dealing with municipalities, we're dealing with very large well-financed companies. And so for the most part in transit I think the receivables are in pretty good shape. Similarly in freight. In freight you're dealing with the Class 1s, the car builders, relatively strong, they're coming off very strong periods. So in terms of quality of the receivables, we've actually looked at them in detail on a unit by unit basis because that is the same question we had internally. And we think we're in pretty good shape there and whatever reserves we have, which aren't very big, we think adequately cover it.

In terms of increases, part of that is POLI. Part of that is increased sales. And part of that is, again, these long-term contracts. When you get into a long-term contract, the percentage of completion revenue recognition is different than the billing cycle, so you could have a build-up in receivables. What we try and do is make our long-term contracts at worst cash neutral. And we take a lot of pains in doing that, and that's why when you take a look at receivables, you also have to look at customer deposits which have gone up by about $32 million since the beginning of the year. It's really a combination of all those three things.

That is very helpful. I don't know if you provided the amount of debt at 9/30 as well as the equity balance?

The amount of debt at 9/30 is basically the $150 million of bonds that we've had outstanding for quite some time. Actually if you take the cash, which is the way that we look at it, and you offset the net debt -- we're positive $36 million. We have more cash than we have debt, which is a nice position to be in during these turbulent times. In terms of shareholders' equity, we don't look at it that, that much, say in terms of financing the strength of our financial position, we tend to look at debt to EBITDA ratios. In our capital structure we have some capital stock transactions, some Treasury stocks -- we have lot of things going in and out of it. In our mind it's a good measure of liquidity, is that EBITDA. But basically I think our total shareholders' equity will be somewhere around $675 million to $690 million to $685 million, somewhere in there -- it's going to vary between those numbers.

That's perfect. And I believe you said that the foreign currency had an impact of dropping your sales by about $4 million in the quarter. Was that correct?

Yes, because basically, again, bottom line is relatively neutral, but when the dollar strengthens, our revenues from the operations overseas are going to be less. But we get a benefit from our cost centers in Canada, so bottom line, they tend to wash, but revenues will show a decrease when the dollar strengthens.

It was a decrease when compared to second quarter to third quarter, but if you compare third quarter '07 to '08, it was a positive $2 million.

Okay. Okay. And finally, you talked about cash a little bit. Just wondering where that's held and if you have any of these instruments that have been getting some of the news lately.

The fortunate thing is that we used to have some of the ABRs, some of the financial institutions were pushing them, but about six to nine months ago, we just decided we just want to keep things liquid. We saw a few of these acquisitions coming down the horizon and we said we don't want to be in a position where we have cash in an instrument that we can't get at for an acquisition, so we basically put it in very liquid money market accounts. Now we've taken some of the domestic cash and put it in Treasury money markets to make sure the principal value stays constant. The cash of $186 million, very roughly I would probably say --- let's say $100 million to a little less of that's domestic, and the balance is abroad, and what we continue to look at is ways to repatriate that cash without adverse tax consequences. Jim Lucas asked earlier about our tax strategy, and that's a key element of our tax strategy -- how can we get some of that cash, or utilize it. When we do a POLI, we actually utilize the cash that we have abroad to make that acquisition rather than domestic cash, which was a good use of it. So we constantly evaluate a way to use that cash but it's in short-term money market funds or Treasury funds.

Great. Thank you very much.

Thank you.

Our next question is from Wendy Caplan from Wachovia. You may go ahead, please.

Hi, I know you want to stop soon because it's 11, but just a quick clarification. Al, the interoperability issue that you raised with the Class 1s and the transit authority, does that imply that it's likely that Wabtec would be a single source supplier of this system, since yours is already there and perhaps you license your technology to another? What's the competitive situation in that market?

Obviously, I think a possibility exists, Wendy. However, I think being realistic, the railroads have always tried to act in a way that would -- you would have a couple suppliers, at least two suppliers and actually they like two. They don't like more than two. So whether we license someone else or not, I don't know. When you look at the interoperability, the biggest thing there is for all of them to agree on the communications network that's required, and I think they're coming very close to that and that's where the focus has been and we actually are involved in that part of the train control system ourselves. So there's some good opportunity there. We're excited. If you look at what Wabtec did, I mean this goes all the way back to an acquisition that was made -- it was a strategic acquisition was made of Rockwell business, it was their train control system. We had acquired electronics division down in Germantown, Maryland and they saw the opportunity for positive train control, which Rockwell was working on. We have actually continued to develop this technology for a lot of years, without any funding or even any revenues. So I think that it's going to take a lot of effort on all of our part to bring this to commercialization, but we're really excited about the opportunity that we have right now.

Thanks so much, Al.

Thank you, Wendy.

Our next question is from Dennis Sabo from Douglas Capital. You may go ahead, please.

Thank you for taking my call. Good quarter. As you look out over the acquisition landscape, I was just curious to see if there were any specific targets that you may be looking at, and does the weakened economy maybe present some more opportunities than normally? And I guess secondly, seems like you do have a good bit of dry powder on the balance sheet. What would you be willing to take the leverage ratio up in order to maybe do some more acquisitions? Thank you.

We've stated time and time again, we feel that a debt of 2 to 2.5 times our EBITDA would be something that we would consider livable. As far as specific acquisitions, I really can't comment on that. But I will comment on the fact that we do have -- our pipeline is flowing, we've got some opportunities. The landscape has changed. I think the number of deals really hasn't changed, but the number of deals that are strategic are probably higher than those with private equity right now. I think you're also seeing that the same credit crunch, money is no longer free, nor is it as available, so it's very tight right now. I think all those dynamics play in and we continue to be very active and although active, we will maintain our discipline and only going forward on those strategic acquisitions that meet our criteria. Okay? Yes, thank you.

Thank you.

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With that, we really thank you all for your participation and look forward to talking to you early next year again. Thank you.

Thank you, everyone.

This concludes today's Wabtec conference call. Thank you very much for your participation.