Form 10-K
Table of Contents

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-K

 

x Annual report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the fiscal year ended December 31, 2003

 

Or

 

¨ Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the transition period from                      to                     

 

Commission file number 1-13782

 

WESTINGHOUSE AIR BRAKE TECHNOLOGIES

CORPORATION

(Exact name of registrant as specified in its charter)

 

Delaware   25-1615902

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

1001 Air Brake Avenue

Wilmerding, Pennsylvania 15148

  (412) 825-1000
(Address of principal executive offices, including zip code)   (Registrant’s telephone number)

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Class


 

Name of Exchange on which registered


Common Stock, par value $.01 per share   New York Stock Exchange

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for at least the past 90 days. Yes þ No ¨.

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. þ

 

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes þ No ¨

 

The registrant estimates that as of June 30, 2003, the aggregate market value of the voting shares held by non-affiliates of the registrant was approximately $448 million based on the closing price on the New York Stock Exchange for such stock.

 

As of March 11, 2004, 44,687,830 shares of Common Stock of the registrant were issued and outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE:

 

Portions of the Proxy Statement for the registrant’s Annual Meeting of Stockholders to be held on May 19, 2004 are incorporated by reference into Part III of this Form 10-K.

 



Table of Contents

TABLE OF CONTENTS

 

          Page

     PART I     

Item 1.

   Business    2

Item 2.

   Properties    9

Item 3.

   Legal Proceedings    10

Item 4.

   Submission of Matters to a Vote of Security Holders    10
     Executive Officers of the Company    10
     PART II     

Item 5.

   Market for Registrant’s Common Stock and Related Stockholder Matters    12

Item 6.

   Selected Financial Data    13

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    14

Item 7A.

   Quantitative and Qualitative Disclosures About Market Risk    25

Item 8.

   Financial Statements and Supplementary Data    26

Item 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    26

Item 9A.

   Controls and Procedures    26
     PART III     

Item 10.

   Directors and Executive Officers of the Registrant    26

Item 11.

   Executive Compensation    26

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters    26

Item 13.

   Certain Relationships and Related Transactions    26

Item 14.

   Principal Accountant Fees and Services    26
     PART IV     

Item 15.

   Exhibits, Financial Statement Schedules, and Reports on Form 8-K    27

 

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Table of Contents

PART I

 

Item 1. BUSINESS

 

General

 

Westinghouse Air Brake Technologies Corporation, doing business as Wabtec Corporation, is a Delaware corporation with headquarters at 1001 Air Brake Avenue in Wilmerding, Pa. Our telephone number is 412-825-1000, and our website is located at www.wabtec.com. All references to “we”, “our”, “us”, the “Company” and “Wabtec” refer to Westinghouse Air Brake Technologies Corporation and its subsidiaries. Originally founded by George Westinghouse in 1869, Westinghouse Air Brake Company (“WABCO”) was formed in 1990 when it acquired certain operations from American Standard, Inc. (ASI). The current business includes the combined assets from the November 1999 merger of WABCO and MotivePower Industries, Inc. (“MotivePower”).

 

Wabtec is one of the world’s largest providers of value-added, technology-based equipment and services for the global rail industry. We believe we hold a greater than 50% market share in North America for our primary braking-related equipment and a number 1 or number 2 position in North America for most of our other product lines. Our highly engineered products, which are intended to enhance safety, improve productivity and reduce maintenance costs for customers, can be found on virtually all U.S. locomotives, freight cars and passenger transit vehicles. We are a “Tier 1” supplier with approximately 44% of our net sales in 2003 to Original Equipment Manufacturers (OEMs). In 2003, the Company had sales of $717.9 million and net income of $22.7 million.

 

Management and insiders of the Company own approximately 12% of Wabtec’s outstanding shares, with the balance held by investment companies and individuals. Executive management incentive compensation focuses on earnings, cash flow and working capital targets to align management interests with those of outside shareholders.

 

Industry Overview

 

The Company primarily serves the worldwide freight and passenger transit rail industries. The worldwide market for rail equipment has been estimated at about $70 billion annually, and it is estimated to grow at about 4% annually for the next five years. Our operating results are largely dependent on the level of activity, financial condition and capital spending plans of the global railroad industry. Many factors influence the industry, including general economic conditions; rail traffic, as measured by freight tonnage and passenger ridership; government investment in public transportation; and investment in new technologies by freight and passenger rail systems. Customers in North America account for about 79% of Wabtec’s sales.

 

In North America, railroads carry about 42% of intercity freight, as measured by ton-miles, which is more than any other mode of transportation. They are an integral part of the continent’s economy and transportation system, serving nearly every industrial, wholesale and retail sector. Through direct ownership and operating partnerships, U.S. railroads are part of an integrated network that includes railroads in Canada and Mexico, forming what is regarded as the world’s most- efficient and lowest-cost freight rail service. There are more than 500 railroads operating in North America, with the largest railroads, referred to as “Class I,” accounting for more than 90% of the industry’s revenues. Although the railroads carry a wide variety of commodities, coal accounts for the most tons and revenues (about 45% and about 20%, respectively, in 2003). Intermodal traffic – the movement of trailers or containers by rail in combination with another mode of transportation – has been the railroads’ fastest-growing market segment in the past 10 years. Railroads operate in a competitive environment, especially with the trucking industry, and are always seeking ways to improve safety, cost and reliability. New technologies offered by Wabtec and others in the industry can provide some of these benefits.

 

Outside of North America, most of the rail systems have historically been focused on passenger transit, rather than freight. In recent years, however, railroads in countries such as Australia, India and China have been investing capital to expand and improve both their freight and passenger rail systems. Throughout the world, government-owned railroads are being sold to private owners, who often look to improve the efficiency of the rail system by investing in new equipment and new technologies. These investment programs represent additional opportunities for Wabtec to provide products and services.

 

In the U.S., public transportation is a $32 billion industry, dependent largely on funding from federal, state and local governments, and from fare box revenues. With about 40% of the nation’s transit vehicles, New York City is the largest transit market in the U.S. Transit ridership is near an all-time high, after increasing throughout the 1990’s due to steady growth in the U.S. economy. Ridership declined 1.3% in 2002, however, as the economy slowed. Based on preliminary figures for 2003, ridership is expected to decline at about the same rate. In response to lower fare box revenues and government funding cutbacks, transit authorities have delayed capital expenditures for new equipment and deferred maintenance on existing equipment. New York City, however, has continued to invest in new equipment, as demonstrated by its order for up to 1,700 new subway vehicles, including options, which are expected to be delivered beginning in 2006.

 

Demand for our products and services in North America are driven by a number of factors, including:

 

Rail traffic. The Association of American Railroads (AAR) compiles statistics that gauge the level of activity in the freight rail industry. Two important statistics are revenue ton-miles and carloadings, which are generally referred to as “rail traffic”. According to preliminary AAR estimates for 2003, revenue ton-miles increased about 1.9% and carloadings increased about 0.4% compared to

 

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2002. This is the first year since 1999 that both measures increased in the same year, which we believe should maintain an improving marketplace for Wabtec. As rail traffic increases, we believe that our customers will increase their level of spending on equipment and equipment maintenance.

 

Demand for new locomotives. Currently, the active locomotive fleet in the North American market is about 20,000 units. The average number of new locomotives delivered over the past 10 years was about 1,000 annually. In 2003, about 750 new, heavy-haul locomotives were delivered, down from 969 in 2002. In 2004, we expect the industry to deliver about 1,050 new locomotives, as railroads opt to purchase new units before stricter U.S. federal government emissions standards take effect in January 2005.

 

Demand for new freight cars. Currently, the active freight car fleet in North America is about 1.3 million units. The average number of new freight cars delivered over the past 10 years was about 50,000 annually. In 2003, new freight car deliveries were substantially below the 10-year average for the third consecutive year (about 31,400 compared to about 17,700 in 2002). We expect that about 37,500 new units will be delivered in 2004 and that the rate of new deliveries will continue to increase by about 10% in the next several years to meet railroad demand.

 

Demand for North American transit products is driven by a number of factors, including:

 

Replacement, building and/or expansion programs of transit authorities. These programs are funded in part by national and local government programs. Currently, the U.S. federal government is considering a new spending proposal, known as SAFETEA, that would provide federal funding for transit projects for the fiscal years 2004-09. Although the amount of future funding is yet to be finalized, the current proposal calls for a funding level of about $7.2 billion in fiscal year 2004 (about the same as in fiscal year 2003), with annual increases of about 2% per year through fiscal year 2009. The amount of funding in the legislation will have an impact on the capital spending plans of transit authorities. In recent years, U.S. federal funding for transit projects has generally served as a countercyclical balance during the downturn in our freight rail markets. The average annual number of new transit car deliveries over the past 10 years was about 600 units. In 2003, we estimate that about 670 transit vehicles were delivered compared to 1,320 in 2002. The decrease was due to the completion of a major multiple-year car replacement program for New York City. In late 2002, New York City placed another major order for new subway cars, with deliveries expected to begin in 2006. Management expects the annual transit vehicle delivery rate to be in the range of 500-800 units for the next several years as disclosed under item 7 of this report.

 

Ridership levels. Ridership on U.S. transit vehicles increased steadily from 1995-2001. In 2002, ridership decreased for the first time since 1995 due to higher unemployment levels in the U.S. The lower ridership level, as well as government funding cutbacks, negatively impacted aftermarket spending in 2002 and 2003. We anticipate that the current underspending will create a pent-up demand for maintenance and service work when ridership and funding levels increase in future years.

 

Business Segments and Products

 

We provide our products and services through two principal business segments, the Freight Group and the Transit Group. The Freight Group manufactures and services components for new and existing freight cars and locomotives, while the Transit Group does the same for passenger transit vehicles, typically subways and buses. Both business segments serve OEMs and provide aftermarket services with the aftermarket accounting for about 56% of net sales. In 2003, the Freight Group accounted for 73% of our total net sales, and the Transit Group accounted for the remaining 27%. In 2003, the Freight Group generated 39% of its net sales from OEMs and Class I railroads and 61% of its net sales from the aftermarket, while the Transit Group generated 59% of its net sales from OEMs and 41% of its net sales from the aftermarket. A summary of our leading product lines across both of our business segments is outlined below.

 

Brakes and related components

 

Brake assemblies

 

Draft gears, couplers and slack adjusters

 

Air compressors and dryers

 

Railway electronics, including event recorders, control and monitoring equipment, and end of train devices

 

Friction products

 

Rail and bus door assemblies

 

Heat exchangers and cooling systems

 

Sanitation systems and locomotive refrigerators

 

Switcher and commuter locomotives

 

Heating, ventilation and air conditioning systems

 

We manufacture, sell and service high-quality electronics for railroads in the form of on-board systems and braking for locomotives and freight cars. We harden our products to protect them from severe conditions, including extreme temperatures and high-vibration environments. Recently, we have concentrated our new product development on extending electronic technology to braking and control systems.

 

We have become a leader in the rail industry by capitalizing on the strength of our existing products, technological capabilities and new product innovation. Our new product development effort has focused on electronic technology for brakes and controls. Over the past several years, we introduced a number of significant new products including electronic brakes and Positive Train Control equipment that encompasses onboard digital data and global positioning communication protocols. The Transit Group also focuses on new product development

 

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and has introduced a number of new products during the past several years. Supported by our technical staff of over 500 engineers and specialists, we have extensive experience in a broad range of product lines, which enables us to provide comprehensive, systems-based solutions for our customers. We currently own over 2,000 active patents worldwide and 500 U.S. patents. During the last three years, we have filed for more than 150 U.S. patents in support of our new and evolving product lines.

 

For additional information on our business segments, see Note 20 of “Notes to Consolidated Financial Statements” included in Part IV, Item 15 of this report.

 

Competitive Strengths

 

Our key strengths include:

 

Leading market positions in core products. Dating back to 1869 and George Westinghouse’s invention of the air brake, we are an established leader in the development and manufacture of pneumatic braking equipment for freight and passenger transit vehicles. We have leveraged our leading position by focusing on research and engineering to expand beyond pneumatic braking system components to supplying integrated parts and assemblies for the whole locomotive through the end-of-train. We are a recognized leader in the development and production of electronic recording, measuring and communications systems, highly engineered compressors and heat exchange systems for locomotives and a leading manufacturer of freight car components, including electronic braking equipment, draft gears, brake shoes and electronic end-of-train devices. Additionally, we are a leading provider of complete door systems and couplers for passenger and transit vehicles.

 

Breadth of product offering with a stable mix of OEM and aftermarket business. We believe that our substantial installed base of products to the OEMs is a significant competitive advantage for providing products and services to the aftermarket because end-users often look to purchase safety and performance-related replacement parts from the original supplier. In addition, we believe our product portfolio is one of the broadest in the rail industry, as we offer a wide selection of quality parts, components and assemblies across the entire train. Over the last several years, approximately 50% of our total net sales have come from our aftermarket products and services business.

 

Leading design and engineering capabilities. We believe a hallmark of our relationship with our customers has been our leading design and engineering practice, which has, in our opinion, assisted in the improvement and modernization of global railway equipment. We believe both our customers and the federal transit authorities value our technological capabilities and commitment to innovation, as we seek not only to enhance the efficiency and profitability of our customers, but also to improve the overall safety of the railways through continuous product improvement.

 

Significant barriers to entry. We believe that there are a number of company- and industry-specific factors that represent meaningful barriers to entry:

 

  Proprietary product offering. We have an established record of product improvements and new product development. We have assembled a wide range of patented products, which we believe provides us with a competitive advantage.

 

  Substantial installed base. We believe our installed base presents a meaningful barrier to entry in both the new product market and the aftermarket. As OEMs and Class I railroad operators attempt to modernize fleets with new products designed to improve and maintain safety and efficiency, new products must be designed to be interoperable with existing equipment. We believe our dedicated research and development staff and comprehensive product offering enables us to leverage our installed base to maintain our leadership position with OEMs and the Class I railroads. Similarly, we believe our substantial installed base makes us a preferred supplier in the aftermarket, as end-users typically prefer to source performance and safety-related replacement parts and service from the original product supplier.

 

  Regulatory nature of the rail industry. Oversight of the U.S. rail industry is governed by a number of federal regulatory agencies, including the National Transportation Safety Board (NTSB), the Federal Railroad Administration (FRA) and the AAR. These groups mandate rigorous manufacturer certification and new product testing and approval processes that we believe are difficult for new entrants to meet cost-effectively and efficiently without the scale and extensive experience we possess.

 

Experienced management team. Our management team has over 150 years of combined experience with the Company, and implemented numerous initiatives that enabled us to manage the sharp cyclical downturn in the rail supply market in 2001 and 2002. Our management team has implemented the Wabtec Quality and Performance System (QPS), an ongoing program that focuses on “lean manufacturing” principles and continuous improvement across all aspects of our business. In addition, in 2001, we completed a plan to eliminate excess manufacturing capacity by closing several facilities, realigning operations, reducing head count and divesting certain non-core assets. Since 2000, we have also reduced our debt by approximately $350 million, lowering our percentage of debt to book capitalization from 73% at December 31, 2000 to 43% at December 31, 2003. As a result of these initiatives, our management team has improved our cost structure, operating leverage and financial flexibility and placed us

 

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in an excellent position to benefit from growth opportunities in an improving market environment.

 

Business strategy

 

We are focused on executing the following four-point growth strategy:

 

Expand systems offerings as “Tier 1” supplier. We are currently a “Tier 1” supplier to OEMs in certain markets, but desire to expand our business with these customers to become an even more integral part of their operations. We plan to focus on integrating our electronic, pneumatic and mechanical technologies within and across business units and combining them as a complete package. Increasingly, customers will be able to purchase complete assemblies from us, rather than purchasing individual components from multiple suppliers. This will likely improve reliability and reduce product integration issues. We expect this capability to strengthen our position against competitors that do not have the breadth and depth of our product line. In addition, we will have the opportunity to service these assemblies in the aftermarket when they require replacement, upgrade or repair. In this way, we expect to increase the installed base of our products over time.

 

Accelerate new product and service development. During the recent industry downturn, we maintained research and development spending at historical levels and continued to fund major development projects, and we will continue to emphasize research and development to create new and improved products. We are focusing on technological advances, especially in the areas of electronics, braking products and other on-board equipment, as a means of new product growth. We seek to provide customers with incremental technological advances that offer immediate benefits with cost effective investments. In addition, we are focused on expanding the level and type of aftermarket services that we currently provide to customers. In this way, we expect to take advantage of the industry trend toward outsourcing, as railroads and transit authorities’ focus on their core function of transporting goods and people, rather than maintaining and servicing their equipment.

 

Expand globally. Our net sales outside of North America totaled 21% in 2003, up from 16% in 2002, and we believe that international markets represent a significant opportunity for future growth. We intend to increase our existing international sales through strategic acquisitions, direct sales of products through our existing subsidiaries and licensees and joint ventures with railway suppliers having a strong presence in their local markets. We are specifically targeting markets that operate significant fleets of U.S.-style locomotives and freight cars, including Australia, China, India, Russia, South Africa, South America and select areas within Europe.

 

Continuous improvement through lean principles. We intend to build on what we consider to be a leading position as a low-cost producer in the industry while maintaining world-class product quality, technology and customer responsiveness. Through QPS and employee-directed initiatives such as Kaizen, a Japanese-developed team concept, we continuously strive to improve quality, delivery and productivity, and to reduce costs. These efforts enable us to streamline processes, improve product quality and customer satisfaction, reduce product cycle times and respond more rapidly to market developments. Over time, we expect these lean initiatives to enable us to increase profit margins, which would improve cash flow and strengthen our ability to invest in new product and service programs.

 

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Backlog

 

In 2003, 56% of our sales came from aftermarket orders. Aftermarket orders typically carry lead times of less than 30 days, so they are not recorded in backlog for a significant period of time. As such, the Company’s backlog is primarily an indicator of future original equipment sales, not expected aftermarket activity.

 

The Company’s contracts are subject to standard industry cancellation provisions, including cancellations on short notice or upon completion of designated stages. Substantial scope-of-work adjustments are common. For these and other reasons, completion of the Company’s backlog may be delayed or cancelled, so backlog should not be relied upon as an indicator of the Company’s future performance. The railroad industry, in general, has historically been subject to fluctuations due to overall economic conditions and the level of use of alternative modes of transportation.

 

The backlog of customer orders as of December 31, 2003, and December 31, 2002, and the expected year of completion are as follows.

 

In thousands   

Total
Backlog

12/31/03


   Expected Delivery

  

Total
Backlog

12/31/02


   Expected Delivery

        2004

  

Other

Years


      2003

  

Other

Years


Freight Group

   $ 177,963    $ 111,545    $ 66,418    $ 237,654    $ 151,583    $ 86,071

Transit Group

     284,006      151,116      132,890      180,942      127,002      53,940
    

  

  

  

  

  

Total

   $ 461,969    $ 262,661    $ 199,308    $ 418,596    $ 278,585    $ 140,011
    

  

  

  

  

  

 

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Engineering and Development

 

To execute our strategy to develop new products, we invest in a variety of engineering and development activities. For the fiscal years ended December 31, 2003, 2002, and 2001, we invested about $32.9 million, $33.6 million and $33.2 million, respectively, on product development and improvement activities. Approximately 40% of these costs comprise activities solely devoted to new product development in any given year. These engineering and development expenditures, in total, represent about 4.6%, 4.8% and 4.2% of net sales for the same periods, respectively. Sometimes we conduct specific research projects in conjunction with universities, customers and other railroad product suppliers.

