WAB

Business Context and Reporting Period

Company: Westinghouse Air Brake Technologies Corporation (Wabtec)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: March 31, 2007
Business Overview: Wabtec is a global provider of technology-based products and services for the rail industry, operating in 11 countries. Approximately 37% of revenues in the first quarter 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 19.8% ($51.9 million) driven by internal growth in locomotive build contracts ($19 million), transit car refurbishment ($9.6 million), and radiator equipment ($8.9 million), as well as $19.7 million from acquisitions completed in late 2006. This was partially offset by a $10.7 million decrease due to lower freight car deliveries.
• Profitability: Net income rose 27.3% to $25.5 million. Operating income increased 30.3% to $42.1 million. Despite sales growth, gross margin percentage declined slightly from 28.6% to 27.5% due to a revenue mix shift toward Transit OEM contracts, which typically carry lower margins.
• Cash Flow: Operating cash flow decreased significantly by $26.3 million to $18.8 million. This decline was primarily due to a $57.4 million increase in accounts receivable (collections lagged compared to Q1 2006) and increased inventory levels, despite higher net income.
• Segment Performance: Transit Group sales surged 59% to $129.6 million, while Freight Group sales grew modestly by 2% to $184.7 million.

Guidance, Outlook, Risks, and Unusual Items

• Outlook: Management expects generally favorable conditions in freight and passenger transit markets for 2007. Demand for new locomotives is projected to be slightly higher than 2006, while new freight car demand is expected to be slightly lower. A strong backlog of transit projects is anticipated to drive future revenue.
• Unusual Items:
  • Acela Claim Provision: The company recorded a $2.5 million liability in Q1 2007 related to a tentative commercial resolution with Bombardier regarding brake disc cracks on Amtrak's Acela Express. The potential settlement framework could total up to $4.4 million through 2009.
  • Restructuring: Additional severance, pension, and asset impairment charges of $1.1 million were recorded in Q1 2007 related to Canadian operations.
  • Accounting Change: Adoption of FIN 48 (Accounting for Uncertainty in Income Taxes) on Jan 1, 2007, resulted in a $2.7 million reduction to retained earnings and established a $13.5 million liability for unrecognized tax benefits.
• Risks: Key risks include raw material cost increases, foreign currency fluctuations, potential curtailment of customer spending, and ongoing litigation regarding asbestos claims (though management believes these will not be material) and the Acela matter.

Investor Verification Checklist

• Cash Conversion: Verify the sustainability of operating cash flows given the significant increase in accounts receivable and inventory relative to net income growth.
• Margin Mix: Monitor the shift in revenue mix between Freight and Transit segments, as Transit OEM contracts currently exert downward pressure on gross margins.
• Acela Settlement: Track the finalization of the Bombardier settlement framework to confirm if the total liability remains within the $4.4 million maximum.
• Freight Market: Watch industry freight car order volumes, which slowed significantly in Q1 2007 (11,152 orders vs. 35,991 in Q1 2006), to assess future revenue stability.
• Debt Covenants: Confirm continued compliance with the Refinancing Credit Agreement covenants, specifically the minimum interest coverage ratio of 3.0 and maximum debt-to-cash flow ratio of 3.25.