WAB

Business Context and Reporting Period

Company: Westinghouse Air Brake Technologies Corporation (Wabtec)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2007
Business Overview: Wabtec is a global provider of technology-based products and services for the rail industry, operating in 11 countries. Approximately 38% of revenues in the first six months of 2007 originated outside the U.S. The company operates two primary segments: Freight Group and Transit Group.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Net sales increased 24.4% in Q2 2007 and 22.1% for the six-month period compared to 2006. Growth was driven by internal expansion in locomotive contracts, transit car refurbishment, and acquisitions (Ricon, Schaefer, Becorit). This offset a decline in freight car deliveries.
• Profitability: Net income rose 33.0% in Q2 and 30.3% for the six months. Operating income increased 29.4% in Q2. However, gross margins compressed slightly (27.9% vs. 29.4% in Q2) due to a revenue mix shift toward lower-margin Transit OEM contracts and restructuring charges.
• Cash Flow: Operating cash flow decreased significantly to $26.2 million for the six months ended June 30, 2007, from $73.2 million in the prior year. This was primarily due to a $52.1 million decrease in cash collected from accounts receivable and increased inventory investment.
• Acquisitions: The company acquired Ricon Corporation for $73.3 million in June 2007, resulting in $45.1 million of preliminary goodwill. Total goodwill increased to $224.1 million.

Guidance, Outlook, and Risks

• Market Outlook: Management expects demand for new locomotives to be slightly higher than 2006, while demand for new freight cars is expected to be lower. The transit market is viewed favorably due to increased ridership and federal funding.
• Restructuring: A restructuring plan approved in July 2006 to downsize Canadian plants resulted in $4.0 million in charges for the six months ended June 30, 2007. Total charges to date are $10.8 million.
• Legal Contingencies:
  • Acela Claim: A potential settlement framework with Bombardier regarding Amtrak Acela brake disc issues is in place, with a maximum potential payment of $4.4 million. A $2.5 million provision was recorded in Q1 2007.
  • Asbestos: Claims continue to be filed against subsidiary RFPC. Management believes the ultimate liability will not be material to financial position, citing insurance coverage and lack of legal liability for Wabtec.
  • India Compliance: An internal investigation into a subsidiary in India revealed potential violations of laws regarding disbursements. Management has informed authorities; penalties are possible but deemed inconsequential to overall operations.
• Liquidity: The company maintains a $175 million revolving credit facility with $152.1 million available. It holds $150 million in 6.875% Senior Notes due 2013.

Investor Verification Checklist

• Freight Car Demand: Verify the sustainability of the slowdown in new freight car orders (22,747 in H1 2007 vs. 54,181 in H1 2006) and its impact on the Freight Group segment.
• Acquisition Integration: Monitor the integration and performance of the Ricon acquisition, which added significant goodwill ($45.1 million) and sales volume.
• Cash Conversion: Investigate the reasons for the sharp decline in operating cash flow, specifically the $52 million reduction in cash collected from receivables compared to the prior year.
• Margin Pressure: Assess whether the shift in revenue mix toward Transit OEM contracts will permanently lower gross margins or if cost-saving initiatives will offset this trend.
• Legal Exposure: Track the finalization of the Bombardier/Acela settlement and any developments regarding the India compliance investigation.