 

Our engineering and development program is largely focused upon train control and new braking technologies, with an emphasis on applying electronics to traditional pneumatic equipment. Electronic braking has been used in the transit industry for a long time, but freight railroads have been slower to accept the technology due to issues over interchangeability, connectivity and durability. We are proceeding with efforts to enhance the major components for existing hard-wired braking equipment and development of new electronic technologies for the freight railroads.

 

We use our Product Development System (PDS) to develop and monitor all new product programs. The system requires the product development team to follow consistent steps throughout the development process, from concept to launch, to ensure the product will meet customer expectations and internal profitability targets.

 

Intellectual Property

 

We have more than 2,000 active patents worldwide. We also rely on a combination of trade secrets and other intellectual property laws, nondisclosure agreements and other protective measures to establish and protect our proprietary rights in our intellectual property.

 

Certain trademarks, among them the name WABCO®, were acquired or licensed from American Standard Inc. in 1990 at the time of our acquisition of the North American operations of the Railway Products Group of American Standard.

 

We are a party, as licensor and licensee, to a variety of license agreements. We do not believe that any single license agreement is of material importance to our business or either of our business segments as a whole.

 

We entered into a license agreement with SAB WABCO Holdings B.V. (SAB) on December 31, 1993, pursuant to which SAB granted us a license to the intellectual property and know-how related to the manufacturing and marketing of certain disc brakes, tread brakes and low noise and resilient wheel products. SAB is a former affiliate of Wabtec, since both were owned by the same parent company in the early 1990s. In 2002, SAB was purchased by Vestar Capital Partners IV, L.P., an affiliate of Vestar Equity Partners, L.P. and Vestar Capital Partners, Inc., both of which were then significant shareholders of Wabtec.

 

In November 2003, Vestar Equity Partners and Vestar Capital Partners sold their entire stake in Wabtec, consisting of 2,440,000 Wabtec common shares, in a registered secondary offering. The SAB license expired December 31, 2003, but has been renewed for an additional one-year term as provided in the license agreement. The license may be renewed for additional one-year terms.

 

We have issued licenses to the two sole suppliers of railway air brakes and related products in Japan, NABCO Ltd. and Mitsubishi Electric Company. The licensees pay annual license fees to us and also assist us by acting as liaisons with key Japanese passenger transit vehicle builders for projects in North America. We believe that our relationships with these licensees have been beneficial to our core transit business and customer relationships in North America.

 

Customers

 

Our customers include railroads throughout North America, as well as in Australia, South Africa, India, Italy and the United Kingdom; manufacturers of transportation equipment, such as locomotives, freight cars, subway vehicles and buses; lessors of such equipment; and passenger transit authorities, primarily those in North America.

 

In 2003, about 79% of our sales were to customers in North America, but we also shipped products to more than 62 countries throughout the world. About 56% of our sales were in the aftermarket, with the rest of our sales to OEMs of locomotives, freight cars, subway vehicles and buses.

 

Our top five customers, Northeast Illinois Railroad Corporation (Metra), General Electric Transportation Systems, Bombardier, Burlington Northern Santa Fe and Alstom accounted for 26% of our net sales in 2003. Our top customer, Metra, represented 7% of consolidated sales. We believe that we have strong relationships with all of our key customers.

 

Competition

 

We believe that we hold a greater than 50% market share in North America for our primary braking-related equipment and a No. 1 or No. 2 market position in North America for most of our other product lines. Nonetheless, we operate in a highly competitive marketplace. Price competition is strong because we have a relatively small number of customers and they are very cost-conscious.

 

In addition to price, competition is based on product performance and technological leadership, quality, reliability of delivery, and customer service and support. Our principal competitors vary to some extent across product lines, but most competitors are smaller, privately held companies. Within North America, New York Air Brake Company, a subsidiary of the German air brake producer Knorr-Bremse AG, is our principal overall OEM competitor. Our competition for locomotive, freight and passenger transit service and repair is

 

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primarily from the railroads’ and passenger transit authorities’ in-house operations, the Electro-Motive Division of General Motors, General Electric Transportation Systems, and New York Air Brake/Knorr. We believe our key strengths, which include leading market positions in core products, breadth of product offering with a stable mix of OEM and aftermarket business, leading design and engineering capabilities, significant barriers to entry and an experienced management team enable us to compete effectively in this marketplace.

 

Employees

 

At December 31, 2003, we had 4,482 full-time employees, approximately 36% of whom were unionized. A majority of the employees subject to collective bargaining agreements are within North America and these agreements generally extend through late 2004, 2005 and 2006.

 

We consider our relations with our employees and union representatives to be good, but cannot assure that future contract negotiations will be favorable to us.

 

Regulation

 

In the course of our operations, we are subject to various regulations of agencies and other entities. In the United States, these include principally the FRA and the AAR.

 

The FRA administers and enforces federal laws and regulations relating to railroad safety. These regulations govern equipment and safety standards for freight cars and other rail equipment used in interstate commerce.

 

The AAR oversees a wide variety of rules and regulations governing safety and design of equipment, relationships among railroads with respect to railcars in interchange and other matters. The AAR also certifies railcar builders and component manufacturers that provide equipment for use on railroads in the United States. New products generally must undergo AAR testing and approval processes.

 

As a result of these regulations and regulations in other countries in which we derive our revenues, we must maintain certain certifications as a component manufacturer and for products we sell.

 

Effects of Seasonality

 

Our business is not typically seasonal, although the third quarter results may be impacted by vacation and plant shutdowns at several of its major customers during this period.

 

Environmental Matters

 

Information on environmental matters is included in Note 19 of “Notes to Consolidated Financial Statements” included in Part IV, Item 15 of this report.

 

Available Information

 

We maintain an Internet site at www.wabtec.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to such reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as well as the annual report to stockholders and other information, are available free of charge on this site. The Internet site and the information contained therein or connected thereto are not incorporated by reference into this Form 10-K. Our Corporate Governance Guidelines, the charters of our Audit, Compensation and Nominating and Corporate Governance Committees, our Code of Conduct, which is applicable to all employees, and our Code of Ethics for Senior Officers, which is applicable to all of our executive officers, are also available free of charge on this site and are available in print to any shareholder who requests them.

 

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Item 2. PROPERTIES

 

Facilities

 

The following table provides certain summary information about the principal facilities owned or leased by the Company. The Company believes that its facilities and equipment are generally in good condition and that, together with scheduled capital improvements, they are adequate for its present and immediately projected needs. Leases on the facilities are long-term and generally include options to renew. The Company’s corporate headquarters are located at the Wilmerding, PA site.

 

Location


  

Primary Use


  

Segment


  

Own/Lease


   Approximate
Square Feet


 

Domestic

                     

Wilmerding, PA

   Manufacturing/Service    Freight Group    Own    365,000 (1)

Boise, ID

   Manufacturing    Freight Group    Own    294,700  

Lexington, TN

   Manufacturing    Freight Group    Own    170,000  

Jackson, TN

   Manufacturing    Freight Group    Own    150,000  

Chicago, IL

   Manufacturing    Freight Group    Own    111,500  

Laurinburg, NC

   Manufacturing    Freight Group    Own    105,000  

Greensburg, PA

   Manufacturing    Freight Group    Own    97,800  

Germantown, MD

   Manufacturing/Service    Freight Group    Own    80,000  

Willits, CA

   Manufacturing    Freight Group    Own    70,000  

Kansas City, MO

   Manufacturing    Freight Group    Lease    55,900  

Columbia, SC

   Service Center    Freight Group    Lease    40,250  

Cedar Rapids, IA

   Manufacturing    Freight Group    Lease    37,000  

Racine, WI

   Engineering/Office    Freight Group    Lease    32,500  

Carson City, NV

   Service Center    Freight Group    Lease    22,000  

Chicago, IL

   Service Center    Freight Group    Lease    19,200  

Spartanburg, SC

   Manufacturing/Service    Transit Group    Lease    183,600  

Buffalo Grove, IL

   Manufacturing    Transit Group    Lease    115,570  

Plattsburgh, NY

   Manufacturing    Transit Group    Lease    64,000  

Elmsford, NY

   Service Center    Transit Group    Lease    28,000  

Baltimore, MD

   Service Center    Transit Group    Lease    7,200  

Richmond, CA

   Service Center    Transit Group    Lease    5,400  

Sun Valley, CA

   Service Center    Transit Group    Lease    4,000  

Atlanta, GA

   Service Center    Transit Group    Lease    1,200  

Mountaintop, PA

   Idle         Own    225,000 (2)

St. Louis, MO

   Idle         Own    62,000  

International

                     

Doncaster, UK

   Manufacturing/Service    Freight Group    Own    330,000  

Stoney Creek, (Ontario), Canada

   Manufacturing/Service    Freight Group    Own    189,200  

Wallaceburg, (Ontario), Canada

   Foundry    Freight Group    Own    127,600  

San Luis Potosi, Mexico

   Manufacturing    Freight Group    Own    48,600  

San Luis Potosi, Mexico

   Foundry    Freight Group    Own    24,500  

Wetherill Park, Australia

   Manufacturing    Freight Group    Lease    73,100  

Kolkatta, India

   Manufacturing    Freight Group    Lease    32,000  

Schweighouse, France

   Manufacturing    Freight Group    Lease    30,000  

Tottenham, Australia

   Manufacturing    Freight Group    Lease    26,900  

Sydney, Australia

   Sales Office    Freight Group    Lease    11,250  

St. Laurent, (Quebec), Canada

   Manufacturing    Transit Group    Own    106,000  

Jiangsu, China

   Manufacturing    Transit Group    Own    80,000  

Sassuolo, Italy

   Manufacturing    Transit Group    Lease    30,000  

Pointe-aux-Trembles, (Quebec), Canada

   Manufacturing    Transit Group    Lease    20,000  

Burton on Trent, UK

   Manufacturing    Transit Group    Lease    18,000  

Etobicoke, (Ontario), Canada

   Service Center    Transit Group    Lease    3,800  

Calgary, (Alberta), Canada

   Idle         Own    32,000 (3)

 

(1) Approximately 250,000 square feet are currently used in connection with the Company’s corporate and manufacturing operations. The remainder is leased to third parties.

 

(2) As of January 2004, this property is under contract for sale.

 

(3) As of February 2004, this property is under contract for sale.

 

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Item 3. LEGAL PROCEEDINGS

 

Information with respect to legal proceedings is included in Note 19 of “Notes to Consolidated Financial Statements” included in Part IV, Item 15 of this report.

 

Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

 

None.

 

EXECUTIVE OFFICERS AND DIRECTORS

 

The following table provides information on our executive officers and directors. Messrs. Brooks, Kassling and Miscoll will serve as directors until the 2004 annual meeting of stockholders and until their successors have been duly elected and qualified. Messrs. Fernandez, Foster and Napier will serve as directors until the 2005 annual meeting of the stockholders and until they or their successors have been duly elected and qualified. Messrs. Davies, Davis and Howell will serve as directors until the 2006 annual meeting of stockholders and until their successors have been duly elected and qualified. The executive officers are elected annually by our Board of Directors, at an organizational meeting held immediately after each annual meeting, and serve at the discretion of the Board.

 

Name


   Age

  

Position


William E. Kassling

   60   

Director and Chairman of the Board

Gregory T. H. Davies

   57   

Director, President and Chief Executive Officer

Robert J. Brooks

   60   

Director and Executive Vice President — Strategic Development

Alvaro Garcia-Tunon

   51   

Senior Vice President, Chief Financial Officer and Secretary

Anthony J. Carpani

   51   

Vice President, Group Executive, Friction

Patrick D. Dugan

   37   

Vice President and Controller

Paul E. Golden

   34   

Vice President, Group Executive, Freight

Robert P. Haag

   39   

President, Railway Electronics

Timothy J. Logan

   50   

Vice President, International

James E. McClaine

   62   

Vice President, Railroad Service

Barry L. Pennypacker

   43   

Vice President, Performance First

Gary P. Prasser

   46   

Vice President, Group Executive, Transit

George A. Socher

   55   

Vice President, Internal Audit and Taxation

Scott E. Wahlstrom

   40   

Vice President, Human Resources

Mark S. Warner

   49   

Vice President and General Manager, MotivePower, Inc.

Timothy R. Wesley

   42   

Vice President, Investor Relations and Corporate Communications

 

William E. Kassling has been a director and Chairman of the Board of Directors since 1990 and served as Chief Executive Officer until February 2001. Mr. Kassling was also President of WABCO from 1990 through February 1998. From 1984 until 1990 he headed the Railway Products Group of American Standard Inc. Between 1980 and 1984 he headed American Standard’s Building Specialties Group, and between 1978 and 1980 he headed Business Planning for American Standard. Mr. Kassling is a director of Aearo Corporation, Scientific-Atlanta, Inc. and Parker Hannifin Corporation.

 

Gregory T. H. Davies has served as a director since February 1999 and Chief Executive Officer since February 2001. Mr. Davies joined us in March 1998 as President and Chief Operating Officer. Prior to March 1998, Mr. Davies had been with Danaher Corporation since 1988, where he was Vice President and Group Executive responsible for its Jacobs Vehicle Systems, Delta Consolidated Industries and A.L. Hyde Corporation operating units. Prior to that, he held executive positions at Cummins Engine Company and Ford Motor Company.

 

Robert J. Brooks has served as a director since 1990 and Executive Vice President-Strategic Development since March 2003. Mr. Brooks was Executive Vice President, Chief Financial Officer and Secretary of the Company from 1990 until March 2003. From 1986 until 1990 he served as worldwide Vice President, Finance for the Railway Products Group of American Standard, Inc. Mr. Brooks is a director of Crucible Materials Corporation.

 

Alvaro Garcia-Tunon has been Senior Vice President, Chief Financial Officer and Secretary of the Company since March 2003. Mr. Garcia-Tunon was Senior Vice President,

 

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Finance of the Company from November 1999 until March 2003 and Treasurer of the Company from August 1995 until November 1999. From 1990 until August 1995, Mr. Garcia-Tunon was Vice President of Business Development of Pulse Electronics, Inc.

 

Anthony J. Carpani has been Vice President, Group Executive, Friction since June 2000. Previously, Mr. Carpani was Managing Director of our Australian-based subsidiary, F.I.P. Ltd. (formerly known as Futuris Brakes, International) from 1992 until June 2000.

 

Patrick D. Dugan joined Wabtec as Vice President, Corporate Controller in November 2003. Prior to joining Wabtec, Mr. Dugan served as Vice President and Chief Financial Officer of CWI International, Inc. from December 1996 to November 2003. Prior to 1996, he worked for PricewaterhouseCoopers providing business assurance and advisory services.

 

Paul E. Golden has been Vice President, Group Executive, Freight, since February of 2001. Prior to that, he was President of the Company’s Cardwell Westinghouse business unit from November 1999 until February of 2001. Previously, Mr. Golden served as Vice President and General Manager of the Cardwell Westinghouse business unit and as Director of WABCO Performance Systems from June 1998 until November 1999. Prior to 1998, Mr. Golden held management and operations positions with Danaher Corporation and Federal-Mogul Corporation.

 

Robert P. Haag, President of Railway Electronics, joined Wabtec in 1999. He has over 18 years’ experience in communications and systems requirements analysis. Before joining Wabtec, Mr. Haag was employed at GTE where he developed telephone switching systems.

 

Timothy J. Logan has been the Vice President, International, since August 1996. Previously, from 1987 until August 1996, Mr. Logan was Vice President, International Operations for Ajax Magnethermic Corporation and from 1983 until 1987 he was President of Ajax Magnethermic Canada, Ltd.

 

James E. McClaine joined Wabtec with the Pulse Electronics acquisition in 1995 and became President of Wabtec’s Railway Electronics division. Mr. McClaine now serves as Vice President of Railroad Service.

 

Barry L. Pennypacker has been Vice President, Performance First since February 2004. Previously, from 1999 until 2004, Mr. Pennypacker was Vice President of Quality and Performance Systems. From 1997 to 1999, Mr. Pennypacker was director of manufacturing of Stanley Works. He has been a practitioner of lean manufacturing principles for almost 20 years in both private and public organizations.

 

Gary P. Prasser has served as Vice President, Group Executive, Transit, since September 2003. From October 2001 to September 2003, he served as President of the Company’s Cardwell Westinghouse business unit and Vice President, Manufacturing of the Company’s Freight Group. He joined Wabtec in August 1999 and served as President of the Company’s Motor Coils subsidiary from November 1999 to October 2001. From January 1996 to July 1999, Mr. Prasser was President of Joslyn Manufacturing, a subsidiary of Danaher Corporation.

 

George A. Socher has been Vice President, Internal Audit and Taxation, of the Company since November 1999. From July 1995 until November 1999, Mr. Socher was Vice President and Corporate Controller of the Company. From 1994 until June 1995, Mr. Socher was Corporate Controller and Chief Accounting Officer of Sulcus Computer Corp. From 1988 until 1994 he was Corporate Controller of Stuart Medical, Inc.

 

Scott E. Wahlstrom has been Vice President, Human Resources, since November 1999. Previously, Mr. Wahlstrom was Vice President, Human Resources & Administration of MotivePower Industries, Inc. from August 1996 until November 1999. From September of 1994 until August of 1996, Mr. Wahlstrom served as Director of Human Resources for MotivePower Industries, Inc.

 

Mark S. Warner has served Wabtec as Vice President and General Manager of MotivePower, Inc. since July 2000. Mr. Warner became Vice President, Operations and Maintenance, Motive Power Industries, Inc. which he was responsible for from 1994 until July 2000. From 1991 until 1994, Mr. Warner was Division Materials Manager for MK Rail Corporation.

 

Timothy R. Wesley has been Vice President, Investor Relations and Corporate Communications, since November 1999. Previously, Mr. Wesley was Vice President, Investor and Public Relations of MotivePower Industries, Inc. from August 1996 until November 1999. From February 1995 until August 1996, he served as Director, Investor and Public Relations of MotivePower Industries, Inc. From 1993 until February 1995, Mr. Wesley served as Director, Investor and Public Relations of Michael Baker Corporation.

 

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PART II

 

Item 5. MARKET FOR REGISTRANT’S COMMON STOCK AND RELATED STOCKHOLDER MATTERS

 

The Common Stock of the Company is listed on the New York Stock Exchange. As of March 11, 2004, there were 44,687,830 shares of Common Stock outstanding held by 991 holders of record. The high and low sales price of the shares and dividends declared per share were as follows:

 

2003


   High

   Low

   Dividends

First Quarter

   $ 14.28    $ 10.16    $ 0.01

Second Quarter

   $ 14.97    $ 11.15    $ 0.01

Third Quarter

   $ 16.83    $ 13.30    $ 0.01

Fourth Quarter

   $ 18.44    $ 14.44    $ 0.01

 

2002


   High

   Low

   Dividends

First Quarter

   $ 15.48    $ 11.85    $ 0.01

Second Quarter

   $ 15.99    $ 12.50    $ 0.01

Third Quarter

   $ 14.15    $ 11.80    $ 0.01

Fourth Quarter

   $ 14.73    $ 12.85    $ 0.01

 

The Company’s credit agreement restricts the ability to make dividend payments, with certain exceptions. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and see Note 9 of “Notes to Consolidated Financial Statements” included in Part IV, Item 15 of this report.

