WAB

Business Context and Reporting Period

Company: Westinghouse Air Brake Technologies Corporation (Wabtec)
Filing Type: Form 10-Q (Unaudited)
Reporting Period: Quarter and six months ended June 30, 2006
Business Overview: Wabtec is a global provider of technology-based products and services for the rail industry, including braking systems, electronics, and couplers for freight and transit vehicles. Operations span 11 countries, with approximately 32% of revenue generated outside the U.S. in the first half of 2006.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue: Six-month sales increased 3.2% to $524.3 million, driven by a $38 million increase in freight component sales due to strong freight car deliveries. This was partially offset by a $14 million decrease in transit air conditioning renovation contracts and an $8 million decrease in locomotive module sales compared to 2005.
• Profitability: Net income for the six months ended June 30, 2006, surged 68.8% to $41.2 million. Gross margin expanded from 24.2% to 29.0%, primarily due to improved performance on a locomotive module contract (turning a loss in 2005 into a profit in 2006) and cost savings from lower-cost suppliers.
• Operating Expenses: Increased 6.7% year-over-year for the six-month period, largely due to the adoption of SFAS No. 123(R) requiring fair value accounting for stock-based compensation ($6.0 million expense in 2006 vs. $0.6 million in 2005).
• Cash Flow: Operating cash flow improved significantly to $73.5 million (vs. $30.3 million in 2005), aided by a $59 million improvement in accounts receivable collections related to locomotive contracts.

Guidance, Outlook, Risks, and Unusual Items

• Restructuring Plan: On July 19, 2006, the Board approved a plan to downsize two Canadian plants. This will result in approximately $11 million in pre-tax expenses (pension curtailments and asset write-downs) recognized in late 2006 and early 2007.
• Share Repurchase: The Board authorized a $50 million share repurchase program on July 31, 2006, with no set time limit.
• Legal Contingencies:
  • Asbestos: Claims continue against subsidiary RFPC. Management believes final resolution will not be material to financial position, citing insurance coverage and lack of assumed liability.
  • Acela Brake Discs: Wabtec is involved in disputes regarding cracked brake discs on Amtrak's Acela trains. While Bombardier and Knorr reported $48 million in costs, Wabtec asserts Faiveley Transport is fully responsible and does not believe it has material legal liability.
  • India Compliance: An internal investigation into a subsidiary (Pioneer Friction Limited) in India revealed potential violations of laws regarding disbursements. No reserve has been recorded as exposure cannot be estimated.
• Outlook: Management expects continued growth driven by increasing freight car orders (backlog at 85,692 units) and ramp-up of large transit contracts in late 2006 and 2007. Risks include raw material costs (steel), foreign currency fluctuations, and customer spending curtailments.

Investor Verification Checklist

• Stock-Based Compensation Impact: Verify the sustainability of earnings growth given the significant one-time increase in stock-based compensation expense due to SFAS 123(R) adoption.
• Restructuring Costs: Monitor the timing and magnitude of the $11 million restructuring charge related to Canadian plant downsizing in the second half of 2006.
• Legal Exposure: Track developments in the Acela brake disc litigation and the India compliance investigation to assess potential for unrecorded liabilities.
• Freight Cycle Dependence: Confirm the correlation between Wabtec's revenue growth and the broader freight rail industry's carloading and new car order statistics.
• Warranty Reserves: Review the $2.0 million increase in warranty reserves, specifically regarding freight components and electronic products, to ensure adequacy against future claims.