 

At the close of business on March 11, 2004, the Company’s Common Stock traded at $14.47 per share.

 

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Item 6. SELECTED FINANCIAL DATA

 

The following table shows selected consolidated financial information of the Company and has been derived from audited financial statements. This financial information should be read in conjunction with, and is qualified by reference to, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements of the Company and the Notes thereto included elsewhere in this Form 10-K.

 

     Year Ended December 31,

 

In thousands, except per share amounts


   2003

    2002

    2001

    2000

    1999

 

Income Statement Data

                                        

Net sales

   $ 717,924     $ 696,195     $ 783,698     $ 811,178     $ 844,079  

Gross profit (1)

     189,450       179,471       209,926       235,662       274,910  

Operating expenses (2)

     (137,741 )     (131,937 )     (152,145 )     (139,669 )     (144,255 )

Merger and restructuring charge

     —         —         (3,723 )     (18,202 )     (42,903 )
    


 


 


 


 


Income from operations

   $ 51,709     $ 47,534     $ 54,058     $ 77,791     $ 87,752  
    


 


 


 


 


Interest expense

   $ (10,377 )   $ (18,072 )   $ (33,501 )   $ (43,649 )   $ (44,109 )

Other (expense) income (3)

     (6,290 )     (5,558 )     (2,130 )     3,776       428  

Income from continuing operations before cumulative effect of accounting change

     22,252       16,310       13,962       19,200       23,184  

Income from discontinued operations (net of tax)

     451       403       6,360       6,193       13,439  

(Loss) gain on sale of discontinued operations (net of tax)

     —         (529 )     41,458       —         —    
    


 


 


 


 


Income before cumulative effect of accounting change

     22,703       16,184       61,780       25,393       36,623  
    


 


 


 


 


Net income (loss) (4)

   $ 22,703     $ (45,479 )   $ 61,780     $ 25,393     $ 36,623  
    


 


 


 


 


Diluted Earnings per Common Share

                                        

Income from continuing operations before cumulative effect of accounting change

   $ 0.51     $ 0.37     $ 0.32     $ 0.45     $ 0.52  

Net income (loss) (4)

   $ 0.52     $ (1.04 )   $ 1.43     $ 0.59     $ 0.83  
    


 


 


 


 


Cash dividends declared per share

   $ 0.04     $ 0.04     $ 0.04     $ 0.04     $ 0.04  
    


 


 


 


 


     As of December 31

 
     2003

    2002

    2001

    2000

    1999

 

Balance Sheet Data

                                        

Total assets

   $ 656,305     $ 588,865     $ 729,952     $ 984,047     $ 996,676  

Cash

     70,328       19,210       53,949       6,071       7,056  

Total debt

     190,225       195,151       241,870       540,197       568,587  

Shareholders’ equity

     248,293       199,262       245,271       196,371       181,878  

 

(1) In 2000, includes charges for merger and restructuring plan of $2 million and legal settlement of $2 million. In 1999, includes charges for merger and restructuring plan of $5.2 million.

 

(2) In 2003, includes $1.6 million of write-offs relating to non-operating assets. In 2001, includes charges for asset writedowns of $9.3 million. Goodwill and other indefinite life intangibles amortization was $7 million, $6.9 million and $6.5 million in 2001, 2000 and 1999, respectively. There was no such amortization expense recorded in 2003 and 2002, respectively.

 

(3) In 2001, includes gain on asset sales of $685,000. In 2000, includes gain on asset sale of $4.4 million.

 

(4) Includes the items noted above, as well as the following: In 2002, a $61.7 million, net of tax, cumulative effect of accounting change for goodwill. In 2001, a $2 million tax benefit for research and development tax credits. In 2000, a write-off of $5.1 million for a deferred tax asset relating to the termination of the Employee Stock Ownership Plan (ESOP).

 

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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

OVERVIEW

 

Wabtec is one of the world’s largest providers of value-added, technology-based products and services for the global rail industry. Our products are found on virtually all locomotives, freight cars and passenger transit vehicles in the U.S., as well as in certain markets throughout the world. Our products enhance safety, improve productivity and reduce maintenance costs for customers, and many of our core products and services are essential in the safe and efficient operation of freight rail and passenger transit vehicles.

 

Wabtec is a global company with operations in nine countries. In 2003, about 79 percent of the Company’s revenues came from its North American operations, but Wabtec also sold products or services in 62 countries around the world.

 

Management Review of 2003 and Future Outlook

 

Wabtec’s long-term financial goals are to generate free cash flow in excess of net income, maintain a strong credit profile while minimizing our overall cost of capital, increase margins through strict attention to cost controls, and increase revenues through a focused growth strategy. In addition, management monitors the Company’s short-term operational performance through measures such as quality and on-time delivery.

 

In 2003, we achieved the following:

 

Generated cash of $56 million, more than double net income of $23 million;

 

Debt net of cash, was $120 million at Dec. 31, 2003, compared to $176 million at the end of 2002;

 

Gross margin increased to 26.4% compared to 25.8% for 2002, as a favorable product mix and cost reductions more than offset the negative impact of foreign currency exchange rates;

 

Revenues increased 3%, as higher sales of freight car original equipment in North America and higher international sales combined to offset lower sales of aftermarket components and transit original equipment;

 

Product quality, as measured by first-time pass rate, improved by 40%;

 

On-time delivery increased 8%.

 

We achieved these results despite continued weakness in demand for aftermarket products and services, and a 23% drop in sales in the Transit Group, which completed several major contracts in 2002. In addition, foreign currency exchange rates had a negative impact on the Company’s Canadian operations.

 

We expect increased demand for our products as the U.S. economy recovers, government transit spending increases and Class I railroads, utilities and leasing companies begin to reinvest in their fleets after deferring capital spending during the difficult U.S. economic environment since 2001. We anticipate that this increased capital spending will positively impact rail industry fundamentals, which have shown gradual improvement over the past few quarters, as evidenced by better-than-expected freight car orders and backlog. For example, freight car deliveries increased to 9,170 in the fourth quarter of 2003, an increase of 11% over the prior quarter and up 91% over the prior year. The table below demonstrates the improving trends in the freight car segment of the rail industry:

 

     Orders

   Deliveries

   Backlog

First quarter 2002

   2,637    3,855    24,055

Second quarter 2002

   6,973    4,155    9,281

Third quarter 2002

   10,135    4,925    14,491

Fourth quarter 2002

   8,712    4,801    18,402

First quarter 2003

   11,767    6,614    24,055

Second quarter 2003

   16,693    7,365    33,383

Third quarter 2003

   6,726    8,251    31,858

Fourth quarter 2003

   12,063    9,170    33,967

 

Source: Railway Supply Institute

 

Freight car, locomotive and transit car deliveries for the industry are expected to trend upwards providing an expanding market for the Company:

 

     Actual

   Forecast

     2002

   2003

   2004

   2005

   2006

Freight car

   17,714    31,400    37,500    41,500    45,000

Transit

   1,322    669    754    540    798

Locomotive

   969    749    1,050    785    980

 

Based on company estimates

 

In 2004, we expect demand to improve in two of our key markets (components for new freight cars and new locomotives), but we do not expect growth in the aftermarket, which represents about 56% of sales.

 

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Table of Contents

Looking beyond 2004, we expect to generate increases in sales and earnings from executing our four-point growth strategy (see page 5 for more details):

 

Expand sales of systems offerings as “Tier 1” supplier;

 

Accelerate new product and service development;

 

Expand globally;

 

Continuous improvement through lean principles.

 

In 2004 and beyond, we will continue to face many challenges, including increased costs for raw materials, especially steel; higher costs for medical and insurance premiums; and foreign currency fluctuations. In addition, we face general economic risks, as well as the risk that our customers could curtail spending on new and existing equipment. Risks associated with our four-point growth strategy include the level of investment that customers are willing to make in new technologies developed by the industry and the Company, and risks inherent in global expansion. When necessary, we will modify our financial and operating strategies to reflect changes in market conditions and risks.

 

RESULTS OF OPERATIONS

 

The following table shows our Consolidated Statements of Operations for the years indicated.

 

     Year Ended December 31,

 

In millions


   2003

    2002

    2001

 

Net sales

   $ 717.9     $ 696.2     $ 783.7  

Cost of sales

     (528.5 )     (516.7 )     (573.8 )
    


 


 


Gross profit

     189.4       179.5       209.9  

Selling, general and administrative expenses

     (100.5 )     (93.0 )     (96.7 )

Merger and restructuring charges

     —         —         (3.7 )

Engineering expenses

     (32.9 )     (33.6 )     (33.2 )

Asset writedowns

     —         —         (9.3 )

Amortization expense

     (4.3 )     (5.3 )     (13.0 )
    


 


 


Total operating expenses

     (137.7 )     (131.9 )     (155.9 )
    


 


 


Income from operations

     51.7       47.6       54.0  

Interest expense

     (10.4 )     (18.1 )     (33.5 )

Other expense net

     (6.3 )     (5.6 )     (2.1 )
    


 


 


Income from continuing operations before income taxes and cumulative effect of accounting change

     35.0       23.9       18.4  

Income tax expense

     (12.8 )     (7.6 )     (4.4 )
    


 


 


Income from continuing operations before cumulative effect of accounting change

     22.2       16.3       14.0  

Discontinued operations

                        

Income from discontinued operations (net of tax)

     0.5       0.4       6.4  

(Loss) gain on sale of discontinued operations (net of tax)

     —         (0.5 )     41.4  
    


 


 


Income before cumulative effect of accounting change

     22.7       16.2       61.8  

Cumulative effect of accounting change for goodwill, net of tax

     —         (61.7 )     —    
    


 


 


Net income (loss)

   $ 22.7     $ (45.5 )   $ 61.8  
    


 


 


 

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Table of Contents

2003 COMPARED TO 2002

 

The following table summarizes the results of operations for the period:

 

     For the year ended December 31,

 

In thousands


   2003

   2002

    Percent
Change


 

Net sales

   $ 717,924    $ 696,195     3.1 %

Income from operations

     51,709      47,534     8.8 %

Income before cumulative effect of accounting change

     22,703      16,184     40.3 %

Net income (loss)

     22,703      (45,479 )   149.9 %

 

In 2002, we completed fair value assessments of goodwill and wrote down the carrying value of goodwill by $90 million ($83.2 million for the Freight Group and $6.8 million for the Transit Group) in accordance with the adoption of SFAS No. 142 “Goodwill and Other Intangible Assets.” The total impact of the writedown, net of taxes, was $61.7 million.

 

The following table shows the Company’s net sales by business segment:

 

     For the year ended
December 31,


In thousands


   2003

   2002

Freight Group

   $ 522,279    $ 443,443

Transit Group

     195,645      252,752
    

  

Net sales

   $ 717,924    $ 696,195
    

  

 

Net sales. Net sales for 2003 increased $21.7 million, or 3.1%, as compared to 2002. The increased sales in the Freight Group more than offset lower sales in the Transit Group. The Freight Group’s increased sales reflected higher sales of components for new freight cars and locomotives, and commuter locomotives, as well as higher international sales. Industry deliveries of new freight cars for 2003 increased to about 31,400 units as compared to about 17,700 in 2002. The Transit Group’s decreased sales were due to the completion of a contract to supply components for New York City subway cars in 2002 and lower aftermarket sales.

 

Gross profit. Gross profit increased to $189.5 million in 2003 compared to $179.5 million in 2002. Gross profit is dependent on a number of factors including pricing, sales volume and product mix. Gross profit, as a percentage of sales, was 26.4% compared to 25.8% in 2002. The increase in gross profit percentage is primarily due to higher sales and favorable product mix, which more than offset the negative impact of the weakening U.S. dollar versus the Canadian dollar.

 

The following table shows our operating expenses:

 

    

For the year ended

December 31,


 

In thousands


   2003

   2002

   Percent
Change


 

Selling, general and administrative expenses

   $ 100,503    $ 93,023    8.0 %

Engineering expenses

     32,929      33,592    (2.0 )%

Amortization expense

     4,309      5,322    (19.0 )%
    

  

  

Total operating expenses

   $ 137,741    $ 131,937    4.4 %
    

  

  

 

Operating expenses. Operating expenses increased $5.8 million in 2003 as compared to 2002 due to the write-off of non-operating assets of $1.6 million, and higher medical and insurance premiums, partially offset by reduced amortization expense. Amortization expense decreased due to certain intangible assets having been fully amortized.

 

Income from operations. Income from operations totaled $51.7 million (or 7.2% of sales) in 2003 compared with $47.5 million (or 6.8% of sales) in 2002. Higher operating income resulted from increased sales and gross margins, but was partially offset by increased operating expenses in 2003.

 

Interest expense. Interest expense decreased 42.6% in 2003 as compared to 2002 primarily due to a substantial decrease in debt.

 

Other expense. The Company recorded foreign exchange losses from the translation of balance sheet accounts of $2.8 million and $1.2 million, respectively, in 2003 and 2002.

 

Income taxes. The effective income tax rate was 36.5% for 2003 and 32% for 2002. The change in the effective tax rate was due to a higher effective state tax rate and increased statutory rates in foreign jurisdictions. Also, increased income has reduced the significance of the favorable impact the Company’s utilization of foreign tax credits has on the effective tax rate.

 

Net income. Net income for 2003 increased $68.2 million, compared with 2002, which included a $61.7 million, net of tax, write off of goodwill. Income before the cumulative effect of an accounting change increased $6.5 million, compared with 2002. The increase was due to increased sales, improved margins, and lower interest expense.

 

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Table of Contents

2002 COMPARED TO 2001

 

The following table summarizes the results of operations for the period:

 

     For the year ended December 31,

 

In thousands


   2002

    2001

   Percent
Change


 

Net sales

   $ 696,195     $ 783,698    (11.2 )%

Income from operations

     47,534       54,058    (12.1 )%

Income before cumulative effect of accounting change

     16,184       61,780    (73.8 )%

Net (loss) income

     (45,479 )     61,780    (173.6 )%

 

A number of events occurred over the comparative period that impacted our results of operations and financial condition including:

 

In 2002, we completed fair value assessments of goodwill and wrote down the carrying value of goodwill by $90 million ($83.2 million for the Freight Group and $6.8 million for the Transit Group) in accordance with the adoption of SFAS No. 142 “Goodwill and Other Intangible Assets.” The total impact of the writedown, net of tax was $61.7 million.

 

In July 2002, we redeemed at par (face) $175 million of the 9.375% senior notes due in 2005 through the use of cash on hand and additional borrowings under the credit agreement. This redemption resulted in a non-cash loss of $1.9 million, relating to a write-off of deferred debt issuance costs, which was recorded as interest expense.

 

In November 2001, we sold certain assets to GE Transportation Systems for $238 million in cash. The assets sold primarily included locomotive aftermarket products and services for which we were not the OEM. The sale resulted in an after-tax gain of $48.7 million, which is reflected on the income statement as a gain, net of tax, on the sale of discontinued operations.

 

In the fourth quarter of 2001, we decided to exit certain businesses. The net amount of these businesses was written down to their estimated realizable value. This resulted in a pre-tax charge of $9.3 million and an after-tax charge of $7.2 million.

 

Merger and Restructuring Plan. In 2001, the Company completed a merger and restructuring plan with costs totaling $71 million pre-tax, with approximately $2 million of the charge expensed in 2001, $20 million in 2000 and $49 million in 1999. The plan involved the elimination of duplicate facilities and excess capacity, operational realignment and related workforce reductions, and the evaluation of certain assets as to their perceived ongoing benefit to the Company.

 

The following table shows the Company’s net sales by business segment:

 

     For the year ended
December 31,


In thousands


   2002

   2001

Freight Group

   $ 443,443    $ 490,261

Transit Group

     252,752      293,437
    

  

Net sales

   $ 696,195    $ 783,698
    

  

 

Net sales. Net sales for 2002 decreased $87.5 million or 11.2% to $696.2 million as compared to the prior period. Both the Freight Group and Transit Group had lower sales. The Freight Group’s decreased sales reflected lower sales of components for new freight cars and locomotives. In 2002, industry deliveries of new freight cars decreased to 17,717 units as compared to 34,247 in the same period in 2001. In 2002, industry deliveries of new locomotives decreased to 969 as compared to 1,085 in the same period in 2001. The Transit Group’s decreased sales were primarily due to the completion of a supply contract for New York City subway cars in the third quarter of 2002.

 

Gross profit. Gross profit decreased to $179.5 million (or 25.8% of sales) in 2002 compared to $209.9 million (or 26.8% of sales) in the same period of 2001. The decrease in gross profit and margin is largely attributed to the effect of a decrease in sales volumes, which had a negative impact of about $35 million.

 

The following table shows our operating expenses for the period:

 

    

For the year ended

December 31,


 

In thousands


   2002

   2001

   Percent
Change


 

Selling, general and administrative expenses

   $ 93,023    $ 96,723    (3.8 )%

Merger and restructuring charges

     —        3,723    NA  

Engineering expenses

     33,592      33,156    1.3 %

Asset writedowns

     —        9,253    NA  

Amortization expense

     5,322      13,013    (59.1 )%
    

  

  

Total operating expenses

   $ 131,937    $ 155,868    (15.4 )%
    

  

  

 

Operating expenses. Operating expenses improved by $23.9 million in 2002 as compared to 2001. Included in operating expenses for 2001 were goodwill amortization of $7 million, $9.3 million for asset writedowns, $3.7 million for merger and restructuring charges and $1.7 million for severance costs in 2001. The remaining decrease in operating expenses was due to a decrease in selling, general and administrative expenses.

 

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Income from operations. Income from operations totaled $47.5 million in 2002 compared with $54.1 million in 2001. Operating income would have been $75.8 million in 2001 excluding the adjustments discussed in the prior paragraph. Lower operating income resulted from decreased sales volumes in 2002 (see Note 20 of “Notes to Consolidated Financial Statements” included in Part IV, Item 15 of this report).

 

Interest expense. Interest expense decreased 46.1% in 2002 as compared to 2001, primarily due to a decrease in debt and interest rates.

 

Other expense. The Company recorded foreign exchange losses of $1.2 million and $1.7 million, respectively, in 2002 and 2001 due to exchange rate fluctuations. Also in 2002, the Company wrote down a facility held for sale, resulting in a $2 million charge.

 

Income taxes. The effective income tax rate for 2002 was 32% as compared to 24.2% in 2001. The rate includes the effect of research and development and foreign tax credits of $772,000 and $2 million respectively, for 2002 and 2001. Excluding these tax credits, the rate would have been 35% in both 2002 and 2001.

 

Net income. Net income decreased $107.3 million, or 173.6%, compared with the same period the prior year. However, adjusting for the 2001 gain on sale of certain businesses of $41.5 million, and the 2002 goodwill writedown of $61.7 million (net of tax), net income declined $4.1 million, principally the result of overall lower sales activity in 2002 compared to 2001.

 

Income taxes

 

In the next three years cash outlays for income taxes will be less then income tax expense due to the amortization of goodwill and intangible assets which will continue to be amortized for tax purposes. The Company’s current level of pre-tax income is sufficient to utilize the deferred tax assets. As of 2003 the Company has utilized all previous federal net operating losses, and a portion of the reported federal credits in the amount of $3.2 million will be realized through a carry back regardless of current income generated. The Company engages in diverse foreign activity whereby certain funds could be repatriated to the U.S. This would afford the Company the opportunity to utilize certain assets more quickly. Management believes tax planning opportunities exist in various foreign countries that will allow the Company to utilize foreign net operating loss carryforwards. Any tax assets that are uncertain regarding realization have a valuation allowance in the full amount of the asset. Management believes the remaining assets will be realized in the normal course of business.

 

Significant differences between pre-tax earnings for financial reporting purposes and taxable income for income tax purposes consist of the following:

 

     For the year ended December 31,

 

In thousands


   2003

    2002

    2001

 

Accrued environmental expense

   $ (800 )   $ (360 )   $ (850 )

Deferred compensation expense and other benefits

     (4,800 )     3,650       (2,025 )

Plant, equipment, and intangibles

     (17,300 )     (16,600 )     (3,100 )

Inventory reserves

     925       250       (3,525 )

Pension liabilities

     2,600       145       2,700  

Warranty reserves

     (5,900 )     2,800       (3,900 )

Other reserves

     (8,000 )     (5,700 )     (10,300 )

Non-recurring items

     (3,900 )     —         —    

Extraordinary/discontinued

     —         90,000       40,800  

 

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Liquidity and Capital Resources

 

Liquidity is provided primarily by operating cash flow and borrowings under our credit facilities with a consortium of commercial banks (“credit agreement”). The following is a summary of selected cash flow information and other relevant data:

 

    

For the year ended

December 31,


 

In thousands


   2003

    2002

    2001

 

Cash provided (used) by:

                        

Operating activities

   $ 55,904     $ 15,658     $ 119,097  

Investing activities

     (12,549 )     (10,817 )     227,413  

Financing activities:

                        

Debt paydown

     (4,949 )     (45,941 )     (298,280 )

Other

     14,125       1,887       1,093  

Earnings before interest, taxes, depreciation and amortization (EBITDA)

     71,154       67,363       132,807  

 

The following is a reconciliation of EBITDA to net income (loss):

 

    

For the year ended

December 31,


In thousands


   2003

   2002

    2001

Net income (loss)

   $ 22,703    $ (45,479 )   $ 61,780

Interest expense

     10,377      18,072       33,501

Income tax expense

     12,790      7,594       4,465

Cumulative effect of accounting change, net of tax

     —        61,663       —  

Depreciation

     20,975      20,191       20,048

Amortization

     4,309      5,322       13,013
    

  


 

Earnings before interest, taxes, depreciation and amortization (EBITDA)

   $ 71,154    $ 67,363     $ 132,807
    

  


 

 

EBITDA is defined as earnings before deducting interest expense, income taxes and depreciation and amortization. Although EBITDA is not a measure of performance calculated in accordance with generally accepted accounting principles, management believes that it is useful to an investor in evaluating Wabtec because it is widely used as a measure to evaluate a Company’s operating performance and ability to service debt. Financial covenants in our credit facility include ratios based on EBITDA. EBITDA does not purport to represent cash generated by operating activities and should not be considered in isolation or as substitute for measures of performance in accordance with

 

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generally accepted accounting principles. In addition, because EBITDA is not calculated identically by all companies, the presentation here may not be comparable to other similarly titled measures of other companies. Management’s discretionary use of funds depicted by EBITDA may be limited by working capital, debt service and capital expenditure requirements, and by restrictions related to legal requirements, commitments and uncertainties.

 

Operating activities. Operating cash flow in 2003 was $55.9 million as compared to $15.7 million in 2002. Working capital remained relatively unchanged, as receivables and inventory increased $13.2 million, and accounts payable increased $14.1 million.

 

Operating cash flow in 2002 was $15.7 million as compared to $119.1 million in the same period a year ago. Working capital decreased $6 million in 2002, as inventory decreased by $16 million while payables and accruals decreased by $10 million. Cash from operating activities in 2001 was positively impacted by the sale of certain businesses and its corresponding reduction in working capital.

 

During 2002 and 2001, cash outlays for merger and restructuring activities were approximately $2.5 million and $6.8 million, respectively, and are reported as a reduction to cash provided by operating activities. Also, in 2002, $30 million was paid in taxes related to the gain on the sale of locomotive aftermarket assets in 2001. The operating cash flow in 2002 excluding the $30 million tax payment from 2001 was approximately $46 million.

 

Investing activities. In 2003 and 2002, cash used in investing activities was $12.5 and $10.8 million, respectively, consisting almost entirely of capital expenditures, net of disposals. In 2001 cash provided by investing activities was $227.4 million. Adjusting 2001 for the gross proceeds from the sale of certain businesses for $238 million, cash used by investing activities would have been approximately $10.6 million. In 2002 and 2001 we used $1.7 million and $3.7 million for certain business acquisitions. See Note 5 of “Notes to Consolidated Financial Statements” included in Part IV, Item 15 of this report, for further information.

 

Capital expenditures for continuing operations were $17.5 million, $14.1 million and $20.7 million in 2003, 2002 and 2001, respectively. The majority of capital expenditures for these periods relates to upgrades to and replacement of existing equipment.

 

Financing activities. In 2003, cash provided by financing activities was $9.2 million compared to cash used by financing activities of $44.1 million in 2002.

 

In 2003, we issued $150 million of Senior Notes due in August 2013 (“the Notes”). The Notes were issued at par and interest accrues at 6.875% and is payable semi-annually on January 31 and July 31 of each year, commencing on January 31, 2004. The proceeds were used to repay debt outstanding under the Company’s then existing bank credit agreement, and for general corporate purposes.

 

The Notes are senior unsecured obligations of the Company and rank pari passu with all existing and future senior debt and senior to all our existing and future subordinated indebtedness of the Company. The indenture under which the Notes were issued contains covenants and restrictions which limit among other things, the following: the incurrence of indebtedness, payment of dividends and certain distributions, sale of assets, change in control, mergers and consolidations and the incurrence of liens.

 

In November 2003, we issued common stock in connection with the registration and sale of stock by certain selling shareholders. We issued 726,900 shares of common stock realizing total proceeds of about $10 million. See “Prospectus Summary — Recent development.”

 

Cash used for financing activities was $44.1 million in 2002 versus $297.2 million in 2001. During 2002, we reduced long-term debt by $45.9 million. During 2001, we reduced long-term debt by $298.3 million. We repaid $175 million of senior notes in the third quarter of 2002 to take advantage of lower interest rates on our revolving credit agreement. Historically, we have financed the purchase of significant businesses utilizing cash flow generated from operations and amounts available under its credit facilities.

 

The following table shows our outstanding indebtedness at December 31, 2003 and 2002. The revolving credit note and other term loan interest rates are variable and dependent on market conditions.

 

     December 31,

In thousands


   2003

   2002

Revolving credit agreement due 2004

   $ 40,000    $ 189,700

6.875% Senior notes

     150,000      —  

5.5% Industrial revenue bond due 2008

     —        4,909

Other

     225      542
    

  

Total

     190,225      195,151

Less–current portion

     —        833
    

  

Long–term portion

   $ 190,225    $ 194,318
    

  

 

Cash balance at December 31, 2003 and 2002 was $70.3 million and $19.2 million, respectively. The financial statements have been prepared based on the terms of the Refinanced Credit Agreement.

 

Credit agreements. In November 1999, we refinanced the then existing unsecured MotivePower credit agreement (the “Credit Agreement”) with a consortium of commercial banks. This unsecured Credit Agreement provided a $275 million five-year revolving credit facility expiring in November 2004 and a 364-day $275 million convertible revolving credit facility maturing in November 2004. In November 2001, we

 

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and the banks negotiated a reduction in the 364-day facility to $100 million, as a result of the $208 million, net of tax, cash proceeds from the sale of locomotive businesses to GE. In November 2002, we negotiated a further reduction in the 364-day facility from $100 million to $95 million. In July 2003, we and the banks negotiated a reduction in both facilities to a total of $225 million as a result of the issuance of the Senior Notes. The $225 million facility provided a reduced five-year facility of $167.2 million and a reduced 364-day facility of $57.8 million. In November 2003 we allowed the $57.8 million 364-day facility to expire. At December 31, 2003, we had available bank borrowing capacity, net of $19.6 million of letters of credit, of approximately $107.7 million.

 

Under the Credit Agreement, we may elect a base rate, an interest rate based on the London Interbank Offered Rates of Interest (“LIBOR”), a cost of funds rate and a bid rate. The base rate is the greater of LaSalle Bank National Association’s prime rate or the federal funds effective rate plus 0.5% per annum. The LIBOR rate is based on LIBOR plus a margin that ranges from 87.5 to 200 basis points depending on our consolidated total indebtedness to cash flow ratios. The current margin is 137.5 basis points. The cost of funds rate is a fluctuating interest rate based on LaSalle Bank National Association’s then cost of funds. Under the bid rate option, any participating bank may propose the interest rate at which it will lend funds, which rate may either be a fixed rate or a floating rate based on LIBOR.

 

The Credit Agreement limits our ability to declare or pay cash dividends and prohibits us from declaring or making other distributions, subject to certain exceptions. The credit agreement contains various other covenants and restrictions including the following limitations: incurrence of additional indebtedness; mergers, consolidations and sales of assets and acquisitions; additional liens; sale and leasebacks; permissible investments, loans and advances; certain debt payments; capital expenditures; and imposes a minimum interest expense coverage ratio and a maximum debt to cash flow ratio.

 

The Credit Agreement contains customary events of default, including payment defaults, failure of representations or warranties to be true in any material respect, covenant defaults, defaults with respect to other indebtedness of the Company, bankruptcy, certain judgments against the Company, ERISA defaults and “change of control” of the Company.

 

Credit Agreement borrowings bear variable interest rates indexed to the indices described above. The maximum credit agreement borrowings, average credit agreement borrowings and weighted-average contractual interest rate on credit agreement borrowings were $209 million, $129.3 million and 2.68%, respectively for 2003. To reduce the impact of interest rate changes on a portion of this variable-rate debt, we entered into interest rate swaps which effectively convert a portion of the debt from variable to fixed-rate borrowings during the term of the swap contracts. On December 31, 2003, the notional value of interest rate swaps outstanding totaled $40 million and effectively changed our interest rate from a variable rate to a fixed rate of 3.98%. The interest rate swap agreements mature in February 2006. We are exposed to credit risk in the event of nonperformance by the counterparties. However, since only the cash interest payments are exchanged, exposure is significantly less than the notional amount. The counterparties are large financial institutions and we do not anticipate nonperformance.

 

In January 2004, we refinanced the Credit Agreement with a consortium of commercial banks. This “Refinancing Credit Agreement” currently provides a $175 million five-year revolving credit facility expiring in January 2009. Under the Refinancing Credit Agreement, we may elect a base rate or an interest rate based on the London Interbank Offered Rates of Interest (“LIBOR”). The base rate is the greater of LaSalle Bank National Association’s prime rate or the federal funds effective rate plus 0.5% per annum. The LIBOR rate is based on LIBOR plus a margin that ranges from 100 to 200 basis points depending on our consolidated total indebtedness to cash flow ratios. The current margin is 175 basis points.

 

The Refinancing Credit Agreement limits our ability to declare or pay cash dividends and prohibits us from declaring or making other distributions, subject to certain exceptions. The Refinancing Credit Agreement contains various other covenants and restrictions including the following limitations: incurrence of additional indebtedness; mergers, consolidations and sales of assets and acquisitions; additional liens; sale and leasebacks; permissible investments, loans and advances; certain debt payments; capital expenditures; and imposes a minimum interest expense coverage ratio and a maximum debt to cash flow ratio.

 

The Refinancing Credit Agreement contains customary events of default, including payment defaults, failure of representations or warranties to be true in any material respect, covenant defaults, defaults with respect to other indebtedness of the Company, bankruptcy, certain judgments against the Company, ERISA defaults and “change of control” of the Company. Financial covenants include Minimum Interest Coverage Ratio, Maximum Total Debt to EBITDA Ratio, Minimum Net Worth Measurement, and Capital Expenditures Limitations. The Company is in compliance with these measurements and covenants and expects that these measurements will not be any type of limiting factor in executing our operating activities. See Note 9 of “Notes to Consolidated Financial Statements” included in Part IV, Item 15 of this report.

 

We believe, based on current levels of operations and forecasted earnings, cash flow and liquidity will be sufficient to fund our working capital and capital equipment needs as well as meeting the debt service requirements. If our sources of funds were to fail to satisfy our cash requirements, we may need to refinance our existing debt or obtain additional financing. There is no assurance that such new financing alternatives would be

 

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available, and, in any case, such new financing, if available, would be expected to be more costly and burdensome than the debt agreements currently in place.

 

Extinguishment of other debt. In June 1995, the Company issued $100 million of 9.375% Senior Notes due in 2005 (the “1995 Notes”). In January 1999, the Company issued an additional $75 million of 9.375% Senior Notes due in 2005 (the “1999 Notes”). The 1995 Notes and the 1999 Notes were redeemed at par (face) on July 8, 2002 through the use of cash on hand and additional borrowings under the credit agreement. This redemption resulted in a non-cash loss of $1.9 million relating to a write-off of deferred debt issuance costs.

 

In July 1998, a subsidiary of the Company entered into a 10 year $7.5 million debt obligation for the purchase of a building used in the Company’s operations. The debt was repaid in September 2003.

 

Effects of Inflation

 

General price inflation has not had a material impact on the Company’s results of operations. Some of our labor contracts contain negotiated salary and benefit increases and others contain cost of living adjustment clauses, which would cause our labor cost to automatically increase if inflation were to become significant.

 

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Contractual Obligations and Off-Balance Sheet Arrangements

 

We are obligated to make future payments under various contracts such as debt agreements, lease agreements and have certain contingent commitments such as debt guarantees. We have grouped these contractual obligations and off-balance sheet arrangements into operating activities, financing activities, and investing activities in the same manner as they are classified in the Statement of Consolidated Cash Flows to provide a better understanding of the nature of the obligations and arrangements and to provide a basis for comparison to historical information. The table below provides a summary of contractual obligations and off-balance sheet arrangements as of December 31, 2003:

 

In thousands


   Total

   2004

   2005 to 2006

   2007 to 2008

   Thereafter

Operating activities:

                                  

Unconditional purchase obligations (1)

   $ —      $ —      $ —      $ —      $ —  

Long-term purchase obligations (1)

     —        —        —        —        —  

Operating leases (2)

     43,500      7,056      12,763      10,786      12,896

Estimated pension funding (3)

     —        6,400      11,800      11,800      —  

Postretirement benefit payments (4)

     —        2,928      7,930      11,803      —  

Financing activities:

                                  

Long-term debt (5)

     190,225      —        225      —        190,000

Dividends to shareholders (6)

     —        —        —        —        —  

Investing activities:

                                  

Capital projects (7)

     20,000      20,000      —        —        —  

Other:

                                  

Standby letters of credit (8)

     19,563      19,563      —        —        —  

Guarantees (9)

     3,000      —        —        —        —  
    

  

  

  

  

Total

          $ 55,947    $ 32,718    $ 34,389       
    

  

  

  

  

 

(1) Unconditional purchase obligations for the purposes of this disclosure have been defined as a contractual obligation to purchase utilities, electricity, natural gas that is in excess of $100,000 annually, and $200,000 in total. Long-term purchase obligations for the purposes of this disclosure have been defined as a contractual obligation to purchase raw materials or supplies that are non-cancelable, and are in excess of $100,000 annually, and $200,000 in total.

 

(2) Future minimum payments for operating leases are disclosed by year in Note 15 of the “Notes to Consolidated Financial Statements” included in Part IV, Item 15 of this report.

 

(3) Annual payments and funding are expected to continue into the foreseeable future at the amounts or ranges noted. Pension funding payments are based on actuarial estimates using current assumptions for discount rates, expected return on long-term assets and rate of compensation increases. See further disclosure in Note 10 of the “Notes to Consolidated Financial Statements” included in Part IV, Item 15 of this report.

 

(4) Annual payments and funding are expected to continue into the foreseeable future at the amounts or ranges noted. To estimate the funding requirements, historical benefit payments were utilized assuming 22 percent rate of inflation. See further disclosure in Note 10 of the “Notes to Consolidated Financial Statements” included in Part IV, Item 15 of this report.

 

(5) Scheduled principal repayments of outstanding loan balances (as refinanced subsequent to December 31, 2003) are disclosed by year in Note 9 of the “Notes to Consolidated Financial Statements” included in Part IV, Item 15 of this report.

 

(6) Shareholder dividends are subject to approval by the Company’s Board of Directors, currently at an annual rate of $1.8 million.

 

(7) The annual capital expenditure budget is subject to approval by the Board of Directors. The 2004 budget amount of $20 million was approved at the February 2004 Board of Directors meeting.

 

(8) The Company has $19.6 million in outstanding letters of credit for performance and bid bond purposes, all of which expire in 2004.

 

(9) Guarantee for debt of former operating unit sold in 2001.

 

Obligations for operating activities. We have not entered into any material long-term non-cancelable materials and supply purchase obligations. Operating leases represent multi-year obligations for rental of facilities and equipment. Estimated pension funding and post retirement benefit payments are based on actuarial estimates using current assumptions for discount rates, expected return on long-term assets, rate of compensation increases and health care cost trend rates. Benefits paid for pension obligations were $5.7 million and $5.6 million in 2003 and 2002, respectively. Benefits paid for post retirement plans were $2.1 million and $1.9 million in 2003 and 2002, respectively. We expect these minimum levels of funding to continue in future periods.

 

Obligations for financing activities. Cash requirements for financing activities consist primarily of long-term debt repayments and dividend payments to shareholders. We have historically paid quarterly dividends to shareholders, subject to quarterly approval by our Board of Directors, currently at a rate of $1.8 million annually.

 

In 2001, we sold a subsidiary to that unit’s management team. As part of the sale, we guaranteed approximately $3 million of bank debt of the buyer, which was used for the purchase financing. In the event that the purchaser cannot repay or refinance the debt without a guarantee by us, the subsidiary would be returned to us. This debt is due in 2004. We have no reason to believe that this debt will not be repaid or refinanced.

 

Obligations for investing activities. Historically, we typically spend approximately $15-20 million a year for capital expenditures, primarily related to facility expansion efficiency and modernization, health and safety, and environmental control.

 

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We expect annual capital expenditures in the future will be within this range. In 2004, we have two properties currently under contract for sale and expect to generate approximately $5 million in sale proceeds once these transactions close.

 

Forward Looking Statements

 

We believe that all statements other than statements of historical facts included in this report, including certain statements under “Business” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” may constitute forward-looking statements. We have based these forward-looking statements on our current expectations and projections about future events. Although we believe that our assumptions made in connection with the forward-looking statements are reasonable, we cannot assure you that our assumptions and expectations are correct.

 

These forward-looking statements are subject to various risks, uncertainties and assumptions about us, including, among other things:

 

Economic and industry conditions

 

  materially adverse changes in economic or industry conditions generally or in the markets served by us, including North America, South America, Europe, Australia and Asia;

 

  demand for freight cars, locomotives, passenger transit cars, buses and related products and services;

 

  reliance on major original equipment manufacturer customers;

 

  original equipment manufacturers’ program delays;

 

  demand for services in the freight and passenger rail industry;

 

  demand for our products and services;

 

  recovery in our industry, and in particular, orders either being delayed, cancelled, not returning to historical levels, or reduced or any combination of the foregoing;

 

  consolidations in the rail industry;

 

  continued outsourcing by our customers; industry demand for faster and more efficient braking equipment; or

 

  fluctuations in interest rates and foreign currency exchange rates;

 

Operating factors

 

  supply disruptions;

 

  technical difficulties;

 

  changes in operating conditions and costs;

 

  successful introduction of new products;

 

  labor relations;

 

  completion and integration of acquisitions; or

 

  the development and use of new technology;

 

Competitive factors

 

  the actions of competitors;

 

Political/governmental factors

 

  political stability in relevant areas of the world;

 

  future regulation/deregulation of our customers and/or the rail industry;

 

  levels of governmental funding on transit projects, including for some of our customers;

 

  political developments and laws and regulations; or

 

  the outcome of our existing or any future legal proceedings, including litigation involving our principal customers and any litigation with respect to environmental, asbestos-related matters and pension liabilities; and

 

Transaction or commercial factors

 

  the outcome of negotiations with partners, governments, suppliers, customers or others.

 

Statements in this 10-K apply only as of the date on which such statements are made, and we undertake no obligation to update any statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events.

 

Critical Accounting Policies

 

The preparation of the financial statements in accordance with generally accepted accounting principles requires management to make judgments, estimates and assumptions regarding uncertainties that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities and the reported amounts of revenues and expenses. Areas of uncertainty that require judgments, estimates and assumptions include the accounting for derivatives, environmental matters, warranty reserves, the testing of goodwill and other intangibles for impairment, proceeds on assets to be sold, pensions and other postretirement benefits, and tax matters. Management uses historical experience and all available information to make these judgments and estimates, and actual results will inevitably differ from those estimates and assumptions that are used to prepare the Company’s financial statements at any given time. Despite these inherent limitations, management believes that Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) and the financial statements and related footnotes provide a meaningful and fair perspective of the Company. A discussion of the judgments and uncertainties associated with accounting for derivatives and environmental matters can be found in Note 2 in the “Notes to Consolidated Financial Statements” included in Part IV, Item 15 of this report.

 

A summary of the Company’s significant accounting policies is included in Note 2 in the “Notes to Consolidated Financial Statements” included in Part IV, Item 15 of this report. Management believes that the application of these policies on a consistent basis enables the Company to provide the users of the financial statements with useful and reliable information about the Company’s operating results and financial condition.

 

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In 2002, we adopted the new standard of accounting for goodwill and intangible assets with indefinite lives. The cumulative effect adjustment recognized on January 1, 2002, upon adoption of the new standard, was a charge of $61.7 million (after tax). Also in 2002, amortization ceased for goodwill and intangible assets with indefinite lives. Total amortization expense for intangible assets recognized was $3.4 million in 2003 and $4 million in 2002. Additionally, goodwill and indefinite-lived intangibles are required to be tested for impairment at least annually. The evaluation of impairment involves comparing the current fair value of the business to the recorded value (including goodwill). We use a combination of a guideline public company market approach and a discounted cash flow model (“DCF model”) to determine the current fair value of the business. A number of significant assumptions and estimates are involved in the application of the DCF model to forecasted operating cash flows, including markets and market share, sales volume and pricing, costs to produce and working capital changes. Management considers historical experience and all available information at the time the fair values of its business are estimated. However, actual fair values that could be realized in an actual transaction may differ from those used to evaluate the impairment of goodwill.

 

The allowance for doubtful accounts receivable reflects our best estimate of probable losses inherent in our receivable portfolio determined on the basis of historical experience, specific allowances for known troubled accounts and other currently available evidence.

 

Other areas of significant judgments and estimates include the liabilities and expenses for pensions and other postretirement benefits. These amounts are determined using actuarial methodologies and incorporate significant assumptions, including the rate used to discount the future estimated liability, the long-term rate of return on plan assets and several assumptions relating to the employee workforce (salary increases, medical costs, retirement age and mortality). The rate used to discount future estimated liabilities is determined considering the rates available at year-end on debt instruments that could be used to settle the obligations of the plan. The long-term rate of return is estimated by considering historical returns and expected returns on current and projected asset allocations and is generally applied to a five-year average market value of assets.

 

As a global company, Wabtec records an estimated liability or benefit for income and other taxes based on what it determines will likely be paid in various tax jurisdictions in which it operates. Management uses its best judgment in the determination of these amounts. However, the liabilities ultimately realized and paid are dependent on various matters including the resolution of the tax audits in the various affected tax jurisdictions and may differ from the amounts recorded. An adjustment to the estimated liability would be recorded through income in the period in which it becomes probable that the amount of the actual liability differs from the recorded amount. Management does not believe that such a charge would be material.

 

Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Interest Rate Risk

 

In the ordinary course of business, we are exposed to risks that increases in interest rates may adversely affect funding costs associated with its variable-rate debt. After considering the effects of interest rate swaps, further described below, our variable rate debt represents 0% of total long-term debt at December 31, 2003 and 66% in 2002. Management has entered into pay-fixed, receive-variable interest rate swap contracts that mitigates the impact of variable-rate debt interest rate increases. At December 31, 2003, an instantaneous 100 basis point increase in interest rates would not reduce our annual earnings. We have adopted Statement of Financial Accounting Standards (“SFAS”) No. 133, and as amended by SFAS 138, “Accounting for Derivative Instruments and Hedging Activities” effective January 1, 2001. In the application, we have concluded that our swap contracts qualify for “special cash flow hedge accounting” which permit recording the fair value of the swap and corresponding adjustment to other comprehensive income on the balance sheet (see Note 21 of “Notes to Consolidated Financial Statements” included in Part IV, Item 15 of this report). This fluctuation is not expected to have a material effect on our financial condition, results of operations and liquidity.

 

Foreign Currency Exchange Risk

 

We occasionally enter into several types of financial instruments for the purpose of managing our exposure to foreign currency exchange rate fluctuations in countries in which we have significant operations. As of December 31, 2003, we had several such instruments outstanding to hedge currency rate fluctuation in 2004.

 

We entered into foreign currency options and forward contracts to reduce the impact of changes in currency exchange rates. A currency option gives us the right but not the obligation to exchange currency at a pre-determined exchange rate either on a specific date or within a specific period of time. Forward contracts are agreements with a counterparty to exchange two distinct currencies at a set exchange rate for delivery on a set date at some point in the future. There is no exchange of funds until the delivery date. At the delivery date we can either take delivery of the currency or settle on a net basis. All outstanding forward contracts and option agreements are for the sale of U.S. Dollars (USD) and the purchase of Canadian Dollars (CAD). As of December 31, 2003, we had outstanding option agreements with a notional value of $10.5 million CAD resulting in the recording of a current asset of $270,000 and an increase in comprehensive income of $171,000, net of tax and has forward contracts with a notional value of $13.5 million CAD, resulting in the

 

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recording of a current asset of $100,000 and an increase in comprehensive income of $64,000, net of tax.

 

Subsequent to December 31, 2003, The Company entered into additional forward contracts to hedge its exposure to Canadian currency risk. Including the forwards outstanding at the end of 2003, the forward contracts currently have a total notional value of $83 million CAD (or $62 million USD), with an average exchange rate of $0.747 USD per $1 CAD.

 

We are also subject to certain risks associated with changes in foreign currency exchange rates to the extent our operations are conducted in currencies other than the U.S. dollar. For the year ended December 31, 2003, approximately 69% of Wabtec’s net sales are in the United States, 9% in Canada, 1% in Mexico, and 21% in other international locations, primarily Europe. (See Note 20 of “Notes to Consolidated Financial Statements” included in Part IV, Item 15 of this report).

 

Our market risk exposure is not substantially different from our exposure at December 31, 2002.

 

Recent Accounting Pronouncements

 

See note 2 of “Notes to Consolidated Financial Statements” included in Part IV, Item 15 of this report.

 

Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

Financial statements and supplementary data are set forth in Item 15, of Part IV hereof.

 

Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

 

As reported in a Current Report on Form 8-K dated May 30, 2002, we dismissed Arthur Andersen LLP as our independent public accountants on May 30, 2002 and, after a review of several possible candidates, appointed Ernst & Young LLP to serve as our independent public accountants for the fiscal years ended December 31, 2003 and 2002 in accordance with the recommendation of our Board of Directors and its Audit Committee. We dismissed Arthur Andersen LLP as our auditor because we believed that the firm could no longer provide the necessary services on a global basis. There were no disagreements with Arthur Andersen reported.

 

Item 9A. CONTROLS AND PROCEDURES

 

Wabtec’s principal executive officer and its principal financial officer have evaluated the effectiveness of Wabtec’s “disclosure controls and procedures,” (as defined in Exchange Act Rule 13a-15(e)) as of December 31, 2003. Based upon their evaluation, the principal executive officer and principal financial officer concluded that Wabtec’s disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by Wabtec in the reports filed or submitted by it under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and to provide reasonable assurance that information required to be disclosed by Wabtec in such reports is accumulated and communicated to Wabtec’s management, including its principal executive officer and principal finance officer, as appropriate to allow timely decisions regarding required disclosure.

 

There was no change in Wabtec’s “internal control over financial reporting” (as defined in Rule 13a-15(f) under the Exchange Act) that occurred during the quarter ended December 31, 2003, that has materially affected, or is reasonably likely to materially affect, Wabtec’s internal control over financial reporting

 

PART III

 

Items 10 through 14.

 

In accordance with the provisions of General Instruction G to Form 10-K, the information required by Item 10 (Directors and Executive Officers of the Registrant), Item 11 (Executive Compensation), Item 12 (Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters), Item 13 (Certain Relationships and Related Transactions) and Item 14 (Principal Accountant Fees and Services) is incorporated herein by reference from the Company’s definitive Proxy Statement for its Annual Meeting of Stockholders to be held on May 19, 2004. The definitive Proxy Statement will be filed with the Securities and Exchange Commission not later than 120 days after December 31, 2003. Information relating to the executive officers of the Company is set forth in Part I.

 

Wabtec has adopted a Code of Ethics for Senior Officers which is applicable to all of our executive officers. As described in Item 1 of this report the Code of Ethics for Senior Officers is posted on our website at www.wabtec.com. In the event that we make any amendments to or waivers from this code, we will disclose the amendment or waiver and the reasons for such on our website.

 

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PART IV

 

Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K

 

The financial statements, financial statement schedules and exhibits listed below are filed as part of this annual report:

 

               Page

(a)    (1)    Financial Statements     
          Report of Independent Auditors (Ernst & Young LLP)    31
          Report of Independent Auditors (Arthur Andersen LLP)    32
          Consolidated Balance Sheets as of December 31, 2003 and 2002    33
          Consolidated Statements of Operations for the three years ended December 31, 2003, 2002 and 2001    34
          Consolidated Statements of Cash Flows for the three years ended December 31, 2003, 2002 and 2001    35
          Consolidated Statements of Shareholders’ Equity for the three years ended December 31, 2003, 2002 and 2001    36
          Notes to Consolidated Financial Statements    37
     (2)    Financial Statement Schedules     
          Schedule II - Valuation and Qualifying Accounts    60
(b)         Reports on Form 8-K     
         

During the fourth quarter of 2003, the Company filed or furnished the following Current Reports on Form 8-K pertaining to the following items:

 

(1) A report dated October 15, 2003, which included under Items 5 and 7, the press release dated October 15, 2003 announcing the signing of a contract to supply brakes, couplers and current collectors for New York City subway cars, and under Items 7 and 12, the press release, dated October 15, 2003 announcing the financial results of the Company for the quarter ended September 30, 2003.

 

(2) A report dated October 20, 2003, which included under Items 5 and 7, certain reclassifications to the Company’s Form 10-K for the year ended December 31, 2002.

    

 

         Filing Method

(c)   Exhibits     
  2.1   Amended and Restated Agreement and Plan of Merger, as amended (originally included as Annex A to the Joint Proxy Statement/Prospectus)    8
  3.1   Restated Certificate of Incorporation of the Company dated January 30, 1995, as amended March 30, 1995    2
  3.3   Amended and Restated By-Laws of the Company, effective November 19, 1999    8
  4.1(a)   Indenture with the Bank of New York as Trustee dated as of August 6, 2003    15
  4.1(b)   Resolutions Adopted July 23, 2003 by the Board of Directors establishing the terms of the offering of up to $150,000,000 aggregate principal amount of 6.875% Notes due 2013    15
  4.2   Purchase Agreement, dated July 23, 2003, by and between the Company and the initial purchasers    15
  4.3   Exchange and Registration Rights Agreement, dated August 6, 2003    15
10.1   MotivePower Stock Option Agreement (originally included as Annex B to the Joint Proxy Statement/Prospectus)    8
10.2   Westinghouse Air Brake Stock Option Agreement (originally included as Annex C to the Joint Proxy Statement/Prospectus)    8
10.3   Voting Agreement dated as of September 26, 1999 among William E. Kassling, Robert J. Brooks, Harvard Private Capital Holdings, Inc. Vestar Equity Partners, L.P. and MotivePower Industries, Inc. (originally included as Annex D to the Joint Proxy Statement/Prospectus)    8

 

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10.9    Amended and Restated Refinancing Credit Agreement dated as of November 19, 1999 among the Company, various financial institutions, ABN AMRO Bank N.V., The Chase Manhattan Bank, and The Bank of New York (Schedules and Exhibits omitted)    9
10.10    Amended and Restated Stockholders Agreement dated as of March 5, 1997 among the RAC Voting Trust (“Voting Trust”), Vestar Equity Partners, L.P. (“Vestar Equity”), Harvard Private Capital Holdings, Inc. (“Harvard”), American Industrial Partners Capital Fund II, L.P. (“AIP”) and the Company    5
10.12    Indemnification Agreement dated January 31, 1995 between the Company and the Voting Trust Trustees    2
10.13    Agreement of Sale and Purchase of the North American Operations of the Railway Products Group, an operating division of American Standard Inc., dated as of 1990 between Rail Acquisition Corp. and American Standard Inc. (only provisions on indemnification are reproduced)    2
10.14    Letter Agreement (undated) between the Company and American Standard Inc. on environmental costs and sharing    2
10.15    Purchase Agreement dated as of June 17, 1992 among the Company, Schuller International, Inc., Manville Corporation and European Overseas Corporation (only provisions on indemnification are reproduced)    2
10.16    Asset Purchase Agreement dated as of January 23, 1995 among the Company, Pulse Acquisition Corporation, Pulse Electronics, Inc., Pulse Embedded Computer Systems, Inc. and the Pulse Shareholders (Schedules and Exhibits omitted)    2
10.17    License Agreement dated as of December 31, 1993 between SAB WABCO Holdings B.V. and the Company    2
10.18    Letter Agreement dated as of January 19, 1995 between the Company and Vestar Capital Partners, Inc.    2
10.19    Westinghouse Air Brake Company 1995 Stock Incentive Plan, as amended    7
10.20    Westinghouse Air Brake Company 1995 Non-Employee Directors’ Fee and Stock Option Plan, as amended    9
10.22    Letter Agreement dated as of January 1, 1995 between the Company and Vestar Capital Partners, Inc.    2
10.23    Form of Indemnification Agreement between the Company and Authorized Representatives    2
10.27    Amendment No. 1 to Amended and Restated Stockholders Agreement dated as of March 5, 1997 among the Voting Trust, Vestar, Harvard, AIP and the Company    5
10.28    Common Stock Registration Rights Agreement dated as of March 5, 1997 among the Company, Harvard, AIP and the Voting Trust    5
10.29    1998 Employee Stock Purchase Plan    7
10.32    Westinghouse Air Brake Technologies Corporation 2000 Stock Incentive Plan    10
10.33    Amendment No. 1, dated as of November 16, 2000, by and among the Company and the Guarantors from Time to Time Party Thereto, and the Banks From Time to Time Party Thereto, and ABN AMRO Bank N.V. as bookrunner and co-syndication agent, The Bank of New York, as co-syndication agent, Mellon Bank, N.A., as documentation agent, and The Chase Manhattan Bank USA, N.A., (successor in interest to Chase Manhattan Bank Delaware), as an issuing bank, to the Amended and Restated Refinancing Credit Agreement, dated as of November 19, 1999 among the Company, various financial institutions, ABN AMRO Bank N.V., The Chase Manhattan Bank, and The Bank of New York which was filed as Exhibit 10.9 to the Company’s Annual Report on Form 10-K for the period ended December 31, 1999 (Exhibits omitted)    11
10.34    Amendment No. 2, dated as of March 30, 2001, by and among the Company and the Guarantors from Time to Time Party Thereto, and the Banks From Time to Time Party Thereto, and ABN AMRO Bank N.V. as bookrunner and co-syndication agent, The Chase Manhattan Bank as administrative agent, The Bank of New York, as co-syndication agent, Mellon Bank, N.A., as documentation agent, and The Chase Manhattan Bank USA, N.A., (successor in interest to Chase Manhattan Bank Delaware), as an issuing bank, to the Amended and Restated Refinancing Credit Agreement, dated as of November 19, 1999, as amended, among the Company, various financial institutions, ABN AMRO Bank N.V., The Chase Manhattan Bank, and The Bank of New York which was filed as Exhibit 10.9 to the Company’s Annual Report on Form 10-K for the period ended December 31, 1999 (Exhibits omitted)    13

 

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10.35    Amendment No. 3, dated as of July 18, 2001, by and among the Company and the Guarantors from Time to Time Party Thereto, and the Banks From Time to Time Party Thereto, and LaSalle Bank National Association and ABN AMRO Bank N.V. as bookrunner and co-syndication agent, The Bank of New York, as co-syndication agent, The Chase Manhattan Bank as administrative agent, Mellon Bank, N.A., as documentation agent, and The Chase Manhattan Bank USA, N.A., (successor in interest to Chase Manhattan Bank Delaware), as an issuing bank, to the Amended and Restated Refinancing Credit Agreement, dated as of November 19, 1999, as amended, among the Company, various financial institutions, ABN AMRO Bank N.V., The Chase Manhattan Bank, and The Bank of New York which was filed as Exhibit 10.9 to the Company’s Annual Report on Form 10-K for the period ended December 31, 1999 (Exhibits omitted)    13
10.36    Amendment No. 4, dated as of September 17, 2001, by and among the Company and the Guarantors from Time to Time Party Thereto, and the Banks From Time to Time Party Thereto, and LaSalle Bank National Association as bookrunner and co-syndication agent, The Chase Manhattan Bank as administrative agent, The Bank of New York, as co-syndication agent, Mellon Bank, N.A., as documentation agent, and The Chase Manhattan Bank USA, N.A., (successor in interest to Chase Manhattan Bank Delaware), as an issuing bank, to the Amended and Restated Refinancing Credit Agreement, dated as of November 19, 1999, as amended, among the Company, various financial institutions, LaSalle Bank National Association, The Chase Manhattan Bank, and The Bank of New York which was filed as Exhibit 10.9 to the Company’s Annual Report on Form 10-K for the period ended December 31, 1999 (Exhibits omitted)    13
10.37    Amendment No. 5, dated as of November 14, 2001, by and among the Company and the Guarantors from Time to Time Party Thereto, and the Banks From Time to Time Party Thereto, and LaSalle Bank National Association as bookrunner and co-syndication agent, JP Morgan Chase Bank (formerly known as The Chase Manhattan Bank) as administrative agent, The Bank of New York, as co-syndication agent, Mellon Bank, N.A., as documentation agent, and The Chase Manhattan Bank USA, N.A., (successor in interest to Chase Manhattan Bank Delaware), as an issuing bank, to the Amended and Restated Refinancing Credit Agreement, dated as of November 19, 1999, as amended, among the Company, various financial institutions, ABN AMRO Bank N.V., The Chase Manhattan Bank, and The Bank of New York which was filed as Exhibit 10.9 to the Company’s Annual Report on Form 10-K for the period ended December 31, 1999 (Exhibits omitted)    13
10.38    Amendment No. 6, dated as of November 13, 2002, by and among the Company and the Guarantors from Time to Time Party Thereto, and the Banks From Time to Time Party Thereto, and LaSalle Bank National Association as bookrunner and co-syndication agent, JP Morgan Chase Bank as administrative agent, and The Bank of New York, as co-syndication agent, Mellon Bank, N.A., as documentation agent, LaSalle Bank National Association, as an issuing bank, ABN AMRO Bank N.V., as an issuing bank, and The Chase Manhattan Bank USA, N.A., (successor in interest to Chase Manhattan Bank Delaware), as an issuing bank, to the Amended and Restated Refinancing Credit Agreement, dated as of November 19, 1999, as amended, among the Company, various financial institutions, ABN AMRO Bank N.V., The Chase Manhattan Bank, and The Bank of New York which was filed as Exhibit 10.9 to the Company’s Annual Report on Form 10-K for the period ended December 31, 1999    14
10.39    Asset Purchase Agreement, by and between General Electric Company, through its GE Transportation Systems business and Westinghouse Air Brake Technologies Corporation, dated as of July 24, 2001    12
10.40    Refinancing Credit Agreement by and among the Company, the Guarantors, various lenders, LaSalle Bank National Association, JP Morgan Chase Bank, The Bank of New York, Citizens Bank of Pennsylvania, National City Bank of Pennsylvania, The Bank of Nova Scotia, Bank of Tokyo-Mitsubishi Trust Company and PNC Bank, National Association dated January 12, 2004    1

 

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21    List of subsidiaries of the Company    1
23.1    Consent of Ernst & Young LLP    1
23.2    Information Regarding Consent of Arthur Andersen LLP    1
31.1    Rule 13a-14(a)/15d-14(a) Certifications    1
32.1    Section 1350 Certifications    1
99.1    Annual Report on Form 11-K for the year ended December 31, 2003 of the Westinghouse Air Brake Technologies Corporation Savings Plan    1
99.2    Annual Report on Form 11-K for the year ended December 31, 2003 of the Westinghouse Air Brake Technologies Corporation Savings Plan for Hourly Employees    1

1   

Filed herewith.

2   

Filed as an exhibit to the Company’s Registration Statement on Form S-1 (No. 33-90866).

3   

Filed as an exhibit to the Company’s Current Report on Form 8-K, dated October 3, 1996.

4   

Filed as an exhibit to the Company’s Registration Statement on Form S-8 (No. 333-39159).

5   

Filed as an exhibit to the Company’s Annual Report on Form 10-K for the period ended December 31, 1997.

6   

Filed as an exhibit to the Company’s Current Report on Form 8-K, dated October 5, 1998.

7   

Filed as an exhibit to the Company’s Annual Report on Form 10-K for the period ended December 31, 1998.

8   

Filed as part of the Company’s Registration Statement on Form S-4 (No. 333-88903).

9   

Filed as an exhibit to the Company’s Annual Report on Form 10-K for the period ended December 31, 1999.

10   

Filed as an exhibit to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2000.

11   

Filed as an exhibit to the Company’s Annual Report on Form 10-K for the period ended December 31, 2000.

12   

Filed as an exhibit to the Company’s Current Report on Form 8-K, dated November 13, 2001.

13   

Filed as an exhibit to the Company’s Annual Report on Form 10-K for the period ended December 31, 2001.

14   

Filed as an exhibit to the Company’s Annual Report on Form 10-K for the period ended December 31, 2002.

15   

Filed as an exhibit to the Company’s Registration Statement on Form S-4 (No. 333-110600).

 

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REPORT OF INDEPENDENT AUDITORS

 

To the Board of Directors and Shareholders of

Westinghouse Air Brake Technologies Corporation:

 

We have audited the accompanying consolidated balance sheet of Westinghouse Air Brake Technologies Corporation and subsidiaries as of December 31, 2003 and 2002, and the related consolidated statements of operations, shareholders’ equity and cash flows for the years then ended. Our audit also included the financial statement schedule for the year ended December 31, 2003 listed in the index in Item 15(a) of this Registration Statement. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audit. The financial statements of Westinghouse Air Brake Technologies Corporation and subsidiaries as of December 31, 2001, and for the year then ended were audited by other auditors who have ceased operations. Those auditors expressed an unqualified opinion on those financial statements in their report dated February 18, 2002.

 

We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Westinghouse Air Brake Technologies Corporation and subsidiaries as of December 31, 2003 and 2002, and the results of their operations and their cash flows for the years then ended in conformity with accounting principles generally accepted in the United States. Also in our opinion, the financial statement schedule referred to above, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

 

As more fully discussed in Note 8 to the consolidated financial statements, effective January 1, 2002, Westinghouse Air Brake Technologies Corporation adopted the provisions of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets (SFAS No. 142).

 

As discussed above, the consolidated financial statements of Westinghouse Air Brake Technologies Corporation as of December 31, 2001, and for the year then ended were audited by other auditors who have ceased operations. As described in Note 8, these financial statements have been revised to include the transitional disclosures required by SFAS No. 142, which was adopted by the Company as of January 1, 2002. Our audit procedures with respect to the disclosures in Note 8 with respect to 2001 included (a) agreeing the previously reported net income to the previously issued financial statements and the adjustments to reported net income representing amortization expense (including any related tax effects) recognized in those periods related to goodwill as a result of initially applying Statement No. 142 to the Company’s underlying records obtained from management, and (b) testing the mathematical accuracy of the reconciliation of adjusted net income to reported net income, and the related earnings per share amounts. In our opinion, the disclosures for 2001 in Note 8 are appropriate. However, we were not engaged to audit, review, or apply any procedures to the 2001 financial statements of the Company other than with respect to such disclosures and, accordingly, we do not express an opinion or any other form of assurance on the 2001 financial statements taken as a whole.

 

/s/ ERNST & YOUNG LLP

 

February 17, 2004

 

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REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

 

To the Board of Directors and Shareholders of

Westinghouse Air Brake Technologies Corporation:

 

We have audited the accompanying consolidated balance sheets of Westinghouse Air Brake Technologies Corporation (a Delaware corporation) and subsidiaries as of December 31, 2001 and 2000, and the related consolidated statements of operations, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2001. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Westinghouse Air Brake Technologies Corporation and subsidiaries as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States.

 

/s/ ARTHUR ANDERSEN LLP

 

Pittsburgh, Pennsylvania

February 18, 2002

 

This is a copy of the audit report previously issued by Arthur Andersen LLP in connection with the Company’s Annual Report on Form 10-K for the year ended December 31, 2001. This audit report has not been reissued by Arthur Andersen LLP in connection with this Annual Report Form 10-K. See Exhibit 23.2 for further discussion.

 

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WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

CONSOLIDATED BALANCE SHEETS

 

     December 31,

 

In thousands, except share and par value


   2003

    2002

 
Assets                 

Current Assets

                

Cash

   $ 70,328     $ 19,210  

Accounts receivable

     129,074       108,019  

Inventories

     91,809       88,470  

Deferred income taxes

     23,457       23,613  

Other

     7,424       5,911  
    


 


Total current assets

     322,092       245,223  

Property, plant and equipment

     332,619       308,495  

Accumulated depreciation

     (178,780 )     (159,903 )
    


 


Property, plant and equipment, net

     153,839       148,592  

Other Assets

                

Assets held for sale

     1,974       10,105  

Goodwill

     109,450       109,450  

Other intangibles, net

     37,776       41,524  

Deferred income taxes

     20,315       26,112  

Other noncurrent assets

     10,859       7,859  
    


 


Total other assets

     180,374       195,050  
    


 


Total Assets

   $ 656,305     $ 588,865  
    


 


Liabilities and Shareholders’ Equity                 

Current Liabilities

                

Current portion of long-term debt

   $ —       $ 833  

Accounts payable

     79,747       62,104  

Accrued income taxes

     126       3,928  

Customer deposits

     16,818       10,827  

Accrued compensation

     18,131       19,814  

Accrued warranty

     13,307       17,407  

Other accrued liabilities

     24,651       20,350  
    


 


Total current liabilities

     152,780       135,263  

Long-term debt

     190,225       194,318  

Reserve for postretirement and pension benefits

     39,055       38,266  

Deferred income taxes

     11,631       8,771  

Commitments and contingencies

     5,536       7,568  

Notes payable

     3,198       —    

Other long-term liabilities

     5,587       5,417  
    


 


Total liabilities

     408,012       389,603  

Shareholders’ Equity

                

Preferred stock, 1,000,000 shares authorized, no shares issued

     —         —    

Common stock, $.01 par value; 100,000,000 shares authorized: 66,174,767 and 65,447,867 shares issued and 44,631,733 and 43,440,840 outstanding at December 31, 2003 and 2002, respectively

     662       654  

Additional paid-in capital

     282,872       272,782  

Treasury stock, at cost, 21,543,034 and 22,007,027 shares, at December 31, 2003 and 2002, respectively

     (267,586 )     (273,634 )

Retained earnings

     252,234       231,282  

Deferred compensation

     —         270  

Accumulated other comprehensive loss

     (19,889 )     (32,092 )
    


 


Total shareholders’ equity

     248,293       199,262  
    


 


Total Liabilities and Shareholders’ Equity

   $ 656,305     $ 588,865  
    


 


 

The accompanying notes are an integral part of these statements.

 

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WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

 

     Year ended December 31,

 

In thousands, except per share data


   2003

    2002

    2001

 

Net sales

   $ 717,924     $ 696,195     $ 783,698  

Cost of sales

     (528,474 )     (516,724 )     (573,772 )
    


 


 


Gross profit

     189,450       179,471       209,926  

Selling, general and administrative expenses

     (100,503 )     (93,023 )     (96,723 )

Merger and restructuring charges

     —         —         (3,723 )

Engineering expenses

     (32,929 )     (33,592 )     (33,156 )

Asset write-downs

     —         —         (9,253 )

Amortization expense

     (4,309 )     (5,322 )     (13,013 )
    


 


 


Total operating expenses

     (137,741 )     (131,937 )     (155,868 )

Income from operations

     51,709       47,534       54,058  

Other income and expenses

                        

Interest expense

     (10,377 )     (18,072 )     (33,501 )

Other expense, net

     (6,290 )     (5,558 )     (2,130 )
    


 


 


Income from continuing operations before income taxes and cumulative effect of accounting change

     35,042       23,904       18,427  

Income tax expense

     (12,790 )     (7,594 )     (4,465 )
    


 


 


Income from continuing operations before cumulative effect of accounting change

     22,252       16,310       13,962  

Discontinued operations

                        

Income from discontinued operations (net of tax)

     451       403       6,360  

(Loss) gain on sale of discontinued operations (net of tax)

     —         (529 )     41,458  
    


 


 


Total discontinued operations

     451       (126 )     47,818  

Income before cumulative effect of accounting change

     22,703       16,184       61,780  

Cumulative effect of accounting change for goodwill, net of tax

     —         (61,663 )     —    
    


 


 


Net income (loss)

   $ 22,703     $ (45,479 )   $ 61,780  
    


 


 


Earnings Per Common Share

                        

Basic

                        

Income from continuing operations before cumulative effect of accounting change

   $ 0.51     $ 0.37     $ 0.33  

Income from discontinued operations

     0.01       —         1.11  

Cumulative effect of accounting change

     —         (1.42 )     —    
    


 


 


Net income (loss)

   $ 0.52     $ (1.05 )   $ 1.44  
    


 


 


Diluted

                        

Income from continuing operations before cumulative effect of accounting change

   $ 0.51     $ 0.37     $ 0.32  

Income from discontinued operations

     0.01       —         1.11  

Cumulative effect of accounting change

     —         (1.41 )     —    
    


 


 


Net income (loss)

   $ 0.52     $ (1.04 )   $ 1.43  
    


 


 


Weighted average shares outstanding

                        

Basic

     43,538       43,291       42,949  

Diluted

     43,974       43,617       43,198  

 

The accompanying notes are an integral part of these statements.

 

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WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     Year Ended December 31,

 

In thousands


   2003

    2002

    2001

 

Operating Activities

                        

Net income (loss)

   $ 22,703     $ (45,479 )   $ 61,780  

Adjustments to reconcile net income to cash provided by operations:

                        

Cumulative effect of accounting change for goodwill, net of tax

     —         61,663       —    

Depreciation and amortization

     25,284       25,513       33,061  

Results of discontinued operations, net of tax

     (451 )     126       (47,818 )

Loss on sale of product line

     —         —         521  

Write-down of assets

     —         —         9,253  

Deferred income taxes

     8,824       702       (6,278 )

Other, primarily non-cash portion of merger and restructuring charges

     —         —         160  

Discontinued operations

     107       58       (1,213 )

Changes in operating assets and liabilities, net of acquisitions

                        

Accounts receivable

     (12,410 )     (548 )     49,772  

Inventories

     (796 )     17,812       12,670  

Accounts payable

     14,138       (12,814 )     (4,330 )

Accrued income taxes

     286       (30,262 )     5,021  

Accrued liabilities and customer deposits

     2,836       1,964       (20,856 )

Commitments and contingencies

     (2,032 )     (3,033 )     (2,251 )

Other assets and liabilities

     (2,585 )     (44 )     29,605  
    


 


 


Net cash provided by operating activities

     55,904       15,658       119,097  

Investing Activities

                        

Purchase of property, plant and equipment

     (17,470 )     (14,137 )     (20,674 )

Proceeds from disposal of property, plant and equipment

     5,048       3,673       5,873  

Acquisitions of businesses, net of cash acquired

     —         (1,654 )     (3,730 )

Cash received from disposition of discontinued operations

     —         1,400       240,900  

Cash received from disposition of product line

     —         —         4,120  

Discontinued operations

     (127 )     (99 )     924  
    


 


 


Net cash (used for) provided by investing activities

     (12,549 )     (10,817 )     227,413  

Financing Activities

                        

(Repayments) borrowings of credit agreements

     (149,700 )     129,700       (298,000 )

Borrowings (repayments) of senior notes

     150,000       (175,000 )     —    

Repayments of other borrowings

     (5,249 )     (641 )     (280 )

Stock issuance

     9,977       —         —    

Purchase of treasury stock

     —         —         (585 )

Proceeds from treasury stock from stock based benefit plans

     5,899       3,695       3,359  

Cash dividends

     (1,751 )     (1,808 )     (1,681 )
    


 


 


Net cash provided by (used for) financing activities

     9,176       (44,054 )     (297,187 )

Effect of changes in currency exchange rates

     (1,413 )     4,474       (1,445 )
    


 


 


Increase (decrease) in cash

     51,118       (34,739 )     47,878  

Cash, beginning of year

     19,210       53,949       6,071  
    


 


 


Cash, end of year

   $ 70,328     $ 19,210     $ 53,949  
    


 


 


 

The accompanying notes are an integral part of these statements.

 

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WESTINGHOUSE AIR BRAKE TECHNOLOGIES CORPORATION

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

 

In thousands


  

Comprehensive

Income (Loss)


   

Common

Stock


  

Additional

Paid-in

Capital


   

Treasury

Stock


   

Retained

Earnings


   

Deferred

Compensation


   

Accumulated

Other

Comprehensive

Loss


 

Balance, December 31, 2000

           $ 654    $ 273,494     $ (281,665 )   $ 218,470     $ 900     $ (15,482 )

Cash dividends

                                    (1,681 )                

Purchase of treasury stock

                            (585 )                        

Proceeds from treasury stock issued from the exercise of stock options and other benefit plans, net of tax

                    (820 )     4,398               1          

Compensatory stock options granted through a Rabbi Trust

                            363               (363 )        

Net income

   $ 61,780                              61,780                  

Translation adjustment

     (5,170 )                                            (5,170 )

Cumulative effect of change in accounting for derivative financial instruments, net of $(665) tax

     (1,234 )                                            (1,234 )

Unrealized losses on derivatives designated and qualified as cash flow hedges, net of $(705) tax

     (1,310 )                                            (1,310 )

Additional minimum pension liability, net of $(4,144) tax

     (6,479 )                                            (6,479 )
    


                                              
     $ 47,587                                                 
    


 

  


 


 


 


 


Balance, December 31, 2001

           $ 654    $ 272,674     $ (277,489 )   $ 278,569     $ 538     $ (29,675 )

Cash dividends

                                    (1,808 )                

Proceeds from treasury stock issued from the exercise of stock options and other benefit plans, net of tax

                    108       3,587                          

Compensatory stock options granted through a Rabbi Trust

                            268               (268 )        

Net loss

   $ (45,479 )                            (45,479 )                

Translation adjustment

     3,165                                              3,165  

Unrealized gains on derivatives designated and qualified as cash flow hedges, net of $755 tax

     1,538                                              1,538  

Additional minimum pension liability, net of $(4,551) tax

     (7,120 )                                            (7,120 )
    


                                              
     $ (47,896 )                                               
    


 

  


 


 


 


 


Balance, December 31, 2002

           $ 654    $ 272,782     $ (273,634 )   $ 231,282     $ 270     $ (32,092 )

Cash dividends

                                    (1,751 )                

Stock issuance

             8      9,969                                  

Proceeds from treasury stock issued from the exercise of stock options and other benefit plans, net of tax

                    121       5,778                          

Compensatory stock options granted through a Rabbi Trust

                            270               (270 )        

Net income

   $ 22,703                              22,703                  

Translation adjustment

     13,962                                              13,962  

Unrealized gains on other derivatives, net of $135 tax

     235                                              235  

Unrealized gains on derivatives designated and qualified as cash flow hedges, net of $496 tax

     799                                              799  

Additional minimum pension liability, net of $(728) tax

     (2,793 )                                            (2,793 )
    


                                              
     $ 34,906                                                 
    


 

  


 


 


 


 


Balance, December 31, 2003

           $ 662    $ 282,872     $ (267,586 )   $ 252,234     $ —       $ (19,889 )
            

  


 


 


 


 


 

The accompanying notes are an integral part of these statements

 

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WESTINGHOUSE AIR BRAKE

TECHNOLOGIES CORPORATION

NOTES TO CONSOLIDATED FINANCIAL

STATEMENTS

 

1. BUSINESS

 

Wabtec is one of the world’s largest providers of value-added, technology-based products and services for the global rail industry. Our products are found on virtually all U.S. locomotives, freight cars and passenger transit vehicles, as well as in certain markets throughout the world. Our products enhance safety, improve productivity and reduce maintenance costs for customers, and many of our core products and services are essential in the safe and efficient operation of freight rail and passenger transit vehicles.

 

Wabtec is a global company with operations in nine countries. In 2003, about 79 percent of the Company’s revenues came from its North American operations, but Wabtec also sold products or services in 62 countries around the world.

 

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

Principles of Consolidation The consolidated financial statements include the accounts of the Company and its majority owned subsidiaries. Such statements have been prepared in accordance with generally accepted accounting principles. Sales between subsidiaries are billed at prices consistent with sales to third parties and are eliminated in consolidation.

 

Cash Equivalents Cash equivalents are highly liquid investments purchased with an original maturity of three months or less.

 

Allowance for Doubtful Accounts The allowance for doubtful accounts receivable reflects our best estimate of probable losses inherent in our receivable portfolio determined on the basis of historical experience, specific allowances for known troubled accounts and other currently available evidence. The allowance for doubtful accounts was $4.5 million and $4.6 million as of December 31, 2003 and 2002, respectively.

 

Inventories Inventories are stated at the lower of cost or market. Cost is determined under the first-in, first-out (FIFO) method. Inventory costs include material, labor and overhead.

 

Property, Plant and Equipment Property, plant and equipment additions are stated at cost. Expenditures for renewals and improvements are capitalized. Expenditures for ordinary maintenance and repairs are expensed as incurred. The Company provides for book depreciation principally on the straight-line method. Accelerated depreciation methods are utilized for income tax purposes.

 

Leasing Arrangements The Company conducts a portion of its operations from leased facilities and finances certain equipment purchases through lease agreements. In those cases in which the lease term approximates the useful life of the leased asset or the lease meets certain other prerequisites, the leasing arrangement is classified as a capital lease. The remaining arrangements are treated as operating leases.

 

Intangible Assets The Company adopted SFAS No. 142 effective January 1, 2002, and, as a result, goodwill and other intangible assets with indefinite lives are no longer amortized. Other intangibles (with definite lives) are amortized on a straight-line basis over their estimated economic lives. Goodwill effective January 1, 2002 is reviewed annually for impairment while amortizable intangibles are reviewed for impairment when indicators of impairment are present.

 

Warranty Costs Warranty costs are accrued based on management’s estimates of repair or upgrade costs per unit and historical experience. In recent years, the Company has introduced a number of new products. The Company does not have the same level of historical warranty experience for these new products as it does for its continuing products. Therefore, warranty reserves have been established for these new products based upon management’s estimates. Actual future results may vary from such estimates. Warranty expense was $10.5 million, $17.6 million and $14.1 million for 2003, 2002 and 2001, respectively. Warranty reserves were $13.3 million and $17.4 million at December 31, 2003 and 2002, respectively.

 

Deferred Compensation Agreements In May 1998, a consensus on Emerging Issues Task Force Issue No. 97-14, “Accounting for Deferred Compensation Arrangements Where Amounts Earned Are Held in a Rabbi Trust and Invested” (“EITF 97-14”), was issued. The adoption of EITF 97-14 required the Company to record as treasury stock the historical value of the Company’s stock maintained in its deferred compensation plans.

 

Income Taxes Income taxes are accounted for under the liability method. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. The provision for income taxes includes federal, state and foreign income taxes.

 

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Table of Contents

Stock-Based Compensation Effective January 1, 2003, the Company adopted SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure.” SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternate methods of transition to SFAS No. 123’s fair value method of accounting for stock-based compensation. The statement amends the disclosure requirements of SFAS No. 123 to require prominent disclosures about the method of accounting for compensation cost associated with employee stock option plans, as well as the effect of the method used on reported results. The Company adopted the disclosure requirements of SFAS No. 148 and has not changed its method for measuring the compensation cost of stock options.

 

The Company continues to use the intrinsic value based method and does not recognize compensation expense for the issuance of options with an exercise price equal to or greater than the market price of the stock at the time of grant. As a result, the adoption of SFAS No. 148 had no impact on our results of operations or financial position.

 

Had compensation expense for these plans been determined based on the fair value at the grant dates for awards, the Company’s net income and earnings per share would be as set forth in the following table. For purposes of pro forma disclosures, the estimated fair value is amortized to expense over the options’ vesting period.

 

    

For the year ended

December 31,


In thousands, except per share


   2003

   2002

    2001

Net income (loss)

                     

As reported

   $ 22,703    $ (45,479 )   $ 61,780

Stock based compensation under FAS123

     1,940      1,635       3,089
    

  


 

Pro forma

     20,763      (47,114 )     58,691

Basic earnings (loss) per share

                     

As reported

   $ 0.52    $ (1.05 )   $ 1.44

Pro forma

     0.48      (1.09 )     1.37

Diluted earnings (loss) per share

                     

As reported

   $ 0.52    $ (1.04 )   $ 1.43

Pro forma

     0.47      (1.07 )     1.36
    

  


 

 

For purposes of presenting pro forma results, the fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions:

 

    

For the year ended

December 31,


 
     2003

    2002

    2001

 

Dividend yield

   .3 %   .3 %   .3 %

Risk-free interest rate

   5.2 %   5.6 %   5.9 %

Stock price volatility

   46.1     46.7     47.3  

Expected life (years)

   5.0     5.0     5.0  
    

 

 

 

The Black-Scholes option valuation model was developed for use in estimating fair value of traded options, which are significantly different than employee stock options. Although this valuation model is an acceptable method for use in presenting pro forma information, because of the differences in traded options and employee stock options, the Black-Scholes model does not necessarily provide a single measure of the fair value of employee stock options.

 

Financial Derivatives and Hedging Activities The Company periodically enters into interest rate swap agreements to reduce the impact of interest rate changes on its variable rate borrowings. Interest rate swaps are agreements with a counterparty to exchange periodic interest payments (such as pay fixed, receive variable) calculated on a notional principal amount. The interest rate differential to be paid or received is recognized as interest expense.

 

The Company has adopted Statement of Financial Accounting Standards (“SFAS”) No. 133, and as amended by SFAS 138, “Accounting for Derivative Instruments and Hedging Activities” effective January 1, 2001, resulting in the recording of current assets of $266,000, long term assets of $399,000, current liabilities of $760,000, long term liabilities of $1.1 million, and a decrease in other comprehensive loss of $1.2 million. In the application, the Company has concluded its interest rate swap contracts qualify for “special cash flow hedge accounting” which permit recording the fair value of the swap and corresponding adjustment to other comprehensive income (loss) on the balance sheet. At December 31, 2003, and as a result of entering into these interest rate swaps, the Company is expected to incur $600,000 in additional interest expense in 2004.

 

The Company also entered into foreign currency options and forward contracts to reduce the impact of changes in currency exchange rates. A currency option gives the Company the right but not the obligation to exchange currency at a pre-determined exchange rate either on a specific date or within a specific period of time. Forward contracts are agreements with a counterparty to exchange two distinct currencies at a set exchange rate for delivery on a set date at some point in the future. There is no exchange of funds until the delivery date. At the delivery date the Company can either take delivery of the currency or settle on

 

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Table of Contents

a net basis. All outstanding forward contracts and option agreements are for the sale of U.S. Dollars and the purchase of Canadian Dollars (CAD). As of December 31, 2003, the Company has outstanding option agreements with a notional value of $10.5 million CAD resulting in the recording of a current asset of $270,000, and an increase in comprehensive income of $171,000, net of tax and has forward contracts with a notional value of $13.5 million CAD, resulting in the recording of a current asset of $100,000, and an increase in comprehensive income of $64,000, net of tax. At December 31, 2003, and as a result of entering into these foreign currency forward and option contracts, the Company is not expected to incur any additional currency exchange loss or gain in 2004.

 

Subsequent to December 31, 2003, The Company entered into additional forward contracts to hedge its exposure to Canadian currency risk. Including the forwards outstanding at the end of 2003, the forward contracts currently have a total notional value of $83 million CAD (or $62 million U.S.), with an average exchange rate of $0.747 USD per $1 CAD.

 

Foreign Currency Translation Assets and liabilities of foreign subsidiaries, except for the Company’s Mexican operations whose functional currency is the U.S. Dollar, are translated at the rate of exchange in effect on the balance sheet date while income and expenses are translated at the average rates of exchange prevailing during the year. Foreign currency gains and losses resulting from transactions, and the translation of financial statements are recorded in the Company’s consolidated financial statements based upon the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 52, “Foreign Currency Translation.” The effects of currency exchange rate changes on intercompany transactions and balances of a long-term investment nature are accumulated and carried as a component of shareholders’ equity. The effects of currency exchange rate changes on intercompany transactions that are non U.S. dollar denominated amounts are charged or credited to earnings. Foreign exchange loss was $2.8 million, $1.2 million and $1.7 million for 2003, 2002 and 2001, respectively.

 

Other Comprehensive Income (Loss) Comprehensive income (loss) is defined as net income and all other non-owner changes in shareholders’ equity. The Company’s accumulated other comprehensive income (loss) consists of foreign currency translation adjustments, unrealized gains and losses on derivatives designated and qualified as cash flow hedges, foreign currency hedges and pension related adjustments.

 

Revenue Recognition Revenue is recognized in accordance with Staff Accounting Bulletin (SAB) 101, “Revenue Recognition in Financial Statements.” Wabtec recognizes revenue upon the passage of title, ownership and risk of loss to the customer.

 

The Company recognizes revenues on long-term contracts based on the percentage of completion method of accounting. Contract revenues and cost estimates are reviewed and revised quarterly, at a minimum, and adjustments are reflected in the accounting period as known. Provisions are made for estimated losses on uncompleted contracts as known, if necessary. Certain pre-production costs relating to long term production and supply contracts have been deferred and will be amortized over the life of the contract. Deferred pre-production costs were $3.4 million and $700,000 at December 31, 2003 and 2002, respectively.

 

Significant Customers and Concentrations of Credit Risk The Company’s trade receivables are primarily from rail and transit industry original equipment manufacturers, Class I railroads, railroad carriers and commercial companies that utilize rail cars in their operations, such as utility and chemical companies. No one customer accounted for more than 10% of the Company’s consolidated net sales in 2003. One customer, in the transit group, accounted for 11% of the Company’s consolidated net sales in 2002 and 2001.

 

Shipping and Handling Fees and Costs All fees billed to the customer for shipping and handling are classified as a component of net revenues. All costs associated with shipping and handling is classified as a component of cost of sales.

 

Research and Development Research and development costs are charged to expense as incurred. For the years ended December 31, 2003, 2002 and 2001, the Company incurred costs of approximately $32.9 million, $33.6 million and $33.2 million, respectively.

 

Employees As of December 31, 2003, approximately 36% of the Company’s workforce was covered by collective bargaining agreements. These agreements are generally effective through 2004, 2005 and 2006.

 

Earnings Per Share Basic earnings per common share are computed by dividing net income applicable to common shareholders by the weighted-average number of shares of common stock outstanding during the year. Diluted earnings per common share are computed by dividing net income applicable to common shareholders by the weighted average number of shares of common stock outstanding adjusted for the assumed conversion of all dilutive securities (such as employee stock options).

 

Reclassifications Certain prior year amounts have been reclassified, where necessary, to conform to the current year presentation.

 

Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual amounts could differ from the estimates. On an ongoing basis, management reviews its estimates based on currently available information. Changes in facts and circumstances may result in revised estimates.

 

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Recent Accounting Pronouncements. In April 2003, the Financial Accounting Standards Board issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS No. 149 amends and clarifies accounting for derivative instruments, including certain derivative instruments embedded in other contracts, and for hedging activities under SFAS No. 133. The provisions of this statement are effective for contracts entered into or modified after June 30, 2003 and for hedging relationships designated after June 30, 2003 and should be applied prospectively. SFAS No. 149 has no impact on the Company’s financial statements or results of operations.

 

In May 2003, the Financial Accounting Standards Board issued SFAS No. 150, “Accounting for Certain Instruments with Characteristics of Both Liabilities and Equity.” SFAS No. 150 requires that certain financial instruments embodying an obligation to transfer assets or to issue equity securities be classified as liabilities. It is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective July 1, 2003. SFAS No. 150 has no impact on the Company’s financial statements or results of operations.

 

Effective December 31, 2003, Wabtec adopted SFAS No. 132 (revised 2003), “Employers’ Disclosures about Pensions and Other Post-retirement Benefits – an Amendment of FASB Statements No. 87, 88 and 106” for its U.S. pension plans. This standard requires additional disclosures about an employer’s pension plans and postretirement benefits such as: the type of plan assets, investment strategy, measurement date, plan obligations, cash flows, and components of net periodic benefit costs recognized during interim periods. See Note 10 to the Consolidated Financial Statements for the required additional disclosures.

 

During 2003, the Company adopted FASB Interpretation No. (“FIN”) 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees.” FIN 45 requires increased disclosure of guarantees, including those for which likelihood payment is remote, and product warranty information (see Note 16). FIN 45 also requires that guarantors recognize a liability for certain types of guarantees equal to the fair value of the guarantee upon its issuance. The adoption of FIN 45 has no impact on the Company’s financial statements or results of operations.

 

In January 2003, the Financial Accounting Standards Board issued Interpretation No. 46, “Consolidation of Variable Interest Entities.” A variable interest entity (“VIE”) is one where the contractual or ownership interests in an entity change with changes in the entity’s net asset value. This interpretation requires the consolidation of a VIE by the primary beneficiary, and also requires disclosure about VIEs where an enterprise has a significant variable interest but is not the primary beneficiary. The Company does not believe that this statement will have a material impact on the Company’s financial statements or results of operations.

 

On December 8, 2003, President Bush signed into law the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act). The Act expanded Medicare to include, for the first time, coverage for prescription drugs. In January 2004, the FASB issued Staff Position 106-1, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003,” (FSP FAS 106-1). This position permits a sponsor of a postretirement health care plan that provides a prescription drug benefit to make a one-time election to defer accounting for the effects of the Act. As permitted by FSP FAS 106-1, the Company has elected to defer financial recognition of this legislation until the FASB issues final accounting guidance. In accordance with FSP FAS 106-1, appropriate disclosures related to the deferral election have been made in Note 10 to the consolidated financial statements.

 

3. DISCONTINUED OPERATIONS

 

On November 1, 2001, the Company completed the sale of certain assets to GE Transportation Systems (GETS) for $238 million in cash. The assets sold primarily included locomotive aftermarket products and services for which Wabtec was not the original equipment manufacturer. Under the terms of the sales agreement, the Company has agreed to indemnify GETS for, among other things, certain potential third party, off site environmental cleanup or remediation costs. The Company has purchased an insurance policy to mitigate its exposure for the environmental indemnities. The Company reported a $48.7 million after tax gain on the sale in 2001.

 

In the fourth quarter of 2001, the Company decided to exit other businesses and put these businesses up for sale. The net assets of those businesses were written down to their estimated realizable value based on a multiple of earnings and was classified as Assets Held for Sale on the balance sheet. The Company reported a $7.2 million after tax loss on the write-down of these entities.

 

As of December 31, 2003, one of the businesses has not sold. The Company actively solicited but did not receive any reasonable offers to purchase the asset and, in response, had reduced the price. The asset is no longer being actively marketed and as a result, the Company reclassed the business to continuing operations in the fourth quarter of 2003. Such reclassification had no material impact on the financial statements.

 

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In accordance with SFAS 144, the operating results of these businesses have been classified as discontinued operations for all years presented and are summarized as of December 31, as follows:

 

    

For the year ended

December 31,


In thousands


   2003

   2002

   2001

Net sales

   $ 6,593    $ 11,158    $ 156,803

Income before income taxes

     710      593      9,785

Income tax expense

     259      190      3,425

Income from discontinued operations

   $ 451    $ 403    $ 6,360

 

4. SUPPLEMENTAL CASH FLOW DISCLOSURES

 

    

For the year ended

December 31,


 

In thousands


   2003

    2002

    2001

 

Interest paid during the year

   $ 6,478     $ 18,111     $ 37,181  

Income taxes paid during the year

     8,185       34,452       8,318  

Business acquisitions:

                        

Fair value of assets acquired

   $ —       $ 1,654     $ 5,275  

Liabilities assumed

     —         —         (842 )
    


 


 


Cash paid

     —         1,654       4,433  

Less cash acquired

     —         —         703  
    


 


 


Net cash paid

   $ —       $ 1,654     $ 3,730  
    


 


 


Noncash investing and financing activities:

                        

Notes payable

   $ 3,198       —         —    

Deferred compensation

   $ 270     $ 268     $ 363  

Treasury stock

     (270 )     (268 )     (363 )

 

5. MERGERS AND ACQUISITIONS

 

The Company did not make any acquisitions in 2003. During 2002 and 2001 the Company completed the following acquisitions:

 

i) In February 2002, the Company purchased the minority interest of a business in India that the Company did not already own for $1.7 million.

 

ii) In October 2001, the Company purchased certain assets of Milufab, a supplier of door panels for subway trains for $3.7 million.

 

These acquisitions were accounted for under the purchase method. Accordingly, the results of operations of the applicable acquisition are included in the Company’s financial statements prospectively from the acquisition date. The excess of the purchase price over the fair value of identifiable net assets was approximately $2.9 million and was allocated to goodwill. Effective January 1, 2002, goodwill was no longer amortized upon adoption of SFAS No. 142.

 

6. INVENTORY

 

The components of inventory, net of reserves, were:

 

     December 31,

In thousands


   2003

   2002

Raw materials

   $ 28,711    $ 56,016

Work-in-process

     45,559      27,856

Finished goods

     17,539      4,598
    

  

Total inventory

   $ 91,809    $ 88,470
    

  

 

7. PROPERTY, PLANT & EQUIPMENT

 

The major classes of depreciable assets are as follows:

 

     December 31,

 

In thousands


   2003

    2002

 

Machinery and equipment

   $ 249,604     $ 229,813  

Buildings and improvements

     76,290       72,848  

Land and improvements

     6,435       5,572  

Locomotive leased fleet

     290       262  
    


 


PP&E

     332,619       308,495  

Less: accumulated depreciation

     (178,780 )     (159,903 )
    


 


Total

   $ 153,839     $ 148,592  
    


 


 

The estimated useful lives of property, plant and equipment are as follows:

 

     Years

Land improvements

   10   to   20

Buildings and improvements

   20   to   40

Machinery and equipment

   3   to   15

Locomotive leased fleet

   4   to   15

 

Depreciation expense was $21 million, $20.2 million and $20 million for 2003, 2002 and 2001, respectively.

 

8. INTANGIBLES

 

The Company has adopted SFAS No. 142, “Goodwill and Other Intangible Assets” effective January 1, 2002. Under its provisions, all goodwill and other intangible assets with indefinite lives are no longer amortized under a straight-line basis over the assets estimated useful life. Instead, they will be subject to periodic assessments for impairment by applying a fair-value-based test. In 2002, the Company completed the Phase I and Phase II assessments and wrote down the carrying value of goodwill by $90 million ($83.2 million for the Freight Group and $6.8 million for the Transit Group), resulting in a non-cash after-tax charge of $61.7 million. The fair value of these reporting units was determined using a combination of

 

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discounted cash flow analysis and market multiples based upon historical and projected financial information. The Company also performed the required impairment test in 2003 which resulted in no additional impairment charge. Goodwill still remaining on the balance sheet is $109.5 million at December 31, 2003.

 

As of December 31, 2003 and 2002, the Company’s trademarks had a net carrying amount of $19.5 million and the Company believes these intangibles have an indefinite life. Intangible assets of the Company, other than goodwill and trademarks, consist of the following:

 

     December 31,

In thousands


   2003

   2002

Patents and other, net of accumulated amortization of $21,053 and $18,492

   $ 13,675    $ 16,124

Covenants not to compete, net of accumulated amortization of $9,437 and $7,632

     137      1,480

Intangible pension asset

     4,401      4,357
    

  

Total

   $ 18,213    $ 21,961
    

  

 

In connection with the adoption of SFAS No. 142, the Company reassessed the useful lives and the classification of its identifiable assets and determined that they continue to be appropriate. The weighted average useful life of patents was 13 years and of covenants not to compete was five years.

 

Amortization expense for intangible assets was $3.4 million, $4 million and $11.3 million for the years ended December 31, 2003, 2002, and 2001, respectively. Amortization expense for the five succeeding years is as follows (in thousands):

 

2004

   $ 2,162

2005

   $ 2,137

2006

   $ 1,973

2007

   $ 1,863

2008

   $ 1,790

 

The changes in the carrying amount of goodwill by segment for the years ended December 31, 2003 and 2002, respectively, are as follows:

 

In thousands


   Freight
Group


    Transit
Group


    Total

 

Balance at December 31, 2001

   $ 175,085     $ 23,703     $ 198,788  

Goodwill acquired

     664       —         664  

Goodwill written off

     (83,179 )     (6,823 )     (90,002 )
    


 


 


Balance at December 31, 2002

   $ 92,570     $ 16,880     $ 109,450  

Goodwill acquired

     —         —         —    

Goodwill written off

     —         —         —    
    


 


 


Balance at December 31, 2003

   $ 92,570     $ 16,880     $ 109,450  
    


 


 


 

Actual results of continuing operations for the year ended December 31, 2003 and 2002, and pro forma results of continuing operations for 2001 had we applied the non-amortization provisions of SFAS No. 142 in these periods are as follows:

 

    

For the year ended

December 31,


In thousands, except per share amounts


   2003

   2002

   2001

Reported income before cumulative effect of accounting change

   $ 22,703    $ 16,184    $ 61,780

Add: goodwill amortization, net of tax

     —        —        4,147

Add: trademark amortization, net of tax

     —        —        376
    

  

  

Adjusted income before cumulative effect of accounting change

   $ 22,703    $ 16,184    $ 66,303

Basic earnings per share

                    

Reported income before cumulative effect of accounting change

   $ 0.52    $ 0.37    $ 1.44

Goodwill amortization

     —        —        0.09

Trademark amortization

     —        —        0.01
    

  

  

Adjusted income before cumulative effect of accounting change

   $ 0.52    $ 0.37    $ 1.54

Diluted earnings per share

                    

Reported income before cumulative effect of accounting change

   $ 0.52    $ 0.37    $ 1.43

Goodwill amortization

     —        —        0.09

Trademark amortization

     —        —        0.01
    

  

  

Adjusted income before cumulative effect of accounting change

   $ 0.52    $ 0.37    $ 1.53
    

  

  

 

9. LONG-TERM DEBT

 

Long-term debt consisted of the following:

 

     December 31,

In thousands


   2003

   2002

Revolving credit agreement due 2004

   $ 40,000    $ 189,700

6.875% Senior notes

     150,000      —  

5.5% Industrial revenue bond due 2008

     —        4,909

Other

     225      542
    

  

Total

   $ 190,225    $ 195,151

Less–current portion

     —        833
    

  

Long–term portion

   $ 190,225    $ 194,318
    

  

 

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Credit Agreement

 

In November 1999, Wabtec refinanced the then existing unsecured MotivePower credit agreement (the “Credit Agreement”) with a consortium of commercial banks. This unsecured Credit Agreement provided a $275 million five-year revolving credit facility expiring in November 2004 and a 364-day $275 million convertible revolving credit facility maturing in November 2004. In November 2001, the Company and the banks negotiated a reduction in the 364-day facility to $100 million, as a result of the $208 million, net of tax, cash proceeds from the sale of certain businesses. In November 2002, the Company negotiated a further reduction in the 364-day facility from $100 million to $95 million. In July 2003, the Company and the banks negotiated a reduction in both facilities to $225 million as a result of the issuance of the Senior Notes. The $225 million facility provided a reduced five-year facility of $167.2 million and a reduced 364-day facility of $57.8 million. In November 2003, the Company allowed the $57.8 million 364-day facility to expire. At December 31, 2003, the Company’s available bank borrowing capacity, net of $19.6 million of letters of credit, was approximately $107.7 million.

 

Credit Agreement borrowings bear variable interest rates indexed to the indices described below. The maximum credit agreement borrowings, average credit agreement borrowings and weighted-average contractual interest rate on credit agreement borrowings were $209 million, $129.3 million and 2.68%, respectively for 2003. To reduce the impact of interest rate changes on a portion of this variable-rate debt, the Company entered into interest rate swaps which effectively convert a portion of the debt from variable to fixed-rate borrowings during the term of the swap contracts. On December 31, 2003, the notional value of interest rate swaps outstanding totaled $40 million and effectively changed the Company’s interest rate on bank debt at December 31, 2003 from a variable rate to a fixed rate of 3.98%. The interest rate swap agreements mature in February 2006. The Company is exposed to credit risk in the event of nonperformance by the counterparties. However, since only the cash interest payments are exchanged, exposure is significantly less than the notional amount. The counterparties are large financial institutions and the Company does not anticipate nonperformance.

 

As required by SFAS 145, the Company has reclassified a $1.2 million net of tax charge related to the early extinguishment of debt in the third quarter of 2002, which had been previously recorded as an extraordinary item, to interest expense and income tax expense.

 

Refinancing Credit Agreement

 

In January 2004, the Company entered into a new credit agreement, refinancing its existing unsecured revolving Credit Agreement with a consortium of commercial banks. This “Refinancing Credit Agreement” provides a $175 million five-year revolving credit facility expiring in January 2009. The financial statements have been prepared based on the terms of the Refinanced Credit Agreement.

 

Under the Refinancing Credit Agreement, the Company may elect a base rate or an interest rate based on the London Interbank Offered Rates of Interest (“LIBOR”). The base rate is the greater of LaSalle Bank National Association’s prime rate or the federal funds effective rate plus 0.5% per annum. The LIBOR rate is based on LIBOR plus a margin that ranges from 100 to 200 basis points depending on the Company’s consolidated total indebtedness to cash flow ratios. The current margin is 175 basis points.

 

The Refinancing Credit Agreement limits the Company’s ability to declare or pay cash dividends and prohibits the Company from declaring or making other distributions, subject to certain exceptions. The Refinancing Credit Agreement contains various other covenants and restrictions including the following limitations: incurrence of additional indebtedness; mergers, consolidations and sales of assets and acquisitions; additional liens; sale and leasebacks; permissible investments, loans and advances; certain debt payments; capital expenditures; and imposes a minimum interest expense coverage ratio and a maximum debt to cash flow ratio.

 

The Refinancing Credit Agreement contains customary events of default, including payment defaults, failure of representations or warranties to be true in any material respect, covenant defaults, defaults with respect to other indebtedness of the Company, bankruptcy, certain judgments against the Company, ERISA defaults and “change of control” of the Company.

 

6.875% Senior Notes Due August 2013

 

In August 2003, the Company issued $150 million of Senior Notes due in 2013 (“the Notes”). The Notes were issued at par. Interest on the Notes will accrue at a rate of 6.875% per annum and will be payable semi-annually on January 31 and July 31 of each year, commencing on January 31, 2004. The proceeds were used to repay debt outstanding under the Company’s existing credit agreement, and for general corporate purposes.

 

The Notes are senior unsecured obligations of the Company and rank pari passu with all existing and future senior debt and senior to all our existing and future subordinated indebtedness of the Company. The indenture under which the Notes were issued contains covenants and restrictions which limit among other things, the following: the incurrence of indebtedness, payment of dividends and certain distributions, sale of assets, change in control, mergers and consolidations and the incurrence of liens,

 

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Table of Contents

Scheduled principal repayments of outstanding loan balances required as of December 31, 2003 are as follows:

 

In thousands    Original

   As
refinanced


2004

   $ 40,000    $ —  

2005

     225      225

2006

     —        —  

2007

     —        —  

2008

     —        —  

Future years

     150,000      190,000
    

  

Total

   $ 190,225    $ 190,225
    

  

 

Extinguishment of Other Borrowings

 

In June 1995, the Company issued $100 million of 9.375% Senior Notes due in 2005 (the “1995 Notes”). In January 1999, the Company issued an additional $75 million of 9.375% Senior Notes due in 2005 (the “1999 Notes”). The 1995 Notes and the 1999 Notes were redeemed at par (face) on July 8, 2002 through the use of cash on hand and additional borrowings under the credit agreement. This redemption resulted in a non-cash loss of $1.9 million relating to a write-off of deferred financing costs.

 

In July 1998, a subsidiary of the Company entered into a 10- year $7.5 million debt obligation for the purchase of a building used in the Company’s operations. The debt was repaid in September 2003.

 

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10. EMPLOYEE BENEFIT PLANS

 

The Company sponsors defined benefit pension plans that cover certain U.S., Canadian and United Kingdom employees and provide benefits of stated amounts for each year of service of the employee.

 

     For the years ended December 31,

 
     Pension Plans

    Postretirement Plans

 

In thousands, except percentages


   2003

    2002

    2003

    2002

 

Defined Benefit Plans

                                

Change in benefit obligation

                                

Obligation at beginning of year

   $ (92,751 )   $ (89,449 )   $ (23,700 )   $ (21,368 )

Service cost

     (2,425 )     (2,658 )     (330 )     (232 )

Interest cost

     (6,474 )     (6,008 )     (1,715 )     (1,447 )

Special termination benefits

     —         (1,241 )     —         —    

Actuarial (loss) gain

     (7,762 )     2,767       (5,495 )     (2,581 )

Benefits paid

     5,666       5,634       2,150       1,928  

Expenses paid

     372       326       —         —    

Effect of currency rate changes

     (9,743 )     (2,122 )     —         —    
    


 


 


 


Obligation at end of year

   $ (113,117 )   $ (92,751 )   $ (29,090 )   $ (23,700 )
    


 


 


 


Change in plan assets

                                

Fair value of plan assets at beginning of year

   $ 67,600     $ 77,711       —         —    

Actual gain (loss) on plan assets

     11,834       (8,732 )     —         —    

Employer contribution

     5,554       2,465       —         —    

Participant contributions

     401       353       —         —    

Benefits paid

     (5,666 )     (5,634 )     —         —    

Administrative expenses

     (1,081 )     (695 )     —         —    

Effect of currency rate changes

     7,939       2,132       —         —    
    


 


 


 


Fair value of plan assets at end of year

   $ 86,581     $ 67,600       —         —    
    


 


 


 


Funded status

                                

Funded status at year end

   $ (26,536 )   $ (25,151 )     (29,090 )     (23,700 )

Unrecognized net actuarial loss

     29,213       25,628       8,961       3,922  

Unrecognized prior service cost

     4,237       4,376       22       34  

Unrecognized transition obligation

     3,084       3,031       194       216  

Effect of currency exchange rates

     1,399       139       —         —    
    


 


 


 


Prepaid (accrued) benefit cost

   $ 11,397     $ 8,023     $ (19,913 )   $ (19,528 )
    


 


 


 


Amounts recognized in the statement of financial position include:

                                

Prepaid pension cost

   $ 323     $ 110     $ —       $ —    

Reserve for postretirement and pension benefits

     (19,142 )     (18,738 )     (19,913 )     (19,528 )

Intangible asset

     4,401       4,357       —         —    

Accumulated other comprehensive loss

     25,815       22,294       —         —    
    


 


 


 


Prepaid (accrued) benefit cost

   $ 11,397     $ 8,023     $ (19,913 )   $ (19,528 )
    


 


 


 


 

     Pension Plans

    Postretirement Plans

 
     2003

    2002

    2001

    2003

    2002

    2001

 

Net periodic benefit cost

                                                

Service cost

   $ 2,425     $ 2,658     $ 1,447     $ 330     $ 232     $ 240  

Interest cost

     6,474       6,008       4,382       1,715       1,447       1,524  

Expected return on plan assets

     (6,576 )     (6,591 )     (5,846 )     —         —         —    

Net amortization/deferrals

     1,406       617       680       489       19       (3 )
    


 


 


 


 


 


Net periodic benefit cost

   $ 3,729     $ 2,692     $ 663     $ 2,534     $ 1,698     $ 1,761  
    


 


 


 


 


 


Assumptions

                                                

Discount rate

     6.25 %     6.75 %     7 %     6.25 %     6.75 %     7.5 %

Expected long-term rate of return

     7.75 %     8.25 %     9 %     NA       NA       NA  

Rate of compensation increase

     3.75 %     4 %     5 %     NA       NA       NA  

 

Included in the above table, the aggregate benefit obligation and fair value of plan assets for the pension plans with plan assets in excess of benefit obligations were $3 million and $3.4 million, respectively, as of December 31, 2003; and $2 million and $2.1 million, respectively, as of December 31, 2002 (the total of which was pension plan benefit obligation in excess of plan assets).

 

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The components of prepaid (accrued) benefit costs by country are as follows:

 

In thousands    2003

    2002

U.S. plan

   $ 1,539     $ 1,716

Canadian plans

     10,103       6,307

U.K. plan

     (245 )     —  
    


 

Prepaid (accrued) benefit cost

   $ 11,397     $ 8,023
    


 

 

Pension Plan Assets

 

The composition of U.S. plan assets consists primarily of equities, corporate bonds, governmental notes and temporary investments. This Plan’s asset allocations at December 31, 2003 by asset category are as follows:

 

Asset Category


   %

 

Equity securities

   49 %

Debt securities

   46 %

Other, including cash equivalents

   5 %
    

Total

   100 %
    

 

Investment policies are determined by the Plan’s Pension Committee and set forth in the Plan’s Investment Policy. Pursuant to the Plan’s Investment Policy, the investment strategy is to use passive index funds managed by the Bank of New York. The target asset allocation and composite benchmarks include the following:

 

Asset Allocation


    

Composite Benchmark


 

Category


   %

    

Benchmark


   %

 

Bonds

   50 %   

Lehman Aggregate

   50 %

Large Cap Stocks

   35 %   

S&P 500

   35 %

International Stocks

   10 %   

MSCI-EAFE

   10 %

Small Cap Stocks

   5 %   

Russell 2000

   5 %
    

       

     100 %         100 %
    

       

 

The Company’s funding methods, which are primarily based on the ERISA requirements, differ from those used to recognize pension expense, which is primarily based on the projected unit credit method applied in the accompanying financial statements.

 

The Company expects to contribute $6.4 million to the pension plan during 2004 and that this level of funding to continue in future periods. Rebalancing of the asset allocation occurs on a quarterly basis.

 

In 2002, as a result of an early retirement package offered to certain union employees, the Company incurred charges of approximately $1.2 million reflected above as a special termination benefit.

 

In addition to providing pension benefits, the Company has provided certain unfunded postretirement health care and life insurance benefits for substantially all U.S. employees. In January 1995 the postretirement health care and life insurance benefits for salaried employees was modified to discontinue benefits for employees who had not attained the age of 50 by March 31, 1995. The Company is not obligated to pay health care and life insurance benefits to individuals who had retired prior to 1990.

 

The assumed health care cost trend rate grades from an initial rate of 8% to an ultimate rate of 4.75% in four years. A 1% increase in the assumed health care cost trend rate will increase the amount of expense recognized for the postretirement plans by approximately $358,000 for 2004, and increase the service and interest cost components of the accumulated postretirement benefit obligation by approximately $4.1 million. A 1% decrease in the assumed health care cost trend rate will decrease the service and interest cost components of the expense recognized for the postretirement plans by approximately $286,000 for 2004, and decrease the accumulated postretirement benefit obligation by approximately $3.4 million.

 

On December 8, 2003, President Bush signed into law the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the Act). The Act expanded Medicare to include, for the first time, coverage for prescription drugs. The Company sponsors retiree medical programs for certain of its locations and expects that this legislation will reduce the Company’s costs for some of these programs in the future.

 

In January 2004, FASB Staff Position 106-1, “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (FSP FAS 106-1) was issued which permits a sponsor of a postretirement health care plan that provides a prescription drug benefit to make a one-time election to defer accounting for the effects of the Act. The Company is awaiting guidance from various governmental and regulatory agencies concerning the requirements that must be met to obtain these cost reductions as well as the manner in which such savings should be measured. Based on this preliminary analysis, it appears that some of the Company’s retiree medical plans may need to be revised in order to qualify for beneficial treatment under the Act, while other plans can continue unchanged

 

Defined Contribution Plans

 

The Company also participates in a variety of defined contribution, 401(k) and multiemployer pension, health and welfare plans. Additionally, the Company has stock option -based benefit and other plans further described in Note 14.

 

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Costs recognized under multi-employer and other defined contribution plans are summarized as follows:

 

    

For the year ended

December 31,


In thousands


   2003

   2002

   2001

Multi-employer pension and health & welfare plans

   $ 1,531    $ 1,310    $ 994

401(k) savings and other defined contribution plans

     6,828      6,929      8,172
    

  

  

Total

   $ 8,359    $ 8,239    $ 9,166
    

  

  

 

The 401(k) savings plan is a participant directed defined contribution plan that holds shares of the Company’s stock. At December 31, 2003 and 2002, the plan held on behalf of its participants about 776,000 shares with a market value of $13.2 million, and 861,000 shares with a market value of $12 million, respectively.

 

11. INCOME TAXES

 

In general, the Company is responsible for filing consolidated U.S., foreign and combined, unitary or separate state income tax returns. The Company is responsible for paying the taxes relating to such returns, including any subsequent adjustments resulting from the redetermination of such tax liabilities by the applicable taxing authorities.

 

The components of the income (loss) from continuing operations before provision for income taxes for the Company’s domestic and foreign operations for the years ended December 31 are provided below:

 

    

For the year ended

December 31,


In thousands


   2003

    2002

   2001

Domestic

   $ 35,470     $ 12,226    $ 10,287

Foreign

     (428 )     11,678      8,140
    


 

  

Income from continuing operations

   $ 35,042     $ 23,904    $ 18,427
    


 

  

 

No provision has been made for U.S., state or additional foreign taxes related to undistributed earnings of foreign subsidiaries which have been or are intended to be permanently re-invested. It is not practical to estimate the income tax expense or benefit that might be incurred if these earnings were to be remitted to the U.S.

 

The consolidated provision (credit) for income taxes included in the Statement of Income consisted of the following:

 

    

For the year ended

December 31,


 

In thousands


   2003

    2002

    2001

 

Current taxes

                        

Federal

   $ 763     $ 609     $ 28,703  

State

     1,470       (2,421 )     4,919  

Foreign

     1,993       2,876       3,345  
    


 


 


     $ 4,226     $ 1,064     $ 36,967  

Deferred taxes

                        

Federal

     11,525       (14,788 )     1,106  

State

     821       (4,364 )     287  

Foreign

     (3,522 )     (2,716 )     (325 )
    


 


 


       8,824       (21,868 )     1,068  
    


 


 


Total provision (credit)

   $ 13,050     $ (20,804 )   $ 38,035  
    


 


 


 

Consolidated income tax provision (credit) is included in the Statement of Income as follows:

 

    

For the year ended

December 31,


In thousands


   2003

   2002

    2001

Continuing operations

   $ 12,790    $ 7,594     $ 4,465

Income (loss) from discontinued operations

     260      (59 )     33,570

Cumulative effect of accounting change for goodwill

     —        (28,339 )     —  
    

  


 

Total provision (credit)

   $ 13,050    $ (20,804 )   $ 38,035